The Sunday Leader

Electricity Hike To Up Rates

State controlled Census and Statistics Department (CSD) on Thursday (March 28) reported that the year on year (YoY) increase in the new Colombo Consumers’ Price Index slowed down to 7.5% this month, a month on month decline of 230 basis points (bps), compared to the previous month’s figure of 9.8%.

However this reported deceleration in inflation appeared not to have had a similar impact on the market, with commercial banks’ average weighted prime lending rate (AWPLR), ie the lending rate it charges good or blue chip borrowers, declining by a mere 10 bps to 13.77% week on week (WoW) as at Thursday, Central Bank of Sri Lanka (CBSL) data showed.

Friday was a holiday for the market on account of Good Friday. In the previous week this figure (AWPLR) increased by six bps WoW to 13.88%.
“With the expected increase in electricity prices next month and the cascading effect thereof, this ‘low’ inflationary data thrown up by CSD is unlikely to lessen the pressure for a rate rise,” a market source told this newspaper.

The ripple effect of an electricity hike is that it would tend prices to rise and therewith inflation.

The source further said that Thursday’s secondary market trading in Treasury (T) Bonds and Bills was dominated by interest in T Bonds of 2018 maturity.

As a result their yields fell by 25 bps to 11.15%, before ending the week at the 11.20%, he said.

He further said that despite this low inflation figure, in the backdrop of an expected electricity price hike, this week’s T Bill auction will continue to see pressure for yield hikes.

The weighted average yields (WAYs) for T Bills of 91 day (three months), 182 day (six months) and 364 day (one year) maturities in the last four weekly auctions held to date have seen those rise by 17 bps each for those of 91 and 182 day maturities to 9.26% and 10.25% respectively, while the WAY of T Bills of 364 day maturity has seen it increase by 25 bps to 11.35%.

Meanwhile CBSL’s gross T Bill holdings WoW marginally declined by 0.06% (Rs. 93.14 million) to Rs. 168,539.88 million by the weekend.

CBSL’s T Bill holdings  are a reflection of how much of an equivalent amount of new money has entered the system, without a corresponding value of foreign exchange inflows  having had entered the economy to support such money printing activities.
Therefore an increase in CBSL’s T Bill holdings is equivalent to the amount of such new money that has entered the economy during a given period.

Likewise a decrease in CBSL’s T Bill holding reflects that an equivalent amount of such money has been taken out of the economy and transferred into CBSL’s accounts by the retirement of a corresponding value of T Bills.

Issuing of T Bills is the way CBSL funds the Treasury at no interest cost to the latter.  But the flip side in such a funding mechanism is that it may stoke inflationary pressure on the economy due to demand creation.

CBSL’s gross T Bill holdings are equivalent to its net T Bill holdings plus those which have been surrendered to the market as security on account of CBSL’s repo borrowings from the same.

Meanwhile market’s excess liquidity during this one week period increased by 120% to Rs. 38,388 million.
In the absence of loose money printing as reflected by the relatively static position of CBSL’s gross T Bill holdings in the review period, the increase in market’s excess liquidity therefore may be attributed to inflows that have been bought by CBSL, and reciprocating that action by the release of an equivalent amount of rupees to the market.

The availability of a sizeable amount of excess liquidity in the market may offset pressure for a rate rise.

But as experience has shown, the biggest culprit in draining off excess liquidity from the market and therewith causing pressure on rates is the Government of Sri Lanka (GoSL).

This occurs due to a submarket operation indulged by it in collaboration with the CBSL. It takes place when GoSL has to meet an external commitment such as the settlement of an oil bill.

In such an instance while GoSL borrows the required rupees from the market through its agent bank/s to buy the necessary foreign exchange (forex) for the settlement of such commitments, it however refrains from purchasing the required forex from the market.
This abstinence is to prevent any possible downward pressure on the exchange rate (ER), ie the depreciation of the ER.

So instead of the rupees remaining in circulation in the market in such an exercise, the borrowed rupees from the market is paid to the CBSL, where the required forex is procured from CBSL’s external reserves for the settlement of such external commitments in exchange.
Such submarket operations may also drain off market’s excess liquidity, therewith causing upward pressure on interest rates.

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