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Sovereign Bond Not To Strengthen Reserves

  • Part To Service Foreign Debt

Proceeds of The US$ ($) one billion Sovereign Bond which the Government of Sri Lanka (GoSL) recently sold in international capital markets and which entered the GoSL’s Treasury account in the week ended January 17, 2014; will not be used to strengthen Central Bank of Sri Lanka’s (CBSL’s)  foreign exchange (FX)reserves, it’s learnt.

“Part of it will however be used for foreign debt servicing,” official sources told this newspaper. According to CBSL’s 2012 Annual Report, foreign debt servicing in that year alone had cost GoSL a bill of $ 2,879 million ($ 2.879 billion).

According to CBSL’s Weekly Economic Indicators (WEI) for the week ended January 17, 2014; total foreign debt as at end June 2013 stood at Rs. 2,882 billion; a  year on year (YoY) increase of Rs. 85.7 billion (3.1%).

The Sovereign Bond proceeds are believed to be lodged with the account (s) maintained by GoSL’s Treasury with CBSL.

However it’s unclear whether such accounts are maintained in the form of a non-interest earning account similar to that of a current account or whether it’s lodged as an interest earning investment account with CBSL.

According to CBSL’s WEI for the week ended January 17, 2014; total reserves as at end November 2013 stood at $ 8,282.4 million; a 0.9% decline over its end December 2012 figures.

Further, gross official reserves at $ 6,879.6 million were a marginal $ 1.4 million (0.00%) increase over the end December 2012 figure of $ 6,878.2 million.

CBSL said that by end November 2013, the total level of foreign reserves was equivalent to 5.3 months of imports and gross official reserves were equivalent to 4.4 months of imports.

Meanwhile foreign investments in Treasuries as at January 15, 2014 stood at Rs.482,588 million; data showed (see also last week’s The Sunday Leader business pages).

Total reserves in rupee terms as at end November 2013 stood at Rs. 1,086,673.9 million while gross official reserves stood at Rs. 902,635.9 million; data showed.

Short Term Debt

As a percentage of total reserves and gross official reserves, short term debt, ie foreign investments in GoSL Treasuries comprised 44.4% and 53.5% respectively, on the assumption that total reserves and gross official reserves as at January 15,2014 were the same as at end November 2013 figures.

But the danger in short term debt is that it may dissipate as fast as it came in as experienced as recently as last year, thereby causing pressure for the rupee to depreciate.

As recently as on August 28, 2013, due to the exit of foreign funds from the government securities market (short term debt), the exchange rate (ER) in interbank spot trading against the $ fell to as low as to the Rs. 135.20 level.

The decline was a gradual process, beginning from June 2013. This was due to the rise in interest rates in the US market, with the benchmark 10 year US Treasury even going up to 3% from the previous under 1% figure as the US economy started recovering, with it, demand growing and the Federal Reserve System making moves to scale down its bond buying programme which provided cheap money to borrowers due to the liquidity available, as a counter to the liquidity crisis caused by the 2007-9 global financial and economic crisis of then.

But with the US economy once more getting in to gear and the announcement of a possible tapering off of the Fed’s bond buying programme made last year; resulted in certain foreign funds exiting from the local Government securities market and parking their investments in the US market, to take advantage of rising interest rates there. This however caused pressure on the ER, making it to fall.

This decline was possibly temporarily stayed with the Fed in September 2013 saying that the time then was not opportune to start tapering off of its bond buying programme, but reversed this decision three months later in December 2013.

As a result, from this month, the Fed has begun scaling down on its bond buying programme from $ 85 billion a month to $ 75 billion, with the possibility of further cutbacks as the US economy grows, unemployment falls and US inflation inches up to the approved 2% level.

Currently the 10 year US Treasury is demanding an interest rate of 2.82% in the secondary market. Under such circumstances there is a possibility of the ER coming under renewed pressure once more, if in the event foreign funds again begin to exit from the government securities market, like they did in the brief June-September 2013 period.

This however has thus far not taken place, with the rupee stable at the Rs. 130.70 level against the greenback in interbank spot trading,

unchanged from its last year end figures.

The sources further said that the $ one billion Soverign Bond proceeds will not be used to swell market’s excess liquidity.

Market liquidity may be swelled if CBSL buys these proceeds to increase its FX reserves.

In this exercise it releases rupees in lieu to the Treasury which action in turn increases market’s excess liquidity.

“The current excess liquidity position in the market is sufficient,” the sources said.

Tuesday’s data showed that market’s excess liquidity, Tuesday over Monday increased by Rs. 4,106 million (7.7%) to Rs. 56,198 million. In tandem with these developments, CBSL’s gross T Bill holdings increased by Rs. 3,932.59 million (7.5%) to Rs. 56,599.05 million.

Under perfect conditions, the increase in CBSL’s gross T Bill holdings should be equivalent to the increase in market’s excess liquidity. But here, market’s excess liquidity increased at a pace faster by Rs. 173.41 million (Rs. 4,106 million-Rs.3,932.59 million) over that of CBSL’s T bill buying programme of Monday’s (January 20).

This increase may be due to inflows other than excess liquidity caused by CBSL buying T Bills.

The danger in fuelling liquidity by buying T Bills is that it may cause demand side inflationary pressure on the economy.

CBSL however may subvert inflationary pressure through its open market operations (OMO) by mopping up excess liquidity that way.

But the ideal way to build rupee liquidity may be by encouraging inflows (and not by buying T Bills), the best of which may be either in the form of FDI or enhanced exports or remittances. This is because inflows in to the stock market or to the government securities market for that matter may also exit as fast as it came in.

And, If there is a danger of demand side inflationary pressure being fuelled due to CBSL buying such inflows, other than by an OMO,  CBSL, by selling $s to the market at a discount from its reserves, may also absorb excess liquidity from the market from that way too, thereby mitigating any demand side inflationary pressure.

This may also help to bring the cost of imports down due to a stronger rupee, thereby further eradicating inflationary pressure as the island is an import dependent economy.

However a stronger rupee may affect exporters due to the fewer rupees they may be able to get for their $ holdings.

If CBSL bought a whole or a part of the $ one billion Sovereign Bond proceeds, two things would have had happened. Those are that it would have had swelled CBSL’s FX reserves by an equivalent amount, which in turn would have had increased the market with rupee liquidity equivalent to its rupee value.

When CBSL’s buys FX, in this instance from the Treasury, it pays the latter an equivalent rupee value, similar to a customer going to a bank and changing his $s for rupees.

But if that doesn’t take place, ie if the Treasury doesn’t sell its $ proceeds to CBSL, but keeps it in its account for various reasons and if GoSL faces a liquidity crunch during this period, then what CBSL does is it buys T Bills at no interest cost to GoSL to meet its liquidity requirement.
But the danger in fuelling liquidity that way is that it may cause demand side inflationary pressure on the economy.

When inflation increases, interest rates also rise to tempt people to save by giving them a better return over inflation, but that dissuades borrowings made for the purposes of investments, needed to create employment opportunities to the thousands who enter the job market annually and also to increase production and exports.

CBSL is owned by GOSL, CBSL Governor Ajith Nivard Cabraal speaking at a recent function said.

This reporter, last week, erroneously said in these columns that the proceeds of GOSL’s $ one billion Sovereign Bond was received by GoSL in the week ended Friday, January 24, whereas it had factually been received in the previous week, ie in the week ended Friday January 17.

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