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FINANCIAL CHRONICLE™ » DAILY CHRONICLE™ » Market Depends On $ Borrowings To Strengthen Rupee

Market Depends On $ Borrowings To Strengthen Rupee

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Redbulls

Redbulls
Director - Equity Analytics
Director - Equity Analytics
Export Downturn Adds To ER’s Woes

The breakdown in confidence in the foreign exchange (forex) market coupled with inadequate inflows are two major stumbling blocks that hinder the strengthening of the exchange rate (ER), a market source told this newspaper.

As such he had expected the ER to weaken to Rs. 132.50 to the US$ ($) in spot, interbank trading last week as opposed to a figure of Rs. 131.90 in the previous, this was a prediction that he made at the beginning of last week. However that may be, the ER till Friday was holding on to the Rs. 131.85-90 levels in spot, interbank trading (see also connected article found elsewhere on this page).

It closed the week (ie last week) at Rs. 131.90, after earlier sliding down to the Rs.132 levels on thin volumes, he said. State owned People’s Bank was there in the market, buying $s at the Rs. 131.80 level and selling the same at a profit, at Rs. 131.90, the source said.

Import demand is weak due to new controls imposed and policies adopted, he said.

On the previous day Thursday it closed slightly weaker at the Rs. 131.95 level.

Those controls and policies include increasing policy rates, providing ER flexibility thereby leading to its depreciation, increasing import taxes on motor-vehicles, imposing an 18% ceiling on credit growth this year which may be enhanced by a further 5% if the source of additional funding is foreign and uplifting the administered prices of energy, bus fares and bread.

“Exports were down 15% in May according to the latest of such data made available by the Central Bank of Sri Lanka (CBSL), and, added to that the ER has had been depreciated by 20% in under a year, the steepest of such depreciations witnessed in recent times, where, previously the rupee used to usually annually depreciate only in the single digit range then,” the source said.

All this doesn’t lend credibility to the ER.

As a result the market depends on overseas borrowings to strengthen the ER, he said. Giving credence to his hypothesis, recently the Government of Sri Lanka (GoSL) raised $ one billion from international bond markets which helped the ER to strengthen from its previous low Rs. 134 levels to its current levels. But such borrowings, especially as those are of a commercial and also of a short term nature (unlike concessional loans which generally are of a longer tenure), may also bring with it its own problems such as when repayments are due, causing further pressure on the ER.

During a sizeable part of last year the ER was defended at the Rs. 110.20 levels in spot, interbank trading to the $, prior to the presentation of Budget 2012 on November 21 when it was devalued by 3%.

The ER has since depreciated by Rs. 21.70 (19.7%).

On Wednesday it marginally appreciated (over the previous day Tuesday’s close) to Rs. 131.85, yet a Rs. 21.65 decline (19.6%) over the Rs.110.20 figure it commanded, albeit administratively, nine months ago.
On Tuesday (August 7) the ER depreciated to the Rs. 131.90 level, a five Sri Lanka cents fall from the previous day Monday’s Rs. 131.85 close due to state names buying $s from the market, a source said.

In the previous week’s closing, ie on Friday, August 3, the ER finished the week at Rs. 131.90 to the $.
However that may be, earlier, especially last year, CBSL had had been defending the ER at the Rs. 110 levels by expending its forex reserves in order to carry through with this exercise, and even going to the extent by saying that the ER may even appreciate, thereby giving a false sense of direction to the market as subsequent events showed, beginning with the surprise 3% devaluation of the local currency on November 21, followed by its virtual free float three months later on February 9, events which don’t help the market to have confidence on a stronger ER in the future.

In other negative developments, tight liquidity levels in both the forex and money markets also tend to make both expensive.

Money Market
In money markets, the market on Friday threw up an excess liquidity amount of Rs. 13,847 million ($ 104.90 million*), largely helped by the recent $ one billion Sovereign Bond issue, which part proceeds at least were sold to CBSL through state banks in exchange for rupees, the chief reason for the market’s current excess liquidity.

On the previous day Thursday, the market’s excess liquidity was Rs. 18,591 million ($ 140.80 million*). The reduction in market’s excess liquidity may be due to GoSL having to meet certain foreign debt service commitments (where they buy $s from CBSL at administered, ie low prices by paying for the same in rupees, thereby reducing market’s excess rupee liquidity) or due to banks’ having to meet their statutory reserves ratio commitment with CBSL, or a mix of both.

CBSL in order to get rid of its over Rs. 200 billion worth of Treasury (T) Bill stock conducted an auction for the outright sale of a paltry Rs. 4,000 million worth of this stock. This was on Friday. The T Bills on offer was of a 32 day maturity, ie maturing on 14.9.12.

However CBSL was able to get rid of only Rs. 2,000 million of this stock at a weighted average yield (WAY) of 10.98%. Previously CBSL had an auction for the outright sale of some of its T Bill stock on Monday. At that auction it got rid of Rs. 1,100 million worth of T Bills of 10 day maturity (maturing on 17.8.12.) at a WAY of 10.69%.

Meanwhile on Wednesday (August Cool the market threw up an excess liquidity amount of Rs. 19,759 million ($ 149.7 million*).

But when the state has to service foreign debts or make imports, such a oil, they swallow up at least part of this excess liquidity by buying $s from CBSL to settle such dues, while making payment to the CBSL in rupees for the $s bought.

Generally such purchases from CBSL may be made at administered prices, ie at prices lower than market prices. One possible reason why such commitments are made from outside of the market may be due to the fact that if they don’t do that (ie if they make such $ purchase from the market), it may cause pressure on the ER to depreciate, with socio-political ramifications in such a scenario.

CBSL Governor Ajith Nivard Cabraal is reported to have had said that CBSL may intervene in respect of making oil purchase commitments, rather than allowing the state to buy $s from the market for the settlement of the same.

When excess liquidity diminishes that generally causes pressure on rates. However a source said that as much of this current excess liquidity is held by state banks, the same adopts greater flexibility in interbank lending (call money) than allegedly compared to foreign banks, which are apparently more cautious in interbank lending, preferring to park their excess liquidity with CBSL, rather than lend those to banks.

Prior to the entry of the sovereign bond proceeds, much of the excess liquidity in the market then was held by foreign banks, he said. “Now we don’t see that much of stress in call money markets as the present bulk of the excess is in the hands of state banks,” the source further said. However that may be, the weighted average rate (WAR) of call money transactions stagnated at the 10.50% on Friday (over that of the previous day Thursday, August 9 close), but overnight (o/n) market repurchase transactions increased by two basis points (bps) to 9.49%. Meanwhile the WAY in the o/n repo auction remained unchanged at the 9.43% level on Friday, over that of the previous day Thursday’s figure.

However that may be, the WAR of call money transactions increased by one bp to 10.50% on Thursday (over that of the previous day Wednesday, August 8 close), but o/n market repurchase transactions stagnated at the 9.47% level. This was also the case in regard to the WAY in the o/n repo auction, which also remained unchanged at the 9.43% level on Thursday, over that of the previous day Wednesday’s close.
On Wednesday, the WAR of call money transactions stagnated at the 10.49% level (over that of the previous day Tuesday, August 7 close), while o/n market repurchase transactions too followed suit, stagnating at the 9.47% level. This was also the case in regard to the WAY in the o/n repo auction, which also remained unchanged at the 9.43% level on Wednesday, over that of the previous day Tuesday’s close.
Meanwhile, on the previous day Tuesday too the WAR of call money transactions stagnated at the 10.49% level (ie the rate which was also commanded on Monday, August 6). However, o/n market repurchase transactions declined by two basis points (bps) to 9.47% coinciding with market’s excess liquidity, probably due to inflows, increasing by Rs. 763 million to Rs. 19,867 million on Tuesday, over that of the previous day

Monday’s close.
However the WAY in the o/n repo auction increased by one bp to 9.43% on Tuesday. At the beginning of last week on Monday, probably as a result of the diminishment of excess liquidity from the market, due to either the GoSL having to settle an import bill, or due to its foreign debt servicing commitments, or due to a mixture of both, where in both of these instances GoSL buys $s from CBSL and pays rupees in lieu to meet such obligations, thereby diminishing excess rupee liquidity from the market, rates increased. Market’s excess liquidity on Monday contracted by Rs. 2,070 million to Rs. 19,867 million over the previous day Friday (August 3) close. As a result the WAR of call money transactions edged up by one bp to 10.49% on Monday (over that of its previous day August 3 close), while o/n market repurchase transactions increased by three bps to 9.49%. Meanwhile the WAY at Monday’s o/n repo auction by which Rs. 15,719 million of excess liquidity was drained out remained stagnant at 9.42%, while CBSL, in a seeming desperate attempt to get rid of its over Rs. 200 billion worth of T Bill stock (which gives it little manoevrability to intervene in money markets in order to bring down rates), did an outright sale, but only got rid of a paltry Rs. 1,100 million of 10 days tenure (maturing on 17.8.12.) at a WAY of 10.69%, this was on Monday.
*1$=Rs.132
http://www.thesundayleader.lk/2012/08/12/market-depends-on-borrowings-to-strengthen-rupee/

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