By Paneetha Ameresekere
Ceylon Finance Today:The government securities market (GSM), namely the Treasury (T) Bond and T-Bill market, in the week ended Wednesday (16 March), saw a massive net foreign inflow of Rs 9,587.16 million; thereby bringing down foreign holdings in such securities to Rs 237,648.16 million in the week under review; data showed.
Such exits are caused due to a combination of global uncertainty led by weak economic performances in the Euro Zone, and also by China and Japan, the world's second and third largest economies respectively; and, internally, seeming political instability, at least in the eyes of foreign investors; the recent downgrading of the country rating by Fitch and S&P, an unstable rupee and rising interest rates.
When foreigners exit, either from the GSM or from the Colombo Stock Market, which is also usually the case, now-a-days, Central Bank of Sri Lanka (CBSL), to avoid depreciative pressure on the rupee in the event market forces are freely allowed to impress upon the local currency, sells US dollars to such exiting foreigners, at the discounted spot rate of Rs 144 to the dollar.
The market, which is virtually strangled by CBSL's alleged moral suasion persuasions, of not allowing the exchange rate (ER) to go below the Rs 144 level in interbank spot trading, has, during the past few weeks, resorted to trading in one week's forwards in order to circumvent CBSL's strictures on the administered spot value of the rupee.
As at 3.30 p.m. on Friday (18 March), the ER in one week's forwards was dealing at Rs 144.75 to the dollar, down from the previous day's (ie at 4.15 p.m. on Thursday, 17 March, 2016) wide band (due to uncertainty) of Rs 144.55/70 to the dollar in two way quotes in one week's forwards, market sources told this reporter. (See also yesterday's Ceylon FT).
CBSL, in its foreign exchange (FX) transactions deals in "spot", where settlement takes place after two market days from the date of transaction. The reason why CBSL wants to control the ER without allowing it to depreciate by allowing market forces to impress upon it is because Sri Lanka is an import dependent economy.
Therefore, a depreciated local currency would cause inflationary pressure on the economy. Also, a depreciated rupee would also cause the Government of Sri Lanka's (GoSL's) foreign debt servicing costs to rise, as GoSL would have to buy dollars after paying in rupees, in this instance to the CBSL (to avoid depreciative pressure on the ER if such dollars are bought from the foreign exchange market).
As such a depreciated ER would make GoSL's rupee costs to rise in such an exercise.
However, when CBSL sells dollars at discounted rupee rates to such exiting foreign investors, ipso facto it not only depletes its foreign reserves but it also depletes excess liquidity from the money market, thereby causing upward pressure on rates, due to the paucity of such excess liquidity.
This is reflected by the fact that the average weighted prime lending rate (AWPLR) of banks in the week ended Friday, increased sharply by 24 bps to 8.81%, CBSL data showed.