ECONOMYNEXT – Sri Lanka hosts the first non-price-controlled Treasury bill auction on Wednesday that crippled bond markets and led to liquidity injections that ravaged the rupee and pushed the economy into a currency crisis triggering the world’s worst deficits. balance of payments history.
Price controls on bill and bond auctions have gradually discouraged investors in longer-term bonds and 12-month bills, and secondary market trading has dried up.
Bond auctions crippled
On Tuesday, a single 2024 bond was listed at 8.35 / 45%, down from 8.25 / 40, according to brokers on Friday.
The central bank offers 39.5 billion rupees in 3, 6 and 12 month bills.
There were no secondary market quotes for the 12 month notes.
Sri Lanka’s 3, 6 and 12 yields flattened as price controls and cash injections continued over the past year and a half, a telltale sign that signals currency crises.
When the offers are rejected and the central bank prints money to buy banknotes, rates remain stable week after week, giving a straight curve over time until the currency collapses.
In times of monetary stability, however, there is a spread of around 100 basis points or more between 3 and 12 month bills.
The wand anomaly continues until deferred corrections are made to stabilize the rupee.
Then the gap between the 3 and 12 month bills widened, accentuating the steepening of the yield curves.
As stability returns, credit slows after rate hikes, rates fall. If the currency is allowed to rebound, rates fall faster. At the moment, however, Sri Lanka’s foreign exchange markets are also dysfunctional.
The new central bank governor, Nivard Cabraal, ended price controls last week.
There is a high degree of uncertainty among market players.
“The offers can be high,” said one dealer. “We don’t know if they will be accepted.”
The interbank money market is now short of 200 billion rupees following an increase in the reserve requirement ratio as well as some foreign exchange interventions in September. The shorts are filled with 6.0 percent printed window silver.
It is not clear why the statutory reserve rate was raised before the crippled bond auctions were allowed to operate.
In order to fill liquidity with purchases of foreign assets after the liquidity injections stop, interbank foreign exchange markets where internally unmatched net dollar balances are traded between banks must also function.
Hindered Forex Markets
In addition to crippled bond markets, Sri Lanka’s foreign exchange markets are also hampered by a series of controls. There is no spot market and term hedging is prohibited.
The exchange rate is decreed at 203 per US dollar but there is no monetary policy to support it as long as there are injections of liquidity to apply artificially low interest rates.
Despite the weakening of the peg through liquidity injections and low interest rates, more liquidity is injected into the system through currency buybacks by exporters, which exacerbates the pressure on the exchange rate. Similar cascading policy mistakes have been seen in the past, analysts have shown.
In order to maintain a stable exchange rate (a credible anchor), the monetary authority must allow interest rates to move so that no currency is printed to keep rates artificially low and interventions must be unsterilized, or mostly unsterilized so that the credit system tightens. and overnight rates are going up.
Social unrest exchange rate
Sri Lanka follows a so-called “flexible exchange rate”, a highly unstable anchor regime involving two conflicting anchors exploited with an inflationary policy to keep rates low until the currency peg collapses .
“These are new words to describe a very unstable third world after WWII or flexible ankles without a credible monetary anchor that trigger currency crises, social unrest and sometimes civil wars”, explains the economic columnist of ENs, Bellwether.
“Flexible exchange rates for social unrest were previously also known as dirty floats or managed floats.”
Importers are now buying dollars at 230 for one or more US dollars in the over-the-counter market, as the low interest rates of the rupee have caused exporters to hold onto the dollars instead of converting them.
In the absence of liquidity injections, any hoarding of the dollar should have pushed up rupee rates and crowded out domestic credit, keeping the external sector in balance.
However, cash injections keep dollars low and also domestic credit to grow uncontrollably, triggering imports.
Sri Lanka’s key rate is still 6.00 percent at which all procedures are sterilized.
The central bank effectively halted the convertibility (float) of the rupee for business transactions, which caused the rupee to drop to 230 or less.
A float does not work, however, if liquidity continues to be injected either through failed bond auctions or sterilized interventions. (Colombo / September 22/2021)