Interest rates, rupee under pressure

* Dealers say domestic economy okay, problem with global economy
* Benchmark Treasury bill yields inch-up, Rs. 30bn excess liquidity mopped up

Interest rates are under pressure to increase while the rupee is being pressurised to weaken against the dollar and dealers said this was not because the country’s economic fundamentals were under stress but rather, were manifestations of the global economy being in a ‘dangerous place’.

"Interest rates are expected to increase and the rupee to depreciate, but this has nothing to do with the fundamentals of the economy, which are still strong. It’s just that the global economy is taking a turn for the worst," a dealer said.

The International Monetary Fund yesterday said the world economy had entered a dangerous new phase resulting in gloomy forecasts for both the US and Europe (see elsewhere on this page for more on these forecasts), both major export markets for Sri Lanka.

Benchmark Treasury bill rates increased marginally at yesterday’s auction, but this was significant given that the Central Bank had managed to keep these rates steady for weeks despite the fact that market players had been bidding for higher rates.

The three-month Treasury bill saw its yield move up 3 basis points to 7.14 percent while the six-month bill was up 2 basis points to 7.22 percent and the yield on the 12-month bill was up 4 basis points to 7.26 percent. The auction was for maturing bills amounting to Rs. 10 billion. Bids received amounted to Rs. 19.6 billion. The Public Debt Department of the Central Bank accepted bids amounting to Rs. 9.53 billion.

The Island Financial Review spoke with several dealers who said interest rates are likely to move up in the short term. "This is the trend and we have seen the pressure build up for some time. The increase maybe marginal, but the trend would be upwards nonetheless," a dealer said.

The Central Bank also mopped up Rs. 27.1 billion at 7.08 percent yesterday from the market through the active open market operations widow. The usual repurchase window was used to mop up an additional Rs. 2.36 billion at 7 percent.

"The Central Bank mopped up excess liquidity amounting to almost Rs. 30 billion. The Central Bank is concerned about inflationary pressures exerted by excess rupee levels, and the mopping up operations has almost drained the market," a dealer said.

Meanwhile, pressure on the rupee to depreciate continues unabated and the Central Bank is determined to intervene and prevent a sharp fall. This has been done at the expense of the reserves but the bank has maintained that reserves were at record levels.

With the US and Europe expected to record dismal economic growth rates in the near term, exports are likely to come under severe stress, and dealers said a slight depreciation would help the country’s exporters maintain competitiveness, especially since exports from regional competitor countries were becoming more attractive as their currencies have depreciated against the dollar.

The sale of dollars to keep the exchange rate stable has put pressure on domestic interest rates and we are now in a situation we never thought we would be in, given where the economy was at the beginning of the year; interest rates were low and the exchange rate was feeling some pressure to appreciate.

Dealers believe the Central Bank would continue to defend the exchange rate. A depreciation of the rupee would immediately affect prices in the import-dependent economy. They anticipate the adjustment to come from the interest rates.

"In the short term the rupee is expected to depreciate. But in the long term, around next year, the expectation is for the rupee to remain strong against the dollar," a dealer said.

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