Interest rates under pressure

Benchmark Treasury bill rates shot up for a second week as Central Bank intervention to keep the exchange rate steady at Rs.113.90 against the greenback is causing a liquidity crunch in the banking system with foreign banks holding a majority of excess liquidity in the system, dealers said.

These banks, and some state-owned banks, are unable to lend to their counterparts because of limit restrictions. Therefore these funds end up with the Central Bank overnight at a rate of 7 percent. Yesterday Rs. 31.63 billion had been absorbed by the Central Bank.

The Central Bank’s holding of government securities reached Rs. 117.3 billion, an indication that the overall excess liquidity in the market was short by Rs. 85.6 billion. This shortfall is largely driven by the dollar sales of the Central Bank to maintain the exchange rate where it is, dealers said.

Appetite for government securities have also fallen, dealers said.

The yield on the three month Treasury bill jumped to 8.20 percent yesterday from 7.95 percent a week earlier, the six months bill saw its yield move up to 8.50 percent from 8.18 percent and the yield on the 12-month bill moved up to 8.99 percent from 8.50 percent. The auction was for maturing bills amounting to Rs. 10 billion. Bids amounted to Rs. 21.8 billion but only Rs. 9.6 billion was accepted.

Dealers said pressure would continue to mount as dollars continue to be sold to maintain the exchange rate.

"There is severe import demand and some foreign investors are also exiting from the bond market. All these have to be funded through rupee resources. For each dollar that goes out an equivalent in rupees is mopped out of the system. We believe the Central Bank has sold a little over a billion dollars over the last few months," a dealer said.

The market is still uncertain about where the exchange rate would head.

"But one thing seems clear. The Central Bank seems to be comfortable to defend the exchange rate at the expense of interest rates. Hopefully, the global economic environment would improve and commodity prices would cool off. Then further depreciation could be allowed without making much of an impact. This would keep the reserves secure and also keep interest rates in check," a dealer said.

Central Bank Governor Ajith Nivard Cabraal told Bloomberg newswire services on November 29 that Sri Lanka will probably refrain from rate cuts for the rest of 2011 even as it has room to lower borrowing costs, as this month’s 3 percent currency devaluation revives price pressures. He has left rates unchanged for 10 months as Asian nations from Thailand to Indonesia take fiscal or monetary stimulus steps to counter the threat to exports from Europe’s debt crisis, Bloomberg said.

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