Sri Lanka bond rates ease amid flight to quality

Jan 07, 2008 (LBO) - Sri Lankan gilts edged lower amid a flight to quality and excess liquidity in the inter bank market, as well as lower inflation expectations for the current year, dealers said. A bond maturing in April 01, 2012 fell from the auction level of 20.02 percent to 19.80 percent levels and a bond maturing on October 15, 2011 fell from 20.40 levels to 20.15 levels, Wednesday.

"One reason could be that all debt maturities are coming to government securities," a dealer told LBO.

"People who held commercial paper and asset backed paper are now going for government securities."

Following the collapse of Golden Key, a company in the Ceylinco group, risk perception in the banking sector has heightened.

Seylan Bank, a Ceylinco unit, was handed over to the state-run Bank of Ceylon by the Central Bank to prevent a run on its deposits in December.

Sri Lanka's inflation also fell to 14.4 percent in December, and the Central Bank has forecast inflation at around 9.0 percent by the middle of the year and promised single digit inflation by the year-end.

At the weekly Treasury bill auction 3-month bills fell 02 basis points to 17.31, 6-month bills by 02 basis points to 18.

55 and 12-month bills also by 02 basis points to 19.10 percent.

Overnight rates which were at 18.00 to 19.00 percent levels, - around the central bank's penal discount window - fell to around 13.00/14.00 percent levels after the Central Bank ended active peg defence in mid-December.

Easing peg defence has allowed some of the adjustment pressure to shift from interest rates to the exchange rate.

The interbank market has also seen heightened counterparty risk perceptions with some players borrowing at 19.00 percent while liquid banks were parking money at the central bank's 10.

50 percent overnight window.

Excess liquidity then built up in the market, which analysts say is partly a reflection of central bank credit extended to government, which shows a loosening of policy.

But the latest developments also underline one of the key uncertainties in the fiscal sector, which is the final driver of interest rates in the country.

In addition to a slowing economy, which may hurt revenues, as well as an intensifying conflict which requires massive outlays, Sri Lanka is also finding it difficult to borrow abroad and roll-over existing commercial foreign debt.

Meanwhile, official intervention in the forex market has also picked up in the last few days. The spot dollar traded around 113.

75/85 rupees late Wednesday with intervention at 13.85/90 levels earlier in day, dealers said.