Sri Lanka bonds spike, bills rejected amid heavy forex interventions

Oct 22, 2008 (LBO) – Sri Lanka rejected an entire Treasury bill auction Wednesday while the yield of a bond popular among foreign investors spiked and heavy central bank intervention in currency markets continued, dealers said. The government’s debt office said all bids at the auction were rejected. Last week 3-month bills were auctioned at 17.20 percent, 6-months 18.28 percent and 12-months at 19.06 percent.

Bond Yields

Meanwhile longer term rates spiked in the secondary market. A bond maturing in April 2012, which is popular among foreign investors, was sold at 20.50 percent up from around 19.75 levels a day earlier, dealers said.

The bond was quoted later in the day at 20.20/50 percent.

In currency markets the central bank continued to intervene heavily to defend a peg with the US dollar, selling dollars at 108.00 rupees, effectively underwriting the currency risks of foreign bond holders.

Foreign bond holdings have now come down to around 43 billion rupees from peaks of about 60 billion in mid 2008 and 50 billion in early September and bill holdings have fallen to around 13 billion rupees from around 18 billion at the beginning of September, dealers said.

Central Bank has in recent weeks rejected market bids and repaid holders with printed money.

The central bank’s holdings of Treasury bills, which are purchased to create new money and offset foreign reserve losses, in a process known as sterilized intervention, rose to 46.7 billion rupees on Tuesday.

Foreign Assets

Sri Lanka’s central bank has a reserve money (monetary base) target and domestic asset increases broadly equal foreign asset losses.

The monetary authority also released about 7.5 billion rupees to the system through a reserve ratio cut of 75 basis points, bringing up the total cash injected since September to 54.2 billion rupees or 501 million US dollars.

In September the bank lost only 202 million dollars according to official data.

Analysts say sterilized currency interventions tend to snowball over time as liquidity injections work their way through commercial bank reserves and the economy.

Pakistan’s central bank, which engaged in heavy currency interventions and badly hurt the economy, is now seeking International Monetary Fund help.

Countries that defend currency pegs usually get into such difficulties. But with growing knowledge, most countries have moved to floating exchange rates and abandoned soft currency pegs or moved to hard pegs (currency boards).

The IMF has also lost customers to lend because fewer central banks were getting into trouble and has been cutting expenses and trying to find other ways to earn revenue.

Sri Lanka officially ‘floated’ the rupee after a severe currency intervention crisis in 2000/2001, but later moved towards a peg.

Mexico, which also moved to a floating exchange rate after a peg brought repeated peso crises, panicked and intervened, spending 10 percent of the country’s foreign reserves in a few hours, the Economist magazine said this month.

“Unfortunately you cannot just unlearn a reflex developed over decades of financial crises,” the Economist quoted an analyst as saying.