Sri Lanka dollar peg breaks Rs110 level

Sept 05, 2011 (LBO) – Sri Lanka’s peg to the US dollar weakened 10 cents to 110.10 Monday with the spot dollar being quoted around 110.09/110.10 rupees as the currency continued to be under pressure, dealers said. Analysts say there could also be a ‘supply shock’ to the system in the form of low rainfall, which requires power utilities to spend more on thermal energy (and are not allowed to charge more from customers), resulting in higher credit flows to the power distributor or generating firms.

Excess reserves in the banking system fell to about 40.0 billion rupees Friday, as continued non-sterilized dollar sales mopped up excess liquidity, despite a spike at the end of the month, possibly from an official inflow, analysts said.

Over July excess liquidity has fallen about 35 billion rupees, pointing about 300 million US dollars of reserve losses.

Meanwhile at the Treasury bill auction last week 17 billion rupees of bills was sold without a single basis point change in yields.

Financial repression increases pressure on the currency.

Currency shortages and balance of payments crisis happens when a central bank tries to control both interest rates and the exchange rate.

When foreign reserves are spent to defend a peg and liquidity shortages are filled (sterilized intervention), a full-blown currency crises can be triggered.

Corrected highest spot quote Rs110.09/110.10 Sri Lanka’s has defended the currency at 110.00 rupees to the US dollar over the past several months, as pressure mounted on the monetary system from fast growing credit.

On Monday the rupee was quoted around 110.09/110.10 though at times it was also quoted around 110.07/09 a tad below the monetary authority’s unofficial two way quote of 109.60/110.10 which is defended through a state bank.

Analysts have said that Sri Lanka’s high credit growth is now requiring a higher interest rate for the banking system to regain equilibrium or a weakening of the peg to avoid a balance of payments crisis.

Over the past two months, excess reserves in the banking system has rapidly dwindled indicating that interest rates have to move up to match deposits to higher credit demand.