Sri Lanka lifts forex forward curbs

May 25, 2009 (LBO) – Sri Lanka’s central bank Monday lifted restrictions on foreign exchange forward contracts imposed late last year amid a balance of payments crisis, allowing the market to act freely, a top official said.

The IMF loan has been delayed amid political wrangling from the US in particular, but the lenders said last week that it was hoping to approve the loan within “weeks.”

After a float, under an IMF program a country usually moves to a contractionary peg defence phase, where domestic liquidity generated from forex interventions are ‘sterilized’, allowing the central bank to lock up foreign reserves.

Under an expansionary peg defence cycle, liquidity is added to domestic money markets to ‘sterilize’ cash shortages created by central bank dollar sales, putting pressure on the domestic currency.

A float is needed to break the cycle ‘sterilized intervention’. The rupee weakened to around 120.00 rupee after the float before appreciating.

The central bank also cut overnight trading positions of commercial banks during the period of foreign exchange pressure. Central Bank governor Nivard Cabraal said last week the overnight limits will be reviewed.
“We have overall flexibility; we have the space to do it. But we do not want to do too many things at the same time,” he said. Last October the Central Bank imposed a 100 percent margin deposit on importers who booked foreign exchange forward and also limited the duration of forward deals to 180 days.

Both restrictions have now been lifted.

“There is no pressure in the foreign exchange market, so we thought we should allow market players to act freely,” Central Bank’s chief economist Nandalal Weerasinghe said.

The central bank ‘floated’ the rupee in late March 2009 ahead of an International Monetary Fund bailout ending a period of expansionary peg defence that put pressure on the rupee.

From April the Central bank has been a net buyer in the forex market.

Weerasinghe said the bank has also been buying dollars in May. The rupee is now pegged at around 115.00 to the US dollar.

The rupee was quoted 114.90/95 with a state bank that usually represents the monetary authority on the buying side, dealers said.