Sri Lanka shops for 400 million dollars as rupee dips to new low

June 12, 2007 (LBO) – Sri Lanka is shopping for 400 million dollars in medium term finance in global markets as a rising budget deficit is sending local interest rates rocketing up and the rupee fell to a new life low, bankers said.

“Sooner or later it is going to blow up.” The Central Bank, which runs the government’s debt office, has asked for bids from international banks to raise the dollars in medium term bonds.

Banks that participated in a conference Wednesday in Colombo have been given until July 16 to submit proposals, with the deal expected to be closed by October.

The government is seeking 4 to 5 year money, bankers said.

JP Morgan, Merrill Lynch, Standard Chartered Bank (Dubai), Deutsche Bank and Royal Bank of Canada, UBS and ABN-Amro were among the banks that participated in the conference.

Bankers were asked to propose their own rates and interest payments, whether quarterly or semi-annually, priced on the London Interbank Offered Rates (LIBOR).

Other Asian countries of a similar standing have raised funds around 200 basis points above LIBOR, bankers said, but Sri Lanka has previously raised dollars from local banks at lower rates.

Earlier in the year the government also raised more than 400 million dollars by selling rupee bonds to foreign investors.

But with interest rates rocketing up with rising government expenditure, foreign buyers have become jittery as bond prices crashed. Analysts say bond investors would either have to sell or move to shorter term instruments to avoid taking further hits.

Meanwhile, the Sri Lanka rupee has come under pressure in the past few weeks requiring outside finance to boost reserves.

The rupee hit a new life-low of 111.83 against the dollar in intra-day trading Thursday despite muted activity after the monetary authority came down heavily on dealers late last month.

A rising budget deficit has pushed up Sri Lanka’s rupee gilt rates above 17.4 percent with the central bank keeping monetary policy tight since January, after money printing drove inflation to 20 percent last year.

But domestic assets of the monetary base has been climbing up in recent weeks as the central bank printed money to top up an outflow of reserves believed to have been partially triggered by foreign debt repayments.

Analyst say such ‘sterilized interventions’ will only further accelerate the slide, even if interbank forex trading is limited to almost nothing.

With the budget deficit threatening to strangle economic activity, the government needs an injection of foreign cash to give the nation a breathing space.

While an intensifying conflict has pushed up defence spending, economists have warned that reckless fiscal policy led by the hiring of tens of thousands into an already bloated public sector and politically oriented subsidies were undermining the economy.

An international economist warned that despite better monetary policy from the central bank, an expanding budget deficit estimated at 9.2 percent of the economy this year would eventually explode.

“In the end, no matter how successfully the central bank tries to maintain financial and monetary stability, if governments keep spending more than they collect in taxes, eventually you have a time bomb,” Peter Sinclair, Professor of Economics at the Birmingham University said in Colombo.