Sri Lanka to review overnight forex trading limits: CB governor

May 19, 2009 (LBO) – Sri Lanka will “review” overnight forex trading positions of commercial banks which were slashed during the height of a balance of payments crisis last year, Central Bank Governor Nivard Cabraal said. The central bank stopped counting dollars advanced to state banks under a tighter reserve classification process ahead of an IMF bailout.

The central bank said gross official reserves – which include fiscal reserves – were 1,227 million US dollars in March, but 200 million was advanced to two banks to settle petroleum bills. The overnight trading positions of commercial banks were slashed twice late last year as the monetary authority tried to prevent ‘speculative’ trading as the rupee came under severe pressure due to an ill-fated peg defence exercise.

Dealers estimated the total overnight volume – the amount of dollar balances banks can hold overnight – to be about 30 million dollars, which is less than a third of the pre-crisis limit for the entire market.

“We will review that, but not immediately,” Cabraal said yesterday.

“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.”

The narrow overnight positions create volatility in the forex market, either pushing the rupee steeply up or steeply down as there is no ‘depth’ in the market to absorb inflows and outflows.

The rupee was quoted at 114.95/115.10 against the US dollar Tuesday. On Monday the rupee opened around 117.40/60 levels.

Sri Lanka’s foreign reserve hemorrhage has now largely stopped, and the currency has strengthened after the central bank ended intervention in forex markets.

Though reserves are technically irrelevant in a floating exchange rate regime, in Sri Lanka foreign reserves can help preserve the external solvency of the government, which makes the IMF loan important.

The latest official data showed that Central Bank’s own net foreign reserves were down to 830 million US dollars in March after a change in the classification of foreign assets.