Sri Lanka money rates ease after hitting a 7-year high; volatility may worsen ahead

January 26, (LBO) – Overnight call rates eased to 14.5 percent Friday after a hitting a 7-year high of 23.5 percent two days ago, but dealers expect greater volatility in overnight rates, as liquidity curbs begin to bite. “The Central Bank has restricted the use of reverse repo facility to six times a month, this force banks that are short to borrow at very high rates to square their positions,” a dealer said.

Central Bank started tightening policy in late 2006, after consumer inflation hit 19.3 percent following a bout of money printing to finance the fiscal deficit.

The Interbank market has frequently hit liquidity shortages due to lumpy dollar outflows throughout 2006.

But during most of 2006, unrestricted liquidity via the standing reverse repo window has kept rates below steady.

This weeks’ rate spike was highest since Interbank call rates hit 32 percent in 2000, when Sri Lanka was trapped in a severe balance of payments crisis in a year the fiscal deficit hit 9.9 percent of GDP.

Sri Lanka’s central bank does not defend a single short term rate, but provides liquidity through a daily auction supplemented by a standing facility.

The use of the overnight facility is expected to be slashed to three times a month per bank from the current six times in March, which can increase volatility of overnight rates further.

In January the Central Bank Governor Nivard Cabraal said in the course of presenting a monetary policy road map for 2007 that the bank was concerned about the inflationary impact of the regular use of reverse repo cash and would discourage its use.

“We would also closely monitor the Banks that seek this facility regularly to ascertain whether they are doing so because of any structural deficiencies they are suffering from,” Cabraal said.

Though some private banks have also not raised deposits to cover their lending, analysts it is mostly state banks that go short, due government overdraft that suddenly go up.

On Wednesday call money rates hit 23.5 percent and market repo transactions went at 20 percent with liquidity shortfall of one billion and no auction of cash.

On Thursday call rates remained as high as 22 percent, and repo transactions at 18.25 percent.

But overnight call rates eased Friday to 14.5 percent from and market repo transactions to around 12 and 13 percent, dealers said.