Sri Lanka rupee ‘floats’ for a day

Dec 12, 2008 (LBO) – The Sri Lanka rupee traded freely for possibly the first time in 2008, on last trading day of the week dealers said, while inter bank money market liquidity turned positive.

Analysts say dealers would be treading warily when the market opens next week to see whether the central bank allow the currency to ‘float’ on Monday or intervene.

But the central bank is fast running out of ammunition with foreign reserves falling from 3.5 billion US dollars in early September to 2.3 billion by end-October according to official figures.

Opposition lawmakers have claimed that by the end of November foreign reserves were down to 1.9 billion dollars.

Unsustainable Peg

Currency pegs collapse because a central bank cannot target the exchange rate and the money supply (or interest rates) at the same time by printing money.

Economic analysts say in the past the central bank and government policy makers have tried to pull the wool over peoples’ eyes by blaming the oil bill for currency collapse, but with falling oil prices that excuse can no longer be given.

A ‘float’ breaks the currency crisis, and a lower rate for the rupee also impoverishes the local population (a de facto fall in living standards), curtailing people’s ability to import goods.

This compensates for the liquidity injections made by the central bank (money printed) in the period of the currency crisis.

Economic analysts say the latest crisis in the forex markets has underlined the urgency to reform the central bank.

Economists and financial analysts have already called for the complete abolition of the central or at least to have legislated inflation targeting.

The four day trading week ended Thursday with the rupee closing at 111.30/45 with the local currency falling about a rupee against the greenback, against last week’s close of 110.00 rupees to the US dollar.

Crisis Trigger

The central bank started a balance of payments crisis in mid-September by intervening in forex markets and filling up liquidity shortages with printed money, a process known as ‘sterilized intervention’.

On Thursday the market liquidity unexpectedly turned positive with 5.5 billion rupees of excess liquidity being parked at the Central Bank’s repo window and only 985 million being borrowed from the discount window auction.

Earlier the central bank was printing just enough money through the reverse repo auction to keep liquidity neutral, keeping steady pressure to de-stabilized its own peg with the US dollar.

The central bank’s total Treasury bill stock climbed to 120 billion rupees from 115 billion rupees a day earlier with money being printed to repay bill holders.

But analysts say excess liquidity will increase the pressure on the rupee to depreciate further.

One Day Float

In technical terms, with no intervention on Thursday, the rupee ‘floated’ for a day, and it was quoted at prices ranging from 111.30/60 to 110.85/111.00 with dealers expecting central bank intervention at 111.00.