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The forex and interest rate markets may become volatile in the near term following the Government’s announcement of temporary suspension of repayment of external debt, Frontier Research opined last week.
Following is a snapshot of its insights on short to medium term impact from the move on the rupee and interest rates.
Governor Dr. Nandalal Weerasinghe has mentioned at the press conference that CBSL will be reducing the mandatory dollar sales by banks from 50% to 25%. This should help improve dollar liquidity in banks once there is more clarity and calm over the debt suspension.
Secretary Treasury Mahinda Siriwardena said that he will be issuing a circular soon cutting down expenditure and announcing new revenue measures. The external debt suspension also reduces the Treasury’s expenditures and reduces the issuance of Government rupee securities to the CBSL to facilitate dollar purchases for debt repayments.
The next key steps would be to see if this pathway continues with additional steps taken, particularly in terms of politically difficult actions such as fully cost-reflective energy pricing and raising taxes.
Regardless of these policy statements and the new team’s increased transparency on issues, the market may become volatile in the near term given the preference for a negotiated suspension versus a pre-emptive suspension. So, it is possible the rupee overshoots beyond the most likely scenario, the upper end of Rs. 350 for a dollar.
On the rates side, the market could continue to be illiquid awaiting more clarity and the next set of bill and bond auctions. But overshooting of both yields above 25% is possible in limited trades.
But it is important to understand that this outlook for end-2022 is 8.5 months further away. Key determinants are going to be the political standstill resolving in a way that brings back confidence to both local and international business stakeholder, whether the steps the Treasury Secretary and the CBSL Governor are taking and signalling actually do happen as soon as possible, the pace and success of IMF and debt restructuring negotiations, alongside the realisation of bridging finance.
The most likely scenario expects the rupee exchange rate to stand between Rs. 270 and Rs. 350 (against the dollar) by end-2022. As of 12 April, CBSL official dollar/rupee rate was Rs. 313.67.
On the 12-month T. Bill rate, the most likely scenario expects it to stand between 14.0% to 20.0% by end-2022. At the 11 April T-bill auction, the 12-month’s weighted average yield was 23.36%.
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