BENCH MARK RATES UP

Short-term benchmark Treasury bill rates gained further this week as the Central Bank continues to maintain a stable exchange rate and the market adjusts itself to what some dealers called an over-reaction.

Dealers said benchmark interest rates were going up as the Central Bank was continuing to maintain exchange stability by purchasing excess dollars from the domestic market with the rupee trading between 114.30/55 against the dollar.

"But there is a price to pay. When the exchange rate is kept stable, which is being done to benefit exporters, the Central Bank has to purchase the excess dollars and this releases rupees into the market. This in turn can be inflationary with lots of money chasing fewer goods," a dealer said.

"The Central Bank then conducts open market operations to absorb the excess rupees, offering rates above the 7.50 percent policy rate (repurchase rate by which a commercial bank can place its excess funds with the Central Bank).

"This is what is reflected in the increases to benchmark Treasury bill rates," the dealer said.

The three-month Treasury bill rate increased to 7.76 percent at this week’s auction of Treasury bills at the primary market from 7.60 percent a week ago. The rate for six-month bills increased to 8.65 percent this week from 8.59 percent.

The 12-month Treasury bill rate remained unchanged at 9.32 percent.

"In an economy you cannot control inflation, have a stable exchange rate and low interest rates all at the same time. Stability in one of these will require another to be sacrificed. At the moment authorities seemed to be concerned about rejuvenating the export sector," a dealer said.

Over-reaction…

Dealers said short term Treasury bill rates were low in the recent past because markets over-reacted to policy rate cuts of the Central Bank.

Earlier this year, the Central Bank brought down policy interest rates to 7.50 percent and 9.75 percent (both overnight rates for commercial bank placements and borrowings from the Central Bank), as the rate of inflation began to decline after peaking at 28.2 percent in June 2008.

"The three-month Treasury bill fell below the 7.50 percent policy rate which does not make sense as shorter the term lower the risk. Earlier this month, the three-month Treasury bill rate fell to as low as 7.25 percent," a dealer said.

"We have now seen the market correcting itself over the past few weeks," he said.



Inflation…

The fall in the rate of inflation has bottomed out since reaching 0.7 percent last September. Last month inflation reached 2.8 percent and is expected to reach around 4 percent by the year-end, according to Department of Census and Statistics.

A contracting trade deficit as imports fell sharply, and a tight monetary policy helped contain inflation and bring to it lower levels.

But with imports expected to pick up in 2010, and as the government struggles to fund a budget deficit, inflation is expected to increase but remain within single digits in 2010.

Some dealers said inflation could reach eight percent next year. The Central Bank, however, maintains there is still room for commercial banks to lower lending rates and increase their lending to the real economy.

source - www.island.lk