Market Watch: Eyes on policy decision, liquidity in surplus (Updated)

(Updated with 330 billion rupee CBSL holding of government securities) Dec 30, 2016 (LBO) - All eyes were on the Sri Lanka monetary policy decision to be announced later on Friday, with secondary market bond yields ticking slightly higher. Dealers said the central bank was likely to keep rates steady, though there was pressure to tighten to mop up excess liquidity. A 50 billion rupee surplus in the money market, with the Central Bank not rolling over all bond maturities, could increase further in January, with around 70 billion rupees likely to hit the system, dealers said. The central bank's holding of treasury bills and bonds rose to a record high of 330 billion rupees on Friday, up from 219 billion rupees on Thursday, reflecting market operations of the central bank. "Taking money on an overnight basis, is not the best idea. Excess liquidity at a very low rate can lead to credit growth," one dealer said, referring to overnight auctions to mop up excess liquidity. "Longer term bills and bonds could be offered instead," he said. Secondary market bond yields edged up 30-40 basis points this week for 8- and 10-year bonds, with yields at the auction weakening slightly, which suggested some captive fund intervention. The spot rupee weakened against the dollar by 20 cents to close the year at 150. Market participants suggested that a further depreciation could ease some of the pent up pressure in the system, and increase tourism and export proceeds. The first few months of next year will be crucial in terms of balancing dollar outflows.
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An outflow of dollars from the domestic treasury bonds has put pressure on foreign reserves, and the government is counting on proceeds from a one-billion dollar 3-year financing facility, investment in the Hambantota port, and an IMF support facility to ease balance of payment difficulties next year. The yield on Sri Lanka's 10-year sovereign bonds remained high at 7.08 percent on Friday, although ticking slightly lower after U.S. treasuries took a dip this week.