CB suspends banks from entering into forward forex contracts

• Suspension is for three months; comes into action with immediate effect 
• Says move is required to avoid excess volatility in foreign exchange market

Adding another one to the recent measures implemented to contain the excess volatility in the foreign exchange market, the Central Bank yesterday suspended the licensed commercial banks from entering into forward rate agreements for foreign exchange for three months, with immediate effect. 

Forward rate agreements are commonly used derivative instruments in financial markets to hedge one’s possible losses from foreign exchange transactions. Importers hedge against possible further depreciation of the rupee against the US dollar and exporters enter into such agreements to minimise their exposure from the appreciation of the rupee. 

These are over-the-counter instruments, where either an importer or an exporter can get into with a bank for a fee. 

“In view of the need to avoid excess volatility in the foreign exchange market and the impact on banks’ risk management, the licensed commercial banks are hereby informed to refrain from entering into forward contracts of foreign exchange for a period of three months, with immediate effect,” said a Banking Act Directive issued by the Central Bank. 

In December, the Central Bank said it would “take appropriate action aggressively” to contain this volatility in the domestic foreign exchange market. Accordingly, it sold US $ 22.0 million from the reserves in December, to contain the depreciation of the rupee against the dollar. 

In the same month, it suspended the licensed commercial banks and National Savings Bank from purchasing Sri Lanka international sovereign bonds for three months. 

The rupee came under intense pressure from the second week of January 2021, amid deferred import payments, exporters waiting to convert dollars, expecting further depreciation of the rupee and a drought in foreign inflows. The Sri Lankan rupee closed around 196.00/199.00 to a US dollar in the spot next market yesterday, stronger from 197.00/200.00 on Friday. Both the government and Central Bank maintain that the current volatility is temporary. During the first three weeks, the foreigners added rupee bond holdings into their portfolios but the flight in foreign capital in the Colombo Stock Exchange happens unabated while the local investors are on a buying spree, sending the stock indices into new highs, almost on a daily basis.