SRI LANKA RUPEE BREAKS PEG AS MONETARY AUTHORITY STEPS BACK.

COLOMBO, Oct 1 Asia Pulse - Sri Lankan currency the rupee broke its peg at 107.90 and spiked to 108.35 rupees against the green back on Tuesday after the monetary authority ended a week of heavy intervention that saw more than US$100 million flow out of the country.

Sri Lanka's central bank has intervened heavily in currency markets in the past two weeks and injected liquidity to plug reserve outflows, in a process that could have undermined its tight monetary program and put further pressure on the currency.

But an effective float of the rupee on Tuesday could nip the process in the bud, protect the country's reserves and keep inflation on a downward trend, but put pressure on interest rates.

Domestic assets of the monetary system in the form of Treasury Bills had risen by about 15 billion rupees by Monday indicating a reserve outflow of about 139 million US dollars, from September 18, which analysts say pointed to a need to abandon the US dollar peg the central bank has been maintaining, at least temporarily.

By Tuesday T-bill holdings had risen to 19 billion rupees from near zero levels a month ago indicating a reserve outflow of more than 175 million US dollars.

A float is needed to avoid further injections of money via domestic asset purchases.

Such injections can worsen pressure on the currency by administratively reversing a reduction of loanable reserves in the banking system which should be a natural result of an outflow of capital from the country in the context of maintaining a pegged exchange rate system.