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The rupee closed at Rs. 113.88/90 against the dollar yesterday after the government announced in the 2012 Budget the previous day that the currency would be depreciated by three percent. Dealers said there was some uncertainty in the morning before the Central Bank stepped into issue the new trading band which was Rs. 113/90.
There was little confusion in the market but the Central Bank issued the adjusted trading band. The rupee depreciated and closed at Rs. 113.88/90, but import demand was still high and the Central Bank was intervening in the market, selling dollars to keep the exchange rate stable, dealer said.
While the market believed a depreciation of the rupee against the dollar was long overdue, the manner in which it happened left it concerned.
"We are moving back to a controlled exchange rate regime where the state decides the best rate of exchange and not the market, and this is the downside, because the credibility of the Central Bank has been compromised by the government," a dealer said.
However, he went on to say a one-off adjustment was preferable to a gradual depreciation because it did not lead exporters to book forward in a state of panic and uncertainty. "But this should have been done by the Central Bank," he said.
A country’s monetary policy must be independent of the fiscal policy for macroeconomic stability. This also provides credibility and assurance to investors.
The Central Bank has always been perceived as not being totally independent, but the President’s announcement in the 2012 Budget to devalue the rupee with immediate affect, also showed the Central Bank had no say in the exchange rate policy, of which it had the sole purview.
Dealers said the announcement not only surprised the market, but also the Central Bank.
The country’s macroeconomic stability had been pressurised due to the exchange rate policy followed by the Central Bank. The Institute of Policy Studies strongly argued in favour of a more flexible exchange rate as the best option. Several economists too highlighted the need to allow the rupee to depreciate in the face of severe import demand. The exchange rate policy was also a contentious issue with IMF.
Dealers said that the Central Bank had been ‘adamant’ that the rupee would appreciate in the short term and the market accepted this stance.
"The Central Bank’s credibility was destroyed by the Treasury. Of course, the depreciation was the right move, but the manner in which it was done would raise severe credibility issues for the country," a dealer said.
The Island Financial Review contacted Central Bank Governor Ajith Nivard Cabraal but he was unavailable.
Dealers said that once the exchange rate was readjusted it was business as usual.
The market had always appreciated Central Bank intervention to keep the exchange rate stable, but inflexibility has always been an issue.
When the rupee appreciate nearly 3 percent in 2010 and was expected to appreciate further this year, the Central Bank had been absorbing the dollars into reserves. Analysts said the inflows, which were mostly short term was running the risk of turning into a Dutch Diesis, where short term foreign investors benefit at the expense of exporters. When depreciation pressure set in half way through this year on growing importer demand, the Central Bank did not allow any movement.
The depreciation of the rupee was a long felt need and many had championed the cause, despite government backers using the nationalistic card to silence them.
"When foreign inflows were strong the Central Bank allowed some appreciation and intervened in the market to prevent a sharp gain, but when there is pressure to depreciate it is not allowed to do so at all," Dr. Saman Kelegama, Executive Director of the Institute of Policy Studies recently said addressing the annual sessions of the Sri Lanka Economic Association last month.
Cheap credit and increasing commodity prices have resulted in a sharp expansion of the current account deficit of the balance of payments (BOP).
The current account deficit of the BOP which was 4 percent of GDP during the first quarter of this year has increased to 7 percent of GDP by the end of the second quarter. This is because imports have exceeded exports despite the attractive growth of some exports during the first half of 2011. Two reasons among several for imports to sharply increase is the increases in prices of commodities such as oil and cheap domestic credit financing imports," Dr. Kelegama had said.
Dr. Kelegama said the present exchange rate policy had to be revisited because non-reserves and export competitiveness were on the decline.
Amidst large capital inflows it is difficult to manage exchange rates due to pressures for an appreciation of the rupee. Since 2010, there have been high levels of capital inflows to the country due to low interest rates in the West. With ten percent of issued government securities open to foreign investment, IMF installment funds and commercial borrowing proceeds such as the US$ 1 billion Eurobond, took the country’s official reserves beyond US$ 8 billion.
"However, non-borrowed reserves are not strong, although the overall reserves are high, with a major component of the reserves made up with debt. Our own earnings from exports and tourism are low. This is mainly due to the appreciated exchange rate. Exchange rate management needs more flexibility downwards, for depreciation, which is now restricted by sales of foreign currency in the market to defend the existing rate," he said.
Dr. Kelegama said the government had three policy options to reverse this trend.
The option is to appreciate the currency. This would discourage imports and encourage exports.
The second option is to increase policy interest rates, thereby raising rates across the board which would reduce demand for credit to pay for imports.
The third option is to increase taxes on imports.
"The first option is the most affective, but being politically sensitive, the last two options may be considered instead," Dr. Kelegama said.
He went on to suggest that Sri Lanka needed to boost its external trade with policy that would improve export earnings, thereby building reserves without a too heavy debt component.
He said export earnings amounted to 25 percent of GDP in 1990 and has declined gradually to 16 percent of GDP in 2010.
http://island.lk/index.php?page_cat=article-details&page=article-details&code_title=39590
There was little confusion in the market but the Central Bank issued the adjusted trading band. The rupee depreciated and closed at Rs. 113.88/90, but import demand was still high and the Central Bank was intervening in the market, selling dollars to keep the exchange rate stable, dealer said.
While the market believed a depreciation of the rupee against the dollar was long overdue, the manner in which it happened left it concerned.
"We are moving back to a controlled exchange rate regime where the state decides the best rate of exchange and not the market, and this is the downside, because the credibility of the Central Bank has been compromised by the government," a dealer said.
However, he went on to say a one-off adjustment was preferable to a gradual depreciation because it did not lead exporters to book forward in a state of panic and uncertainty. "But this should have been done by the Central Bank," he said.
A country’s monetary policy must be independent of the fiscal policy for macroeconomic stability. This also provides credibility and assurance to investors.
The Central Bank has always been perceived as not being totally independent, but the President’s announcement in the 2012 Budget to devalue the rupee with immediate affect, also showed the Central Bank had no say in the exchange rate policy, of which it had the sole purview.
Dealers said the announcement not only surprised the market, but also the Central Bank.
The country’s macroeconomic stability had been pressurised due to the exchange rate policy followed by the Central Bank. The Institute of Policy Studies strongly argued in favour of a more flexible exchange rate as the best option. Several economists too highlighted the need to allow the rupee to depreciate in the face of severe import demand. The exchange rate policy was also a contentious issue with IMF.
Dealers said that the Central Bank had been ‘adamant’ that the rupee would appreciate in the short term and the market accepted this stance.
"The Central Bank’s credibility was destroyed by the Treasury. Of course, the depreciation was the right move, but the manner in which it was done would raise severe credibility issues for the country," a dealer said.
The Island Financial Review contacted Central Bank Governor Ajith Nivard Cabraal but he was unavailable.
Dealers said that once the exchange rate was readjusted it was business as usual.
The market had always appreciated Central Bank intervention to keep the exchange rate stable, but inflexibility has always been an issue.
When the rupee appreciate nearly 3 percent in 2010 and was expected to appreciate further this year, the Central Bank had been absorbing the dollars into reserves. Analysts said the inflows, which were mostly short term was running the risk of turning into a Dutch Diesis, where short term foreign investors benefit at the expense of exporters. When depreciation pressure set in half way through this year on growing importer demand, the Central Bank did not allow any movement.
The depreciation of the rupee was a long felt need and many had championed the cause, despite government backers using the nationalistic card to silence them.
"When foreign inflows were strong the Central Bank allowed some appreciation and intervened in the market to prevent a sharp gain, but when there is pressure to depreciate it is not allowed to do so at all," Dr. Saman Kelegama, Executive Director of the Institute of Policy Studies recently said addressing the annual sessions of the Sri Lanka Economic Association last month.
Cheap credit and increasing commodity prices have resulted in a sharp expansion of the current account deficit of the balance of payments (BOP).
The current account deficit of the BOP which was 4 percent of GDP during the first quarter of this year has increased to 7 percent of GDP by the end of the second quarter. This is because imports have exceeded exports despite the attractive growth of some exports during the first half of 2011. Two reasons among several for imports to sharply increase is the increases in prices of commodities such as oil and cheap domestic credit financing imports," Dr. Kelegama had said.
Dr. Kelegama said the present exchange rate policy had to be revisited because non-reserves and export competitiveness were on the decline.
Amidst large capital inflows it is difficult to manage exchange rates due to pressures for an appreciation of the rupee. Since 2010, there have been high levels of capital inflows to the country due to low interest rates in the West. With ten percent of issued government securities open to foreign investment, IMF installment funds and commercial borrowing proceeds such as the US$ 1 billion Eurobond, took the country’s official reserves beyond US$ 8 billion.
"However, non-borrowed reserves are not strong, although the overall reserves are high, with a major component of the reserves made up with debt. Our own earnings from exports and tourism are low. This is mainly due to the appreciated exchange rate. Exchange rate management needs more flexibility downwards, for depreciation, which is now restricted by sales of foreign currency in the market to defend the existing rate," he said.
Dr. Kelegama said the government had three policy options to reverse this trend.
The option is to appreciate the currency. This would discourage imports and encourage exports.
The second option is to increase policy interest rates, thereby raising rates across the board which would reduce demand for credit to pay for imports.
The third option is to increase taxes on imports.
"The first option is the most affective, but being politically sensitive, the last two options may be considered instead," Dr. Kelegama said.
He went on to suggest that Sri Lanka needed to boost its external trade with policy that would improve export earnings, thereby building reserves without a too heavy debt component.
He said export earnings amounted to 25 percent of GDP in 1990 and has declined gradually to 16 percent of GDP in 2010.
http://island.lk/index.php?page_cat=article-details&page=article-details&code_title=39590
