Sri Lanka central bank says narrow trade gap is good for rupee

Sept 19, 2007 (LBO) – Sri Lanka’s central bank says a recent fall of the rupee is not in line with a narrowing of the trade gap, as the rupee dipped to a new low Wednesday but closed firmer.

The bank said exports have grown 15.8 percent and the trade gap had narrowed to 1,806 million dollars from January to July 2007 and the current account deficit had fallen to 478 million dollars from 786 million dollars up to June.

“These developments are expected to continue throughout 2007,” the Central Bank said.

“Hence the Central Bank is of the view that the currency depreciation is in excess of the path that is consistent with the strong external sector developments.”

The bank said reports suggesting that the exchange rate has been overvalued and needs further depreciation according to relative inflation of two countries or the principle of two-country purchasing power parity (PPP) were misleading.

“To work on the Purchasing Power Parity to assess the status of a currency, it is necessary to take into account the position of a currency with all its trading partners,” the Central Bank said.

“Hence, any conclusion drawn on the basis of only one trading partner is misleading and does not depict the actual picture.”

“It is only in simple economic textbooks that the PPP is analysed using only two countries as has been done by some analysts in the past few weeks.”

However economic analysts say the Central Bank should pay close attention to the parity with the US dollar due to the high dollar billings in Sri Lanka’s external trade, particularly exports.

The Central Bank says it computes Real Effective Exchange Rates (REER) for five major international currencies as well as a basket of 24 major trading partners.

“Based on the recent trade pattern among major trading partners, the PPP or (REER) has fallen below the 100 mark in 2007, implying that the nominal bilateral exchange rates have already depreciated beyond the parity level,” the Central Bank said.

“Furthermore, the behaviour of the exchange rate does not strictly follow the inflation differential.”

The rupee closed at 113.47/53 after falling to 113.65 in intra-day trading but later firmed to 113.38/48 after bankers met central bank officials.

State names were on the sell side in the morning, but were seen buying later in the day, dealers said. Dealers say there is exporter selling but somewhat intense importer demand.

Economic analysts have said earlier that the mis-pricing of imported energy and fertilizer is putting pressure on the currency and politicians need to be educated on economic fundamentals, to prevent avoidable overshoots of currency adjustments.

Updated