Sri Lanka central bank talks up the rupee

August 31, 2007 (LBO) – Sri Lanka’s central bank is talking up the rupee saying a one percent fall in the currency during the past two weeks is ‘unwarranted’ because exports are strong, imports weak and remittances are flowing in. The comments came after the spot dollar broke the 113.00 rupee barrier this week and the Central Bank says the rupee had fallen 0.99 percent against the dollar from August 16 to August 29.

Good Backing

In the first half of the year export earnings have grown 12.9 percent to 3,569 million dollars, and imports only 3.9 percent to 5,150 million dollars.

As a result the trade deficit has narrowed to 1,581 million dollars from 1,793 million dollars.

Meanwhile worker remittances had increased by 18 percent to 1,314 million financing 83 percent of the trade deficit. Foreign direct investment was 60 million dollars higher in the first six months of 2007 at 260 million dollars.

Financial flows to government had increased to 603 million dollars in the first half of 2007 to from 358 million US dollars last year.

At the end of July international reserves without the Asian Clearing Union balance was 2,681 million, 151 million dollars higher than the January figure. This was enough to finance three months of imports.

The real effective exchange rate (REER) on a 24 currency basket had depreciated 2.4 percent up to July indicating an improvement in external competitiveness.

Standard and Poor’s had also lifted the country’s sovereign rating outlook to ‘stable’ from ‘negative’ which the Central Bank says reflects the country’s favourable medium-term prospects.

“Based on strong economic fundamentals particularly in the external sector, the Central Bank is of the view that the depreciation of rupee that has taken place during the past two weeks is unwarranted,” the monetary authority said.

The bank says the fall of the Sri Lanka rupee against the US dollar in the last two weeks was “not based upon any fundamental macroeconomic factors.”

Why?

Despite a generally favourable external structure, economic analysts say the rupee came under pressure from an earlier attempt by the authorities to preserve a soft-pegged exchange rate after the balance of payments turned negative in May.

Critics have also pointed out that Sri Lanka’s international reserves had been mis-used in June to pay off state liabilities which had then been balanced out with an increase in liquid reserves in the domestic banking system delivering another shock to the monetary system.

Meanwhile mis-pricing of imported energy and other imported commodities like fertilizer is also adding to the problem.

However analysts also say that considering the volatility of stronger global currencies in recent weeks, including the US dollar, the Sri Lanka rupee adjustment after authorities stopped active intervention indicates that the fundamentals behind local the currency are favourable. A flexible currency that responds to short-term changes in the economy as well as long-term changes should be viewed positively rather than negatively as it will eventually strengthen economic fundamentals by preventing imbalances from building up.