Sri Lanka exchange rate defence seen as unsustainable

Dec 08, 2008 (LBO) – Sri Lanka’s government cannot afford to defend the rupee peg against the dollar at unsustainable levels, a senior aid agency official said the same day authorities let the rupee move down marginally against the US dollar. To receive instant alerts from LBO on your Dialog mobile type ‘lbo’ and send to 678

Asian Development Bank’s Sri Lanka country director Richard Vokes said the island’s foreign exchange reserves now cover less than three months of imports.

Unsustainable

“You can’t afford to keep the exchange rate at unsustainable levels,” Vokes said.

“But a sustainable level depends on the trade side and capital flows. So it is the external side that must be monitored closely.”

The exchange rate has already been allowed to depreciate somewhat, Vokes told a news conference Monday, referring to last month’s depreciation of the rupee against the dollar from 108 to 110 rupees.

“They (the government) are going to have to continue to monitor that closely in the light of developments on the external side.”

The news conference was held to mark the ADB’s 40th year of operations in Sri Lanka.

The remarks by Vokes came the same day the central bank eased up on its defence of the rupee and allowed a de facto peg with the US dollar to move 30 cents to 110.30 rupees.

“The main risks for Sri Lanka come from the external side and balance of payments,” said Vokes.

But he said it is difficult to predict what will happen as oil is now down to 45 dollars, a huge positive for Sri Lanka, and remittances are holding out.

Sterilized Intervention

Economists have said the Sri Lanka rupee is under heavy pressure from sterilized intervention activities of the central bank even as the country’s oil bill is falling steeply.

The country’s foreign reserves were down to 2.6 billion dollars by October 24.

The foreign exchange intervention figures for November which was due last week were not released.

Opposition lawmakers have said reserves are below 2.0 billion dollars.

The Central Bank’s treasury bill stock which represents the amount of liquidity injected to cover foreign reserve losses rose to 111 billion rupees on Friday from almost nothing in mid September when intervention began.

The monetary authority has also cut the reserve ratio twice, injecting 24 billion rupees more into the system.

During this time the monetary base has fallen only about 10 billion rupees.

To break the cycle of intervention and sterilization, the rupee has to be ‘floated’, economists have said.

Remittances sent back by large numbers of Sri Lankans employed in the Middle East, mainly as unskilled labourers and housemaids, are a key source of foreign exchange earnings for the island and help to shore up the balance of payments.

Vokes said the ADB was looking at how changes in remittances would affect countries which depend on them like Sri Lanka, Nepal and the Philippines.

Slowdown

The economy has been boosted by remittance from Sri Lankans employed abroad.

“But how well they will hold out is hard to say as a lot comes from the Middle East. Will they be affected and how?”

Vokes said Sri Lanka’s exports had also begun to slow down with recession in key Western economies.

“Exports are clearly going to go down but the apparel sector also has a very high import content so imports will go down,” Vokes said.

“We certainly expect some stresses and strains on the external account but how far depends on how things play out,” Vokes said.

“At some point oil prices will rise again but the government has put in place its own plans. The 2009 budget is based on much higher oil prices.”

Vokes also said it was now more difficult for the government to borrow at commercial rates in global credit markets because of the financial crisis and reluctance of banks to lend.

“It’s going to be difficult for the government to borrow commercially in the current environment.”