Feb 10, 2012 (LBO) – A decision by the Sri Lanka’s central bank to allow the exchange rate to move more in line with its monetary policy has been welcomed by the International Monetary Fund. “We welcome the move toward greater exchange rate flexibility announced today,” IMF resident representative Koshy Mathai said.
“This step, supported by a firm monetary and fiscal policy stance, should help to reduce the trade deficit and safeguard reserves at the central bank.”
A rupee peg with the US dollar came under pressure from strong credit growth in mid 2011, with a sudden spike in borrowings by the state and state enterprises adding on to already strong borrowings by private citizens.
From September the rupee came under further pressure from liquidity injected to sterilize interventions, which added fresh reserves for banks to lend and pushing up credit growth further.
On Thursday the Central Bank removed its intervention band allowed the rupee to float more freely, though Governor Nivard Cabraal said the monetary authority may continue to supply dollars to meet large oil bills up to some level.
“We are going to intervene with quantity. It will not be based on the price,” Governor Cabraal said.
“We will supply a part of the oil bills as our interventions. The rest of the market will be determined by its mechanism.”
The rupee weakened to around 115.70 from 114.30 against the US dollar in the spot market before recovering to close at 115.20/30 levels.
Analysts say if a clean float is firmly established in the coming days, Sri Lanka’s monetary (interest rates) and exchange rate policies will become complementary allowing the forex markets to settle. Interest rates can also stabilize.
Last Friday the Central Bank raised interest rates by 50 basis points to 9.0 percent and asked banks to slow loan growth to 18 percent in 2012 from over 34 percent in 2011.
Thought the peg was lowered earlier, interventions continued as the exchange rate was not allowed to float cleanly.