Sri Lanka forex markets search for direction after announcement

Oct 30, 2008 (LBO) – Sri Lanka’s forex markets and debt ran out of quotes as dealers searched for direction after the central bank said it was breaking a peg with the US dollar at 108.00 following prolonged intervention lasting over seven weeks. “We are not yet quoting a rate,” a dealer told LBO soon after the announcement.

Quotes in debt markets also dried up soon after, as dealers digested the latest policy direction of the monetary authority.

In the past Sri Lanka’s rupee had proved resilient and had stabilized with an initial fall soon after the central bank broke the peg, though there is a tendency for the rate to overshoot initially when a ‘float’ is started.

In August 2007, the central bank also broke the peg and floated the rupee and the market later stabilized.

Central Bank said it allowed the exchange rate to respond with ‘greater flexibility’ due to the slowing down of the global economy and a recent sharp appreciation in the US dollar.

Sri Lanka’s exporters have also complained that their competitiveness had been hurt.

“The envisaged limited depreciation is also timely since it will not adversely affect the declining trend in Sri Lanka’s inflation as global prices of petroleum, gas, wheat, sugar, milk powder, etc are declining and this trend is expected to continue during the next few months as well,” the Central Bank said.

“Therefore, as a measure of reducing pressure on the real sectors, the Central Bank would favour a limited depreciation of the Sri Lanka Rupee so as to enable the real sector to maintain Sri Lanka’s export competitiveness across all export and import competing industries.”
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Sri Lanka’s reserves fell to 2.6 billion dollars in mid-October due to currency defence, but analysts say a central bank that does not intervene in the market do not need any reserves to ensure economic stability.

In late 2000 Sri Lanka has had much lower levels of reserves, and after an initial fall, the rupee had stabilized.

An expatriate workforce remits large volumes of dollars to the country each month and together with export revenues, they are sufficient to meet import needs.

Imports also go up if there are capital inflows. Analysts say any decline in capital inflows is also unlikely to affect the exchange rate in the medium term, once the market settles, as imports will also moderate.