'[T]he recent depreciation of the Sri Lanka Rupee, which seems to be a reaction of forex dealers adjusting to the more vibrant market driven policy framework, would appear to be a temporary overshooting of the realistic level," the Central Bank said.
The Central Bank said policy rates have been raised, a credit ceiling imposed and energy prices adjusted.
The rupee fell steeply over several days after the Central Bank stopped interventions as nervous importers bought dollars and pre-paid creating a stronger than normal demand for dollars.
Exporters were also not selling actively.
Analysts say in previous occasions also the exchange rate has tended to overshoot in the first few days when interventions were stopped.
The full statement is reproduced below
As has been announced from time to time, the Central Bank has been intervening in the domestic forex market in recent years to build up foreign reserves and to smooth out any undue fluctuations in the exchange rate. Such interventions resulted in the build up of foreign reserves to a historically high level of US dollars 8.2 billion by August 2011, thereby preventing an excessive appreciation of the rupee. However, during the second half of 2011, the widened trade deficit underpinned mainly by the sharp increase in import expenditure necessitated the Central Bank to supply foreign exchange to meet a part of such increased demand, despite increased receipts on account of remittances, tourism and inflows to the capital and Financial Account.
Although the Central Bank expected this import demand to decelerate towards the latter part of 2011 due to the uncertain global conditions, such a moderation did not take place and therefore, on 3rd February 2012, the following policy measures were introduced to strengthen the external sector of the economy, and to contain the high growth in bank credit:
first, an increase in the policy interest rates by 50 basis points with effect from 3rd February 2012, so that the resultant increase in borrowing cost would restrain credit growth leading to the reduction of import demand;
and second, a Central Bank direction to commercial banks to limit their credit expansion in 2012 to 18 per cent [23 per cent if 5 per cent of funds could be raised from abroad] as compared to the 2011 increase of 34 per cent, with a view to effectively reduce the quantity of credit granted.
At the same time, in view of increased oil prices in the international market, the government has also decided to increase the domestic prices of petroleum products with effect from 12th February 2012. Such policy action would encourage energy conservation and help reduce the use of oil products, thereby reducing the expenditure of imports further. In addition, several expected inflows to the Financial Account of the Balance of Payments in 2012, as set out in the Central Bank’s ‘Road Map for 2012 and beyond’, are now at varied stages of realisation and such inflows are expected to augment inflows during 2012.
In this background, with effect from 10th February 2012, the Central Bank decided to limit its intervention in the forex market, so as to limit the supply of foreign exchange to the extent needed to settle the bulk of petroleum import bills, and to absorb surplus forex liquidity that would flow into the market from various sources including the issue of Tier-2 capital by banks, inflows to equity and bond markets etc., that may otherwise lead to the undue appreciation of the rupee.
In light of the above measures and actions, the Central Bank has projected that the Balance of Payments in 2012 would record a comfortable surplus and such a surplus would serve to ease any pressure on the forex market. In that context, the recent depreciation of the Sri Lanka Rupee, which seems to be a reaction of forex dealers adjusting to the more vibrant market driven policy framework, would appear to be a temporary overshooting of the realistic level.