Sri Lanka spends US$587mn to prop up rupee in October

Nov 08, 2008 (LBO) – Sri Lanka has spent 587 million dollars to prop up the rupee in October, pushing the total to 790 million dollars over past two months, the latest official data showed. On Thursday and Friday the rupee strengthened against the 110 rupee peg maintained by the island’s central bank with credit restrictions slapped on international trade, beginning to bite.

The restrictions were brought soon after the rupee was allowed to fall from 108 to 110 rupees.

The penal interest premium of 10 percent slapped on export packing credit, forces exporters to sell dollars, while restrictions on forward dollar covering and import letters of credit also curbs dollar demand.

On Friday the rupee strengthened as much as 109.75, before dropping to 110.35 to the dollar in late trading.

The Central Bank raised deposits for import letter of credit to 100 percent and slapped penal rates on exporters.

The extra cash margins can take some of the pressure off the billions of liquidity pumped into the system in the past seven weeks – money printed to make up for rupees that go out of the banking system (liquidity shortfalls) from central bank dollar sales.

Analysts have warned that the process known as ‘sterilized intervention’ is a recipe for a currency crisis. In the past two days the t-bill stock has been stable, indicating that intervention volumes in the two days had declined.

The restrictions on international trade imposed by the central bank, as well as new import taxes slapped as part of revenue proposals in the 2009 budget Thursday is likely to curb international trade and impact economic growth this year and in the next.

During the 2000/2001 crisis, similar trade restrictions (including a 10 percent surcharge on imports) pushed the country into its first economic contraction in its post independence history.

Sri Lanka’s foreign reserves were down to 2.6 billion dollars in late October on official data, from 3.5 billion two months ago.

More money was spent on intervention since then, with foreign hot money brought into plug the island’s budget deficit pulling out.