Sri Lanka's exchange rate has started to depreciate faster despite the Central Bank using its reserves to defend the currency. From November 2003 the Sri Lanka rupee fell rapidly as government fiscal discipline slipped and dollar inflows slowed.
The fall accelerated after April 2004 as the Central Bank printed billions of rupees to finance subsidies on imported goods such as oil.
Low interest rates maintained by the Central Bank promoted credit growth, which put further pressure on the exchange rate.
But with the tsunami the domestic currency received a sudden boost.
The rupee jumped from 105 to the dollar to about 98 and later stabilized around 99.
With domestic inflation at about 18 percent by the year-end, this sudden strengthening made the currency over-valued by some 5 percent.
Some critics say the government and Central Bank used the overvalued rupee as a short term fix to stabilize inflation, without treating the basic causes, which were weak fiscal policies and loose monetary policy.
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Though the government cut some of the subsidies, and the Central Bank curbed its money printing activities, analysts say monetary policies continued to remain loose.
The fiscal side also remained weak with revenues falling short, as predicted by most independent analysts and the International Monetary Fund (IMF) when the budget was announced in November 2004.
The IMF continued to call for more prudent monetary policy measures and additional revenues to bridge the deficit.
By May the Central Bank was a net seller in the forex market as the forex flows slowed and import demand picked up.
In June it was selling more dollars to defend the currency.
Central Bank has only released reserve numbers for May.
From April to July the rupee depreciated by about 50 cents.
But in the last month the rupee has depreciated about 50 cents against the dollar.
In a notice released on Wednesday, the IMF executive directors warned the Central Bank not try to defend the currency against fundamentals.
The IMF also called on the Central Bank to curb inflation and stop creating additional poverty.
Some of the directors also called for more independence of the Central Bank to conduct monetary policy.
Critics have charged that starting from 2004, the Central Bank had been reduced to "a money printing inflation machine," which has worsened poverty in the country by undermining the incomes of the poor, who have the least protection against inflation.
-LBR Newsdesk: LBOEmail@vanguardlk.com