Sri Lanka central bank to allow dollar peg to move

Oct 30, 2008 (LBO) - Sri Lanka's central bank said it was allowing 'greater flexibility' in foreign exchange markets signaling a depreciation in the rupee that can break a dangerous sterilized intervention cycle in forex markets and bring stability back to the monetary system.

In the meantime, in order to ensure the financial market stability, the Central Bank stands ready to provide liquidity to maintain stability of the exchange rate if the rate tends to be more volatile than warranted.

Further, as in the recent past, the Central Bank will continue to monitor the developments carefully and respond promptly with timely interventions in order to ensure economic stability, and to mitigate the impact of any external shocks arising from turbulence in global financial markets. The full statement is reproduced below:

Central Bank allows greater flexibility in the exchange rate to improve competitiveness

Considering the recent sharp decline in export prices, prospects of lower export demand due to a likelihood of further slowing down in the global economy and the recent sharp appreciation of the US dollar against most major international currencies, the Central Bank of Sri Lanka has decided to allow the rupee exchange rate against the US dollar to respond with greater flexibility, when compared to the very stable level that was maintained during the recent past.

This move is particularly necessitated by the fact that the currencies of some of Sri Lanka’s major trading partners and competitors have, since mid September 2008, depreciated sharply against the US dollar leading to some pressure on the competiveness of Sri Lanka’s exports.

While Sri Lanka’s export sector has been growing well above 12 per cent during the first eight months of 2008, and has shown commendable resilience in the light of the current unfavourable global conditions, it is now considered desirable that an added support be granted in order to provide the impetus for the exports to remain competitive in the months ahead.

At the same time, the Central Bank of Sri Lanka recognizes the vital importance of maintaining stability of the financial markets, in both the foreign exchange and rupee markets, even in the face of the current global financial crisis.

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.

As a result, the export sector could continue to perform well in the future while of course taking the necessary measures to improve their productivity and cost effectiveness in order to further enhance their competitiveness in global markets.

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.

In addition, the move will help to contain inflation in the medium term, since there would be a lesser likelihood of higher fiscal deficits in the medium to longer term, as this measure may reduce the need to provide fiscal subsidies to the export sector.
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