Sri Lanka’s Central Bank not unduly worried about weak exchange rate

November 02, 2006 (LBO) - Sri Lankan rupee briefly sank to a lifetime low on Wednesday, but the Central Bank says they are not worried about it, despite regularly pumping 390 million dollars to defend the currency. "Public enemy no: 1 is inflation," says deputy governor W A Wijewardena. "Its like people have a good party, spending lots of money and the Central Bank intervenes and withdraw the punch bowl. One of the Central Bank’s role is price stability, and we need to keep inflation in check through price stability." The Central Bank has been playing a game of tug-of-war with foreign exchange traders, intervening in the currency markets, selling dollars to prop up the rupee against the U.S. dollar.

The bank even warned traders not to ‘excessively’ speculate on the currency, bringing in restrictions to limit non-essential imports.

The rupee briefly touched 108.05 to the U.S. dollar in trade on Wednesday, before climbing back to close at 107.91 as import demand for dollars to cover fairly large trade bills outweighed exporter sales and profit taking by banks, dealers said.

The rupee, down about 5.2 percent against the dollar this year, is struggling to retain its footing, in the absence of Central Bank intervention, and dealers say the currency may sink further in the run up to the festive weeks amidst dollar buying by the government buys to pay for oil import bills.

“Our exchange rate is free to move,” says Central Bank Governor Nivard Cabraal. “But we step in to smoothen the volatility at various times by selling dollars.”

From Jan-Oct, the bank has sold 390 million dollars from its stockpile of cash reserves to artificially keep the currency at around 105.00 levels to the greenback.

“Its nothing new to defend the currency, Central Bank’s do it all over the world. In 2004 we sold 570 million dollars, while in 2005 we sold 200 million dollars to defend the rupee,” Cabraal told bankers and businessmen during a presentation late Wednesday.

“We are not looking at a comfortable exchange rate anymore,” the bank’s Assistant Governor H N Thenuwara said. “We are looking at the reserve level.”

Sri Lanka’s net international reserves are due to rise to 2.5 billion dollars (sufficient to cover 3-months of import bills) by end 2006, from 2.115 billion dollars as at Oct. 27, 2006, the Central Bank said.

“The demand for dollars to make oil payments are showing on the exchange market,'' Cabraal said. “We need to ensure that the balance of trade is more healthy so that the tension on the rupee will lessen. To that effect we are pushing avenues to increase our earnings from worker remittances and encourage exporters to covert their dollar proceeds.”

Cabraal said the government is not working on hedging future oil shipments after historically high crude prices will push the island’s year end oil bill to 2.186 billion dollars.

“Hedging will help us to weather the shocks, as well as help businessmen to forecast their running costs,” he said.

Balancing Act

Sri Lanka’s trade deficit extended 28 percent to 260 million dollars for the eight months to August, as a hefty 994 million dollar import bill outweighed gains of 734 million dollars worth of export earnings.

“Our merchandise trade gap is now partly financed by high inflows of worker remittances and earnings from shipping services, telecommunications and IT, the hospitality sector,” explains Thenuwara.

Worker remittances have gone up 23 percent to 1.727 billion dollars from Jan-Sept, while proceeds from foreign investment into telecom, IT, textile and clothing sector have brought in just over 300 million dollars.

“We are also now allowing overseas investors to buy rupee-denominated government bonds for the first time starting today. That together with other net foreign inflows will help us achieve a balance of payment surplus of between 150-200 million dollars by year-end,” Thenuwara said.

Galloping Inflation

However, the bank says ‘unusual’ lending to the private sector is fuelling inflation growth in this 24 billion dollar economy, hinting they may lift policy rates for the fourth time.

Consumer prices rose to 17.2 percent in October from 15.4 percent in September, the Census & Statistics Dept said, after hitting a high of 17.7 percent in June.

“Credit growth is still high and we are looking at how to bring it down. We are trying to control credit-driven inflation,” Thenuwara said referring to private sector credit that has expanded to 23 percent so far this year.

The repurchase rate, at which the bank lends to commercial banks, is at a 3 ½ year high of 9.625 percent and market player expect the bank to hike it by another 50 basis points when policy rates announcement comes out on Nov. 14.

Despite interest rates being one of the highest in Asia, Sri Lankan companies are on a borrowing spree for investment, working capital. Economists say private consumption is also high because interest rates are now below inflation.

“Government borrowing and rapid growth in private-sector credit have also contributed to excessive broad money growth,” Cabraal said.