By Hema Senanayake –

Hema Senanayake

The rupee is depreciating fast. This has been happening for a while now. Former governor of the central bank Ajith Nivard Cabraal squarely blamed the “Good-governance Government” and the Central Bank for rupee depreciation. His article on this subject titled “Government and CB have abdicated vital statutory duty by not being able to deal with rupee depreciation” has been published in a few newspapers on 08^th and 09^th October 2018, just 18 days prior to the beginning of constitutional crisis. On October 11^th, the Central Bank issued a communique to the media insisting that Cabraal’s article was misleading. To my mind Cabraal’s article was misleading and the CB’s response too, is misleading, in the sense that both arguments would not stabilize the rupee putting the macroeconomic fundamentals in good shape.

Cabraal had in his article argued that, “during the nine years from 2006 to 2014, the Central Bank successfully intervened in the Forex market (in accordance with its statutory duty) with a net supply of Forex of $ 2,283m, while simultaneously building-up its Reserves by a substantial $ 5,473m. By doing so, the Central Bank was able to limit the depreciation of the rupee to a manageable 2.8% per year over the nine years 2006 to 2014; by far the lowest average depreciation since 1977.” These statistics are true. His argument is that during his period as the governor of CB, the interventions made in the Forex market by way of supplying and absorbing foreign exchange to and from the market, he and Rajapaksa regime were able to limit the rupee depreciation for 2.8% per year. This is what is false and misleading. We will discuss it later.

On the contrary CB argues, that they too, intervene in the Forex market initially under Good-governance government and has given it up now. I quote; “…during 2011, 2012, 2015 and 2016, the Central Bank has supplied to the market US dollars 3,184 million, US dollars 1,797 million, US dollars 3,429 million and US dollars 1,900 million, respectively, on a gross basis. In spite of these interventions, the rupee depreciated by 10.4 per cent in 2012 and 9.0 per cent in 2015.” This is interesting. CB concludes that interventions in Forex market did not help in stabilizing rupee in 2012 and 2015. So, the CB has changed the course.

CB argues that, “… the Central Bank has increasingly realized that efforts to artificially stabilize the exchange rate extensively by supplying foreign exchange out of its official international reserves have only worsened Sri Lanka’s macroeconomic conditions and medium-term prospects. Propping up the exchange rate through intervention makes imports artificially cheaper, contributing to a continued widening of the trade deficit and leaving the country vulnerable to exogeneous shocks. Moreover, the loss of reserves due to such intervention has been replenished mostly by commercial borrowing including the issuance of International Sovereign Bonds.” In general, all points are valid but useless in practical sense because free float of rupee will not strengthen macroeconomic conditions instead improved macroeconomic conditions would strengthen the rupee.

Let us continue with the CB’s argument further. It argues that, there are a few more factors that affect to the recent depreciation of rupee. Those are, (1) reduction in foreign investment inflows to the government securities market, (2) increased foreign currency debt service obligations of the government, (3) favorable global market conditions prevailed previously during periods of quantitative easing by major economies have now been reversed. 

Finally, justifying recent rupee depreciation, CB points out that most international currencies have depreciated against US dollar in 2018, for example Indian rupee depreciated 13 per cent, Indonesian rupiah depreciated 10.8 per cent, Australian dollar depreciated 9.4 per cent where as Sri Lankan rupee depreciated 10.1 per cent. However, missing point is that Indian currency depreciated by 5 per cent in 2015 while Sri Lankan rupee depreciated by 9.0 per cent and in addition it has further depreciated by 10.1 per cent in 2018 too. Also, some countries allow their currencies to depreciate due to various reasons such as to reduce capital outflow, to increase international competitiveness, to support (accidental) reflation etc. Hence comparing data out-of-context is not scholarly. In fact, this is what both CB and Cabraal did in their arguments. What the country need is a solution, not fake arguments.

Let me ask a fairly simple question. CB and Cabraal have agreed that in 2012 and in 2015 in spite of heavy intervention made in supplying foreign exchange to the market, the rupee depreciated 10.4 per cent and 9.0 per cent respectively. Why? We did not find any convincing answer to this question from CB’s response or in Cabraals article other than CB concluding that intervention in Forex market would not stabilize rupee. 

Now, in 2015, I pointed out that if the new government wanted to increase the salaries by Rs. 10,000/=, then the CB had to reduce the domestic credit growth, so that increased salaries would not badly affect to the country’s current account. If the CB, operates with a macroeconomic view, this was what they should have done. In the year 2014, the credit growth to private sector was 8.8 per cent and in 2015 the credit growth to private sector amounted to 25.1 per cent. In 2015 rupee depreciated by 9.0 per cent. This was the primary causal effect to depreciate the rupee in 2015 and this parameter has nothing to do with the reasons mentioned by the CB.

The same point is true in 2012 under Rajapaksa regime when Cabraal was the governor of the CB. In 2011 and till the end of first quarter of 2012, the credit growth to private sector was approximately 34%. In 2012 the rupee depreciated by 10.4 per cent. 

In fact, the point of truth is that, CB does not have an effective policy tool regulating the domestic credit growth while maintaining the stable rate of interest and regulating market liquidity. In such a circumstance talking about macroeconomic view or intervention in Forex market are both useless. Unfortunate for our country, the government is not ready to listen to those who are outside the establishment.