23 October, 2020

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Government Set Policies For Another Rupee Crisis

By Hema Senanayake –

Hema Senanayake

The Exchange Control Department has issued a press release on June 12, 2013. The objective of the press release was to relax foreign exchange regulations. The press release justified the relaxation of regulations and says “During the past few years, Sri Lanka’s macroeconomic fundamentals have improved and the domestic financial sector has become stronger and more resilient.” This was the learned conclusion of the Exchange Control Department (ECD).

Within one week of the said press release, it has been proved that the “learned observation” of the ECD was grossly wrong. Within days after the press release the rupee depreciated quickly; the selling rate of U.S. dollar hit Rs. 130 on some days. However, exporters wanted to take the advantage quickly and they began to exchange part of their dollars to rupees which helped to stabilize the rupee a few days later.

However the rupee will never gain the value it had on the day of the said press release of ECD. Why? Forget about the appreciation of rupee, even significant depreciation cannot be stopped, at least, due to two reasons if the government fails to borrow in USD.

Firstly, by issuing the above said press release the ECD relaxed a number of regulations to facilitate the outflow of foreign exchange or if I simply put that it enables to take dollars out of the country easily than before. The result was that it increased the demand for U.S. dollars quickly. According to the basic rule of demand and supply, if the demand for dollar could have been supplied, the rupee would not have to be depreciated. The rupee depreciates when the economic system cannot meet the demand for dollars in medium term –And, medium term consists with a few short term time periods.

From the same press release, the ECD says, “…the domestic financial sector has become stronger and more resilient.”  It has been accepted that the rupee should depreciate gradually but if the depreciation that needs to take place with the span of one year took place in one week then that shows not the strength and resilient nature of the domestic financial sector but the exact opposite of it.

The Central Bank of Sri Lanka (CBSL) and the Treasury must take good care about the stability of the domestic currency than they do now. This is very important to ensure the economic growth and also very important to the average consumer of the country. Why the stability of the rupee is important to the common man? For an example the rapid depreciation of rupee means that you pay increasing prices for your gasoline when the fuel prices in the global market are falling, period.

ECD says that “during the past few years, Sri Lanka’s macroeconomic fundamentals have improved …” On the contrary, what we saw was a massive depreciation of the rupee in the second quarter of 2012. In January of 2012, the price of one U.S. dollars was roughly Rs. 110; but in the second quarter the selling price of U.S. dollar peaked to Rs. 135. This situation shocked the entire business community and the government. If the macroeconomic fundamentals have improved during past few years as observed by ECD, how such a massive plunge in the rupee could have had happened just 12 months ago.

I have nothing to offer as an advice to this useless rhetoric of the governmental institutions/ departments which are responsible in executing monetary and fiscal policies rather than quoting Minister DEW Gunasekera. He opined “the SLFP-led alliance could become a victim of its own propaganda unless tough corrective measures were taken instead of boasting of unprecedented growth in the post-war era. The country is in peril due to economic mismanagement rather than international conspiracy.” (The Island, May 11, 2013).

The rupee crisis that took place in the middle of the last year destroyed the expectations of achieving higher growth rate over 8% GDP. In order to contain the currency depreciation, amongst other measures it was required to reduce credit growth (issue of loans) drastically. As a result finally the achieved GDP figure was 6.3%; this even looks great but in compared to the forecasts issued by the CBSL, it was a significant failure.

So, forget about the improved macroeconomic fundamentals during past few years, yet it seemed that some improvement had taken place during the past few months. This appears so not due to any improvement in the macroeconomic fundamentals but due to the continuing containment of private sector credit growth that effected during the last year’s rupee crisis. But there is a negative effect when you contain the credit growth; that is you are going to miss the GDP growth target this year too.

This may be the reason for the recent reduction of interest rates by CBSL and for the reduction of what is known as Statutory Reserve Ratio. Both measures will encourage lending or in other words will help to increase private sector credit growth. The effect of the reduction of Statutory Reserve Ratio by 2% is significant at this point of time. It has been reported that this action will increase the money that remain in commercial banks by around 35 to 40 billion rupees. In the event banks can create new credit, roughly amounting to ten times of this amount under the banking practice of Fractional Reserve Banking which is the core banking practice in Sri Lanka too.

Within weeks after the reduction of Statutory Reserve Ratio, financial dealers now think that already about Rs. 35 billion is in excess liquidity in the financial market. Excess rupee liquidity creates more demand for dollars and if enough dollars are not in circulation the rupee should keep on depreciating. If the market is already in excess rupee liquidity then imagine what would happen if the banks create additional 350 to 400 billion rupees by granting loans. In months to come there will be an increasing demand for dollars which has the potential to create another rupee crisis for this year too. This is the second reason for my conclusion that significant depreciation of rupee cannot be stopped; if the government could not borrow in dollars directly or indirectly. The real mismanagement of the economy started when the government presented its budget for 2013 from which the government drastically and willfully proposed to reduce foreign borrowing to a level that is not practically feasible.

I do not wish to advise the government to borrow in dollars but that is the only option when the entrepreneurs’ sentiment is not so great so as to increase the inflow of non-credit based dollars through exports, foreign direct investments and tourism etc. One exporter recently opined that he wished to keep his extra funds outside the country. He knows that the interest payment is fairly higher in Sri Lankan banks for dollar savings. Then why he prefers to keep extra dollar funds outside Sri Lanka? May be entrepreneurs have succumbed to an unexplainable uncertainty perhaps after the CBSL unlawfully revealed the bank account details of former Chief Justice  and perhaps after the alleged kidnapping and killing of Muslim businessman Shyam for money orchestrated by a senior law enforcement officer. The general feeling of the business community is that anybody could be framed if the authorities wanted to do so. Perhaps they take precautions in keeping dollars outside the country.

Accordingly the government has not only set the necessary policies such as proposing to reduce foreign borrowing by the budget, relaxing exchange control regulations and reducing the Statutory Reserve Ratio etc., but also has created the unpleasant sentiment among business community for another rupee crisis. That would happen when the demand for credit increases; perhaps within a few months.

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Latest comments

  • 0
    0

    How long can the real value of the SLR be kept under artificial
    control? The business community fears the bottom has to fall out
    sooner than later and wonders if the generous relaxation of Exchange Control rules seen in recent weeks has anything to do with cronies
    engaging in a the flight of capital of their ill-earned lucre – before the inevitable crash occurs.

    Senguttuvan

    • 0
      0

      You hit it on the head. That was my take too.

  • 0
    0

    How long can the real value of the SLR be kept under artificial
    control? The business community fears the bottom has to fall out
    sooner than later and wonders if the generous relaxation of Exchange Control rules seen in recent weeks has anything to do with cronies
    engaging in the game of flight of capital of their ill-earned lucre – before the inevitable crash occurs.

    Senguttuvan

  • 0
    0

    What about the very real “possibility” of the Government freezing all foreign currency accounts when they run out of reserves ?

    Another sterling reason to keep your foreign currency abroad , Pun intended !

    • 0
      0

      Whats the possibility your FX account abroad could be frozen and haircuts made to your accounts like what happened to Brits and Russians in Cyprus.

      Thats already considered a template for the EuroZone to “bail-in” bankrupt banks.

      If you are thinking Gold, whats the possibility that it could be criminal to posses monetary gold by any individual, partnership, association or corporation e.g.
      Executive Order 1933 by FDR “forbidding the Hoarding of Gold Coin etc”

    • 0
      0

      Don Quixote – That is possible as Argentina did it a few years ago. When we come to the patheitc state of cutting down trees to meet EPF/ETF payments, we are scraping the bottom of the barrel.

      Senguttuvan

  • 0
    0

    Couple of points I disagree with in the article.

    a) Oil prices are increasing.

    b) Japan and Europe are trying hard to depreciated their currencies to make their exports competitive. Indian rupee to has depreciated sharply.

    c) The US has initiated regulations (Patriot Act) to obtain information of world wide assets and accounts of US citizens. Be be prepared for reciprocal actions from other countries too.

    • 0
      0

      Looks like interesting times ahead for some. Panic too I suspect!

  • 0
    0

    According to the latest claims of this government,our island is floating on gas and oil!! When they are brought out our rupee will be stronger than any other currency of the world, and would replace the US dollar in international trade and as a reserve currency! A glorious future awaits us just round the corner!

    We need not manage anything now, including the exchange control. We have to only pray that the oil and gas will gush out in such force the day after tomorrow, to lift us into the high heavens!

    Dr.Rajasingham Narendran

    • 0
      0

      Dr.Rajasingham Narendran

      In most cases oil is not a blessing but a curse.

      Future Sri Lanka would reconfirm this if and when oil is found in and around this island.

    • 0
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      Dr.R.N. My fear is that when we are lifted heavenwards we may go in to orbit and become another moon, or better still, end up in another part of the galaxy.

      • 0
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        Native Veddah and Wickremasiri,

        The oil has been in the making for a long time and gas has been now been added to the product mix. Sirimavo claimed that the Russians have found oil in Lanka. It later transpired that oil lowered into the test well was brought up. the UPFA claimed that oil had been found in the Mannar basin by the Indian oil explorer, Cairns. Where is the oil and where is Cairns. Now the public struggling for their daily bread are being fed the fantasy of the island floating on oil and gas!

        If by a sheer miracle oil or gas is found in substantial quantise in this country, it will be our biggest curse, considering the quality of our politicians and public service. We will be worse off than Nigeria!

        Dr.RN

  • 0
    0

    Indeed the coming crisis will also be fed by govt. spending for the useless CHOGM show to boost Rajapassa’s ego and support an irrelevant and obsolete British Colonial organization..

    People need to go on the streets and protest the Commonwealth Circus and Rajapassa’s economic policies as in Brazil.
    The poor of Lanka are subsidizing the extravagance of the Rajapassa family and Carleton Sports circuses – since the depreciation of the rupee means that the CoL goes up as Sri Lanka is very import dependent for energy and most consumer goods.

  • 0
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    Unless the core issue of the balance of payments are addressed it is useless to fiddle around with exchange regulations and the interest rates. The takeover of certain private enterprises gave the message to investors that investing in Sri Lanka is a risky business. The first impression of investors when they are asked for 10% is that the govt is not sincere about developing the country.

    Instead of playing around with the indicators and regulations govt should introduce stable policies backed by medium term contractual agreements to ensure that genuine investors can take profits out of the countries. A lot more has to be done by BOI to support investors. Preferential tariffs for casinos and nightclubs indicates that govt merely wants to put up a show. These are very superficial. A lot can be done to promote and encourage core industries and agriculture.

  • 0
    0

    What ever controls being effective are a toss of the coin for Sri Lanka.

    The world, specially the West is awash in debt and desperately trying to manipulate consequences by having low (effectively negative) interest rates (ZIRP). i.e. Effectively printing money.

    wheels are coming off the whole of southern Europe Nothing is clear, read comments as well.

    Making comments about the demise of SL economy without taking into consideration the eminent crisis of the Global Economy implies agendas.

    Reminds me of Arjunan Sivanathan writing about the dire straits of the SL economy in transcurrents and elsewhere calling for “Sri Lanka must be subject to a regime of punitive economic sanctions”

  • 0
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    The economy will crash ultimately. Till the dooms day people will be hoodwinked with statistics manufactured daily by PBG and NC. This inefficient government will carry on as long as RW is the leader of the opposition.

    • 0
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      concerned,

      [Edited out], Haven’t you got anything sensible to write, donkey?

  • 0
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    Wonder how many of these posters have their hard earned moolay invested in Srilanka?.

    Drs Anoop Singh and Koshi Mathai, both Directors of the IMF have ticked all the boxes on our Economy.

    They have pledged all the support going forward, and patted Rajapaksa on the back for the fantastic Economic and Infrstructure development, especially over the last three years.

    What does this writer do for a living?.

  • 0
    0

    Sumane,

    The lending agencies ticked off most of the boxes when Greece
    laid a claim to hold the expensive Olympics in 2004. It was the bounden duty of the agencies to caution Greece they could not possibly afford the burden – but they did not. See where Greece is now. 60% unemployment and people are in the streets – some for their daily bread.

    Senguttuvan

  • 0
    0

    The main reason for rupee to depreciate is the US dollar appreciation because of positive US economic indicators. Not only LKR but also all other Asian currencies (AUD, SGD, NZD, Indian rupee etc..) got depreciated due US dollar move. Even gold price went due to same reason.

    But still the underlying weekness of our econmy is worry factor for all of us. Specially the leaders are messing with borrowed money.

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