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.