By Hema Senanayake –

Hema Senanayake

Sri Lanka’s rupee … is hovering near a record low after being floated by the central bank last week, (Reuters). Today that is on September 10th Ravi Karunanayake the Minister of Finance has admitted indirectly that rupee has depreciated to an unacceptable level. That is why he told Reuters that, “We will ensure that before too long it will be brought back to an acceptable level.” What should be the acceptable value for rupee? He did not comment for this question. Good, let us leave it there.

But he told parliament on or around June 23rd that, “Sri Lanka will strengthen the rupee to 130 to the US dollar in two weeks from the current 133.90 to the US dollar” (Economynext). Opposite of his prediction proved right by now, not after two weeks from his above comment but nearly after 10 weeks. Instead of strengthening the rupee, it is depreciating. Now, let me quote something published on June 19th.

“… if Arjuna Mahendran thinks that market forces should determine the exchange value of the rupee, then this particular view might transcend into the general thinking of the CBSL staff resulting them allowing the rupee to float freely. If this happens most likely we will see the rupee which depreciates on a continuing basis.” (Hema Senanayake, June 19, 2015)

Please compare what Ravi Karunanayake has uttered and what the above named writer wrote on June 19th. Perhaps, Colombo Telegraph readers might clearly understand now that not only the value of rupee is unacceptable but also the shear perception or knowledge of Ravi on these matters is not acceptable.

My piece appeared on June 19th in Ceylon Today could be an interesting one for unbiased and concerned readers of CT. Hence I submit it below as it was. It was an appeal to all Sri Lankans. Here it is.

DANGEROUS – The ideology behind rupee devaluation is

Before it becomes too late, the whole nation should defeat a certain ideology or dogma. That ideology relates to a person none other than the Governor of the Central Bank of Sri Lanka (CBSL), Arjuna Mahendran. He believes that market forces should determine the exchange rate of the rupee. He said this openly on a TV programme known as Naduwa conducted by ITN. Further, he said that he believes it when the country is in a situation of having over-borrowed.

His views are nonsense. If any other economist believes this nonsense, it won’t affect our economy. But when Arjuna Mahendran believes in this nonsense, it affects the stability of the rupee and would result in devaluing our currency resulting inflation and other bad repercussions in the economy.

Previously he held a personal belief that there was an artificial depression of interest rates from September 2014 up to the presidential election. This artificial depression of interest was not observed by the Monetary Board that met on 23 February 2015; instead the Board considered in lowering the rates further and finally agreed maintaining the rate levels that existed in February. But the CBSL Tender Committee which handled the Treasury Bond issue at the end of February decided to go back to the interest rates that prevailed prior to September 2014, in accordance with Arjuna Mahendran’s personal opinion. That decision pushed the interest rates up. This is how CBSL Governor’s personal economic opinions could affect the interest rates and economy.

Similarly, if Arjuna Mahendran thinks that market forces should determine the exchange value of the rupee, then this particular view might transcend into the general thinking of the CBSL staff resulting them allowing the rupee to float freely. If this happens most likely we will see the rupee which depreciates on a continuing basis. In the event Arjuna Mahendran would come and tell us that the previous regime did not allow the rupee to float and now the value of the rupee is being determined by the market forces. What kind of market forces is he talking about?

In fact, I have no idea about the market forces he was talking about. But all sensible economists know one simple fact. That is, one of the core functions of the Central Bank is to keep the inflation low (or at required level). Arjuna admits to this view when he says that maintaining price stability is one of the key functions of the Central Bank. You can’t achieve this objective with a rupee which devalues on a continuing basis.

Also, what I know is that one of the macroeconomic objectives that countries like ours should have is to have the same inflation rate of the country in whose currency we use as our reserve currency. For example, Sri Lanka uses the United States’ dollar as its main reserve currency. Therefore, Sri Lanka’s objective must be to have the same or closer inflation rate that exists in the United States. If Sri Lanka uses a few reserve currencies the CBSL must arrive at a reasonable rate of inflation that is appropriate in accordance with our economic development objectives. You can’t achieve this goal by allowing the so called market forces to determine the value of a rupee.

In regard to market forces, what I know is that the so-called market forces are mostly the resultant effects of the prior decisions made by the CBSL. For example, Arjuna says that there was a 25% devaluation of the rupee in early 2012 under the previous regime. True, but that was the resultant effect of mainly allowing an unprecedented level of domestic credit growth to take place, by CBSL; prior to that it was reported that credit growth was around 35%. Domestic credit growth is something that the CBSL can regulate. (Please note that there are other few variables that affect sudden devaluations).

However, therefore, if the rupee is devalued more than what was required, Arjuna Mahendran should not come and tell us that devaluation of the rupee has determined by his so-called market forces. I agree that the value of the rupee must reflect the true economic relations of present day, but those economic relations are mostly the resultant effects of prior decisions made by CBSL. Therefore, talking about market forces in determining the value of the rupee by the Governor of CBSL is total nonsense because market forces that affect the value of currency, to a greater extent, are the resultant effects of prior decisions made by the CBSL.

However, there are certain economic situations where a country needs to plan for a higher devaluation of its currency than normal. For example, if a country might need to deflate debt then it might choose to devalue its currency by having wage increased bound moderate inflation; another country might try to achieve the same objective by having austerity programmes. Therefore, if Arjuna Mahendran argues that the Japanese yen devalues 20% against the US dollar in the recent past and try to prove that it is the global trend, then it is a statement made out of context.

Also, if a developing country like ours might plan to increase exports by devaluing the currency, yet it must be a conscious and calculated decision made by CBSL, again it cannot be a devaluation determined by market forces. Depreciation of the rupee can be temporarily good for exports, but surely negative in increasing Foreign Direct Investments (FDI). Having a stable currency and an economy which has the same inflation rate as of the country of reserve currency would be beneficial in increasing FDIs. Therefore, it is clear that the devaluation of the currency might be a calculated decision that should be made by CBSL in order to optimize at least the combined effect of increasing exports and FDIs. This decision cannot be left to determine by market forces.

I never insist that we must peg the value of the rupee to the dollar artificially. Yet, let us assume that we want to peg the rupee to the dollar. It can be done. But, nobody can peg the rupee to the US dollar, if he or she can’t peg the domestic credit growth at the desirable level. And if he or she can peg the credit growth at the desirable level, then he does not need to peg the value of the rupee to the US dollar, artificially. This phenomenon explains that we can maintain the advantageous rate of exchange or even we can peg the rupee to dollar if we want, by regulating domestic credit growth but not by artificial pegging. So, what are the market forces that involve in this case? Nothing, other than the Central Bank’s calculated decision to contain domestic credit growth.

In view of above, what I want to point out is that the ideology held by the Governor of CBSL, Arjuna Mahendran, is not only wrong, but dangerous too. If his beliefs led to a sudden devaluation of the rupee, then CBSL would have no other option than borrowing quickly from the international financial markets. There are chances that interest rates for sudden borrowings would be relatively higher. If the CBSL has to borrow in dollars suddenly at a higher rate, then who should be responsible for it? – Nobody other than CBSL. Borrowing is a big business; sudden borrowings are a bigger business.