Thursday September 20, 2018
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Sri Lanka should allow the rupee to float: IMF

Jun 20, 2018 18:37 PM GMT+0530 | 3 Comment(s)

ECONOMYNEXT - Sri Lanka should allow the rupee to float, an International Monetary Fund official said as the central bank defended an unstable soft-peg at around 160 to the US dollar.

"The central bank should let the exchange rate float," Manuela Goretti, the head of an IMF mission to Sri Lanka said.

"The exchange rate should be the first line of defence."

In May the central bank sold 190 million dollars to defend the currency, selling 220 million dollars and buying 30 million dollars. June data is not yet out.

Sri Lanka printed tens of billions of rupees in March and April and put pressure on the rupee, by trying to keep down a spike in the overnight money market rates which may have come from an attempt to manipulate long term bond yields though a so-called a 'buffer'.

It then tried to float it with excess liquidity in money markets and the credibility in the peg was lost.

However the excess liquidity has since been taken away and money markets are now tighter.

The overnight call and repo rates are now around 8.45 to 8.50 percent, which is right at the 8.50 percent ceiling policy rates. Overnight rates cannot go up further without a rate hike, under the liquidity arrangement the central bank currently operates. 

But central bank, which is also sells debt for the Treasury has kept the three month gilt rate below the overnight money market rate in another distortion that supports speculation against the currency by encouraging exporters to borrow rupees at low rates.

This Wednesday, the 3-month rate fell to 8.32 percent from 8.34 percent a week earlier.

Analysts say ideally the rupee should be floated after the anomaly in the short term risk free rate is fixed.

Long-term central bank watchers say that the central bank also tends to buy dollars from the Treasury in times of currency pressure, providing new rupees, altering the monetary base, loosening the credit system to undermine any float from taking hold.

If a float is attempted, such practices should be immediately stopped they say, and the Treasury should sell all dollars in the market for existing rupees.

Goretti said the rupee had depreciated less than other emerging market currencies.

"When you look at emerging markets, the rupee has been depreciated less. We do not want to create competitiveness differentials."

She said Sri Lanka's central bank has followed a more flexible exchange rate in the recent past.

In 2017 better managed East Asian currencies and most floating rates (i.e those with a policy rate), appreciated as the dollar weakened and oil rose, while Sri Lanka resisted currency appreciation and collected dollars, raising doubts wheter there was a 'flexible exchange rate policy'.

In recent weeks, other emerging market currencies which have relatively credible pegs such as in the Middle East have remained steady amid recent Fed rate hikes, while those with a independent policy rate has weakened.

Hong Kong which has a credible peg through an orthodox curency board has also held as usual, though it is defending the currency with unsterilized dollar sales. Sri Lanka which has a discount widnow, cannot engage in unsterilized currency defence after hitting the 8.50 percent ceiling rate.

Goretti said a hike in rates would increase real interest rates, raising concerns about growth. Growth was low in the last year amid a drought and forex reserve collections.

Until March 2018 the central bank was sterilizing foreign exchange purchases, in a tightly pegged exchange regime, which was in effect tighter than an orthodox currency board, analysts have pointed out.

When purchases are sterilized the money supply is smaller than is determined by the balance of payments, at the de facto pegged rate which dollar purchases are made.

After making massive liquidity injections in May, expanding the monetary base beyond what is required by the BOP, the central bank then suddenly switched to a floating rate.

Analysts have called for the consistent monetary policy, either to have a credible peg, or a fully floating rate.

However under an IMF program to collect forex reserves from current transactions, a peg has to be followed. (Colombo/June20/2018  - Update II - The opening paragraph has been corrected to make clear that the IMF did not say the rupee was pegged to the US dollar. IMF has classified regime as a "a crawl-like arrangement as of March 31, 2017.


 

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3 Comments

  1. Harith September 20, 07:21 AM

    The flow of Range Rovers ,BMW and many luxury models started flooding in with less than 40 effective duty on CIF value (import cost). The damage is done.

  2. ksoysa June 21, 03:16 AM

    1. Demonitize, like what N.M Perera did (2) put a moratorium on all imports of vehicles and luxury goods, (2) charge taxes from all. Watch the national economy stabilize in a few weeks.

  3. Bandula June 20, 09:29 AM

    One of the bigger problems for Sri Lanka is the outflow of Dollars been more than the inflow. Few of suggestions are to restrict imports of vehicles (cars and three wheelers ) by stopping duty free permits and levying hire import duty. Foreign trips of politicians and state sector funded by public funds should be restricted unless really necessary and beneficial to the country. Further borrowing for multi million projects should be put on hold and development projects should be entrusted to local enterprises till we can manage the foreign debt repayment.

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