Sri Lanka looking at ‘market orientation’ of the rupee CB Governor

ECONOMYNEXT – Sri Lanka is moving towards a ‘market-oriented rupee’ Central Bank Governor Indrajit Coomaraswamy said, amid speculation of a policy discussion on a ‘devaluation’ in recent days.

"You know, we look at all the instruments," Governor Coomaraswamy said responding to a question whether ‘devaluation’ had been discussed by policymakers.

"As I said, right now, we are happy that the overall policy stance will get us to the targets."

"We discuss all instruments at every meeting."

Sri Lanka’s rupee weakened sharply in the last two days of September to around Rs147 to the US dollar.

Up to September 29, there were indications that Central Bank-bought dollars, as a liquidity shortage, went down steadily, although liquidity increased on September 30, showing currency defence.

Over the past three months, however, the Central Bank had been a net buyer in forex markets, as money printing reduced and the Central Bank started to actively withdraw liquidity by selling down its Treasury bill stock.

But it still injects money overnight after defending the currency, to temporarily sterilise outflows and keep a cap on rates at 8.50 percent.

Sri Lanka has a crawling soft-peg, indicating that it moves uni-directionally downward, leaving destroyed real wages, savings and overall impoverishment in its wake that has made the country a lagging region.

The steady currency depreciation (especially in the 1980s, in addition to generating economic instability and labour unrest) also gave strength to anti-free trade activists to launch a backlash, pointing to trade deficit as a cause for the currency collapse.

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Currency collapses, however, are a money and credit issue and have little to do with the trade deficit, which is a symptom of overall credit conditions, net services and capital inflows.

However, currency depreciation can help boost low wage exports by removing incentives and the ability for firms to move into capital intensive areas using higher technology.

Currency depreciation will also encourage low-skilled workers to move to the Middle East and Korea, which have strong exchange rates and highly qualified globally mobile service sector workers to also move out, generating a ‘brain drain’ and putting brakes on service sector expansion and innovation.

Some critics say the combination of monetary policy that accommodates budget deficits and delayed rate hikes, surrenders of Treasury borrowings to the Central Bank, and a belief in maintaining ‘export competitiveness’ by destroying real wages have helped keep Sri Lanka’s currency weak.

"In recent months we haven’t been expending reserves to defend the rupee," Coomaraswamy said.

"In fact, there had been capital inflows, which have been helpful."

"But it is no secret that the spot rate has been fixed. What we want to do over is to move to a more market-oriented system over time, which has flexibility."

"But one thing we don’t want is big fluctuations in the rate."

Some analysts say Sri Lanka’s Central Bank in the past has allowed ‘big fluctuations’ downwards after printing money, but it usually prevents sharp appreciations, when credit stabilses.

Some analysts say this is due to a policymaker’s urban intellectual fascination with ‘devaluationism’ and ‘inflationism’, as the country does not have a strong ideological base with sound money.

The International Monetary Fund also urged the Central Bank to allow the rupee to be ‘flexible’, to prevent one-sided defence of the currency, which will lead to a balance of payments crisis. (Colombo/Oct03/2016)

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