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Wednesday May 18th, 2022

Sri Lanka needs ‘real depreciation’ World Bank economist claims

According to World Bank’s own REER indices, Korea, People’s Republic of China and Hong Kong have index number around 120 and 140.

ECONOMYNEXT – Sri Lanka will need “a real depreciation” of its currency in the longer term to stimulate its exports, World Bank’s chief economist for South Asia said articulating an oft-repeated claim by domestic Mercantilists.

“Let me make a longer term view on the currency, looking at the circumstances in Sri Lanka,” Hans Timmer, the Chief Economist for the World Bank’s South Asian region told a business forum organized by Sri Lanka’s Ceylon Chamber of Commerce.

Ever since Latin America style central bank was set up in 1950 by a US ‘money doctor’ to pursue ‘independent monetary policy’ despite operating a pegged regime, Sri Lanka’s rupee has fallen from 4.70 to 203 to the US dollar.

“Independent monetary policy” involving large scale liquidity injections in 2020 and 2021, on top of monetary instability in 2015, 2016 and 2018, which led to a ratcheting up of dollar foreign debt, has brought the country to the brink of external default.


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Timmer did not elaborate on how or whether Sri Lanka now had a “real appreciation” and if so by what measure.

A “real depreciation” can also be achieved (based on the measure used) by reducing domestic inflation or with deflation.

“Overvaluation” is generally defined by a real effective exchange rate, a nakedly Mercantilist measure of money, which is the basis of a social stability and incomes of people – on trade considerations.

A real effective exchange rate adjusts the nominal exchange rate by a consumer price index of trading partners. If it is above 100, it is claimed to be overvalued.

According to Sri Lanka’s central bank, the rupee is now ‘undervalued’ with the REER at 85 in October. Inflation however is rising.

A nominal depreciation destroys real wages of workers – including in non-export sectors – triggering strikes and social unrest in its wake as the price structure of the country is altered. The profits to exporters remain until wages catch up.

Sri Lanka for some time had been destroying the exchange to keep the REER below 100, an exercise which critics said from the begining would destroy sound money and get the country into trouble as it had done in other countries, throughout history.


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When currency pegs collapse due amid high ‘REER’ indices, Mercantilists blame ‘overvaluation’ rather than liquidity injections, though Sri Lankas

East Asian export powerhouses, which have strong currencies frequently have high REER Indices, compared to Latin America which depreciates like Sri Lanka and are generally referred to as ‘basket cases’ by some.

“When nearly two-thirds of our citizens’ expenditure is spent on imported goods, a strong Singapore Dollar helps to keep consumer prices down,” Singapore’s economic architect and the key theorist behind Prime Minister Lee Kwan Yew said explaining the three key reasons the country chose a strong exchange rate based on currency board principles (no policy rate).

“The second purpose was to inform our citizens that if they wanted more and better services, they must pay for these through taxes and fees. There is no free lunch here.

“Third, we wanted to indicated to academics, both local and foreign; that what is fashionable in the West is not necessarily good for Singapore. A perceptive mind is needed to distinguish the peripheral form the fundamental, transient fads from permanent values.”

According to World Bank’s own REER indices, Korea, People’s Republic of China and Hong Kong have REER indices between 120 and 140.

Many Mercantilists claimed during the East Asian Crises claimed that ‘overvalued’ as non-credible pegs collapsed.

However Hong Kong which had a currency board did not collapse as it is legally barred from injecting money at a fixed rate despite having a REER in excess of 150 as defined by the World Bank.

Speculators who tried to generate liquidity to hit the peg as they had in Thailand and Malaysia found themselves with enormous losses as short term rates shot up.

The International Monetary Fund now claims that East Asian currencies are ‘undervalued’ in tandem with claims peddled by the US Treasury, if a country has a current account surplus and it collects forex reserves.

Vietnam which has a REER of 130 has been falsely blamed by the US for ‘manipulating’ its currency simply because the State Bank of Vietnam operated a peg with a higher level of credibility now using a somewhat wide policy corridor which responds to interventions.


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Sri Lanka’s peg with the US dollar had lost credibility and is now under pressure.

Countries with strong exchange rate, who do not need to borrow abroad much due to high real domestic savings and their central banks sterilizes inflows tend to have a current account surplus.

Countries who get financial inflows and spend them domestically tend to have current account deficits.


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When money is printed, the current account deficit exceeds financial inflows and the currency peg collapses.

Whenever the US tightens – then Fed chief Janet Yellen tightened in 2014 and 2018 – both nominal and real effective exchange rate indices of countries with good central banks tend to go up as currencies of trading partners with bad central banks collapse,

REER indices can later moderate as inflation in countries with bad central banks in the basket catch up. (Colombo/Dec09/2021)

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