Sri Lanka rupee can go to 300-350 to the US dollar: Trade Minister
ECONOMYNEXT – Sri Lanka is controlling the price of the rupee with great difficulty and the it could fall to as much 300 to 350 to the US dollar, given past trends, Trade Minister Bandula Gunewardene told parliament without giving a time frame for the target.
“Now it is with the greatest difficulty (ithar visharler amaruwen) that the exchange rate is controlled at 200 levels (to the US dollar),” Minister Gunewardene told parliament this week.
“What if this rupee goes to 250, or 300 or 350? It can go to that level (ehemer ven-ner puluwan) because when we got independence we paid only 4.77 to the US dollar.”
Minister Gunewardene did not give a timeline for 350 rupees.
Sri Lanka got independence from British rule in 1948.
At the time Sri Lanka had a currency board which could not legally print money to control interest rates and the exchange rate was fixed (externally anchored) 1 to 1 with the Indian rupee from 1885.
The Indian rupee was originally a silver based currency. While the rupees produced by the Board of Commissioners of Currency of Ceylon could move against gold standard moneys such as the sterling, it could not depreciate against the anchor Indian rupee currency.
The Indian rupee also moved to a gold linked standard later.
A currency board (a hard peg) is prohibited from issuing notes against Treasury bills and can only issue notes against foreign currency inflows, making it impossible to generate Keynesian (or post-Keynesian) excess demand, currency depreciation and balance of payments crises.
The Board of Commissioners of Currency was set up in 1885 by British administrators after the collapse of the main note issuing bank at the time, the Oriental Bank Corporation, which suspended payments in May 1884.
Sri Lanka had several note issuing free banks in its history.
At the time a series of chartered and free banks in the world had fired a bubble, which collapsed bringing commodity prices including coffee down, generating bad loans in many banks in Asia and Ceylon.
Oriental Bank Corporation was also hit by collapsing sugar plantations in Mauritius and unhedged currency risks (borrowing in gold and lending in silver), which analysts say is similar to a modern central bank swap.
Latin America style soft-peg
Sri Lanka set up a Latin America style central bank in 1950 with advice from a Federal Reserve ‘money doctor’ to become part of the Bretton System of failed soft-pegs.
Soon after World War II the US was intent on breaking the so-called ‘Sterling area’, where a partially closed trade system was taking place due to Bank of England money printing dating back from the war years was creating forex trouble with the ‘dollar area’.
Countries like Malaysia, Singapore and the Maldives which got independence around a decade later escaped the central banking debacle.
After the Great Depression the Latin America unit of the Fed had set up a series of money printing central banks which were supposed to do ‘counter cyclical policy’ in several countries, inspired by Argentina’s central bank set up by Raul Prebisch.
Many of those Latin American countries ended up with forex shortages, import substitution and sovereign default. Some central banks struck zeroes off the money, and accumulated more zeroes. Others dollarized.
After the currency board was converted to a soft-peg Sri Lanka had foreign reserves measured in 11 months of imports, which dwindled rapidly as money was printed.
Meanwhile Gunewardene said by 1978 Sri Lanka’s rupee was around 8 to the US dollar.
In 1978 it was devalued to 16 he said during then Finance Minister Ronnie de Mel’s budget.
By 2005 it was down to 105 to the US dollar.
When Mahinda Rajapaksa left office in 2014 it was around 130 he said.
During the five years of the last administration the rupee had fallen to 182 to the US dollar, he said.
Economic analysts had blamed ‘flexible’ policy involving un-anchored monetary policy (flexible exchange rate or no external anchor/flexible inflation targeting or no domestic anchor) for the currency collapse in the past five years, which happened despite steep and unpopular tax hikes and market pricing of fuel.
Gunewardene said the current administration had cut value added tax to help bring down prices and costs to business. Now unprecedented volumes of money was being printed to keep rates down and also finance the deficit.
In 2020, the highest balance of payments deficit of 2.3 billion dollars was recorded with over 650 billion rupees being printed, apparently under ‘Modern Monetary Theory’.
In 2015 the central bank printed money claiming inflation was too low, and in 2018 and 2019 money was printed to target an ‘output gap’. However the central bank has no growth mandate.
The central bank printed money to target an output gap, despite budget deficits coming down, triggering monetary instability.
Analysts have pointed to factors showing that interest rate were controlled as a final target, through overnight liquidity operations for call money, administrative price ceilings as well and outright purchases of longer terms bonds to influence the yield curve.
The resulting monetary instability then forces the central bank to apply brakes through a rate hikes rates and tighter liquidity.
However the currency collapse leads to a consumption collapse, implosion of domestic real capital and a relative inflation of foreign debt, driving short and long term growth down.
Such ‘stop-go’ policies also wreaked havoc in the US and UK in the 1960s and 1970s.
Analysts have called for a overhaul of the central bank or to re-establish the currency board to reign in monetary instability.