ECONOMYNEXT – Sri Lanka’s forex markets are braced for a float of the rupee after the central bank said it will no longer hold the rupee at 200 to the US dollar, amid suggestions that further monetary tightening is needed to prevent a steep fall of the rupee.
The central bank itself has called for tighter fiscal policy to help manage the exchange rate better.
The central bank said on Monday night “greater flexibility in the exchange rate will be allowed to the markets with immediate effect and it was “of the view that forex transactions would take place at levels which are not more than Rs. 230 per US dollar.”
Central Bank Governor Nivard Cabraal said the change in stance was needed to given the changing global scenario.
“We have given a guidance. It is a float,” Cabraal told EconomyNext. “We stand ready to take additional policy measures.”
However the current policy measures were sufficient, he said.
The central bank has also suggested hiking fuel and energy prices to the government as part of an 8 point plan.
The central bank is awaiting a response to the 8 point plan, Cabraal said.
Hiking taxes and fuel prices bring in tighter fiscal policy allowing the central bank to better conduct monetary policy.
Hiking fuel prices and taxes would reduce domestic credit and reduce the required corrective interest rate.
Sri Lanka has to free float the rupee and not try to peg it at a new level, former Deputy Governor W A Wijewardane said.
“In principle allowing the exchange rate is the right move,” he said. “But if this is a devaluation and they try to keep at 230 it will not eliminate the parallel exchange rates. The kerb rate will simply go up.”
A float will end interventions (reserves for imports) and their sterilization with new money, which triggers new import demand.
However recent interest rate hike of 100 basis points is not enough, he said.
“This interest rate hike is also not enough,” Wijewardane said. “Just increasing it by 1 percent is not enough.
“Inflation is at 15 percent and the budget deficit is high. The rate has not addressed the macro-economic imbalances.”
If interest rates are too low to curb domestic credit and finance the budget, the rupee can fall further than required.
At last some wisdom has dawned on CB’s Monetary Board to allow rupee to fall to 230/$;this should be the beginning ¬ the end;the appropriate rate would be the one which reduces premium in black market rate to -Rs2;this quest should continue till that rate is found: pic.twitter.com/YJf8GW7YOZ
— W A Wijewardena (@waw1949) March 7, 2022
Sri Lanka business chambers also suggested pre-emptive debt restructuring which would also reduce the corrective interest rates.
Analysts had also warned that a surrender requirement to the central bank which create money will also undermine the exchange rate further. (Colombo/Mar08/2022 – Update IV)