Sri Lanka rupee not overvalued by econometrics: IMF

ECONOMYNEXT – Sri Lanka’s rupee is not ‘overvalued’ by when analysed with several techniques, with some methods showing undervaluation, the International Monetary Fund had said.

In a March country report that has just been made public, the IMF said based on an External Balance Assessment (EBA) method the rupee was overvalued by 5 percent.

There were mixed results from other approaches.

"..The macro balance and external sustainability approaches pointing to an undervaluation of 2–4 percent, while the equilibrium exchange rate approach suggested an overvaluation of about 7 percent," the IMF report said.

However the report said quantitative analysis suggested that the rupee had entered a period of downward pressure from late 2014 and there was steady foreign exchange sales.

"Despite the favorable outlook for the balance of payments with respect to trade in goods and services, market expectations (based on forwards) are leaning toward a depreciation of the rupee," the report said.

Other independent analysts had warned from late December 2014 that the rupee will come under pressure when credit turned positive.

The Central Bank had kept large volumes of excess liquidity unsterilized and when it turned into credit and demand it has to defend the currency and ‘mop up the rupees’ in forex markets instead.

The bank also injected more liquidity by outright purchase of Treasuries later in 2015, driving credit and demand into unsustainable levels.

Sri Lanka has a so-called ‘soft-pegged’ central bank which prints money to delay interest rate hikes amid when credit recovers and defends the currency at the same time, generating inherently unstable conditions for the currency.





It also buys dollars in the throes of balance of payments pressure, generating a unit-directionally depreciating currency or a crawling peg.

The rupee has so far collapsed from 131 to 143 to the US dollar. Analysts have warned that the rupee will continue to fall if the central bank creates more liquidity and then does not defend the currency when the money comes up for redemption in forex markets.

On Monday the rupee fell to a new record low of 143.65 to the US dollar. Over the last week the Central Bank had mopped up some of the excess liquidity through domestic operations, instead of waiting for the money to turn into credit and hit the forex markets.

In most years December the rupee usually comes under appreciation pressure when remittances come in and bank credit slows.

Some analysts have called for the central bank to be abolished and for Sri Lanka to return to a currency board, to prevent exchange rate and economic instability.

Countries can show over-valuation or real effective exchange rate appreciation by statistical methods but the currency will not fall unless money is printing.

The Hong Kong dollar for example was about 40 percent overvalued by real exchange rate measures at one time according to IMF calculations, but it had stayed at 7.8 to the US dollar because money printing is illegal under the territory’s linked exchange rate system or currency board.

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