ECONOMYNEXT – Sri Lanka’s recent appreciation is starting to squeeze apparel exporters as their domestic costs including wages and energy, were hiked over recent months, when the rupee fell steeply, an industry official said.
Companies had raised salaries and emoluments at rates averaging 25 percent for workers while transport costs have also gone up but not has come down, Yohan Lawrence Director General of the Join Apparel Association Forum said.
Apparel factories in particular also provide transport and some meals for workers.
Electricity prices have also been hiked, based on the rupee which was weaker. A tariff cut is expected from June after the rupee appreciated and imported fuel prices fell.
Sri Lanka’s rupee collapsed in 2022 from 200 to 360 to the US dollar as interest rates were suppressed with liquidity injections and a failed attempt was made to float the rupee with surrender requirement in place.
From the second half of 2022, with higher interest rates and negative private credit, the central bank has avoided printing money under conditions which are generally accepted to be difficult, and is broadly running deflationary open market operations, triggering a balance of payments surplus and putting the rupee under upward pressure.
Central bank net credit to government which was 3,302 billion rupees in September in 2022, was down to 3,209 billion rupees by March 2023, part of which was due to rollovers, analysts say.
Market pricing of fuel and electricity by the Ministry of Energy and also spending controls and tax hikes buy have also helped contain domestic credit.
Sri Lanka also has mandatory conversion rules, imposed on exporters, which is a concern for exporters.
“We believe rupee should be at its natural level, but with forced conversions you won’t get the correct picture,” Lawrence said.
Sri Lanka has to release a plan to remove import controls, exchange controls and other restrictions imposed in the period where policy rates were suppressed with liquidity injections (so-called multiple currency practices and capital flow measures) by June under the IMF program.
Apparel exporters have also seen orders fall amid tighter conditions in Western markets.
The central bank has to peg (intervene actively in forex markets and create money) to meet reserve targets under an IMF program and cannot free float (avoid creating money through international operations) the rupee.
The newly created money has generally been absorbed in an overnight liquidity shortage.
There have also been foreign purchases of rupee Treasuries. Amid a contraction in credit, the inflows also do not turn into imports fast as the money if the money is spent.
By making purchases a little below what is allowed by the contraction in domestic credit, the rupee can be allowed to appreciate, analysts say.
The central bank has so far allowed the rupee to appreciate to around 300 to the US dollar from 360 levels under a transparent guidance peg up to February.
Except after the 2008/2009 currency crisis, Sri Lanka’s central bank has not previously allowed to the rupee to appreciate under IMF programs where the first year in particular sees balance of payments surpluses, before private credit and domestic investments picks up again.
One of the considerations used by third world central banks are Real Effective Exchange Rate indices.
The REER of the Sri Lanka rupee based on a basket of currencies calculated by the central bank was 61.12 points in February before the rupee was allowed to appreciate by lifting a surrender rule.
In March the index went up to 69.55 points, but remained steeply below 100. Real effective exchange rates are calculated also taking into account inflation in counterpart trading nations.
Sri Lanka’s inflation index had hardly risen since September amid rupee gains. Falling food prices can help contain pressure for further wage hikes, analysts say. (Colombo/May30/2023)