BLUNDERS BEHIND THE Rupee DEBACLE
Posted on October 6th, 2018

By Udaya P Gammanpila Courtesy Ceylon Today

The rupee is now resting for a while in its continuous sliding journey, thanks to the Central Bank.  The Central Bank has generously released its foreign reserves to the forex market to stabilize the rupee. The Bank has released 184 million dollars for this purpose.

As a result, instead of the rupee, foreign currency reserves are now sliding at an alarming rate.  Any country should maintain foreign reserves  sufficient to cover import costs for three months. Sri Lanka is an import-dependent nation with a colossal foreign debt burden.  Hence, Sri Lanka cannot afford to lose foreign reserves in this manner for a long time.  In this backdrop, the rupee will recommence its downward slide in the near future.

When the rupee depreciation was obvious,  Ministers praised it as a positive trend.  Within weeks the very same Ministers urged the public to curtail foreign travel and imports to arrest the sliding rupee. The Government has imposed a rule that a 100% margin should be deposited with the Bank when Letters of Credit are opened to import household electrical appliances.

The deposit for vehicles is 200%.  In other words, vehicle importers should deposit double the value of the vehicle with the Bank to open LCs.  These measures were taken with a view to curtail import and to mitigate the pressure mounted by imports on the exchange rate.  However, these measures show the Government’s poor understanding in macroeconomics.

The import cost of vehicles and household electrical appliances constitute only 4.4% of total import expenditure in 2017.  Hence, even if the government imposes a total ban of importation of these goods, it can reduce the imports only by 4.4%.

The government entirely forgot its rupee coffers in its attempt to safeguard its Dollar coffers.  Taxes on a vehicle are several fold its value and such taxes are a major contributor to State revenue.  Low vehicle importation means low State revenue.  If there is a drastic drop in revenue, the Government will face difficulty in meeting essential expenses such as salaries and pensions.

The second blunder was the Central Bank’s lethargic attitude towards managing the exchange rate.  The Central Bank has a statutory obligation to stabilize the exchange rate.  However, it did not actively intervene to stabilize the rupee when the US Dollar appreciated by Rs 6 within seven working days from 13 to 21 September.  Traders’ perception play a crucial role in the forex market.  If the people believe that the dollar would further appreciate in the near future, importers expedite imports to purchase dollars at a lower rate.

Thus, the demand for the dollar increases.  On the other hand, exporters delay receiving export income expecting to receive more rupees for a dollar. Consequently, supply of the dollar goes down.  The result of these reactions is the further appreciation of the dollar.

If the Central Bank released several million dollars from its reserves at the early stages, rupee would have stabilized at Rs 163 levels.  Although the Central Bank intervened on 24 September, by then it was too late.  Market forces had already commenced to react expecting the rupee to rapidly slide.

Although the Government’s attempts to stabilize the rupee by curtailing imports, there was no significant increase in import expenditure in the recent past.  The actual cause for the rupee depreciation are three blunders committed by the Government during the first three months of its rule.  In January 2015, the Government announced unbelievable budget proposals to attract voters at the forthcoming parliamentary election.

Sharp drop of fuel prices, salary increase by Rs 10,000 for Government officers were among those.  International fund managers realized that the Sri Lankan economy is at the risk of collapsing since such luxuries cannot be afforded by the already vulnerable economy.  Hence, they commenced to withdraw their investments from the share market.  When they converted their rupee investments to dollars to withdraw from Sri Lanka, the demand for dollars increased appreciating the dollar.

In February 2015, the notorious Government bond scam took place.  The alleged culprit was no less a person than the former Governor of the Central Bank.  The Central Bank is the regulator of the money market.  The Governor is the top officer of the Bank.  When foreign investors are subject to fraud, the Governor is the highest person, they can complain to.  In this situation, the regulator is the culprit as well.

Hence, investors in the money market realized that their investments were not safe.  They began to withdraw from the Sri Lankan money market eying genuinely secure Government securities in other countries. In March 2015, the Government unilaterally stopped the Port City Project.  It is not only a massive Chinese investment and it was none other than the President of China who laid the foundation stone.  No nation in the world, including the USA, dare to terminate a project ceremonially commenced by the Chinese President.

The Chinese Government is the undisputed number one investor in the world.  The other foreign investors in Sri Lanka were terrified by this action.  They could not imagine their fate considering the arrogance of the Sri Lankan Government regarding the largest investor in the world.  Hence, direct foreign investors also began to withdraw from Sri Lanka placing added pressure on the exchange rate.

Friction between President Maithripala Sirisena  and Prime Minister Ranil Wickremesinghe has been obvious since the inception of the Government.  This column named it three years ago as the ‘Smith Syndrome’ elaborating the plot in the Hollywood movie titled ‘Mr& Mrs Smith’.  This friction and indecisiveness of the Government has devastated the confidence of investors in addition to the above-mentioned factors.

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