COLOMBO: Sri Lanka needs to maintain a competitive exchange rate that would promote Sri Lankan exports and not allow an overvaluation of the rupee that would reduce export competitiveness, the Central Bank said. Sri Lanka has trouble with exchange rate becuase the central bank follows soft-pegged or ‘managed float’ regime involving controlling interest rates (by printing money) and trying to and failing to hold the exchange rate at the same time. A managed float in the Sri Lankan context also means that the exchange rate does not strengthen when large inflows come, leading to ‘crawling peg’ which only crawls downwards, leading to disbelief on any claims of a ‘flexible’ or ‘floating’ exchange rate.
Countries with better central banks or monetary authorities and stable economies including UAE, Qatar, Saudi and Hong Kong raised policy rates earlier this month after the US Federal Reserve raised rates. “Maintaining a competitive exchange rate aimed at promoting Sri Lankan exports in the international market and attracting foreign direct investment to Sri Lanka will remain vital in promoting the country as a globally competitive export-led economy,” the Central Bank said in a statement. The implication that the rupee is overvalued comes as the central bank’s own index shows the Real Effective Exchange Rate is around 100 at only 103. The Nominal Effective Exchange Rate is at 92.
The REER can go up because other currencies in basket (such as China or India) also weakens. “If the exchange rate is overvalued/appreciated especially for a country like Sri Lanka, which continues to record a budget deficit and imposes significant tariffs on foreign trade, the budget deficit would further expand,” the central bank said. This would create the need to borrow more from domestic and external sources to finance the budget deficit, it claimed.
“Therefore, maintaining a stable exchange rate against the US dollar cannot be considered as a sustainable approach since this would lead to an overvaluation of the Sri Lankan rupee which would in turn reduce the competitiveness of our exports.” Analysts say controlling the budget deficit is a matter of the fiscal discpline. In the 1980s Sri Lanka had some of the worst deficits, despite a rapidly depreciating currency.
While there may be no inherent reason for a currency to fall if monetary and exchange rate policies are in compatible, analysts say speculative pressure can build up with investors and others knowing that a pegged central bank which engages in behavior involving in ‘smoothening out volatility’ or a managef float’ but does not raise rates and continues to print money cannot hold an exchange rate indefinitely. Analysts have called for the abolition of the centarl bank and a return to a Hong Kong or Singapore style monetary regime, to bring back stability, and prevent the impovershment of an entire population through currency depreciation. A rise in US interest rates (involving a strenthenin of the US dollar) would allow the rupee to fall without imposing too much inflation as commodity prices woudl also fall.
