Flexible forex management comes under spotlight amid brewing CB- FinMin conflict

The Central Bank’s laissez-faire policy towards the country’s foreign exchange management came under severe scrutiny yesterday as the country’s financial sector stakeholders argued whether such a policy has delivered the desired outcomes in terms of maintaining lower interest rates and a stable currency. 
The Central Bank in December said it would follow a more hands-off approach in managing the foreign exchange giving it more flexibility as the regulator will have to let go of either the exchange rate or the interest rates as it cannot manage both at once.   
“It doesn’t seem sensible to spend large amounts of reserves defending the currency if you are going to depreciate (anyway),” the Central Bank Governor. Dr. Indrajit Coomaraswamy told reporters in January.
As a result of allowing the rupee to take bulk of the adjustment, Sri Lanka’s rupee continued to depreciate and year-to-date it has fallen by1.1 percent against the US dollar after falling 3.9 percent in 2016.   
However, the country’s belligerent Finance Minister last week said protecting the rupee is more important than interest rates.
The two diametrically opposed views held by the Central Bank and the Finance Minister over the management of the economy has clearly baffled many, as participants at yesterday’s Capital Market Conference held for the fifth time sought clarification from the panelists present as to whom to be trusted.  “It’s very difficult to keep a situation of low interest rates and a stable rupee at the same time. You have to let one of the two go,” said Deshal De Mel, Senior Economist at the 
Hayleys Group. 
In 2015, Sri Lanka had to let the rupee to take a larger adjustment after easing the monetary and fiscal policies to deliver on the election promises. This fuelled the imports and drove away the foreigners from the government securities market putting pressure on the currency and the 
balance of payment. 

The rupee depreciated by almost 10 percent in 2015 having exhausted as much as US $ 2.1 billion in foreign exchange reserves.  
However Channa De Silva, the Chairman of Sarvodaya Development Finance said interest rates must come down significantly because he fails to see any logic in offering as much as 600 basis points above the inflation for a bank deposit while charging anywhere between 18 to 50 percent or more for micro, small and medium enterprise loans making a killing out of them. 
“High interest rates, sliding rupee (against the dollar) is a disaster for us. No foreign, (or) sensible investor will come in; if you see the rupee depreciating at 15 percent, where is your return going to be? And the interest rates have to be brought down,” charged De Silva taking a shot at the Central Bank.
He also asked the logic behind the government borrowing at rates as high as 11 to 13 percent through government securities.
However, the analysts and economists have cautioned against bringing the interest rates further down when the inflation and the private sector credit remain high. Some predict another rate hike by the Central Bank when the monetary board 
meets in March.