Because transactions are made in US dollars in international trade, the value of the rupee is measured against the US dollar. Any country engaged in importing and exporting activities has to buy US dollars for its transactions in the foreign exchange market, the market where currencies are exchanged.
If we put it simply, when we have to pay more for buying a dollar, it says that the rupee has depreciated against a dollar. On the other hand, when we have to pay less for buying a dollar, it can be said that the rupee has appreciated against a dollar.
For an example, recently, the dollar reached up to Rs.155. However, it was about Rs.8 in 1977. Accordingly, it is needless to state how the rupee has deprecated for the past few decades.
Whenever we talk about the exchange rate, attention has to be paid to export and import, as those are the key factors that decide the exchange rate, only if it is allowed to float as per the market forces, supply and demand in the foreign exchange market. Seemingly, rupee depreciation is good for exports and bad for imports.
In other words, when exporters can earn a higher amount of rupees, due to depreciation, exporters are encouraged to export more and make profits. However, this should not be a long-term strategy for improving the export competitiveness in the world market.
Importers are discouraged to imports, since they become very expensive with rupee depreciation. Things go from bad to worse when the economy is more import-oriented and can never cut imports like crude oil under any circumstances. Higher cost of imports can result in higher level of inflation especially in an economy where people consume more and more imported goods rather than locally produced goods and services.
Furthermore, inflation goes up, purchasing power of the currency goes down, pressurizing people to cut their essential expenses which ultimately challenge the living standard in the country. Imports in June in 2017 have gone down by 8 percent.
It creates a favourable situation for foreigners to travel in the country. Tourists that got Rs.8 in 1977 can get nearly Rs.150 in 2017. This encourages tourists to come and spend here in Sri Lanka. However, no one can say that the rupee depreciation itself can boost tourism, as there are many more factors that develop the tourism industry.
Even though the market forces are allowed to behave freely and decide on price in the market, a debate has emerged whether the government should get involved in the foreign exchange market or not by pumping dollars into the market and imposing laws so and so forth.
Nevertheless, Sri Lanka, since 2001, has been following the floating exchange rate system, which allowed an independent adjustment of the exchange rate, according to the market forces of demand and supply. The Central Bank of Sri Lanka, from time to time, intervenes in the foreign exchange market to control over-depreciation of the rupee by releasing dollar reserves. In my opinion, this should not be done because it reduces reserves in the Central Bank, endangering the stability of the economy.
Every government is politically motivated by nature. If they want to be in power, they have to cushion the economic impact on the public. Hence, governments are likely to interfere with the exchange rate system, in order that import-driven inflation can be prevented. However, it may open a can of worms in the future.
For developing economies like ours are badly affected by currency depreciation, sustainable solutions have to be found out for the genuine development of the country. Central Bank Governor Dr. Indrajit Coomaraswamy recently stated that the rupee has to depreciate a little more. We would do it in a very orderly way.
In fact, it has depreciated 2.5 percent against the US dollar this year. Their target by allowing the rupee to further depreciate is to push exporters to be more competitive in the world market. However, this may in my opinion seem to be a solution in the short term, only an export-driven economy can deliver the expectations.
It is when the cash inflow of dollars is coming into the country that the rupee can be stable. That’s why the country needs more foreign direct investment (FDI), more tourist arrivals and any kind of dollar inflow like remittances, most importantly increased exports.
Furthermore, regaining GSP Plus is very helpful to increase exports. It is up to the government to sign more free trade agreements (FTA) with strategically important countries in the region as well as beyond the region, so that exports can be boosted in our favour.
We can have positive expectations over the economy, as US $ 1.12 billion from the Hambantota port deal and US $ 205 million from the Mattala airport deal will inflow to the country. Presumably, this will strengthen the dollar reserve and then economy. In conclusion, steps should be taken to develop an export-driven economy, in order that the rupee will not further depreciate.
(Amila Muthukutti is an economist)
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