What value would CB think to stop depreciation – At Rs.200, Rs.250 or Rs.300?

In response to my article regarding the government and Central Bank abdicating their duty to support the rupee, the Central Bank, by its statement of October 10, 2018, has gone to embarrassing lengths to downplay its current inability to defend the rupee. 

The bank has also indirectly suggested that the depreciating rupee is not detrimental to the economy or the country. 

In fact, the bank seems eager to project the view that a drastically weak rupee would help achieve the government’s single-most important mission of improving the “percentage of merchandise exports to GDP”, even if the attempt to achieve that goal could lead to the crash of all other macro-fundamentals. 

All knowledgeable analysts know that the real reason for the Central Bank’s “sour grapes” claim is because it has exhausted its “free” reserves and does not now have any “spare” forex that could be supplied to the forex market to stabilize the currency. That is simply because the Central Bank has not built up sufficient reserves in order to be ready to meet with such situations, as was done during the period 2006 to 2014, when the reserves were increased by three times from US $ 2,735 million to US $ 8,208 million.   

In the eight months up to August 2018, the Central Bank absorbed forex amounting to US $ 547 million from the forex market, while supplying US $ 434 million to stabilize the exchange rate. Thereafter, in September 2018, the bank supplied a further US $ 298 million out of its official international reserves to the forex market in a desperate attempt to stabilize the exchange rate.

The External Sector Performance Report of the Central Bank issued on October 8, 2018 also confirmed that the Central Bank “intervened” in the foreign exchange market to curtail the “volatility in the exchange rate”. In that background, it is simply amazing that the Central Bank has now claimed on October 10, 2018 (two days later), that “the Central Bank has increasingly realized that efforts to artificially stabilize the exchange rate extensively by supplying foreign exchange out of its official international reserves have only worsened Sri Lanka’s macro-economic conditions and medium-term prospects”. 

It is a truly remarkable about-turn in the Central Bank exchange-rate policy, based on a sudden “realization”, after intervening in the forex market continuously for 22 years, from 1996 to September 2018.

If the bank truly subscribes to what they say in their October 10 statement, such a policy stance suggests that they would now be willing to allow the rupee to slide towards any value against the US dollar. 

Needless to say, the implementation of such an ill-advised policy would cause serious panic amongst investors, which could be highly damaging to the economy, as it would soon cause the cost of living to rise, public debt to balloon, businesses to collapse, unemployment to escalate, business confidence to plunge, bank and finance company NPL’s to sky-rocket, as well as lead to a host of other disastrous outcomes. 

As is already known, a state minister, who is regarded as the key economic guru of this government, is already on record as having said that the rupee depreciation is “beneficial”. The finance minister has said he does not want the rupee defended.

Now, judging by the enthusiasm of the Central Bank to justify the recent massive depreciation of the rupee, the Central Bank has firmly confirmed that its policy stance is now not to intervene in the forex market in order to stabilize the rupee, which further suggests that it is quite comfortable to leave the rupee value to be decided by other forces. 

In such a scenario, the stakeholders of the Sri Lankan economy cannot surely be faulted if they were to expect the current rampant depreciation of the rupee to continue unabated, as well as harbour anxieties that the rupee could soon reach Rs.200 per US dollar or Rs.250 or who knows, even Rs.300!

The government and Central Bank certainly do not seem to care or have any answers!

(Ajith Nivard Cabraal is former Governor of the Central Bank)

Central Bank’s “sour grapes” claim 

In Aesop’s Fables’ ‘The Fox and the Grapes’, the fox, when it finds that it is unable to reach the grapes it is seeking, claims that the “grapes are sour” and hence, it’s not worthwhile reaching for the grapes. 

In Sri Lanka today, the Central Bank, when it finds that it does not have sufficient forex reserves to defend the rupee and maintain the international stability of the country’s currency, claims that intervention in the forex market is not advisable.