Currency depreciation in the offing
Sri Lanka appears to be steadily tilting towards another Balance of Payment (BOP) crisis as the country’s volatile economy is facing multitude of issues from falling exports, weakening rupee and dwindling foreign reserves.
Data showed that falling exports, strong importer dollar demand fuelled by cheaper bank credit, capital flight from government securities market and the absence of substantial dollar flows into the country were putting pressure on the rupee.
It is evident that the Central Bank no longer can hold the currency by selling its external reserves.
The Central Bank has sold as much as US $ 600 million of reserves in defense of the rupee in a matter of 30 days as the gross official reserves have come down to US $ 6.9 billion end July from US $ 7.5 billion a month earlier.
“We don’t know how long we can hold the currency because our exports are falling,” interim government’s Policy Planning and Economic Affairs Deputy Minister and MP Dr. Harsha de Silva, who is a trained economist, told a recent forum.
This statement from the former Deputy Minister gives an indication that the rupee is likely to be depreciated soon.
The foreigners, during the first seven months sold US $ 425 million worth of government securities. The corresponding amount last year was an inflow of US $ 232 million.
The selling is prompted by the narrowing margins between the yields of US government securities and the Sri Lankan securities, which currently hovers around 100 basis points.
The scenario doesn’t offer a reasonable incentive for foreigners to hold Sri Lankan securities given the foreign exchange risk as the US Federal Reserve is expected to raise treasury yields shortly.
On Friday, the rupee closed at Rs.134 per US dollar, 0.07 percent weaker than Thursday amid heavy intervention from the Central Bank through selling dollars to keep the currency from further decline.
The economists have pointed out that the Central Bank’s foreign exchange management policy of defending the rupee at the expense of foreign reserves is contradictory to every other emerging and developed market where currencies are depreciated against the US dollar.
According to the head of a leading stock brokerage in the country, this policy is making imports cheaper than what it should be and interest rates lower than what it should be (the impossible trinity), pushing the country towards a vicious cycle.
“In the meantime, there are capital outflows from FIIs (foreign institutional investors) either selling or not rolling over government securities—a sizeable currency adjustment will follow; deja vu early 2012,” JB Securities CEO Murtaza Jafferjee said.
It appears that the current account flows, which generally come to the rescue of the BoP, are unlikely to turn the situation for the better with the absence of strong capital flows towards the remainder of the year.
In the case of current account flows, tourism earnings have grown both in July and during the six months by 31.2 percent and 16.8 percent yoy to US $ 280 million and US $ 1.6 billion, respectively.
Worker remittances grew 7.6 percent yoy in June to US $ 630 million while the six months inflows grew 2.2 percent yoy to US $ 3.4 billion.
The net cumulative outflow from the secondary market of the Colombo Stock exchange through August 18 was US $ 9 million.
Meanwhile, during the first six months, the government borrowed only US $ 491 million, a significant decline from US $ 1 billion recorded for the corresponding period last year.
The Central Bank said the overall BOP is estimated to have recorded a deficit of US $ 791.7 million during the first six months of 2015 in comparison to a surplus of US $ 1,954 million recorded during the corresponding period of 2014.