26 September 2018 11:10 am
“Social consciousness of our high income people is also important now; perhaps postpone by just a couple of months that new luxury car or that trip to Alaska. These will all help to cut the demand at the margin,” Dr. Silva said in a Facebook post.
The full post;
I feel that the LKR has overshot (depreciated more than) its fair value; it should strengthen somewhat in the coming weeks. But, the fundamental issue is lack of exports.
The LKR is again under pressure. The reasons for the current episode are primarily exogenous; driven mainly by outflows of US dollars from emerging markets due to a robust US economy, gradual tightening (of interest rates) by the Federal Reserve and investors taking refuge in the US with escalating trade tensions with China. While the impact of this shock is being felt across the world, current account deficit emerging countries, like Sri Lanka, are getting battered more than those with healthy trade balances.
However, whether the slide we saw was fully warranted is a question I have in my mind. I feel the LKR at 170 has overshot its market-determined fair value. It could be partly disruptive speculation and partly genuine lack of confidence in the Central Bank to have the situation under control. However, I think both these issues have now been addressed and the LKR will find its equilibrium once the dust settles. Some appreciation of the currency is warranted.
The Central Bank must be credited for being responsible and not burning reserves to defend the LKR at levels earlier not feasible. We saw how during the 2011-12 home made crisis (having held the currency artificially at 110 levels for months) ended up; losing almost USD 4 billion or close to half of the reserves in just a few months and yet the LKR depreciating by close to 13 percent. (Look at the graph)
My view is that the Central Bank could maintain the LKR at a level adjusted slightly upwards to correct for the overshooting.
A criticism, however, is that they should not sterilize the interventions; in other words, the loss of LKR in the market to purchase USD sold by the CBSL should not be replaced with new LKR by the CBSL. The unsterilized defence will lead to some tightening of rates but that is an okay price to pay for a short while to stabilize the markets and build confidence around the new equilibrium exchange rate.
The (brave) decision of our government to introduce the fuel price formula is certainly a huge boost to limit demand and the temporary measure like 100 percent margin on LC for import of cars for personal use will help stem import demand. The social consciousness of our high income people are also important now; perhaps postpone by just a couple of months that new luxury car or that trip to Alaska. These will all help to cut the demand at the margin.
I am not planning on explaining the more fundamental reason for the continuous pressure on the LKR today, but those who follow my writing are fully aware of how strongly I have been arguing for even stronger policy measure to increase the exports to GDP share of Sri Lanka including FTAs and unilateral liberalization of trade to increase investments and more conducive immigration policy to bring in technical expertise to move from producing low value simple products to high value complex products. That is the only sustainable solution to the continuous pressure on the LKR and to create high wage jobs.
When our exports to GDP share started to decline steadily year after year; from around 27 percent in 2005 to around 12.5 percent in 2015 with the Rajapaksa regime dismissing it with talk of ‘economic nationalism’ the writing was on the wall. What we see today is clearly and absolutely the outcome of that purely short-term populist economic policy of 10 plus years. I shudder to think what could happen if God forbid those who continue to advocate inward-looking policies grab 'power'; where will the LKR stop? 500?
We are doing our best to turn the declining export ratios. I am happy to note it has finally turned around. WE have succeeded in getting duty free access to the EU via GSP plus and exports are increasing. We have successfully signed the first FTA in decades with Singapore and others are in the offing. We have liberalized trade further and will do so with immigration.