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Floating the rupee: Incentives threaten further depreciation?

12 Mar 2022

  • Rs. 38 incentive falls to Rs. 20 for festive season
  • Remittances fell by 60% in Dec. ’21, fell further in Jan. ’22
  • Expert warns remittances may force Govt. to print more rupees
By Skandha Gunasekara Following confusion over last week’s announcement by the Central Bank of Sri Lanka (CBSL) on the floating of the rupee, the exchange rate finally appears to be settling at the market rate. However, experts warn that the proposed incentives for remittances could cause further depreciation of the rupee.   The week started with the CBSL announcing that it was of the view that foreign exchange transactions could take place at levels not exceeding Rs. 230 per US Dollar and that the bank would be closely monitoring developments in the local foreign exchange market.  This left many in the foreign exchange market confused as to whether it was a controlled depreciation of the rupee at Rs. 230 or whether it would be allowed to depreciate further. This was followed by the Ministry of Finance announcing a Rs. 38 incentive per US Dollar remitted by migrant workers.  However, sans further clarifications, the industry remained confused as to whether the Rs. 38 incentive was in addition to the depreciation of the rupee value to Rs. 230.  On Wednesday (9), the Ministry of Finance in a statement announced that Rs. 20 per US Dollar would be given as an incentive for March and April in lieu of the upcoming Sinhala and Tamil New Year festive period. This led to questions over the previously proposed Rs. 38 incentive. Come Thursday (10), however, a little clarity followed with the CBSL announcing official rates of the US Dollar at Rs. 249.96 (buying) and Rs. 259.99 (selling).  A senior CBSL official speaking to The Sunday Morning clarified that the Rs. 230 was merely a guidance and that the market would determine the exchange rate. “Based on the recent steps taken we expect the market to react and work on it. We will be looking at how things proceed and as informed the necessary actions will be taken. The Rs. 230 was merely a guidance given allowing flexibility in letting the market take its course.” The senior source, who wished to remain anonymous, also confirmed that the Rs. 38 incentive had been replaced by the Rs. 20 New Year incentive. “The Government has now announced a Rs. 20 incentive for foreign remittances for the months of March and April. Further instructions will be given to the banks on how it should be worked on.”  With regard to the thriving grey market, the CBSL official noted that it would lose its value with the floating of the rupee, since market rates would be in play.  “I don’t think there will be any issues with the black market anymore, as the rupee has now been allowed to float and the market will now determine the rate.”  The CBSL’s decision to ‘float’ the rupee or to let it depreciate to the market value comes as a direct result of a lack of foreign remittance inflows into the country as the rupee had been pegged artificially high at Rs. 200 per dollar for months on end.  In November 2021, foreign worker remittances stood at $ 271 million, a reduction of 55.6% when compared with November 2020, which saw remittances worth $ 612 million.  December 2021 saw a 60% drop in remittances at $ 325 million, compared to $ 813 million worth of remittances in December 2020.   CBSL Foreign Remittance Facilitation Department Director Dr. B.H.P.K. Thilakaweera, revealing statistics for January 2022, confirmed that the trend was only worsening: “For January, $ 259 million foreign remittances have been received – a drop of 61% from remittances of January 2021 which saw $ 675 million being remitted.” Advocata Institute Chief Operating Officer and Economist Dhananath Fernando noted that the key issue causing the lack of foreign remittances was the artificial pegging of the rupee by the Central Bank.  “When you operate at the market rate, people will start sending remittances. The previous problem was that we were operating way below the market rate for the dollar, which resulted in remittances not coming into the country.”  However, Fernando warned that an additional incentive on a dollar remitted could cause inflation and the depreciation of the rupee.  “The Rs. 20 will incentivise people to send in more dollars, but we have to look at this from both sides. It is true that we have a dollar shortage so we need remittances, and therefore we need to bring the exchange rate to the market rate so that remittances will flow in. You can of course go one step further and give perhaps an additional Rs. 10 as an incentive, but then you have to look at how you are going to finance this incentive. For example, if we have monthly remittances worth $ 600 million, and the Government gives Rs. 10 per dollar, then it becomes Rs. 6 billion per month. For two months, it would be Rs. 12 billion. This money will have to be printed because the Government doesn’t really have the money and our tax revenue is not enough to even cover the interest payments of our debt. Additional printing of money will result in the rupee depreciating further,” he explained.  Fernando added that allowing the rupee to be valued at the market rate would ensure the flow of foreign remittances. “I think the rupee being floated will result in remittances coming in. As I see it, the incentive can cause other inflationary problems.”  He stated that while the extent of the further depreciation of the rupee could not be predicted and although costs may increase as a result of the depreciation, foreign currency inflows would help ensure that there were no shortages of goods and services. “I cannot predict how low the rupee will depreciate. I believe you have to let it float because we really don’t have reserves to back it up, and even if we had reserves, we shouldn’t have pegged it. Given the crisis that we are in – with people in long queues and power cuts due to the lack of dollars – there was a shortage of goods and services, which did more damage than if the rupee had been floated and certain product costs had increased.”  With regard to the black market, Fernando pointed out that the Government had limited options in controlling and curtailing its activities, as such transactions were carried out unofficially.  “There isn’t much the Government can do to curtail the black market. It can try bringing in certain measures but it is very difficult because these activities happen in a very informal way. Therefore it is very difficult to implement a crackdown.”  


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