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The falling Rupee and the economy

15 Jul 2021

  • Can we pull up the falling Rupee?
  • Politicians and economists share their two cents
By Sumudu Chamara The value of the Rupee – despite falling in almost all aspects – has at least risen to the top of discussion again, after widespread news that the Central Bank of Sri Lanka (CBSL) printed billions of Rupees, which caused controversy in both the political and economic arenas. Irrespective of the necessity, many viewed this as an unwise decision that is likely to cause inflation. Last December, the CBSL said that the increase in the volatility of the exchange rate at that time was unwarranted and unacceptable, and that among other measures, the CBSL was planning to take appropriate action to contain that volatility in the domestic foreign exchange market. Even though it expressed hope that the planned actions together with the import restrictions would enable the Rupee to appreciate soon, to go below Rs. 185 per US Dollar, as was observed in November 2020, the latest CBSL statistics state otherwise. The recent CBSL statistics show that despite occasional appreciation, the Rupee has largely been depreciating against the US Dollar, especially since January of this year. On 30 June, the Rupee depreciated to Rs. 201.13, even though it has now climbed back to Rs. 199.89. To look into the nature of the true impact of the Rupee’s depreciation on the country’s dwindling economy, we spoke to several persons knowledgeable about the situation.  The status quo and the Rupee’s value Advocate Institute Chairman and economist Murtaza Jafferjee explained the economic aspect of the fluctuation of the value of the Rupee: “The exchange rate is a price; no different from the prices for any other commodity. The movement of the exchange rate is determined by the confluence of demand and supply. So what has happened to date is that the Rupee has depreciated about 6.5%, which, relative to historic norms, is not a large amount. Actually, if you adjust for the average in the month of December last year, the depreciation is perhaps less than 6.5%, because we are taking the 31 December 2021 figure, which was perhaps artificially strengthened to dress up the balance sheet.” However, Jafferjee explained that the exchange rate alone does not reflect the pressure on the Sri Lankan Rupee – which is currently valued between about Rs. 198 and Rs. 202 to the dollar – because the free market is not permitted to operate. Jafferjee explained: “First of all, we imposed restrictions on imports, including vehicle imports, which have been curtailed for almost one year and four months; and certain other items have also been restricted. The inherent forces of demand and supply are not all being reflected in the exchange rate. Further, there have been restrictions on capital outflows, to the effect that any kind of capital being converted from Rupees to Dollars have been curtailed.  “Also, the holding of US Dollars in exporters’ foreign currency accounts, which are called business foreign currency accounts and personal foreign currency accounts, have been curtailed. Further, the other form of market intervention is through moral suasion. So, if there is a scarcity, then the price should be going up, in this case, causing the depreciation of the Sri Lankan Rupee.”  It should be noted that moral suasion, in this context, is when pressure is indirectly applied on individuals or businesses to act a certain way. Considering the Covid-19 situation, there are several options open for such pressure to be exerted on players in the market, even by those not on the topmost levels. However, Jafferjee noted that the bulk of this pressure is coming from the very regulator of the system. He noted: “However, the CBSL is exercising moral suasion, where they do not allow dealers in the interbank market to quote a price above some level, which I believe is currently at the upper end – about Rs. 200-203 – and where you need special permission to pay any customer above that line. Movements in current account debits and credits create supply and demand for foreign exchange – it does not necessarily have to be in US Dollars.  He further explained, another factor that plays into the management of the Rupee value is the other currencies that are being traded by Sri Lankan banks, and the value of those particular currencies against the dollar, stating: “The next channel that is creating flows is the balance sheet management of banks. So, all borrowings, deposits, and lending activity of banks does not necessarily take place in Rupees. Some of the activity, which may be in the range of about 10-15%, is in US Dollars.  “So there are some who borrow in Dollars. Perhaps the best example is the Ceylon Petroleum Corporation (CPC), where a significant amount of Dollar borrowings takes place – close to about a billion Dollars each from the Bank of Ceylon and People's Bank. There are also export companies who borrow in Dollars to finance working capital.” Thus, the pressure on the Rupee is a lot higher than what is seen in the exchange rate, according to Jafferjee, who added that since there is a shortage of Dollars, those who want to have access to foreign exchange are unable to get it from the banks – the banks simply lack enough dollars to disburse them to all parties. “If you go to a particular bank, and say that I would like to get a certain amount of money that you are legally entitled to, or if you want to pay for some import – unless you have a privileged relationship with the bank, you are not going to get the Dollars. So quite literally, the banks have to ration this scarce resource. Thus, what is happening is that a lot of trade activity is getting curtailed because of the shortage of Dollars.  “If the market was allowed to operate freely, what would have happened is that the currency would have depreciated. In the absence of a pricing mechanism, what is happening is that the banks are using some arbitrary methodology, which is not based purely on the price, to decide who will get the Dollars and who will not get the Dollars. This is not an ideal situation in a free market.” Again, we are reminded of how moral suasion takes place; although this is not what it is by definition, the “need” created from the topmost levels carries onwards to lower and lower levels – “possibly” resulting in long-term negative effects on the economy. Meanwhile, speaking of the status quo, economist and Sri Lanka Podujana Peramuna (SLPP) MP Prof. Ranjith Bandara said that even though many parties are raising questions about Sri Lanka’s situation, the prevailing economic situation is common to the entire world and that it is therefore, a global issue. However, the issue of the Rupee’s depreciation is unique to the Sri Lankan economy, and thus the solutions to this issue will depend on the context of Sri Lanka, according to Prof. Bandara. He also opined that the prevailing pandemic has created a political and financial crisis that Sri Lanka has had to deal with. For an opposing point of view, we also spoke to former Power and Energy Minister and incumbent Samagi Jana Balawegaya (SJB) MP Patali Champika Ranawaka, who has been vocal about the incumbent Government’s economic management during the pandemic. Adding that the depreciation of the Rupee is an issue that directly leads to many other issues, Ranawaka noted that Sri Lanka is currently on the path to a very serious economic crisis, which will cause political chaos as well. He is of the opinion that Sri Lanka should employ the talents of those who are capable of actually changing this situation. He further added: “The prevailing situation is a very serious problem, and the country is now having a very serious energy crisis as well because we do not have Dollars to buy fuel or fulfill coal-related needs. In fact, the main cause of the so-called ban on chemical fertiliser is also this scarcity of Dollar reserves the country has.  “We are now facing a looming energy crisis, because we do not have enough Dollars to pay for our energy needs – we need around $ 250 million each month to fulfill our energy and medicinal needs. We are having a kind of financial crisis, and there is looming bankruptcy, and we are now trying to obtain money from friendly countries.  “However, that will not solve the problem, and it is an extremely temporary measure. We should have a proper policy framework and a capable team to handle the economy in a transparent manner,” he said. Money printing and inflation Speaking further, Ranawaka alleged that it had been reported that during the last 18 months, the Government had printed around Rs. 1 trillion through the CBSL, and that in 2019, the former United National Front (UNF)-led Government had printed only Rs. 29 billion. He claimed: “This Government has printed around Rs. 1 trillion, and when it comes to debts, each citizen is being subjected to a share of Rs. 120,000. This is a huge problem for the country, and this Government is facing debts from both foreign markets and also from local markets through Treasury bills and Treasury bonds, among others.  “They can raise money; however, unfortunately, the local market is somehow quite reluctant to buy Treasury bills or Treasury bonds. So the CBSL was forced to buy their own Treasury bills, and its holding of Treasury bills has gone up to the 1 trillion mark. So, that is why we are saying that the present Government is printing money in an extraordinary manner.” Ranawaka expressed concerns that Sri Lanka will soon exhaust its foreign reserves, adding: “That is why the scarcity of Dollars, and the black market, is intensifying and illegal transactions are taking place. The black market is quite active. Although the Government is saying that the US Dollar rate is Rs. 202, we all can buy US Dollars from the black market for around Rs. 230.” Speaking of the same, Prof. Bandara, however,  professed his confidence that the Rupee will appreciate within two to three months, and that it will not depreciate further, adding: “The current Finance Minister Basil Rajapaksa is quite confident, and has mentioned that the foreign reserves Sri Lanka had in 2007 were just $ 1.5 billion. Currently we have around $ 4 billion in hand.” With regard to CBSL printing money, he opined that the CBSL can employ various policies and approaches to manage the value of the Rupee as well as goods and services, adding that there is nothing to fear of the status quo of such decisions or actions. He added: “It was not just about printing money and adding to the circulation. If there is inflation, the CBSL can apply various monetary policies. Also, people are concerned about inflation. Inflation is a natural phenomenon which has existed over the last 100-200 years.”  Pointing out the extent to which various demands play into the matter, he said: “Consumers’ expectations have gone up, and at the same time, the market has been diversified. Hundreds of new things have been added to our consumption basket. Not only the food we eat; during the pandemic, we have witnessed a 40% increase in the prices of various goods and services.  “We are lucky as Sri Lankans that we are managing inflation at a single-digit rate. Our local economy is strong enough for us to provide the basic needs, while going into different markets and looking for cheap commodities has given us a lesson over the last 73 years. Inflation and the depreciation of the Rupee could have both positive and negative impacts.” “Why do we look only at the negative impacts? Have we not witnessed that the export income has increased? When looking at the positive side of the current pandemic, one could see that there are a lot of opportunities which have not been exploited. It is an encouragement for the people to think twice about how we could get out of this mess and seek new opportunities.” The Rupee and Sri Lanka’s future Those who spoke with us also expressed their opinions about the future of the value of the Rupee and the economic aspects it entails, as well as what Sri Lanka can do to minimise the impact of the Rupee’s fluctuation against the US Dollar. According to Jafferjee, repaying foreign debts – which is something Sri Lanka has been able to manage thus far without a stain on its record – is one of the biggest challenges the country is facing that can worsen the prevailing situation, because we are facing an scenario that has been unprecedented in our history “The first issue we have to address is what we do about the debt servicing, because this problem is only going to get worse. Every year, Sri Lanka has to pay $ 4-5 billion worth of foreign debt. It does not seem like our rating is going to improve anytime soon, and the Covid-19 crisis is continuing. It is going to be very difficult, and almost impossible to earn our way out of this crisis.  “We now have to make a decision as to whether we are going to continue to service our foreign debt with a meagre resource of $ 4 billion, which is declining continuously. Also, we will probably have to think about restructuring some of the timings of these debt payments, which is called ‘re-profiling’. It goes without saying that we will have to go to the International Monetary Fund (IMF), because the IMF exists to address this kind of balance of payments crisis. We have been to the IMF 16 times before, and I do not think that it is going to make any difference if we go back to them for the 17th time.” According to Jafferjee, the Government being able to earn a proper income, especially through taxes, is a factor that can help make the situation better, if addressed. According to him, several measures adopted by the Government – which could be interpreted by many as being populist – are exacerbating the situation. In this regard, he stated: “We are not compressing imports through prices; we are compressing imports through import bans and restrictions and such. So one way to reduce this is by addressing the issue of many commodities being underpriced. Diesel, petrol, liquid petroleum, and milk powder are some examples. If we allow prices of certain administered commodities to reflect their true market value and tax them at an appropriate level, the country would benefit from them properly. “Although there has been a recent increase in the prices of petrol and diesel, the actual increase should have been at least another 20% more than what was increased. If these prices had been allowed to increase, so as to reflect their true scarcity and value in the world market, then this huge import pressure would be reduced.” Jafferjee also noted that the Covid-19 vaccination process is a priority in this situation, as it could expedite the reopening of the country’s economy. He explained: “If the economy opens, then import demand will also increase. But, hopefully, some of the exports which are being held back because our factories are unable to operate at full capacity will also kick in.  “Most importantly, the winter tourism season generally starts in November, and the tourism sector plays a massive role. If we can double vaccinate about 30-40% of the population, some of the restrictions can be lifted. The perception of Sri Lanka being a safer place to travel will improve, and in the next few months starting from November, which is the peak season for tourists, we will probably be able to attract a maximum of the tourists. That should hopefully improve our foreign exchange situation.” Expressing sentiments similar to those expressed by Jafferjee, Ranawaka also said that Sri Lanka has to fight the prevailing pandemic via scientific methodology. However, Ranawaka was of the opinion that Sri Lanka’s economic crisis is not a novel issue, even though it had intensified in the recent past – due to the pandemic – and noted that curtailing unnecessary expenses is one way of managing the situation. “We are now experiencing things Lebanon experienced, and what has happened in Greece for the last 10 years in the time to come, is going to befall us. Therefore, we should refrain from spending money unnecessarily, such as spending money for mega projects, which do not have a proper return on investment (ROI).  “In the meantime, the Government’s expenditures also have to be curtailed and corruption should be dealt with severely. On the other hand, the Government should improve its income levels. At the same time, we must ensure welfare security for the poor, because the pandemic has created a new poor class, and we have to protect them.” Even though those who spoke with us expressed differing and sometimes contradictory opinions, they all agreed on certain steps Sri Lanka should look into, including increasing the State’s revenue, expediting the vaccination drive, and considering less strict ways to continue to repay loans. The CBSL and the Government have assured that the country will meet its debt obligations regardless. However, what the public needs is assurance through actions, over words. Irrespective of the mechanism the Government is planning to employ to address the situation, amidst declining foreign reserves, it is evident that more measures need to be taken besides merely printing money.    


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