On the last day of February, Bloomberg reported that the Sri Lankan Rupee was the third best performing currency in the world so far in 2024, with a gain of 4.4%. It had gained further by 7 March as the buying rate of the US Dollar fell below Rs. 306.
However, such fluctuation was seen in 2023 as well, when the dollar fell below Rs. 300 in May due to the low outflow of foreign currency from the country with most import restrictions still in place.
In 2024, however, the situation is different. All import restrictions, except on motor vehicles, have been lifted and the monthly import bill has been slowly surpassing $ 1.5 billion as of January. Although the rupee continues to appreciate, there has been minimal change in the cost of living as prices of essential goods still remain at the same levels.
Improved tourism and remittance inflows push rupee up
Speaking to The Sunday Morning, Softlogic Stockbrokers Co-Head of Research Raynal Wickremeratne said that among the reasons for the current appreciation of the rupee was the strong inflow of tourism and tourism spending witnessed in the last couple of months.
He added that when compared to last year, tourism arrivals had increased by over 100% on a Year-on-Year (YoY) basis in the first two months of 2024, while tourism spending had also increased significantly with the increase in prices.
According to Central Bank of Sri Lanka (CBSL) data, tourism arrivals in the first two months of 2024 increased by 103% compared to the corresponding period in 2023, with 426,603 arrivals, while earnings increased by 118% to $ 687.5 million.
Moreover, Wickremeratne said that foreign remittances, which were down to $ 270-300 million per month 18 months ago, had now increased to $ 500 million per month consistently, providing more inflow to ease exchange rate pressures.
“Basically, foreign earners such as tourism and remittances have been improving continuously over the past year. Over that period, we haven’t seen the completion of debt restructuring in order to allow Sri Lanka to commence repaying its loans,” he said.
However, Wickremeratne also noted that the current rupee appreciation was a relatively temporary easing, and with a floating policy adopted for the exchange rate, it would see small fluctuations of this nature in future as well.
He added that this could not be viewed as a major economic improvement. “We don’t expect this appreciation to continue much further. Realistically, we view this more as a temporary phenomenon and will not change any long-term forecasts based on it either,” Wickremeratne said.
Further, commenting on Sri Lanka’s plan to obtain a debt moratorium until 2027, he said that if creditors agreed to such a moratorium, then the Government could not justify any import controls. “Once we lift the import controls, including on motor vehicles, pressure will be placed on the currency,” he said.
He noted that the International Monetary Fund (IMF), Asian Development Bank (ADB), and World Bank funds that would come at different periods of the IMF programme would contribute to providing dollars to the market.
With the appreciation of the rupee, he added that importers may use the opportunity to import goods as improved consumption in December 2023 had provided them sufficient cash in hand, which could be used to import again when the rupee had further appreciated.
According to Wickremeratne, consumption picked up in December 2023 due to the festivities, an increase of remittances, and people attempting to purchase goods prior to the Value-Added Tax (VAT) hike implementation from January onwards.
Speaking to The Sunday Morning, a debt analyst who wished to remain anonymous said that it was unlikely that creditors would accept a moratorium for Sri Lanka until 2027.
Speaking in Parliament on Wednesday (6), President Ranil Wickremesinghe said that Sri Lanka hoped to secure temporary relief from servicing external debt for the period between January 2023 and December 2027 from the ongoing external debt restructuring, hoping to resume its debt repayment from 2027, which would continue until 2042.
“I am not sure whether they will accept that practically, and even if they do, we need to ensure that the country is properly run,” he said.
Low import demand due to stockpiling
Speaking to The Sunday Morning, First Capital Chief Research and Strategy Officer Dimantha Mathew said that most importers had imported goods prior to the VAT hike in December, ensuring sufficient stocks for the next three months.
“There were excessive imports in November and December, sufficient for January, February, and March,” he added.
Mathew added that there was a very low demand in the system, with overall economic activities having slowed down. He noted that companies with consumer demand had observed a significant slowdown in demand with the VAT hike implemented in January.
According to the CBSL, the value of imports gradually increased from $ 1.38 billion in November 2023 to $ 1.48 billion in December 2023.
However, Mathew added that with the appreciation of the rupee, costs would decrease in the local market as already witnessed in fuel prices, where the price of 1 litre of octane 95 petrol dropped by Rs. 9 alongside a Rs. 10 reduction in the price of 1 litre of super diesel. He said that the appreciation cycle would end with demand picking up again, placing pressure on the exchange rate.
He further noted that with electricity price reductions, anticipated wage hikes, and decreasing interest rates, which would reduce the finance cost, disposable incomes would improve.
“When disposable income increases, we will see a gradual recovery in the economy and a rise in economic activities which will lead to more consumer demand and more imports,” he said, adding that since Sri Lanka was a net importer, the currency would see a slight depreciation with rising demand.
Mathew also predicted that the current trend of rupee appreciation would continue until the end of the first quarter, with demand being seen in the market again in April.
Global commodity price increase negates rupee benefits
Speaking to The Sunday Morning, a market analyst from a leading investment firm in Colombo said that the benefit of the rupee appreciation would reduce prices in the near term.
However, he added that prices of commodities had increased in global markets. For example, he noted that sugar prices had risen by 25% in the global markets so far in 2024, potentially causing the rupee appreciation to be negated, resulting in no significant reduction in the prices of sugar.
Moreover, he said that while importers had sufficiently stockpiled goods for the first quarter, people were not buying non-essential goods, which had led to low import demand so far in the year, resulting in the appreciation of the rupee.
Rupee forecast for 2024
According to the market analyst, consumer demand is expected to pick up in the second half of the year while the electricity tariff revision will result in people consuming more power.
He forecast the dollar to be at Rs. 335 at the end of the year after stabilising at around Rs. 310-315 mid-year. Meanwhile, First Capital expects the dollar to be at the Rs. 320-330 level mid-year and reach the Rs. 320-340 range by the second half of the year.
Mathew said that the arrival of about $ 1 billion in pledged loans from India and Japan following the completion of debt restructuring would help stabilise the currency towards the end of the year, should the loans arrive within 2024.
Softlogic Stockbrokers expects 5-10% fluctuations either way in the currency from a baseline of Rs. 320 per dollar. Wickremeratne said that the rupee may become stable with minor fluctuations in the range of Rs. 320-360 per dollar, while clarity on debt restructuring would immediately push rates down.
Domestic forex market should be developed
Speaking at the ‘Global Research Briefing Economic Outlook 2024’ organised by Standard Chartered on Monday (4), CBSL Governor Dr. Nandalal Weerasinghe said that the domestic foreign exchange market needed to be developed and deepened further so that there could be instruments that would allow exporters, importers, or anyone engaged in foreign exchange-related business to hedge their exposures from the market.
He said that market players should be allowed to be more active and provide services and hedges for people engaged in business with banks.
Dr. Weerasinghe noted that the current exchange rate policy was based on a flexible exchange rate under the inflation-targeting regime and that the exchange rate had to act as a shock absorber in relation to external shocks.
He added that the policy would also help build up reserves at the CBSL to meet any excess shocks, so that the bank had a sufficient foreign exchange position to smoothen out the volatility.
“Because of the compressed demand, the import demand is not picking up yet, but as a result, tourism and remittances are doing well and exporters are obviously doing reasonably well compared to what we thought. Accordingly, there is a pressure for the currency to appreciate,” he said.
However, the Governor said that the CBSL was intervening heavily to prevent appreciation and that it was not a 100% market-determined exchange rate: “We have been using this opportunity to build up our positions, which is why we think we are already above $ 4.5 billion (in reserves).”
According to the CBSL, official foreign reserves stood at $ 4.517 billion at the end of February.
“We keep building up our positions and preventing sharp volatility and further appreciation, but we need to allow some kind of adjustment in the market,” Weerasinghe said, adding that any institute could have their projections on the exchange rate but that the Central Bank did not have any such projections.
“I don’t think anyone can expect the exchange rate to appreciate continuously or be fixed at a certain level,” he said.
Oligopolistic market does not pass benefits to consumers
Speaking during an interview with TV Derana on Thursday (7), State Minister of Finance Ranjith Siyambalapitiya said that although the value of the dollar had dropped from the Rs. 365 level to Rs. 308, there was a problem with the people directly benefiting from it.
“In a free market, even if one manufacturer does not lower prices, others will lower prices due to competition, but the Sri Lankan market is built on an oligopolistic structure where the manufacturers have an agreement among themselves,” he said.
He said the Sri Lanka market had a different type of monopoly which operated in a very different manner to that of the open market.
“It is more cruel than the open market system, where there can be certain shortages,” he said, adding that sellers and manufacturers sold goods claiming they were old stocks without passing the benefit onto the consumers, with the characteristics of such a market being to maximise profits.
Importers cannot pass on benefits due to supply chain costs
Speaking to The Sunday Morning, Ministry of Trade, Commerce, and Food Security Secretary A.M.P.M.B. Atapattu said that the reduction in prices of goods could be expected only in relation to those which were imported with the rupee appreciation.
He said that although prices of imported food items such as potato, onion, and dhal had come down, with importers passing the benefits to the consumer, the extent of the price drop was not in line with expectations.
He said that as the goods were passed along the supply chain from the wholesaler to retailer to consumer, with the cost involved along the supply chain, there was no significant reduction in prices seen so far in imported goods.
According to the CBSL, the retail price of 1 kg of imported big onions at the Pettah market stood at Rs. 400 as of Thursday (7) compared to Rs. 450 a week earlier, while dried chilli and dhal prices remained unchanged at Rs. 1,000 per kg and Rs. 320 per kg, respectively.
However, he said that a programme would be launched targeting the Sinhala and Hindu New Year, where prices at Sathosa outlets would be reduced to ensure competitive prices in the market.