What Happened To The Rupee?
A little more than a month ago the rupee was doing fine. Ticking along at a nice pace of about 110 ish. The subsequent move to 115 shocked a few people, but in true Sri Lankan fashion, we put up and shut up about it and just moved on with our lives. After the sudden hike in petrol prices and the dollar skyrocketing to 124 rupees however, even the most cynically stiff eyebrows in the country raised in consternation.
A higher dollar is going to limit all those luxury imports, and the not so luxury ones too. Fuel for one thing. And all those imported items you see in supermarkets for another. Cornflakes, chocolates, ice cream etc etc. Online shoppers are going to find it harder to buy things they like, and inflation is going to gradually pick up as markets start reflecting the cheaper rupee in commodity prices.
Many greeted the devaluation of the rupee with shock. They weren’t expecting this. Where did it come from? Why did the government do this overnight? What in blue blazes is going on?
But was it really so shocking? Actually, it shouldn’t have been. For one, things were boiling up to this point for a while now, and for another, the government should have been way less abrupt in their decision to float the rupee. But of course, as all Sri Lankans like doing, they left it until the very last minute.
In economics we have what is known as the impossible trinity. Interest rates, exchange rates and inflation cannot be kept favourable at the same time. If you try to keep them all low, somewhere some pressure is going to build up and the dam will pop. The Central Bank has long been propping up the rupee. They did this by selling dollars, buying rupees and keeping the rupee demand high, and keeping its price at somewhere around 110 per dollar. In the meanwhile, they also lowered interest rates, facilitating large amounts of imports into the country. The imports dwarfed the exports and put a lot of pressure on the exchange rate, and it got harder and harder to keep propping it up.
In the meanwhile, a policy conflict developed between P.B. Jayasundera and the Central Bank. Jayasundera wanted the rupee to be devalued because he thought the price was too artificially high. This political uncertainty and lack of credibility drove would be investors to reconsider investing in Sri Lanka. Spooking the much needed forex (that was used to prop up the rupee) from coming in to the country. This essentially fulfilled the treasury secretary’s prophesy; the rupee had to be let go.
That, however, is not to say that the rupee devaluation is the treasury secretary’s fault. Many economists have been maintaining for a while that the rupee should have been eased. The central bank’s intervention couldn’t go on forever. The large amounts of imports resulting from the low interest rates coupled with the cheaper rupee was causing a lot of pressure on the country’s Balance of Payments, or BOP. The BOP is basically the status of a country’s financial dealings with the rest of the world in a given period of time. And if we owe much more money that we are taking in, as it happens when exports are dwarfed by imports, it is generally not a good sign.
Will this situation last forever? Analysts favour both sides of the argument. Some say it’ll skyrocket on past 130, while others believe it will stabilise around 117. The bottom line? It’s hard to say. If Sri Lanka continues to get more foreign inflows via stock market investments and FDI (a Malaysian entity just bought a Rs. 14bn in JKH for instance) the Rupee might rise in value. But If capital flees the country for some reason like another global crisis or local political uncertainty the the rupee could devalue even more. The fuel prices are also a primary concern, and have increased due to international speculation on the Iran issue. If the iran issue escalates globally then Sri lanka will be in a bit of hot water (or should i say hot petrol?) because we are highly dependent on Iranian oil. This is not an entirely inviting prospect to the Rupee or the economy as a whole, but this issue probably warrants a column of its own.