By Mandana Ismail Abeywickrema

Whether the Central Bank's decision to permit limited depreciation of the rupee alone would be sufficient to increase the competitiveness of local exports in a slowing global economy has been questioned by analysts.

According to analysts it is inadequate to permit the depreciation of the rupee by 2% when neigh- bouring India has allowed its currency to depreciate by 20%, so as to increase the country's competitiveness in the foreign export market.

It has been pointed out that India has allowed its currency to depreciate at a 20% level while holding foreign reserves amounting to almost US$275 billion.

Limited depreciation - CB

The Central Bank last week announced its decision to permit "limited depreciation of the Sri Lanka Rupee."

The bank stated, "a limited depreciation of the Sri Lanka Rupee has been permitted so as to enable the real sector to maintain Sri Lanka's export competitiveness across all export and import competing industries."

The rupee last week declined to Rs.111 against the US dollar which is the lowest recorded by the rupee in the last 10 months. The rupee, till the Central Bank decision, had been trading at Rs.108 to the dollar.

The depreciation, as pointed out by economists is not enough and the artificial hold on the currency is not appropriate, they said. "With falling demand competitiveness should be increased."

The Central Bank stated that its decision was made "Considering the recent sharp decline in export prices, prospects of lower export demand due to a likelihood of further slowing down in the global economy and the recent sharp appreciation of the US dollar against most major international currencies, the Central Bank of Sri Lanka has decided to allow the rupee exchange rate against the US dollar to respond with greater flexibility, when compared to the very stable level that was maintained during the recent past."

Added support

According to the Bank, this move is particularly necessitated by the fact that the currencies of some of Sri Lanka's major trading partners and competitors, have, since mid September 2008, depreciated sharply against the US dollar leading to some pressure on the competitiveness of Sri Lanka's exports. "While Sri Lanka's export sector has been growing well above 12% during the first eight months of 2008, and has shown commendable resilience in the light of the current, unfavourable global conditions, it is now considered desirable that an added support be granted in order to provide the impetus for the exports to remain competitive in the months ahead," the Bank said.

Help contain inflation

The Bank also said the envisaged limited depreciation is also timely since it will not adversely affect the declining trend in Sri Lanka's inflation as global prices of petroleum, gas, wheat, sugar, milk powder, etc., are declining and this trend is expected to continue during the next few months as well. "In addition, the move will help to contain inflation in the medium term, since there would be a lesser likelihood of higher fiscal deficits in the medium to longer term, as this measure may reduce the need to provide fiscal subsidies to the export sector." 

Analysts however feel that the Bank's move was not enough and said that this is the ideal time to permit the depreciation of the rupee as it would not increase import inflation due to the declining commodity prices.

Economist, Dr. Harsha de Silva said that the Bank's decision to hold on to the dollar at Rs.107 was a bad decision.

"Exports started to fall and the trade deficit ballooned within the first eight months," he said.

He explained that although there was a lot of pressure on the rupee for it to depreciate, the Bank did not allow it.

The rupee has been relatively stable for most part of this year due to a combination of inflows from syndicated loans, remittances and foreign investment in Treasury securities that were even opened to foreigners.

Prevented appreciation

The bank prevented the appreciation of the rupee in the first eight months of the year by buying US$ 622 million worth of dollars in the market and later switched its position in mid-September and began protecting the rupee.

"When all other currencies were falling the rupee remained at the same level. The Bank sold dollars to hold the value," he said.

Dr. de Silva added that the Central Bank by introducing limited depreciation and introducing exchange controls was not helping Sri Lanka to remain competitive.

"If the rupee is over valued than the competitors, how can Sri Lanka compete?" he questioned, adding that the bank did not have the power to control the rupee.

The Bank also stated last week that in order to ensure the financial market stability, the Central Bank stands ready to provide liquidity to maintain stability of the exchange rate if the rate tends to be more volatile than warranted. "Further, as in the recent past, the Central Bank will continue to monitor developments carefully and respond promptly with timely interventions in order to ensure economic stability, and to mitigate the impact of any external shocks arising from turbulence in global financial markets."

Market unsettled

Soon after the Bank announced its decision several currency dealers were reported by the media saying the policy change was a long overdue correction, but that the sharp fall to Rs.110 had unsettled the market.

It was also reported that there was panic among importers in forward booking, while exporters cancelled their bookings. "A two-rupee depreciation in a day is too much for a market like this," the dealers have reportedly said.