By Mandana Ismail Abeywickrema

With calls from the export sector to devalue or permit the depreciation of the rupee against the dollar for the sector's survival in the international market, on the flip side the import sector has expressed concern over the possibility of huge price increases in essential commodities if the government decides to allow devaluation of the rupee.

The decline in the country's foreign reserves has further compounded the situation with the government being unable to devalue or allow the depreciation of the rupee against the dollar in line with market forces.

However, the government has so far claimed it has no intention of either devaluing or allowing the depreciation of the rupee due to the impact it would have on the country's imports and has also said the position of the currency should be determined by market forces.

Exporters claim that the Central Bank's intervention to peg the rupee at various levels has had an adverse impact on the export sector.

According to exporters, if the currency is allowed to depreciate in line with the market forces, the export sector could be competitive in the international market.

Expressed concern

Exporters have expressed concern over the Central Bank's intervention to stabilise the rupee against the dollar due to its negative impact on the export sector.

"The fact is that we lose competitiveness. When the cost increases, the buyers are hesitant to purchase," exporters said.

Members of the export sector have also highlighted the need for a stable mechanism to be put in place to reflect the market forces.

Secretary General, Joint Apparel Associations Forum (JAAF), Rohan Masakorale explained that had the government allowed the rupee to depreciate gradually in line with market forces, the impact of a sudden depreciation could be minimised.

However, due to the government's short-term borrowings from the international market, the rupee that was depreciating against the dollar began to appreciate. The last few months saw the rupee pegged between the levels of 107 and 108 against the dollar.

According to Masakorale, the situation would see a change once the short-term borrowings and the oil bills are paid back.

He pointed out that the rupee has seen a depreciation of about 5% during the last two to three months.

He notes that the sudden ups and downs in the rupee value was indicative that there was no free depreciation and that market forces were not allowed to take their course.

"The rupee according to current market forces should be around 135 against the dollar, but we could even manage if it is 120 against the dollar at present," Masakorale said.

Depreciation of the rupee

Exporters have called on the government to allow market forces to determine the depreciation of the rupee.

The solution now they say is to allow the rupee to first depreciate to a level of 120 against the dollar and then permit a gradual depreciation of the rupee while discouraging the import of non essential items.

However, the Central Bank would not be able to sustain the sudden depreciation of the rupee, it has been pointed out.

Masakorale said that there was a clear intervention of the Central Bank in the foreign exchange market. The rupee that was pegged at 108 against the dollar increased to 113 in a short period. However, analysts note that if the real effective rate was in place, the rupee should be at around 135 against the dollar at present.

Masakorale observed that the export sector in the country was currently facing serious issues due to the Central Bank intervention in holding the rupee at current levels.

The pressure felt by the export sector in the country would undoubtedly be felt by the government in the days to come.

Countries in the region like India and Bangladesh have so far allowed the gradual depreciation of their currencies.

While the exporters continuously call for the depreciation of the rupee according to market forces, the import sector of the country has voiced a different opinion.

Adverse impact

Importers have voiced their disapproval over the request made by exporters claiming there would be an adverse impact on the import sector if the government were to devalue the rupee.

According to importers, consumers would be directly affected by such a decision due to the price increases in many essential items and the cost of living is likely to soar.

"Prices of commodities like sugar, dhal and wheat flour, which are imported to the country, would increase if the rupee is devalued," importers said.

They say that the positive market conditions experienced currently due to the decline in global commodity prices would be lost if the rupee is devalued.

"Even the country's oil import bill that has seen a decline in the recent months would see an increase once again," importers warned.

Meanwhile, President Mahinda Rajapakse has ruled out devaluation or the depreciation of the rupee to levels in keeping with other countries due to the impact on import costs.

Sri Lanka Tea Board Chairman, Lalith Hettiarachchi had reportedly said at a recent meeting, the President had explained that it was not possible to devalue the rupee to the levels that other countries have devalued their currencies, because of the impact on the import bill.

Solution to the problem

Trade and Consumer Affairs Minister Bandula Gunawardena said that the government's solution to the problem was to follow market forces. He says that lobbying by the export and import sectors cannot determine the position of the exchange rate as it is impractical.

The position of the rupee according to him should reflect the supply and demand situation.

He explained that artificial devaluation of the rupee was a proposal by the International Monetary Fund (IMF) to solve any foreign exchange issue, but was now an outdated formula.

According to Gunawardena, the J.R. Jayewardene government on November 15, 1977 artificially devalued the rupee to boost the export market.

The answer to the problem as noted by Gunawardena is to allow market forces to determine the position of the rupee. He said that while Sri Lanka followed a 'guided market exchange rate,' the Central Bank intervenes when certain elements in the foreign exchange market try to artificially change the market conditions.

"We do not have an open capital account, we only have an open current account when you take balance of payments," he said.

Decline in foreign reserves

However, Gunawardena admitted to a short-term decline in the country's foreign reserves due to the payment of high fuel import bills made a few months back and the outflow of dollars from the country during the onset of the global recession.

He said that the Central Bank has already taken steps to solve the crisis within the next few months.

The solutions adopted by the bank include the selling of Treasury Bills to Sri Lankans living overseas, the increase of interest rates for NRFC accounts and the money that would flow in to the country through new investments.

According to Gunawardena, an increase in the country's foreign reserves would prevent any need for the rupee to be devalued. He said that the rupee has been allowed to depreciate according to market forces.

Referring to the currencies of other countries in the region, especially India, Gunawardena said that even the Indian authorities did not artificially devalue the currency but allowed market forces to determine its position.

Rupee was devalued

The first time the rupee was devalued was in 1977 during President J.R. Jayewardene's tenure in office. The rupee at the time was devalued by then Finance Minister Ronnie de Mel. The rupee that stood at 8 to the dollar was devalued overnight to 16 to the dollar.

The next instance was in 2000 when the rupee was allowed to free float during President Chandrika Kumaratunga's tenure.

The then PA government announced that it would let the rupee fall against the US dollar in a bid to boost the country's exports.

The devaluation of the rupee came when an increase in defence spending was experienced, as the government sought to bolster the armed forces in the war against the LTTE.

"The Central Bank has now decided to allow the market further freedom to determine the exchange rate . . . the spread between its buying and selling rates for the US dollar will be widened to 5% (from the earlier 2%)," the Central Bank of Sri Lanka said in a statement in 2000.

Then Central Bank Governor A.S. Jayawardena told journalists he expected the rupee to lose up to 4% of its value.

"We consider this to be a desirable band which will help stabilise economic activity. Exporters will gain. We expect the balance of payments to improve by around $150 million."

Analysts said the announcement followed increasing pressure on the currency as a result of the worsening balance of payments situation.

While defence expenses increased in 2000, exports saw a steady decline, leaving the government with a trade deficit of nearly US$ 2 billion.

Sri Lanka had an overall balance of payments gap of US$ 263 million in 1999 and a current account deficit of US$ 495 million.