Sri Lanka is set to institutionalize a ‘flexible’ exchange rate regime instead of a floating exchange through the central bank while continuing ‘flexible’ inflation targeting regime.
Countries with successful inflation targeting frameworks, such as New Zealand, Australia or the UK, have a floating exchange rate, where base money is not altered through pegging in either direction, or reserve money is backed by domestic assets.
However Sri Lanka will continue with an intermediate managed exchange arrangement, or a soft-peg which is called a flexible exchange rate.
Interest rates have been increased by 1 percent on the behest of the International Monetary Fund (IMF) and an inflation target will be set in consultation with the finance ministry.
The Central Bank on Friday 04 declared that the country would pursue a flexible exchange rate policy from this week in line with recommendation of the International Monetary Fund (IMF).
The move entails the removal of the trading band and variation margin and letting the market (demand and supply) determine the rate.
The CBSL will also suspend the mandatory forex sales requirement of banks. The latter was reduced to 15% from 25% earlier this week.
However other requirements such as 100% repatriation of export proceeds and conversion will continue.
The CBSL has been widening the trading band of dollar this week to give more leeway for the forex market.
CBSL expanded the daily trading band to +/- of Rs. 5 from Rs. 2.60 previously. Thereafter it was increased to Rs. 7.50 on Thursday and to Rs. 10 yesterday. This will be done away with from next week.
CB Governor Nandalal Weerasinghe revealed that last week the CBSL absorbed a recent time record US$ 308 million from the market thereby checking a sharper appreciation of the Rupee.
The Rupee had appreciated by nearly 5%. He said that CBSL will accept the 15% mandatory forex sales by banks on Tuesday and desist from such a move thereafter. HoweverWeerasinghe said that CBSL will remain in the market to buy or sell Dollars if and when needed to bring stability in the event of extreme volatility.
He said by absorbing $ 308 million, the money market has benifitted from an additional liquidity of Rs. 108 billion. “This week the forex market began to be active as before with participants having extra options of spot and forward contracts as opposed to swaps only,” CBSL Chief said.
“Going forward we expect both forex and money markets to be active as before. We are happy to see this development especially the former following stabilization measures earlier on and a pick-up in forex inflows and availability,” Weerasinghe added.
