By Our Special Political Correspondent
Both Central Bank Governor Dr. Indrajit Coomaraswamy and Finance Minister Mangala Samaraweera yesterday treading on very dangerous ground warned of a tendency of a further rupee depreciation against the US dollar within the next few weeks. Immediately the cost for forwards for foreign currency swaps went up by 20%.
To many of us it reminded us how President D.B. Wijetunga got up one morning and announced that the two State banks were insolvent. Immediately, there was a run on the two State banks.
When both the Finance Minister and the Central Bank Chief publicly say we cannot defend the rupee, two things happen immediately. Foreigners invested in rupees immediately look to bail out and locals having USD oversees don’t want to bring their dollars back and look to convert their rupees to USD. Overall it ends up in a disaster for the economy.
We all know not only the Sri Lankan Rupee but also currencies of most Asian countries had depreciated during the recent past. The Sri Lankan Rupee has depreciated by 8%, while the Indian Rupee has depreciated by 13%, the Pakistan Rupee by 12% and the Indonesian Rupiah by 9%.
Unfortunately for Sri Lanka, we are a small economy with a $ 90 billion GDP, unlike the other three economies that have export income more than our GDP. We all know the value of the rupee is determined by the foreign exchange market and primary determinants of the demand for currency are import and export of goods and services.
All this chaos has disrupted the business of importers. Exporters also waste time in speculating, instead of making longer-term plans. They will borrow to keep dollars out, crowding out other businesses. Today for most companies their business plans and costs budgets have been disrupted.
The Government to control the outflow of foreign currency has imposed a 100% cash margin requirement for LCs on non-commercial vehicles with immediate effect. While the imposition of minimum tax on vehicles less than 1,000 cc and market determinant fuel price formula has been successful in curbing excessive import growth so far, the taxes of luxury vehicles still remain the same.
What is alarming is, a falling rupee will push up prices and kill purchasing power and economic activity. It seems increasingly unlikely that the 6.25% overnight rates seen in 2014 may ever come back. But we need to have a rate cut to boost growth. When the credit cycle turns, economic activity picks up.
Of course there are many other factors that can drive economic activity in the short term. Business confidence is one. In well-managed countries, interest rates have been moving up, but growth is also there. Singapore’s and the US short-term rates have been steadily moving up. Singapore does not have a policy rate. It manages to grow without ‘rate cuts’.
Ours is, however, very different; the Central Bank needs to find a way to create a buffer in the exchange rate, because there is now regular capital flight from time to time. The US will no doubt continue to raise rates, making the dollar more and more expensive to us. This buffer has to be done, even if we are not prepared to defend the rupee publicly.
Sri Lanka has a small domestic production base of tradable goods relative to their level of consumption, and the dollarisation of domestic debt increase the probability of a financial crisis. Unfortunately for Sri Lanka, majority of its external liabilities consists of sovereign debt.
The political situation is also not helping our overall effort to create economic stability in the country. With President Sirisena taking pot shots at Prime Minister Wickremesinghe on a regular basis, business confidence has taken a heavy beating.
GDP is likely to grow at 3.7% in 2018 despite below-trend growth and mid-single digit inflation. This is however against a five-year average of 4.2%. The President, who is increasingly showing a willingness to contest the next presidential election in 2020, may after the Budget weed out the economic pundits managing the economy who have messed up and put his own to team to manage the economy, to give him an outside chance to become the common candidate once more.
He has publicly criticised the effort of the UNP so far and even threatened action against Wickremesinghe’s cronies. He has publicly criticised the performance of the two State banks for dolling out money, especially to a builder with close connections to a UNP Minister.
On the other hand the Joint Opposition (JO) led by Mahinda Rajapaksa is also plagued with big problems. The public protest held recently was a disaster by their standards. Basil Rajapaksa has publicly expressed his displeasure for staging a poorly-planned protest. The honeymoon for the JO is clearly over. There is clearly now resentment for another Rajapaksa within their ranks. This is how democracy actually works.
However, what this country needs are good laws, strong institutions and political leaders who abide by the limits, however unwillingly, to protect Sri Lanka from sudden external shocks that causes economic hardships for the poorest of the poor.