At what value of rupee would CB think it needs to stop depreciation? At 200 or 250 or 300?

A Response from Ajith Nivard Cabraal, former Governor of the Central Bank


In Aesop’s Fables’ "The Fox and the Grapes", the fox, when it finds that it is unable to reach the grapes it is seeking, claims that the "grapes are sour", and hence it’s not worthwhile reaching for them.

In Sri Lanka today, the Central Bank, when it finds that it does not have sufficient Forex reserves to defend the rupee and maintain the international stability of the country’s currency, claims that intervention in the Forex market is not advisable.

In response to my article on the government and the Central Bank abdicating their duty to support the rupee, the Central Bank, by its statement of 10th October 2018, has gone to embarrassing lengths to downplay their current inability to defend the Rupee. The Bank has also indirectly suggested that the depreciating rupee is not detrimental to the economy or the country. In fact, the Bank seems eager to project the view that a drastically weak rupee would help achieve the government’s single-most important mission of improving the "percentage of Merchandise Exports to GDP", even if the attempt to achieve that goal could lead to the crash of all other macro-fundamentals.

All knowledgeable analysts know that the real reason for the Central Bank’s "sour grapes" claim is because it has exhausted its "free" reserves, and does not now have any "spare" Forex that could be supplied to the Forex market to stabilize the currency. That is simply because the Central Bank has not built up sufficient Reserves in order to be ready to meet with such situations, as was done during the period 2006 to 2014, when Reserves were increased by 3 times from USD 2,735m to USD 8,208m.  

In the 8 months up to August 2018, the Central Bank absorbed Forex amounting to USD 547m from the Forex market, while supplying USD 434m to stabilize the exchange rate. Thereafter, in September 2018, the Bank supplied a further USD 298 million out of its official international reserves to the Forex market in a desperate attempt to stabilize the exchange rate. The External Sector Performance Report of the Central Bank issued on 8th October 2018 also confirmed that the Central Bank "intervened" in the Foreign Exchange Market to curtail "volatility in the exchange rate". Against that background, it is simply amazing that the Central Bank has now claimed on 10th October 2018 (2 days later), that "the Central Bank has increasingly realized that efforts to artificially stabilize the exchange rate extensively by supplying foreign exchange out of its official international reserves have only worsened Sri Lanka’s macro-economic conditions and medium term prospects". A truly remarkable about-turn in Central Bank Exchange-Rate Policy, based on a sudden "realization", after intervening in the Forex Market continuously for 22 years from 1996 to September 2018!

If the Bank truly subscribes to what it says in its October 10th statement, such policy stance suggests that it would now be willing to allow the rupee to slide towards any value against the USD. Needless to say the implementation of such an ill-advised policy would cause serious panic amongst investors which could be highly damaging to the economy as it would soon cause the cost of living to rise, public debt to balloon, businesses to collapse, unemployment to escalate, business confidence to plunge, bank and finance company NPL’s to sky-rocket, as well as lead to a host of other disastrous outcomes.

As is already known, a State Minister who is regarded as the key Economic Guru of this Government is already on record as having said that the rupee depreciation is "beneficial". The Finance Minister has said he does not want the rupee defended. Now, judging by the enthusiasm of the Central Bank to justify the recent massive depreciation of the rupee, the Central Bank has firmly confirmed that its policy stance is now not to intervene in the Forex market in order to stabilize the rupee, which further suggests that it is quite comfortable to leave the Rupee value to be decided by other forces.

In such a scenario, stakeholders of the Sri Lankan economy cannot surely be faulted if they were to expect the current rampant depreciation of the Rupee to continue unabated, as well as harbour anxieties that the rupee could soon reach Rs.200 per USD or Rs.250 or who knows, even Rs.300! The government and the Central Bank certainly does not seem to care or have any answers!

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