By Dr Asanka Wijesinghe
On 08 March, Sri Lanka devalued the rupee against the US dollar, entering into a floating exchange rate regime. The Central Bank of Sri Lanka had to abandon the pegged exchange rate as defending the rupee with dwindling reserves was impossible. The inter-bank exchange rate shot up once the banks were assured that the exchange rate was floated. The initial shoot-up was followed by further rallying of the US dollar reaching close to Rs. 300 per USD. With the gradually weakening rupee, inflation is also ascending to worrisome levels calling for radical changes, including adopting a currency board. This article discusses the effectiveness and suitability of a currency board for Sri Lanka in the current macroeconomic context.
Weakening Rupee, Rising inflation, and the
Currency Board Solution
A currency board is a system that issues domestic banknotes in exchange for specific foreign currency – anchor currency like the USD which is used for trade with partner countries – at a constant rate. A cornerstone of the currency board mechanism is the authority’s ability to meet all demand for foreign currency by the holders of the domestic currency.
In Sri Lanka, even after the rupee was floated, reports suggest that an active kerb market with a significant premium above the inter-bank rate exists. While such market behaviour indicates an acute dollar shortage in the market and the equilibrium rate is further away, no official data exists on the kerb market money exchange. However, cryptocurrency platforms provide some critical insights. The Tether coin (USDT), which is closely pegged to the US dollar on a one-to-one basis, is traded for rupees on peer-to-peer (P2P) platforms as USDT is used as a medium to purchase other cryptocurrencies, including Bitcoin.
Data extracted from the P2P platform medium of Binance – a popular cryptocurrency exchange among Sri Lankans – show some supporting evidence for the continually widening gap between official and informal rates again. Significantly, the premium over the official rate plummeted once the rupee was floated, but it gradually recovered to the pre-floated period (A and B panels of Figure 1). The number of sellers and the USDT volume available for sale also went up but riveted back to the levels of the pre-floated period (C and D panels of Figure 1).
The inflationary pressure also does not show any unwinding signs, further eroding people’s purchasing power. These developments encourage the adoption of a currency board as a currency board is believed to be a solution for rising inflation. By the inner mechanics of the currency boards, the independence of discretionary monetary policy is taken away, substituting a disciplined monetary policy – a gold standard without gold – which eliminates the inflationary bias. Indeed, empirical evidence exists in favour of the anti-inflationary effect of currency boards. The inflation rate is lower under currency boards than in pegged or floating rate regimes. Moreover, economies under currency boards grew faster than the average of countries with pegged regimes. However, empirically disentangling multiple influences to pinpoint the low inflation on the currency board is an excruciating task.
Another selling point of the currency board is the fiscal discipline, as currency board regulations prohibit direct monetary financing of government expenditures. A high budget deficit in Sri Lanka and excessive government borrowings from the Central Bank make the fiscal-discipline effect of currency boards much more appealing. Empirical evidence points to low fiscal deficits or larger surpluses under currency board regimes.
Source: Author’s illustration using Binance data
Challenges in Adopting a Currency Board
A significant drawback of a currency board is the need to surrender the monetary policy independence required for managing asymmetric shocks. Such loss is costly when the anchor currency country responds to cyclical conditions, which are different from the prevailing conditions in the country operating the currency board. For example, Hong Kong’s currency board imported low-interest rates from the US in the early 1990s. Such monetary easing was appropriate for the US, but Hong Kong faced an asset price boom that called for monetary tightening. A counterargument against the negative impact of losing monetary policy is the availability of fiscal policy at the operating country’s disposal. However, the maneuverability of fiscal policy is determined by the fiscal and debt positions. In Sri Lanka’s context, the high debt to GDP ratio and fiscal deficits might restrict the use of fiscal policy for pump-priming-stimulating the economy in a recessionary period- due to the fear of losing investor confidence in debt sustainability. Thus, international evidence shows that countries with hard pegged exchange rate regimes generally tighten their fiscal policy in a recession. The Argentinian attempts to bring down the deficit in a recession in 2000 proved to be disastrous.
Sri Lanka’s high indebtedness will also challenge installing a currency board. Once a threat of a possible default looms, the interest rates soar, and refinancing debt will be increasingly difficult. In addition, the operating country needs reserves to back the monetary base in a currency board. In a currency board, the board must continually convert domestic currency for the anchor currency at a constant rate. It should be noted that the reserve level of Sri Lanka has dwindled over time in the recent past. Another drawback of currency boards is the requirement of real sector changes to compensate for the exchange rate deviations. For example, if the anchor currency appreciates against Sri Lanka’s main trading partners, wages should fall to compensate for the increase in foreign consumer prices, restoring competitiveness. Such an exercise needs greater flexibility in the labour markets. Thus, the flexibility of labour markets is a key to the sustainability of currency boards. The political feasibility of the institutional attempts to ease labour market regulations is highly doubtful.
Against this backdrop, the decision to install a currency board should be taken after a careful cost-benefit analysis. A currency board will be helpful to stabilise inflation in the short run but in the long run, Sri Lanka will be better off with a more flexible exchange rate regime. In addition, the benefits of a currency board are not exclusive. For example, fiscal discipline should be stronger in flexible exchange rate regimes as fiscal policy effects are reflected immediately and more transparently. Thus, if Sri Lanka enters into a currency board to stabilise inflation and domestic currency, it needs to contemplate an exit strategy. Generally, it is advisable to leave a currency board when the economy recovers. The requirement to surrender monetary independence and the inability to finance government expenditure under a currency board might reduce the political preference for such a system.
StrEdge calls for SMART restructuring of businesses
In a climate of unprecedented economic challenges, restructuring of businesses, from public enterprises to SMEs is critical, says the leadership of the StrEdge Group of Companies. In a press statement, StrEdge Group, which is a cluster of home-grown enterprises covering consultancy in Processes, People, Finance and Technology, notes that Business Process Reengineering (BPR), Human Resource Restructuring, Financial Restructuring and Automation are crucial not merely to support rebuilding the country but also from a long-term sustainability perspective.
“Multi-dimensional restructuring is a prudent and a tested method to come out of the difficult circumstances the entire country is facing right now. This will create results in national interest if all can adopt SMART methodologies, from entrepreneurs to government hierarchy,” Group Director /CEO StrEdge Advisory, Sumedha Wijesekera notes in the press statement.
StrEdge which brings hands-on experience restructuring multiple businesses from corporates to SMEs, believes that a proper analysis of the existing banking finance structures of a business cannot be undermined. “The rising finance costs and all the macroeconomic constraints coupled with prevailing uncertainties have warranted restructures from both the business perspective as well as that of the bankers’,” observes Wijesekera. From a business perspective, such restructuring would enable solutions for cash flow constraints, save bank interest cost, promote sustainable growth and more importantly, businesses to be future-ready to capture the market potential in the next upward curve of the economy, he says.
From the bank’s perspective, restructuring helps to offer better structures with effective monitoring to match the business requirements, prevent NPLs and build up strong and more profitable relationships by being able to act as an advisor in this setting.
Furthermore, it is very important to revisit the costing of goods and services in any organisation in view of increased raw materials prices, exchange rates, finance cost, loss of sales, diminishing margins and loss of capacity. Introductions of dynamic price mechanisms for each product and service channel of today’s businesses, will give a lot of clarity for the leadership to manage them successfully.
The StrEdge Group which has in depth experience in BPR covering multiple industries including both banks and non-banking financial institutions, believes that SMART restructuring will help organisations re-align their processes with present and future demands, says StrEdge Group Director, Janaka Epasinghe. The current demand to achieve more with less resources, has triggered this as a need, he adds. “Eliminating waste, increasing the service levels, reduction in costs, increased visibility, internal and external customer satisfaction and future-readiness are few of the results that can be derived with this activity. Furthermore, this will strengthen the sustainability of any organisation,” Epasinghe remarks.
Current economic constraints have taken a huge toll on the human resource which is the heart of any organisation, compelling to revisit the HR pillar for sustainability and growth, observes Epasinghe who notes that if organisations are not in a position to compensate with economic benefits, it’s always important to bring other interventions to maintain productivity.
“The biggest bonus here is that even the workforce is ready to embrace changes despite the current challenging environment with a resilient mindset, which the leadership needs to capitalise on,” says the StrEdge Director.
The foreign currency constraints and the lack of resources due to the brain drain in the IT industry have pushed certain organisations to successfully opt for less expensive technology solutions with the help from external and internal experts. “These interventions will give results within a shorter period of time with a very low budget. Empowering the staff, cost reductions, visualisation, better service standards and increased profitability are some of the major benefits of these SMART technology interventions within a company,” observes StrEdge Tech Solutions Director/CEO, Udaya Samaradivakara. It will also help them to address multiple urgent needs from a people-process-finance and technology perspective, without waiting until times get better and this certainly will be a SMART option, notes Samaradivakara.
Oil demand forecasts aren’t as bullish as they seem
Oil has become an attractive alternative fuel because gas prices have soared. But Europe is rapidly replenishing its natural gas stockpiles.Recent revisions to oil demand forecasts aren’t as bullish as they might appear. Don’t get too excited about prices going up just yet.
The International Energy Agency, the US Energy Information Administration and the Organization of Petroleum Exporting Countries all updated their short-term outlooks in the past week. Two of them cut their demand estimates for both this year and next, with only the IEA breaking ranks to increase its forecasts. And it wasn’t just a minor tweak from the Paris-based agency. It revised oil demand higher for this year by a whopping 520,000 barrels a day, with most of that rolled forward into 2023 as well. On the face of it, that’s very bullish for oil.
But there are plenty of reasons to be cautious. First, let’s compare the actual outlooks from the three sets of analysts and put them in their historical context. The IEA’s revision sets its new demand number for 2022 roughly halfway between those of the other two agencies. It also brings its outlook pretty much back to where it saw things in March. So, although the IEA’s revision was big, it’s not out of line with others.
The other noticeable feature in the forecasts is that oil demand growth is disappearing fast, as the chart below illustrates. Global oil demand grew year on year by about 5 million barrels a day in the first quarter of the year — all three sources agree on that — but that increase is now evaporating.
That’s not entirely unexpected when you consider year on year comparisons. Oil demand at the start of 2021 was still adversely affected by the Covid pandemic, so a rebound at the beginning of this year was entirely reasonable. Then economic activity and travel eventually picked up later in 2021, so we would expect demand growth in the corresponding quarters of 2022 to ease.
Digital Marketing Association of Sri Lanka hosts its 1st AGM
The Digital Marketing Association of Sri Lanka (DMASL), Sri Lanka’s national body of digital marketers hosted its 1st Annual General Meeting on the 4th of August 2022. Umair Wolid was ceremoniously inducted as the new President of DMASL for the year 2022/2023 at the event. Additionally, a new Executive Committee was also appointed during the course of the event.
The DMASL was formed in 2021 in an effort to drive the growth of the digital marketing industry. The association plays a pivotal role in recognizing, representing, and supporting Sri Lanka’s digital marketing professionals. Since its inception, the DMASL has implemented professional standards, ethical guidelines and ensured best practices for Sri Lanka’s digital marketing industry.
The newly elected President of the DMASL commented on the event: “I am truly honoured and grateful to have been selected as President of the DMASL. I look forward to working with the entire digital marketing fraternity to help uplift the digital marketing industry in Sri Lanka. The DMASL was created as a platform for individuals to expand their knowledge and provide guidance on running digital businesses in an ethical manner. I look forward to the upcoming year and all the opportunities and challenges it will bring”.
The newly elected EXCO committee for the year 2022/23 includes; Kabeer Rafaideen, Muhammed Gazzaly, Niranka Perera, Rajitha Dahanayake, Jaque Perera, Prasad Perera, Udara Dharmasena, Lalinda Ariyaratna, Infas Iqbal, Amitha Amarasinghe, Sanjini Munaweera, Umair Wolid, Gayathri Seneviratne, Arjun Jeger, Shalendra Mendis and Shehan Selvanayagam.
Over the next year, the DMASL is looking to improve upon its previous efforts and continue implementing training sessions, knowledge sharing, and networking activities which will bring together different sectors in the industry.. The association will also be looking into integration of digital marketing into businesses, as it is an important element in Sri Lanka’s economic recovery. Another key area of focus for the DMASL is working in tandem with selected Government Organisations to help strategize Digital firsts and Digital marketing driven projects.
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