Money Talks: some facts around the depreciation of the Sri Lankan rupee

GROUNDVIEWS- 09/22/2018

The Sri Lankan rupee has depreciated against the US dollar on several occasions this year first on June 11 and then on June 20, when its value stood at Rs. 161.17. Reports that the value of the rupee was falling again began the week of September 17, when it was at Rs. 165.34, and continued till the 21st, where it now stands at Rs. 170.56 against the dollar.

In the past few months, the media has reported continuing currency depreciation. Reactions on social media indicate that there is limited understanding of the factors that contribute to the drop and its implications. This has become a topic of discussion in the political sphere; many are quick to blame the government and various other actors for their negligence of the economy.

Shiran Fernando, Chief Economist of the Ceylon Chamber of Commerce, notes that in the year 2017, currencies like Sri Lanka benefited from a better environment globally,  supported by a weaker US dollar. In a comment to Groundviews, he explained that this year, factors such as a strengthening US dollar – which is based on improving indicators in the US economy and expectations for further interest rate hikes – coupled with the US-China trade wars have dampened global investment confidence. The impact has been felt therefore in emerging markets like Sri Lanka. He clarified that currencies of India and Pakistan have seen above 10% depreciation against US dollar so far this year, while the Indonesian rupiah has lost almost 10% and is currently at its lowest level since the Asian financial crisis two decades ago.

Nevertheless, there have been certain myths perpetuated as a result of the discussion on currency depreciation. There are several factors at play in determining exchange rates of a country’s currency. They are far from clear cut, and the explanations that Groundviews has provided are given assuming that all other factors remain constant. The following was compiled with information provided by several economists working in the public, private and development sectors.

1. Most people interpret the depreciating rupee as having a negative impact on our ability to pay back national debt.

There is a currency mismatch, in that we borrow in dollars, generate rupees and still pay back in dollars. Therefore while the our debt increases in rupee terms, weakening our debt indicators, it doesn’t make an impact in terms of debt repayment. The key is to ensure that we are earning enough dollars to be able to pay back our dollar liability, through increased exports of goods and services or through Foreign Direct Investment (FDI).

In these cases, Sri Lanka would still be paying back more in terms of the rupee, and the increase of foreign exchange reserves is key to ensure that debt doesn’t balloon beyond the existing value. In May 2018, the Central Bank stated that the country ‘has sufficient reserves to meet its external debt servicing obligations’. It is important to note that these reserves are also borrowed, and their depletion would contribute to the debt amount. Therefore Dr. Harsha De Silva, State Minister of National Policies and Economic Affairs, stated that the depreciation could not be managed by releasing these reserves.

2. The depreciating rupee will increase Sri Lanka’s oil import bill in line with global trends, and Sri Lanka’s recent fuel price adjustment was necessary to respond to this.

Fuel price hikes are often met with widespread protests, especially from farmers and fishermen. Their dependence on fuel for their livelihood is compounded by the low yield or unpredictable weather that can often impact these two industries.

3. While a depreciating currency is not necessarily reflective of a weakening economy, the Sri Lankan rupee is a currency that is constantly depreciating.

This indicates structural imbalances that have gone unaddressed, such as low productivity in the economy and imports being persistently higher than exports.

The drought that persisted across the North-Western, North-Central, Northern and Eastern provinces last year is likely to have contributed to the current situation. Rice harvests nearly halved during this period, pushing communities into food insecurity. To encourage imports, taxes were cut further, and an emergency stock of 500,000 tons of rice were imported.

4. An appreciating rupee doesn’t necessarily indicate a strong economy.

This would make imported goods cheaper for the Sri Lankan consumer. However, given that Sri Lanka is not earning enough from its exports, over-dependency on cheap imports could, in the long run, negatively impact the economy. A stronger rupee would make Sri Lanka’s exports relatively more expensive for buyers in the global market, because the USD can now buy less, therefore making us less competitive.

While the country’s exports reached an all-time high of 1108 million USD in March of 2018, the economists Groundviews consulted were of the opinion that the country’s trends and consistency of exports do not warrant this confidence.

5. Exchange rates: if the US Dollar (USD) appreciates, the Sri Lankan Rupee will automatically depreciate, this is not reflective of the economy of individual countries.

The rising USD has impacted the currencies of other emerging markets, in some cases more sharply than it has impacted Sri Lanka. This is because of changing United States federal policy, and is not determined by the strength of other countries’ economies.

Finance Minister Mangala Samaraweera pointed out that the Sri Lankan rupee has depreciated by 7.4 per cent while Indian rupee has depreciated by 13.5, Pakistan rupee by 12.1 per cent, Indonesian rupiah by 9.1.

Ravi Ratnasabapathy, a fellow of the Advocata Institute, thinks that some of the panicked reactions to the depreciation are likely to be informed by the recent report published by Nomura Holdings Inc. It erroneously noted Sri Lanka’s short-term external debt and listed it alongside Argentina and Turkey on an index of countries likely to experience crisis in the period ahead. The Central Bank has since issued a clarification and has requested that Nomura do the same.

Undue pressure by politicians and other actors sometimes push the government to take hasty, reactive measures to depleting currencies. It was hasty measures such as this, where the country’s borrowing far exceeded its export value, that helped Sri Lanka’s fall into the debt trap that it is in today.