The Sri Lankan Rupee’s Perilous Descent + Israeli Interests Under Fire

Thursday, 16 February 2012 

BMI’s prediction of a second devaluation of the Sri Lankan rupee played out on February 14, with the currency ending the day at LKR120.13/US$ – marking a 5.4% drop from when we called such a move in our online service on January 30. At one stage on February 15, the rupee diced with a record low of LKR120.50/US$, a level last seen in early 2009, when Sri Lanka was facing a crippling financial crisis and required an IMF bailout.

Given the extreme volatility over the past few days, the Central Bank of Sri Lanka (CBSL) will likely try to keep the rupee at its current levels to foster stability. Indeed, the CBSL managed to keep the rupee fairly stable for close to three months after the first devaluation in November 2011. As we closely watch the rupee’s movements over the coming days, we reiterate that fundamentally, our bias is for continued LKR weakness. Sri Lanka’s balance of payments position remains under pressure from a bleak external demand picture (in particular, Europe’s economic woes), a deteriorating terms of trade (because of subdued cotton prices and the rising cost of oil imports), and insufficient remittance inflows to cushion the blow of a rising trade deficit.

As the chart above shows, the latest depreciation of the rupee is comparable to its collapse in late 2008-early 2009, at the height of the global financial crisis. The rupee subsequently recovered from mid-2009 onwards, as ‘Sri Lanka mania’ took hold among some investors following the decisive defeat of the Tamil Tiger rebels, thus ending the three-decade civil war, and paving the way for the island’s reconstruction. But this optimism has now petered out. According to Bloomberg data, Sri Lanka’s rupee is the worst-performing currency in the world thus far in 2012 after the Iranian rial, Gambian dalasi, and Syrian pound. Hardly good company.

Israeli Interests Under Fire

Over the past few days, Israeli diplomatic personnel in Georgia and India have apparently been targeted for assassination, and a man with an Iranian passport in Bangkok injured himself when he accidentally detonated a bomb in his home. In January, an alleged plot to assassinate the Israeli ambassador to Azerbaijan was foiled. There are several question marks surrounding these plots. For a start, Iran might be reluctant to carry out an attack in India, which is friendly with Tehran. In addition, the Bangkok blast has the hallmarks of amateurism, and it would be odd if Iranian agents actually carried real Iranian passports.

Although investigations are still in progress, Israel is bound to see the hand of Iran – either directly, or through proxy groups – behind these plots. For its part, Tehran sees the hand of Israel behind the assassinations of several of its nuclear scientists. With a covert war of assassination seemingly in progress, there is a risk that one side may overplay its hand. This could increase pressure on Israel to attack Iran.