Ceylon Today Editorial

‘Demise’ of the rupee

21 December 2016

The exchange rate (ER) fell to its lowest ever value in its history yesterday, declining by six cents to Rs 151.30 to the US dollar according to Central Bank of Sri Lanka (CBSL) data, as foreign investors, mainly US based, continued to pull out their money from the government securities market (GSM), to re-park the same in US based assets, on expectations of rising interest rates in the world's largest economy.

As a result, the ER, in the three consecutive market days to yesterday, has, historically, registered its lowest ever values, with no end in sight to this carnage.

On Friday, 16 December 2016, the ER registered its third lowest value ever, a figure of Rs 151.23 to the dollar, on the following market day Monday (19 December), it fell by a further one cent to Rs 151.24 to the dollar and yesterday, by another six cents to Rs 151.30 to the dollar.

Pressure on the rupee to fall further has been exacerbated by panicky importers making premature bookings of dollars, thereby exerting additional downward pressure on the local currency.
The rupee's 'demise' this year may be divided into three stages.

The first, its natural depreciation caused by Sri Lanka's 'historical' negative trade balance which has been the case since 1978, that year being the first full year since the government opened up the economy in July 1977 due to the political changes that took place on the island's landscape, then, where it also embraced an open economy.

The second was the expectation that the Federal Reserve System (Fed) would raise its key policy rate, the Fed Funds Rate (FFR) this month after a year's hiatus due to the recovery of the world's largest economy, which effect also impacted on the rupee in the period 12 October to 8 November 2016, a short period of a total of 28 days.

This expectation became a reality when the Fed, after the conclusion of its open market committee (OMC) meeting on 14 December 2016, raised the FFR by 25 basis points (bps), for it to be between 50 bps to 75 bps, currently. This has resulted in foreign fund exits led by the financial market (GSM), to US based assets for 'better' returns.

And, lastly, the surprise polls victory of Donald Trump at the US Presidential Election of 8 November 2016. His pre-polls promises of protectionism, tax cuts and infrastructure spending are expected to cause further inflationary pressure on the world's largest economy, speeding up such exits, led by the GSM.

Rise in inflation is a further boost to the raising of rates. This expectation of rate hikes was complemented by the Fed, which after the end of its OMC meeting on 14 December also announced the possibility of a further three rate hikes, next year. That, on top of the rupee's natural depreciation, is causing additional downward pressure on the ER.

Meanwhile, the natural depreciation of the rupee in the current year took place from 1 January, 2016 to 12 October 2016, covering a period of 286 days (inclusive of weekends and other bank holidays), where the ER fell by a modest 1.8% (Rs 2.63) to Rs 148.81 to the dollar.

On top of its natural depreciation, the acceleration of its fall took place in the 28 days from 12 October to 8 November, 2016, due to expectations of the Fed's rate hike this month. In that brief period (i.e. comprising a tenth of the period that fell between 1 January 2016 to 12 October 2016), the ER sharply depreciated by 0.68% (Rs1.01) to Rs 149.82 to the dollar in that short time. Meanwhile, 8 November 2016 was the day of the advent of Trumpism, after the surprise triumph of Donald Trump, at the US Presidential Election, who trumped the more favoured Ms. Hillary Clinton by his 'racist' policies.

Trumpism coupled with the rupee's natural depreciation plus expectations of Fed's upward rate moves saw the ER in the 42-day period from 8 November to yesterday, falling steeply by 0.99% (Rs 1.48) to Rs 151.30 to the dollar. The culmination of all of these external actions in the calendar year to date has had resulted the ER depreciating by a massive Rs 5.12 (3.5%) to Rs 151.30 to the dollar.

As Sri Lanka is an import dependent economy, such sharp depreciations cause inflationary pressure on the economy. Further, as Sri Lanka's foreign debt servicing bill is generally met from CBSL's foreign reserves (after buying those necessary dollars by paying the equivalent in rupees), a depreciated ER increases the Government of Sri Lanka's rupee borrowing costs, while at the same time causing upward pressure on interest rates.

What, therefore, needs to be done to boost the ER is by making the economic, political and social climate suitable to boost exports and the export of a higher level of skilled labour, coupled with the establishment of good governance, justice and fairplay.

The values of the respective ERs are, as per their average selling prices in dollar terms among commercial banks in Colombo for telegraphic transfer as at 9:30 a.m. on those particular days in question, which are in effect the average selling price of the dollar to the consumer (real economy).