Ceylon Today Editorial

Hard times

28 December 2016

The New Year is just four days away. And, if the VAT hike and Central Bank of Sri Lanka (CBSL)'s Treasury (T) Bond scandal took centre stage in the old year, the new year is likely to be dominated by a falling rupee and what conclusions the UN would arrive at, when they are alleged to discuss the Sri Lanka question once more at their human rights sessions in Geneva in March. Therefore, the New Year may be a tougher year than the old year.

The negative performance of the rupee, a hackneyed reason for this, which, nevertheless, paradoxically, may be worth repeating, is all due to the USA. Since October, when the market sniffed at the possibility of the Federal Reserve System raising its key policy rate, the Fed Fund Rate (FFR), at the end of its open market committee (OMC) meeting this month, that led to an exit of foreign funds from the government securities market (GSM), to US based assets.

This demand for US dollars caused depreciative pressure on the rupee. As expected, the Fed, after the conclusion of its OMC meeting on 14 December, after a year's hiatus, raised the FFR by 25 basis points (bps), for it to be currently in the range of 50 to 75 bps. The reason for this hike is the continued recovery of the world's largest economy after the global financial crisis of 2007.

The Fed, after the end of its December OMC meeting, also announced the possibility of three further hikes in the new year. As such, those foreign exits continue from the GSM even to date, giving no rest to the beleaguered rupee, with those outflows being re-parked in US based assets, ostensibly to give 'better' returns to investors.

Its fall however may have had been somewhat blunted due to a rise in remittances, a phenomenon which takes at this time of the year (once more repeated during the 'Avurudu' season in April), coupled with exporter conversions to meet commitments to employees such as bonus payments.

But, with the foreign exchange (FX) market expected to be virtually in a desert for at least another three months till the 'Avurudu' inflows once more start rolling in, that, hopefully, may lead to the strengthening of the rupee. However, until such time, the rupee will continue to be under siege. Nonetheless, the remittances magic didn't work to uplift the rupee this Christmas season. In fact the local currency continued to collapse, pushed down by exiting foreign investors, followed by panicky importers.

As such there is no guarantee that just because of the forthcoming 'avurudu' season, the rupee will not escape the fate that befell it this Christmas season, due to continued foreign exits, being repeated once more. One way of overcoming this situation, to use another oft repeated statement, is for the regulator, the CBSL, to raise its key policy lending rate. Such a hike causes a chain reaction, affecting real interest rates as well.

When real interest rates rise, it will be a disincentive for importers to borrow rupees in order to buy dollars, as their borrowing costs will become expensive. Such an action will lessen the demand for dollars and would bring some sort of sanity to the rupee. And to use another hackneyed statement, rising rates may also induce foreign funds to once more invest in the GSM, thereby further boosting the rupee. Considering the fact that Sri Lanka is an import dependent economy, a stable rupee may be sine qua non to assure political, 'economic' and social stability in the country.

On the other hand, with the money market enjoying a sudden surge of excess liquidity in the past few days, it may not make sense for CBSL to raise its key policy rate.The choice then before CBSL may be to allow the rupee to continue to fall and be prepared to face the consequences. CBSL, on Friday (30 December), after markets close, will make known its monetary policy stance for the current month, then.

Whatever policy measures CBSL may take, the future looks bleak for Sri Lanka. The other Achilles' heel is Geneva in March. Sri Lanka, more than a year ago, gave a commitment to the international community that it will allow foreign jurists to investigate alleged war crimes committed by the Government of Sri Lanka and its agents, especially during the closing stages of its war against the LTTE.

Foreign interference on this score may irk the ire of the island's 70% Sinhala Buddhist majority who consider such personages who may be investigated as war heroes. With the possibility of an ever rising cost of living, made worse by an enhanced VAT charge in November and now, helped by a falling rupee, such a scenario may just be what the likes of Mahinda Rajapaksa would allegedly want to see in order to create social instability in the island and thereby attempt to wrest control of the government. Sri Lankans may have to brace themselves to hard times in the coming year.