Cabraal talks of ‘rupees and reservoirs’ to Wall Street Journal

Conscious of its ballooning currency reserves, the Central Bank last year made the decision to limit its intervention in the foreign exchange market. That initially saw the rupee drop around 17% against the dollar, but it has since recovered more than half of its losses. On the sidelines of the International Monetary Fund’s spring meetings in Washington, DC, Central Bank Governor Ajith Nivard Cabraal gave The Wall Street Journal an update on how the new regime is working and explained the relationship between reservoir levels and intervention. Here are his edited remarks:

Cabraal: We were conscious that as soon as we changed our policy with regard to the exchange rate, that there was definitely going to be a tendency for it to overshoot, which is what has happened in every part of the world. We adjusted the policy carefully, in that from about February 2012 we only moved into the market to intervene for a limited amount of oil bills, so that there was no major pressure on the exchange [rate].

That again was a difficult year last year in the external sector, particularly because we had little rain and most of our energy had to be generated with oil.

Normally Sri Lanka has about 30% of its electricity generated out of hydro, and 70% from other sources. Of the 70%, about 20% comes from coal. But that mix changed and because of the drought, hydro fell to about 18% which meant that… the balance had all got to be generated with very high-priced oil. That put an enormous amount of pressure [on the rupee]. So that’s why we had to support [it] with a reasonable amount of dollars… because otherwise it would have had a serious volatile situation.

This year, it has been much more benign. The reservoirs are reasonably full and we always joke at the monetary board meetings that we give as much attention to the reservoir levels as oil prices, because when the reservoirs are full we know that we can generate electricity with water, and that’s only because the gods have been kind to us. This year it has been around the 40% mark, which is very good, which means that dependence on oil is a lot less, because of our total oil bill about one third is to generate electricity, two thirds is for transport.

If out of the one third we can cut down one third, that is a substantial saving on oil. I think that kind of situation should arise this year, because the reservoirs would be full enough for us to go up to about October without too much difficulty, which means that the whole scenario will change this year.

So last year we supported it, this year we don’t have to, and this year the rupee has been showing signs of appreciation.