Floating the rupee to spare sinking economy; have the tides changed by the ides?

Soldiers abroad preparing for war and now Sri Lankan ‘lions’ roaming the streets; 44BCE Calpurnia’s ominous nightmare appears to repeat itself in the 21st Century. While we are yet to see graves open up, such progress has been made in the past week to signal a course adjustment to perhaps: ‘Brave, the Ides of March’ instead. Then again, the Caesars of today may need to heed the advice of more than just their wives to avoid the wrath of the senate and the public.

The Central Bank of Sri Lanka (CBSL) early last week abandoned the Sri Lankan rupee (LKR) currency peg. Since implementing the peg at Rs. 200 – 203 to the American dollar (USD) it was soon deemed to be non-credible as evidenced by access restrictions to foreign currencies and the black-market rate trudging 250 levels. Put simply, market participants are free to interact with each other and arrive at an acceptable level at which USD can be purchased for and sold at, in LKR.

What was previously communicated as a peg readjustment to Rs. 230 on the USD, this was clarified to be the CBSL stipulated rate while going for a float. This move was lauded as a step in the right direction, albeit, amidst criticisms of being ‘too little too late’, as the effects of a hard peg had perforated confidence in the currency and foreign investment and trade dealings. This loss of confidence and ensuing dollar shortages in the local market hindered trade and overall increased uncertainty, as even students abroad faced issues in making payments.

It is no surprise that following the float the market fell in line with the anecdotal black-market rate of Rs. 255 – 265 to the USD. This is because the best estimate for the rate was unofficially priced here, and given no significant currency inflows or outflows, the CBSL rate influences the rate at which banks trade i.e., the interbank rate and ultimately, merchants and currency traders. As banks no longer needed to hold the 203 mandated rate, more leeway existed for banks to negotiate a favourable price; uncertainty and heightened risk surrounding the USD resulted in a parsimonious spot market and a dried up forward market for currency.

Furthermore, gold-along with other commodities and products that are priced in or linked to USD- edged up. Oil increased by Rs. 50 per petrol litre and Rs. 75 per diesel litre to smart phones, as the Sri Lanka Mobile Phone Importers Association announced a 30% increase; the everyday citizen too must brace for impact from price adjustments to come. In this week the USD rate approached 270/280 levels, with popular trading app Binance quoting upwards of 300 on the USD. However, this is largely due to participants’ reluctance; the sudden hikes aside, the big picture impact is far more favourable. 

As some CBSL sources have disclosed, migrant worker remittances have increased by 400% in the past week alone. The weak rupee is also likely to improve Sri Lankan exports standing compared to foreign competitors and overall improve our terms of trade.

More importantly, this would adjust the shortage of USD available in Sri Lanka. At these rates, it would be more favourable for foreigners to convert their holdings into LKR, subsequently selling USD and contributing to the USD stock within the Sri Lankan banking system. Furthermore, this move would restore foreign investor confidence, alongside speculation of further rate increases and possible asset sales. All these translating to USD inflows, would mean USD reserves growing and a more stable exchange rate going forward.

Therefore, with the rupee being free to float, some pressure has been taken off our economic woes. On the woes to come, one can only hope, “here is a tide in the affairs of men; when taken at the flood, leads on to fortune”.