Indian rupee soars, Lankan rupee slightly recovers

The Indian rupee is gaining at an astounding rate against the US dollar while Sri Lanka’s rupee is depreciating faster than any other regional currency but it picked up last week on the back of the full subscription of the US$500 million bond.

But will the euphoria last? Not so, say analysts, attributing the rupee gains to a short term phenomenon. Upali De Silva, Secretary-General of the Sri Lanka Bankers’ Association says rupee gains against the dollar needs to be sustainable and that can happen only if the bond is used for productive and development purposes. “If not, the effects will only be short term and the cost of living will again spiral out of control,” he told The Sunday Times FT.

The Central Bank (CBSL) said last week that the bond issue will help the rupee to gain against the dollar, which de Silva agrees. "What the CBSL is saying is happening. It has already affected the interest rates as well and those have come down by 1% already," he said adding that with the $500 million inflows Sri Lanka's foreign currency situation will improve similar to what happened after the 2004 tsunami when foreign currency flooded the country and the rupee appreciated.

The repercussions of appreciation will affect imports and exports, de Silva added. Exports will be worth less and imports become far cheaper. "Hopefully, it will bring down the cost of living index as well," de Silva said adding that the main question is whether this can be sustained. He said the Indian rupee has been appreciating sharply mostly due to the inflow of remittances, bringing with it a host of problems for the regional giant, particularly in terms of the decreasing cost of their exports.

As to how this will affect trade between Sri Lanka and India, De Silva said the situation is quite disastrous. "We are losers right round," he said. "We have so much import and export trade with India that it is a disaster for the economy of Sri Lanka."

A senior banker told the Sunday Times FT that the Sri Lankan rupee has depreciated alarmingly as the country depends on imports. There is no decent capital inflow in Sri Lanka and with oil prices increasing all this has become expensive for the country. "The rupee will depreciate unless there is decent capital coming into the country," he said.

Over the past week, the rupee has appreciated, going on the sentiment of the government bond. On Monday, the rupee was pegged at 111.50 against the US dollar and by Friday it was traded at Rs 110.86.

The banker explained that the bond will help the government to repay some of its debts in dollars itself but said some state sector bills will not be coming into the market. Some officials including the Treasury Secretary has said the rupee is going to strengthen but the banker said what is happening with the rupee is going against market fundamentals at the moment. He believes this trend is not sustainable but feels the government will ensure that the process continues.

Another high ranking banking official said it is very difficult at the present time to say where the market is heading. He said though the rupee gained this week it wasn’t sustainable because oil prices are running at US$92 per barrel and gasoline at US$89 per barrel. Combined with the budget deficit and high inflation, it is not sustainable at the moment. He added that sustainability also depends on if the Ceylon Petroleum Corporation (CPC) does not come into the market to buy dollars. Most of the year end import demands have been settled except for the CPC.There is also not much demand coming from the larger importers due to the unsettled bills.

The banking official said the government’s agenda is to keep the exchange rate low to bring down the cost of living but added that eventually, somebody some day will have to pay. Theoretically or even otherwise, all officials interviewed said it is better to import from India and China rather than produce products in Sri Lanka.

Principal Researcher at the Point Pedro Institute of Development Muthukrishnan Sarvananthan said the depreciation of the rupee has positive and negative effects to the economy. The lower value of the rupee lowers the cost of Sri Lanka's exports and thereby increases the demand for export goods. On the other hand, he said the lower value of the rupee increases the cost of imports into the country, thereby increasing the cost of imported goods. This is reflected in the rising cost of living during last year and this year. "So the impact of the depreciation of the rupee is a mixed bag," he said. "However, in the past 4 to 5 months, the negative impact of rising cost of imports has been much more severe than the positive impact accrued from exports. This situation is going to worsen during the closing months of this year, primarily because of the rapid rise in world oil prices which has peaked to US$92 per barrel in the last week of October."

According to Sarvananthan, the appreciation of the rupee in the past week or so is solely due to the bond issue. Therefore, he believes the appreciation is short term and will not last. "Especially due to the rise in world oil prices, the US$500 million would be inadequate to bolster the balance-of-payments for long and sustain the appreciation of the rupee experienced in the past week."

Sarvananthan said the Indian rupee has been appreciating for a considerable time due to soaring exports, remittances and foreign direct investments. In the case of Sri Lanka, only remittances are increasing. "It could negatively affect India's exports but not much in the exports to Sri Lanka," he said. "This is because India would still be cheapest sources of Sri Lanka's imports compared to other competitors." (NG)