Rupee depreciation and past trends

This refers to the article in The Sunday Times FT of December 24, headlined “Central Bank says rupee depreciation in line with past trends,” where the Governor Nivard Cabraal has referred to my statements on the exchange rate claiming that dollars were not sold ‘artificially’ to prop up the exchange rate.

For the benefit of everyone, here are the real fundamentals of the issue.

During UNF rule in 2002 -2003 due to prudent fiscal and monetary policies, the rupee strengthened.

As the chart here shows, within six months of coming to power we had managed to stabilize the rupee. By November 2003 the rupee had appreciated, and the Central Bank was able to buy dollars in the market and increase its reserves. But from the day the three ministries were taken over by the President in November 2003, the rupee stopped appreciating.

After April the rupee depreciated steeply, despite heavy selling of dollars because of the incorrect economic policies of the UPFA government, loss of investor confidence and money printing.

Until then, due to the prudent economic policies of the UNF government, there was an excess of dollars flowing into the country.
In 2001 official reserves were down to US$ 1338 million which was sufficient for 2.7 months of imports. We increased it to US$ 2339 million or 4.2 months of import cover in two years. In 2003 the Central Bank bought US$ 374.9 million on a net basis from the market.

Can the governor prove that the rupee was not strengthened in a relatively short period like this?

Since 2004 public finance management has broken down. As a result the rupee has depreciated daily. In 2004 the Central Bank had to sell US$ 514.9 million and intervene in the market to stop the rupee falling. Even then the rupee fell to 105.70 against the dollar.

In 2005, the tsunami disaster brought massive foreign exchange into the country. As a result the exchange rate suddenly appreciated. But despite this the Central Bank had to sell US$ 173.3 million to defend the rupee. The exchange rate ended at 102.12 at the end of the year.

Now in 2006, despite the dollar falling against world currencies, the rupee is falling again despite dollars being sold in massive quantities. From September 1 to 18 alone, US$ 121.41 million has been sold establishing a new record to keep the rupee at 102. Never has such an amount of dollars being sold in such a short period. As a result, by September 18 official reserves were down by seven percent.Can the Governor certify that?

Due to running down of reserves the Bank could not continue the policy. Soon the exchange rate fell to 108. In October the Central Bank sold US$ 34.6 million. In November US$ 30.85 million was sold in the market. More than US$ 425 million has been sold this year.

Now total reserves are down by 11 percent because the government has been using up private reserves also through dollar bonds. The government is borrowing at high rates, and then this money is spent on propping up the dollar.

The Governor can hide this situation from the President, Cabinet and Parliament but he cannot hide if from foreign investors and international community.

The IMF, in its consultation report has said the Sri Lanka rupee is no longer free floating. They have re-classified it from June 2006, citing the actions of the authorities during the past two years.

They have said Sri Lanka is violating Article VIII provisions and enforcing exchange controls. This is not the UNP but the IMF that is saying the rupee is being artificially controlled due to bad economic management.