Many challenges affected exchange rate management in Sri Lanka, along with widening trade deficit but factors such as the IMF’s loan of US$ 2.6 billion brought about a catch-22 situation, analysts say.
"Balancing strong growth without the luxury of deep pockets proved to be an uphill task which adversely put pressure on the rupee," an analyst pointed out. Many analysts noted that the post war Sri Lankan economy recorded 8% GDP growth for two consecutive years and was projected to record similar growth in 2012 as well.
However financing this strong growth proved to be difficult given the shortfall in FDI’s (which was some US$ 700 million in 2011 while economists believe it should have been around US$1.6 billion which is approximately 3% of GDP in order to drive healthy economic expansion) and outflow of foreign portfolio money given the market correction and global economic implications.
Iranian embargo
Danushka Samarasinghe, Director Research TKS Securities noted that external pressure was inserted on the domestic economy, following the trade embargo on Iran, which was the cheapest supplier of crude oil to Sri Lanka while also providing a six months revolving credit facility.
"Cheap Iranian oil is not available and Sri Lanka has to purchase oil from other suppliers at open market prices which could dwindle the foreign reserves," he pointed out.
Having drawn US$1.8 billion of the IMF loan facility, the domestic economy is subject to certain conditions with regard to macro-economic health, and therefore not in an ideal position to raise fresh debt from international markets in order to maintain the debt-to-GDP level at the current 82% or lower.
“This is why last week the Central Bank had to withdraw from its currency defense policy (which was done in order to create an artificial currency peg) and allow the currency to float (albeit having mentioned that they would provide quantitative intervention with regard to oil bills) in an attempt to safeguard the foreign reserves which we believe is sufficient to service four months’ worth of imports," the analyst noted.
Inconsistent policies
Having upped the interest rates and floated the currency within a period of 10 days, the government increased the retail fuel prices on 11th February 2012."This same government in 2007 initiated the move away from subsidized fuel and made price adjustmens according to world market prices.
However till February 2012, Sri Lanka adopted a cross-subsidy scenario for its fuel sales where petrol was heavily taxed and sold at higher prices when compared to international markets while diesel was sold at a discount to international prices,” the analyst added.
He also said that lower pricing of diesel was a policy adopted by many governments since diesel was the main fuel used in transportation, distribution and power generation in Sri Lanka, hence holding back the fuel price enabled the capping of both consumer and industrial inflation.
With the recent most fuel price revision the price of the most basic diesel fuel was increased by 37% to Rs 115/litre and 90 octane petrol by 9% to Rs 149/litre.
Analysts said that the retail fuel price revision by the government is a bold move in the correct direction to safeguard broad economic health albeit being an unpopular action which has sent shockwaves amongst the masses. “Also the increase in interest rates and the floating of the rupee went against the policies and forecasts put forward by the Central Bank during the past few months, and created a negative sentiment within the business and investing community," an economist noted.
He said that the sharp upward revision in retail fuel prices would trigger a chain of events which would create inflationary pressure (since all goods and services would increase in price) and curtail GDP growth. |
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