Sri Lanka Rupee:

Fluctuating fortunes

A Staff Economist

Globally, currency prices or exchange rates have been highly volatile in the recent past as a result of various factors connected with the current global financial crisis that started to emerge from August 2007. Such volatilities are common phenomenon in the currency markets from time to time.

Uncertainity

Although there are many theories and research on determination of exchange rates, their volatile behaviours and necessary policy measures for maintaining their stability at desirable levels, no economist is able to tell the exchange rate of a currency in the foreseeable future. According to views expressed by some economists in the recent past, the exchange rate between the Rupee and US Dollar ($) would have now reached the levels of depreciation seen in Zimbabwe. Meanwhile, currencies of some countries, e.g., Korean Won, have depreciated recently as much as 50 percent. US$ has been volatile against many currencies in various directions and magnitudes, despite the efforts of the world to maintain its stability.

Factors

Although various economic fundamentals can be used to explain the behaviours of exchange rates during a reasonably long period of the past (e.g., five to 10 years), the aggregate speculative behaviour of market participants, i.e., foreign exchange dealers, exporters, importers, investors and policymakers based on various factors or shocks is the key drive of the exchange rate volatility during the shorter periods, beyond the demand and supply conditions of currencies for underlying real transactions.

For example, in the inter-bank market, the Rupee has been depreciating in 2007 from Rs. 108 a dollar in January to Rs.113 a dollar by mid October. However, originating from foreign exchange proceeds on the international bond issue and partial opening of Government securities market to foreign investors, the Rupee tended to pass through an appreciation drive back to Rs. 108 a dollar. Conversely, from the mid October 2008, the Rupee started to depreciate reaching Rs. 116 a dollar by third week of April 2009, mainly on account of factors connected with global financial crisis. One can observe that within those directions/trends, there have been very short-term volatilities as well as stability too.

The volatility is the source of exchange risk that would create losses to various parties whose speculative powers and arrangements are poor.

Information

Therefore, market participants must gather sufficient amount of information and manage the speculation prudently, rather than blaming the policymakers for not maintaining the exchange rate to accrue profit/benefits to them.

In Sri Lanka, current inter-bank exchange rate is around Rs. 116 a dollar. However, the policymakers’ action to improve foreign reserve position through currency swaps with foreign countries/central banks and prospective borrowing from the IMF and the loan from Libya would cause market speculation towards appreciation of the Rupee in the foreseeable future. In addition, huge amount of money printing and Government stimulus packages in the US may add a significant amount of dollar liquidity in the international market causing a depreciation of the dollar. Although Sri Lanka’s current account deficit on international transactions involving trade of goods, services and remittances may continue to grow requiring the Rupee to depreciate as predicted in certain economic views, the speculative behaviour of the market participants will decide the future exchange rate movements.

Speculation

Accordingly, along with the policymakers’ motive to maintain a greater exchange rate stability (globally too), the specific circumstances prevailing in Sri Lanka may likely to cause speculation on the Rupee to appreciate in the near future and markets participants may plan their transactions appropriately.