Exchange rate movements and its impact on the economy

The exchange rate movements and exchange rate regimes assume very high priority in the management of macro-economic policies in the economy.

The exchange rate movements has direct impact on the export competitiveness, cost of imported raw material and consumer products, cost of serving foreign borrowings, services sectors such as tourism, BPO, foreign direct investments, the general inflation, the price stability, general employment and income of the economy.

The business community is more concerned about the volatility of exchange rates, as high volatile exchange rates would erode business competitiveness and the long-term business relations with both buyers and the sellers overseas, the Research and Policy Advocacy Unit of Federation of Chambers of Commerce and Industry of Sri Lanka (FCCISL) said.

Fractional or slight changes in the movement of exchange rates will have profound and occasionally even disproportionate impact on the economy at large. The monetary policy formulators therefore naturally focus heavily on maintaining stability in the domestic foreign exchange market.

International trade transactions in Sri Lanka are largely carried out in US dollars. Therefore, the external value of the Sri Lankan Rupee in terms of the US Dollar denotes very high significance over other freely convertible foreign currencies. Foreign exchange transactions for international trade are being predominately carried out by licensed commercial banks.

However, approved foreign exchange dealers in the private sector also play an important role particularly for foreign exchange transactions pertaining to non-trade domain.

In the recent past, the Sri Lankan Rupee has been gradually appreciating vis-…-vis major foreign currencies mainly due to the US Dollar loosing its value steadily in international financial markets recently.

Increasing foreign exchange inflows from the services sector, workers’ remittances and financial flows from the international sovereign bond issues and gradual increase of export revenue are some of the other reasons attributed to the appreciation of the Rupee.

The Central Bank of Sri Lanka intervenes regularly in the market to mitigate excessive volatility in the exchange rate and to ensure competitiveness of exports would not be eroded due to undue appreciation of the Rupee.

According to the Central Bank of Sri Lanka, during 2010 both Nominal Effective Exchange Rate (NEER) and Real Effective Exchange Rate (REER) appreciated against the entire major currencies except the Japanese Yen and Indian Rupee. It is observed that Sri Lanka maintains a managed exchange rate policy. In other words, the market forces do not solely determine the external value of local currency.

While market forces are largely reflected in the value of the exchange rates, monetary policy also intervenes to avoid excessive volatility of the exchange rate. In this process, one of the soft instruments being practised by the Central Bank of Sri Lanka is daily publishing of the Approximate Indicator Exchange Rate based on the previous day’s market weighted average rates for the US Dollar.

Although this is the average rate for the US Dollar, the different commercial banks quote different buying and selling rates with variant degrees of margins between the buying and selling rates.

Understandably, as a general rule no commercial bank buys foreign exchange higher than the buying rates quoted or sells below the daily selling rate indicated by the Central Bank.

However, some commercial banks depending on the quantum of the turnover of foreign exchange dealing carried out by the bank and the amount tendered or purchased makes certain exceptions to this rule.

The approved exchange dealers prepare to offer higher rates of buying than the Central Bank indicative rates depending on the quantum of foreign exchange tenders, denomination of the currencies and the bargaining power of the customers. High valued foreign currencies always maintain high margin of difference between the selling and buying price.

The variation of the margin though not very high yet reflected noteworthy differences when it comes to the question of large-scale international trade transactions. According to representations made by the Sri Lankan entrepreneurs engaged in international trade, transactions, this variation with a high margin than the margin stipulated by the Central Bank erode their competitiveness in the international market and the cost of imported raw materials, inputs and consumer products.

Substantial number of workers’ remittances transactions are still conducted outside the banking system via the Hawala System, depriving valuable foreign exchange to the country due to the bottlenecks observed at the point of sending money and even at the point of receiving money in Sri Lanka.

If this problem can be addressed effectively, the current workers remittances of foreign exchange could be further enhanced to strengthen international reserves of the country, the Research and Policy Advocacy Unit of FCCISL said.

CdeS