Written by – Siyathma at OmeBiz
Every Sri Lankan today is talking about how the Sri Lankan Rupee has taken a plunge. During the past year, the Sri Lankan Rupee has depreciated by 11%! The Sri Lankan exchange rate has been an issue since April 2018 where it has depreciated by approximately 8%.
However, the Sri Lankan Rupee is not the only currency that has been affected, Argentinian exchange rate has depreciated by 50%, Turkey by 40%, India by 10% and Philippines and Australia by 8%.
Why is this happening?
The fast-paced decline in the exchange rate is due to the normalization of interest rates in the US. The US Federal Reserves have been rapidly increasing the federal funds rate which has led to the large-scale capital movements from emerging markets back to the US.
The Federal Reserve Chairman Jerome Powell mentioned that;
“The really extremely accommodative low-interest rates that we needed when the economy was quite weak, we don’t need those anymore. They’re not appropriate anymore,”
“Interest rates are still accommodative, but we’re gradually moving to a place where they will be neutral,” “We may go past neutral, but we’re a long way from neutral at this point, probably.”
This could mean that interest rates could increase further which led to greater capital outflows in financial investments in stock markets and security markets. The increased interest rates in US could mean that borrowing would now be more costly and there would be less credit-financed spending. Most importantly, this would mean that US would be importing less.
Sri Lanka has seen a foreign outflow of LKR 64 Billion from the local Treasury Bill and Bond Market since the last week of April.
Other factors that could possibly worsen exchange rates
The other factors that have likely added to the depreciation of the exchange rate;
- Trade tensions between US and China where both countries are implementing tariffs on imports from each country. As US and China are two of the world’s superpowers today and together they possess about 40% of the world’s GDP, this would translate to exchange rates around the world becoming more worse.
- US pulling out of the Iran nuclear deal has created uncertainty in both the oil industry and within the region, due to this capital is being moved to safe areas. This would mean that oil prices would in turn increase and this would cause pressure on each country’s current account in their balance of payment.
What can be done?
The first and foremost argument that would come up is that Sri Lanka’s economy should be more stable enough to withstand outside pressures. Also, find ways to substitute imports by producing food items and more locally. However, there are scarce resources, hence this would be a goal that should be achieved in the long term.
So, what could be done in the short term?
The biggest problem we face is that we are entirely too dependent on importing too many goods into the country. Imports have more than counterbalanced the gains made from exports and caused huge levels of trade deficits of US$ 10 billion this year. The goods produced for exports are manufactured with high import content and infrastructure development is highly dependent on capital goods and construction materials.
- 2017 – 16% of the import bill.
- 2018 – 18% of import bills in the first half of this year.
Basic food imports (wheat, sugar, dhal and milk)
- 2017 – 10.5% of import bills.
- 2018 – 9.6% of import bills in the first half of this year.
Gold and Vehicle imports
- 2017 – 6.7% of total import bills.
- 2018 – 10.9% of import bills in the first half of this year.
The government has taken measures to reduce imports by imposing controls on non-essential imports such as butter and cheese. Furthermore, they have imposed higher taxes on air conditioners, refrigerators, speakers, luggage, luxury cars, mobile phones and other electronic items. The government has even placed a 100% margin required on import letters for credit for vehicle imports.
CPC and LIOC have been directed to enter into specific contracts with foreign oil suppliers to take delivery from the seller, a specific quantity of oil at a predetermined price on a future delivery time. It has also been considered to introduce a designated dollar swap window for the CPC and LIOC as another option in tackling the rupee fall as fuel prices are exerting pressure on Sri Lanka’s import bill.
The overall goal should be that export growth must go hand in hand with a containment of imports to achieve an improvement in the trade balance for a long-term improvement.
What does this mean for your business?
Import businesses would be drastically affected by this depreciation in the Sri Lankan Rupee. Import costs will be more expensive which in turn would reduce their profits. Moreover, this would mean that there would be limited choices available to everyone, which then would reduce the living standards of Sri Lankans.
As well as this, the appreciation of the dollar means that most currencies will be affected which in turn disrupts exports businesses. Thus, due to the decrease in prices, the export businesses will be forced to compete with one another. Implying that the profitability of these companies would entirely depend on the quality of their products.
For a long-term solution, the government would have to reconsider the policies that they have passed on for the betterment of the country. Also, it would help the economy to be more stable in order to be prepared for future increases in the interest rate.