Sri Lanka affirms flexible FX policy, but will intervene if needed

• Central Bank Governor says rupee’s trends will depend on flows
• Bank will intervene if needed to curb volatility
• Bank sees 125/dollar as equilibrium level, but not a target
• July annual inflation to ease from 41-month high

Reuters: Sri Lanka will maintain a flexible exchange rate, allowing flows to determine trends, though the Central Bank will intervene, if needed, should fluctuations of the rupee currency become too sharp, the Bank’s Governor told Reuters on Thursday.

Since the Central Bank switched to a flexible exchange rate regime in February, the currency has depreciated around 16 per cent and the rupee is now expected to recover thanks to inflows from last week’s $ 1 billion euro bond issue and a continuous inflow of funds to buy Government bonds.

“We have committed ourselves to a flexible regime,” Central Bank Governor Ajith Nivard Cabraal said in an interview.

“We will allow the trends to take place, but at a manageable pace. It will not be at an unmanageable pace which can put people off gear,” he said, adding, “We are in a position to intervene if necessary, also. I am not ruling that out.”

Cabraal said the Central Bank would, at times, use other methods, including “moral suasion,” to moderate movements in the exchange rate, without recourse to intervention.

The Central Bank spent more than $ 2.6 billion to stave off depreciation in the second half of 2011, but a sharp depletion of its reserves, a $ 9.7 billion trade deficit, and a $ 1 billion deficit in balance-of-payments, compelled the Government to devalue the rupee by three per cent in November.

After the Central Bank adopted a flexible exchange rate regime, Sri Lanka’s Treasury later said the move was made due to a shortage of dollars to defend the rupee.

The rupee hit a record low of 134.30 per dollar on 28 June despite the Central Bank and Finance Ministry repeatedly saying it should regain the 125 per dollar level.

“We are not targeting it, neither do we need to push towards it with a time table,” Cabraal said.

“But in our view that should be what it will settle at in the current macroeconomic fundamental arena. Knowing what our imports should be, knowing what are the other inflows are going to be, we believe that would be a reasonable rate overall.”

Treasury Secretary P.B. Jayasundera on Tuesday said the Government would sell the market $ 500 million of the proceeds from last week’s euro bond issue to help stabilise both the exchange rate and interest rates.

The rupee’s depreciation, along with high import taxes on some essential goods, drove June inflation to a 41-month high of 9.3 per cent.

“We think this month it should come down. Of course the base is again quite low, so it will be not a substantial reduction,” Cabraal said.