Random observations on forex rates movements

The exchange rates movements and the exchange rate regimes assume very high priority in the management of macro-economic policies in the economy. The exchange rates movements has direct impact on the export competitiveness, cost of imported raw material and consumer products, cost of serving the foreign borrowings, services sectors such as tourism, BPO, foreign direct investments, the general inflation, the price stability, general employment and income of the economy. Fractional or slight changes in the movement of exchange rates will have profound and occasionally even disproportionate impact on the economy at large.

The monitory 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 is significantly high over other freely convertible foreign currencies. Foreign exchange transactions for international trade are being predominantly carried out by the 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. (Foreign exchange requirements for personal reasons, such as overseas travel and en-cashing foreign currency to Sri Lankan currency).

In the recent past, Sri Lankan Rupee has been gradually appreciating vis-a-vis major foreign currencies mainly due to US Dollar loosing its value steadily in the international financial markets recently. Increasing foreign exchange inflows from 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 our exports would not be eroded due to undue appreciation of the Rupee. The business community is more concerned about the volatility of the exchange rates as the high volatile exchange rates would erode the business competitiveness and the long term business relations with both buyers and the sellers overseas. According to the Central Bank of Sri Lanka, during 2010 both Nominal Effective Exchange Rate (NEER) and Real Effective Exchange Rate (REER) appreciated against all the major currencies except Japanese Yen and Indian Rupee.

It is observed that Sri Lanka maintains a managed exchange rate policy. In other words, the external value of local currency is not solely determined by the market forces. While market forces are largely reflected in the value of the exchange rates, monitory policy also intervenes to avoid excessive volatility of the exchange rate. In this process, one of the soft instruments being practiced by the Central Bank of Sri Lanka is daily publishing of the Approximate Indicator Exchange Rate based on the previous day’s market waited average rates for the US Dollar. For an example, the Central Bank’s indicative rate for US Dollar (1 Dollar) on 6 May 2011 is Rs. 109.7130. The Central Bank also publishes the average rates quoted by the commercial banks daily in the public domain for the information of the general public. On 6 May, the Central Bank quoted the Rupee value for US Dollar buying rate at Rs. 108.99 and the selling rate is at Rs. 110.67 with a margin between the buying and selling per Dollar at Rs. 1.68. Although this is the average rate for 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 purchase 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 (larger the denomination higher the rates) and the bargaining power of the costumers. High valued foreign currencies always maintain high margin of difference between the selling and buying price. (eg. Euro)

In addition to the above rates, for the purpose of calculating tariff, the Sri Lanka Customs applies a different rate of exchange that of commercial banks on weekly basis. During the period of 9 May 2011 to 15 May 2011 the Sri Lanka Customs indicates the value of Rs. 110.66 for a US Dollar.

Table 1 shows without mentioning the names of the Banks, the buying and selling rates for US Dollar and the margins between the two as quoted by the major six commercial banks of Sri Lanka, on 6 May 2011.

It would be observed from the above table that the margin between buying and selling rates of US Dollar varies from lowest of Rs. 1.20 to highest of Rs.2.61. Both rates were quoted by private commercial banks. The lowest rate quoted by the private sector bank is surprisingly not the largest private sector bank which engaged in substantial foreign exchange transactions. This bank may be attempting to attract private foreign exchange transactions than engaged in international trade. 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 the 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 erodes their competitiveness in the international market and the cost of imported raw materials, inputs and consumer products. These traders are of the view that the margin should be not more than Rs. 0.5 of the margin stipulated in the Central Bank’s daily indicative price. This thesis is earning merit for further examination by the monitory policy makers and banking community of Sri Lanka. Furthermore, the importers of consumer products and investment goods alleged that they have to pay high rates at two points viz. at the time of opening of letter of credit and the clearance of goods at the custom making the imported goods more expensive.

In an associated issue, we also observe a substantial number of workers’ remittances transactions are still conducted outside the banking system via 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 the international reserves of the country.

(Research and Policy Advocacy Unit Federation of Chambers of Commerce and Industry of Sri Lanka)