Devaluation divide

•  Conflicting views remain after Budget’s 3% devaluation move
• PB says rupee should be market-driven; Cabraal says will defend

Conflicting views on the country’s currency remain with Treasury Secretary Dr. P.B. Jayasundera saying it should be market-driven, whilst Central Bank Governor Nivard Cabraal maintains that it will be defended.

The simmering or what seems to be the climax of opposing views is getting global spotlight as conflicting comments were made to Reuters.On Thursday Reuters quoted Dr. Jayasundera as saying the rupee devaluation was long overdue and that the exchange rate should be market-driven.

Yesterday Cabraal chipped in, reiterating to Reuters that the Central Bank would defend the rupee rate.

The Reuters story quoting the Treasury Secretary kicked off saying Sri Lanka’s rupee exchange rate should be driven by market forces except in cases of volatility, but this week’s three per cent devaluation was necessary medicine to ease a ballooning trade gap.

“Finance Ministry Secretary P.B. Jayasundera, the top technocrat in the island nation’s Finance Ministry and architect of Sri Lanka’s last 14 budgets, said the devaluation was a considered move that was essentially ‘a market correction,’” the report added.

“(Having) the reserve level of $ 6-7 billion is the time to do this correction. We had $ 8 billion reserves and the reserves are under pressure.

If you continue to let that happen without giving a signal, at some point you will have to do this or take some other drastic measures,” Jayasundera told Reuters.

Jayasundera said the exchange rate policy had encouraged imports, as did low interest rates, while exporters grew less competitive and had less incentive to expand.

Sri Lanka’s trade deficit though August was $ 5.96 billion, nearly as big as 2008’s record shortfall. The full-year forecast is $ 6.76 billion. Despite that, the Central Bank has spent more than $ 1 billion this year defending the rupee, while Asian peers let their currencies drop.

“In my view, some adjustment should have happened even before to prevent this. It should be a market-driven, stable exchange rate. When the market doesn’t produce it, the Central Bank needs to come into help stability,” he said.

The International Monetary Fund praised the devaluation as a move in the right direction, after it withheld the eight tranche of a $ 2.6 billion loan after the Government refused to allow for a more flexible exchange rate.

The Reuters report quoting the Central Bank Chief yesterday kicked off saying “Sri Lanka’s Central Bank on Friday said it will sell dollars from its foreign exchange reserves to defend the rupee currency after it was devalued three per cent this week and may allow appreciation if inflows push back depreciation pressure.

Central Bank Governor Ajith Nivard Cabraal said President Mahinda Rajapaksa has said the devaluation is a one-off change, after he ordered the Central Bank to implement it during his 2012 Budget presentation on Monday.

“I had a discussion with the President and I have got his assurance on that,” Cabraal told Reuters. “We have moved more than what we should have.”

The Central Bank dropped the rupee to 113.90 from 110.40 a dollar on Tuesday and now is maintaining a narrow dollar band of 40 cents between 113.50/90, which Cabraal says is “comfortable”.

Reuters also said contrary to Cabraal’s view, Finance Ministry Secretary P. B. Jayasundera on Thursday told Reuters the exchange rate should be driven by market forces, except in cases of volatility.

Jayasundera and Cabraal are the two most influential economic policymakers in Sri Lanka, except when Rajapaksa steps into economic policy in his role as Finance Minister.

Rajapaksa’s surprise devaluation announcement shocked the markets and surprised many Central Bank officials, who were not prepared to implement the directive.

It is the second time since 2009 that the island nation’s fiscal authority, the Finance Ministry, has made a monetary policy decision that overrode the Central Bank’s authority. The Finance Ministry raised benchmark State bank interest rates in 2009 without informing the Central Bank first.

The Central Bank has spent more than $ 1 billion this year to defend the rupee, while Asian peers let their currencies drop. That prompted the International Monetary Fund (IMF) to withhold the latest tranche of a $2.6 billion loan and warn the exchange rate policy was unsustainable. It praised the devaluation as a “step in the right direction”.

“We are giving back the market some of the reserves we have accumulated and I think that is the way you have to make use of your reserves. If you are not using the reserves, what is the use of keeping reserves?” Cabraal said.

The Central Bank has said it was holding the rupee steady on the expectation of foreign capital inflows. Cabraal has directed local banks to raise $ 800 million from cheaper foreign sources, and said three banks have already secured $ 275 million.

Despite the upward pressure on inflation and interest rates, Cabraal said the monetary policy rates were still appropriate, but the devaluation had increased the country’s debt by Rs. 74 billion ($ 650 million).

On Wednesday, a day after the devaluation implemented, benchmark 91-day T-bill yields jumped 44 basis points, while yields in 182- and 364-day T-bills rose 64 and 91 basis points respectively from the previous auction.