Beware politics of panic

No sooner had America and Israel begun bombing Iran in the closing days of February than Sri Lanka’s familiar anxieties resurfaced. Petrol stations ran dry and queues lengthened as vehicle owners rushed to pumps fearing shortages. Markets panicked before the country itself had fully understood the scale of the shock.

Something similar unfolded last week in the foreign-exchange market. For months, policymakers had quietly modelled scenarios arising from a prolonged Middle East conflict. Then came televised remarks by Central Bank Governor Dr. Nandalal Weerasinghe to Parliament’s Committee on Public Finance (CoPF) warning of the implications of a prolonged supply-side shock for Sri Lanka’s external sector. The market reacted instantly.

Importers rushed to secure dollars, in some cases booking foreign exchange months in advance. Exporters delayed conversions, expecting the rupee to weaken further. Notwithstanding close to $ 7 billion in reserves, strong remittances and tourism holding up reasonably well, sentiment overtook fundamentals.

The numbers reveal how quickly. By 2 April, the rupee had depreciated by just 1.7% yyear-to-date (YTD) against

the dollar, after weakening only 0.3% by 6 March. By 8 May, depreciation had moved to 3.6%, edging up further to 4.5% by 15 May. Within a week of the Governor’s CoPF remarks, YTD depreciation accelerated to 7.2% by 22 May.

The momentum reversed on Friday, not because the Central Bank depleted reserves defending the rupee, but because it intervened verbally, with moral suasion. Foreign-exchange dealers were cautioned to exercise restraint. Policymakers also signalled possible measures to tighten dollar liquidity management, including reducing the mandatory conversion period for exporter dollar earnings. It worked.

Bloomberg reported that the rupee snapped a nine-day losing streak to become Asia’s best-performing currency on Friday, strengthening by as much as 2.7%, and its biggest gain since March 2023.

The episode demonstrated something important. Markets do not always require reserve depletion or sharp interest-rate hikes to restore order. Sometimes credibility, signalling and the prospect of regulatory action are enough to break panic dynamics.

That matters because Sri Lanka’s leadership now faces a temptation that has repeatedly destabilised the economy in the past: the temptation to panic alongside the market.

Some are already demanding reserve deployment to defend the rupee. Others want tighter monetary policy, import restrictions or administrative controls. Familiar accusations about speculators, vehicle imports and capital flight have resurfaced.

But external crises are rarely caused by villains. More often they arise from arithmetic. Sri Lanka imports more than it earns when domestic demand exceeds the economy’s capacity to finance it. That imbalance can be concealed temporarily through reserves, subsidies, controls or borrowed dollars. But not indefinitely.

Leadership matters most precisely when markets lose confidence and politics becomes reactive. This is not the time for contradictory signals, policy improvisation or short-term populism.

Every option now carries costs. Allow the exchange rate to weaken further and consumption will adjust through higher prices. Raise interest rates and economic activity will slow more abruptly. Spend reserves defending the rupee and the country risks replaying the errors that ended in sovereign default. Either way, somebody absorbs the pain. That discomfort is not necessarily evidence of policy failure. In part, it is the adjustment itself.

We learned painfully in 2022 that economic reality cannot be postponed forever. Its leaders now face a simpler challenge: hold their nerve, act decisively and resist the urge to chase temporary calm at the expense of long-term stability.