Hold the line on the Rupee

The Sri Lankan rupee has been under pressure in recent weeks, renewing familiar anxieties about the state of the economy. While the latest tranche of the IMF bailout program, coupled with steady remittance inflows, has eased some of that pressure, the broader trend of the currency has remained one of gradual weakening. This has inevitably triggered criticism from political opponents and concern among the public.

The value of the rupee has long been treated as a political barometer. A weakening currency is often interpreted as a sign of a weakening economy, while a strengthening rupee is presented as evidence of economic competence. Exchange rates do reflect underlying economic fundamentals and investor confidence. However, the excessive focus on the day-to-day value of the currency often creates dangerous incentives for Governments.

Political leaders are understandably reluctant to face accusations that the rupee is losing value under their watch. The temptation, therefore, is to intervene in the foreign exchange market to artificially prop up the currency. This is typically done by selling foreign currency reserves in order to increase demand for the rupee and support its value.

Such measures may provide short-term political relief, but they come at a tremendous economic cost. Foreign currency reserves are not an unlimited resource. They are painstakingly accumulated through exports, remittances, tourism earnings and prudent economic management. Depleting these reserves to defend an unsustainable exchange rate is akin to spending one’s savings to maintain appearances. It may delay criticism for a while, but it does nothing to address the underlying problem.

Sri Lanka has already learned this lesson the hard way. In the years leading up to the 2022 economic crisis, the Government artificially maintained the exchange rate at a level that was increasingly detached from economic realities. Vast amounts of foreign reserves were spent in an attempt to defend the rupee. The result was disastrous. Reserves were drained, confidence evaporated, and the country eventually found itself unable to meet its external obligations, culminating in a sovereign default.

That experience must serve as a cautionary tale for any Government that may lose its nerve in the face of criticism over a depreciating currency. Whatever the reasons for the rupee’s weakness, whether global economic conditions, import demand, capital flows or domestic factors, the solution cannot be to artificially manipulate the exchange rate through reckless reserve depletion.

A market-determined currency may not always be politically comfortable, but it is economically healthier than a managed illusion. Exchange rates must be allowed to reflect economic realities. Attempts to suppress those realities only make the eventual adjustment more painful.

The Government, therefore, must hold its nerve. It should focus on strengthening the fundamentals of the economy, improving export competitiveness, attracting investment and maintaining fiscal discipline rather than chasing an arbitrary exchange rate target. Stability and credibility are far more valuable than a temporarily stronger rupee achieved through unsustainable interventions.

Sri Lanka cannot afford to repeat the mistakes of the past. The lesson of 2022 is clear that protecting foreign reserves and allowing economic realities to guide policy is far wiser than pursuing the illusion of a strong currency. Short-term comfort bought through artificial intervention can quickly become the foundation of a long-term crisis. That is a price the country simply cannot afford to pay again.