Rupee appreciates as CBSL moves to restore order

• CBSL instructs banks to cap interbank spot exchange rate at Rs. 330
• Interbank USD spot rate eases to Rs. 329/335 from Thursday’s Rs. 331/348 peak
• Dealers say forex market was driven largely by sentiment, not fundamentals
• Exporter dollar sales returned liquidity to the market at hint of measures to bolster currency
• Importers step back after earlier front-loading of LCs and FX bookings

The rupee appreciated yesterday after the Central Bank of Sri Lanka (CBSL) moved to calm a nervous and sentiment-driven foreign exchange market following sharp depreciation earlier this week triggered by panic dollar demand and delayed exporter conversions.

The interbank US dollar spot market buy/sell rate eased to Rs. 329/335 yesterday, with the rupee strengthening from Thursday’s Rs. 331/348, which marked the currency’s weakest level against the dollar this week. The rupee had closed last week at Rs. 321.90/326.00.

Market participants said the Central Bank met banking CEOs yesterday and foreign exchange dealers on Thursday and is expected to introduce regulatory measures aimed at reducing volatility in the currency market.

Dealers said CBSL yesterday informally capped the interbank US dollar spot rate at Rs. 330, while market speculation also emerged that the Central Bank could shorten the mandatory conversion period for export proceeds from 90 days to 30 days.

Dealers said the rupee had come under pressure this week after importers began front-loading Letters of Credit (LCs) and booking foreign currency requirements as much as three months in advance amid expectations of further depreciation. At the same time, exporters delayed converting export proceeds into rupees in anticipation of higher exchange rates, tightening dollar liquidity in the domestic market.

The developments triggered increased dollar conversions by exporters, helping restore liquidity to the market, according to dealers.

Importers, who had aggressively purchased foreign exchange earlier in the week, subsequently moved to the sidelines, expecting the exchange rate to ease further.

Market participants said the sharp exchange rate movement during the week reflected a combination of sentiment-driven positioning and external pressures linked to higher global energy prices and Middle East tensions. There will continue to be pressure on the currency if global shocks persist, but what remains to be seen is how the market reacts and how the regulator responds.

International Monetary Fund (IMF) Mission Chief for Sri Lanka Evan Papageorgiou on Thursday also expressed confidence in Sri Lanka’s ability to manage economic pressures arising from the Middle East conflict, saying the country’s stronger policy framework, improved reserves and ongoing reform program had placed the economy in a better position to absorb external shocks than in the past.

He noted that Sri Lanka had made “significant progress” in restoring macroeconomic stability, rebuilding reserves and strengthening confidence over the past several years.

“Recent global developments have brought renewed pressures, as is the case for many economies in a challenging external environment. Navigating these shocks is never straightforward, but Sri Lanka’s policy framework today is considerably stronger than in the past,” he said.

Papageorgiou also stressed the importance of maintaining policy consistency and allowing the economy to adjust to evolving market conditions to sustain the gains achieved under the reform program.