Rupee depreciation vital to face present economic crisis - Dr. Saman Kelegama

by Gamini WARUSHAMANA

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Sri Lanka should depreciate the rupee to face the present economic crisis, the Executive Director of the Institute of Policy Studies Dr. Saman Kelegama told the Sunday Observer.

Here are excerpts from the interview.

Sri Lanka is feeling the impact of the US financial crisis spreading across the world. However, this is mainly felt in the trade sector rather than in finance.

The positive impact in the trade channel is the price decline of some key imports of the country. Oil, wheat and sugar prices have dropped and as a net food importer this price decline is beneficial to Sri Lanka’s economy.

The oil price decline is especially crucial. The high oil price aggravated our trade deficit and it is now cooling down. This will create a more positive impact on our trade balance.

The negative impact is the drastic decline of tea and rubber prices. With the declining commodity prices these prices too are on the same trend. At the same time due to the recession in the US and EU economies, the demand for these two products and apparel will drop.

At present, the GSP+ issue is in the balance. Therefore, the demand decline for our apparel exports is also a major concern, because it accounts for 43% of our overall exports. One way to face this situation is to depreciate Sri Lanka’s rupee.

This is very important because all our competitor countries have seen a depreciation of their currencies.

We have to seriously consider our exchange rate policy, especially during this global economic crisis. When a decision is taken to depreciate a currency several factors are considered and of them inflation, export competitiveness and the burden of debt repayment are the major areas relevant to us. However, there are trade offs.

Though the rupee depreciation has an adverse impact on the cost of living, as the international commodity prices have come down, the imported commodity price increase would not be that much in the current environment.

Currency depreciation will definitely assist the export industries which are facing a very turbulent time at this juncture.

The Sri Lankan rupee has appreciated significantly and as a result our export competitiveness has eroded. The recently released IPS’s State of Economy 2008 has pointed out that the real effective exchange rate of the Sri Lankan rupee calculated against the currencies basket of 24 countries has appreciated by 6.5% in 2007 and by a further 8.5% from December 2007 to May 2008.

The World Bank’s Country Assessment Strategy (CAS) released recently said that the real effective exchange rate of the rupee has appreciated by 25% since early 2000 eroding the export competitiveness of Sri Lanka.

The Rupee depreciation is very important at present for export industries to be competitive to hold the markets, because the domestic cost of production has gone up and industries are in a difficult situation. Interest rates, electricity and wages have gone up while cutting down of cost and productivity increase are limited.

In this situation the only option is to depreciate the currency or else industries will have to gradually close down. If the debt repayment is the concern against depreciation, a prudent debt management policy is very important without depending on the exchange rate to cushion it. With regard to finances, our financial system is not diversified and sophisticated with a number of instruments and therefore it is insulated from the global financial system.

In the banking sector, the amount of non performing loans is not seriously high and is manageable. Therefore, there is no threat to our banking system. All our leading commercial banks are performing well and therefore there are no major worries.

The only concern is the high interest rates. As a result credit to the private sector has substantially reduced. Once inflation comes down serious consideration should be given to cut interest rates.