Depreciation of the Rupee:

Only small section will benefit -Economists

The Sri Lanka Rupee has depreciated against the US Dollar (US$) by around 7% so far this year with the Central Bank’s decision to allow greater flexibility in the determination of the exchange rate.

With the intense volatility in emerging market currencies in the recent past, the depreciation of the Rupee is unavoidable for Sri Lanka’s exports to remain competitive, Director and CEO, Candor Group of Companies, Ravi Abeysuriya, told Sunday Observer Business.

The deepening economic slowdown in China, spurring commodity rout, looming US interest rate increase and increase in outflow from emerging markets have put emerging market currencies under pressure, he said, adding that the Rupee depreciation is in line with the depreciation of other emerging market’s currencies against the US$.

The table above depicts the depreciation of currencies (YTD High versus YTD Low) in 2015 for a few countries with which Sri Lankan exports compete.

The immediate impact of depreciation of the Rupee in September is evident in the narrowing of the trade gap with the reduction of non-essential imports.

However, some economists believe the depreciation will benefit only a small section of the country as Sri Lanka’s exports still account for only a minor share of the total economy. Sri Lanka’s external debt and external debt servicing costs in Rupee terms would increase.

The Rupee depreciation will increase the prices of imports, and will reduce non-essential imports such as motor vehicles. This will have a negative impact on the growth of the leasing portfolio of financial institutions resulting in a slowdown in the growth of the leasing books of finance companies.

Overseas funds unloaded a net of US$ 5.1 billion of Indonesian, Thai and Philippine shares in the third quarter as the MSCI Southeast Asia sank 21 percent.

In the short term, Sri Lanka too will witness more outflow of foreign funds from government securities and the stock market due to expectations of an interest rate hike of the US $. The devaluation of the currency will further deter foreign investors entering the Sri Lankan stock market due to the unpredictability and volatile nature of the currency that will increase the currency risk for the investor.

Textiles and garments which contribute US$ 2.82 bn, account for 44% of local exports, however, the industry imports intermediary goods to the value of US$ 1.39 bn (from January to July 2015). Therefore, the devaluation in the currency will increase the cost of raw materials that could be counterproductive for the local garment export competitiveness.

Sri Lanka during the post-war period focused heavily on infrastructure development funded mainly by foreign debt. At the end of 2014 external debt to GDP stood at 57.4%, and year to date the nation has accumulated a US $ 4.3 billion debt servicing commitment (including, interest and capital payments). Thus, the currency depreciation will increase the country’s foreign debt servicing cost and will contribute towards the widening of the government budget deficit.

During the first seven months of the year (January to July 2015) the country recorded a US$ 4.4 bn trade deficit. This could narrow in the medium to long term, with the expected reduction in imports due to it being expensive. This will have a positive impact on the BOP deficit. If the intervention in the forex markets were to be minimal, this will have a positive impact on foreign reserves. Therefore, excess liquidity levels will be maintained and in turn reduce the impact on interest rates.

The Rupee has been perceived by foreign investors as an overvalued currency due to the constant intervention in the currency.

The currency devaluation is timely with the expected US interest rate hike which will impact all global currencies, therefore, it could help the local currency in the long run.

The floating currency will result in more confidence and better currency risk management for foreign investors. The expected key positive impact is the boost for export industries. However, this comes at the expense of a rise in prices of all imported goods, inflation, increased cost of foreign education and higher debt burden in rupee terms for the Government and corporates that have a foreign currency denominated debt.

- SJ