The Economic Outlook Remains Uncertain!

By Hema Senanayake –January 2, 2016

Hema Senanayake

Calendar year 2016 begins today. In this year the government is going to learn an economic lesson which had never been learnt in their first full year in office. They will learn that ultimately both monetary and fiscal policy narrowed down to the management of exchange rate. In 2015 the government did fail to understand it and as a result the rupee depreciated to an unexpected level. According to the Minister of Finance himself, the expected value of the rupee against U.S. dollar was close to 130. However, on the last banking-day of the last year the exchange value of rupee was around Rs.145 per dollar.

For any country which uses some other country’s currency such as dollar, as its international reserve currency and also for any country which has been posting a current account deficit for a significant number of years like Sri Lanka, the both monetary and fiscal policy ultimately narrowed down to the management of exchange rate, if that country did not have enough non-credit based inflow of dollars (foreign exchange) which are not posted in the nation’s “current account.” This is not difficult to understand. For example, if the rupee depreciated from its current value of Rs.145 to Rs.160 or 165 per U.S. dollar in this year, it will bring negative chain effect across all sectors of the economy with little positive effect on exports.

However, some economists who are critical about the depreciation of rupee do blame the Central Bank of Sri Lanka (CBSL) for adopting “floating exchange rate arrangement.” It is true that Sri Lanka has been previously classified as having stabilized or fixed exchange rate arrangement. Usually International Monetary Fund (IMF) publishes a report each year classifying all its member countries (188) in terms of exchange rate arrangements adopted by each country. Accordingly, in 2014 report IMF has classified Sri Lanka as a country which moved to a stabilized arrangement from floating, (refer page 3 of IMF report). When the 2015 report is published by IMF, it will reclassify Sri Lanka as having moved back to floating regime from stabilized arrangement. Can any country like Sri Lanka which continue to meet its Balance of Payment requirements through borrowed money from foreign sources, choose as to what kind of exchange rate arrangement be adopted? My obvious answer is “NO.” It has to adopt “floating regime” under the given circumstances.

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