Sifting Wheat from Chaff

JUN 28 2018

IMF’s Sri Lanka Mission Head Manuela Goretti speaking to journalists in Colombo via a video conferencing facility from Washington, DC last Wednesday said that a flexible exchange rate (ER) is the first line of defence against inflation.

She also said the country’s foreign reserves were fragile, while expecting an automatic pricing formula (APF) for electricity.

However, Central Bank of Sri Lanka’s (CBSL’s) ER policy pursued immediately after that briefing has been contrary to Goretti’s advice.

CBSL, in order to shore up the rupee amidst depreciative pressure, since last Wednesday, has pumped US dollars from the country’s foreign reserves to the market.
As a result, the benchmark ‘spot’ has strengthened by between Rs 1.55 and 1.45 (0.97-0.91 per cent) in four market days, to have closed at Rs 158.40/60 to the dollar in two way quotes by Tuesday.
Yesterday was a holiday to the market on account of Poson Poya. ‘Spot’ trades are settled after two market days from the date of transaction.

A weak rupee causes inflationary pressure as Sri Lanka is an import dependent economy. CBSL’s writ is to ensure price and financial system stability. By ensuring a stable ER, CBSL aids price stability.

According to latest data, the country’s foreign reserves, year-on-year (YoY) as at the end of last month grew by 30 per cent (US$ 2,023.51 million) to $ 8,769.01 million, giving CBSL adequate room to defend the rupee.

Depreciative pressure on the rupee is caused by exporters holding on to their dollars on expectations that there is room for it to weaken ‘further’ due to the political uncertainty created after former President Mahinda  Rajapaksa’s fledgling Sri Lanka Podujana Peramuna’s surprise landslide win at the 10 February Local Government polls.

Nonetheless, CBSL’s ER policy stance is a battle of wits between it and exporters.  Exporters need rupees to meet their domestic commitments. In the absence of them converting their dollars to rupees to meet such commitments, they would have to resort to bank borrowings.

Another weapon that CBSL has to ‘induce’ exporter conversions is to raise rates. CBSL’s next rates decision is on 6 July. However, Goretti advised against raising rates as it may harm growth.

First quarter (1Q) growth, YoY decelerated from 3.8 to 3.2 per cent, while Q on Q it has stagnated at 3.2 per cent. Therefore, it’s unlikely that CBSL will raise rates, instead, opting to continue to defend the ER from its reserves, hoping that this will wear down exporters.

Last month, the Government backed down from an administered price regime for fuel, to an APF, centring round variables such as the ‘spot’ value and the world market price of crude.

IMF wants a similar mechanism adopted for electricity which prices too is currently administered.

However, hydroelectricity, the cheapest source of electricity, stayed in the positive growth terrain on a YoY basis for the eighth consecutive month to March, according to latest data.

As at last year, hydroelectricity unit cost to the CEB was Rs 2.77, whereas currently the electricity unit price charged to the consumer is seven times more at Rs 20.06.

In the1Q of the year, hydroelectric power generation grew by 87.6 per cent YoY to 650 gWh comprising 16.93 per cent of total electricity generated in the review period. The biggest generator was coal, comprising 39.81 per cent or 1,528 gWh, out of total electricity generated of 3,838 gWh, a 9.6 per cent YoY growth. As at last year, the cost of a ‘coal electricity’ unit was more than four times hydroelectricity, at Rs 9.74 a unit.

Nevertheless, considering that coal and hydroelectricity comprise more than 50 per cent of Sri Lanka’s total electricity requirements and also the fact that the ‘spot’ YoY has fallen by between Rs 5.07 and 5.20 (3.31-3.39 per cent), while Ceylon Petroleum Corporation’s crude oil import prices having had increased by $ 29.02 (56.17 per cent) to

$ 80.68 a barrel as at last month according to available data, it may be prudent for the Government to defer implementing an APF for electricity at this juncture, considering the fact its implementation would result in the price of an electricity unit increasing further, from the current ‘high’  levels of
Rs 20.06.