20% Rupee Dip & Its Impact

The 20% rupee depreciation has made Sri Lanka’s expenditure to go awry, thereby hurting its ability to balance its budget, a banker told this newspaper.
The exchange rate (ER) which prior to the presentation of Budget 2012 on November 21 was administered at the Rs. 110.20 levels to the US dollar ($) in spot, interbank trading, has since been allowed to free float, resulting in its depreciation to the Rs. 131.90 levels currently, a Rs. 21.70 or a 19.7% depreciation since.
A reflection of the possible impact of the rupee depreciation may be seen when one examines Government of Sri Lanka’s (GoSL’s) foreign debt.
According to the latest statistics thrown up by state controlled Central Bank of Sri Lanka (CBSL), GoSL’s foreign debt in rupee terms increased by Rs. 688.5 billion (33.2%) to Rs. 2,759.7 billion year on year (YoY) as at May.
In contrast, total domestic debt in the review period increased at a much slower pace, both in absolute and in percentage terms, ie by Rs. 412.8 billion (15.1%) to Rs. 3,142.5 billion compared to that of GoSL’s foreign debt.
Meanwhile, GoSL’s foreign debt component for the totality of last year in rupee terms increased by a mere Rs. 304.7 billion (15%) to Rs. 2,329.3 billion YoY (when compared with its relatively sharper increase since), according to CBSL’s 2011 Annual Report.
It may be seen that in volume terms GoSL’s foreign debt increase in rupee value, at Rs. 688.5 billion as at May of this year,  on a YoY basis, was  more than double when compared with the increase of Rs. 304.7 billion of total foreign debt for the whole of last year.
Similarly, the YoY percentage increase as at May (33.2%) was also more than double when compared with the totality of the percentage increase for the whole of last year, ie a percentage figure of 15%.
In other statistics, total GoSL debt as at end May stood at Rs. 5,902.2 billion. This comprised a domestic debt component of Rs. 3,142.5 billion or 53.2% of GoSL’s total debt basket, while the foreign debt figure comprised 46.8% (Rs. 2,759.7 billion).
On the other hand GoSL’s total debt stock as at last year end stood at Rs. 5,133.4 billion. This comprised a domestic debt component of Rs. 2,804.1 billion or 54.6% of GoSL’s total debt component, while the foreign debt component comprised 45.4% of this figure (Rs. 2,329.3 billion).
Meanwhile GoSL’s debt stock in the review period had increased by Rs. 768.8 billion (15%), ie in the five month period from 31.12.11. to 31.5.12. When one breaks down this increase, it may be seen that the foreign debt component within those five months, ie from 31.12.11. to 31.5.12. had had increased by Rs. 430.4 billion (18.5%)-ie over its 31.12.11. outstanding foreign debt amount.
However, the domestic debt stock in the review period had had increased at a much slower pace, by Rs. 338.4 billion (12.1%)-ie over its 31.12.11. outstanding amount.
Of this Rs. 768.8 billion increase, it may also be seen that the foreign debt stock increase of Rs. 430.4 billion comprised 56% of this increase or volume, while the domestic debt component increase of Rs 338.4 billion, 44% of this Rs. 768.8 billion figure.
So the foreign debt component figure in this increase was bigger both in volume and in percentage terms than that of the domestic component, probably a first, in Sri Lanka’s debt management history where the foreign debt basket has had overtaken the domestic debt basket.
It may therefore also be seen that the foreign debt component as a percentage of GoSL’s total debt basket in the five month period from December 31, 2011 to May 31, 2012 has had increased by 1.4 percentage points to 46.8% in rupee terms, while the domestic debt component in the review period had had decline by an equivalent amount to 53.2% in the review period.
The possible repercussions in such a scenario may be the need for more rupees to buy the required US dollars ($s) to service such foreign debt liabilities.
Such a requirement may also cause pressure on the rupee liquidity position in the island’s banking system as GoSL would need rupees to buy the necessary $s (generally from CBSL’s external reserves) to service such foreign debt, generally in an  off market operation.
However when rupee liquidity is depleted, that causes pressure on rates to rise, but a high interest rate regime is no spur to development. So these are some of the issues that may have to be dealt with, when operating in an environment where the rupee is weak.
To counter such a scenario, two of the possible instruments that may be needed, are to boost export earnings and increase foreign direct investments (FDI).
But in May, exports in $ terms dipped by 15% (see The Sunday Leader business editorial of 5.8.12.), while CBSL’s FDI projections for the first five months of the year were $ 437 million (see The Sunday Leader business pages of 29.7.12.).
According to reports, Government’s debt service commitments alone for the year is $ 1.4 billion (see The Sunday Leader business editorial of 5.8.12.).
So if one extrapolates this $ 437 million figure for the year, one ends up with a number of $ one billion as FDI, not enough to service GoSL’s foreign debt services for the year.
Some of these FDI inflows may also go out of the country as imports- to buy certain fittings, such as that which is required by the hotel industry, thereby further drawing out foreign currency from out of the island, and in the process, increasing the strain on Sri Lanka’s balance of payments position.
And a quick snapshot on trade according to available statistics show that exports in the first five months of the year retarded by 5.4% YoY to $ 4,023.9 million while imports increased by 7.8% to $ 8,208.1 million, resulting in a $ 4,184.2 million trade deficit, a 24.7% YoY increase in the review period.
If this deficit is extrapolated for the full year, Sri Lanka may end up with a $ 10 billion trade deficit, a tall order for GoSL to bridge this gap with the drought making matters even worse, including affecting Sri Lanka’s agriculture exports, primarily tea.
As it’s there was a 11.5% decline in agriculture exports in $ terms in May (see The Sunday Leader business pages of 29.7.12.).
A businessman involved in the tea industry told this reporter with the drought and therewith a reduction in supply, one would have had expected tea prices to move up on the demand and supply theory, but that was not to be due to sanctions imposed by the USA on Iran, Sri Lanka’s second biggest tea export market, thereby making it difficult for the industry to make exports to Iran.
According to available statistics, tea prices in the Colombo auctions marginally increased by 0.7% YoY to $ 3.06 per kg. in May. Meanwhile Sri Lanka’s biggest export, garments, declined by 13.5% in $ terms in May (see The Sunday Leader business pages of 29.7.12.).
In other developments, in the first five months of the year the expenditure to revenue gap widened to Rs. 306.9 billion ($ 2.3 billion* or 3.9% of GDP**) compared to a figure of Rs. 186.2 billion ($ 1.7 billion*** or 2.9% of GDP**) in the commensurate period last year, according to CBSL statistics.
According to CBSL, the budget deficit last year was 6.9% of GDP, while GoSL targets to reduce the deficit to 6.2% of GDP this year.  But if one extrapolates this figure, the budget deficit for the year end may well be 7% and not 6.2%, ie equivalent to a gap of $ 4.13 billion.**
This will result in more borrowings, both domestic and international and more pressure on rates. And last but certainly not the least, a weak rupee will make the cost of imported essentials such as medicines, sugar and dhal to name a few, too expensive to the poor of this country.
*On the basis that 1$= Rs. 131.90 currently
** On the basis that the GDP value of the economy last year was $ 59 billion as per CBSL statistics.
*** On the presumption that the value of the ER then was 1$=Rs. 110.20