Why The Sri Lankan Rupee Is Appreciating

By Harsha Gunasena –

From November 30th last year, the Sri Lankan Rupee is appreciating against the US Dollar gradually. The Rupee value of a dollar on November 30th was Rs. 329 and the same on March 20th was Rs. 304. Sri Lanka is experiencing an appreciation of the Rupee for a second time.

Over decades the value of the Dollar in Rupees increased gradually. During the economic crisis for a short period from March 7th 2022 to May 13th 2022 the value of a Dollar in Rupees increased from Rs. 202 to Rs. 369. For the first time in the history the value of the Dollar in Rupees started decreasing from February 26th 2023 to June 8th, 2023 from Rs. 364 to Rs. 290. This was the result of stabilizing the Rupee shedding the speculative trends.

There are interpretations that the prevalent situation is an indication of the recovery of the economy. There is a truth in that. According to the Central Bank reports there is a positive balance in the Current Account after 1977. Current Account balance is comprising of the  trade balance, which is the difference between export income and the import expenditure, remittances by the Sri Lankans working abroad and service income such as income on tourism. In 2023 as usual import expenditure was more than the export income as  a result there was a deficit  in the Trade Balance. (USD 4.9 billion) However since foreign remittances (USD 6 billion) and service income such as tourism (USD 2.1 billion) increased we could achieve a positive balance in the Current Account.

Graph – Exchange Rate Movement – Rupees per USD

Finance Account has not shown a progress and the country has received the installments of IMF loan and loans from the World Bank and the Asian Development Bank. Also, there was a net inflow of the transactions of Colombo Stock Exchange and Government Securities. These are the positive signs of the revival of the economy. The other point is that the consumption of imported goods may have dropped due to the affordability. This would reduce the cost of imports.

The inflow of Dollars to the market is more the outflow. Hence there is a surplus of the Dollars in the market. As a result, the value of the Dollar in Rupees drops in the market. In order to control the drop the Central Bank buys Dollars from the market by giving Rupees. At the end of 2023 the Central Bank increased the foreign reserves to the level of USD 4.4 billion. Out of that USD 1.7 billion was net purchases of Dollars from the market.

This is the reason of the appreciation of the Rupee. However, this is not the total picture. Now there is an import control. Some of the goods such as vehicles were not allowed to be imported. Exporters have to convert their receipts in Dollars to Rupees immediately. The country has not yet started to repay all the loans. Therefore, the excess of Dollars in the market is not real since some elements were kept away from the market forcibly. When these elements come into the market there is a possibility that the Rupee will start to depreciate.

Sri Lanka is importing consumer goods, intermediate goods and capital goods. There is no reduction yet of the imported consumer goods in the market in relation to the reduction of the Dollar in Rupees in the market. The cost of oil is also not reduced to reflect the reduction. The reasons may be the slight increase of the oil prices in the international market and  the increase of VAT from January.

The notable point here is this. The country will have to increase the level of exports of goods and services. For exporters, when exporting goods and services, the price is determined not only based on the cost of production and the profit margin but also the prices quoted by our competitors supplying the same products to the international markets. Our competitors are countries such as India, Thailand,  Indonesia, Bangladesh and Vietnam. The exchange rate in those countries are not in a scenario of appreciating the home currencies continuously. Hence the international prices are not getting increased.

Interest rates were dropped and dropping, and inflation is controlled. These are good signs of a progressing economy. However, the cost of the goods increased during the inflationary period remains. The cost of the goods increased further due to the increase of VAT. If exporters buy good from the VAT registered ventures, the increased VAT is not an expenditure to the exporters which could be claimed from the Inland Revenue Department.

In this scenario if the value of the Dollar comes down to the level around Rs. 280, all export ventures may record losses.

In 2022 when the value of the Dollar increased in a short period to the level of Rs.360, the exporters gained windfall profits. This was a benefit to set off the increased costs of the local goods due to high inflation and high interest rates. This situation was eased later and in June 2023 the value of the Dollar was Rs. 290. Within a short period of time it went up to Rs. 309.

Since there is an influx of tourists the turnover of the tourism industry increased but their profit margins are getting eroded due to the reduction of the Rupee value of the Dollar. The recipients of foreign remittances also are getting lesser amount of Rupees into their hands.

We should pay attention to this sector since the sector would be the savior of recovering the economy. The answer to our economic ailment is to promote exports of goods and services including tourism. Therefore, it is ideal that if the Rupee is kept at the level that it is not  overvalued and if so it would be detrimental to the exports and thereby to the economic recovery of the country.

If the appreciation of the Rupee happens in the background of increasing of production and exports of the country, then it is natural. The current situation is a temporary one. In the future when the imports are relaxed further and when the country starts to repay all the loans the situation will be changed, and the value of the Dollar in Rupees will be increased.

There are stories that economic recovery is an illusion, and we will fall back to the same level in time to come. Yes, if not proper policies are not followed. Otherwise not. It is a reality that the tourism industry is developed and the foreign remittances were increased. Promoting the tourism industry is one of the best ways to develop foreign income in the short run.

Management of the economy is a balancing act and the policy makers and implementors cannot go to extremes.

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