(Bloomberg) – Sri Lanka is effectively devaluing its currency as its foreign exchange reserves dwindle, potentially accelerating Asia’s worst inflationary spurt as the country struggles to service its debt and pay for imports.
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The Central Bank of Sri Lanka said in a statement late Monday that “greater exchange rate flexibility will be permitted in the markets with immediate effect.” The central bank also said it was “of the view” that transactions would be capped at 230 rupees to the dollar, about 12% lower than the current market level of 201.49 rupees.
The decision comes as Gotabaya Rajapaksa’s government grapples with a spiraling economic crisis, as its foreign exchange reserves dwindle and after consumer prices accelerated by 15% last month, the fastest on record. .
The island nation’s debt burden, which the International Monetary Fund has described as ‘unsustainable’, is becoming increasingly difficult to manage as it also struggles to pay for imports of fuel and other commodities. necessity, resulting in power outages and other shortages.
“It was really necessary to relieve the pressure in the system. We have seen the impact on fuel,” said Kavinda Perera, head of research at Asia Securities in Colombo. He added that inflation would be fueled in the short term.
Speculation has started to grow recently that the central bank will not be able to defend the currency as its reserves dwindle. Economists at Standard Chartered Plc had seen the rupee fall to 230 to the dollar at the end of June as the central bank ran out of dollars.
The local currency has traded in a relatively narrow range of 201 to 203 to the dollar since October, a range that central bank governor Ajith Nivard Cabraal last month called “fair” for all stakeholders.
But in unofficial trade, the rupee was quoted at a much lower rate as exporters were mandated by the central bank to convert 25% of their earnings while importers were forced to seek dollars from exporters on the so-called curb market.
“There was no choice but to let the exchange rate move. Most importers were already importing between 230 and 240,” said Udeeshan Jonas, chief strategist at CAL Securities. “Monetary policy should be tightened further to avoid a very sharp drop in the currency,” he said.
WA Wijewardena, a former deputy central bank governor, said the monetary authority would not be able to eliminate “parallel exchange rates” unless the rupee was allowed to float freely.
“The restriction rate is just going to go up,” he said, adding that further monetary policy tightening was needed to support the currency.
Shortly before the currency’s announcement on Monday, the central bank said foreign currency holdings fell to $2.31 billion in February, the lowest since November 2021, from $2.36 billion a month. earlier.
The government has so far relied on bilateral loans to bolster its finances, notably from China and India, while avoiding an IMF bailout.
A depleting currency stack raises the risk that the country will struggle to meet its next external debt repayment in July.
The Sri Lankan dollar bond which matures in April 2023 was up about 0.5 cents on the dollar at 43.3 cents as of 8:30 a.m. Hong Kong time on Tuesday, according to data compiled by Bloomberg. The price had fallen 4.6 cents on Monday, the biggest drop since April 2020, the data showed.
The central bank last week raised borrowing costs for a second meeting and urged the government to provide economic support by taking measures such as discouraging non-emergency imports and raising fuel costs.
Sri Lanka dollar-denominated debt repayments due this year total more than $6 billion, including a $1 billion sovereign bond maturing in July.
The central bank also said on Monday that it would “continue to closely monitor developments in the domestic foreign exchange market and make appropriate policy adjustments accordingly.”
(Updates with analyst quote in fifth paragraph.)
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