Q+A-Where is Sri Lanka’s rupee heading?

By Shihar Aneez

COLOMBO, March 6 (Reuters) – Sri Lanka’s central bank is negotiating a $1.9 billion loan with the International Monetary Fund, and that has left the rupee currency <LKR=> market without a clear direction since hitting an all-time low last week. [ID:nCOL298469]

Here are some questions and answers about where the rupee is and where it could be headed:

WHY HASN’T THE RUPEE FALLEN YET?

The central bank has been defending the rupee since August, and that cost it half of its foreign exchange reserves in the last four months of 2008. By the end of the year, reserves fell to around six weeks of import cover, or $1.75 billion. Downward pressure remains, and the state of reserves and a balance of payments deficit in 2008 prompted Fitch Ratings to downgrade Sri Lanka’s debt outlook last week. But news of the IMF loan has brought some confidence back in the short term, and has both importers and exporters hedging their bets on the direction of the rupee, currency dealers say.

WHAT HAPPENS IF THE DEAL IS SIGNED?

The loan, nearly all of which the central bank expects to be paid upfront, should boost $32 billion economy’s outlook. The resulting investor confidence should give short-term support, currency dealers say. The central bank expects to sign the deal before April.

WILL THE IMF DEMAND DEPRECIATION?

Two sources briefed on the IMF negotiations say the lender wants gradual depreciation of around 6 percent this year, with the aim of making the currency free-floating. Economists say gradual depreciation is the best option to maintain export competitiveness amid the global economic crisis. Neither the IMF nor the central bank has divulged any conditions being discussed.

WHERE WOULD THE RUPEE BE NOW WITHOUT INTERVENTION?

Economists and dealers say the rupee should have hit around 125.00 against the dollar by now, if not for central bank intervention. In any case, the central bank no longer has the money to aggressively support it. Currency dealers say they expect it to find some equilibrium once the condition of the loan are known. It has depreciated an average of 3.95 percent per year since 1999, and so far this year is down an average of 1.05 percent. It plunged as low as 2.46 percent when the rupee hit a life low of 115.75/85 on Feb. 27.

WHAT WILL BE THE OVERALL IMPACT OF DEPRECIATION?

Sri Lanka’s rapidly easing inflation could reverse course if the rupee’s fall continues, since the island is a net importer of consumables. On the other hand, exporters could earn more rupees from their revenue. But global demand is down so the effect is likely to be muted in the near term.

For economist comments on Sri Lanka’s negotiations with the IMF, click on: [ID:nCOL394407] (Editing by Bryson Hull & Jan Dahinten)

Source :  Reuter

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