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Amidst a falling Rupee, IMF says ‘Exchange rate flexibility is the first line of Defence’

June, 21, 2018

Global lender backed by largely Western Economies, the International Monetary Fund (IMF) yesterday (20) backed a floating exchange rate, labelling it as the “first line of defence” to protect Sri Lanka against external shocks, and called for enhanced implementation of structural reforms to speed up sluggish growth.

Amidst inflation shooting up and deposit interest rates shooting up from 5.5% per annum to 10% per annum in a 3 year horizon, in the face of over 20% fallen value in Sri Lankan Rupee against the US Dollar from 2014 December to 2018 June, IMF Sri Lanka Mission Chief Manuela Goretti, speaking to reporters, yesterday backed Sri Lanka’s present Central Banking authorities’ flexible exchange rate policy.

“Most importantly, exchange rate flexibility needs to remain as the first line of defence in case of volatile capital outflows. The exchange rate should be allowed to adjust freely as has been done in other emerging markets” Goretti said.

“The Central Bank has attempted to enact a fully flexible exchange rate as market conditions change and the Central Bank should only smoothen excess volatility. When we compare Sri Lanka to other emerging markets, the rupee has been depreciating less. We don’t want to create competitiveness differentials between Sri Lanka and other markets that are letting their exchange rates adjust more to these pressures. These efforts should also be supported on the fiscal side to strengthen investor confidence, but also on growth enhancing structural reforms. So, this is a joint effort by the Central Bank and the Government,” the Missions Chief Goretti said.

Despite Sri Lankan currency dropping to record lows over the last few weeks, IMF advocated that it be allowed to become a free float, pointing out that the rupee remains at a higher level than similar emerging markets.  The IMF is on its second year of a $ 1.5 billion Extended Fund Facility with Sri Lanka, and has completed its fourth review. 

“The program remains broadly on track with important reforms being implemented by the Government. The Central Bank has been conducting monetary policy prudently, bringing back inflation within its band and managed the recent period of market volatility.” Goretti said.

“It is critical to support Central Bank efforts with fiscal consolidation and improved timelines for structural reforms,” she added, responding to questions as to why growth remained low despite the IMF program.

The Government announced this week that Sri Lanka grew by 3.2% in the first quarter of 2018, which is 0.3% decline from 3.5% in the fourth quarter of 2017.

Goretti stressed that the Sri Lankan economy is recovering, but the country remains vulnerable to adverse domestic and external shocks, given the still sizable public debt, large refinancing needs, and low external buffers.

“We think the Central Bank’s current policy stance is appropriate, but feel that that they should be vigilant about adjustment as warranted” she added.

 

- Reporting by Devendra Francis