CBSL currency intervention tops US $ 284 Mn by March 2018 to control Rupee

April, 16, 2018

Rupee down by over 16% against US Dollar from December 2014 Levels

Central Bank of Sri Lanka (CBSL) had purchased over US $ 284 million on a net basis up to March 6, 2018, from the domestic foreign exchange market to control the rupee depreciation, amidst a 2% depreciation against the dollar during the year 2017, from Rs. 149.80 as at end 2016, to Rs. 152.85 as at end 2017. Since the beginning of 2018, the Sri Lankan Rupee further depreciated by 1.5% against the US dollar from Rs. 152.9 as at 2017 year-end to Rs.155.1 as at March 6, 2018.

The Sri Lankan Rupee had depreciated markedly against all other major currencies in 2017, in comparison to the previous year. Accordingly, reflecting the movements in the cross-currency exchange rates against the US dollar in international markets, the rupee had depreciated against the euro by 13.49%, the Indian rupee by 7.54%, the Japanese yen by 5.10%, and the pound sterling by 10.46% by the year 2017. The figures were released to the international investors, by the latest financials of the Sri Lanka’s International Sovereign Bond (ISB) offer document. On 11th April 2018, the Central Bank of Sri Lanka on behalf of the Sri Lankan government launched two US$ 1.25 billion International Sovereign Bond issue, with a 5-year and a 10-year Senior Unsecured Fixed Rate Notes with maturity dates of April 18th 2023 and April 18th 2028 respectively. The Notes were rated 'B1', 'B+' and 'B+' by Moody's Investors Service, Standard and Poor's and Fitch Ratings respectively, which marked Sri Lanka's twelfth US dollar benchmark offering in the international bond markets since 2007 being the largest offshore bond offering ever by Democratic Socialist Republic of Sri Lanka.

This year to date as per the latest average rates of the US Dollar quoted by commercial banks in Colombo for Telegraphic Transfers (TT) as at 9.30 a.m. on 16th April 2018 was Rs. 153.75 for Buying and Rs. 157.53 selling per US Dollar ($).

According to the ISB offering document, significant depreciation pressure on the rupee that prevailed, particularly during the first two months of 2017 was mainly due to continued outflows stemming from import expenditure, debt service payments and unwinding of foreign investments in the government securities market. However, this situation has turned around since March 2017, particularly with increased foreign investments in the CSE and the government securities market.

The ISB offer document further highlights that the depreciation pressure on the rupee further eased gradually from May onwards with the issuance of the ISB, the receipt of the foreign currency term financing facility, and disbursements of the third and the fourth tranches of the IMF EFF (Extended Fund Facility) programme, which helped improve investor confidence. Sri Lanka is pursuing a 3-year reform program with IMF support under the extended arrangement under the Extended Fund Facility (EFF) that was approved on June 3, 2016 in the amount of about SDR 1.1 billion (US$1.45 billion, or 185 percent of quota in the IMF at that time of approval of the arrangement. The government’s reform program, supported by the IMF, aims to reduce the fiscal deficit, rebuild foreign exchange reserves, and introduce a simpler, more equitable tax system to restore macroeconomic stability and promote inclusive growth

This had contributed towards the stability of the rupee against the US dollar during the period from March to December 2017 with periods of gradual appreciation of the rupee amidst substantial absorption of foreign exchange liquidity by the Central Bank.

Meanwhile, the Central Bank had intervened in the domestic foreign exchange market by absorbing US $ 1.66 billion on a net basis in 2017 to achieve the net international reserves (“NIR”) targets of the IMF EFF programme. This included an absorption of US $ 2.21 billion and a supply of US $ 550 million during 2017. “This was a complete turnaround in terms of the intervention by the Central Bank in 2016 during which year, the Central Bank sold US $ 1.9 billion and purchased US $ 1.13 billion” according to Sri Lanka’s ISB offering document.

The document notes that Sri Lanka’s exchange rate policy in 2014 focused on reducing short-term volatility to promote stability in the foreign exchange market. The rupee appreciated against the US dollar by 0.29% during the first three quarters of the year 2014. However, as import demand increased and Government securities market recorded net outflows in the last quarter of 2014, the rupee had depreciated by 0.47% against the US dollar, resulting in an overall depreciation of 0.23% in 2014.

The lower than expected foreign exchange inflows, coupled with high levels of outflows, exerted

significant pressure on the exchange rate during 2015. This had been recorded mainly due to the reversal of foreign investments in the Government rupee securities market, in anticipation of a, and the subsequent, hike in interest rates in the United States, and the high level of demand for foreign exchange, due to the increased expenditure in non-oil imports and foreign debt service payments. The resultant persistent depreciation pressure on the rupee against the US dollar necessitated the continuous intervention of the Central Bank in the domestic foreign exchange market, in order to reduce volatility. Supported by the supply of US$1.9 billion by the Central Bank, on a net basis, the rupee recorded a marginal depreciation of 2.42% against the US dollar, during the first eight months of 2015. However, on September 3, 2015, the Central Bank decided to limit its intervention in the domestic foreign exchange market and allowed the exchange rate to be largely determined by the demand and supply conditions of the market. This resulted in the rupee depreciating by 6.64% against the US dollar, during the period from September 4, 2015 to December 31, 2015. Overall, the rupee depreciated against the US dollar by 9.03% to Rs. 144.06 as at December 31, 2015. The annual average exchange rate of the rupee against the US dollar also depreciated to Rs. 135.94 in 2015 from Rs. 130.56 in 2014.

In 2016, the rupee depreciated by 3.83% against the US dollar from Rs. 144.06 as at 2015 year-end to Rs. 149.8 as at 2016 year-end. The relatively low depreciation of the rupee in the first half of 2016 was supported by supply of foreign exchange liquidity by the Central Bank amounting to US $ 1.09 billion on a net basis. Subsequently, the rupee depreciated at a higher rate with the curtailment in intervention by the Central Bank with a net absorption of US $ 325 million during the second half of the year. A substantial amount of the foreign exchange supplied during the second half was to partially ease the pressure arising due to the disinvestment by non-resident investors in the Government securities market, particularly during the last quarter of 2016. This outflow from the Government securities market was driven by the expectation and the subsequent increase in interest rates by the US Federal Reserve Bank.

The ISB offering Document notes that in its announcement of the “Road Map: Monetary and Financial Sector Policies for 2017 and Beyond”, the Central Bank announced that it would accommodate a greater flexibility in the exchange rate by allowing market forces to determine the exchange rate.

Accordingly, ISB Offering Document adds that the exchange rate policy would entail the REER (Real Effective Exchange Rate) to be maintained at around 100 index points to ensure external competitiveness of the country and that the Central Bank intervention in the form of supplying of

liquidity to the domestic foreign exchange market would be curtailed only to address undue volatilities in the exchange rate. The real effective exchange rate is the weighted average of a country's currency relative to an index of other major currencies adjusted for inflation.