Rupee: To depreciate or not to depreciate

The intention of the government was to reduce imports and encourage exports. The policy document, ‘Vistas of prosperity and splendour’ page 36 refers to reducing the trade deficit and go for import substitution and encourage exports. So, the general public have expected imports to come down in 2021. In fact, the imports have gone up to US$ 20.6 billion in 2021. This may be partly due to the fixed exchange rate policy of having relatively lower value for US$ in rupee terms and high international prices of commodities. The trade deficit has also increased to US $ 8 billion as export revenue was US$ 12.5 billion, which is an increase from 2020 and 2019 export figures of US$ 10 billion and US$ 11.9 billion respectively.

I give below actual expenditure on Imports of selected consumer food items (In US$ million): (See Table 1)

It is also evident from the Central Bank data published, the spending on import of vegetables incl. onions, potatoes, which was US $ 353 million in 2020 has further increased to US $ 384 million in 2021. The Country has spent some US $ 1.4 billion on these four items of imports which is more that the export revenue from Tea (US$ 1.3 billion) How did Sri Lanka manage to bear this high import bill and finance the deficit?

Our foreign exchange revenue was not enough and, therefore, we were compelled to borrow funds through foreign loans and have also used our valuable foreign exchange reserves to pay for these imports and to repay foreign loans amounting to US$ 6 billion. In 2021, the FDI figure is only US $ 560 million and foreign remittances are also US$ $ 5.5 billion only. If this trend continues, our obligations on foreign debt will increase further.

Compared to other regional counterparts, Sri Lankan export performance has been declining. Exports as a % of GDP has been declining during the last 12 years. The export performance reflects 26% of the GDP during the two decades ending 1999 in 1980’s and 90’s. However, the next two decades commencing 2000 to end 2019, the export performance of Sri Lanka has drastically declined to 16% of the corresponding GDP figures. (See Table 2 – How trade deficit widens during the four decades (Annual Average in US$ billion)

As can be seen, our trade deficit during the period 2010 to ‘19 has widened to 78% of total exports and our exports as a % of GDP has also decreased from 28% during the period 1990-99 to 14% during the ‘10 years period’ of 2010 to ‘19. In fact, it was an average of only 13% during the period 2015 to ‘19.

The exchange rate policy has created competitiveness issues for exporters, as external trade counterparts have become more competitive at the global market place due to their currencies getting depreciated at a faster rate. We would like to see our rupee getting strengthened but reality is because of continuous trade deficits, our rupee has been depreciating. If the $ is artificially controlled and fixed at Rs 202/ then it’s an encouragement for importers to buy $s even at higher rates from the black market and arrange import of goods. This is because they know that in future, the rupee will further depreciate.

The exporters will also discourage themselves to convert $ at this rate. As a result, now some exporters have become indirect importers outside the banking system, some get extra Rs 25 per US $ from importers outside the system. However, allowing rupee to float freely depending on market forces (will automatically depreciate the rupee further) will also create serious issues such as revaluing the foreign debt portion and the book value of the debt servicing will go up and thus increasing the budget deficit further. The cost of living will skyrocket, as the imported goods will cost more, nevertheless it’s a disincentive to go for non-essential imports and encourage to look for domestic alternatives.

As I mentioned, the intention of the government was to curtail and reduce import expenditure and encourage exports, however, both the current account deficit as well as government budget deficits are ever increasing. From the above economic indicators, it can be seen that during the last seven years, the economic situation got severely affected, out of which during the last two years, it was mainly due to Covid-19, quite apart from structural weaknesses.

No FDIs nor foreign remittances will flow in without addressing those structural weaknesses in the macroeconomic fundamentals- if not inflation will skyrocket and banks are compelled to raise interest rates as well. Foreign inputs such as fossil fuel and fertiliser need to be partially replaced with domestically sourced materials and other inputs as far as possible. It is in that context only the Presidents renewable energy initiatives and green natural agriculture methods need to be viewed. India and Kenya and many other countries have also decided to follow these initiatives in order to address ever increasing social and environmental costs associated with not adopting mitigating strategies to overcome climate change ill effects globally.

It is necessary to keep a close tab on spending foreign exchange on non-essential imports every month. The government needs to deploy people including our armed forces in the agriculture sector and farming activities coupled with appropriate technology and increase domestic production utilising our arable underutilized agricultural land based on a carefully prepared crop calendar for different districts.

Jayampathy Molligoda