According to media reports, economists and other experts are of the view that the most damaging policy blunder was to imagine that Central Bank can fix the exchange rate at an arbitrary rate it wishes to maintain and persist for a considerable time period.
As can be seen from Figure 1, there has been a major policy shift effected on March 7 2022. It was allowed to float (managed floating), and CBSL expects the upper limit as Rs 230.
Until March 7, both ‘fixed exchange rate’ and ‘managed floating’ policy regimes have been adopted for a long period of time.
However, the Rs 230 for $ could not be defended and consequently, the rupee was allowed to be floated based on market forces until 12/5/22.
Since 8/3/22 to date, ‘managed floating’ and ‘free floating policy regimes have been adopted.
Let us discuss the sequence of events and ‘pros and cons’ of the different exchange rate regimes by summarising the salient features to understand the fluctuations in the rupee in relation to US$ and its impact in the economy.
Sequence of events:
The private sector including Chambers of Commerce, the opposition and even few government members of parliament and many professionals/academics/economists have insisted that the rupee be floated based on market forces. Then administration was reluctantly compelled to do so, having maintained the rupee around Rs. 203 per US $ from September ’21 up to 7/3/22. It was allowed to float (managed floating), and CBSL expected the upper limit as Rs 230. It can be concluded that wef 8/3/22, both the ‘managed floating’ (pegged) as well as ‘floating exchange rate’ regimes are being adopted to-date. Thereafter, wef 13/5/22, it was slightly changed to a ‘managed floating’ (pegged) policy regime, thereby preventing further depreciation of rupee up to date.
‘Pros and cons’:
One can argue that cost of living has gone up shapely with the depreciation, especially wef 8/3/22 as seen in the inflation graph reproduced below. The Institute of policy studies (IPS) in the ‘State of the economy,2022’ report stated that steep increases in inflation, which is a global phenomenon has really intensified following Ukraine war and also due to supply chain disruptions on account of COVID 19 and relaxed monetary policy adopted. IPS further stated that supply side factors are playing a key role in the increases in inflation and therefore bank interest rate hikes will not address these inflationary trends. It appears the CBSL has adopted a strategy of curbing inflation as a high priority by increasing the interest rate, imposing high taxation and further tightening monetary policy, knowing very well that this strategy will badly affect the economic growth and majority of the households. The IPS report stated that only remedy on hand now to curb inflation is through a forced economic recession. CBSL had no choice at that time, however, they established IMF anchor and debt restructuring.
The management of ‘reserve money’ is the most important aspect to have proper liquidity and manage inflationary expectations. In simple terms, money printing is issuing new money to the economy by a Central Bank- also known as issuing “reserve money”. After estimating the economic growth, Central banks used to add new money to the economy in order to meet the amounts of growing transactions. If more money is printed than required, it will increase the demand for goods and services, thus creating inflationary pressures in the economy. On the other hand, policy makers can adopt relaxed monetary policy by increasing the money supply to stimulate economic growth.
The commercial banks and the government treasury receive foreign exchange through export proceeds, tourism, inward remittances from expats and even from foreign loans/FDIs etc. These foreign currencies are usually sold to the Central Bank in order to meet the rupee requirements by com banks and the treasury. When foreign exchange is purchased by the Central Bank from commercial banks and from the government, the Central Bank issues rupees. Through this mechanism, the Central Bank adds new money or ‘reserve money’ to the existing money stock of the country. When the Central Bank purchases foreign currency, it increases foreign exchange reserves maintained by the Central bank as well. Similarly, when making foreign debt repayments by the Central Bank in foreign currency, the government should pay an equal value of rupees back to the Central Bank. It then reduces the existing money stock in circulation -it reduces the level of reserve money. These are positive features.
In addition to foreign exchange transactions, the Central Bank can also influence the total stock of money in circulation through rupee transactions with the commercial banks or with the government, for example; to make salaries and pension payments etc. When the government issues Treasury bills to finance its budgetary needs, the Central Bank under the provisions of the Monetary Law Act could purchase part of TBs at the request by the government. In order to make payments for the Treasury bills purchased, CBSL should issue new money in rupees equivalent to the value of theTreasury bills purchased. This is where the government expenditure cuts are important including interest payments.
Perception is the reality:
From the above analysis, it can be concluded that there is nothing wrong in increasing money supply based on the needs of the society. However, money printing by the Central bank needs to be done cautiously in order to avoid inflationary pressures in the economy. Same can be said with exchange rate policies as well.
The stories stemming from recent economic activities and performance were blown out of proportion in the media without finding the truth and without realizing the gravity of the situation, when it deliberately created false perceptions in the market place. Unfortunately, perception is the reality.
Therefore, its counter- productive in blaming each other, instead it is suggested to work towards achieving common goals to address critical issues.
To be fair by the Monetary Board of CBSL, along with their decision on March 7 ‘22 to move away from ‘fixed exchange rate’, it was announced that they expect an upper limit of Rs 230. Nevertheless, from March 8 or 9 ’22 onwards, the rupee was allowed to be floated based on market forces until May12.
The issue here is during this period, with two different Governors and Monetary boards functioning, its rather difficult to understand as to why they waited so long till 12 May to rectify this market behaviour through shifting its policy to a ‘managed floating’ with an upper cap. By that time, Rs.230 has gone up to Rs 377 per US $.
That’s the period, where inflation skyrocketed due to supply side ‘cost push’ inflation, more than the ‘demand pull’ inflation due to excessive money printing. One possible reason was that flexibility that was allowed in March 22 fell short of market expectation.
The rupee was kept at an artificially low figure for so many years, especially when CBSL holdings of government bonds/bills increased substantially during the last three to four years without having buffer of foreign reserves.
However, 2021 Central Bank report released by the new administration of CBSL in April ‘22 defended the policies adopted such as maintaining somewhat stable exchange rates, CB intervention in the domestic foreign exchange market stating that it helped avoid large volatility in the exchange rate and in fact, supported the need for financing essential imports to ensure economic support to people. However, the exporters were reluctant to convert their export proceeds impacting the domestic foreign exchange market negatively.
Now that the damage is done, the recent IPS report stated that only remedy on hand now to curb inflation is through a forced economic recession, meaning economic growth to be minus for many more months and thus adversely affecting the most vulnerable segments in the society including SMEs, construction industry, unemployed youth, consumers.
Positive impacts of the shape depreciation of the rupee:
On the other hand, there are obvious positive impact of the shape depreciation of the rupee on some ‘export oriented’ businesses including companies involved in indirect exports such as plantation companies, who have made substantial profits from April to end September 22 as their revenue has increased in nominal terms.
The total profitability of RPC sector is around 20 billion rupees for 18 RPCs quoted at Colombo stock exchange (published data is not available in respect of two companies which are not in the Stock Exchange) The above profits are before income tax and majority is for six months -accounting period starts from April 1 and few others are for ‘nine- month period’.
The financial performance so reported are the highest ever profits recorded and it was only 6 billion rupees PBT last year corresponding period and previous years, it was even lower than these figures.
This is mainly due to government policy, enabling rupee to be floated/depreciated-despite having negative effects on other sectors, at the expense of average consumers/ small businesses which are suffering.
Substantial profits are there with most of the private tea factories as well.
Thanks to the ‘reasonable price formula’ administered by the Tea Commissioner, the small holders are also getting good prices but their tea production is lower than the previous year.
The Minister in charge of plantations has recently requested the tea growers to undertake 3% replanting which is timely because many RPCs have surplus cash and expected economic returns are attractive. Already some companies such as Talawakelle Tea Estates Plc, Malwatte Valley Plantations and other predominantly tea- based RPCs and many other proprietary small holder tea estates are reaping the benefits, as they have been undertaking infilling and good agricultural practices (GAP) in the past.
Another important factor here is the ‘real wage rates’ are low and there could be pressure to increase the nominal wages, where a new remuneration model based on revenue cum productivity linked wage model is desirable to motivate real producers, whilst keeping healthy cash flows for the RPCs to reinvest on development activities. In the meantime, tea productivity issue needs to be addressed as a matter of priority.
In addition to the nutrient deficiency, another issue is delaying plucking rounds more than seven days due to shortage of pluckers and other labour deployment issues. As a result, both quality and productivity of those tea estates drop.
We are pleased to note that Tea Commissioner division of Tea Board, TSHDA along with TRI are creating awareness programmes under ‘B60 programme’ and work hitherto done by many RPCs are commendable.
From the above, it can be seen that nobody could be blamed for adopting different policies at different times as these policies are in accordance with accepted norms & practices.
The economic theory of “Deadweight loss” will come in to play, which is counterproductive.
Misconceptions about ‘money printing’ exercise:
The Central Bank of Sri Lanka was established in1950 under Monetary Law Act No.58 of 1949 and since then, the operations connected with money printing has been done by CBSL. Some people seem to mistakenly believe it’s only the Treasury bills bought by CB. Instead, we need to understand the relationship between money printing and ‘reserve money’ and how to analyse data and quantify whether there has been any excessive money printing or not and impact thereon.
As per the table above, the total new ‘ money printing’ of the Central Bank during theperiodfrom 2017–2021 was Rs.5,960 billion and as a % of GDP it ranges between 6 to 8%.
Note: The writer is former Chairman Sri Lanka Tea Baord.