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Challenges and Barriers of Developing Sri Lankan Economy..!

2019-06-29 7706

Rupee depreciation has been the hot subject in current economic scenario. We are experiencing a tough time with rupee depreciation every day. Current economic context created anxious moments to various industrial sectors in Sri Lanka. The experts in the field perceived the situation in different manners. Some considered it has highly depressed and threatening environment; some other considered it as an opportunity in disguise. There are various positive and negative impacts which are being predicted by experts in the fields. Rupee depreciation, no doubt it will affect upper and lower sectors of the economy. This paper tries to explore the causes and impact of rupee depreciation on the Sri Lankan economy and also tries to review various measures to the Government to get over the present crisis.

Recently every Sri Lankan economic and political discussions toss around the subject of the upsetting news of rupee depreciation and its effects, both long term and short term on Sri Lankan economic context. Sri Lanka rupee has experienced considerable depreciation of value in recent times and that has affected even the bottom lines of Sri Lankan economic scenario. Currency depreciation, as the name suggest refers to fall in value of one currency with respect to another. That is one US dollar can buy 176 today, and can buy 176.3 tomorrows. SL would have depreciated by percent. The value of rupee had weekend about this financial year.

Increased price of oil

Increased prices and demand for Oil is another reason for rupee fall. Sri Lanka has to import Bulk of its oil requirements to satisfy its local demand which is increasing every year. The domestic demand for oil is increasing which cause causes the price of the oil to increase in the international market. The demand for dollar increases as we have to make payments to our suppliers in dollars. This increase in demand for dollar weakens the rupee. 55% of the Sri Lankan oil import is used for transportation of goods and people and 50% of that or 27% of the total is used for transporting the 3Sri Lankan who owns cars. 36% of total population owns any kind of vehicle including the motor cycles.

Low growth Lower

growth is another reason for currency depreciation. That is due to the low growth foreign institutional investors were pulling of money from Sri Lanka. Sri Lanka GDP growth rate dropped to 3.1% for the first quarter of the financial year which was much lower compared to 4.5% in the previous year. Sri Lanka’s economic grew by only 3.1 per cent last year, the lowest in 16 years with the fall blamed on mostly adverse weather conditions, according to Central Bank (CB). Though this data was contained in the CB's annual report for 2017 released to the public. CB officials have indicated in the past few months that economic (GDP) growth was expected to fall to 3 per cent from 4.5 per cent in 2016. The worst year before this was in 2001 when the economy contracted and recorded negative growth of 1.4 per cent after being hit by a series of global and domestic economic issues.

High demand for gold

Increased demand for gold or increased import of gold is another reason for the crisis. In Sri Lanka there is a tradition to wear gold and diamond ornaments for the auspicious occasions. So there are more requirements for these but are not abundantly available in Sri Lanka so Sri Lanka has to import these at huge price. When the rupee value gets depreciating, the percentage for each dollar increases making the demand increase. Total demand for gold -whose twin drivers are jewellery and investment buying -- advanced two percent to 4,309 tonnes compared with 2015,

However, in the final three months of 2016, overall demand retreated 11 percent to 994.1 tonnes from a year earlier. Investment demand rose in the first, second and third quarters of 2016 by inflows into exchange-traded funds (ETF) -- which allow investment without trading on the futures market. But this hit reverse in the fourth quarter. Jewellery demand meanwhile sank over the year on the back of higher gold prices.

High fiscal deficit

High fiscal deficit can be regarded as another reason for this crisis. It is the difference between Govt. receipt and Govt. spending. Sri Lanka is expecting to end the year with a deficit of 5.2 percent of GDP (680 billion rupees) in a revised out-turn presented in a budget for 2018 to parliament, steadily improving from 5.4 percent in 2016. The fiscal consolidation comes after a disastrous 7.6 percent deficit in 2015, which generated a balance of payments crisis in after the central bank printed money and the currency collapsed, pushing inflation up. Improvements in the deficit may not bring much benefits to the ordinary people as the central bank is depreciating the currency and generating high inflation by targeting a real effective exchange rate index, instead of prices, some analysts have warned.

The central bank has also overshot its 'mid-single digits' inflation target up to October 2017, and is giving old excuses seen in Sri Lanka in the past about supply driven or 'cost-push' inflation, 'beyond its control.' In 2017, Sri Lanka is hoping to collect 2,250 billion rupees from the people, including from value added tax on healthcare, and 705 billion rupees will be busted on salaries. Tax to GDP is expected to rise to 16.4 percent in 2018 (2,326 billion rupees), after rising to 15.3 percent in 2016 from 14.9 percent in 2015. However, since the new administration took over, current spending rocketed to 16.2 percent of GDP with the runway 2015 budget, came down to 15.5 percent and deteriorated against to 15.8 percent in 2017, amid some drought related spending

Dollar gaining strength against other currencies

Dollar gaining strength against other currencies is considered as another reason. The US Federal Bank’s Chairman Mr. Ben Bernanke introduced the unwinding bond purchase program in the US. The US had been printing money to bolster the economy. Now with the revival of the economy the Chairman plans to unwind the program. This statement led to unrest in the US economy and US investors started withdrawing money from the overseas markets. With the increase in demand for dollar, the prices of dollar in the global market rose and price of all currencies weakened against dollar, among which rupee also affected.

Great volatility of stock market

Great volatility in stock market also regarded as another reason for the currency devaluation. Our equity market is volatile for some time now. Equity means the investments in Sri Lanka companies made by foreign institutional investors. Sri Lanka stock market is mainly dominated by overseas investors. But as the US federal Bank start scaling back to monetary stimulus that has kept invest rate ultras low and send investors to developed market in search for high return. A latest regional World Bank report indicated the correlation between global trends and stock market developments in Pakistan and Sri Lanka are weaker compared to other regional peers such as India and Bangladesh.CSE’s main indices only recorded single digit growths in 2017 against the double digital growths across the global markets.

CSE’s S&P SL Index comprising of top 20 blue-chip companies only recorded a gain of 4.93 percent in 2017 while All Share Price Index (ASPI) gained in 2.39 percent, which were well below the performance of global markets such as India’s BSE Sensex, which gained 29.58 percent and the NSE Nifty that recorded a gain of 30.28 percent.

Withdrawal by investors

Withdrawal by investors affects the rupee to decline in value. The economic slowdown of many industries, in the Sri Lankan environment, the market’s weakness for the government to implement public policies are increasingly disappointed. Global giants decided to withdraw their investments. The withdrawal by foreign investors in different sectors shows that policy changes made by Sri Lanka is country slowed down the Government is difficult to make corresponding change in policy. Economists say that this mass withdrawal of foreign investors from Sri Lankan Treasury Bonds and Bills, has caused the weakening of the rupee against the US dollar. In its article, the Ceylon Today reports that foreign exits topped the 100-billion-rupee mark in the 18 weeks ending on Wednesday February 15, after they pulled out Rs. 17,707 million during the week. In the 18-week review period, foreign investments in the Government Securities Market has dropped by a third or 33.22 percent to 211,494 million rupees caused by a withdrawal of Rs. 105,222 million in Treasury bills and treasury bonds

Lack of clarity in policy reforms

Lack of clarity in policy reforms is another reason for depreciation of currency. Perception of lack of clarity on the policy front is also fanning speculative demand wherein Government on one day said it will tighten liquidity and on yet another said it will inject $ 1 billion in the market. Then Key reforms like Tax and Goods and Service Tax (GST) have been in the pipeline for years. The government announced FDI in Retail, but had to hold back amidst huge furor from both opposition and allies. Strong opposition never allow to do something good. Sri Lanka attracts less foreign investment than other comparable economies - and only a small proportion of these investments generate diversified exports or jobs. Enhancing the Board of Investment’s capacity to attract and retain foreign investment, creating a one-stop shop that streamlines all foreign investment-related approvals in Sri Lanka, will be key to attracting more businesses. Second, Sri Lanka needs to improve its trade regime.

Trade as a proportion of GDP has decreased from 88% in 2000 to 50% in 2016, while the composition of exports has remained stable with a high concentration on garments and raw materials

Interest rate difference

Invest rate difference is another factor, that is higher interest rate generally attract foreign investment but due to slowdown in growth there is increasing pressure on Central bank to decrease policy rates. Under such conditions investors stay away from Sri Lankan market. This effects capital account flows to Sri Lanka and put a decreasing pressure on rupee. The Central Bank of Sri Lanka left its benchmark interest rate unchanged at 7.25 percent on August 3th, 2018, saying the decision is consistent with stabilizing inflation at mid-single digit levels in the medium term, thereby contributing to a high and sustainable growth outlook. Economic growth is projected to record a gradual acceleration from the second quarter of the year supported by the expansion in services and industry related activities. Over the medium term, the economy is expected to reach its potential amid a competitive flexible exchange rate, a low inflation and stronger policy framework. The standing lending facility rate was also kept at 8.50 percent. Interest Rate in Sri Lanka averaged 7.83 percent from 2003 until 2018, reaching an all-time high of 10.50 percent in February of 2007 and a record low of 6 percent in April of 2015.

Higher inflation

Sri Lankan economy is experiencing higher inflation which will decrease purchasing power of rupee against other currencies. This will lead to rupee depreciation. Over the last 24 calendar months Sri Lanka’s money supply grew at around certain% while its GDP grew at a much lower pace. This essential means that more rupees were printed than required which causes a rise in inflation. Inflation in Sri Lanka is expected to remain high next year as anticipated fuel price hikes push up other prices, the Asian Development Bank has said. The island’s inflation had already been pushed up beyond anticipated levels owing to higher food prices, the bank said in its latest update to the Asian Development Outlook (ADO) 2017, which forecast firmer growth for Asia.In South Asia, inflation below expectations in India prompts a downward revision to the 2017 forecast, to 4.0% from 4.2% in the previous update, according to the ADB. “Elsewhere, projections for inflation remain in line with those in the Update for the rest of the sub region except Sri Lanka, where a sharp spike in food inflation pushed consumer prices above earlier expectations,” the ADO update said. “The sub regional inflation forecast for 2018 is maintained at 4.7%, as projections are unchanged for all individual economies except Sri Lanka, where expected higher fuel prices next year will likely exert upward pressure on other prices as well.” In India, the ADB said, inflation is still expected to inch up to 4.6% in FY 2018, driven by an uptick in fuel prices and higher aggregate demand.

Senior Professor

-Kennedy D. Gunawardhana-

Professor of Accounting, University of Sri Jayawardhanapura