November 21, 2011 6:02 pm by David Keohane

Sri Lanka announced a shock 3 per cent currency devaluation on Monday in an attempt to boost export competitiveness and keep the country’s paymasters at the International Monetary Fund happy.

Mahinda Rajapaksa, who is both president and finance minister, made the announcement to parliament while presenting the 2012 budget. His speech – interrupted when ruling party politicians attacked protesting opposition members – included a projected 14.15 per cent increase in spending and a narrowing budget deficit based on increased revenues.

“We need to reduce the import cost and increase export revenue. When our currency has strengthened, our trading partners’ currencies have depreciated. So I propose to devalue the currency by 3 per cent with effect from today,” Rajapaksa said, according to Reuters.

Stuart Culverhouse, economist with Exotix, said the depreciation announcement was not entirely unexpected. However, he told beyondbrics the “3 per cent devaluation was a token gesture” and he “would not rule out further downward moves in the future”.

Ajith Nivard Cabraal, governor of the central bank, confirmed the devaluation would go through on Tuesday – the central bank controls exchange rate movement within a trading band. The rupee is currently trading at Rs110.39 against the dollar.

The devaluation is sure to please the IMF, which in early September remarked that non-borrowed reserves – those not including IMF funds or foreign holdings of treasuries, for example:

[Have] steadily declined, reflecting foreign exchange sales by the Central Bank. This policy does not seem to be in line with the current fundamentals of the economy. In responding to market pressures, the Central Bank should henceforth limit its intervention and allow more exchange rate flexibility. Flexibility in the exchange rate, which has appreciated substantially in real terms over the past two years, is also an essential component in ensuring Sri Lanka’s export competitiveness.

Source: Asian Development Bank

The IMF gave Sri Lanka a $2.6bn loan after the country’s bloody civil war ended in 2009. Sri Lanka is reported to have spent more than $1bn of its reserves this year keeping the rupee near Rs110 to the dollar, prompting the IMF’s concern.

It is not the first time the IMF has had problems with Sri Lanka. The fund had delayed disbursement of the third, $400m, tranche of its loan in 2010 after Sri Lanka recorded a fiscal deficit of 9.9 per cent of gross domestic product in 2009, missing an earlier agreed target of 7 per cent.

Sri Lanka isn’t totally reliant on the IMF, having raised $1bn in July 2011 after a 10-year bond sale was seven times oversubscribed – a strong sign investors remain confident the island’s sustained economic recovery is on track.

Sri Lanka’s growth rate has rebounded sharply since the end of civil war in May 2009, with GDP growth expected to come in near 8 per cent this year. It follows a record 8 per cent in 2010 and just 3.5 per cent in 2009. Stocks on the local Colombo Stock Exchange have soared from a immediate post-war low of 3,000 points to a current 6119.86.

Sri Lanka’s parliament shocked many this month by passing a law allowing the government to take control of businesses deemed under-performing or underutilized, although the law has limited reach and the government has a reputation for being business friendly. Leif Eskesen, HSBC’s chief India and Asean economist, remains confident about the island’s future, writing in a recent note to clients:

Sri Lanka is relatively domestically oriented and is somewhat sheltered against spill overs from a global economic downturn… The domestic sources of growth are indeed the key drivers of the economy. They include the structural underpinnings from tapping underutilized agricultural land and fishing zones in previously war torn areas. Add to that the rapid rise in incomes, post-war rebuilding efforts, and the confidence gain achieved after the peace was won. Also, monetary policy settings are highly accommodative. That’s not to say that Sri Lanka is immune to global economic gyrations, but that the central bank can worry somewhat less about these than its peers in higher beta economies.

Related reading:
Sri Lanka turns to show business to rebuild image, beyondbrics
Sri Lanka seeks to end its cold war, beyondbrics
Sri Lanka and war crimes, The World

Tags: currency, economy, IMF
Posted in Asia, Sri Lanka | Permalink