Govt. the heaviness to blame for exchange rate problems


There is a lot of talk these days about the pressures the Sri Lankan Rupee faces, but it is important that we understand the mechanics and the broader economic context. Currency crises have been common in our modern history with countries facing sudden devaluations to the point where we can predict trends. There was the Mexican peso crisis of 1994 and the Asian financial crisis of 1997. Both examples may highlight the dangers of maintaining an exchange ratio that does not reflect the real value of the currency.

A currency can fulfill its function if it constitutes a stable store of value. If there is a sudden divergence from the market, it threatens savings. The reason I am writing today’s article is to assert that the lens through which we view economic phenomena is narrow. Some believe that the government should be at the center of the economy and that it must take measures to respond to the external economic environment. This is true in a relatively controlled economy, but it is far from the only means by which prosperous economies operate.

The problem with putting government at the center of economic decision-making is that the economy has to be monitored and operated by individuals who have to make decisions while many countries let markets decide what prices and other parameters should be. The best markets are by no means perfect and need a correction sometimes, but in many ways, it’s better to be reactionary than to have a poorly managed economy.

Exchange rates are determined in different ways. Many developed countries have floating systems where buyers and sellers of currencies can step in and buy and sell at a rate determined by the free market, but our currency is severely constrained compared to free-floating currencies. What can happen in situations like ours is that the central bank tries to keep the rate at the level it wants, but at some point you have to accept reality. As much as you want $ 1 to be around Rs. 200, you need the reality to be on your side. In a healthy economic system, your cash inflows and outflows would naturally determine that $ 1 is worth around Rs. 200. You may also have a scenario where the government has large reserves to be able to support its valuation of the currency by buying and selling. reserves, and unfortunately we do not have that credibility. This is why countries with currency problems have exchange rates parallel to the black market.

It is better to face the reality of the situation and not try to force things to turn out the way we would like. The reality is that we have a debt burden that needs to be paid off, and we need imports to live on which we should not be particularly wary of either. Imports play an important role in any dynamic economy. Add to that the lax monetary policy that has been used to ease the burden of the pandemic. Countries typically raise rates when the currency faces pressure related to how Turkish President Erdogan is asked to raise rates in defense of the Turkish lira.

I believe that any help the IMF is prepared to provide is crucial to get us back on track and correct the mistakes in our economic management. The downside of trying to fix the problem rather than kicking the box is that the immediate consequences can be hard to swallow, but it’s reasonable to believe it’s way better than having to react. to the suddenly arising problem where the fallout would be much worse.

Just like a business, we have to make sure that our fundamentals are worked out, because the day of the accounts of each country or company is inevitable if the fundamentals diverge too sharply. Not so long ago, Black Wednesday was when the UK government had to take the pound sterling out of the ERM (exchange rate mechanism) for failing to keep the pound within a certain range due to the pressures. against the currency.

History has repeatedly shown us the fallout from poorly managed currency valuations. While economic turmoil affects all countries, it is important to note that our problems are not simply the consequence of negative external factors but made worse by our own underlying shortcomings.


(Vinuja Singharachchige was a former Research Fellow at the Advocata Institute and is currently a Forex Analyst at JP Morgan. He can be contacted at [email protected] The opinions expressed are those of the author and do not reflect those of associated organizations.)



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