Sri Lanka has won a thumbs up from ratings agencies and economists for floating its rupee currency after last month's general election, but more reforms will be needed to support the currency and conserve the central bank's modest reserves. The rupee has fallen 4.4 percent to a record low against the dollar since it was floated on September 4, extending losses suffered in a year that has seen President Maithripala Sirisena win power and form a strong government of national unity.
The central bank ran down its foreign reserves by $1.4 billion in the first half of the year, leaving just $7.5 billion in ammunition to defend the currency - including a $1.5 billion swap line from India. With a heavy foreign debt burden, government officials say Sri Lanka could have to contend with further pressure on the rupee after China's devaluation triggered a broader selloff in emerging markets currencies.
"This is a move due to international currencies. Most of the emerging markets have done it. There could be a second round (of currency weakness) if the Fed raises its interest rate this week," R.H.S. Samaratunga, the top finance ministry official, told Reuters. Analysts say while the float is positive, Finance Minister Ravi Karunanayake needs to deliver on plans to simplify and reduce the number of taxes, and to widen the tax net. Officials say the annual budget in November will include some tax reforms. The International Monetary Fund recently expressed concern that the Sirisena administration would struggle to meet its fiscal deficit target of 4.4 percent of GDP this year because of government hikes in wages and spending.
Populist policies have often put pressure on Sri Lanka's public finances - an issue that analysts say needs to be addressed to restore investor confidence now that the elections are over. Andrew Colquhoun, senior director at Fitch Ratings in Hong Kong, said the float was credit positive because it preserves foreign reserves. "We think the answer is partly to do with loose monetary policy so far in 2015, which has spurred credit growth and therefore sucked in imports. The focus now is on whether the new government's economic policy strategy will strengthen Sri Lanka's economic fundamentals," he said in an emailed statement.
Sri Lanka cut its key lending rate in April to 7.5 percent, a record low. Although consumer prices are actually falling, the loose monetary mix stoked domestic demand and boosted growth in imports to 19.4 percent, in year-on-year terms, in June. Atsi Sheth, lead analyst for Sri Lanka at Moody's Investors Service said the rupee move would help boost trade competitiveness. "But it is negative in terms of cost of paying back debt," she added. Sri Lanka's foreign debt accounts for 48 percent of total government debts of 8.2 trillion rupees ($58.7 billion), putting the onus on the government to pass revenue-raising measures to stabilise the public finances.
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