As the Sri Lankan rupee breached the 120 mark against the dollar with most dealers, the Central Bank of Sri Lanka (CBSL) sought to reassure people that this was nothing but a “temporary overshooting of realistic level.”

The country's banks began selling dollars, in what appeared a roundabout way to stabilise the Sri Lankan currency.

The slide was LKR 1 against the dollar on Wednesday, while it was LKR 4 on Tuesday, one dealer said, and added that he was expecting the LKR to lose even more ground.

According to the Central Bank's release, as at 9.30 am on Wednesday, the buying rate was 119.16 while the selling rate of the dollar was 122.35.

Temporary dip

As the day wore on, the LKR was seen losing more ground, though the Bank insisted that this was because of speculation.

Before the Bank stopped propping up the LKR, the exchange rate was in the region of 113 to the dollar.

“The recent depreciation of the Sri Lanka rupee, which seems to be a reaction of forex dealers adjusting to the more vibrant market-driven policy framework, would appear to be a temporary overshooting of the realistic level,” the Bank said in a statement released mid-day.

The Central Bank said that it had been intervening in the domestic forex market in recent years to build up foreign reserves and to smooth out any undue fluctuations in the exchange rate.

Such interventions resulted in the build up of foreign reserves to a historically high level of $8.2 billion by August 2011, preventing an excessive appreciation of the rupee.

However, during the second half of 2011, the widened trade deficit underpinned mainly by the sharp increase in import expenditure necessitated the Central Bank to supply foreign exchange to meet a part of such increased demand, despite increased receipts on account of remittances, tourism and inflows to the capital and Financial Account.

Uncertain conditions

The Bank's calculations went awry because, in the latter part of 2011, import demand did not decline despite uncertain global conditions.

The Bank stopped its forex market intervention from February 10, “so as to limit the supply of foreign exchange to the extent needed to settle the bulk of petroleum import bills, and to absorb surplus forex liquidity that would flow into the market from various sources including the issue of Tier-2 capital by banks, inflows to equity and bond markets etc., that may otherwise lead to the undue appreciation of the rupee.”

Many forex watches here say that the International Monetary Fund, which has advanced a $2.6-billion Standby Arrangement, wanted the Central Bank to stop market invention and allow the LKR to find its level.

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