Rupee devaluation on course; prices of fuel, imported items to rise

The Central Bank on Friday finally veered towards IMF calls for a devaluation of the rupee, depreciating the local currency marginally against the US dollar and initiating measures to curb credit growth.

Bankers, however, said these measures were unlikely to dampen imports and ease pressure on the US dollar, unless a bigger rupee devaluation was in place through the daily market operations. The rupee was devalued by 3% in a November budget announcement.

The Central Bank (CB) on Friday raised interest rates by 0.5 % on its reverse and re-purchase rates with banks, a signal for all commercial banks to increase their lending and borrowings by a similar or higher margin. At the same time the CB depreciated the rupee by 20 cents pegging its selling rate per dollar at Rs 114.10 from Rs 113.90 on Thursday.

Both measures are aimed at curbing surging imports, reducing demand for US dollars and thereby re- ducing a burgeoning trade deficit.

The announcement came just after the CB and a visiting IMF review mission concluded a two-week discussion on the US$ 2.6 billion Standby Arrangement (SBA) facility and the fate of the final two tranches totaling US$ 800 million.

On the same day (Friday), the IMF team told reporters that while it appreciated the 3% devaluation announced in November, there was still a need for a more ‘flexible exchange rate policy’ – loosely speaking a bigger devaluation of the rupee.

While the CB appeared to finally move in line with IMF thinking that the rupee is over-valued and hurting exports, bankers and economists were not too optimistic whether these new measures would pull back the overheated economy to a more export-dependent one from one being driven by costly imports.“my own feeling is that import demand will continue to rise and similarly pressure will continue on the Central Bank to utilize its dollar reserves to stop any sharp depreciation of the rupee,” said a senior banker dealing with foreign exchange trading.

The foreign exchange markets swallowed more than US$1 billion from the CB last year, bringing down foreign reserves to US$ 5.9 billion by end December from a healthy US$8 billion in around August 2011.

And that alarming trend continues in 2012 with the CB pumping in US$ 400 million in January and an average US$ 25 million per day in February 1-3 period, forcing the CB to reverse its policy of defending the rupee in view of the import of essential commodities.

“It has been a one-way flow, reserves being sold and not replenished (bought back) through the banking system,” the banker said.

Economists said the Ceylon Petroleum Corporation borrows heavily to service fuel imports and increased interest rates would add to fuel costs and further burden the consumer. State banks have also borrowed over US$1 billion dollars on behalf of the government and have to pay back.