11th February 2001
Front Page
Editorial/Opinion| Plus| Business
Sports| Mirror Magazine
The Sunday Times on the Web

   Herbal remedies and five star hospitality!!!

Contents Index Page
Front Page
Mirrror Magazine

'Hearts and Minds' to counter JVP unions

By Chanakya Dissanayake
Sri Lanka's top corporates are launching a "hearts and minds" campaign among their workers to counter the rapid infiltration in the workplace of unions led by the firebrand Janatha Vimukthi Peramuna (JVP), according to business sources.

The sources said that the government, in a bid to nip in the bud a potential crisis brewing in companies, has in turn posted intelligence operatives in some of the worst affected companies to monitor trade union activities.

Many of the companies which have come under the influence of JVP trade unions are meeting the issue head-on by obtaining the services of leading socio economists and industrial relations experts to educate their workforce on the current economic situation in the country. 

The sources said there was a growing incidence of cases where the JVP had either established or taken over current trade unions in a number of companies, raising fears of a possible 1988-1989 scenario of strikes and crippling shutdowns or excessive wage demands.

But JVP leaders are ruling out the fears and blaming the government for a mis-information campaign. 

They assert that their programme for workers rights through the workplace would essentially be a democratic one.

The issue is grappling the attention of top corporate heads including captains of Sri Lanka's business community. 

While many are concerned about the emergence of JVP unions fighting for workers' rights, others believe the situation is inevitable. 

"I am not surprised. When the country is going downhill and the common man is being hit below the belt from all sides, it is natural that he needs a forum to voice his grievances. I wouldn't blame the JVP for being that voice," said a top business leader.

In recent months, trade unions have been active across the island demanding wage hikes to match the high cost of living now aggravated by the free float of the US dollar.

At the same time, many companies have also announced their inability to increase wages due to low growth of sales and the cost inflation, the source said. The return of the high interest regime and the rapid depreciation of the rupee has inflated operating costs of the firms, while the overall economic downturn has contracted markets.

Among companies using the "hearts and minds" approach is the Hemas group which recently held a workshop with the assistance of Ajit Colonne, a socio economist, to educate it's workforce on the prevailing economic situation and it's implications on the company.

"We concentrated on making the workforce realize the hardships the companies are going through and the implications of low profitability. Many companies are on the verge of a financial crisis. If a wage pressure builds up at this moment, many will go out of business, resulting in loss of employment," Colonne told the Sunday Times Business. 

"If employees realize that if they assist their companies to survive this difficult period, they will in turn be benefited by securing their employment against retrenchment," he added. An industrial relations expert, who carried out a similar program for

employees in the manufacturing sector, said he explained to the employees that wage increases were possible only through higher productivity and growth in sales.

He said, while speaking on possible management strategies that could be adopted in this sector, the creation of gain sharing schemes for both the management and the employees was suggested. "Many agreed to the suggestion," the expert, who declined to be named

Vijitha Herath, head of the JVP's Inter-Company Employees Union, said the wage hike was justifiable since the cost of living index has al

most touched the Rs 3000 mark. " It is common knowledge that the workers cannot survive without a wage hike. Our members are currently negotiating with their respective employers for a wage hike," he added.

Referring to the possibility of a general strike if the demands are not met, Herath said the JVP would resort to strike action only as the last option. 

"Currently we are not contemplating strike action," the JVP activist said, a week after the group collected more than a million signatures from the public demanding a wage rise among other issues. The petition and signatures were handed over to President Chandrika Kumaratunga.

K.D. Lal Kanth, national organizer of the Socialist Labour Union - a JVP affliated group-said a wage hike would not affect the profitability of the companies since most of them have price adjusted their goods in keeping with escalating production costs.

He said their members would launch a protest in their respective places on February 20, if there is poor response to the wage hike.

Political analysts said the JVP has now shifted it's focus from the traditional power base of students and the rural community, to the urban private sector employees in the past few years. 

"This is mainly because they have identified the urban worker as the most affected and discontent in times of a economic downturn in Sri Lanka," one analyst noted.

The JVP's trade union wing has grown by leaps and bounds during the past few years to achieve an official membership of more than 200 companies, party officials said but other sources said their reach in the corporate sector is much greater.

Analystss said the growth of the union was further assisted by the defunct state of traditional left trade unions at a time when JVP focusing on the private sector.

Herbal remedies and five star hospitality!!!

It was not the usual upmarket power point presentation by Sri Lanka’s business community.  But Tropical Herbs (PVT.) Ltd. launched their range of herbal balms, shampoos and remedies - ideal for today’s busy corporate executive and without side effects too - with a difference. It was  tom, tom beating and traditional dancing to the strains of lilting Sinhala melodies at a Colombo hotel that heralded the entry of “Seveni - a herbal drink for fever, coughs, colds, influenza and you name it; NeelaShoba - a hair shampoo; and Isiwara - a soothing balm to take your worries away.” The ingredients in these products - mukunuwenna, madathiya leaves, nelli, dry ginger, Katuwal batu, corriander, pepper, cummin seed and other herbs. The company, which has a factory in the BOI industrial complex at Pallekele in Kandy, has ambitious plan to attack the local and foreign markets in a new-found environment of herbal remedies to tackle almost any medical problem without recourse to Western medicine. Watch out Siddhalepa and Vendol, you have a new competitor on the block! Picture shows gotukola leaves laid at a table near a row of chairs at the  Galadari hotel.

Mind your Business 

Floating rupee, sinking cars
Among the industries crippled by the floating dollar is the car market, those in the trade say.

The rupee may have stabilized but customers don't want to take a chance and the market has stopped dead on it's tracks, they say.

All cars have gone up in price from twenty to fifty thousand bucks at least, brokers say, and buyers are holding on hoping that the market will settle down. But, in the mean time, sales are almost zero... 

You too rail?
Still on the subject of transport, fuel price increases and bus-fare hikes have been the order of the day, despite the various protests from the masses.

The only factor that remained unchanged was rail fares, or so it seemed.

But now, a revision of rail fares also seems likely unless the state wishes to change track and let the railways lose an awful lot of money....

Soft drinks 'n soft packs
The soft drink market is as competitive as any and everyone is trying innovations to try and get the leading edge.

And that is why one well-established manufacturer is contemplating including a packeted drink among its repertoire.

Bottles, after all mean unnecessary overheads which are so dear in these days with production costs running high and profit margins low...

Fitch Ratings fetch results

Sri Lanka's only credit rating agency has provided ratings for two commercial banks and two or three finance companies in a gradual expansion of its role in the country's capital markets, officials said.

Ravi Abeysuriya, CEO/Managing Director of Fitch Ratings Lanka Ltd, said by expanding the scope of their business - which in the past has concentrated on ratings for corporates, commercial paper, bonds and debentures - it was the public that would be the ultimate beneficiary.

"By rating these companies and recommending the risk levels, the public is aware of the risk of investing in A company or B bank which should instil some confidence," he said.

He declined to name the banks and finance companies that have been rated, for the first time in Sri Lanka, and the rating category. The company was also considering ratings' offers from insurance and securitisation (any regular income assets offered as collateral for a loan instead of fixed assets).

Fitch Ratings is partly owned by Fitch overseas with a 45 percent stake. World Bank-affiliate International Finance Corporation has 20 percent, Central Bank 10 percent and a group of state and private banks and connected institutions a joint 25 percent shareholding.

Fitch Ratings is also in the process of preparing proposals to the government for the creation of a mutual fund structure - helped by generous concessions and incentives to investors in these funds - in a bid to kick-start an inactive stockmarket.

"I feel this could boost the market and draw investments from other captive sources like savings, banks, etc," Abeysuriya said.

The proposal come in the wake of a trip earlier this month to India by the Fitch CEO and other senior officials in the capital markets business where they had meetings with a cross-section of the Indian industry including the Unit Trust of India, the country's monopoly mutual fund operator.

UTI mobilises billions of rupees of investor cash and mops up much more liquidity than any other source in India. 

Abeysuriya said that with proper awareness programmes for the general public, he was confident properly-structured mutual funds would draw in much more than the 20,000 investors who are currently listed with Sri Lanka's four unit trusts.

With this in mind, Fitch has scheduled 10 programmes in Sinhala on Rupavahini state television, starting in mid-February, with the objective of guiding the public on how to become financially successful in saving and investing wisely.

Central Bank governor A.S. Jayawardene would launch the first programme with Abeysuriya while CEO's and officials representing various sectors in the market would participate in other programmes. The programmes will focus on "how to save money and make your money grow", on returns and risks and the importance of savings as an individual pursuit coupled with its impact on the economy.

The Fitch CEO said the capital markets were not active as corporates while raising money from the public were not giving proper returns in the form of dividends, etc. Only a few gave dividends while others ploughed back their profits or earnings as working capital or for expansion.

This was also because the cost of borrowings in the commercial bank was too high and resulted in a situation where corporates found the cheapest form of borrowings was by way of retaining earnings and profits, he added.

Econsult is back

Econsult, Sri Lanka's only private economic consultancy which has been dormant for a few years, is being revived to provide high quality economic research to the private sector, its founder said.

Dr Howard Nicholas, a Sri Lankan-born economist and social scientist attached to the Netherlands-based Institute of Social Studies (ISS), said the agency would be restarted in June. It would be headed by a top Sri Lankan economist and will have a team of qualified economists.

Econsult is planning a major state of the economy conference in January next year where the agency's economic forecasts and annual projections would be discussed.

"We are hoping to invite about 300 members of the business community and present our annual findings and projections," said Nicholas. The January conference will be an annual event.

Nicholas, who helped set up the Colombo-based Institute of Policy Studies in the 1980s and guide the postgraduate economics programme at the Colombo University, said Econsult had been inactive since 1995-1996. 

"We plan to focus on training and other seminars of one week duration in addition to handling research and projections for the corporate sector. 

The training workshops would be on financial markets, macro economic forecasting, project appraisal work and review of world economies," he added.

Econsult has also handled research for donors and once undertook a project for the World Bank. It also plans to issue annual and quarterly reports on the economy.

Free float gains? No way

Exporters are said to be the main beneficiaries of a floating US dollar but Sri Lanka's garments exporters are unlikely to be on that list!

"We are facing many problems and the free float is not going to help at all," said Lyn Fernando, a veteran garments exporter and past president of the Sri Lanka Exporters Association.

Garments accounts for 50 percent or more of the country's foreign exchange earnings but exporters said the industry - mainly driven by the US market - is facing a crisis and many factories are not having work.

The 90-day limit of holding export proceeds abroad would complicate matters, Fernando said dismissing allegations that garments exporters were hoarding currency abroad. "Exporters are not keeping their money overseas. They are not making money. We are working at breakeven point."

Export volumes have increased but the unit price has come down resulting in marginal profits. Fernando said there was a major drop in US buying of Sri Lankan garments - for the summer season - in November 2000 to January 2001 while other suppliers were selling at lesser prices.

A Sri Lankan manufacturer based in Botswana, who Fernando met during a recent business trip to the US ,was offering garments at prices "that we cannot match at all." In Botswana, the government was paying 80 percent of the wages of garments workers enabling exporters to offer a very competitive price.

Fernando said interest rates were high and there was wage pressures which would erode profits and take away any benefit, if ever, from dollar gains.

Printers see devil

Sri Lanka's upmarket printing industry, struggling like many other industrialists to compete against rising costs and cheaper imports, is rapidly losing business to their Indian counterparts.

Industry sources say this has been caused mainly by consumer goods' multinationals and local book publishers, preferring to shift their printing to India. The lower costs prevailing in India due to economies of scale and the local import duty structure favouring books, are cited as the main reasons for the shift.

"We simply cannot match the prices they quote," said Sathish Abeywickrema, president of the Sri Lanka Printers Association. Sri Lanka's printing industry is heavily dependent on the imported raw materials comprising of paper and box board. " We are only producing the inks in Sri Lanka. In contrast India is producing all its raw materials and their cost of production is much lower than us," Mr. Abeywickrama added.

Asoka Gunarathne, managing director of Gunarathne Printers, said if the government removed the tariff for imported raw materials for printing, it would allow local printers to compete effectively with India.

According to leading book publishers with their own printing facilities, it has become cheaper to print the manuscripts in India due to the zero duty here for book imports.

The local printing industry could recover and compete effectively if Sri Lanka expands it's paper milling capability. " The main competitive advantage of India is it's self sufficiency in paper. Five years ago Indian paper was of low quality and no one considered them as a threat. But during the past few years India was able to attract the expertise of multinational paper millers and produce paper and box board suitable for high quality printing," Mr. Abeywickrama noted. 

Meanwhile another sector of the printing industry, the flexible packaging industry is losing out to Indonesian competitors. The biggest customers , the tea exporters, are obtaining flexible packages from Indonesia to cut costs.

"What we need is the infrastructure. If the government could revitalise it's own paper mills and create a local supply of high quality paper, it will greatly enhance our competitiveness", said Abeywickrama.

Hard times and low growth

There is little doubt that this year spells hard times for the people and a low economic growth for the country. The expectation of a low rate of economic growth has already been recognized by the Central Bank, which has projected the economic growth for the year to be around 4.5 per cent. Most analysts expect the rate of growth to be about one percentage point below at 3.5 per cent. The Central Bank estimates inflation to be 9 per cent, a most unlikely figure given the current escalation in prices and costs of production.

Sharp increases in prices of basic items and utilities are expected to raise the costs of living of the common man, public servants and most employees to unbearable levels. Food costs have already risen and the expectations are of further increases. The prices of gas, diesel, bus fares, electricity and many other items will bear heavily on the purse of most people. If the Rupee depreciates further there would be a continuous rise in prices.

The prices of locally produced food items are likely to rise this year. The depletion of imported rice stocks, a shortfall in rice production last year and a reduced Maha paddy output will lead to higher rice prices. Imported rice prices would also be higher owing to the depreciation of the Rupee.

The increased price of diesel has raised prices of vegetables and other produce through higher transportation costs and larger marketing margins.

Sugar prices have already risen sharply.

Further changes in administered prices could also be expected owing to the inability of the government to sustain losses through subsidization due to the widening fiscal deficit. The surcharge in electricity charges will not only be a severe burden on households directly, but will also affect prices of other commodities indirectly. The state of the public finances are such that the next budget would require to raise revenues by further taxation which would once again add to higher costs in living indirectly.As happened so often recently, the upward revision of administered prices and higher taxes are likely to precede or follow the Budget 2001 rather than be a part of it. It is quite certain that these impositions would raise the prices further.

The Central Bank estimates the price rise this year to be 9 per cent.It is most likely to shoot up to about 15 per cent.

In any event, the burdens on the consumer are likely to be much higher than what the official indices would reflect. The basic living costs of the ordinary man are high and a very high proportion of average incomes. Therefore the increases in the costs of living this year are unbearable burdens.

There are several reasons why the economic growth rate could be expected to be as low as 3.5 per cent this year. Although export industries are likely to receive a boost owing to the depreciation of the currency, industries catering largely to the domestic market are likely to face higher costs owing to the increased price of imported raw materials, higher borrowing costs and increased fuel costs. Even export industries would find the advantages conferred by the depreciation to be eroded by the price increases. The electricity surcharge would be a significant cost hike for many industries.

The agricultural sector is not likely to post any significant growth this year, with decreased paddy output likely and gains in tea production modest after last year's record output of 305 million kilograms. Some of the service incomes are also likely to be modest owing to the downturn in trading activities. Tourism alone may gain owing to the better value to tourists consequent on the depreciation.

In a context of higher overall prices , shrinkage in demand is also likely. In such a situation we may find many industries catering to the local market to be not viable. We may even see the spectacle of industry closures on this account. It can only be hoped that there would be an adequate expansion in export industries to offset this setback to employment.

Even export industries which benefit from the depreciation may not get the full benefit if the anticipated slowing down of the global economy occurs.

Already there are signs of the US economy slowing down. This itself would have a debilitating impact on other economies and a global downturn could occur. If this were to happen our export industries may not gain the expected advantages next year. Such a global downturn would also affect our tourist earnings and capital inflows. Our highly trade dependent economy would fare badly in the face of a global downturn, there can be no doubt about this.

There can be little good news on the economic front this year. When the Central Bank describes it as a year of adjustment it is partly a euphemism for hard times. Let us prepare to adjust ourselves by tightening our belts.

And hope that the promise of better times next year would materialise.

Is the rupee float a panacea for economic ills?

Consistent policy signals are imperative to restore market confidence. Current inconsistent policies could aggravate market uncertainty and destabilise the rupee. As a result of devaluation, war costs - even if there are cuts - will rise due to the depreciation of the US dollar. 
By Dr. S. S. Colombage
Increasing public debates on the recent decision of the Central Bank to float the Rupee reflects how closely our day-to-day life is influenced by the exchange rate. The Central Bank has given signals to the market during the last several months to raise interest rates and to depreciate the currency in a desperate effort to arrest the rapid depletion of foreign exchange reserves. In the wake of the rupee float, the Central Bank has reintroduced an earlier rule for exporters asking them to bring back their foreign exchange earnings in 90 days after the shipment. In addition, restrictions on forward transactions have been imposed. These restrictive measures were fashionable in the trade and exchange control regimes, but they may not go hand in hand with the present Rupee float, which is based on free market principles. All these policy decisions have far reaching implications for the economy.

The Central Bank took action to allow the Rupee to depreciate at a faster pace since the middle of last year. Since 23rd January, the Central Bank has abandoned the daily announcement of its buying and selling rates thus allowing the market forces to determine the equilibrium exchange rates. The rupee is thus allowed to "float" freely in the market. Hitherto, a "managed floating system" had been in operation. Immediately after the revision, the selling rates of commercial banks reached an exorbitant level of around nearly Rs. 100 per dollar, reflecting an annual depreciation (or devaluation) of the rupee by about 40 per cent. Then it has gradually declined to about Rs. 90 per dollar by the beginning of February.

Theoretically, currency devaluation helps to reverse a worsening Balance of Payments situation, inter alia, by (1) boosting exports; exports become cheaper in Dollar terms due to the devaluation, and therefore, demand for exports rises, and, (2) discouraging imports; imports becomes expensive in rupee terms after the devaluation and as a result, import demand falls. Are these hypotheses realistic? A trade theorist might reply, "Well, the success of a devaluation depends on many factors. In particular, it depends on the fact that how far our exports and imports would respond to such price changes." Unfortunately, in a developing country like ours, the benefits expected from devaluation may not materialize very much due to the nature of goods that we import and export. The bulk of our imports consist of essential consumer goods, raw materials, machinery, and equipment. Any reduction of such imports will have adverse repercussions on production growth and living standards. In addition, the government is compelled to import armament for the ongoing war. Such imports, of course, are unlikely to decline in response to an increase in import costs resulting from the devaluation. On the export side, it is well known that agricultural production cannot be expanded in response to price changes in the short run due to the longer gestation period involved in such products in contrast to industrial goods. Besides, in the case of a country like ours it would be difficult to boost agricultural exports, even in the medium or long term, merely through a price gain backed by devaluation due to structural factors like, productivity related problems, labour immobility, land tenure problems, and management inefficiencies. The agricultural sector in Sri Lanka is still not commercially oriented due to such factors and therefore, a mere devaluation would not bring about a miraculous increase in agricultural export earnings. Hence, these structural problems that hamper the agriculture sector need to be addressed.

One could expect a faster rise in industrial exports in the short run following a devaluation, as the producers of these goods enjoy much flexibility in determining their production volumes, compared with agricultural products. However, industrialists also face various constraints in expanding their production in response to a devaluation including capacity limits of the factories, quota restrictions imposed by importing countries, and competition from other exporting countries. The short-term benefits for industrial exports anticipated from devaluation are usually mitigated by subsequent cost increases of labour (wages), raw materials, fuel, and machinery in subsequent rounds following devaluation. Partly as a result of the recent currency depreciation, the costs of fuel used in industries (i.e. gas, electricity and diesel) have already risen. Manufacturing industries are hit by a 35 per cent price hike in industrial gas effected by the Shell Gas Company immediately after the rupee Float. The situation will be aggravated by the 25 per cent 'fuel adjustment charge' to be imposed by the Ceylon Electricity Board shortly on all electricity bills. The recent upward revisions of water also adversely affects the industries. The rising cost of living accelerated by the currency depreciation prompts the trade unions to ask for higher wages and these moves have adverse repercussions on export industries. As a result of these currency depreciation effects, cost overruns around 25-30 per cent are expected for manufacturing industry. In the circumstances, industrialists fear that these cost overruns have already taken away any benefit that was to be enjoyed by the industrial sector through the rupee depreciation. 

Theoretically, a country's currency should depreciate to compensate for the loss in export competitiveness resulting from the inflation differential between the home country and its trading partners (broadly, world inflation). By this means, the home country could prevent any appreciation of its Real Effective Exchange Rate and thereby sustaining its export competitiveness. If we apply this yardstick, it is difficult to justify the recent depreciation of the rupee. The annual average inflation rate of Sri Lanka was 7.5 per cent for the 12 months ending January 2001. Assuming a world inflation rate of 3 per cent for the same period, the inflation differential would amount to about 4.5 per cent for the last 12 months. Accordingly, the Rupee should have depreciated only by around 4.5 per cent during this period. In contrast the Rupee has actually depreciated by 20 percent between January 2000 and January 2001. Therefore, the present currency depreciation cannot be simply explained by inflation differentials. It is much more a reflection of the deep-rooted weaknesses in macroeconomic fundamentals. 

The foreign reserves of the country have been falling for quite sometime. The total external assets of the country which stood at US Dollars 2,582 million at the end of 1999 fell by about 20 per cent to Dollars 2,072 million by Nov. 2000. The fall in official reserves was even more dramatic. Gross official reserves declined by about 40 per cent from Dollars 1,639 million at end of 1999 to Dollars 978 million by November 2000. Thus, the Central Bank did not have sufficient foreign exchange reserves to intervene in the foreign exchange market and to defend the rupee. The continuous depletion of foreign reserves tended to erode confidence of foreign exchange earners about the stability of the rupee. Particularly exporters, viewed the rupee as a weakening currency and therefore, they anticipated it to depreciate continuously vis-a-vis foreign currencies. Naturally, they held on to their foreign exchange without remitting the funds to Sri Lanka. As there was no surrender requirement to bring back export earnings, they could legitimately keep their foreign funds abroad. This tendency aggravated the balance of payments situation further and the depletion of foreign reserves continued. Uncertainty and speculation were the order of the day. Attempts taken by the Central Bank to arrest this situation by means of interest rate hikes and widening the exchange rate bands failed.

The Central Bank raised the interest rate offered to commercial banks for their overnight deposits (known as Repurchase or Repo rate) to 20 per cent recently; in comparison this was only 9 per cent a year ago. Also, the overnight lending (reverse repurchase or reverse repo) rate charged by the Central Bank from commercial banks was raised to 23 per cent; this was only around 13 per cent a year ago. Commercial banks can use the overnight Repo window to deposit their excess funds with the Central Bank and earn interest. Commercial banks can obtain liquidity through the Reverse Repo window from the Central Bank using Treasury Bills and Bonds as collateral when they are short of funds. The Repo and Reverse Repo rates are used by the Central Banks in many countries nowadays as main instruments for signalling the anticipated movements of interest rates to the market. An upward revision of these rates signals a rising trend of interest rates and vice-versa. Accordingly, the upward revision of the Repo and Reverse Repo rates by the Central Banks over the last several months led to an upheaval of market interest rates. 

Sri Lanka Inter-bank Offer Rate (SLIBOR) which reflects the borrowing rates among banks continued to exceed 28 per cent (for seven day borrowings) by the end of January; this was only about 13 per cent a year ago. A similar hike in rates was observed in Treasury Bill and Bond markets as well as in deposit and lending operations of commercial banks and other financial institutions despite the currency depreciation. High interest rates are detrimental to investments. 

The economy is encountering severe difficulties at present. Despite the satisfactory GDP growth rate of 6 per cent achieved last year, many other economic indicators point to a dismal economic performance. The external trade deficit has widened considerably resulting in a continuous fall in foreign reserves and a rapid depreciation of the Rupee. Foreign exchange earnings from tourism also declined due to a drop in tourist arrivals causing further pressure on the foreign reserve position. A considerable rise in the world prices of essential commodities like crude oil, sugar and rice not only led to deteriorate the balance of payments but also to escalate domestic inflation. This coupled with the rapid depreciation of the Rupee in recent months triggered the inflationary forces further. Domestic prices of diesel, kerosene and gas were raised several times in recent months and the actual effects of these price revisions on cost of living are yet to be seen. Leaving aside the price increases in international markets, continuous depreciation of the Rupee will cause further domestic price increases. The annual inflation rate is bound to accelerate this year from the present 7.5 per cent. If action is not taken to arrest this situation, the repercussions will be both economically and politically harmful. 

As regards the money market, excessive government borrowings from the market have tended to push up the rates on Treasury Bills and Treasury Bonds. In the circumstances, the Central Bank raised its Bank Rate, Overnight Repurchase rate (Repo) and Reverse Repurchase rate (Reverse Repo) rates to historically high levels as explained above. As a result, both deposit and lending rates of commercial banks and other financial institutions are on an upward trend. Theoretically, one could expect a rise in savings following such a hike in interest rates. But it may not be materialized in the current context due to factors like low-income growth and declining purchasing power of money resulting from inflation. Therefore, any positive impact of the interest rate rise on savings would be minimal. On the investment front, higher interest rates are detrimental to investments. With rising lending rates, borrowers encounter difficulties in servicing their loans. This is reflected in the large number of public auctions of mortgaged properties effected frequently by banks and other financial institutions to recover their loans. Apparently, most of such unsuccessful borrowers are industrialists and traders who would have utilized the funds to develop their enterprises. The reasons for non-servicing of loans vary from borrower to borrower, but doubtlessly, high interest cost might have been a major factor. The current prime lending rate of commercial banks exceeds 22 per cent, compared with the corresponding rate of 14 per cent a year ago. Lending rates applicable to an ordinary borrower are much higher. The rising cost of funds eats into producers' profit margins and thus discourages investments. 

The rise in Treasury Bill and Bond rates has resulted in an increase in the interest payments of the government. This leads to a further expansion of the budget deficit. Fiscal imbalance is further aggravated by the recent currency depreciation, which has led to increase the foreign debt burden, in rupee terms. The total outstanding foreign debt amounts to US dollars 6.8 billion. This works out to be around Rs. 503 billion if we apply the exchange rate of Rs. 74 per Dollar which prevailed a year ago. But at the present exchange rate of Rs. 90 per Dollar, the foreign debt has gone up by Rs. 109 billion (or by 30 per cent) to about Rs. 612 billion. This means that the government will have to bear this additional rupee cost in repaying the loan. In addition, the interest cost will be higher. Thus, a higher allocation of funds from the government budget to service foreign loans is required as a result of the depreciation. This will lead to a further expansion of the budget deficit. If this widening deficit is financed by money creation (printing of new money), inflation will accelerate further, nullifying the anticipated beneficial effects of the depreciation.

In this background, it is unrealistic to predict that the exchange rate would settle down at a particular level. Some officials have claimed that the equilibrium rate would be Rs. 89-90 per Dollar. We can use such a "magic" number to say that it is "the equilibrium rate" if we live in a static economic environment, or in other words, "if other things do not change." But the inflationary implications triggered by the recent rupee float, as explained above, necessitates a continuous fall of the Rupee vis-a-vis foreign currencies in the coming months to offset any adverse effects emerging from the widening differential between the domestic inflation and foreign inflation, and thereby to safeguard the export competitiveness. 

In the midst of the currency depreciation, there is much concern about speculative foreign exchange transactions. In the meantime, the Central Bank has warned the financial institutions that if anyone plays up, it would even withdraw the licence to trade in currency. Besides, certain restrictions have been imposed on forward transactions to suppress any speculative trading.. In a "free float currency" environment, speculation is unavoidable. The renowned economist, Milton Friedman argues that speculation will persist only if it is profitable. According to him, speculation is not necessarily harmful and it may even help to stabilize the foreign exchange market. Speculation continues to remain profitable as long as there are variations in buying rates and selling rates of foreign currency. These rates may fluctuate violently in a free float environment, and as a result, importers as well as exporters face larger exchange risks in making their transactions. 

They attempt to minimise these exchange risks normally by entering into forward contracts. Forward and futures markets have evolved in the developed financial centres like those in New York, London and Frankfurt over the years to provide such cover so as to reduce exchange risks. In a fixed exchange rate regime, speculation does not arise and therefore, forward markets do not make much sense. What we are experiencing today is a freely floating rupee. With the free float of the rupee, buying and selling rates are subject to greater volatility and as a result, exchange risks involved are much higher than ever before. In such a situation, there is a greater need for forward cover. In the circumstances, it would be desirable to promote forward transactions in the foreign exchange market, instead of suppressing them. Perhaps, such a move will help to reduce the prevailing market uncertainty. 

Consistent policy signals are imperative to restore market confidence. Current inconsistent policies could aggravate market uncertainty and destabilise the rupee. As a result of devaluation, war costs - even if there are cuts - will rise due to the depreciation of the US dollar. 


More Business

Return to Business Contents


Business Archives

Front Page| News/Comment| Editorial/Opinion| Plus| Business| Sports| Mirror Magazine

Please send your comments and suggestions on this web site to 

The Sunday Times or to Information Laboratories (Pvt.) Ltd.

Presented on the World Wide Web by Infomation Laboratories (Pvt.) Ltd.
Hosted By LAcNet