The fall of the rupee against the dollar could not be sustained despite Central Bank’s non intervention to prop up the rupee as it did in the past as analysts say the exchange rate is allowed to float freely, a precondition to the US$ 1.9 billion IMF loan authorities are confident will come soon.

"The rupee strengthened against the dollar and ended the week at about 117 because there was no one to buy dollars at the 120 levels that was being traded at the beginning of the week. So dealers had to offer dollars at the lowest margin which was around the 116 mark," a dealer said last Thursday, the last trading day of the week before the Vessak holiday.

"After it seemed the Central Bank’s hand were tied and did not intervene in the foreign exchange market we tried to take the exchange rate to as higher rate as possible. That is why two weeks ago the rupee fell to more than 120 against the dollar," he said.

But with the rupee slipping, importers were reluctant to forward their bills and dealers say banks were forced to offer dollars from the bottom, at lower profit margins.

"So the rupee strengthened because of this to about the 117 mark. Now exporters are not forwarding their foreign exchange," the dealer said. The Governor Central Bank is reported to have said this was a more realistic rate of exchange and that the 120 levels were unwarranted.

In the past the Central Bank had intervened to stabilize the rupee with the country’s trade deficit consistently widening. This invention cost the country its foreign currency reserves resulting in the negotiations for the US$ 1.9 billion IMF standby facility to help stabilize the balance of payments position. Exporters too suffered because the artificial rate eroded their competitiveness.

"The rupee’s fall was largely due to speculative trading and not necessarily market forces driven. At first there was speculation the IMF loan would be delayed or not come through at all. However, the market gained some confidence after officials indicated that the loan would come through for certain," the dealer said.

"The foreign exchange market was driven mostly by expectations. When the rupee fell it was because there was speculation the IMF loan would not come through. When the rupee gained it was because there was speculation that US$ 500 million loan from Libya was through and banks tried to cover their positions," another dealer said.

Economists are calling for the depreciation of the rupee to help bolster the export sector amidst the global economic crisis as they felt the rupee would depreciate given the trade account deficit. But dealers admit that much of the depreciation over the past week or so was not trade driven.

While the rupee fell against the dollar to the 120 levels it had to readjust back to the 117 level as importers withheld their bills, forcing dealers to offer dollars at a lower level.

Sri Lanka’s trade account deficit constantly widened until recently when for the first time in years the deficit contracted with imports falling sharply compared to the fall in exports.

According to the Central Bank, the trade deficit in February 2009 contracted by 75.5 year-on-year to record US$ 78 million, the lowest in four years. In February last year, the trade deficit stood at US$ 317 million.

Meanwhile, the cumulative trade deficit for the first two months of the year dropped by 72 percent to US$ 262 million from US$ 937 million recorded during the corresponding period in 2008.

Interest rates…

Despite relaxing its monetary policy stance banks are not in a position to reduce their lending rates.

"The Central Bank is making a huge effort to stimulate the economy by bringing down policy rates but the translation into bank lending rates will take some time. However, lending rates are progressively coming down," a dealer said.

The Average Weighted Prime Lending Rate of commercial banks came down by about 70 basis points from 18.83 percent to 18.16 percent during the week.

"With inflation coming down to single digit levels and the Central Bank relaxing monetary policy we could see the results next year where lending rates would really come off," another dealer said.

However, with world economy in turmoil government revenue is expected to take a hit.