The Sri Lankan rupee, which
emerged as the top-performing emerging market currency in 2024 with a
remarkable appreciation of 10.85%, has started 2025 on a less favorable note.
By the end of January’s fourth week, the rupee recorded a depreciation of 1.72%,
making it the worst-performing emerging market currency so far this year,
according to Bloomberg market data. The depreciation
has raised concerns about external sector stability, particularly as the
Central Bank of Sri Lanka (CBSL) warns of rising risks tied to increasing
aggregate demand, potential import surges, and global economic uncertainties
A Shift in Performance
In 2024, Sri Lanka’s rupee gained strength due to several key factors. The Central Bank successfully maintained exchange rate stability, supported by strong dollar inflows from tourism ($5 billion), worker remittances ($4.6 billion), and export earnings of $13 billion. Combined, these inflows helped the Central Bank purchase $2.6 billion from the market, driving the rupee to below Rs. 300 per US dollar by year-end.
However, as of 24 January 2025, the rupee has seen a reversal, posting a negative spot return of 1.72%. This depreciation places it behind other struggling currencies, such as the Argentine peso (-1.46%) and Turkish lira (-0.89%). In contrast, the Russian ruble (+16.07%) and Colombian peso (+5.45%) lead the emerging market currency rankings for 2025, highlighting their resilience amid global economic headwinds
Emerging Risks to the External
Sector
The Central Bank has attributed the rupee’s recent depreciation to growing
risks within the external sector. Despite the stabilizing measures implemented
in 2024, several factors could strain Sri Lanka’s economy in 2025.
Rising Aggregate Demand
Robust economic growth in 2024 and projections for continued expansion in 2025
have driven up aggregate demand. This surge could lead to higher imports,
adding pressure on the trade deficit
Planned Import Relaxations
After years of import restrictions, Sri Lanka is planning to ease policies,
including the reintroduction of motor vehicle imports. This move, while
potentially boosting economic activity, is likely to exacerbate import demand
and widen the current account deficit
Global Commodity Price
Uncertainty
Heightened geopolitical tensions have created volatility in global commodity
markets, increasing the unpredictability of prices for essential imports such
as oil and food. Such fluctuations could further strain Sri Lanka’s external
balance
External Debt Servicing
Resumption
With the resumption of external debt repayments in 2025, the Central Bank
cautioned that overly accommodative monetary policies could amplify import
demand, potentially leading to a significant depreciation of the rupee
Policy Implications and
Central Bank’s Outlook
The Central Bank has stressed the importance of cautious policymaking to manage
the growing risks to the external sector. Policymakers are tasked with striking
a balance between supporting economic growth and maintaining exchange rate
stability.
The planned relaxation of import restrictions will require careful timing and monitoring to avoid a significant impact on the current account. Additionally, global geopolitical developments and commodity price trends will need close observation to mitigate adverse effects on the trade balance
The Central Bank’s 2024 report to Parliament on inflation target breaches emphasized the inter connectedness of monetary policy, aggregate demand, and external sector stability. The report warns that failure to manage these dynamics could lead to increased volatility in the currency market, with broader economic repercussions
Looking Ahead
While the depreciation of the rupee in early 2025 signals emerging challenges,
Sri Lanka's economic fundamentals remain relatively stable, supported by strong
inflows from exports, tourism, and remittances in the previous year. However, the government and the Central Bank must proactively
address external vulnerabilities by implementing policies to control demand,
stabilize the trade deficit, and navigate global uncertainties.
With a cautious and adaptive policy framework, Sri Lanka can mitigate the risks to its external sector and ensure that the gains made in 2024 are not eroded. The performance of the rupee in the coming months will serve as a critical barometer for the country's economic resilience in 2025
Conclusion
The Sri Lankan rupee's depreciation at the beginning of 2025 underscores the
challenges facing the country’s external sector. Rising aggregate demand,
relaxed import policies, and global uncertainties pose risks that require
prudent management. As the government and the Central Bank navigate these
hurdles, the broader objective of sustainable growth and economic stability
remains paramount. Whether Sri Lanka can sustain its gains from 2024 will
depend on its ability to adapt to changing domestic and international dynamics.
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