It is not a weak rupee, it is weak policy

By Dhananath Fernando

Originally appeared on The Morning

At the end of March, the Sri Lankan Rupee was trading at around Rs. 310 to the US Dollar. By the week before 21 May, it had moved to around Rs. 321–326. On 21 May, the exchange rate moved sharply, fluctuating between Rs. 331 and Rs. 348, before settling again at around Rs. 328–330.

Many looked at this movement and concluded that the rupee was getting weaker. But the exchange rate, by itself, is not the best indicator of whether an economy is performing well or badly. A currency can move for many reasons. What matters is whether the movement reflects market fundamentals or policy mistakes.

In this case, the recent rupee movement tells us less about the weakness of the LKR and more about the weakness of our policy environment.

Market signals

One clear example came from the data shared at a recent press conference by the Deputy Minister of Finance. According to him, after the surcharge on Customs duty for vehicle imports, vehicle-related Letters of Credit (LCs) dropped to about $ 4 million a day. However, one day after the surcharge announcement, the value of LCs opened for vehicle imports was $ 88 million.

That means one policy announcement created 22 times the normal daily demand for dollars in a single day.

The surcharge was announced on 15 May. Whether intended or not, it signalled to the market that dollars were in short supply. When markets receive such signals, they do not wait patiently. Importers rush. Businesses panic. Anyone planning to open an LC tries to do it before the next restriction arrives.

The additional demand was not only for vehicles. It likely spilled over into other non-perishable imports as well. That sudden dollar demand put pressure on the exchange rate. Within a week of the vehicle import surcharge announcement, the pressure became difficult to manage, and the Central Bank reportedly had to release around $ 200 million from reserves to calm the market.

The story did not stop there.

On 24 May, loan-to-value ratios were imposed on vehicles and gold. Again, the signal to the market was obvious: the authorities were worried about dollar demand. But the bigger issue was left untouched.

Impact of policy uncertainty

More than 20% of our import bill is fuel. Yet we continue to delay proper fuel price adjustments. In effect, we are subsidising fuel while burning the hard-earned gains of the primary balance. The failure to adjust fuel prices has now spilled over into vehicle imports, gold loans, and eventually monetary policy.

There is also a revenue contradiction here. The Government earns far more tax revenue per dollar spent on vehicle imports than on many other imports. Vehicles are taxed at around 120% on average, one of the most extreme border tax structures in the world. So when we slow down vehicle imports while failing to address fuel pricing properly, we reduce dollar demand in one place but also lose a major source of Government revenue per dollar spent.

Then came 26 May. To contain demand and absorb excess liquidity, the Central Bank increased policy interest rates by 100 basis points. Given the liquidity conditions, the move was understandable. The market had excess liquidity, and the Central Bank had already been absorbing rupees through repo operations.

But the broader point is this: the reluctance to make the politically difficult decision on fuel prices eventually pushed the burden onto interest rates. What began as a fiscal and pricing problem became a monetary policy problem. The Central Bank then had to do the unpopular job.

On 9 June, another measure followed. The mandatory conversion period for exporters’ foreign currency earnings was reduced from 90 days to 30 days.

This will not build confidence. It will erode whatever little confidence remains.

Exporters will now have even stronger incentives to delay bringing money into Sri Lanka, keep funds offshore for as long as possible, or structure transactions in ways that reduce exposure to forced conversion. That is not because exporters are unpatriotic. It is because policy uncertainty changes behaviour.

Fixing the fundamentals

When we look at the sequence of decisions, the problem becomes clear. The reason for the rupee pressure and the tools used to address it did not match. The pressure came from panic, excess liquidity, fuel pricing failures, and poor policy signalling. But the response was a mix of import surcharges, credit restrictions, higher interest rates, and forced exporter conversion.

This is not a weak rupee story. It is a weak policy story.

The next episode is easy to predict. Exporters will be accused of keeping money offshore. They will be blamed for not bringing dollars into the country. They may even be treated like traitors responsible for the currency movement.

But this is deeply unfair.

For years, we have said exports must grow. We want exporters to bring in dollars. We want them to compete globally. We want them to diversify Sri Lanka’s economy. But what have we given them in return?

We have made exports difficult through para-tariffs, labour regulations, land issues, high energy costs, policy uncertainty, and a generally unfriendly business environment. At the same time, the Ministry of Industry runs special credit schemes for exporters. The Export Development Board takes part in international exhibitions to find new markets. We talk endlessly about export growth.

And after all that, our final policy response is to tell exporters: bring your dollars back faster and convert them within 30 days instead of 90.

This is not how confidence is built. This is how confidence is destroyed.

The exchange rate is only a price. It reflects the demand and supply of dollars. But behind that price are expectations, confidence, policy credibility, and market behaviour. When policy becomes unpredictable, people protect themselves. Importers rush. Exporters delay. Consumers speculate. Banks become cautious. The currency then reflects that uncertainty.

So the real problem is not that the LKR is weak. The real problem is that our economic policy environment is weak.

A strong currency cannot be built on weak policy. It has to be built on predictable rules, market confidence, fiscal discipline, realistic pricing, and an export-friendly economy.

Until we fix those fundamentals, blaming the rupee will not help. The rupee is only telling us the truth.