“This seems to be a logically adjustment which is not unusual.”
The rupee was quoted as low as 129.05 in morning trade Friday and later recovered to 128.50/80 levels.
The underlying strength of the US dollar had increased in recent months, which is shown in falling oil and gold prices, indicating that currencies that are not tightly pegged to the US dollar could also weaken.
Most Asian currencies have fallen against the US dollar.
In some countries there have been bond sales by foreign investors amid higher US interest rates.
Governor Cabraal said there were no unusual bonds sales by foreign investors. Sales are usually offset by purchases by others and the ceiling of 12.5 percent was generally maintained and it was not a major contributory factor for the currency weakness, he said.
“There is a still a strong external demand. We don’t see any risk materializing there, because the cap is holding at 12.5 percent,” he said.
“If someone sells, there are also purchasing foreign bonds and it evens out. As a result the Sri Lankan bond limit being maintained.
“This used to happen earlier. The main reason is not the bonds, there has been an upturn in imports, we have seen a activity in the gold market. People are importing gold.”
Bond yields have also not surged much though yields are elevated compared to last week, dealers said.
A 5-year bond which is popular among foreign and local investor rose to 11.22/25 percent and fell back to 11.15/18 percent, in intra-day trading Friday, compared around 11.05/10 percent last week, dealers said.
Sri Lanka’s central bank does not now intervene in the forex market as it used to do up to 2012, after prolonged sterilized forex sales led to a balance of payments crisis in 2011 and 2012.
A central bank that intervenes in the market selling dollars, creates liquidity shortages in banks, automatically triggering hikes in interests and reductions in domestic credit.
While such ‘unsterilized sales’ can hold a peg tightly as happens in countries like Hong Kong, where the exchange has not changed since 1982.
But most other monetary authorities in Asia which are true central banks, also an interest rate target, and they liquidity into banks to keep rates from going up or ‘sterilizing’ the effects of the forex sale.
The liquidity triggers more credit and imports, a vicious cycle which eventually steadily weakens the currency peg and balloons into a what is known as a ‘balance of payments crisis’, which requires a float of the currency to cure.
Allowing the currency to be ‘flexible’ can nip the problem in the bud. The International Monetary Fund has asked Sri Lanka to make the exchange rate flexible.
In a recent report the IMF said no longer referred to Sri Lanka as having a de facto peg.
“Exchange rate flexibility will also be critical to buffer external shocks and provide appropriate relative price signals,” the IMF May 2013, staff report said.