Thread by @ChayuDamsinghe

With the recent appreciation of the currency and the interest rate hike as well, a lot of questions floating around so doing a quick explainer

#Sr

Disclaimer - Personal views all. Key point is that very specific short-term moves are rarely due to overall factors, but more day-to-day decisions made in the forex market. Bankers have more visibility into those than I do, especially into how it'll perform next few days

3/ I'm also very aware now that economic developments have an overtly political narrative around them now. To be very clear, I'm merely trying to explain what I think happened rather than make any political point.

4/ So getting to the points themselves - I think it's accurate to think of the currency move and the rate hike together rather than as two separate events, since they affect each other quite directly.

5/ For any currency to appreciate against the USD, there needs to be one of two things happening. Either the demand for dollars has to fall to a level lower than the supply of dollars, or the supply of dollars has to rise similarly.

6/ For the LKR, I think it's clearly visible that the demand for dollars has fallen significantly over the past few months. As the economy contracted, fewer importers would bid for dollars, while capital and import controls also helped to an extent.

7/ For me, the contraction in demand is far more important than the controls - our import controls don't really affect too many imports in terms of value, but looking at import data, it's clear there's a big fall (from ~$2bn per month end-2021 to ~$1.4bn end-Jan)

8/ So from the demand side, there's a clear fall. On the supply side, there's also been an increase for the last few months as tourism and remittance inflows have increased (from <$450mn before Nov-22 to ~$600mn since Dec-22)

9/ On that basis, I think it's clear that the improvement in the currency was driven by those factors. But why now? Why not earlier?

10/ There are a few reasons I can think of.

First, there were some rupee liquidity injections in January and February (think as increased supply of rupees=price of rupee falls).

Second, CBSL was also buying dollars in Dec and Jan (likely also in Feb).

11/ Third, the data I have is only until end-Jan. It's possible that the supply and demand factors improved a lot in Feb. Eg- I'm not too clear how the IFC swap affected this or how exporters have converted USD. Bankers would have more visibility into these compared to me.

12/ Fourth, the relaxation of the exchange guidance band and surrender requirement also seems to have improved sentiment - but again, I'm just guessing here. I don't have enough insight into this to confidently say anything.

13/ On the back of all this, I think it's also likely that the sentiment around the IMF and the IMF conditions are also part of what led all of this to happen together at this point, given there's a move towards a full market rate from next week.

14/ How does the rate hike factor in? We know that CBSL bought some ~$300mn last week, which is ~Rs. 100bn in an infusion in return (buy dollars by giving rupees). So in that context, the rate hike also serves to "adjust" against so many rupees suddenly going into the system.

15/ The risk I see of NOT doing the hike, would possibly be that all those rupees COULD cause the currency to depreciate outside expectations again later on - meaning that there's a chance that there's further inflation.

16/ While inflation is falling, it's still above 50%, so if anything goes wrong, there's still a risk of inflation remaining significantly higher than normal. So it seems that the rate hike also works as a sort of "insurance" against that.

17/ Of course, it's clear that the hike was also an IMF condition - the CBSL referred to it - but what I said is the reasoning I see for it. This overall situation hopefully creates a better place for the forex and rates markets to behave on moving forward.

18/ Once again, I only have visibility into some factors, the ones where data is already out. Beyond this, I see very little into short-term factors. So take my short-term explanations with a heavy grain of salt.

19/ But overall, I don't necessarily see this movement as "artificial" by any means. The question is whether this will continue or not. I don't know for sure.

20/ If the factors point towards appreciation, then yes, it can continue or stay at these levels. If instead, the factors weigh towards depreciation, then it won't. Yes, that's not a useful forecast. The truth is, I not only don't know, but think I CAN'T know either.

21/ A few days ago, I jokingly retweeted this, but frankly - it's a true part of economic forecasting. We don't know the future anymore than anyone else. Understanding the underlying factors, then guessing how they will go is likely the best anyone can do.

https://twitter.com/ChayuDamsinghe/status/1631118235339980800

22/ This "guessing" can happen through a model, through thinking, through looking at past data, but in the end - noone knows what the future is. It's all just "guesswork" in the end, sophisticated though the process may be.

23/ So hopefully, you get some idea about what moved the currency and rates over the last week, and have a better platform to think about how the future may move. If you know EXACTLY what will happen though, tell me :)

No idea what happened to the hashtags lol