Spotlight: Econ Op-eds in Summary (Week ended 5th May '21)
1. Can forward market restrictions mitigate foreign exchange volatility?
By: Professor Sirimevan Colombage
The CBSL has issued a circular to prevent banks from entering into forward contracts of foreign exchange, except for a few specialized purposes since the 25th of April 2021. This restriction was initially put in place in January 2021. Despite this, the exchange rate has continued to depreciate. To hedge against this volatility, two parties enter into a forward contract to buy or sell a specified amount of currency at an agreed exchange rate at an agreed future date.
Alternatively, entrepreneurs have adopted the use of different derivatives such as futures and currency swaps to mitigate forex volatility. Recently, a severe shortage of foreign reserves and a weak BOP position alongside rising debt service commitments are key factors for higher forex volatility. The CBSL can intervene in the forex market using forward market restrictions to protect the rupee.
In the absence of forward trading restrictions, exporters and importers would try to take advantage of rupee deprecation, intensifying forex volatility. This can also arise due to the “twin deficit” issue in Sri Lanka. Unless fiscal consolidation is achieved in combination with prudent monetary policy, the CBSL’s interventions such as forward market restrictions intensify official speculation on the currency, thus worsening market volatility.
(Compiled by: Compiled by: Promodhya Abeysekara, Malitha Goonerathne & Mariyan Perera)
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