The depreciation of the rupee (LKR) is likely to have a negative impact on the Sri Lankan banks that have borrowed in foreign currency, according to the research findings of a local equities brokerage.

The LKR has depreciated 1.3 percent against the US dollar year-to-date. In 2014, the rupee depreciated by only 0.3 percent as opposed to 2 percent depreciation in 2013 and a massive 12.6 percent in 2012.

With the prevailing global and local economic developments, the rupee is expected to slide further at the end of this year.

Equities brokerage Asia Securities estimates the LKR to depreciate over 5 percent this year to Rs.138 per US dollar and a further 1.4 percent each in the next two years and stabilize thereafter.

As at end-2014, foreign borrowings represented 59.8 percent of the total borrowings of the banking sector and 48.5 percent of new borrowings was in foreign currency.

In rupee terms total foreign currency borrowings in 2014 amounted to Rs.582,730 million while LKR borrowings stood at 582,730 million.

However, Asia Securities said the hedging mechanisms generally employed by the banks and other regulatory requirements should somewhat soften the impact.

The foreign borrowings of the local banks are also exposed to the risk of potential rate increase by the US Federal Reserve, Asia Securities pointed out.

“The Fed has set its deposit rate at 0 percent and lending rate at 0.25 percent in 2008 and it remains unchanged to-date. Even though a rate-hike will directly impact dollar borrowings, if hedged, there will have a minimum impact on local banks.”

However, the recent bond issue and currency swap agreement with India and China, are expected to mitigate the downward pressure on the LKR. The Finance Minister last week said Sri Lanka is planning to borrow up to US $ 2 billion via a syndicated loan.  

The crude oil prices are expected to increase amid growing tensions in the Middle East, which will negatively impact Sri Lanka’s import bill. Along with this, the higher import of vehicles, fuelled by lower tariffs, will put pressure on the LKR going forward.   

The slowdown of European markets, to which 30 percent of Sri Lanka’s exports go, and the lower commodity prices are also expected to exert pressure on the LKR.