Mighty dollar likely to inflict more pain on struggling Lankan economy

• Strong dollar makes imported inflation higher and more greenbacks needed to buy same amount of imports 

The continued dollar rally on the back of the fast rise in interest rates in the United States and the investors’ search for safe havens are creating fresh risks to the emerging markets and more so for Sri Lanka, which is scrambling to collect dollars even to keep its basic needs met.

While some emerging markets have some firepower to defend their currencies against the mighty dollar, Sri Lanka has absolutely no way of supporting its currency after it exhausted all its foreign exchange reserves early in the year, plunging the economy into its worst Balance of Payment (BoP) crisis, which precipitated into a prolonged and painful economic and political crisis.

Hence Sri Lanka, compared to rest of the developing Asia with few exceptions such as Pakistan, is at the receiving end of the strengthening dollar. 

The dollar index measured against a basket of other currencies is up 13 percent from the beginning of the year through September 11 and is at the highest in decades. 

According to Larry Summers, the economist and the Former US Treasury Secretary who spoke on this phenomenon last week, the dollar has more room to continue appreciating. 

Why the dollar strength could spell more trouble for Sri Lanka is that global commodities are priced in dollars and thus it exacerbates the inflation by making it more expensive to import goods and services as a stronger dollar makes rupee less valuable. 

Inflation is already raging at over 65 percent in Sri Lanka and things could get uglier if the dollar rally continues as most food, fuel, medicine and other essentials are imported.

While the emerging markets and to a degree Sri Lanka could weather some of the pressure coming from the strengthening dollar due to higher commodities prices, the commodities super cycle is fading on fears of a global economic slowdown due to aggressive actions by global central banks to tamp down inflation.

For instance, as of late, Sri Lanka has witnessed its rubber auction prices dipping partly due to lower demand from foreigners as a global economic slowdown looms. 

Apparel makers also sounded some caution last week over the slowing demand for garments from the US and Europe as consumers are pulling back on spending amid decades-high inflation. 

Meanwhile, the overall terms of trade – ratio of price of exports to price of imports – for July showed a deterioration by 3.0 percent compared to a year ago due to the increase in import prices over the increase in exports prices, reflecting Sri Lanka’s exports are fetching relatively less prices compared to the prices of what it imports.