President Mahinda Rajapaksa's proposal to drop the rupee rate — which by law is the responsibility of the central bank — came as he presented a development-heavy 2012 budget to Parliament, acting in his capacity as finance minister.
Overall 2012 spending was forecast to climb 14.15 percent to 1.59 trillion Sri Lanka rupees ($14.4 billion) while the budget gap in 2012 will be narrowed to 6.2 percent versus a 7.0 percent forecast this year, in line with IMF targets.
"We need to reduce the import cost and increase export revenue. When our currency has strengthened, our trading partners' currencies have depreciated. So I propose to devalue the currency by 3 percent with effect from today," Rajapaksa said.
Central Bank Gov. Ajith Nivard Cabraal confirmed the devaluation would go through on Tuesday. The central bank controls exchange rate movement with a trading band, with one state bank selling and another buying.
The IMF, which has given a $2.6 billion loan program to help the Indian Ocean nation improve its fiscal discipline and sustainability after the end of a long civil war in 2009, has been urging a more flexible exchange rate.
Sri Lanka has blown through more than $1 billion this year keeping the rupee near 110 to the dollar, prompting concern from the global lender that non-borrowed reserves are shrinking while the balance-of-payments surplus is narrowing. It withheld the eighth tranche of the loan.
IMF country representative Koshy Mathai declined to comment.
Bankers and economists welcomed the decision as positive for Sri Lanka's garment and tea exporters, and expatriate remittances — the top three foreign exchange sources for the $50 billion economy.
"It will make Sri Lankan exporters more competitive compared to their regional peers, because a lot of Asian currencies have depreciated, and if that leads to more exports that will be more positive for the balance of trade," Nick Nicolau, chief executive of HSBC in Sri Lanka, told Reuters.
Currency traders said there was some initial panic from offshore investors who wanted to sell their rupee-denominated treasury securities, but were unable to get a rate quote after the shock announcement halted dealing in its tracks.
"Some will want to sell but there are still some guys who will want to hold it because it is paying them 7-8 percent, so they are getting 4 percent after the depreciation. Anyway there is hardly enough liquidity for them to exit," a trader at a major commercial bank told Reuters on condition of anonymity.
The president also said the government would redistribute to families 37,000 acres of unused state tea and rubber plantation land leased to the private sector.
The move goes one step past a newly-passed takeover law that drew ratings agency criticism as a threat to foreign investor confidence. The government had said there would be no further takeovers.
"This doesn't augur well for investor confidence. This means he is trying to get funds domestically," opposition legislator and economist Harsha De Silva said.
