COLOMBO, Nov 24 (Reuters) - Sri Lanka's rupee exchange rate should be driven by market forces except in cases of volatility, but this week's 3 percent devaluation was necessary medicine to ease a ballooning trade gap, the country's finance secretary said on Thursday.
Finance Ministry Secretary P.B. Jayasundera, the top technocrat in the island nation's finance ministry and architect of Sri Lanka's last 14 budgets, said the devaluation was a considered move that was essentially "a market correction."
Sri Lanka's currency, share, and bond markets are still adjusting to the devaluation after the central bank implemented it as ordered by President Mahinda Rajapaksa during his 2012 budget presentation on Monday.
"(Having) the reserve level of $6-7 billion is the time to do this correction. We had $8 billion reserves and the reserves are under pressure. If you continue to let that happen without giving a signal, at some point you will have to do this or take some other drastic measures," Jayasundera told Reuters.
Jayasundera said the exchange rate policy had encouraged imports, as did low interest rates, while exporters grew less competitive and had less incentive to expand.
Sri Lanka's trade deficit though August was $5.96 billion, nearly as big as 2008's record shortfall. The full-year forecast is $6.76 billion. Despite that, the central bank has spent more than $1 billion this year defending the rupee, while Asian peers let their currencies drop.
"In my view, some adjustment should have happened even before to prevent this. It should be a market-driven, stable exchange rate. When the market doesn't produce it, the central bank needs to come into help stability," he said.
The International Monetary Fund praised the devaluation as a move in the right direction, after it withheld the eight tranche of a $2.6 billion loan after the government refused to allow for a more flexible exchange rate.
SHERATON IN SRI LANKA
Jayasundera and Central Bank Governor Ajith Nivard Cabraal are the two most influential economic policymakers in Sri Lanka, aside from Rajapaksa, who at times steps into economic policy in his capacity as finance minister -- often surprising markets.
The honeymoon investor sentiment Sri Lanka enjoyed as an emerging frontier destination, after winning a 25-year civil war in 2009, has taken a series of hits in the past two months.
It cancelled a $500 million Chinese hotel deal over a land dispute, transferred a capital markets regulator who cracked down on investor misconduct, and rammed through a law allowing the state to take back assets leased to private companies.
"In my view none of the investors have been affected by these incidences. But of course the sentiment has. Serious investors are not worried," Jayasundera said.
The voiding of the hotel deal with China National Aero Technology Import and Export Corp. (CATIC) may hit the 2011 $1 billion foreign direct investment (FDI) target, he said.
The land in question, on the historic Galle Face seafront in Colombo, will be given to India's ITC Ltd. conglomerate, to build a hotel under the Sheraton name. ITC is a franchisee of the largest of Starwood Hotels and Resorts Worldwide's brands.
"The land will cost $70 million and the CATIC land will be released. The total investment would be $450 million," Jayasundera said.
Officials from ITC could not be reached for comment. (Additional reporting by Aniruddha Basu in Mumbai; Editing by Bryson Hull)
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