Registration Number : FIN-20-03-021

Student Name : Rajakarunakara Wanigakoon Mudalige Sahan

Rodrigo

Module Title : Business Risk Management

Study Centre : Cambridge College of Business and Management

Sri Lanka

By submitting this assignment I confirm that I understand and abide by the Cambridge College’s
plagiarism and collusion regulation

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 Table of Contents
Part “A”

1.1 Introduction – PART “A”

1.2 Reasons of LKR Weakening Heavily Against USD Recently
1.2.1 Influence on the Monetary Policy in the U.S. Federal Reserve
1.2.1.1 How FR Uses the Interest Rate as a Tool
1.2.1.2 The History of Rate Cutting by FR
1.2.2 Strengthens of USD in Recent Years
1.2.3 Impact of trade war
1.2.4 Higher Oil Prices and Increasing Trade Deficit
1.2.5 Current account deficit countries most vulnerable
1.3 Correlation Between USD and Sri Lankan Rupee (LKR)
1.4 Risk Factors to an Importer in Sri Lanka

Part “B”

2.1 Introduction
2.2 Reasons to Slower Economic Growth in Globe in Recent
2.3 Summary of current interest rates & Directions of central banks.
2.4 Local Interest Rates and Central Bank of Sri Lanka
2.5 Why Sri Lankan Economy Not Immune to Diminishing Global Interest Rates
2.6 Lower Interest Rates & Local Economy

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 PART “A”

The US dollar has been strengthening across major currencies in recent times. Aggressive
interest rate cut by the Federal Reserve is widely known to have caused this rally. You are an
importer based in Sri Lanka and the local currency has been weakening heavily against USD
recently. Critically evaluate if the situation, highlighting various aspects of risks that maybe
involved.

1.1 Introduction – PART “A”

Objective of part “A” of the paper is, to discuss about the strength of the US Dollar as the
dominant global reserve currency and how the Central bank of USA the “Federal Reserve” has
cut the interest rates to maintain the stability of USD according to the behavior of the global
economy. By considering the current situation of global economy and US dollar which is Sri
Lanka’s base currency in international Trade, as an importer to evaluate the various risks that has
to be faced while engaging in to the international market.

1.2 Reasons of LKR Weakening Heavily Against USD Recently

The Sri Lankan currency (LKR) has weakened heavily against the US dollar in recent times. In
2018 (9.4% as at 26 September 2018) with close to 4% of the depreciation has being shown.
Currencies like the Indian rupee, Indonesian rupiah and Philippines peso have also seen
declivitous depreciation in 2018. The weakness is since the global and local factors which
effected to depreciate the local currency against the global reserve currency.

 Influence on the monetary policy in the U.S. Federal Reserve

 Strengthens of USD in recent years
 Impact of trade war
 Higher oil prices and increasing trade deficit
 Current account deficit countries most vulnerable

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1.2.1 Influence on the Monetary Policy in the U.S. Federal Reserve

In the recent times U.S Federal Reserve (The central banking system of United States of
America) has pulled down the interest rates several times to stable US economy. During this
period of time, as other countries in the world Sri Lanka has allured to invest on US bond and
equity markets. In terms of monetary Policy most of the Central Banks of the other countries
went on similar direction. Sri Lankan foreign outflow of LKR 64 billion from the local Treasury
Bills and Bonds during the period

1.2.1.1 How FR Uses the Interest Rate as a Tool

The Federal Reserve uses interest rates as a key element to grow the economy or slow down the
current situation. If the economy is dropping down, the Fed can cut the interest rates to make it
cheaper for businesses to borrow money, invest, and create jobs. Lower interest rates also
encourage consumers to borrow and spend, which helps improve the economy.

On the other hand, if the economy is growing rapidly and inflation led to high levels, the Federal
Reserve may increase the interest rates to reduce spending and borrowing.

1.2.1.2 The History of Rate Cutting by FR

Previous time the FR cut the interest rate to 0.25% was in December 2008, during the worst
financial crisis since the Great Depression. The rate remained at virtually zero, until 2015. Then,
as the economy resurrected, the FR started to increase the benchmark, and it continued steadily
until 2018.

In 2019, the FR slowly lowering the rates since growth was beginning to slow. Then in 2020, the
rapid outbreak of the COVID-19 dominated not only the financial markets but the entire global
economy and its being a life threat to the people around the world. Through March 18, there
were more than 200,000 confirmed cases and over 8,000 deaths in 168 countries, according to
the World Health Organization, which has become a pandemic.

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1.2.2 Strengthens of USD in Recent Years

The US Dollar is the most commonly using currency and regularly used as a benchmark in the
Forex market. As the dominant global reserve currency, it is held by nearly every central bank in
the world. In Addition, the Dollar is used as the standard currency in the commodity market and
therefore has a direct involvement with commodity prices. The U.S. dollar index is the common
measure for the strength of the dollar.

The U.S. dollar is strong when the dollar's value is high relative to other currencies. When the
US dollar strengthens, there is an opposite depreciatory pressure on local currency Currently the
USD is been increasing its strength because of three main reasons.

First, the Federal Reserve reduces interest rates; to limit the money supply to the
economy this enforces the supply of the dollar and increased its demand/value

Second, the European Central Bank drops euro value. Political instability in the European
Union also pull-down the euro. The euro to dollar conversion and its history shows how the euro
has gone through against the USD through the years.

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Draft 1.1

Finally, Forex traders intensified the strength of the dollar over the years. They have
taken the advantage of dropping down of euro and strengthen the US dollar.

1.2.3 Impact of trade war

The trade war between the United States and China, Increased trade volumes of both countries &
engaging in putting import tax on imported goods.
Since the geopolitical tensions are high in both countries the global economy is at risk. As a
result, global investors have engaged to do investments in less risk assets & there are portfolio
outflows from markets like Sri Lanka.

1.2.4 Higher Oil Prices and Increasing Trade Deficit

The Trade deficit is increasing continuously of the oil importing countries like Sri Lanka because
increasing the prices of oil in the world market in the recent past. This increases import
expenditure adding with higher importing items like Gold and consumer goods which is not so
good to a developing economy like Sri Lanka.

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1.2.5 Current account deficit countries most vulnerable

During times of global volatility, Countries with current account deficits like India and Sri Lanka
are mostly unsafe. During these times of periods the capital inflows to reduce the deficits are
reducing, which is not healthy to an economy.

1.4 Correlation Between USD and Sri Lankan Rupee (LKR)

Like all other nations when it comes to the International Trade Sri Lanka is also based on US
Dollar. When it comes to the past records LKR has been weakening against USD continuously
and heavily in recently. (Refer draft 1.2).

Dra
ft 1.2

1.4 Risk Factors to an Importer in Sri Lanka

Due to the evaluation done so far, Following risks are to be faced as an Importer.

* Interest Rate Risk & Foreign Exchange Risk * Liquidity Risk

* Business Risk * Economic Risk

* Regulatory Risk * Default Risk

* Operational Risk * Reputational Risk
* Social Risk * Political Risk
* Legal Risk

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 Market Risk

 Interest Rate Risk & Foreign Exchange Risk

The risk of increasing in foreign exchange rates (USD) will impact to the
value of business transactions. As an importer the payment to be done in USD & LKR value is
depreciating against the USD continuously, as a result the amount that has to pay in future is
increasing simultaneously.
At the point of agreement signing, it’s difficult to get a clear idea about the certain amount that
has to pay for imports.

 Liquidity Risk
Due to uncertainty of LKR at the stage of settlement/Payment, Company
may face to liquidity issues. Since the exact amount to be paid is unpredictable, Company may
find the difficulties to do the payments against the imports.

 Business Risk

Since the payment to be done from local currency (LKR) and since the LKR is depreciating, that
will directly effect to the cost, as a result the profitability will be flagging. In a certain point the
profit will convert in to a lost.

 Economic Risk

Economic risk also known as forecast risk, which means as an importer the market value is been
continuously effecting by unavoidable situations such as government regulation, exchange rates,
or political stability. This can be effected to currency fluctuations and this can be reduce the sales
and increase the cost.

 Regulatory Risk

This risk type refers change or establishment of regulations / laws related to imports by
governments & central banks of either country. As a result following problems will be raised
Higher cost, thin profit margins, transport problems, Taxes of higher tariffs etc.…..

 Default Risk

As a result of thin profit margin and poor cash flows the company may unable to pay its debts or
required payments to other related parties. Ex. - Bank loans, Payments for imports on agreed
time etc…..

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 Operational Risk

The failures can conceivable while proceeding day-to-day operations of an organization. Mostly
due to process failures

When an order is placed, due to a human error the quantity, the right quality, required date of
stocks, payment or payment method are can be mistaken or the frauds can be happened due to a
lack of security in the day to day systems.

 Reputational Risk

By affecting its revenue or due to losses or due to thin profit margins, potential for negative
publicity or negative impact on company’s reputation.

 Social Risk

This risk type arises when the actions that affects to the entities around the organization. This can
create with or without perceptions of an organization to impact on the community. Due to the
losses uncertainty and job losses of the employees can be happened.

For the purpose of cost cutting if the company functions to work extra hours, human rights
violations can be happened within the work place. Should be considering about public health, air,
water pollutions, and ecofriendly environment as well.

 Political Risk

Due to political instability or due to actions of the government, war, revolution, terrorism, strikes
can be happened. Further during the business due to government changes, decisions of the other
foreign policymakers & military control political risk can be created.

Currently Sri Lanka is in a unstable political situation. Cabinet may change due to the election to
be taken place, Monitory policy can be changed, Government regulations against imports (import
restrictions) can be changed, Taxes – reliefs / reductions, Tariffs can be changed.

 Legal Risk

Legal risks refer when engaging to a business the damages or losses due to negligence in
compliance breaking of laws directly related to the business. This can be happened at any level
of a business proceeding.

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 Part “B"
Interest rates have been dropping rapidly recently across the globe. Explain possible risk
implications and evaluate knock on effects this may have on the local economy.

2.1 Introduction

Due to the instability & slowness of the world economy, interest rates are dropping down
automatically and central banks of most of the countries are doing interest cutoffs. By cutting off
interest rates central banks are aiming to boost their economies.

The rapid drop down of global interest rates refers to Interest Rate Risk of an economy and there
are many types of risks implications are being involving to local economy too. From the part “B”
of the paper, possible risk implications involved to the Sri Lanka economy to be evaluated.

2.2 Reasons to Slower Economic Growth in Globe in Recent

 Lower Global Growth Rate

Global Growth Rate is required to recuperate to 2.5 percent in 2020 up marginally

from the post-crisis low of 2.4 percent enrolled last year dropping trade and investments and
edge up further over the estimate skyline. The world economy has to be rebuild by increasing
productivity and need a boost to expand. Key pointers deteriorated in equal, to a limited extent
reflecting elevated trade protectionism. While monetary accommodation has expanded, fiscal
help is required to melt away.

 Chinese Trade War

Ongoing economic clash between United States & China which are the world's
two biggest national economies. US has a larger nominal GDP (Gross Domestic Product), China
has a larger GDP when measured in terms of purchasing power parity (PPP). United States is
the world's largest importer and the China is the world's largest exporter both economies are been
very critical so far pillars for the global economy.

The two nations have imposed higher tariffs on each other’s goods. Even though negotiations are
going the trade war has proven difficulties, brought uncertainty, hurt to the businesses and slow
down the global economic growth.

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  Covid-19 & Emergency rate cuts by UK USA and Australian Central Banks

* As an emergency action Federal Reserve of US by cutting off their interest rates

to near zero. This has been done less than two weeks after the Fed cut interest rates by half a
point and marks continued effort to minimize the economic impact of the coronavirus.

* As a result of meeting held on March 3, 2020, the Reserve Bank of Australia

(RBA) announced cutting the cash rate by 25 basis points (bps) to 0.50 percent, according to the
updated figures it is the lowest on record & this is the first cut of the year for Aussies to defend
the threat of Corona Virus

* Bank of England has announced an emergency cut on interest rates to defend

the impact from COVID 19 to its economy. According to the special meeting ending on 10
March 2020, the Monetary Policy Committee (MPC) has taken a straight forward decision to
reduce Bank Rate by 50 basis points to 0.25%.

2.3 Summary of current interest rates & Directions of central banks.

Below provided chart (chart 1) gives an outline of the present Interest Rates of central banks of
the several countries in the world.

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2.4 Local Interest Rates and Central Bank of Sri Lanka

The world is currently entering a time of unprecedented monetary easing, following the US rate
cut, India, Philippines, and New Zealand cut their interest rates referring to economic growth
concerns. At the meeting held on 29 January 2020, CBSL to reduce the Standing Deposit Facility
Rate (SDFR) and the Standing Lending Facility Rate (SLFR) by 50 basis points to 6.50 per cent and
7.50 per cent, respectively.

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* The History of Changes in Policy Interest Rates of the Central Bank of Sri Lanka

2.5 Why Sri Lankan Economy Not Immune to Diminishing Global Interest
Rates

As a developing 3rd world country Sri Lankan economy is not a strong stand alone economy. It
depends on most of the strong economies in the world. The sensitiveness is high with other
economies & Global economy.

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  International Trade

International Trade is an important segment of the local economy.

Major imports are petroleum, consumables, machinery and capital equipment, motor vehicles,
and various manufactured goods. The main exports of Sri Lankan economy are garments, tea,
rubber, coconut products, foodstuffs, gems, and jewelry. Sri Lanka is the largest exporter of
black tea in the world and the third largest producer of natural rubber. Since the majority of the
work force attached to international trade (Directly & Indirectly), Sri Lankan economy is
largely attached to the global economy

 External Debts

External debt 55.2Mn USD in the last quarter of 2019, The Sri Lankan
government has struggling with slows economic growth to balance its budget deficit. The
government spent more than 4.8 percent of GDP on debt repayments and 1.5% and 1.9% on
health and education respectively. Most of the loans (with & without interest) & donations have
taken from USA & China which. As a result local economy has bounded with other economies.

 Tourism

Nearly 10 years after the end of a brutal civil war, Sri Lanka was
recently named as one of the top tourist destinations for 2019 by According to the World Bank,
Sri Lanka is highly depending on tourism income to pay its high interest on foreign loans.
According to data from the World Travel and Tourism Council, the tourism industry, is one of
the major parts of the Sri Lanka’s economy, also employs more than one million people. As a
result of the depreciation of local currency against USD, the converted income is getting lower
on the other hand due to the rate cuts and low economic growth tourism income is dropping
down.

2.6 Lower Interest Rates & Local Economy

Due to the lower interest rates & continuously depreciation of local currency, following risk
implications may effect in the local economy

 Increasing Bond Prices

 Increase of demand for Fixed Assets

 Drop of Savings & Increase of Investments

 Aggressive Lending by Financial Institutions

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  Credit Growth & depreciation of Local Currency

 Local Business Expansion & Diversification

 Formation of economic Bubbles

 Dollar Demand Increase

 Increase in Imports

 Encourage in Exports

Increasing Bond Prices

In a condition of dropping down of interest rates, the demand for long term bond is increasing
and the demand for short term bonds are decreasing. Long term bonds have an opposite
relationship with interest rates. Most bonds pay fixed rates, if the interest rate is falling down,
Long term bond interest rate become more profitable comparing to interest rates in the future.
Therefor in a situation of diminishing interest rates there is a highly demand for long term bonds

Increase of Demand for Fixed Asset

As a result of lower interest rates and depreciation of local currency the demand for fixed assets
which are not interest sensitive is being increasing. Since there is not a direct relationship in
interest rates with fixed assets such as debentures, Lands.

Drop in Savings & Increase of Investments

Due to lower interest rates in the market business entities or Individuals may not have an interest
with saving money as well as saved money will be withdrawn and spend or consume.

In the present condition investments in long terms will be increased. If individuals and entities
are searching for the best yields for their investments due to faster interest rate drop in the
current economy they should fix their future income on present values. Further to maximize the
profitability in a rate dropping situation long term investments should have been take place.

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Aggressive Lending by Financial Institutions

Since the lending rates are dropping down. Individuals and entities are looking towards
investments, Establishment new businesses, expand businesses etc…. therefore the demand on
loans from financial institutions and banks are increasing or credit requirement is heating up. As
a result banks & FIs are focusing to expand their landings under lower rates.

Credit Growth & Depreciation of Local Currency

When the interest rates are dropping rapidly a higher demand will be creating for credit, as a
result this might create good quality loan as well as bad quality loans. Most individuals may use
credits for consumption. Since there is no return on these loans a default risk will be created.
There may be a chance to majority of the loans get defaulted. After all due to the higher rate of
default loans the LKR is depreciating. As a remedy government has to print money and release
to economy which is not good situation to an economy like Sri Lanka.

Local Business Expansion and Diversification

Due to lower interest rates in the market the saved and short term invested money will be pulling
out and invest in expansion of business targeting more growth & diversify the same by expecting
economic growth since the consumption level of the economy is getting high.

Formation of economic Bubbles

Due to Aggressive Lending by Financial Institutions economic bubbles might get formed. This
means when interest rates dropped, demand for credit is increasing, after that money invested in
properties then if the interest rates are increasing these entities is not be able to afford the loan.
They are starting defaulting.

Dollar Demand Increase

When the interest rates are going down, due to the stability, acceptable rate of return and safety,
investors all over the world are tend to invest their money on USD. As a result it creates a high
demand for dollars

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Increase in Imports

As a result of low interest rates individuals withdraw their savings and consumption rate will be
increasing. Due to higher demand on various products, businesses are motivating to expand. As a
result some goods may create more profits by importing rather than produce in locally. This
point of view there may Increase in imports due to lower interest.

Encourage in Exports

Due to the consumption and investment on businesses and expansion, exports are encouraged.
On the other hand since the local currency is depreciating in front of USD & since the payments
for imports are received by USD exports are being encouraged on this situation (since the
exchange rates are increasing).

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