IMF understands need for Sri Lanka trade restrictions: CB Governor
ECONOMYNEXT- The International Monetary Fund(IMF) has understood the need for temporary trade restrictions put in place by Sri Lanka in the face of global instability, Central Bank Governor Indrajit Coomarawamy said.
"They (IMF) realise that we need to find a way of stabilizing," Governor Coomaraswamy told EconomyNext.
"When there is this kind of currency disturbance all across the emerging market space, the priority has to be to stabilize the situation. Then you can go back."
Sri Lanka rupee has slid to below 170 to the US dollar in the current run, down from around 161 in August.
Sri Lanka’s ongoing deal with the International Monetary Fund specifically prohibits trade restrictions or exchange controls, as does its membership rules in general.
"I don’t think so," Coomaraswamy said, when questioned whether Sri Lanka’s current international trade restrictions were violating an ongoing agreement by trying to restrict trade for balance of payments purposes, which is product of monetary policy errors.
"Because we were very careful. We haven’t put duties and we haven’t put quotas. We have essentially asked for margins."
Sri Lanka slapped a series of controls on vehicle imports, including through credit restrictions and double letter of credit margins on cars in September.
Earlier in August however Sri Lanka also raised taxes on gold and cars, which are trade restrictions for managing balance of payments.
In Sri Lanka, cars and oil are the favorite whipping boys for balance of payments troubles caused by loose or contradictory policy.
In a 2015 crisis where hundreds of billions of liquidity was released by the central bank to pump up excess liquidity, authorities and Mercantilists were unable to blame oil for the currency collapse as usual, because crude prices were plunging.
Higher taxes were imposed on car imports, and credit restrictions which were introduced in late 2015, which has continued to become tougher.
Sri Lanka’s Central Bank and Finance Ministry has pledged not to place new import controls for balance of payments purposes under a revised IMF deal signed in May.
"During the program, we will not impose or intensify restrictions on the making ofpayments and transfers for current international transactions; introduce or modifymultiple currency practices; …or impose or intensify import restrictions for balance of payments reasons," the letter of intent underpinning the deal reads.
At a fundamental level a central bank generates balance of payments troubles by targeting the exchange rate and interest rates at the same time, which is why the IMF wants corrections in monetary or exchange rate policies rather than trade or capital controls, which simply give incentives for central banks to continue wrong policies.
The problem is known as the impossible trinity of monetary policy objectives. When interest rates are artificially held down with printed money, the peg weakens, causing the currency to collapse or triggering exchange (or trade) controls.
During the 2015 crisis, Sri Lanka imposed dollar repatriation rules for exporters, which the IMF is also encouraging the island to remove.
"We will assess removing the FX repatriation requirement. We introduced a repatriation requirement of export proceeds with the aim to encourage exporters to keep FX within the domestic financial system and reduce the imbalance of FX market in the face of substantial balance payment pressures," Governor Coomaraswamy and Finance Minister Managala Samararaweera had said in May.
"However, we consider that the role of this capital flows management measure has diminished as the balance of payment pressure receded."
Following the run on the central bank in September 2018, the central bank said it was planning a monitoring system for forex repatriation.
Sri Lanka has missed the June reserves targets in the agreement which analysts trace back to the failure to mop up liquidity in the first quarter of 2018, a rate cut and liquidity injections in April which generated a run on the rupee, and a build-up unsterilized (not mopped up) excess liquidity in the August after the first run ended.
The IMF was set up to help soft-pegged nations that got into trouble by joining the Bretton Woods system after the end of World War II.
During the Great Depression and in the run up to Nazism (National Socialism), many nations saw currency falls (beggar thy neighhour policies) and trade restrictions.
Trade restrictions inspire war. Trade restrictions – discrimination against foreigners – have also led to discrimination against minorities in many countries.
Then US Secretary Cordell Hull, who understood the problem, wanted a working monetary system to allow free trade after World War II.
However due to the view held by US Treasury at the time, which was interventionist and influenced by Keynesianism, the Bretton Woods system of failed soft-pegs was set up.
Hull was also a prime mover behind United Nations, which was also set up to stop another global war inspired by nationalism.
The Bretton Woods system – which was pegged to gold – collapsed because in 1971-73 in part because the Fed tried to fill an output gap followed by sterilized intervention which led to massive gold losses like forex reserves losses in Sri Lanka.
The State Department heavily lobbied countries to switch to dollar pegs. The US loaned a Fed official to Sri Lanka to set up a dollar soft peg and break a hard peg which had more stability.
Many countries including Sri Lanka and Britain, which were in turn soft-pegged to the US dollar had balance of payments troubles also due to targeting interest rates, and lost their reserves, during Bretton Woods which were mostly dollars. (Colombo/Oct10/2018)