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Sunday July 25th, 2021

Sri Lanka central bank has to be restrained for free trade to succeed: Bellwether

ECONOMYNEXT – Sri Lanka’s car owning bureaucrats, politicians and central bankers have started to tighten auto imports in a return to the same old vicious trade controls that follow every bout of money printing showing the urgency of central bank reforms to ensure that any free trade agenda succeeds.

All this shows the importance of reforming Sri Lanka’s soft-pegged central Bank to ensure that any free trade agenda that is pursued is not rolled back and economic nationalism and xenophobic anti-import biases does not re-emerge.

Double Standard Serfdom

These people who impose controls on the hapless citizenry have almost without fail bought tax slashed or tax free cars, in this unjust serfdom that is called Sri Lanka where all private sector people are second class citizens to be economically raped for the benefit of rulers, bureaucrats and unemployed graduates.

In the last column The Price Signal by Bellwether outlined controls usually imposed on the people by rulers who mis-use a flawed central bank, to print money and destroy the currency, with cars being a favourite whipping boy.

This column pointed out that in the past, car imports were restricted including by raising taxes and raising limits on letters of credit.

The central bank raised loan to value ratios of cars this time soon after the last column was published. An attempt was also made to float the rupee.

But upping the loan-to-value ratio is not necessarily a bad thing from a prudential point of view as it may safeguard lenders in a downturn, but it does not address the fundamental issue of printing money to finance, suddenly-hiked state worker salaries and other subsidies.

Car imports, whatever said and done, brings massive taxes to help solve the expanded ‘Yahapalanaya’ deficit for every dollar spent.

Money is fungible

When credit is directed to some other sector, the same foreign exchange will still be lost, but dollar per dollar, tax revenues will be reduced.

The key problem here is loans financed by central bank credit. As long as loan – any loan – is financed by deposits, the economy remains in balance. Whether the loan is likely to go bad is another issue entirely.

Since money is fungible it is not possible to say which loan is being financed by central bank credit.

In the past taxes have been raised on electric goods and other items defined as ‘luxuries’ for Sri Lanka’s citizen serfs by a viciously interventionist elected ruling class and bureaucracy.

The BOP problem came from a state intervention in interest rates and injections of rupee reserves to the banking system by the purchase of Treasury bills by the Central Bank which in turn accommodated another state intervention – a massive hike in state salaries.

The only reason to tax cars if any should be to increase revenue.

The problem can be solved by reducing state interventions, not increasing them, since the balance of payments crisis itself is due to contradictory monetary and exchange policy, where money is printed while trying to intervene in forex markets.

Failed Float?

The Central Bank floated the rupee on September 04, which could have ended sterilized foreign exchange sales, by ending one set of contradictory state interventions.

However early data shows that that contradictory policy is continuing and the float has failed for all intents and purposes. Up to the third week of September as this column is being written over 250 million US dollars may have been lost to interventions.

Some of it has been due to capital flight from bond markets and not necessarily imports fired by printed money. But if even part of the capital flight was accommodated by a reduction in domestic credit and not an expansion of central bank credit, less foreign reserves would be lost.

Sri Lanka has progressively restricted trade after this money printing central bank was built in 1950 abolishing a currency board for political purposes by then Finance Minister J R Jayewardene.

He also fell victim to a diplomatic onslaught by the US State Department to break the ‘Sterling area’ of Britain which had survived for a century or more and create a dollar pegged soft pegged Bretton Woods system which collapsed in just over 20 years.

Self-sufficient Utopia

In 1971-73, when the Bretton Woods collapse Sri Lanka closed her entire external trade, imposed unimaginably draconian foreign exchange controls, dual exchange rates as well as price controls and rationing which created black markets and generally managed to boost unemployment to almost 20 percent by various interventions.

It must be said that President Nixon also imposed massive economic controls (Nixon Shock) in the run up to independently floating exchange rates, as money was printed to finance the Vietnam War amid the legacy problems of Lyndon Johnson’s ‘Great Society’ programs.

The Nixon shock was rolled back because economics survive in some universities in the US and there were real liberals still in the US.

But there was no one in Sri Lanka to stop trade controls in the 1970s as in this country economics appear to be dead and has been replaced by Mercantilism, Marxism and a false belief in a Nazi autarky style self-sufficient utopia.

Sri Lanka exchange controls came thick and fast from 1952, soon after the Central Bank was created.

The post-independent isolation of Sri Lanka involving a mania for ‘saving foreign exchange’ and ‘import substitution’ all came from the BOP troubles of the soft-peg.

All this shows that any free trade agenda would be rolled back in the guise of ‘saving foreign exchange’ and ‘domestic production’, unless the Central Bank was reformed.

It is the flawed soft-peg that allows Mercantilists, nationalists, and advocates of a Nazi autarky to raise their heads.

The ideal solution would be to establish a currency board as a one-off sweeping reform, but a second-best solution would be to reform the Central Bank so that excessively fool hardly and anti-poor actions are legally prohibited through suitable changes to the monetary law.

This column is based on ‘The Price Signal by Bellwetherpublished in the October 2015 issue of the Echelon Magazine. To read Bellwether columns as soon as they are published, subscribe to Echelon Magazine at this link. The i-tunes app can be downloaded from here.

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