ECONOMYNEXT – Sri Lanka’s intermediate central bank, after triggering the worst currency crisis in its history and deploying a wide range of controls to undermine the economic freedoms in the country has threatened stern action to anyone violating its rules.
As the money printing central bank triggered forex shortages the country’s legislature granted it wide powers to control what was previously completely legitimate activity under the currency board and still is in countries with single anchor consistent money regimes.
The legislature, misled by Mercantilist fallacies, also enacted an import control law instead of taming the central bank and its open market operations with strict rules or punitive action on those who try to control interest rates and trigger monetary instability.
The central bank admitted without apology that it had take away the economic freedoms of the populace and imposed draconian controls after printing money to create excess rupees leading to forex shortages.
The central bank also imposed a surrender requirement on banks to force-sell dollars to the central bank on peg that was severely under pressure and engaged in a failed attempt to float the currency leading to the worst currency collapse in its history.
“To ensure adequate foreign exchange liquidity in the banking system, the CBSL had to impose surrender requirements on export earnings,” the Monetary Authority said.
“Further, measures were taken by the Government and the CBSL to discourage foreign exchange outflows, such as imposing restrictions on certain imports and payment terms and introducing margin requirements, while encouraging foreign inflows through the banking system, rather than those being channelled through the grey market.”
The central bank threatened action against those who do not follow its orders.
“Against this backdrop, and in the best interest of the nation, the CBSL wishes to reiterate to all stakeholders of the economy, that, going forward, all efforts would be taken to strictly monitor and ensure compliance with all regulations on foreign exchange transactions, including repatriation requirements of export proceeds, conversions, and mandatory sales to the CBSL etc,” the statement said.
“Any instances of non-compliance will be dealt with stern action within the provisions of all applicable laws.”
If exporters keep money outside the country as claimed, it is a private foreign reserve which is not spent or invested domestically and do not generate imports, similar to the central bank meeting a net international reserve target under an IMF deal after killing domestic credit and there are no forex shortages.
Meanwhile data showed that exporters were repaying dollar debt and the government dollar debt to banks were also going down. Banks are also facing outflows after the low rating which they have to finance with domestic dollar borrowings.
Such actions (outflows through the financial account) tend to reduce the current account deficit by reducing the money available for domestic spending.
If, on the other had exporters take domestic credit – which is re-financed though the central bank either through sterilized interventions or other means – there is a forex shortage.
Unlike countries like Singapore, Sri Lanka set up a Latin America style central bank in 1950 abolishing a currency board that had kept the country stable and trigger-happy potential soft-peggers in check before that.
How Sri Lanka lost the knowledge that money printing is the cause of forex shortages and reserve losses is not clear. In Sri Lanka it is now widely believed that a fixed exchange rate cause reserve losses, not liquidity injections that makes it impossible to maintain the external anchor.
However the knowledge had existed at one time even among politicians.
Prime Minister D S Senanayake opening the central bank had said many had warned against the setting up of a central bank, though most warnings came from outside Ceylon not inside.
“We were fully aware that Central banking had been abused in many countries in the past,” according to the publication ‘Central bank in Retrospect’ which reproduced a report on Prime Minister Senanayake’s speech at the inauguration of the soft-peg.
“We need only remind ourselves of how excessive use of central bank credit reduced the real value of the currency and resulted in the dissipation of foreign exchange reserves in countries like China and Greece after the war,” he warned the agency.
He said central banks in Canada, New Zealand and Australia were operating well. However the banks were set up by mainly British experts not US experts who used Agentina’s BCRA as a model.
New Zealand later systematized inflation targeting after the US Fed destroyed the centuries old gold standard in 1971 under Fed Chief Arthur Burns. Inflation targeting had first been proposed by Henry Thornton during the UK bullionist debates in the early 1800s, analysts say.
How classical economic knowledge disappeared in Sri Lanka and the outright rejection of monetary phenomena clearly explained by the likes of David Ricardo, David Hume, Adam Smith or Henry Thornton, took place in the decades following, with legislators giving more power to the central bank to control the people and punish them instead of taming the agency and its liquidity injections, is part of the island’s sad post-independent history.
By 1969, during the tenure of Senanayake’s son Dudley forex reserves fell to 40 million dollars, a fraction of the 190 million official reserves in 1950 (over nine months of imports) when the soft-peg was created with currency board assets.
In 1969 legislators enacted an import an control law, instead of curbing the ability of development economists and other interventionists to re-finance agriculture, rural credit and other activities with printed money.
The law has since been used to control imports and help the central bank continue policy errors in suppressing rates with liquidity injections, worsening monetary imbalances which then lead to economic crises.
Since ending the currency board, the rupee had been busted from 4.70 to the US dollar to 360.
The central bank however had now sharply raised rates to smash private credit – and the economy along with it – to restore the credibility of its anchor-conflicting soft-peg, now called a ‘flexible exchange rate’.
Sri Lanka goes through repeated cycles of money printing to suppress rates, breaking the peg, smashing credit and economic activity to stabilize it, going to the IMF along with it, re-building reserves and busting them in a new rate suppression cycle.
Inflation is now at 50 percent and expected to rise to 75 percent, interest rates are around 30 percent, and people are in the streets. The police are now rounding up protestors.
The Fed had also printed money and has now belatedly raised rates as food prices soared leaving the poor hungry, and the International Monetary Fund had warned that unemployment would rise.
The full statement is reproduced below:
Importance of ‘fair play’ by all stakeholders of the economy in countering the current unprecedented economic crisis
The Government and the Central Bank of Sri Lanka (CBSL) have been implementing several measures to ease the burden of the current economic hardships on the people. One major factor that is contributing to the current crisis and the resultant hardships is the lack of foreign exchange liquidity in the banking system.
Such shortage of forex liquidity has affected the provision of essential imports, including fuel. To ensure adequate foreign exchange liquidity in the banking system, the CBSL had to impose surrender requirements on export earnings.
Further, measures were taken by the Government and the CBSL to discourage foreign exchange outflows, such as imposing restrictions on certain imports and payment terms and introducing margin requirements, while encouraging foreign inflows through the banking system, rather than those being channelled through the grey market.
The success of these regulatory measures and the ability to achieve the intended outcomes depend on the support and cooperation from the trading community and the banking system. However, it has been brought to the notice of the CBSL that certain market players are not being fully compliant with these regulations. Such practice, if continued, would deprive the people of the support expected from the Government in difficult times, while undermining the moral obligation of ‘equal burden sharing’ that is expected of all stakeholders under difficult and extraordinary circumstances.
Against this backdrop, and in the best interest of the nation, the CBSL wishes to reiterate to all stakeholders of the economy, that, going forward, all efforts would be taken to strictly monitor and ensure compliance with all regulations on foreign exchange transactions, including repatriation requirements of export proceeds, conversions, and mandatory sales to the CBSL etc. Any instances of non-compliance will be dealt with stern action within the provisions of all applicable laws.
It is noteworthy that the CBSL has strengthened its capacity in relation to monitoring of foreign exchange transactions through the implementation of the Export Proceeds Monitoring System (EPMS) and the International Transactions Reporting System (ITRS), which is a comprehensive monitoring system of cross-border transactions and domestic foreign currency transactions.
These systems facilitate regular monitoring of foreign exchange inflows and outflows. Further, assistance from independent professional bodies, including audit firms, is also being sought for the timely identification of any malpractices.
Hence, Licensed Banks and the trading community are urged to comply with the existing regulations and complement the efforts of the Government and the CBSL to provide much-needed assistance to all stakeholders of the economy under these extremely challenging circumstances. The export trading community is urged to continue to repatriate all export proceeds within the stipulated timeframe and surrender the residual earnings in accordance with the regulations. The banking community is requested to ensure strict adherence to all regulations in relation to foreign exchange transactions.
The Government and the CBSL are relentlessly pursuing efforts to secure bridging finance to reduce and alleviate economic stresses in the near term. A notable progress has been made in the ongoing negotiations for an economic adjustment programme with the International Monetary Fund. The debt restructuring process is also underway, capably assisted with the Legal and Financial Advisers. The Government and the CBSL remain committed to implementing much-needed reforms to overcome long-standing structural issues in the economy.
The Central Bank wishes to reiterate that overcoming current economic woes and distresses requires substantial and concerted efforts from all stakeholders of the economy. Foul play on the part of any group of stakeholders would inevitably result in the worsening of the crisis, thereby having widespread detrimental effects. It is the duty of everybody to act conscientiously and responsibly, and extend their unhindered support during this hour of need, for the nation to recover rapidly and emerge stronger from this crisis.