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Thursday June 30th, 2022

Sri Lanka controls imports in ‘Nixon-shock’ move to protect soft-pegged rupee

ECONOMYNEXT – Sri Lanka slapped a series of import restrictions on vehicles, consumer durables and perfumes in a Nixon-shock style move as the island’s notoriously mis-managed unstable soft-peg came under pressure from excess liquidity and later sterilized interventions.

The finance ministry said importers of all vehicles other than buses, lorries (trucks) and ambulances have to keep a 200 percent cash margin to open letters of credit (double the value of a vehicle), up from a recently raised 100 percent.

The loan to value ratio for hybrid cars had been raised so that banks could now only give half the loan, rather than an earlier 70 percent.

A 100 percent margin has been slapped on the import of Refrigerators, Air Conditioners, Televisions, Perfumes, Telephones including Mobile phones, washing machines, footwear and tyres.

"The Government in order to ease the pressure on the Sri Lankan rupee has decided to take the following measures temporarily effective from midnight today Saturday (29), the statement said.

"The government will continuously monitor the exchange rate fluctuations and will take appropriate action accordingly."

Sri Lanka’s rupee came under pressure initially from unsterilized excess liquidity built up by the central bank in July which was not followed up with unsterilized sales.

But in the last week of September massive liquidity shortages developed from intervention in the interbank market and elsewhere, which have been sterilized with 123 billion rupees of printed money, indicating a forex reserve loss of over 700 million dollars. A float is required to break the cycle of interventions and liquidity injections (sterilized forex sales)

Analysts had warned that Sri Lanka’s rupee would come under pressure due to the tendency of the central bank to cut rates as the economy recovered despite operating a de facto soft-peg. (Sri Lanka is recovering, Central Bank threat looms: Bellwether)

The statement echoed the words of President Nixon, who floated the US dollar, after it came under pressure from attempts to boost growth by on the basis of an output gap, despite operating a soft-peg with gold.

"Let me lay to rest the bugaboo of what is called devaluation," President Nixon said at the time shortly before convertibility was suspended to float the dollar.

"If you want to buy a foreign car or take a trip abroad, market conditions may cause your dollar to buy slightly less.

"But if you are among the overwhelming majority of Americans who buy American-made products in America, your dollar will be worth just as much tomorrow as it is today.

"The effect of this action, in other words, will be to stabilize the dollar"

Analysts had warned two years ago that the administration’s free trade agenda was under threat from the soft peg. (Sri Lanka central bank has to be restrained for free trade to succeed: Bellwether)

The credibility of the soft-peg was initially hit by contradictory policy (running a ‘flexible exchange rate’ with unsterilized excess liquidity) in July and August, despite the finance ministry making difficult reforms, in the form of tax hikes and market pricing fuel.

Imports are a key source of tax revenues and cars bring over 100 percent in taxes compared to any other import. Restriction on cars will further hit taxes.

The central bank has printed over 120 billion rupees over the past two weeks to sterilize interventions made in several ways.

Analysts have proposed several ways to overhaul the operating procedures of the central bank so that contradictions in its de facto dual anchor monetary regime (soft-peg) is eliminated (What Sri Lanka can do to improve the credibility of its soft-dollar peg: Bellwether). ( (Colombo/Sept29/2018)

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