ECONOMYNEXT – Sri Lanka’s exports in 2017 reported as 11.36 billion US dollars may have been understated by 500 million US dollars or more because undocumented gold re-exports to India or sales to tourists may not be captured by official accounting.
Sri Lanka has imported 650 million US dollars of gold in 2017, up 73.3 percent from a year earlier, officially after rising from 43 million US dollars to 273 million dollars.
Most of the gold is believed to be re-exported to India. But the gold is hand carried to India by ‘mules’ or independent operates or sold as jewellery or precious metal to visiting tourists.
Mercantilism
In April as the central bank printed large volumes of money to enforce low interest rates, the rupee plunged and Sri Lanka slapped tax a 15 percent tax on gold, in the false belief that gold may be hurting the "balance of payments," rather than monetary instability.
India increased a tax on gold in 2013 several times due to false Mercantilist doctrine that gold imports, the trade deficit (India raises gold import tax to tackle trade deficit), or the current account, rather than monetary instability was responsible for balance of payments troubles. India also has a value added tax on gold.
Sri Lanka also ended a para tariff on gold in 2016, which may have brought previously grey imports in to the open.
Official gold exports were only 18 million dollars last year, Central Bank Governor Indrajit Coomaraswamy said.
"You see that is the problem," Coomaraswamy said. "There was an almost 100 percent increase in imports but that was not reflected in exports.
"So the only conclusion to draw was that this was being imported duty free into Sri Lanka and was being smuggled into India which has something like a 15 percent duty, so people were basically arbitraging the duty differential.
"By equalizing the duty the arbitrage would end.
"There was no export gain. Instead there was a massive increase in imports which was putting pressure on the balance of payments.
Puzzle
If there was arbitrage (up to 13 percent value addition – part of which may go on transport) it is not clear how there was no export ‘gain’.
The central bank believes there has a ‘massive leakage of foreign currency."
The central bank officials was asked whether it seriously believed, that it was conceivable, that gold was sold to India free for there to be a leakage of foreign currency.
"It is inconceivable that it is being given free but where is that money gone?" asked Governor Coomaraswamy.
Part of the sales could be to travellers, whose sales are not documented except as a basic survey by the tourism development authority. A part may also be going to settle payments to imports, and it may also lead to under-invoicing.
Deputy Governor Nandalal Weerasinghe said the money may be going to undervalue imports.
"If there is a significant foreign exchange volume going through informal channels there is a distorted market," Weerasinghe said.
"You cannot have them buying (forex) from banks and selling them outside."
Smuggling in or out?
He says central bank wants to encourage legal business and not under-invoicing. However if under-invoicing of imports is taking place, Sri Lanka’s imports in 2017 would also be understated by 500 million dollars or more.
If imports are also understated there cannot be any pressure on the balance of payments. Last year because the central bank was not printing money, and was in fact sterilizing dollar purchases, it was able to purchase around 1.5 billion US dollars to build up reserves.
If domestic credit picks up however, it will not be able to repeat the exercise this year, regardless of whether gold imports are curbed or not, analysts say.
While it is a laudable objective not to encourage smuggling, the real encouragement comes from the Indian gold tax, not Sri Lanka policy.
If Sri Lanka wants to preserve the morals of Indians as well Sri Lankans, which is a laudable objective, it should lobby India to remove its gold tax. In January there was some expectations that India may cut the tax but it did not happen.
But the gold tax is now encouraging illegal activities in the import of gold in to Sri Lanka.
Already Sri Lanka’s customs officials are apprehending gold smugglers inward. This year, imports would definitely be understated due to gold smuggling inwards in official statistics.
The real victim of trying to correct Indian policy errors with import controls at Sri Lanka’s end has been that jewellery industry (Gold tax shocks jewellers as sales plummet). It is no longer competitive with an area with lower taxes, in a classic case of unintended consequence of a state intervention.
Suggestions have been made for tax free imports for the jewellery trade. Central bank officials say the problem can be solved by giving a tax rebate for tourists at the airport like VAT refunds. It is a classic case of a state regulation requiring two others to fix its consequences.
Analysts say all this underlines the need to reform the Central Bank’s soft-peg, so that the tendency for authorities to control trade, during times of loose policy does not arise.
Sri Lanka fears that gold imports which reached about 200 million dollars in the first two months, may top a billion US dollars in 2018.
But real hubs like Dubai and Singapore and Hong Kong, which have prudent policy and do not print money, (have currency boards or currency-board like systems) do not have worry about declared or undeclared trade done by tourists or the ‘balance of payments."
In the 1970s Sri Lanka closed the entire economy because the central bank at the time did not know how to deal with the consequences of the breaking up of Bretton Woods and its own loose policy.
Exchange controls were tightened barely two year after the soft-pegged central bank was created in 1950 abolishing a currency board that has kept inflation stable and allowed free trade.
That is why analysts and economists have long called for reform on Sri Lanka’s central bank soft-peg, in order to provide a strong foundation for freer trade and also policy and political stability. (Colombo/May14/2018)