ECONOMYNEXT – Sri Lanka should increase ‘domestic production’ to ‘save dollars’ with the possibility of producing all wheelbarrows domestically, Finance Minister Basil Rajapaksa said as the country is engaged in a Latin America style import substitution drive banning various imports.
“We know that we bring in even wheelbarrows,” Finance Minister Rajapaksa said. “We can build them. We can make them at our factories. Like that, import replacements we hope to save some money.”
“We have to help entrepreneurs make product here.”
Sri Lanka’s forex reserves fell to 2.2 billion US dollars by October 2021 from 7.9 billion dollars in February 2020, after 1,571 billion rupees were printed from February 2020.
Inflationary financing was resorted to finance the deficit and also to control overnight rates and gilt yields, which automatically blocked budget deficit from being the bond market (private savings).
Convertibility from reserves was provided to approximately 1,248 billion rupees of printed money and 323 billion rupees remain as an expansion in reserve money amid record inflation. Reserve money had rocketed 33 percent to 1,286 billion rupees from February 2020 to October 2022.
By November gross reserves had fallen to further to 1.6 billion US dollars, mostly due to sterilized interventions.
Sri Lanka has been hit by trade and exchange controls ever since a Latin America style central bank was set up by a US money doctor in 1950.
We know that dollar reserves we earn are spent on what we import. If we can reduce the amount of money spent on imports it is somewhat equal to “dollar earned is dollar saved.”
“So if we save a dollar it is the similar to a dollar earned.”
“The President saw this at the beginning he identified 16 type of crops that farmers can grow – later it became 17 – and has made farmers grow them.
The government had placed an import ban on crops including Rice, Maize, Big onion, Cowpea, Green gram, Groundnut, Chilli, Soya, Red Onion, Potato, Finger Millet and Gingerly, Turmeric and Ginger.
At the time Agriculture Secretary Sumedha Perera said by growing domestically the substitutes of imports, the country could save about 500 million US dollars a year.
Despite the worst import controls since 1970s – when also the central bank was the biggest buyer of Treasury bills – foreign reserves are continuing to fall.
In November reserves have fallen to 1.6 billion US dollars. The central bank’s dollar debt exceeded reserves by 1.2 billion US dollars on October.
The central bank owes money to the International Monetary Fund, swap counterparties and also the Asian Clearing Union.
Swaps taken from domestic counterparties also create money, and when the money is spent by the counterparty more reserves are lost.
Amid money printing Sri Lanka’s imports have soared to pre-pandemic levels as money flowed into areas which are not covered by import controls.
Classical economists have pointed out that external payment problems come due to liquidity injections in a pegged exchange rate regime and controlling trade does not help as liquidity will flow to imports which are not controlled.
Classical economist point out that when money is printed it increases
“..Balance of Payments difficulties cannot be solved by intensifying the rigorous of exchange control and import restrictions; nor by extending the schemes for expanding domestic production to substitute import goods — the so called measures for “economising” on foreign exchange,” B R Shenoy explained in a reform document to the Sri Lanka government in 1966.
“Intensification of the rigorous of exchange control and import restrictions may reduce the quantum of import goods flowing into the market. It cannot reduce the flow of moneys seeking to purchase goods, either for consumption or for investment.
“The remedy to this problem lies in putting a stop to inflationary financing, not in tampering with the normal course of international trade.”
Sri Lanka’s political history is littered with administrations that had built economic programs without restraining central bank activism, controlled imports and at eventually ended up at the International Monetary Fund.
From 2015 to 2019 inflationary inflationary policy was also followed (except for 2017 and 2019) creating forex shortages currency crises and shattering that administration’s free trade agenda to smithereens and ratcheting up foreign debt.
However that central bank liquidity injections leads to outflows in excess of inflows and a fall in central bank reserves when convertibility of provided and may could to external default is a difficult concept to grasp.
Several classical economists including two Nobel laureates tried to explain this to John Maynard Keynes in the 1920s and failed. (Colombo/Dec11/2021)