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Thursday June 30th, 2022

Sri Lanka foreign exchange swap discounts widen, fears of underworld grabbing kerb market

ECONOMYNEXT – Upside down rates in Sri Lanka’s rupee-dollar swap discounts continued to widen this week and market participants lamented the movement of a higher share of kerb market foreign exchange to the underworld, after a crackdown on authorized money changers.

In the official foreign exchange market swap discounts continued to widen, reflecting low rupee yields and low dollar availability for funding purposes, market participants said.

The spot/1 month was quoted -170/-150 cents this week.

The spot two months was -325/-275 cents

The spot/3 months was -500/-450 cents

The spot/6 months was -800/-750 cents

A swap discount of 750 indicates that market participants who sell dollars today at (say) 200 rupees in the swap market will get it back roughly for 192.50 (a discount) in six months, despite continued reserve losses indicating that the peg is under pressure.

The central bank has also forced dollar earnings of exporters and service providers to be converted, indicating that dollar deposit growth will slowdown further, hurting the funding books of banks, analysts warn.

Sri Lanka’s state banks had been among key borrowers in the swap market. State banks have large dollar loans to state-run CPC in particular.

The CPC had been forced to borrow dollars when the central bank printed money to target a call money rate in the past as well as creating forex shortages. Attempts are underway to get credit lines and further expand dollar borrowings of the CPC.

This week the central bank raided several authorized money changers who have been exchanging dollars at above the official non-credible peg of 200 to the US dollar.

Sri Lanka’s authorized money changers are mostly long-standing businesses that have operated across generations. Many belong to the Tamil and Muslim communities.

The communities had been engaged in cross-border trade from the British period and beyond.

“Most of my business is going to the underworld,” a traditional kerb market merchant lamented earlier this week after the first raids of authorized money changers took place.

Hawala operators may also get additional business discouraging people from bringing notes to the country, another said.

There was also a possibility of forged dollar notes being circulated as the underworld expands the business, market participants warned.

Sri Lanka is a country where there was hardly any forged dollar notes due to the screening done by the longstanding kerb market community which included authorized money changers.

Though international card fraudsters targeted credit cards and ATMs in Sri Lanka, forged dollar note operators could not target Sri Lanka due to the business practices of the domestic kerb market, those familiar with the practice say.

Forged foreign currency notes operators are active in countries like Indonesia.

Exchange controls and other controls come when legislators fail to introduce sufficiently tight laws on central banks that try to control interest rates by printing money.

Even behind the Iron curtain money printing made smugglers and black-market

the biggest private sector run business, leading to the Russian mafia and others in the communist bloc.

Forex and balance of payments problems spread like an epidemic after World War II, as central banks earlier run by bankers were nationalized and they came under the control of so-called ‘lost generation economists’ who were spewed out of Anglo-American universities after the Keynesian revolution.

After Hitler was defeated, Germany by Ordoliberals had one of the strongest currencies during the Bretton Woods era, while the UK and the US were hit by inflation and many newly independent countries which printed money for ‘development economics’ became miserable developing countries.

“The root of our present monetary troubles is, of course, the sanction of scientific authority which Lord Keynes and his disciples have given to the age-old superstition that by increasing the aggregate money expenditure, we can lastingly ensure prosperity and full employment,” explained Friedrich Hayek, a classical economist, after the Bretton Woods collapsed.

“Sir John Hicks has even proposed that we call the third quarter of this century, 1950 to 1975, the age of Keynes, as the second quarter was the age of Hitler. I do not feel the harm that Keynes did is really so much as to justify that description.”

The Fed, in the 1960s, as money was printed to target an ‘output gap” also started central bank swaps.

Then the head of the Federal Reserve Bank of New York’s FX desk Charles Coombs went around begging for swaps from prudent European banks, such as the Bundesbank and the Swiss central bank.

They were used in part to stop prudent European central banks from demanding gold (reserves) of the Fed for excess money printed to maintain low rates and delay the inevitable.

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