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Sunday June 23rd, 2024

Sri Lanka hotelier wants rupee to be unit of account to enable external trade

EXTERNAL ANCHORING: Sri Lanka hotelier echoes the words of Singapore economic architect Goh Keng Swee to JR 40 years ago.

ECONOMYNEXT – Sri Lanka’s unstable exchange rate is making it difficult for businesses to price output across time to foreign counter parties and widely expressed fears of future instability also dented investor confidence, a private entrepreneur said.

Sri Lanka’s central bank has since September 2022 provided monetary stability including the elimination of forex shortages with deflationary policy by overshooting its 5 to 7 percent domestic inflation target, providing a strong foundation for growth and economic activities to recover.

However, volatility in the exchange rate was proving troublesome for some businesses as the currency could no longer be used as a unit of account to denominate future prices.

No Credibility?

“I heard the word price stability. Yes, that’s good we have, we have got that,” Gerard Ondaatjie, a business executive and hotelier said at a recent forum at the Central Bank.

“But would there be a more important word? Exchange range stability? Because I’m not convinced that we are on an exchange rate stability path.

He said that the head of Sri Lanka’s Standard Chartered Bank has said at the same forum, that once imports are opened the exchange rate will start sliding.

Economic analysts using classical principles have pointed out that the current exchange rate stability and also appreciation is an outcome of deflationary monetary policy deployed by a reserve collecting central bank amid weak private credit, enabled by a market interest rate.

Exchange rates and the balance of payments are an outcome of monetary and exchange rate policies of a note-issue bank and credit, as explained by classical economists before the emergence of inflationist ideologies led to external trouble from the last century.

When a BOP surplus is created by consistently mopping up liquidity from dollar purchases, at a market interest rate, a reserve collecting central bank can either fix the exchange rate, depreciate or appreciate the currency by purchasing more or less dollars against the intervention currency, than the domestic money it has recently sterilized.

Sri Lanka had the worst import controls since the 1970s from 2020 to 2022, but they failed to halt forex shortages and a currency collapse, due to inflationary monetary policy.

The current monetary stability comes as imports except cars are re-opened, commercial banks are repaying credit lines and also collecting dollars for government forex loans repaid in rupees and the central bank itself is collecting billions of dollars in reserves while also repaying forex swaps.

Regime Warning

But some analysts have warned that Sri Lanka is likely to face forex shortages and depreciation and a second default, as soon as inflationary operations (reverse repo or standing liquidity facilities backed injections) resume to enforce rate cuts made to boost ‘growth’ by denying monetary stability.

This could happen when private credit recovers, as had happened in the past decade, if inflationary rate cuts resume, analysts using classical principles (impossible trinity/ISLM-BOP) have warned.

Related Sri Lanka interest rates are dictated by the IMF reserve target, not inflation

Excess liquidity from dollar purchases (coming from the lack of a clean float), could also lead to depreciation if the exchange rate is not defended when private credit using the liquidity resumes.

Under so-called flexible inflation targeting, interest rates are bureaucratically decided based on historical 12-month inflation and statistical models, apparently without regard to current or future domestic credit trends in a bid to generate 5 to 7 percent inflation.

Data shows that Sri Lanka has triggered multiple currency crises and capital flight by the time money is injected to generate 4 percent inflation, since the end of the war with the country not having a clean float to accommodate a domestic anchor.

There is unlikely to be a different result this time as statistics cannot defy laws of nature, discovered by classical economists, which brought sound money, free trade, free capital flows, as well as individual freedoms before the bureaucratic policy rate, analysts say.

There appears to be no successful clean floating country with a 5 to 7 percent inflation target. Russia, the latest entry to clean floats after the US froze its reserves, is also on a learning curve stumbling along with a 4.0 percent inflation target and 16 percent policy rate at the moment.

The Bank of Russia was the central bank that invented modern style exchange controls in 1906 and communism arrived within a decade.

Sri Lanka has to run sufficiently deflationary policy at a market interest rate irrespective of what the historical 12-month inflation rate is, not only to keep the BOP in balance but also to meet IMF reserve targets (ISLM-BOP + IMF/NIR target), analysts have warned.

Countries that have external anchors eventually end up with very low interest rates as Sri Lanka did before a central bank was created and the external anchor was dumped in 1977.

Unit of Account

Ondaatjie said the recent appreciation had also created problems for businesses that make transactions with foreign customers.

Tourism was an example.

Hotels were finding it difficult to price because the exchange rate was at one level when the price was given but at a different rate (stronger) when the customer eventually paid.  In hotels, customers may book six months or more ahead, industry officials say.

“I look at this in terms of looking at a planning horizon of let’s say your revenue channels. You are doing your costing on your exchange rate,” Ondaatjie explained.

“The tourist industry is saying right now we did our costing at 350, 360 (to the US dollar). But when the remittance comes, it is at 300.”

The rupee, which was around 365 to the US dollar in January 2023, fell to 303 to the US dollar by June 2023. Since then the exchange rate has been broadly stable after spiking to 320 to the US dollar.

The currency appreciation had also led to a fall in electricity prices and fuel this year, key inputs for the tourism sector.

Exchange rate stability will also reduce the cost of building materials and vehicles if the rupee is kept stable beyond the 12-month short-term horizon of flexible ‘inflation targeting’.

Global currencies were fixed with self correcting central banks or free banks until the 1920s, with all gold area countries for example maintaining exchange rate parity with a common anchor, except when money was printed during wars, leading to instability.

However, with the bureaucratic policy rate and active open market operations being devised by the Fed in the 1920s, currencies started to depreciate during peacetime in the 1930s, and money began to lose key attributes that made it useful for businesses, including being a unit of account.

Depreciation also triggered a wave of tit-for-tat import protectionism in the 1930s, with inflationists, who were growing in number, spreading an ideology that depreciation boosted manufactured exports, despite the industrial revolution being founded on fixed exchange rates.

After the end of World War II, to re-establish free trade and the usefulness of money as a unit of account and a medium of exchange for external trade, the Bretton Woods system of soft-pegs was set up.

The soft-pegs collapsed in 1971 amid aggressive macro-economic policy through open market operations – mainly by the US – to boost growth or employment.

Most East Asian nations in the 1980s including larger countries like China from 1993 to 2005 maintained highly successful exchange rate anchors and imported US stability of the 1980s and 1990s by mostly running deflationary policy (selling central bank securities to banks and taking in ‘deposits’ instead of buying government securities) and building up foreign reserves bigger than the domestic monetary base.

The Euro area solved the unit of account and medium of exchange problem by setting up a currency union and enabling a large free trade regime.

Several countries in Europe outside the currency union also ran orthodox currency boards (they were running fixed exchange rates with Deutsche mark earlier) or currency board like regimes, until they switched to the Euro itself.

Denmark (7.46 to Euro), Bulgaria (1.95 to Euro) are still running currency board like arrangements to solve both the unit of account and domestic stability problems.

External Anchor

Meanwhile Ondaatjie said having a stable exchange rate would bring domestic monetary stability to Sri Lanka.

“That is also more important, because the exchange rate will create price stability,” Ondaatjie said.

“Because we are an import driven country. Essential items are imported.”

Ondaatjie was eerily echoing the words of Singapore’s economic architect Goh Keng Swee who advised then President J R Jayewardene in 1980.

At the time the IMF’s Second Amendment had deprived Sri Lanka of an exchange rate anchor without a credible replacement, helping macro-economists drive the island into a fresh IMF program amid a strong economic recovery. The US was also hiking rates to counter ‘Great Inflation’ coming from its floating rate at the time.

The IMF program came within two years of the most radical economic reforms made in the island, perhaps since trading monopolies inherited from the Dutch East India Company were abolished by the British colonial civil service liberals over a 100 years earlier, analysts say.

Goh noted that Jayawardene’s reforms were considered “politically impossible” by many.

Goh, who believed in strong exchange rates for domestic stability without a policy rate, advised President Jayawardene not to depreciate the currency.

He was going against the doctrine that was prevalent after the Second Amendment to IMF articles, of depreciating the currencies of countries without a doctrinal foundation in sound money and therefore susceptible to basket, brand, crawl and similar statistical doctrines.

“Exchange rate policies involve many complicated technical issues which I do not want to discuss here,” Goh, who had a deep knowledge of operational frameworks of note-issue banks and had re-created a currency board on separation from Malaysia, told JR in his report.

It will not be possible to stop depreciation until inflationary policy is stopped, he said. Goh told JR that the central bank’s Treasury bill stock was the most important indicator to watch.

“On balance, the disadvantages of a depreciating rupee will, I believe, outweigh the advantages”, he said, rejecting IMF’s post 1978 doctrine of monetary debasement.

“About a quarter of rice consumption is imported. All wheat from which four and bread are produced is imported.

“The same holds true of kerosene and milk powder. Bus fares ware largely determined by the rupee price of imported oil and spare parts. Fertilizers are also mostly imported.”

Related How Sri Lanka rejected Singapore monetary advice and politicians, people paid the price

He warned in 1980 that Sri Lanka could slide into 100 percent inflation like Poland at the time, if the central bank continued to inject money by purchasing Treasury bills. In 2022 the central bank created 70 percent inflation, 30 percent short of the level warned by Goh.

Sri Lanka was sliding into hyperinflation and possible dollarization, analysts say when Central Bank Governor Nandalal Weerasinghe hiked rates, killed private credit and restored rupee stability by generating a BOP surplus from around September 2022.

At the time the exchange rate externally anchored at 360 to the US dollar, through a surrender rule and dollar sales for imports including oil.

No Exchange Rate Anchor Under Current Regime

Meanwhile Governor Weerasinghe said under the current doctrine the central bank was not providing a fixed exchange rate.

“The core objective is price stability,” he explained. “The argument is, can price stability, or low inflation be by maintaining a stable exchange rate? In very simple terms, price stability is what you measure as inflation.

“In an economy like here, if you look at the overall price level, about 75 percent of the prices are domestically produced and the exchange rate has about a 25 percent impact.

“If we think that we can fix prices by fixing 25 percent of the prices, I think that is not going to work. You need to stabilize domestic prices, because this is a larger domestic economy, compared to the external economy.

“That is why we have this monetary policy regime.”

Currency Competition

Some nations got over the problem of bad central banks with a policy rate, and restored domestic stability by using more than one currency, one of the latest being Cambodia in East Asia (US dollars and the Riel without monetary policy).

Dollarization usually happens when people have no confidence in the central bank’s notes and the agency loses the ability to enforce legal tender laws, with politicians no longer willing to protect its money monopoly by punishing the public for transacting in a foreign currency.

Cambodia has become progressively more externally oriented in the low 3 percent inflation coming from the fully fixed exchange rate (dollars) over the past two decades.

Since the Riel collapsed in 1999 leading to market dollarization, Cambodia’s exports have climbed from very low levels to 34 billion US dollars, according to IMF data, or 77 percent of GDP as foreign investment also came with the stability coming from the fixed exchange rate.  

In 2023, the country of 16 million people welcomed 5 million tourists.

Sri Lanka’s Port City area is also expected to have absolutely fixed exchange rates with currency competition and is expected to easily trade with the rest of the world.

Dollarization is also happening in other ways with renewable energy firms also asking for and getting dollar denominated tariffs.

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Sri Lanka central bank appoints two Deputy Governors

ECONOMYNEXT – Sri Lanka’s central bank said Assistant Governors A A M Thassim and J P R Karunaratne were promoted to the post of Deputy Governor.

The full statement is reproduced below:


In terms of the provisions in the Central Bank of Sri Lanka Act, No. 16 of 2023, Hon. Minister of Finance, as recommended by the Governing Board, has appointed Mr. A A M Thassim, Assistant Governor and Secretary to the Governing Board, and Mr. J P R Karunaratne, Assistant Governor, as Deputy Governors of the Central Bank of Sri Lanka with effect from 20.06.2024 and 24.06.2024, respectively.

Mr. A A M Thassim

Mr. A.A.M. Thassim has over 31 years of service at Central Bank of Sri Lanka (CBSL) in different capacities in the areas of Supervision and Regulation of Banking Institutions, International Operations, Communication, Payments and Settlements, Employees Provident Fund, Finance, Risk Management, Deposit Insurance, Security Services and Information Technology.

He has served as the Director of Bank Supervision (DBS), Director of International Operation (DIO) and Director of Communications (DCM) and has contributed towards strengthening the legal framework, governance, implementation the Basel 3 international guidelines for capital and liquidity and adoption of International Financial Reporting Standards (IFRS) 9 to the banking sector, thereby strengthening the resilience of the Financial Sector.

Further, as the DIO, Mr. Thassim was responsible for the investments and management of foreign reserves of the country and exchange rate management. Mr. Thassim has also gained experience and knowledge in the field of payment systems and was involved in the implementation of the Cheque Imaging and Truncation System. In addition, he has also served on several high-level internal committees including in the areas of monetary policy, financial system stability and international reserves.

Prior to the appointment as the Deputy Governor, Mr. Thassim held the position of Assistant Governor and was in charge of several key departments including the Bank Supervision Department. He also served as the Secretary to the Governing Board, Monetary Policy Board, Audit Committee, Board Risk Oversight Committee, Ethics Committee and Financial Sector Crisis Management Committee.

At present, Mr. Thassim is a board member of the Sri Lanka Export Credit Insurance Corporation and the Vice Chairman of the Institute of Bankers of Sri Lanka (IBSL). Further, he has also served as a board member of the Credit Information Bureau of Sri Lanka and LankaClear (Pvt) Ltd.,

Mr. Thassim is an Associate member of the Chartered Institute of Management Accountants (ACMA) United Kingdom and possesses a Masters in Business Administration (MBA) from the Postgraduate Institute of Management (PIM), University of Sri Jayewardenepura (USJ). He has also completed a programme on Gold Reserves Management from Hass School of Business, University of California, Berkeley, USA.

He is also an Alumni of Harvard University, USA having successfully completed the executive programme on Leaders in Development conducted by the John F. Kennedy School of Government.

Mr. J P R Karunaratne

Mr. J P R Karunaratne has over 33 years of service at the Central Bank of Sri Lanka in different capacities in the areas of supervision and regulation of Banks and Non-Bank financial institutions, Currency management, public debt, Secretariat, Finance, policy review and monitoring. He has served as the Director of Supervision of Non-Bank Financial Institutions (DSNBFI) and the Superintendent of Currency (SC) and has contributed towards strengthening the legal and regulatory framework in the Non-Bank Financial Institutions sector and has played a prominent role in the consolidation of the Non-Bank Financial Institutions sector. Prior to the appointment as a Deputy Governor, Mr. J P R Karunaratne held the position of Assistant Governor and was in-charge of the Department of Supervision of Non-Bank Financial Institutions, Finance Department and the Facilities Management Department.

As an Assistant Governor Mr. Karunaratne has previously overseen several other departments namely, Macroprudential Surveillance, Resolution and Enforcement, Foreign Exchange, Currency, Regional Development, Legal and Compliance, Risk Management, Center for Banking Studies, Security Services and Staff Services Management.

He has also served as the Secretary to the Monetary Board, Secretary to the Board Risk Oversight Committee, Monetary Board Advisory Audit Committee and the Ethics Committee. Further, He was on release to the Ministry of Defence, where he served as a Financial Advisor. He was also appointed as the Chief Operating Officer for the Secretariat of Committee of Chartered Accountants appointed by the Supreme Court in 2009.

He has served as the Chairman of the Sri Lanka Accounting and Auditing Standards Monitoring Board and has been a Council Member of the Certified Management Accountants (CMA) of Sri Lanka. Mr. Karunaratne was awarded the CMA Sri Lanka Business Excellence Award at the CMA Sri Lanka National Management Accounting Conference 2023 in recognition of his service to the profession. He has also received “Long Service Award” of the IBSL in 2019 in recognition of his long career and contribution as a resource person at IBSL.

He was the Project Team Leader of the South East Asian Central Banks (SEACEN) Malaysia, research project on “Implementation of Basel III Challenges and Opportunities in SEACEN Countries” and SEACEN published the research in 2013. He serves as a member of several internal and external committees at present.

Mr. Karunaratne holds a Master of Commerce Degree in Finance from the University of New South Wales, Australia and a Postgraduate Diploma in Applied Statistics and a Bachelor of Science (Physical Science) Degree with a First class from the University of Colombo. He is a Fellow Member of the Chartered Institute of Management Accountants (CIMA), UK and a Chartered Global Management Accountant (CGMA). Further, he is an Associate Member of the CMA Sri Lanka.

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Sri Lanka opposition questions claims that IMF housing tax is only for kulaks

ECONOMYNEXT – Sri Lanka’s opposition has questioned claims made by government spokesmen that a tax on housing proposed in an International Monetary Fund deal is only limited to rich people but if as promised by President one house is exempt, it is welcome, legislator Harsha de Silva said.

Sri Lanka President Ranil Wickremesinghe made a promise in parliament that the first house of a citizen will be excluded from the property tax.

Related Sri Lanka to exempt one house from imputed rent wealth tax: President

But opposition legislator Harsha de Silva pointed out that the IMF program documents clearly says taxes will be levied on owner occupied houses on ‘imputed taxes’, not second houses.

Under current inland revenue laws, actual rent income from a second house is already captured as part of taxable income.

The IMF document mentions a threshold value from which taxes will be exempt but not that a whole owner-occupied primary residence will be exempt.

“The tax is imposed on the income of individuals (rather than real property itself) and thus raises central government revenue in accordance with the constitution,” IMF staff said in their report.

“A similar tax was previously included in the Inland Revenue Act. No. 10 of 2006.

“Under this regime, primary residences were exempt and the assessed values for rating purposes were used to determine the base.

“Given the broad exemption and the use of outdated and downward biased annual values, the tax generated hardly any revenue.”

Meanwhile Sri Lanka has promised to impose the housing tax from April 01, 2025.

“…[W]e will introduce an imputed rental income tax on owner-occupied and vacant residential properties before the beginning of the tax year on April 1st, 2025,” the memorandum of economic policies agreed with the IMF said.

“An exemption threshold and a graduated tax rate schedule would make this tax highly progressive.

“The full revenue yield from this tax is estimated at 0.4 percent and would materialize in 2026 (with a partial yield of 0.15 percent in 2025).

“This yield would still fall short by 1 percent of GDP relative to the expected yield of 1.2 percent of GDP from the property tax envisaged for 2025 onwards.”

Presidential Undertaking

“Whatever the President said the IMF agreement says owner occupied house,” De Silva told in parliament.

“It is not the second house that is mentioned in the agreement.

“But there is one thing. I am happy as Samagi Jana Balawegaya, that we have been able to save the middle class in society from a massive tax that was to be imposed.”

In Sri Lanka there is a belief that the most productive citizens are fair game for excessive or expropriationary taxation, just like kulaks were targeted in the Soviet Union for actual expropriation, critics say.

Wealth taxes have had disastrous effects on some US cities like Baltimore, leading to falling populations and dilapidated houses.

Sri Lanka is currently facing a brain drain due to high income tax after on top of depreciation from severe monetary debasement from a flexible exchange rate, which is neither a hard peg nor a clean float.

Sri Lanka has imposed a wide range of taxes on the people to maintain a bloated state, after inflationists engaged in extreme macro-economic policy (tax and rate cuts) glorified in Saltwater-Cambridge doctrine to boost growth, throwing classical economic principles and monetary stability to the winds and driving the country into external default.

The IMF itself gave technical assistance the central bank to calculate potential output inviting the agency to cut rates to close the perceived econometric ‘output gap’.

In the run up to the default, rate cuts triggered multiple external crises, leading to output shocks as stabilization programs were implemented.

Macro-economic Policy

Macro-economic policy as known now was devised by Cambridge academic J M Keynes in the wake of the Great Depression triggered by the Federal Reserve after it invented open market operations and policy rates in the 1920s and also popularized by Harvard academic Alvin Hansen among others.

Macro-economic policy started to de-stabilize countries in peacetime in the interwar years and after World War II it led to the collapse of the Bretton Woods system.

The Great Depression was also a peacetime collapse of what was later known as the roaring 20s’ monetary bubble.

“They have blithely ignored the warnings of economists,” classical economist Ludwig von Mises wrote of European nations which got into trouble from rate cuts and Keynesian stimulus, which brought currency depreciation and protectionism in its wake from the 1930s.

“They have erected trade barriers, they have fostered credit expansion and an easy money policy, they have taken recourse to price control, to minimum wage rates, and to subsidies.

“They have transformed taxation into confiscation and expropriation; they have proclaimed heedless spending as the best method to increase wealth and welfare.

“But when the inevitable consequences of such policies, long before predicted by the economists, became more and more obvious, public opinion did not place the blame on these cherished policies…”


In Sri Lanka however there is some understanding of the role played by macro-economists in the most recent crisis.

There are rumblings of unhappiness about ‘central bank independence’ given to an agency to create 5 to 7 percent inflation and currency debasement under a flexible exchange rate and its constitutional status relating to parliamentary control of public finances.

Sri Lanka’s central bank’s current flexible inflation targeting (inflation targeting without a floating rate) regime as well as its 1980s money supply targeting without floating rate has busted the national currency for decades and made it impossible to run budgets, made it difficult for people build houses which are now to be taxed, and also for millions to live and work in the country of their birth.

Fiscal metrics deteriorate each time rate cuts drive the country into currency crises and new taxes are brought in stabilization programs, ousting reformist governments and leading to policy reversals.

Sri Lanka’s citizens have suffered for decades from the privilege given to a few macroeconomists to print money to cut rates with inflationary open market operations and trigger forex shortages.

Related How Sri Lanka’s elections are decided by macro-economists and the IMF: Bellwether

Critics have pointed out that since 1954 in particular, central bank rates cuts which drive the country into external crises and the stabilization programs that follow, have been the main determinant of elections in the country and election of fringe political parties. (Colombo/June13/2024)

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India supports Sri Lanka Coast Guard to boost maritime security

ECONOMYNEXT – India has given 1.2 million US dollars’ worth spare parts to Sri Lanka’s Coast Guard to be used in a vessel also gifted to the Indian Ocean Island on an earlier occasion, the Indian High Commission in Colombo said.

“Handing over of the large consignment of spares symbolizes India’s commitment to support capability building towards addressing the shared challenges of Maritime Security in the region,” the Indian High Commission said

The spare parts were brought to Sri Lanka on the Indian Coast Guard Ship Sachet, an offshore patrol vessel that was on a two-day visit to the island.

The spares were formally handed over to the Sri Lanka Coast Guard Ship Suraksha which was gifted to Sri Lanka in October 2017 by India.

India has gifted spare parts for the ship in June 2021 and April 2022 and also provided assistance in refilling of Halon cylinders in January 2024. (Colombo/June23/2024)

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