ECONOMYNEXT – Sri Lanka’s imports have soared to 21.6 billion US dollars in 2021, amid what is popularly characterized as ‘foreign exchange shortages’, the highest since the money printing year of 2018, according to provisional data in the public domain.
Central Bank Governor Nivard Cabraal in a twitter.com message said 2021 imports are estimated at 21.6 billion US dollars, up from 16. 1 billion US dollars in 2020 and 19.9 billion US dollars in 2019.
In 2020 imports fell sharply as lockdowns slashed domestic consumption and private credit collapsed.
The 2021 imports are the highest since 2018 when the central bank also printed money and created forex shortages, driving the rupee down from 151 to 182 to the US dollar.
After printing money and de-stabilizing the external sector, Sri Lanka usually controls imports based on Mercantilist dogma, due to the lack of classical economics knowledge in the country.
Vehicles which are taxed at almost 300 percent was banned in a cascading policy error.
However the printed money flows into permitted goods, which economic planners consider good and are taxed at lower rates. While vehicle imports fell to near zero, other imports have soared.
In October 2021 for example consumer goods imports fell 7 percent to 233 million US dollars and food and beverage imports fell 20.5 percent to 97.7 million US dollars.
But machinery and equipment imports grew 12.3 percent to 205.5 million US dollars and building materials grew 18.5 percent to 103.7 million US dollars.
The current administration has been trying to boost the construction sector with 7 percent interest loans and government projects, while injecting money into the banking system.
“..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, a classical economist wrote in 1966, in a policy document to the then government.
“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.”
“This flow of money is determined by the national product and the inflationary part of the Net Cash Operating Deficit,”
“The remedy to this problem lies in putting a stop to inflationary financing, not in tampering with the normal course of international trade.”
In the 1960s money was mostly printed for rural credit (central bank re-finance), a practice which was halted by then Governor A S Jayewardene. Central Bank re-finance was a culprit in the 1980s high inflation and currency trouble.
Though currency troubles are triggered by ‘excess rupees’, the popular media, financial press and Mercantilists usually characterizes inflationary policy in a pegged regime as ‘dollar shortages’.
Sri Lanka’s external instability had worsened since Deputy Governor W A Wiewardene retired from the Central Bank and ratcheted up sharply after September 2014, with discretionary policy to target a middle or bottom of the policy corridor with excess liquidity.
Sri Lanka has had inflationary policy in 2015, 2016 (policy corrections from 2Q), 2018 and from 2020 to date.
In 2018 the central bank printed money injecting as much as 60 billion rupees of excess liquidity to money markets to keep interest rates below a ceiling policy rate.
From 2020 a ‘Barber boom’ style exercise involving value added tax cuts and money printing began, eventually triggering currency troubles, inflation and social unrest.
By the beginning of 2021 the banking system had has much as much 200 billion rupees (about a billion US dollars) in excess liqudity, which were rapidly used up as the economy recovered.
In 2018 money was printed through the purchase of Treasury bonds, shattering ‘bills only’ policy established by the late Governor Jayewardne, who was also a classical economist.
Money was printed by the central bank in 2018 to keep interest rates down despite politically difficult tax increases to bring the budget deficit down.
The central banks forecasts on imports, trade deficits and year end foreign reserve projections are blown apart every year inflationary policy is followed, triggering currency crises and balance of payments deficits.
However the central bank for 70 years has printed money to keep rates down, finance rural credit or past as well as current deficits.
The inflationary policy (printing money above the anchor) has pushed up inflation as well as imports and triggered balance of payments deficits, or declines in forex reserves as dollars are given by the central bank for imports or other payments.
In the absence of the central bank, spikes in imports or outflows in a pegged regime are met through short term falls in liquidity, rises in interest rates and higher domestic savings.
Sri Lanka is no longer printing money to finance deficits and keep short term rates below the ceiling rate, but the country has no working exchange rate regime, and is forced to give ‘reserves for imports’.
After giving reserves for imports, the liquidity shortage is sterilized with new money to maintain a policy rate of 6.0 percent giving resources to banks which give Treasury bills to the central bank to get printed money and also boost investment and discourage savings.
The cycle continues until the central bank raises rates. A switch to a floating rate (suspending convertibility or completely halting giving ‘reserves for imports) is usually also required to restore a working exchange rate regime with an active spot market.
In the absence of money printing, either to finance the deficit or sterilize ‘reserves for imports’ inflows and outflows of foreign exchange match and the exchange rate stops falling.
When money is printed the government is also unable to settle debt (a capital outflow) with current inflows and ends up borrowing more dollars for debt service.
In a year with inflationary policy, the foreign debt minus reserves goes up by a level higher than the foreign financed component of the budget deficit. In an year with deflationary policy the net increase in debt is lower than foreign financed budget deficit of the year.
In the last two years foreign debt has been repaid by a steep running down of reserves and indebting the central bank. (Colombo/Jan17/2021 – Corrected to three year high)