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Sri Lanka offers foreign exchange carrots amid monetary instability

ECONOMYNEXT – Sri Lanka has proposed a series of incentives to draw in black money, foreign exchange or discourage their outflow in a budget for 2021 without addressing the core cause of a Latin America style pro-cyclical soft-pegged central bank, which can drive a country towards default.

Prime Minister and Finance Minister Mahinda Rajapaksa said he proposed to pay a premium for foreign exchange remittances sent by foreign workers to banks in Sri Lanka, presenting a budget for 2021 to parliament.

“I propose to pay Rs. 2 per dollar above the normal exchange rate for the foreign exchange remittances sent by foreign workers to banks in Sri Lanka,” he said.

Banks generally keep a 4 to 5 rupee spread when dealing with customers. This week banks were buying dollars around 182 rupees and selling around 186.4 with the spot rate around 184/50.

It is not clear where the funds will come to pay the ‘extra’ two rupees. However, if the central bank does not print money, allows short term rates to fluctuate based on liquidity, exchange rates will stabilize and the spread will fall along with interest rates, analysts say.

Prebisch – Triffin

Sri Lanka has severe monetary instability from a central bank which was created in 1950 by a so-called Federal Reserve ‘money doctor’ based on a philosophy propagated by Raul Prebisch, the founder of Argentina’s central bank.

The disastrous central banks were created by the Latin American unit of the Fed under the tutelage of Robert Triffin a Keynesian who admired Prebisch.

Almost all countries with Prebisch-Triffin central banks ran into periodic currency collapses, import-substitution, default, dollarization, re-denomination or permutations of the outcomes.

In March 2020 Sri Lanka’s central bank printed unusually large volumes of money amid a credit surge pro-cyclically cutting rates and drove the rupee towards 200 US dollar, pushing down sovereign bond prices into steep discounts and triggering a credit downgrade.

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Import controls and exchange controls followed.

Due to monetary instability, businessmen others also try to take money abroad and keep them denominated in money produced by better central banks or so-called ‘hard currency’ to stop the state from expropriating their value through currency depreciation or a crawling peg.

When private collapsed after April 2020, monetary has been partly counter-cyclical analysts say, but the economy is shackled in import controls.

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No attempt has been made to reform the central bank.

Prime Minister Rajapaksa called on the central bank to further change monetary policy.

“It is required to reform the banking and financial sectors to ensure availability of credit and financing for the production process and associated transactions,” he told parliament.

“We believe the Central Bank should have a new perspective on the monetary policy regarding money and liquidity management.”

His words are eerily reminiscent of Raul Prebisch.

“The different stages in the production process, from primary production to the sale of the final product in the market, take a certain amount of time,” Prebisch wrote (Five Stages in My Thinking on Development).

“This is where the role of the monetary authority comes in: to supply the larger amount of money needed to pay the growing wage and salary bill.

“This increase in money should be just enough to match the growth of final production owing to the growth of employment.”

More Incentives for foreign exchange

Meanwhile, lures were also offered to businessmen with undeclared funds including money taken breaking foreign exchange controls coming from the soft-peg.

“For the benefit of the country, I request from all entrepreneurs to utilize the funds hidden locally or internationally in order to evade laws relating to taxes and foreign exchange,” Minister Rajapaksa said.

“It is expected to make legal provisions to provide a tax pardon to entrepreneurs thus utilizing funds for any investment facilitated by this budget under the payment of taxes amounting to 1 per cent.”

Tax breaks were also offered to foreign companies and multi-nationals catering to the domestic market.

“I propose to exempt the tax on dividends of foreign companies for three years if such dividends are reinvested on the expansion of their businesses or in the money or stock market or in Sri Lanka International sovereign bonds,” PM Rajapaksa said.

“In order to encourage the exports of multinational companies which are import-based for requirements of the domestic market, it is proposed to reduce the tax imposed on their dividends by 25 per cent in 2021 and 50 per cent in 2023 under the condition that they increase their exports by 30 per cent and 50 per cent in the respective years.

“In order to maintain a similar amount as the import expenditure in foreign exchange in domestic banks, the interest income from such deposits will be exempted from taxes.”

The budget also had a series of import substitution measures.

Thought budget did not have new revenue proposals, maintaining policy stability and reducing regime uncertainty, it also did not have major expenditure proposals such as state salary hikes and many new subsidies. (Colombo/Nov18/2020-sb)

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