ECONOMYNEXT – Sri Lanka’s Colombo Port City Special Economic Zone would be dollarized, according to a draft law for the area, protecting its workers and businesses from the depreciation and monetary instability coming from a currency which does not have a credible anchor.
Foreign and domestic investors who conduct business (authorized persons) within the Economic Zone would have to be approved by a Colombo Port City Economic Commission, according to a draft law to be presented to parliament shortly.
All Investment applications would have to be made in foreign currency.
The money would also have to come from abroad. No domestic bank would be allowed to fund such investments through their foreign currency banking units.
“No foreign currency deposit in an account maintained or operated in Sri Lanka, in any licensed commercial bank or licensed specialised bank within the meaning of the Banking Act and no foreign currency raised through a foreign currency loan obtained from any such licensed commercial bank or licensed specialised bank, shall be used by an authorised person for the purpose of such investment, within the Area of Authority of the Colombo Port City,” the draft law says.
“As such, subject to the provisions of subsection (5) of this section and section 39 of this Act, all investments made to carry on business in and from the Area of Authority of the Colombo Port City shall, in the interest of national economy, be raised outside Sri Lanka.”
Land plots would be sold in US dollars. Workers in the zone would be paid dollar salaries.
Resident workers would be allowed to remit their salaries to a bank account.
The salary which will be exempt from income tax “shall be deemed to be a permissible credit to a personal foreign currency account of such resident employee.”
The Commission is also expected to issue regulation to allow businesses to convert rupee proceeds made by “a citizen of Sri Lanka or resident when using retail facilities or services at restaurants, cinemas, entertainment facilities, shopping facilities, or parking facilities, within the Area of Authority of the Colombo Port City, into a designated foreign currency.”
The port city would also have an off-shore financial centre.
Dollarization allows people’s salaries and lifetime savings as well as the capital to be protected from monetary expropriation by soft-pegged central banks prone to currency depreciation and balance of payments crises.
Currencies depreciate due to a conflict in monetary anchors, where money is printed to keep rates down and the exchange rate is also targeted.
Dollarization involving adopting one or more free floating currencies such as the US dollar and Euro target a low inflation rate of around 2 percent (a credible domestic anchor).
It is possible to adopt more than one foreign currency at the same time (currency competition).
Currency boards also issue money which do not depreciate against the chosen strong currency it is pegged to (credible external anchor) as money printing is prohibited and overnight rates float.
But if money is printed to target a domestic interest rate or a higher level of inflation, that currency will depreciate.
Any attempt to defend the exchange rate (external anchor) while printing money to will trigger a ‘run’ on the foreign reserves of that central bank (a conflict between anchors), typically called a balance of payments deficit.
Sri Lanka’s rupee has depreciated from 4.77 to around 200 to the US dollar amid money printing and conflicts with domestic and external anchors.
Such central banks impose exchange controls and also import controls in order to be able to keep on printing money.
John Exter, a Federal Reserve ‘money doctor’ who helped set up a soft-pegged central bank abolishing the earlier currency board, observed as follows in explaining the planned new Monetary Law Act which later brought currency crises, chronic depreciation and output shocks.
Exter said the currency board was “particularly conducive to foreign investment because investors, especially those within the Sterling area had every assurance that the rupee exchange rate would not get altered in terms of Sterling and that there would be no impediments to realizing profits or repatriating capital”.
During Ceylon’s currency board era, Malaysian and other firms raised capital in the Colombo stock market.
However Exter claimed the automatic rule-based sustainable system was a “mark of Colonialism” and it was “tantamount to a renunciation of a basic element of monetary sovereignty”.
Ironically the Port City Economic Zone would now be dollarized, going beyond a currency board. A currency board, while preserving free convertibility of the rupee, would have given profits of note issue (seigniorage) to the Treasury.
The Port City, reclaimed by China Harbour Engineering group is expected to attract over 15 billion US dollars of investments. (Colombo/Mar28/2021)