Sri Lanka President calls to expand Nixon shock as rupee falls

ECONOMYNEXT – Sri Lanka’s President Maithripala Sirisena has called for more trade controls and import substitution as the rupee fell amid policy errors in operating a soft-peg with the US dollar.

President Sirisena has asked a National Economic Commission to prepare a list of non-essential goods that can be stopped and had it over the Finance Ministry in a week, a statement from his office said.

The goods will be temporarily controlled and attention will be focused on producing import substitution products domestically, President Sirisena has said.

Sri Lanka operates a non-credible foreign reserve collecting soft-peg with the US dollar, involving a de facto external anchor with an undefined convertibility undertaking, which shifts suddenly to a floating rate with a domestic anchor made up of a wide near double digit inflation target with the unsterilized excess liquidity collected during the pegging period intact, sending the rupee crashing down.

This is called a ‘flexible exchange rate’.

The finance ministry has already slapped controls on cars, footware and perfumes in recalling moves by President Richard Nixon as the US dollar’s soft peg with gold failed in 1971, driving the dollar above 86 dollars an ounce from 35.

"I am taking one further step to protect the dollar, to improve our balance of payments, and to increase jobs for Americans," Nixon said at the time.

"As a temporary measure, I am today imposing an additional tax of 10 percent on goods imported into the United States. This is a better solution for international trade than direct controls on the amount of imports.

"This import tax is a temporary action. It isn’t directed against any other country. It is an action to make certain that American products will not be at a disadvantage because of unfair exchange rates. When the unfair treatment is ended, the import tax will end as well."

The US dollar then floated.

Sri Lanka closed the entire economy at the time and people ate ‘sakkara’ for sugar, wore kerosene smelling cloth which were rationed and draconian exchange controls were also imposed.

However, when the economy was re-opened in 1978, no substantial reforms were done to the central bank, and the rupee continued to fall.

The finance ministry has already slapped controls on cars, footware and perfumes, opening a pandora’s box for more controls, and leaving egg in the face of free trade advocates and the main free trade plank of the administration in tatters.

Analysts however had already warned that unless the central bank was reformed or at least it operating procedures overhauled free trade will not be possible. (Sri Lanka’s central bank has to be restrained for free trade to succeed)

In addition liquidity injections will also make it impossible to service foreign debt leading to dollar sovereign default (Sri Lanka’s Weimar Republic factor is inviting dollar sovereign default).

Sri Lanka’s current troubles stem from the first quarter of 2018, when mopping up of dollar inflows suddenly stopped (sterilized foreign exchange purchases), according to analysts who closely study its operations.

There were calls to start issuing central bank securities to permanently mop up inflow purchases, but in the first quarter sterilization suddenly failed amid a series of failed term repo auctions.

Monetary policy is now more pro-rupee with overnight rates near ceiling 8.50 percent policy rate and not all outflows permanently filled with permanently printed money. (Colombo/Oct16/2018)