Sri Lanka rupee collapses as gold imports end

ECONOMYNEXT – Sri Lanka’s rupee started to collapse rapidly from around April 2018 as soon as legal gold imports ended official data show, in a remarkable display of the effects of Mercantilism.

Classical economics pioneered by Adam Smith, David Ricardo and later by Bertil Ohlin, Friedrich von Hayek and Ludwig von Mises among others have shown balance of payment trouble and currency collapses are caused by monetary instability from Central Banks not imports. (Sri Lanka’s Dr de Silva re-kindles debate on Ricardo’s evil and Penelope’s web of Dr Smith as rupee falls)

In a throwback to classical Mercantilism and the Nixon shock era when Bretton Woods collapse after money printing, Sri Lanka slapped an import tax on legal gold imports in April 2018, weeks after the central bank started printing money. (Sri Lanka slaps 15-pct Mercantilist knee-jerk tax).

Sri Lanka’s legal gold imports soared 73 percent to 649 million US dollars in 2017 when the central bank was mopping up dollars (sterilizing inflows) and keeping the peg on the strong side of its convertibility undertaking.

In 2017, Sri Lanka was mopping up between 100 to 200 million US dollars a month off current transactions, reversing money printing (selling down central bank domestic assets, keeping the peg extremely strong).

But the central bank depreciated the currency from around 149 to 153 US dollars during 2017 to target a real effective exchange index despite recording a 2.0 billion US dollar balance of payments surplus, in the style of East Asia laggard Indonesia.

In February 2018, the central bank stopped repo auctions to mop up inflows (sterilizing inflows) as the credit demand picked up and in March terminated repo deals in the style of the central bank of Argentina re-purchasing its own sterilization securities.

In April, rates were cut and excess liquidity was built with reckless injections, critics have said while taxes were slapped on gold.

Gold was being imported to Sri Lanka to mainly to sell to Indian couriers who were smuggling them to India by paying money for it, after the Reserve Bank of India, in a fit of Mercantilism slapped taxes on gold.

RBI’s Mercantilism has been a bad example for Sri Lanka after independence from British colonisation when monetary instability began. Specie-pegged RBI was nationalized and Sri Lanka’s currency board was converted to a money printing central bank.





The gold tax, while curbing smuggling to India, also made Sri Lanka’s jewellery industry un-competitive. It also deprived easy export profits to gold re-sellers, who would have paid income tax, had there been a good tax system.

In 2019, the rupee has started to strengthen as domestic credit fell. Legal gold imports are still near zero, while people are caught by customs for smuggling gold and punished.

However, there is no criminal punishment for the central bank, either for halting mopping up operations in February, terminating term repos in March or recklessly injecting cash in to banking system in April.

The cost of maintaining the soft-pegged central bank has been heavy on the poor and the country.

The central bank and its so-called soft-pegged exchange rate has triggered exchange controls, trade controls, inflation, price controls, black markets and shortages, helping worsen poverty and make Sri Lanka a lagging nation in Asia.

The latest risk to the country is the inability to repay foreign debt with a soft-peg. There have been calls to harden the peg, or go for a clean float. (Colombo/Apr18/2019-SB)


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