ECONOMYNEXT – Foreign exchange inflows to Sri Lanka’s banks dried up after the rupee was administratively revalued to 203 from around 238 to the US dollar and exporters were bracing for more controls, market participants said.
Exporter conversions have dried up after authorities wrote to banks asking the rate to be revalued to 203, despite the note-issuing bank producing reserve money in large volumes after failed bond actions, for which convertibility has been progressively suspended as forex reserves dwindled.
By July net forex asset cover for the trillion rupee monetary bases has dwindled to below 1 percent. Sri Lanka has since raised the reserve ratio which will push up the official reserve money by around 15 percent.
Parallel Exchange Rates
The remittance fall which began after money printing triggered parallel exchange rates, have dwindled further after the revaluation, market participants said.
Parallel exchange rates started to develop around June after controls were place on the interbank spot market and forward trading was also banned.
Sri Lanka’s remittances started to fall as the economy recovered driving credit and imports and the central bank failed to stop new money leading to the emergence of parallel markets.
In the Undiyal unofficial market dollars were going at around 245 rupees, discouraging conversions in the formal market, sources familiar its operations said.
With rationing of letters of credit and dollars amid money printing and the suspension of convertibility for current transactions, a strong demand has come for Undiyal transfers out of the country.
Some imports are also paid though informal systems at high premiums.
Last week some banks were giving high rates in excess of 230 rupees to remitters from Middle East and elsewhere draw in foreign exchange to the formal banking system, before the revaluation request came in from monetary authorities.
With inflows drying up intensified rationing of Letters of Credit can be expected, banking officials said.
Sri Lanka’s exporters are bracing for new controls after the regulator asked for information on their dollar deposits.
Last month banks were barred from paying exporters more than 5 percent for their dollar deposits.
Exporters say they also have dollar loans.
With the credibility of the peg falling some exporters say they are saving dollars to hedge their loans, some of which are in moratorium, so that they could repay banks later.
Many exporters were badly hit 2020 at the start of the pandemic and had put some workers on partial pay and keep them at home, getting moratoriums when export orders dried up.
In the stock market export firms were sold down after the ‘revaluation’, this week.
With low rupee interest rates from money printing, exporters could also fund themselves with cheap rupees.
Sri Lanka had already started action against importers saying they are ‘hoarding’, after declaring emergency rule.
Sugar stocks of five companies were seized and are being sold at controlled prices, through a state retail network.
For the first time rice millers who had been earning import substitution profits (excessive economic rents) under cover of stifled competition from trade restrictions for years, were also targeted Wednesday.
When news of the emergency declaration and sugar seizures spread Indian banks have started to reject Sri Lanka letters of credit, financial sources said.
It is not clear whether the companies from which sugar stocks had any letters of credit re-confirmed by India banks or whether the emergency declaration alone had spooked Indian banks.
Some Indian banks had earlier stepped into to re-confirm import letters of credit as Sri Lanka was downgraded to CCC by rating agencies, along with state banks.
Sri Lanka has been beset by forex troubles ever since a US money doctor set up a Latin America style central bank modeled on the Argentina’s BCRA to do ‘counter-cyclical’ policy in 1950 with a non-credible peg.
Sri Lanka’s currency peg has no credibility due to below market policy rates enforced with liquidity injections.
Over-sterilized Non-credible Peg
In order to have a credible peg, which does not depreciate, a monetary authority has to engage in unsterilized or partially unsterilized interventions and allow short term rates to fluctuate.
A peg has a convertible monetary base requiring unsterilized interventions to maintain credibility.
However most of the liquidity injected in recent months has not come from sterilized forex sales but from failed bill and bond auctions which is equivalent to over-sterilization, analysts say.
Authorities have also imposed surrender requirements, despite the peg being on its weak side, adding further liquidity.
In order to float an exchange rate and prevent falling, a monetary authority has to refrain from interventions and make the monetary base inconvertible.
Sri Lanka operates a flexible exchange rate, or an IMF recidivist peg, which jumps back and forth from pegged to floating and back to pegged (convertible to an inconvertible monetary base from day to day) prompting the monetary authority to return to the agency for bailouts.
Analysts have urged price controls on bond auctions to be lifted and allow rates to go up.
Liquidity injections would make it difficult repay foreign debt, due to forex shortages as domestic credit is not crowded out but boosted above inflows, analysts have said.
Liquidity injections give rise to a Keynesian fallacy involving a spurious ‘transfer problem’ classical economists have long tried to explain.
In order to reduce the corrective rates analysts have called for taxes to be raised and state expenses to be pruned so that expanding economic controls can be halted and monetary stability restored.
A foreign debt workout would also help keep down the corrective interest rate, analysts have said. (Colombo/Sept08/2021)