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Sri Lanka to decriminalize forex transactions, relax exchange controls

ECONOMYNEXT – Sri Lanka will decriminalise foreign exchange transactions, replacing a draconian law that bans the use of foreign currency, which was brought when a money printing central bank started generating foreign exchange shortages after independence.

Sri Lanka would bring in a foreign exchange management law to parliament in 2017 and further relax exchange controls in the medium term, Central Bank Governor Indrajit Coomaraswamy said.

Deputy Governor P Samarasiri said Sri Lanka had draconian foreign exchange controls that prohibited transactions in foreign exchange between Sri Lankan citizens and foreign citizens.

All uses of foreign currency, including for current transactions and the holding of foreign currency accounts, were operated by permission given while the underlying law was still in effect, he said.

As a result, such permission could be revoked at any time, creating uncertainty.

Foreign exchange controls were enacted in 1952, soon after the Central Bank was set up, as it started to print money and generate forex shortages and currency pressure.

Under the British, Sri Lanka had a currency board system where there was no special requirement for capital controls, and the exchange rate was fixed and could not be broken. However, due to money printing by the Bank of England during the war, the British Empire’s so-called Sterling Area had some restrictions with other currencies such as the US dollar.

Sri Lanka has made current transaction free, but there are still capital controls.

Governor Coomaraswamy said there may not be any immediate removals of restrictions in the capital account.

Under the new foreign exchange law, there will be no criminal penalties but only civil penalties would be charged, Samarasiri said.

Analysts say people who ‘violate’ exchange controls and take money out are simply trying to protect their wealth from being expropriated by the state through currency depreciation and inflation created by money printing.

Capital controls evolved in the 20th century, as governments mis-used central banks to create money.

The first of modern style exchange controls were started by Tsar Nicholas II of Russia in 1905, where Russia’s central bank was asked to limit conversions to 50,000 German marks per person and forex sales were limited unless it was required for an actual import of goods.

In Sri Lanka, exchange controls expanded into trade controls and severe economic controls in the 1970s.

"The extent of the control over all life that economic control confers is nowhere better illustrated than in the field of foreign exchanges," economist Friedrich Hayek said in 1944.

"Nothing would at first seem to affect private life less than a state control of the dealings in foreign exchange, and most people will regard its introduction with complete indifference.

"Yet the experience of most Continental countries has taught thoughtful people to regard this step as the decisive advance on the path to totalitarianism and the suppression of individual liberty.

"It is, in fact, the complete delivery of the individual to the tyranny of the state, the final suppression of all means of escape — not merely for the rich but for everybody."

Full convertibility of a currency can be provided if the exchange rate is fixed with a hard peg or currency board, which Sri Lanka had until 1951, and the interest rate free floats.

If the central bank prints money to maintain a policy rate, then the exchange rate has to be allowed to free float. Britain abolished all exchange controls on October 1979, by the Margarast Thatcher administration. Thatcher was a fan of Hayek. Her key economic advistor was Alan Watlter, who helped build a currency board in Hong Kong and accurately predicted the fall of the soft-peg style ERM.

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