ECONOMYNEXT- Sri Lanka will set up a monitoring mechanism to check if exporters are bringing earnings back to the country, the central bank governor Indrajit Coomaraswamy said as the central bank suffered the second consecutive run in 2018 sending the rupee plunging.
“What we can do is put in place a monitoring system which we are hoping to do with the help of the Customs to know whether the money is coming back into the country,” Indrajit Coomaraswamy said.
“Then they (exporters) have to convert it,” he told reporters.
He was responding to a question from reporters whether the central bank is worried about exporters not converting earned dollars to rupees.
He said that the currency depreciation was a problem which filtered into Sri Lanka through external factors.
“But it was greatly amplified by the response of the economic agents of this country fueled by discussion in the media.
“You take all that together and you create a much bigger reaction than is warranted, so that exporters don’t convert, importers rush their purchases,” he said.
No mention was made of central bank liquidity management or monetary instability.
It has now been revealed that part of the liquidity spike in July and August came from getting mired in swaps involving buying dollars spot and selling forward to create new rupees and finance the budget deficit. Similar deals had been used to mount speculative attacks during the East Asian crisis.
Despite claims of ‘exogenous factors’, which people of the country have often heard in the past, exchange rates of countries that have currency boards (including Hong Kong, Macau) and currency-board-like systems such as Dubai have not moved.
All currency pegs collapse (not just in Sri Lanka) from juggling with dual anchors and operating so-called soft-pegs or intermediate regimes and not running consistent policy (fully forex reserve backed floating interest rates) or a floating exchange rate (no forex reserves, policy rates)
Sri Lanka’s rupee was also pushed down in 2017, when there is wide acceptance that the dollar was ‘weak’ and the island’s peg was on the ‘strong side’ with steady permanent mopping up of purchased inflows, due to targeting a real effective exchange rate (REER) index, when most currencies appreciated.
A REER peg involves importing the monetary policy of the worst central banks in the region including India, critics say. Countries usually peg to central banks with the best available policies to try to import their monetary policy.
Sri Lanka’s importers panic and exporters hold back, because the rupee is never allowed to appreciate after policy tightens.
Last Monday the central bank itself admitted that it had bought four million dollars in the market, which is now thin and volatile because bank net open positions were cut, effectively undermining a float. Analysts had warned earlier not to cut NOPs because it had made the rupee volatile in the past (What Sri Lanka can do to improve the credibility of its dollar soft-peg: Bellwether)
“There’s nothing to stop people (exporters) from bringing the money into the country and not converting it,” Coomaraswamy said.
“They can even go and borrow rupees for their working capital, which is what some of them are doing.”
But exporters who fund expenses by borrowing domestically cannot put pressure on the rupee. they can drive up interest rates and crowded out other borrowers in the absense of policy rates.
It is the soft-pegged central bank that pressures the currency by injecting new cash at low rates in to the banking system through term repo auctions and outright purchases of Treasury bills from the banking system, and in the case of Sri Lanka rejecting bill auctions (sterilize outflows) to convert paper debt to new money for banks to give loans to exporters without crowding out other creditors.
Sri Lanka’s soft-dollar peg turned to its ‘weak side’ after failed mopping up operations in February and March 2018, and was worsened by a rate cut and liquidity injections in April. Hedging deals to finance the deficit came in the current episode.
In later September liquidity shortage has hit the credit system from a 2013 hedging deal.
Sri Lanka in 2016 enforced a law which required exporters to repatriate earnings within four months which the International Monetary Fund has said amounts to a prohibited multiple currency practice.
The IMF discourages controls on forex or trade, because currency problems are due to monetary instability and has little to do with trade. But bond holders can run, even when domestic policies are good.
“We will assess removing the FX repatriation requirement,” Coomaraswamy and Finance Minister Mangala Samaraweera pledged in a deal with the International Monetary Fund signed in May.
“We introduced a repatriation requirement of export proceeds with the aim to encourage exporters to keep FX within the domestic financial system and reduce the imbalance of FX market in the face of substantial balance payment pressures.
“However, we consider that the role of this capital flows management measure has diminished as the balance of payment pressure receded.
“We will assess removing the requirement with the timing linked to progress with the macroeconomic adjustments (especially net international reserves) envisaged under the program.”
Instead Sri Lanka’s finance ministry and the central bank has now slapped a series of Nixon-shock style Mercantilist trade controls leaving the administration’s entire free trade strategy and its credibility in tatters.
The trade controls had allowed nationalist critics to blame imports instead of monetary instability for currency volatility and make a fresh case for tariffs and import substitution. (Colombo/Oct08/2018)