ECONOMYNEXT – Sri Lanka central bank has lifted a ban on forex transactions and allowed banks to sell forward to importers, in a new direction issued to lenders, ending one of several cascading policy errors that led to an economic crisis.
The central bank has lifted a restriction on banks providing forward cover to importers from March 22 according to a circular issued to banks.
On April 25, 2021 the central bank limited forward transactions and swaps only to within banks. Banks were only allowed to sell dollars to customers only up to spot. Banks were allowed to buy forward from exporters.
The banking direction “on forward sales and purchases of foreign exchange by Licensed Commercial Banks are hereby revoked”, Central Bank Governor Nivard Cabraal said.
Soon after coming to office Cabraal ended price controls on bonds which was one of the key triggers of the current bout in monetary instability.
The central bank in March 20202 ended 203 to the US dollar peg which was not credible due money printed to enforce a too low policy rate compared to a wide budget deficit, which was worsened by a so-called ‘relief package’ in another cascading policy error.
Sri Lanka firms with billions in trade credits exposed as rupee falls
The rupee has fallen to around 285 to the US dollar so far leaving imports exposed to billions in losses as they were not allowed to cover forward.
However there is also an anomaly in the forward market which is discouraging forward sales.
Due to high dollar yields and low rupee yields, there are forward discounts instead of premiums. According the central bank’s own data as of March 18, the indicative rate for one month dollars was 263.26 rupees and the three month rate was 258.06 rupees.
It implies that the dollar yield in the market is higher than the rupee yield.
In the interbank swap market there was a discount of around 2.58 cents per day for three month deals, market participants say.
It implies a dollar yield of around 15 percent when compared to a 3-month Treasuries yield of 11.35 percent, discouraging forward sales by exporters.
To make the float work a steep policy rate hike is needed, economists have said.
Top economist W A Wijewardena, a former central bank Governor had explained how the Central Bank Governor A S Jayewardene jacked up policy rates to 23 percent, the bank rate to 25 percent. Jayawardena also raised packing credit rates to encourage dollar sales.
Rupee has collapsed b’caz w/out forex to keep it at 203/$, @CBSL had to let it to go;it’s now like a kite floating w/out direction;it was first floated by Governor AS Jayawardena in 2001 planning meticulously;MyView in @FT_SriLanka recalls this saga:https://t.co/00cKfUiXEw
— W A Wijewardena (@waw1949) March 21, 2022
Sri Lanka’s inflation has also topped 15 percent after two years of money printing which has boosted broad money by 40 percent.
In another Zimbabwe style cascading policy error the central bank also imposed mandatory conversion rules on exporters and dollar earners, promoting import spending by the recipients of the rupees with low interest rates discouraging savings in both rupees and dollars.
Analysts have said a more serious policy error is a surrender requirement imposed on banks to sell dollars to the central bank which creates new money, though there is a liquidity short in the banking system.
Sri Lanka central bank explains forex repatriation, Zimbabwe style surrender rules
The surrender requirement undermines the establishment of a float of the rupee and making the regime a peg where its credibility is shattered at every new level it falls to.
Classical economists and analysts have blamed Keynesianism (a type of Mercantilism) for the country’s monetary troubles which began in 1950 with the setting up a soft-pegged central bank which was allowed to print money.
Until August 22, 1950 money printing (purchasing domestic assets) was banned under an earlier currency board law and the country had 11 months of foreign reserves when money printing started.
Analysts have warned that unless the float takes hold, the rupee will continue to fall and spontaneous dollarization may occur. The International Monetary Fund has also warned of a possibility of an economic implosion unless money printing is halted. (Colombo/Mar22/2022)