Sri Lanka’s central bank is studying whether to hike a 25 mandatory dollar conversion requirement in the wake of cabinet decision on the matter, Deputy Governor Dhammika Nanayakkara said amid record low rupee rates and excess liquidity in money markets.
Exporters have increased their dollar deposits and are funding expenses with rupees, he said.
“So what we see here is exporters who used to converts substantial amount of their export proceeds into LKR now prefer holding on to dollar balances,” Nanayakkara told reporters on June 08.
He said there was a cabinet decision asking the central bank to consider increasing the 25 percent limit “to a higher level” after a study.
Meanwhile importers were also borrowing rupees and stocking up, putting pressure on a 200 to the US dollar non-credible rupee peg, which has been maintained for some time.
“The pressure is coming because there is front loading of imports,” Nanayakkara said.
“The importers think that at any time the government would come and place some restrictions on some imports, especially on essential imports.
“And they also think given the developments whet her the exchange rate would depreciation will depreciate to a very low level.
“To avoid that they import as much as possible they borrow in rupees and they demand for dollars for these imports.”
A central bank cannot maintain a credible peg as long as long liquidity injections are made through lender of last resort windows or outright monetization of debt to drive new credit.
Credible pegs have floating short term rates which are slightly above that of the anchor currency.
Sri Lanka’s forward exchange rates are also trading at steep discounts in another perverse effect of money printing.
The liquidity injections have led to a steady drain on forex reserves mainly through the financial account.
Sri Lanka is under the worst import controls since the 1970s when also large volumes of money was printed and import substitution rent seekers were promoted to sell goods (usually low quality) at higher than world prices.