Sri Lanka rupee is hardly traded in official interbank markets after ban on outright trades above a 200 to the US dollar non-credible peg, but parallel foreign exchange markets are coming into play, as they had done in earlier money printing episodes, market participants say.
Sri Lanka’s interbank forex market saw some isolated outright trades over the past week and market based swap deals but activity had largely dried up after outright trades were banned by the central bank above 199.90 to the US dollar.
The central bank has been printing large volumes of money to keep down interest rates artificially which is making it difficult to maintain the exchange rate.
Banks are also not expected to quote over 203 to the US dollar to import customers or buy from exporters below the level.
However some banks including international banks had been paying over the limit to exporters making the original bankers to the firms unhappy, market participants said.
Regulators made physical or on-site visits this week to check the rates at which dollars are being sold.
A parallel exchange rate higher than the 203 limit had emerged for capital outflows, market participants said.
To finance the outflows some banks had bought above the cartel-like agreement supposedly existing among banks not to pay a higher rate to exporters following informal requests.
Meanwhile the kerb market has also seen a steep fall to around 215 to 220 amid money printing.
The interbank trading ban without halting money printing had also led to rationing of Letters of Credit by banks.
“Regular meetings with key officials of the banking community are held by the Central Bank, and the banking community has mutually agreed to manage their outflows within inflows, while giving priority to essential and urgent imports, and discouraging orders of speculative nature,” Central Bank Governor W D Lakshaman said in a statement this week.
“Overall, I wish to assure the media, the general public, the business community and the investor community that the conditions of foreign currency liquidity observed in the domestic market at present are temporary and are driven by excessive speculative activity.”
As a result some importers who had previously gone through formal channels were forced to use the unofficial or ‘undiyal’ net settlement system long used in Asia before the emergence of banks, at around 220 rupees to the US dollar or higher.
Official payments are made through gross settlement systems, where each transaction is settled separately through systems such as SWIFT messaging.
Plus ça change, plus c’est la même chose
Sri Lanka saw official parallel exchange rates during late 1968 with Latin America style Foreign Exchange Entitlement Certificates (FEECs) being developed by the money printing Dudley Senanayake administration instead of restraining, reforming or abolishing the central bank.
The failure to restrain the domestic operations of the central bank had led to forex shortages, currency collapses and repeated trips to the IMF.
“…[I]n May 1968, Ceylon implemented a dual exchange rate (FEECS) that was commonly used in Latin America with tacit acceptance of the IMF,” top economist Saman Kelegama wrote in a summary of memoirs of Gamani Corea, a Sri Lanka planner and central banker.
“The Fund was not entirely happy but approved it by saying it was ‘a wrong step in the right direction’.”
Sri Lanka set up a Latin America style central bank in 1950 using elements of a cookie-cutter monetary law cooked up by Robert Triffin, an admirer of the Argentina central bank built by Raul Prebisch.
Triffin who headed the Latin America unit of the Fed set up a series of central banks with non-credible pegs in the region which ended up in import substitution, parallel exchange rates and sovereign default.
Some ended in dollarization. Dollarization is also picking up in Sri Lanka.
Sri Lanka listed companies cleared to sell dollar shares and bonds
Sri Lanka Port City dollarization upheld, constitution violation from depreciation: SC
In 1969 the Senanayake administration enacted Sri Lanka’s import control law, without reforming or abolishing the central bank.
In the 1970s Sri Lanka closed the entire economy, making extensive use of the law, instead of restraining the domestic operations of the central bank or abolishing it in favour of a currency board.
The law has been used to curb many imports in 2020, which had earlier brought outsize amounts as taxes in 2020.
The import control law to giving massive profits to rent-seeking import substutution businesses which are arbitraging the taxes and reporting large profits at the expense of consumers.
Meanwhile low taxed imports deemed ‘desirable’ by planners have bounced back with credit starting to flow, including with printed money.
Unlike in the 1960s and 1970s however there is now greater scrutiny of central bank activity in Sri Lanka.
This week, a statutory paper transaction involving a customary reversal of provisional advances (a type of printed money relating mostly to deficits in the past) via one-day Treasury bill issue, drew a lot of twitter comments.
However it is a book transaction involving a provision in the original US designed constitution of the central bank and does not acutualy change reserve money, and therefore cannot create monetary instability in the form of credit, forex shortages or inflation.
This week members of the public stormed the Lebanon central bank after it halted withdrawals of forex deposits, in a cautionary message to central bankers the world over.
LEBANON, BEIRUT : LEBANON IS IN MASSIVE ECONOMIC CRISIS
People gathering this evening in front of Central Bank of in #Beirut where it seems that the external grids have been forced. Lebanese pound keeps falling against the dollar. #LebanonProtests #Flash pic.twitter.com/2SVtYVUeLG
— loveworld (@LoveWorld_Peopl) June 26, 2021
Forex deposit withdrawals were in any case only allowed at a parallel exchange rate lower than the kerb market rate.
Foreign exchange is being released for oil at a still different parallel exchange rate.
The US Fed is again firing a commodities bubble which can push up commodity and food prices hurting the poor and the rich alike though some oil companies and can benefit.
Among major central banks the Fed has done the most damage to the world.
The Fed created the Great Depression with its roaring 20s bubble, blew up the centuries old Gold Standard along with the Bretton Woods system of non-credible soft-pegs in 1971 with output gap targeting and generated a massive housing and commodity bubble which ended in the Great Recession in 2008/9.