I was introduced to this gentleman who was described as a leading businessman by my host. When the host said that he owned several islands and resorts, my eyes instantly became awe-stricken. He neither smoked nor sipped coke, as many others had been doing in that hall. He was simply sipping mineral water from a glass he held in his hand.

I tried to strike a conversation with him, but he appeared to be suspicious of strangers. It took some time for me to win his trust. Once a bond was sealed between us, he became quite open and poured out his thoughts freely.

'How is business these days?' I asked him. He nodded his head to indicate his unhappiness.

Dollar shortage and the black market in dollars

'No cash. We're all stuck. No dollars in the market'. His voice wa a little indignant.

'Why is it?’ I asked him innocently.

He cast a surprised look at me as if I had asked a stupid question. Then, he realised that I was a visitor and could not be privy to all that had happened there recently.

‘Why, after the Tsunami of 2004, we didn’t have a good time at all. Tourism, the main foreign exchange earner, was at the lowest,’ he said.

‘Then came the global economic crunch and the commodity inflation. It created a foreign exchange crisis on the external front and a budget crisis on the domestic front. Our currency, Rufiyaa, is under pressure for depreciation, but that is not allowed to happen, because of the fear that it would increase cost of living. It has therefore exacerbated the dollar shortage’

‘But the banks should get dollars from the market. Shouldn’t they?’ I asked.

A smirk appeared on his face, but he managed to hide it quickly.

‘The official rate for Rufiyaa is 12.75 for the dollar. No one sells dollars at that rate. Because of the shortage of dollars, a thriving black market has sprung up. At the curb market, dollar is traded at 14.50. A premium of nearly 14 percent! So, everyone sells the little dollars they have got at the curb market’ He explained.

Whether or not to have exchange controls?

‘Surely, the government can control it. Don’t you have exchange controls?’

‘Unlike you guys in Sri Lanka, we don’t have an exchange control act. So, the government cannot prevent it. The other day, somebody told me that he had 200,000 dollars for sale at 14.50. He wanted to know whether I wanted to buy it. I said no. Then, in the afternoon, one of my business partners wanted some half a million dollars. When I went back to that guy with dollars, he had already sold it. See how quickly the market has settled’

‘Then, you should bring in exchange controls’ I suggested to him.

Now his smirk became wider. I knew that I had uttered a stupid suggestion for the second time that evening.

‘I will tell you a story’ he said conspiratorially. He would have had a guilty feeling that his smirking face might have embarrassed me.

Controls create illegal business opportunities

‘I started my career as a skipper in a small sail vessel that sailed between Male and Colombo in early 1970s,’ he began

‘They were large wooden boats that depended on winds to sail. So, it took about a week to reach Colombo and another week to come back to Male. Our hold was officially full of dry fish and Maldive fish which were in short supply in Sri Lanka, because you had a chronic as well as an acute foreign exchange shortage. So, you had the strictest exchange controls in whole of your history at that time’

His story became interesting, because it was about an era in which everyone believed that exchange controls were desirable and necessary. Even today, many have nostalgic memories about such controls and advocate the same as a solution for current problems.

‘We anchor in Colombo harbour and report to both customs and exchange control of the merchandise in the hold. The officials from exchange control visit the vessel, inspect the goods and open an account in their books in the name of the vessel. The value of the merchandise is credited to that account. Then, we sell dry fish andMaldive fish to traders in Pettah, and buy from them soap, lakspray, sugar, cement and other dry foods’.

He stopped for a while and sipped some water.

Then he started again. ‘It’s pure barter, selling goods for goods, because both our countries didn’t have foreign exchange to pay. Whatever we buy, it is debited to the account opened at the exchange control. At the end of the trade, the net balance, whether it is in our favour or your country’s favour, is settled in dollars. But, very often, the two sides balance and neither party has to pay anything. After that, the exchange control closes the account’.

This was a revelation and I was listening to him with awe-stricken eyes.

‘You would have made millions out of that trade’ I exclaimed.

‘What nonsense!’ he corrected me. ‘We made money, not out of that legitimate trade. We made money through smuggling we had been engaged in. Our dry fish trade was only a cover to hide the actual trade we did. We were smuggling practically every good which your country had banned at that time under exchange and import controls. We were buying them from Singapore and smuggling into Colombo. Saris, wrist watches, electrical items, radios, and every thing. The Pettah traders bought them from us and paid us in Dollars which your banking system did not have. We made good money at both ends. We sold those dollars back at home at the black market prices’

‘But, how did you do it without being caught by customs and exchange controls?’

This time too, I displayed my innocence of not knowing how these controls actually worked.

Public Servants Gain Out of Controls

He let out a spontaneous laugh at my naivety.

‘Both your customs and exchange control were in our pay list. They knew every thing we did’

‘But, what about Singapore? Surely, they wouldn’t have approved of your smuggling business?’ I asked.

‘Singapore did it knowingly, because they could profit out of your strictest exchange controls. You see, your exchange controls benefited us, benefited Singapore, and benefited Pettah traders. It also benefited customs and exchange control officials too. Only your government lost, because it did not get the planned revenue from import duties which at that time was a significant source of government’s revenue’

‘Did you continue that smuggling business for long?’ I asked him.

‘No. Your next government liberalised exchange and import controls. So, the profit opportunity which we had under exchange controls simply disappeared. Our profits, that is, what we earned, what Pettah traders earned and what government officials earned, were accrued to the government in the form of higher import duties. We had to do new legitimate business to make money after that’ He finally said.

The moral of the story?

After his revelation, I reflected for many days upon everything he said to understand the moral of his story. Then, all of a sudden, the hard economic facts dawned on me.

Government controls are loved by people who stand to make money out of such controls. The list is long, but could be narrowed to the following: government officials, crooked traders, politicians, smugglers and law enforcement officials.

Governments resort to controls out of desperation. But, markets are smarter and always come up with ingenious schemes to outwit controls. All systems then get together to make a killing and even the countries out there join the net. The result of all this is the establishment of an enormously powerful underground economy.

The initial solution for the governments would have been a simple one like adjusting the exchange rate to suit the ground realities. But, they fail to see it and even the advisors to governments, purposefully or out of ignorance, fail to give good wisdom to politicians. The economic illiteracy of politicians is being capitalised by advisors for their gain, since they stand to profit out of controls.

Governments then go from one mistake to another: trying to control everything, prices, human behaviour, consumption, job engagements, media freedom and everything possible. At the end, they get entangled in a mess from which they cannot possibly escape. They even try to doctor statistics: growth rates, price indices, employment data, foreign reserves and every number to which the public are sensitive.

This happened on a massive scale in the former USSR which for decades doctored numbers to show its own citizens and the rest of the world that their economic system was the best. But, one fine day in 1990, every thing collapsed on itself and the decade long Soviet supremacy ended up as a sweet dream.

Unfortunately, economic wisdom is not palatable to politicians when they are in power. When in power, they are after only their private gains and scheming how to continue to be in power. It would then give birth to a group of advisors who would whole-heartedly support their views out of dishonest motives.

The solution is for countries to have strong institutions. But that may not be sufficient. They should also have honest and upright people to man them.