Sri Lanka forex liberalization planned for mid-Oct: CB Governor

Sept 30, 2010 (LBO) – A second stage of relaxing foreign exchange controls may take place by mid-October when operating instructions to authorized dealers are fine tuned, central bank Governor Nivard Cabraal said. Sri Lanka’s foreign exchange laws criminalized attempts by citizens to protect the value of their hard earned savings from being destroyed by state-induced currency depreciation.

In January Sri Lanka’s main opposition United National Party and the Marxist Janatha Vimukthi Peramuna raised objections to forex liberalization plans announced by Governor Cabraal.

Frivolous objections by former rulers in opposition has generated calls for ‘a strong government’ in Sri Lanka based on arbitrary action, which has further reduced even the civil liberties of the ordinary people and undermined rule of law.

Flawed Model

Foreign exchange shortages arise when a central bank maintains a peg (or external anchor) with a foreign currency which has its own domestic inflation anchor (indicating that the dollar generates positive inflation on its own) and tries to run independent monetary policy by printing extra money.

The flawed model was the basis of the post-World War II Bretton Woods peg system which collapsed in 1971-73. Countries superior monetary knowledge abandoned it in favour of floating rates.

A widely acclaimed book of old newspaper stories published by the Central Bank this year, quoted Sri Lanka’s first Central Bank governor, John Exter, a US citizen, as having said in 1953 – around the time exchange controls were introduced – that the ‘problem’ dogging the island at the time was central bank money printing.

The central bank was buying Treasury bills with printed money to finance government debt.

Exter was quoted as saying in the report that “the new money has been used by the public to purchase an excessive volume of imports, thus drawing down the country’s external reserves.”

However instead of correcting the problem Sri Lanka imposed exchange controls, import controls and eventually closed the entire economy when the Bretton Woods system collapsed, leading to 20 percent unemployment in the 1970s.

Freer Capital

But from 1977 trade was opened. Stocks were opened to foreigners a decade later.

The central bank had already allowed foreign investors to buy into government debt. In another move state agency debt has also been opened for foreign buyers this month.

A 30 percent quota open to foreigners by in a debt issue by Sri Lanka’s Urban Development Authority (UDA) has been snapped up early, according to a source close to the deal.

“It is a very interesting development. It has proved to the market – it has proved internationally – that Sri Lankan institutions can raise funds, which include funds from outside as well, and there is appetite,” Cabraal said.

“And the UDA bond being oversubscribed is an indication of that situation. We would like to see specific projects being funded by specific lines.”

Snapshot

The following is some of the proposed foreign exchange relaxations listed for implementation in 2010. Others including controls on imports and unification of non-resident investment accounts have already been implemented.

1) Allowing Sri Lankans to open and maintain accounts with banks abroad

2) Allowing Sri Lankans to invest in equity or short term debt instruments in overseas companies

3) Allowing foreigners to invest in rupee denominated debentures issued by local companies

4) Allowing insurance companies to invest part of their assets of the general funds or technical reserves in foreign assets

5) Allowing listed companies to list on foreign stock exchanges

6) Allowing foreigners on tour or business in Sri Lanka to open Sri Lanka rupee accounts.

In earlier statements the Central Bank had said Sri Lankan residents would be allowed to open bank accounts abroad, tourists allowed to open bank accounts in the island and foreign investors would be allowed to buy corporate debt.

The moves when implemented would restore key economic freedoms lost to Sri Lankan citizens after gaining ‘independence’ from British rule.

“We will probably do that by mid-October,” Cabraal told LBO in an interview.

“We have actually already approved some of these liberalization processes but the operating instructions have to be written, they have to be tested.”

Lost Liberties

Draconian foreign exchange controls were imposed in Sri Lanka in 1952, two years after the creation of the Central Bank, after it started printing money to finance the budget deficit, and maintain a foreign exchange peg with the US dollar at the same time.

Sri Lanka’s pegged exchange rate central bank is based on a flawed model originally peddled by the US Treasury to encourage dollar pegs and purchases of US government debt. Such ‘soft-pegged’ models have wreaked havoc in South America.

Some analysts have advocated a return to a hard peg or currency board as Singapore and Hong Kong did, to restore low inflation and allow free flow of capital in Sri Lanka.