Sri Lanka grey market dollar premium high

Mar 31, 2010 (LBO) – Foreign exchange premiums in Sri Lanka’s kerb or black market have widened in recent months to about three rupees above the bank currency rate from below the rate a few years ago. A US dollar note is being sold in the kerb market for around 117.25/50 rupees compared to a rate of slightly over 115.00 for banks and an interbank trading rate of around 114.00 rupees.

In the past the kerb market rate used to be lower than the currency note rate of banks as a more efficient kerb market traded between a spread greater than one percent in the formal banking sector.

The grey market dollar rose to over 119 rupees in early 2010 around the time Sri Lanka had a presidential election, but people familiar with the market say the rate first started to edge up following the end of a war with Tamil Tigers in May 2009.

The rate came down from over 118.00 rupees this month after the government lifted some taxes on gold, but the premium remains wider than levels seen in recent years.

People familiar with the market say the taxes on gold were brought down earlier this month to curb smuggling of gold which had intensified after several taxes including a higher ‘nation building tax’ was slapped on gold.

Gold is high in value and small in volume making it easy to smuggle.

In most countries a high black market rate points to loose monetary policy where a central bank prints money (finances the budget deficit by creating new reserves in the banking system) and tries to maintain a peg with a foreign currency.

Though Sri Lanka’s monetary policy has got loose in recent months, analysts say the high premium cannot be readily explained by looser policy alone as the grey market premium was narrower during a balance of payments crisis in late 2008 and early 2009.

Sri Lanka’s unofficial forex market is mostly supplied by returning expatriate workers who hand carry currency and those who remit money via the so-called ‘havala’ net settlement system especially from European countries like Italy.

The grey forex is usually used to pay for highly taxed imports which are under-invoiced.

Sri Lanka’s import barriers rose dramatically as the government taxed imports, including foods, the prices of which collapsed following a burst commodity bubble in 2008, to get more revenue as volumes themselves fell.

Analysts say a recovery in imports and a high level of protectionism may partially account for the high grey market premium.

At one time the unofficial market was also supplied by over-invoiced car imports.

Sri Lanka’s customs has a practice of charging import taxes on used vehicles based on a pre-determined value, which is higher than the actual value of a used vehicle imported from countries like Japan.

This gives space for vehicle importers to legally remit higher than necessary foreign exchange volumes out of the country by invoicing vehicles at prices around which the customs charges levies instead of the actual cost.

With a dramatic fall in car imports amid very high taxes a part of the unofficial supply of foreign exchange to the grey market may have been cut off.

People familiar with the curb market also say there appeared to have been some capital flight around the time of presidential elections in January 2010 when the grey market rate spike to over 119 rupees, but are unable to say whether it is continuing.

There has been persistent foreign selling in Sri Lanka’s stock market with seasoned investors pulling out though market analysts are hoping that new investors will tip the balance later in the year.

Several economists including Mohsen Bahmani-Oskooee and Gour G. Goswami (Political rights, civil liberties, and the black market premium on foreign exchange: Evidence from developing countries) have found links between repressive economic and political practices and grey market foreign exchange prices.

Sri Lanka has slipped in economic freedom rankings in recent years including the Global Economic Freedom Index compiled by the US-based Wall Street Journal and The Heritage Foundation.