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ECONONYNEXT – More than 300 lawyers appeared on behalf of the 53 people to ensure the rule of law, a senior lawyer said on Saturday, a day after a court granted bail for police-detained suspects following a violent protest near President Gotabaya Rajapaksa’s Mirihana private residence.

Police used tear gas and water cannons late on Thursday to disperse hundreds of protesters who tried to enter Rajapaksa’s residence after a silent protest turned violent.

Except six, all other arrested people were granted bail after police failed to present any strong evidence that the arrested people were involved in damaging public properties. The six under arrest will be produced in an identification parade.

“This is a victory for lawyers,” senior lawyer Saadi Wadood, who appeared on behalf of arrested people, told Economy Next.

“Large number of lawyers voluntarily came forward to ensure the right of the people to express their displeasure is safeguarded.”

Most lawyers stayed most of the Friday at Mirihana police, they called for help from other seniors, ensured all the arrested people were produced in the court and then appeared on behalf of them.

The lawyers included Saliya Pieris, the president of the Bar Association of Sri Lanka, some of the senior civil and criminal lawyers, and their juniors.

All the lawyers first presented to Mirihana police station where the most detained were kept, applauded their braveness by clapping when the arrested people were taken by the police to bus which took them to Nugegoda Magistrate court before gathering in the court.

“All the lawyers came forward because we thought we have a moral duty to make sure the rule of law prevailed,” Wadood said,

“This is the first time we have seen lawyers voluntarily coming together after former Chief Justice Shirani Bandaranayake was removed in 2013,” Wadood said.

Bandaranayake was impeached by the parliament when she opposed a poverty alleviation bill by current finance minister Basil Rajapaksa when his brother and current prime minister Mahinda Rajapaksa was the president.

Bandaranayake was later reinstated in 2015 under a new government before she retired.

Thursday’s protest came amid continuous suffering by the public who were forced to go from pillar to post to find cooking gas, fuel, and milk powder while the power cut duration was extended to a record 13 hours on that day.

The mismanagement of economic policies have resulted in severe dollar shortage and that has resulted in lack of import of essential goods and fuel.

Wadood, however, said protesters also have a duty to make sure they do not resort to any violence.

“People have the fundamental rights to express their displeasure without crossing the limit. If somebody within the group or a third party is trying to create violence. It’s their duty to prevent such violence.”

The protesters had been demanding Rajapaksa to step down citing he has failed to address the ongoing economic crisis amid queues for fuel and cooking gas as well as nearly half a day power cut on a daily basis. (Colombo/April 2/2022)

ECONOMYNEXT – Sri Lanka’s imports grew 23.1 percent from a year ago to 1,959 billion rupees in January 2022 data showed, with a higher volume of exports and tourism revenues giving more income for people to spend.

Exports grew 17.5 percent to 1,101 million US dollars in January.

Tourism revenues grew 148 million US dollars from just 4 million US dollar, also giving more money for tourism workers to spend on imports.

Analysts had warned that a tourism recovery will not help solve forex troubles which was created by money printed to keep interest rates down and a broken monetary regime (a soft-peg which had lost credibility).

Related

Sri Lanka has to hike rates, tourism recovery will not help end forex crisis: Bellwether

Higher interest rates to stop domestic credit and a float was required. An attempt was made to float the currency in March, which has not succeeded as of April 2022.

Worker remittances fell 61 percent to 259 million dollar.

Remittances are however coming through indirect channels boosting incomes of people allowing them to spend on imports. Imports some of which are not coming in official statistics are also being settled through remittances through Undiyal style unofficial channels.

The trade deficit, a legacy measure which ignores services receipts such as remittances or tourism, 859 million dollars in January, up from 655 million US dollars last.

The trade deficit was expected to grow as soon as tourism resumed.

There was a 36 million US dollar inflows to the stock market, which could also add to the trade deficit if the recipients spent the money, or the government borrowed an spent the money after the sellers of the stocks saved it in a bank.

Foreign direct investment data was not available. However FDI would also add to the trade deficit as the money was spent domestically to build factories or buildings.

The overall balance of payments deficits was 3.9 billion US dollars, around the same as in December.

The government had received 111 million US dollars on loans on a gross basis. A 500 million dollar sovereign bond was paid in January and a 400 million US dollar swap was received to replenish central bank reserves from India.

In order to turn the balance of payments around, reduce imports, the central bank has to raise interest rates to curtail domestic credit and the government has to stop capital projects which are not financed with foreign borrowings. (Colombo/Apr02/2022)

ECONOMYNEXT – Sri Lanka’s power regulator has filed action in Supreme Court seeking 200 million US dollars to generate fuel as the island experiences power cuts of over 12 hours due to forex shortages.

Sri Lanka has a severe forex crisis due to money printed to keep interest rates down, and there is also a capacity deficit after coal plant which was about to be built was axed.

The central bank has run out of forex reserves after two years of money printing triggered excess demand creating balance of payments deficits and reserve losses.

The PUCSL says it has named Ministry of Finance, Secretary to the Treasury, Minister of Power and Energy, Monetary Board of the central bank, Central Bank Governor and Ceylon Electricity Board as respondents.

The regulator says relevant authorities have failed to take advice given since 2016 which would have helped prevent the current power crisis. (Colombo/Apr01/2022)

ECONOMYNEXT – Sri Lanka has to work quickly to establish a clean float and contain defaults on multiple fronts that can be triggered if foreign exchange shortages persist from low policy rates and a deadly surrender requirement.

Sri Lanka economic crisis involving foreign exchange shortages, like in Latin America come primarily from its central bank which is operating an unworkable intermediate regime peg called a ‘flexible exchange rate’, which is neither a clean float nor a hard peg.

A flexible exchange rate fails because it is not rule bound and it can and triggers defaults on multiple fronts by encouraging fiscal excesses (either tax cuts or higher spending or both) because state economists falsely believe that the interest rate can be controlled by printing money.

The unstable peg that brought forex troubles to Sri Lanka was set up in 1950 in the style of a Latin America central bank and its underlying law was changed several times to weaken its anchor further. It was originally set up with a gold anchor targeted at 2.88 grains of gold.

But the anchor was changed after the Fed became a floating rate after the collapse of the Bretton Woods system, creating further instability making it the worst central bank in South Asia, overtaking Pakistan.

After 2015 very aggressive open market operations in the form of call money rate targeting and the post 2020 price ceiling on bond auctions were the final nails in the coffin.

Controls

Soft-pegged central banks, through years of forex shortages has also lobbied and received extensive powers from parliaments to impose controls on the people and avoid raising rates.

However the controls make the crisis worse as the underlying anchor conflict is not dealt with.

Exchange controls are one. When a central bank restricts dollar sales, importers who have to pay demurrage or fear further depreciation are willing to buy dollars at high rates in unofficial markets.

When money is printed to maintain low interest rates or to give salaries to state workers, excess demand for goods are created and inflows of dollars are no longer enough to match the supply.

The central bank was earlier printing money to pay premiums to export workers in a parallel exchange rate, which worsened forex shortages.

The outward pressure and high prices allows Undiyal counter parties in the Middle East or Italy to offer similar high premiums.

The various controls by the central bank and other authorities prevent the market from adapting and lead to a worsening of the exchange rate crisis.

The most damaging control now imposed is a surrender requirement where banks are forced to give 50 percent of the dollars they get from exporters and expat workers to the central bank.

A dollar purchase by the central bank can only be made when a peg is strong, and if the rupee is facing upward pressure due to weak domestic credit. But now the peg has lost credibility. It is a suicidal move to impose a surrender requirement on a peg that has lost credibility.

That is why the float has not taken place. Without a float and further tightening of policy, Sri Lanka’s monetary meltdown will accelerate.

If legislators and others want to turn Sri Lanka into an East Asia, these powers have to be removed and the monetary law changed to radically curb open market operations in the future.

It can be done including through a currency board.

Defaults

With greater reliance on bullet repayment sovereign bonds by the government, cross border and interbank loans and swaps by commercial banks and swaps by the central bank, three types of defaults could happen when forex shortages worsen.

There have been extensive warnings of sovereign default in the belief that the problem is caused by the lack of taxes and a failure to roll-over debt as in Ecuador.

If that was the case the problem will be limited to only to sovereign debt and can be easily solved by a re-structuring to reduce the gross financing need (GFN) in the near term.

But Sri Lanka is not Ecuador which was dollarized at 25,000 Sucre many years ago and no longer suffers peg conflicts. Neither is Sri Lanka Greece which was in a monetary union. Sri Lanka is a Latin America style pre-dollarized flexible exchange rate Ecuador. That is why fuel and power shortages happen. (Sri Lanka is not Greece, it is a Latin America style soft-peg: Bellwether)

Foreign exchange shortages are a result of a lack of a working monetary regime, either a working peg or a working floating rate.

Without a working monetary regime several types of defaults can happen and it is not limited to sovereign default.

a) Sovereign debt repayment is at risk as long as foreign exchange shortages (excess rupee creation) persist.

b) The central bank debt repayment is at risk as long as foreign exchange shortages (excess rupee creation) persist.

This column warned about this before and the IMF has now also made the same warnings in its Article IV report.

Related

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Sri Lanka central bank repayment capacity to IMF under scrutiny

c) State banks are at risk due to debt taken to finance Ceylon Petroleum Corporation as money was printed to trigger currency crises in quick succession over a few years as well as dollar loans.

This column has generally avoided talking about banks but rating agencies have already warned about the sovereign link earlier.

All banks have been struggling due to rating cuts that came as money was printed. Tightening limits are a problem for all banks.

d) SOEs and also private firms who are solvent may find it difficult to find dollars to repay dollar loans even if they are solvent and have rupees.

Rating agencies generally talk about the sovereign ceiling.

If a float is quickly reestablished, some of the fallouts could be contained. Alternately fast-track dollarization could be allowed by allowing dollar recipients to make payments in foreign currency and denominating contract in dollars.

Dollarization

The inability to buy dollars is a problem of jumping from the rupee monetary base of the Central Bank of Sri Lanka to the Federal Reserve’s US dollar monetary base.

Let’s say the CPC needs dollars. A dollar has to be sold by an exporter for rupee (wealth jumps from the US to Sri Lanka monetary base) and the exporters pays the CPC in rupees.

CPC now has to jump back from the rupee monetary base into the US monetary base with US dollars.

Hence the exporter dollar conversion rule makes the problem worse because a given transfer of wealth has to jump from US monetary base and to rupees and back again to dollars.

It can be done easily if the peg is credible or if there is a floating exchange rate. When it dysfunctional it cannot be done.

The short cut is to allow dollarization, also known as a hard exit from a broken flexible exchange rate.

Then the government can also charge taxes and fees in rupees first from hotels and exporters.

Related

Sri Lanka should prepare to float, and promote parallel dollarization: Bellwether

An earlier column has explained how dollarization can be allowed.

Depreciation and Tanzi effect

The ability to repay maturing debt is a primarily a matter of available savings. But when the currency depreciates the value of savings evaporate.

New savings also reduce as prices go up.

Economists talk about the Tanzi effect. The Tanzi effect refers to the fall in the real value of taxes in a hyper inflating economy from the time the taxes fall due and the time the payment is made.

However savings and debt have a similar problem. A fall in currency inflates away real wealth. Economist Steve Hanke has already calculated a higher level of inflation implied by exchange rate movements.

When the currency falls, the ability to repay reduces. That is partly why countries that practice ‘competitive exchange rates’ and depreciate their currencies end up importing capital.

The revenue based fiscal consolidation exercise by rejecting spending based consolidation failed to arrest deficits. This was predicted in the 1960s ago by classical economist B R Shenoy when revenues were over 20 percent of GDP.

When government spending goes up from 17 to 20 percent of GDP under revenue based fiscal consolidation but the deficit does not come down total consumption goes up leaving less savings available to repay domestic or foreign borrowings.

To contain cascading defaults it is essential to end the surrender rule, curtail access to open market operations perhaps by placing quantity limits of access to the central bank window and managing government spending.

When money is printed to maintain low interest rates or to give salaries to state workers, excess demand for goods are created and inflows of dollars are no longer enough to match the supply.

The government giving handouts at this time will not help the poor.

Any handouts must be given only after a working exchange rate regime is established. The float has to succeed or dollarization has to be allowed.

Why default now?

Why is Sri Lanka close to default now if a Latin America style central bank was always there?

Sri Lanka has faced currency crises in the past but no default because there was not much commercial debt. Bi-lateral lenders continue to fund the country in a crisis and did not demand their money back at in a crisis.

Latin American nations, which were basically first world nations before soft pegs were set up in the 20th century and faced severe uncertainty from 1980s after the Fed floated, had always borrowed from commercial markets.

Sri Lanka also started to borrow in commercial markets with a similar soft-peg from around 2005 onwards.

But policy deteriorated rapidly from around 2015. A key deterioration was call money rate targeting.

Sri Lanka was on one track downward spiral when call money rate targeting came with excess liquidity was started.

In 2018 Sri Lanka suffered a currency crisis despite budget deficits being brought down.

In 2019 this column warned that Sri Lanka was running out of rating space to print money and operate a flexible exchange rate regime and further downgrades would occur.

Related

Sri Lanka needs monetary discipline to avoid further downgrades: Bellwether

Sri Lanka’s Weimar Republic factor is inviting dollar sovereign default: Bellwether

Single Anchor Regimes

In order to have strong exchange rate a monetary regime must have one anchor only.

A single anchor monetary regime involving a clean floating exchange rate is used by all developed nations.

Successful East Asian nations like Hong Kong use a single external anchor or exchange rate target, and interest rates float.

Depreciating or failing regimes like in Sri Lanka, Latin America and Africa try to juggle with both domestic and external anchors (flexible exchange rates or dual anchor conflicting regimes) and collapse because neither the exchange rate nor interest rates true float.

A flexible exchange rate can collapse and trigger defaults independent of financing fiscal excesses such as in the case of many Latin America defaults.

In countries with failing exchange rate regimes there is almost a religious fear of hard pegs and also true floats. Economists have labeled this ‘fear of floating’.

The experience of the Russian Ruble is a case in point. As this columnist said at the time the ban on the use of forex reserves by the West in their ignorance was a lifeline. And the lady is a champ.

Relate

Sri Lanka rupee appreciates against Ruble, Bank of Russia may clean float

Intermediate regime countries keep going back to IMF. That is because the IMF programs do not end in a hard peg or a true float but yet another permutation of an unstable intermediate regime. (Colombo/Apr01/2022)

ECONOMYNEXT – Sri Lanka’s Institute of Policy Studies, has analysed the advantages of a currency board (an unbreakable fixed exchange rate) as well as its supposed disadvantages, but also repeated a false claim that Argentina at one time had a currency board.

Mercantilists usually oppose currency boards because they cannot depreciate the currency and tilt the playing field towards producers by at the expense of the real wages of workers, pensions of old people and savings of a society.

An IPS researcher in an analysis said a currency board can have short term benefits.

“A currency board will be helpful to stabilise inflation in the short run but in the long run, Sri Lanka will be better off with a more flexible exchange rate regime,” the analysis claimed.

There are a number of stock criticisms made about currency boards made by Western interventionists who lack knowledge of the institutional arrangement of a currency board as well as the process of monetary anchoring to keep inflation down.

What is a currency board?

It is helpful to know what a currency board is.

A currency board is a consistent, neutral policy monetary regime with a single anchor, which for all practical purposes behaves exactly like dollarization, which is the use of a strong foreign currency within a country.

If people wish there can be one or more currency board moneys circulated in a country. The Fed is about to legalize Tether cryptocurrencies which are supposed to behave like a currency board, though balance sheet data is not available to confirm it.

An American Express Travellers cheque operates exactly like a currency board.

Both floating exchange rates and currency boards are consistent regimes which have a single non-conflicting anchor.

A floating exchange rate has has no foreign reserves and the monetary base (the currency notes in use within the country) is determined by an inflation index (a domestic anchor).

A fixed exchange rate or currency board has floating rate interest rates and the monetary base is determined by the balance of payments (an external anchor).

In the gold standard days and the Bretton Woods periods, currencies did not depreciate against each other because they all had the same anchor – gold. The rupee for was a silver currency until the Reserve Bank of India went to gold.

Regimes with anchor conflicts

Intermediate regimes or flexible exchange rates, are systems that collect forex reserves (targets the exchange rate), but also print money to target an inflation index (domestic anchor).

When inflationary policy followed (money is printed when domestic credit expands) the flexible exchange rate collapses.

Sri Lanka abolished its currency board regime and an intermediate regime was externally imposed in 1950 amid US attempts to break the Sterling Area, according to critics.

The peg made the island a top customer of the International Monetary Fund and there were steep economic downturns whenever the US tightened policy and the currency fell.

Up to the collapse of the Bretton Woods, soft-pegs including in Latin America did not break as much as they did after 1980s, as the current Mercantilist competitive exchange rates mantra was not so prevalent in Western interventionist circles, analysts say say.

The Bretton Woods was set up in part to prevent competitive devaluation.

Discrimination against the voiceless

In the early 1980s Washington based Mercantilists such as John Williamson started to advocate a so called basket, band, crawl (BBC) policy of depreciating currencies who apparently had no knowledge about anchoring money.

Read Interview by the Centre for Financial Stability Washington-consensus-John_Williamson_Interview

Competitive exchange rates destroy the basis of society by giving zero-sum profits to producers of goods against the well-being of workers, pensioners and savers generally.

Competitive exchange rates undermines a concept known as sound money which does not discriminate between various individuals and economic sectors at the expense of weaker sections of society who have no voice.

Though such ideologies were develped in Washington to solve Latin America collapses, developing countries also became victims to the social unrest and out migration that comes with depreciation.

The anchor conflicting flexible exchange rate has now brought Sri Lanka near to default.

Using the flexible exchanges, interventionists, used monetary policy (and fiscal policy) for stimulus, which cannot be done in a reserve collecting regime without creating a balance of payments trouble (Why Singapore chose a Currency Board).

Significant public opposition is now building up against the 1980s Mercantilism following the repeated of failure of the intermediate regime and real pain people suffer from deprecation as opposed to the supposed pains of ‘internal devaluation’ as claimed by Western armchair Mercantilists who do not earn or save in depreciating currencies but are protected by single anchor floating rates.

The price of monetary policy independence

Whether Sri Lanka has used its supposed monetary independence to counter US tightening successfully, without creating economic mayhem as claimed by interventionists is something that people can easily decide for themselves by a cursory examination of history.

When the US tightens, Sri Lanka suffers forex shortages if central bank prints money to cut rates.

One of the biggest costs of such flexible exchange rates or intermediate regimes in addition to inflation is the stifling of free trade.

Exchange and trade controls follow whether or not the currency is depreciated as forex shortages emerge from the anchor conflicts, fattening the pockets of import substitution oligarchs who claim that forex shortages can be eliminated by picking the pockets of consumers under tax protection.

“In sum it was a story of tightening partial relaxing, and again tightening the trade regime and associated areas to over a perceived foreign exchange crisis,” writes Saman Kelegama, one of Sri Lanka’s most humane economists who wanted free trade for the poor, in ‘Development in Independent Sri Lanka what went wrong’.

“In the early 1960s strategy for dealing with the foreign exchange crisis was the gradual isolation of the economy from external market forces.

“It was the beginning of a standard import-substitution industrial regime with all the controls and restrictions associated with such a regime.”

In a hard or consistent peg, there is free trade. Monetary policy tightens automatically as US tightens and then loosens and excess liquidity builds up as domestic credit falls, and there are no forex shortages.

Sri Lanka’s recent currency crises occurred in 2015/2016 (following Yellen quantity tightening in 2014) and 2018 (Yellen quantity tightening and rate hikes), which led to political instability as the currency fell an output shocks as reserves were rebuilt.

From 2015 to 2019 the currency collapsed from 131 to 182 in two cycles.

To get out of the resulting crises after ‘monetary policy independence’, a flexible exchange rate country not only has to slow the economy sharply to restore stability but also has to re-build reserves under an IMF program creating a prolonged slowdown.

In a currency board or dollarization if socialist policies lead to default, the fallout is contained in sovereign debt. In a flexible exchange rate, with depreciation it spreads to banks and private firms and also people whose savings evaporate.

Fast Recovery

In a dollar currency board, there is no requirement to re-build reserves at the cost of an 18 month downturn as they are not depleted in the first place but the economy initially slows as the US tightens.

In a currency board due to the lack of floor policy rate, recovery would be quicker than if reserves had to be re-built.

In fact the danger could be a too-fast recovery and a property bubble as the IPS analysis acknowledges and not a prolonged downturn under an IMF program as in a flexible exchange rate with anchor conflicts.

In a currency board regime, banking systems do not usually collapse even if US banks collapse (in part due to the inability to over-trade without open market operations) helping the economy recover faster.

Sri Lanka now has to severely squeeze the economy to prevent a system wide meltdown following stimulus or independent monetary allowed to economists under a flexible exchange rate, even as the US begins its tightening cycle.

Flexible exchange rate regimes that try to engage in independent monetary policy, with foreign commercial debt also end up in sovereign default.

In the 2018 cycle, Sri Lanka cut rates and the currency collapsed and earning lower ratings, while Argentina collapsed and defaulted.

In the 2020/2021/2022 ‘independent monetary policy’ cycle Sri Lanka is heading for default and severe tightening is required due to exercising monetary policy independence. And the rupee has already collapsed steeply in a flexible exchange rate and a float has not been established.

In 1994, Mexico which was running a budget surplus, collapsed due to the flexible exchange rate and defaulted. Mexico was made to run an even bigger budget surplus under the IMF program on top of a steeply depreciated currency.

Argentina False Claim

Meanwhile the IPS analysis repeated a false claim made by Western media that Argentina had a ‘currency board’ up to 2000.

A key feature in a currency board is that foreign exchange interventions are unsterilized and foreign reserves match the monetary base at all times.

Reserves cannot fall below 100 percent of reserve money since interventions cannot be sterilized to keep overnight rates down.

In a currency board, foreign reserves and the monetary base moves lock-step (reserve pass through to the domestic monetary base is one to one).

Under a currency board, foreign reserves usually exceed the monetary base by only 10 percent (from profits of note issue) and any excess reserves are transferred to the government by the governing law.

Currency boards are similar to dollarization (using a foreign currency) except that there are no profits from note issue.

Such profits, annually transferred, can be externally invested to build a bank bailout fund or sovereign wealth fund to spend in a downturn.

Banco Central de la República Argentina law allowed foreign reserves to fall far below 100 percent of the monetary base and the peg collapsed amid sterilized interventions.

Read A MONETARY CONSTITUTION FOR ARGENTINA – A-monetary-constitution-for-Argentina

The BCRA was also allowed to hold government dollar denominated bonds similar to Sri Lanka Development Bonds.

Prior to fall of the convertible peso, the so-called ‘currency board’ had collected reserves over 190 percent of the monetary base and fell to 80 percent, which is impossible under a real currency board which cannot sterilize interventions.

Whether or not a regime is a currency board or not can only determined by analyzing its balance sheet as soft-pegs can be stable for long periods as long as deflationary policy is followed like China from 1993 to 2005.

Flexible Exchange Rate, Flexible Inflation Targeting Peso also collapses

In 2018, Argentina which had operated a ‘flexible exchange rate’ and ‘flexible inflation targeting’ at an unfunny 17 percent, again collapsed and defaulted similar to the so-called ‘currency board’ period.

The IPS also claimed that “flexibility of labour markets is a key to the sustainability of currency boards.”

However in all pegged East Asian nations real wages have risen along with productivity growth, usually in export sectors. In some fixed exchange regimes (dollarized Panama) it was the financial sector, that drove up real wages.

Other counties including Cambodia and several former Latin America flexible exchange rates, which collapsed steeply are also dollarized.

The original Ceylon currency board was one-to-one with India rupee. Bhutan still operates its peg one to one with India rupee which has not broken.

The requirement to maintain a peg is not the budget or labour laws, but the lack of aggressive open market operations and a the outlawing of sterilized interventions.

A currency board country without crises and depreciation usually grow steadily and generate employment beyond 100 percent and attract foreign labour. Guest workers sometime leave when there is a downturn in the anchor currency nation.

However when a flexible exchange rate collapses under US tightening, resident workers lose jobs and expat workers who had gone to work in consistent pegs areas like GCC nations may also return home.

The IPS analysis is reproduced below:

Currency Board: A Solution to Sri Lanka’s Economic Crisis?

By Asanka Wijesinghe

On 08 March, Sri Lanka devalued the rupee against the US dollar, entering into a floating exchange rate regime. The Central Bank of Sri Lanka had to abandon the pegged exchange rate as defending the rupee with dwindling reserves was impossible. The inter-bank exchange rate shot up once the banks were assured that the exchange rate was floated. The initial shoot-up was followed by further rallying of the US dollar reaching close to Rs. 300 per USD. With the gradually weakening rupee, inflation is also ascending to worrisome levels calling for radical changes, including adopting a currency board. This article discusses the effectiveness and suitability of a currency board for Sri Lanka in the current macroeconomic context.

Weakening Rupee, Rising inflation, and the Currency Board Solution

A currency board is a system that issues domestic banknotes in exchange for specific foreign currency – anchor currency like the USD which is used for trade with partner countries – at a constant rate. A cornerstone of the currency board mechanism is the authority’s ability to meet all demand for foreign currency by the holders of the domestic currency.

In Sri Lanka, even after the rupee was floated, reports suggest that an active kerb market with a significant premium above the inter-bank rate exists. While such market behaviour indicates an acute dollar shortage in the market and the equilibrium rate is further away, no official data exists on the kerb market money exchange. However, cryptocurrency platforms provide some critical insights. The Tether coin (USDT), which is closely pegged to the US dollar on a one-to-one basis, is traded for rupees on peer-to-peer (P2P) platforms as USDT is used as a medium to purchase other cryptocurrencies, including Bitcoin.

Data extracted from the P2P platform medium of Binance – a popular cryptocurrency exchange among Sri Lankans- show some supporting evidence for the continually widening gap between official and informal rates again. Significantly, the premium over the official rate plummeted once the rupee was floated, but it gradually recovered to the pre-floated period (A and B panels of Figure 1). The number of sellers and the USDT volume available for sale also went up but riveted back to the levels of the pre-floated period (C and D panels of Figure 1).

The inflationary pressure also does not show any unwinding signs, further eroding people’s purchasing power. These developments encourage the adoption of a currency board as a currency board is believed to be a solution for rising inflation. By the inner mechanics of the currency boards, the independence of discretionary monetary policy is taken away, substituting a disciplined monetary policy – a gold standard without gold – which eliminates the inflationary bias. Indeed, empirical evidence exists in favour of the anti-inflationary effect of currency boards. The inflation rate is lower under currency boards than in pegged or floating rate regimes. Moreover, economies under currency boards grew faster than the average of countries with pegged regimes. However, empirically disentangling multiple influences to pinpoint the low inflation on the currency board is an excruciating task.

Another selling point of the currency board is the fiscal discipline, as currency board regulations prohibit direct monetary financing of government expenditures. A high budget deficit in Sri Lanka and excessive government borrowings from the Central Bank make the fiscal-discipline effect of currency boards much more appealing. Empirical evidence points to low fiscal deficits or larger surpluses under currency board regimes.

Figure 1: Behaviour of USDT Market in P2P Binance Trading Platform

Source: Author’s illustration using Binance data

Challenges in Adopting a Currency Board

A significant drawback of a currency board is the need to surrender the monetary policy independence required for managing asymmetric shocks. Such loss is costly when the anchor currency country responds to cyclical conditions, which are different from the prevailing conditions in the country operating the currency board.

For example, Hong Kong’s currency board imported low-interest rates from the US in the early 1990s. Such monetary easing was appropriate for the US, but Hong Kong faced an asset price boom that called for monetary tightening. A counterargument against the negative impact of losing monetary policy is the availability of fiscal policy at the operating country’s disposal. However, the maneuverability of fiscal policy is determined by the fiscal and debt positions.

In Sri Lanka’s context, the high debt to GDP ratio and fiscal deficits might restrict the use of fiscal policy for pump-priming-stimulating the economy in a recessionary period- due to the fear of losing investor confidence in debt sustainability. Thus, international evidence shows that countries with hard pegged exchange rate regimes generally tighten their fiscal policy in a recession. The Argentinian attempts to bring down the deficit in a recession in 2000 proved to be disastrous.

Sri Lanka’s high indebtedness will also challenge installing a currency board. Once a threat of a possible default looms, the interest rates soar, and refinancing debt will be increasingly difficult. In addition, the operating country needs reserves to back the monetary base in a currency board. In a currency board, the board must continually convert domestic currency for the anchor currency at a constant rate.

It should be noted that the reserve level of Sri Lanka has dwindled over time in the recent past. Another drawback of currency boards is the requirement of real sector changes to compensate for the exchange rate deviations.

For example, if the anchor currency appreciates against Sri Lanka’s main trading partners, wages should fall to compensate for the increase in foreign consumer prices, restoring competitiveness. Such an exercise needs greater flexibility in the labour markets. Thus, the flexibility of labour markets is a key to the sustainability of currency boards. The political feasibility of the institutional attempts to ease labour market regulations is highly doubtful.

Against this backdrop, the decision to install a currency board should be taken after a careful cost-benefit analysis. A currency board will be helpful to stabilise inflation in the short run but in the long run, Sri Lanka will be better off with a more flexible exchange rate regime. In addition, the benefits of a currency board are not exclusive. For example, fiscal discipline should be stronger in flexible exchange rate regimes as fiscal policy effects are reflected immediately and more transparently.

Thus, if Sri Lanka enters into a currency board to stabilise inflation and domestic currency, it needs to contemplate an exit strategy. Generally, it is advisable to leave a currency board when the economy recovers. The requirement to surrender monetary independence and the inability to finance government expenditure under a currency board might reduce the political preference for such a system.

ECONOMYNEXT – Power cuts of up to 12 hours in some areas in Sri Lanka have been approved for Friday (01), Public Utilities Commission Chairman Janaka Ratnayake said as a flexible exchange regime created severe foreign exchange shortages and power deficits in the dry season.

Areas A, B, C, D, E, F, P, Q, R, and S will see two hours of power outages from 4am to 6am, four hours from 8am to 12pm and six hours from 4pm to 10pm.

Areas G, H, I, J, K, L, T, U, V, and W will experience two-hour power cuts from 6am to 8am, four hours from 12pm to 4pm and six hours from 6 pm to 12am.

Areas M, N, O, X, Y, and Z, however, will lose power only for 5.5 hours, with a 3.5-hour interruption from 5.30am to 9am and a two-hour cut from 4pm to 6pm.

Areas in the CC group will have a 3.5-hour power cut from 6am to 9am.

Download the power cut schedule for April 01.

Though the government has said the duration of the power cuts will be reduced gradually, it has been extended mainly due to lack of fuel amid severe shortage of US dollars for imports.

The lack of fuel has also resulted in long queues for diesel and petrol despite record price hikes. (Colombo/Mar31/2022)

ECONOMYNEXT – Sri Lanka’s State Pharmaceuticals Corporation (SPC) has called tenders from Indian medical suppliers for medicine purchase through an Indian credit line in order to fill a gap of medical supplies in the state health sector, an SPC official said.

SPC General Manager Dinusha Dassanayake told EconomyNext on Thursday (31) that tenders were called on Thursday and SPC will take the necessary steps after considering the bids offered by the suppliers.

“The Medical Supply Division sent us a list of medicines they need to get in order to close the supply gap we have in the country at the moment due to the current situation,” said Dassanayake.

“Since this is through the Indian credit line, one condition they had was that the medicine that we import be of Indian origin. So we placed a condition when calling bids that only Indian suppliers may  apply.

“Once we have received all the tenders, we will evaluate them and finalise our orders,” he said.

From the one billion US dollar credit line from India, 200 million USD is to purchase medical supplies.

Sri Lanka is currently in the midst of a severe forex shortage which has hampered imports including essentials such as medicines.

State Minister of Pharmaceutical Production, Supply and Regulation, Channa Jayasumana in a Facebook post said on Thursday that, under the Indian credit line, Sri Lanka has been given a limited time to purchase the medicine.

“Medicines can be bought only by Indian suppliers. They will have the opportunity to open letters of credit (LC) for tender-approved items after the procurement process. That way, only 40 drugs were included,” said Jayasumana.

Jayasumana added that Sri Lanka’s state health sector needs about 1,500 medicines and 3,000 surgical/medical equipment.

“Almost 80 percent of imported medicines are from India anyway. The Medical Supply Unit (MSD, set up a list of essential medicines and surgical equipment for the next year as soon as it became aware that medicines can be available under Indian loan,” he said.

“The relevant payment will be directly done by the State Bank of India (SBI) after sending the list to Indian officials upon selection of suitable suppliers among them. This is going to be done in Indian rupees. The sooner this process is over the sooner we get the medicines. We have been given a limited time range for that,” said the state minister.

Several state-owned hospitals in Sri Lanka were forced to temporarily stop routine surgeries due to a shortage of medicines. Hospital management had informed staff to use the available medicines only in emergency cases till the supply was recovered.

“Private sector suppliers are not in a position to import the medicine ordered last year as it was difficult to open loan letters due to the dollar shortage. If we don’t take advantage of this opportunity to get our medicines for the country when we get US dollars and other foreign currency, we will be in a severe drug crisis in the next few months,” Jayasumana warned.

Private sector condition is worsening

Meanwhile, an industry representative from the private medicine supply sector told EconomyNext that conditions are worsening for private sector importers. He said even the National Medicine Regulatory Authority had authorised a price increase of medicine by 29 percent earlier this month, and private sector supply is down by about 30 at present at the moment.

“The situation is much worse now than when we explained it earlier this month. The banks do not entertain any LC  applications and ask for credit for up to 180 days for both LCs and documents against acceptance documents. In the absence of any forward booking mechanism, who knows what the rupee will be against the USD in 180 days? How do you cost your shipments?” the source told EconomyNext.

He added that many products are out of stock in both the state and private health sectors.

“The last price increase by a whopping 29 percent was when the US dollar reached 260 rupees. The official rate is over 300 now and the unofficial crossed the 400 mark today,” the source said.

He said the situation will get much worse for supplies, and  the industry anticipates most essential price controlled items will be in short supply as the importers are incurring losses on their sale.

Commenting on the tender calls for Indian suppliers under the Indian credit line, he said it is a ray of hope to control the situation.

“The first tenders are being called on Thursday (31). With a 25 percent performance bond, many established companies are reluctant to participate and supply under this scheme.  As the NMRA registration requirement is likely to be waived for this supply, it is mostly the lower end opportunists that are likely to supply,” he said.

The source said the government’s opinion of the local manufacturer is somehow the solution to this problem without realising that local value addition in pharmaceuticals is low as active pharmaceutical ingredients, buffering agents, excipients, machine tools, packaging even most often technical staff all have to come from abroad.

“So the impact of the shortage of foreign currency will affect availability anyway,” he said.

The NMRA was delaying registration and reregistration of drugs, further contributing to supply disruptions in addition to price controls

“The pricing committee consisting of pharmacists completely untrained in pricing matters is seeking prices lower than the gazette price and are holding up registrations,” the source said.

“They have limited the number of registrations to a given molecule to 15, severely limiting competition as a couple of major importer companies account for about 10 of the suppliers,” he added.

He said the registration of new molecules where the number of suppliers are limited is slow, owing to manipulations within the NMRA. Therefore, the prices remain high for these items.

“If there ever was a pharmaceutical mafia, it’s alive and kicking inside the NMRA itself and sadly the outlook for the patients is dire,” he went on to say.

“The Indian line of credit is about a month’s supply. It will be mostly utilized by the state sector. Not much of a help where annual requirement is concerned, but a welcome relief given the situation,” he added. (Colombo/Mar31/2022)

ECONOMYNEXT – Peo TV, Sri Lanka Telecom’s internet protocol television (IPTV) service, has taken three international sports channels off its network citing difficulties in making payments for the service providers in US dollars, officials said.

Three channels owned by the Indian multinational Star Sports network have not been on air on Peo TV from Monday (28) due to payment difficulties, a Sri Lanka Telecom (SLT) official told Economy Next on Thursday (31).

SLT is Sri Lanka’s national telecommunications provider, with the government owning 50.5 percent of the company.

“A few channels aren’t being aired because we are unable to make some of the payments. However, we are working with the bank to get this problem solved. It will most likely be resolved by today or tomorrow,” the official said.

There are issues with remitting payments and restrictions revolving around payments and that is the only barrier in providing the service to consumers, the official said.

The privately owned Dialog Axiata Plc, however, has so far not experienced such issues, a spokesperson said.

Sri Lanka is facing a severe dollar shortage amid a debt crisis, as indiscriminate money printing and dwindling forex reserves take a toll on the island. (Colombo/Mar31/2022)

ECONOMYNEXT – Sri Lanka’s stock index plunged over 7 percent despite the trading was halted twice on Wednesday (30) as on-going economic crisis and extended power cuts prompted heavy selling amid margin calls, brokers said.

The main All Share Price Index (ASPI), however, recovered to close 3.66 percent or 352.66 points lower at 9,294.89, its lowest since September 27. It lost over 700 points during the day.

“All the possible negative factors in the market played a role in today’s plunge,” a market analyst said.

S&P SL20 of the most liquid stocks ended 4.25 percent or 141.84 points lower to 3,196.19 points. It nosed dived over 9 percent triggering two market halts.

On Wednesday, the country saw a 10-hour power cut despite officials assuring no lengthy power cut. The duration of power cuts has been further increased to 13 hours for Thursday (31). Analysts say power cuts and lack of fuel hurt the listed companies across the board though manufacturing firms are hut hard.

Analysts had cautioned that if the market falls below 10,000 mark there would be a spiral effect, creating a downward trend.

Analysts said many investors are still concerned over how the government is going to face the mounting debt as they are not still confident if it would really go to the IMF or drag the decision of seeking IMF help.

The day’s turnover was 3.29 billion rupees, around two-third of this year’s average daily turnover of 5.0 billion rupees.

Analysts said investors are trying to shift their savings to hedge against the rupee fall and inflation, which is at a record high and more than 5 percent higher than one-year Treasury bill yield. Brokers said investors opt for stocks to hedge against inflation.

Sri Lanka’s rupee has fallen over 60 percent since it was allowed flexibility on March 07.

All commodity prices in Sri Lanka have been on the rise due to the currency fall.

Rising oil prices, policy rate hikes, a slowing economy, and shortage of dollars, fuel, and cooking gas along with extended power cuts continues to dampen the sentiment.

The market has lost 19.7 percent so far in March after falling 11 percent in the previous month. Overall the market has lost 23.9 percent so far this year after being one of the world’s best stock markets with an 80 percent return last year.

Foreign investors bucked the trend and bought a net 367.9 million rupees worth of shares. However, the market has witnessed a total foreign outflow of 2 billion rupees so far this year.

Expolanka, LOLC Holdings and Hayleys dragged the index down on Wednesday.

Shares in LOLC Holdings fell 7.6 percent to close at 645.25 rupees a share, Hayleys fell 9.5 percent to close at 80.20 rupees a share while Expolanka plunged 9.1 percent to close at 223 rupees a share. (Colombo/March30/2022)

ECONOMYNEXT – Sri Lanka’s state-run Ceylon Electricity Board (CEB) has imposed up to 13-hour power cut for Thursday (31) as acute diesel shortage has compelled the utility provider to increase the duration of power cuts from the previous day’s 10 hours.

The CEB has decided to cut power from 12am to 8am for the first time in the ongoing power crisis.

Areas ABCDEF and PQRS will see 3 hours of power cut from 3am to 6am, 4 hours from 12pm to 4pm and 6 hours from 6pm to 12am.

Areas GHIJKL and TUVW will experience 3-hour power cut from 12am to 3am, 4 hours from 8am to 12pm and 6 hours from 4 pm to 10pm.

Areas MNOXYZ, however, will witness only 5.5-hour power cut – 3.5-hour interruption from 5.30am to 9am and 2 hours from 4pm to 6pm.

Download the power cut schedule for March 30 from

Though the government has said the duration of the power cuts will be reduced gradually, the power cut has been extended mainly due to lack of fuel amid severe shortage of US dollars.

The lack of fuel also has resulted in large queues for diesel and petrol despite record price hikes. (Colombo/ March 30/2022)