ECONOMYNEXT – Sri Lankan business leaders have said business activities have been disrupted by currency shortages from an unreliable 200-per-US dollar peg to which the central bank no longer offers full convertibility.
The partial suspension of convertibility led to parallel markets of 240 per US dollar in the edge market and for Hawala remittances.
The central bank continues to print money to maintain a 6.0% policy rate, including after donating a limited amount of dollars for oil and drugs, creating a wedge between inflows and outflows.
“The gap between the informal market rate and the official rate has resulted in a shortage of dollars,” Krishan Balendra, chairman of John Keells Holdings PLC, said at a business forum hosted by the Ceylon Chamber of Commerce in Sri Lanka, the Sri Lanka Economic Summit 2021.
“The dollar shortage is obviously having an effect on businesses, whether they are importing materials for large construction projects or for import trade activities, and certain restrictions have disrupted businesses as well.”
Authorities have already checked a number of imports, including cars, but imports exceeded pre-pandemic levels until July as large volumes of money were printed due to price controls bond auctions, which have since been phased out.
The growing gap between the central bank rate and gray market rates has already reduced remittances as many Sri Lankan expatriate workers have shifted to informal hawala and other unofficial channels.
The central bank itself launched a Christmas side market at 210 for remittances in December.
Market analysts also claim that exporters have started to use some loopholes not to bring dollars into the country as they face the risk of a sharp depreciation.
“If you want to recover, you cannot occupy this position,” said Kasturi Chellaraja Wilson, CEO of Hemas Holdings group.
When a central bank falls into the trap of sterilization (intervening and filling liquidity shortages to maintain the policy rate), a float in the currency will result in a complete suspension of convertibility (no intervention) ending the liquidity injections and the currency will stabilize at a lower level.
Mercantilists generally say that currency parities break because they are “overvalued” and not because of injections of liquidity from open market operations.
However, Sri Lanka’s real effective exchange rate is now below 100. The REER is a purely mercantilist (trade-based) measure.
However, central bank governor Ajith Nivard Cabraal said there was no need for depreciation.
“Our view is that the rupee is already depreciated,” Cabraal said at a press conference on Saturday.
“We don’t want to belittle ourselves anymore. We don’t want to go into an auction with the hawala people.
However, with the anchor’s credibility broken and the agency running out of reserves to provide convertibility, it is difficult to enforce the anchor, analysts said.
The central bank launched a pension auction to withdraw money last week. However, due to the lack of credibility of the peg at 200 against the US dollar, there is no spot forex market. A float will reactivate the spot market, however. (Colombo / Dec06 / 2021)