Attracting foreign exchange: Are we on the right track?

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

By Dhananath Fernando

What should be our mandate for the coming Sinhala and Tamil New Year? We have to be psychologically prepared to work harder and develop the ability to drive and lead in the best of times as well as the worst of times that are about to dawn on the horizon. Amidst the COVID-19 battle and a quarantined Sinhala and Tamil New Year, the recent figures by the Department of Census and Statistics indicate that our per capita GDP for the year 2019 (which is a reasonable measure to evaluate the standard of living) is at $ 3,852 per annum, a drop from $ 4,079 in 2018 (In USD terms, this is a 5.5% drop compared to 2018 and a 3.9% increase in LKR terms). In 2015, our GDP per capita was $ 3,842. In USD terms, we have pretty much slipped to where we were five years before.

Just to bring our performance into perspective, Japan’s GDP per capita is around $40,000. The standard of living in Japan is 10x as Sri Lanka. Our GDP growth rate is estimated to be at 2.3%, another 0.3% drop from the initial estimation of 2.6%. What this means is Sri Lanka will take 30 years to double our living standard if we are to move at this pace. And even then, we will be falling 5x behind Japan’s present standard of living. We are heading towards a difficult and challenging time period with a bad start. We can overcome this only by working together locally and forging partnerships globally. We have to find opportunities in this crisis and navigate by adding more value to our goods and services which the global market seeks. Our mandate in this New Year should be to be competitive, serve market opportunities, and capitalise on the limited opportunities before us. However, this is easier said than done. In this context, the decisions we make and the messages we push will determine where we are heading towards and the fate that awaits us in the not-so-distant future.

Measures by the Central Bank

It is no secret that Sri Lanka requires foreign exchange to pay back our import bills and the loans that we have taken. We import almost double what we export, hence the balance in the current account – or in common man’s term, imports exceed our exports. This trade deficit has to be narrowed, and this is the challenge. Over the years, instead of implementing the required reforms to make our exports more competitive and to close the gap, our constant strategy has been curbing imports to narrow the trade deficit. Today, we have arrived at the point of no return. With little growth in exports and debt beyond our means, the Sri Lankan taxpayer has racked up debt of about $ 16 billion payable by 2023. The Government took to implementing a futile policy of banning the importation of non-essentials including vehicles. Our rupee has depreciated nearly 70% over the past decade. On 8 April 2020, the Sri Lankan rupee passed 200 against the dollar. Given the ongoing crisis, we are left with few options to save precious foreign reserves as raising money from the market at the present risk premium is almost impossible. However, data indicates that the Central Bank continues with quantitative easing – printing money or adding more money into our financial system – which is the main reason for our currency to depreciate. On 24 February 2020, the Central Bank of Sri Lanka made a Rs. 24 billion profit transfer; on 13 March, the Central Bank injected Rs. 50 billion by buying government securities; and on 17 March, the Statutory Reserve Ratio (SRR) was brought down to 4% from 5%, which injected a further Rs. 50 billion to the Sri Lankan economy. The meaning of the statutory rate cut is that all licensed commercial banks earlier had to maintain a mandatory reserve of 5% of their total deposits with the regulator (deposit liabilities), but now have to maintain only 4%. This money will most likely be utilised towards relief measures provided by the Government. As we continuously highlighted in this column, the Yahapanala Government made the same mistake of imposing import controls and providing cash injections to the system, which resulted in the rapid depreciation of the rupee. The value of the rupee is a market function and trying to distort (it) by intervention is not advisable. In this case, with the devaluation of our rupee, the prices of food and medicine will go up, thereby increasing poverty levels.

Appealing for foreign currency deposits

On 2 April 2020, the Governor of the Central Bank appealed to domestic and international well-wishers on behalf of the Government of the Democratic Socialist Republic of Sri Lanka to deposit foreign exchange into Sri Lankan banks with an assurance that no questions would be asked on the financial trail of the funds. In the appeal, the Governor of the Central Bank mentioned that the money would be accepted without any hindrance from the Central Bank and the banking system and will be exempted from exchange control regulations and taxes for three months from 2 April 2020 onwards. At the point of writing this article, the Central Bank has not published further guidelines; only the statement by the Governor is available. However, it is of paramount importance that these measures do not impact Sri Lanka’s ratings by rating agencies as this would further erode our capacity to work with international donor agencies and financial markets. We have to be cautious not to open space for money laundering while we take decisions at this serious moment to attract more foreign currency. As a result of the serious efforts by the Central Bank of Sri Lanka, we were delisted in the grey list of the Financial Action Task Force (FATF) in October 2019. The FATF is the global policy setter on anti-money laundering and countering the financing of terrorism. A delisting from the FATF grey list is a positive indication to the market to attract quality investments which look for a credible financial system. At the same time, we have to be vigilant not to breach the code of conduct and ethical guidelines of international donor agencies, as there is a high possibility of Sri Lanka knocking on their door as a fallback option. In 2001/2002, a similar tax amnesty scheme was brought by then Minister of Finance K.N. Choksy and the proposal was reversed soon after the new Government was elected in 2004. There are no short-term solutions to mitigating long-term macro issues. Time and time again, it has been proven that curbing imports is not the solution and monetary prudence is the way to stabilise the rupee. The motivation behind these measures is understandable as our foreign exchange income is very tight, but in this new Sinhala and Tamil New Year, we must ensure the cure is not worse than the illness.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.