Originally appeared on The Morning.
By Dhananath Fernando
At a recent press conference, the Central Bank of Sri Lanka (CBSL) announced that importing goods through open accounts was going to be banned as a move to curb the money transfer through undiyal and hawala. In my view, this will have a negative impact on the supply of essential food items, drugs, and some raw materials.
When a merchant imports goods, they can pay their supplier through a letter of credit. A letter of credit is simply a letter of guarantee by a bank or a financial institution to the supplier/seller that the correct amount will be paid in full on time. To open a letter of credit, the Sri Lankan importers should be able to buy foreign exchange or simply purchase US Dollars. But as we are all aware, all Sri Lankan banks have a drastic shortage of foreign exchange. The shortage is of such severity that we can’t import essentials, and in some cases even life saving drugs.
In the case of imports, if the buyer and the seller have mutual trust, a letter of credit is not mandatory. They can settle on a credit basis later on. The goods will be cleared on Documents against Payments (DP) or Documents against Acceptance (DA). Most importers and their buyers/suppliers have long-standing business relationships. They pay later either through different modes including hawala and undiyal. This is no secret. They pay an additional charge for hawala and undiyal to buy USD for a reason, which is simply that our banks don’t have sufficient dollars to facilitate imports even if the importer requests the opening of a letter of credit. Otherwise, no businessman would want to pay a higher price for forex if there were cheaper options available. Especially in the areas of food, medicine, essentials, and raw materials, these open account transactions are common. According to a recent news report, approximately $ 1.6-1.8 billion worth of transactions are done on open accounts every month.
So what could happen when the Central Bank forces these importers to conduct transactions only through letters of credit? Simply put, they may not have any option other than to stop importing. Because banks don’t have USD, they can’t even import on open accounts to settle later. The Central Bank expects more USD to flow into formal channels since the demand for USD through undiyal and hawala is set to decline with the new regulation banning open accounts. Even if the Central Bank’s assumption is right, it won’t happen overnight. Given the uncertainty, importers will either hold or slow down the imports to observe the situation. It will take a few months to settle even if all USD inflows started flowing through official channels. What would happen to our essential food items, certain raw materials for businesses, and drugs during those long months?
However, so far the Gazette notification has not been issued by the Central Bank, and we have to wait and observe the situation in the next few months.
It is not the first time the Central Bank has burnt its fingers by unnecessary attempts to control the market.
First, the Central Bank imposed a 100% cash margin requirement on vehicle imports in 2018 and later vehicle importation was banned completely (1).
Later, the Central Bank’s 100% cash margin requirement on selected imports categorised as non-essentials was extended from vehicles to many other imports (2). This column questioned how an officer decides what is essential and what is not essential. A digital camera may not be considered an essential by a writer or a banker, but a camera is an essential to a wedding photographer whose livelihood depends on it.
Then, the Central Bank stopped the forward purchasing market and only provided space to open letters of credit with a 180-day limit.
It was then decided to artificially keep the currency at Rs. 200 per USD, and the undiyal and hawala market expanded dramatically.
All the main Key Performance Indicators (KPI) of the Central Bank have been eroded drastically during the same period in which these controls were imposed. Our inflation has increased to 29.8% and our food inflation has increased to almost 50%. Our currency has depreciated by more than 75% in a matter of a few months. Simply put, our Central Bank has fallen far short on all its key indicators regardless of back-to-back controls and interventions. Many new theories employed by CBSL economists, including Modern Monetary Theory, have backfired spectacularly and unfortunately it is the poor people who have to pay the ultimate price in hunger and inconvenience for the grave mistakes of the Central Bank and the Monetary Board.
As a remedial action to these mistakes, our Central Bank has now made an attempt to ban open accounts and cripple the undiyal and hawala systems.
In my humble opinion, this may potentially create shortages of essentials and inconvenience the traders and importers who have been supplying the essentials at a higher price. These merchants have been bearing the higher cost of the informal markets boosted by the Central Bank due to mistakes beyond their control made by policymakers.
We have to first ask ourselves why an importer should bear a higher price on USD to import. Without fixing our monetary policy, there is no point passing the blame to the hawala and undiyal markets. They have existed for centuries in Sri Lanka and around the world because of their competitive and evolving nature. The buck stops with policymakers, and not with merchants or foriegn currency middlemen.
Quite frankly, it will accomplish very little to close the stable door after the horse has already bolted.
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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.