A System That Failed to Connect the Dots

By Dhananath Fernando

Originally appeared on The Morning

Anyone who has tried to send foreign exchange through a Sri Lankan bank knows the drill. The bank asks for the invoice, purpose, source of funds, and supporting documents. Sometimes the questions feel longer than the transaction.

That is why the allegation that as much as $ 1 billion was sent abroad as import payments, while the goods did not arrive, is difficult to digest. The Police has arrested four managers from four private banks. The investigation is still unfolding, and neither the final amount nor individual responsibility has been established by a court.

First, we must get the economics right. This was not $ 1 billion physically removed from the Central Bank’s reserves. Customers would have paid rupees and purchased foreign exchange through commercial banks. 

If the allegations are correct, Sri Lankan wealth moved abroad illegally and extra demand was created for dollars. That is serious, but it does not mean our reserves would automatically be $ 1 billion higher today or that this incident caused the 2022 balance of payments crisis.

A TT is not the crime

The reported payments appear to have been advance Telegraphic Transfers, commonly called TTs. A TT is neither illegal nor unusual. A supplier may demand a deposit before building a customised machine that takes months to arrive. Small Sri Lankan importers often lack the bargaining power to refuse.

A letter of credit is not an iron shield either. Banks examine documents, not containers. If an invoice is fabricated, a company is a shell, or insiders collude, both TTs and letters of credit can be abused.

Misinvoicing includes underinvoicing to reduce tariffs, overinvoicing to move extra money abroad, and phantom imports where no goods arrive. High and complicated border taxes encourage underinvoicing. But the answer is not to label every importer or exporter a criminal. Our exporters need imported machinery, raw materials, and packaging.

The failure between institutions

The alleged fraud appears to have travelled through the gaps between institutions. A bank sees the customer and payment. Customs sees the goods. The company registry records directors and shareholders, the Inland Revenue Department sees turnover, and the Financial Intelligence Unit (FIU) sees suspicious patterns. Auditors and bank supervisors are expected to test the controls.

A connected system should see the whole pattern. Repeated large advances without matching Customs declarations should raise a red flag. So should a shell company sending amounts that do not match its business. If several institutions see warnings but no one connects them together, compliance exists only on paper.

Sri Lanka still operates under Customs Ordinance No.17 of 1869. Customs reform and digitisation have been attempted many times, but have faced resistance and delay. This is the price of postponing reform. The 2026 requirement for a unique transaction number for import-related foreign exchange payments is a sensible start, but it must connect the payment to the Customs declaration, arrival, delay, or refund.

The system must also understand genuine business. A delayed shipment is not automatically fraud. One delayed order may need an explanation. Repeated unmatched payments, hidden beneficial owners, and transfers inconsistent with turnover need immediate investigation.

Independent, but accountable

It would be easy to place the entire blame on the Central Bank. That would be neither fair nor useful. The Central Bank cannot inspect containers, while Customs cannot see the complete behaviour of a bank customer. Commercial banks and their boards are responsible for Know Your Customer (KYC), internal controls, and suspicious transaction reporting. Auditors, company regulators, and law enforcement also have duties.

But collective responsibility cannot become nobody’s responsibility. Bank supervision sits with the Central Bank, while the FIU collects, analyses, and disseminates information on suspicious transactions. The public deserves to know whether warnings were filed, patterns identified, and action taken. Banks, auditors, and Customs must answer the same questions.

The Central Bank is, comparatively, one of Sri Lanka’s better-managed public institutions. Its independence must be protected because monetary decisions should not serve short-term politics. However, independence is not immunity from scrutiny. Independence and accountability must travel together. Demanding answers should not become an excuse to weaken the institution.

The response should not be a blanket ban on TTs or a requirement that every importer use an expensive letter of credit. Such rules raise costs, hurt smaller businesses, and may push genuine transactions into informal channels. Modernise the Customs law, connect the databases, reveal the real beneficial owners, publish relevant audit findings, and hold individuals and institutions accountable where failures are proven.

Rather than criminalising deliberate unauthorised transfers, we have to look at the overall policy framework that has failed us. Creating an offence after the money has gone is weaker than a system that raises the warning before the next payment leaves.

This is not a story that trade is dangerous or that Central Bank independence has failed. It is a story of old laws, disconnected databases, and reforms delayed until they become headlines. When institutions work in silos, fraudsters work as a network. 

The billion-dollar question is not only who sent the money. It is why the red flags did not rise together. Sri Lanka cannot postpone that reform again.

Central Bank Defends Liquidity Injections Amid “Money Printing” Controversy

By Dhananath Fernando

Originally appeared on Ada Derana Business

A fresh controversy has erupted following reports that Sri Lanka’s Central Bank (CBSL) injected nearly 100 billion rupees into the banking system by October 25. Given that money printing was the major cause of the country’s financial crisis, this news has sparked considerable attention. CBSL has defended its actions, arguing that these liquidity injections do not equate to money printing.

What is the CBSL’s Argument?

CBSL asserts that these liquidity injections were necessary to address persistent imbalances among banks. Despite an overall surplus of funds in the banking system, this liquidity is unevenly distributed. Foreign banks operating in Sri Lanka hold significant liquidity surpluses but remain cautious about interbank lending due to strict risk management guidelines. As Sri Lanka’s sovereign rating is still ‘Default, this limits their exposure to local financial institutions. As a result, foreign banks deposit excess rupees with the Central Bank rather than in the interbank market.

While this was a serious problem in the midst of the crisis things have improved since: interbank call market (clean or unbacked) trading volumes, once as low as zero 1-2 billion rupees daily, has now returned to Rs10bn to Rs20bn (averaged 10 billion last month). Repo volumes (backed by T-bills) are back around 30 to 70 billion rupees, which is higher than pre-crisis levels.

Notably, auction data shows the central bank offering more than what banks bid for, with some banks bidding close to the deposit rate, indicating a willingness to lose bids—yet CBSL still provided new funds.

Given the much healthier interbank volumes, the CBSL should avoid undermining the working of the interbank market. The CBSL should be the last resort for a bank facing a liquidity crunch, not the first.

The Core Issue: Temporary vs. Longer-Term Impact

The debate centers on whether these injections are temporary or enduring. If CBSL swiftly withdraws the new money by selling Treasury bills or foreign exchange, the money supply remains stable. However, if these short-term purchases are repeatedly rolled over, the increase in money supply could become more long-term. Critics warn that this scenario is no different from lending money to the government, potentially triggering balance of payments problems and inflation, thus jeopardising the ongoing economic recovery.

A Matter of Terminology

CBSL’s reluctance to label this as “money printing” is essentially terminological. Regardless of whether the funds are lent to banks or the government, the impact on the money supply is fundamentally the same. Therefore, interventions must uphold the principle of currency stability, given the grave consequences of unchecked money creation.

Acknowledging CBSL’s Efforts

It is It is important to acknowledge that since September 2022, the CBSL has done an admirable job in restoring monetary stability. The critical task now is to maintain this hard-won stability. These points are presented to promote a healthy academic debate on an issue of great importance, not to cast blame on any specific entity or person.

Potential Alternative Strategies

What alternatives could CBSL have considered?

Purchase Foreign Exchange from Banks: Where balance of payments conditions permit, CBSL could continue the practice of buying foreign exchange, injecting rupees but reducing foreign currency in the If the injected rupees were later used for imports, CBSL could sell foreign exchange back, maintaining balance and avoiding exchange rate issues.

Use the Standing Lending Facility: Lending at the Standing Lending Facility Rate of 9.25% would ensure banks only borrow for urgent liquidity needs. As this penal rate is higher than the interbank rate, it discourages long-term dependency and helps avoid a lasting increase in the reserve money supply.

Reduce the Standing Deposit Facility Rate: If the CBSL wishes to lower rates, it could reduce the rate on deposits held at the Central Bank, which would encourage banks to lend more in the interbank market. However, this would also lower overall interest rates and must be carefully managed. To support reserve accumulation, interest rates need to remain at an appropriate level to curb credit and keep imports in check.

The Balancing Act

CBSL faces the difficult task of supporting the banking sector while safeguarding monetary stability. Any intervention must be carefully weighed to mitigate risks such as inflation and currency destabilisation.

Beyond profit margins and scandals

By Dhananath Fernando

Originally appeared on the Morning

Blaming imports and importers has long been ingrained in Sri Lankan culture, often seen as a root cause of the country’s economic issues. This perspective not only overlooks the fact that many importers are also exporters, but also fails to recognise that imports and exports are fundamentally interconnected components of the global trade system.

Despite this, it is crucial to acknowledge that not all imports are conducted ethically or transparently. Recent scandals, such as the sugar scam, misinvoicing, bribery, and procedural irregularities at Customs, highlight the darker aspects of importation. However, casting imports in a universally negative light and fostering resentment based on ideological reasons could prove to be more harmful than beneficial.

Recent investigative reports have revealed staggering profits made by importers on essential commodities like green gram, B-onions, and potatoes. Some profit margins have been reported as high as 280% when comparing the Cost, Insurance, and Freight (CIF) value to the market prices of these goods.

Before rushing to judgement on these profit margins, it is essential to delve deeper into the circumstances surrounding these imports. For example, the importation of green gram has been severely restricted since the onset of the Covid-19 pandemic, requiring special approval from the Ministry of Agriculture. As a result, the quantity of green gram imported in 2023 has been minimal.

Thus, comparing the CIF value at the port to market prices can be misleading, as it does not accurately reflect the profits made by importers. This situation raises questions about the high market prices for green gram, pointing to inefficiencies in local production rather than exorbitant profits by importers.

The scenario with undu, a staple food item, is similar. With a Rs. 300 import tariff, the market price for 1 kg of undu ranges between Rs. 1,500-1,700. This high cost is partly because importers cannot bring in undu without approval from the Ministry of Agriculture, despite the imposition of tariffs.

Allowing imports could potentially reduce the price of undu to around Rs. 700 per kg, even after tariffs. The restriction on undu imports exacerbates price inflation, making it unaffordable for many, particularly those in estate regions and the northeast, leading to food insecurity among vulnerable populations.

During the recent economic crisis and the consequent shortage of foreign exchange, many imports were facilitated through informal payment channels and ‘open papers’ in undiyal markets. This practice, aimed at evading high tariffs and taxes through under-invoicing, underscores the complexity of Sri Lanka’s tariff structure and the urgent need for its simplification.

The report by the Ways and Means Committee suggests that focusing solely on the cost of goods at the port does not provide a complete picture of the import value, especially considering the prevalence of informal payments. This approach to calculating profits, based solely on declared document values, overlooks additional costs borne by importers, thus distorting the perception of their profit margins.

Moreover, the perishability of essential food items, along with the significant costs associated with storage, wastage, and the impact of rising fuel and electricity prices, further complicates the economic landscape. These factors, combined with high inflation rates, have significantly influenced the cost structure of both the wholesale and retail markets, affecting pricing and profit margins.

The impact of export controls on certain commodities, such as B-onions by India, has also played a role in inflating global prices, illustrating the complex interplay of international trade policies and local market dynamics.

This situation underscores the phenomenon of unintended consequences in economic policy, where well-intentioned policies can lead to outcomes that are diametrically opposed to their original goals. Sri Lanka’s intricate tariff structure and monetary instability have inadvertently encouraged informal payment methods on one hand and escalated costs on the other, placing the poorest members of society in an increasingly precarious position.

While it is undeniable that practices like misinvoicing represent clear violations of the law and must be addressed through appropriate legal channels, attributing the entirety of Sri Lanka’s economic challenges to importers overlooks the broader systemic issues at play. Simplifying the tariff structure, as this column has long advocated, could lead to increased Government revenue and minimise systemic leakages, offering a more sustainable solution to the economic challenges faced by importers and consumers alike.

In conclusion, while illicit practices within the import sector must be rigorously tackled, the solution to Sri Lanka’s economic dilemmas lies not in vilifying importers but in addressing the complex policy and structural issues that underpin the nation’s trade dynamics. A comprehensive approach, focusing on policy reform, tariff simplification, and enhancing local production efficiencies, is essential for creating a more stable and equitable economic environment.

Unveiling the true culprit behind economic woes

By Dhananath Fernando

Originally appeared on the Morning

Sri Lankans have a very negative view of imports, which are often portrayed on TV as the problem behind the economic crisis. Not only politicians, but also those who have opinions on our economy subscribe to the idea that imports are the problem.

Our politicians’ favourite pastime is to blame imports and impose various tariffs or ban imports. Banning imports also makes for a very pro-Sri Lankan image, because a common excuse provided is that high imports are damaging to local industries. Accordingly, the banning of imports has been portrayed as a measure to help develop local industries.

A favourite area when it comes to cutting down imports is food imports. Often, media headlines and politicians comment aggressively, even quoting figures on the value of food imported. The middle class, upper middle class, and wealthiest of society often make the argument of needing to save valuable foreign exchange by cutting down food imports.

However, when we consider the data, it indicates the exact opposite. The middle class, upper middle class, and the wealthiest are the ones who consume the most amount of imports in the form of fuel, mainly through personal vehicles and as energy. About 27% of our imports in January was fuel. Fuel is the largest component of our import basket as a single commodity.

What we have imported as food is less than 11% of our total imports. Non-food consumer goods are just 8% of our total imports. Most pharmaceutical products and medicines for patients fall under the non-food consumer goods category, which are primarily consumed by the most vulnerable people in society.

Imported food items are also consumed by the most vulnerable sections of society. Food items such as canned fish, maize, green gram, lentils, black gram, sprats, b-onions, potatoes, and wheat flour are critical food items for the poorest of the poor.

Firstly, these can be stored without a refrigerator, which saves their energy cost. Secondly, they are easily available and affordable compared to many other items of food they consume. Therefore, the request of politicians and academics to cut back on these food items, which comprise less than 11% of our total imports, is nearly impossible to fulfil, and reducing these imports further is tantamount to asking the poor to live in hunger and their children to suffer from malnutrition.

Thirty-seven percent of our import basket comprises intermediate goods, besides food. These are goods required for exports and to produce many things without interrupting the supply chain. For instance while our main export is apparels, our main import is also apparels. Therefore, asking to reduce apparel sector imports amounts to reducing our valuable exports.

In reality, while there persists a belief that imports have to be reduced, it is not the solution it is touted to be. If we have to cut down on food imports, it will lead to increased malnutrition, hunger levels, or food costs for Sri Lankans.

Ways of reducing imports

If we want to bring down our imports, cutting down on fuel is one way to consider. A World Bank study revealed that 70% of the fuel is consumed by the wealthiest 30% of society. Therefore, it only makes sense to maintain fuel prices at market price.

As indicated in the graphs, there is a correlation between high fuel prices and fuel imports. Our fuel imports have decreased when prices are high as people use it sparingly. Compared to January 2023, our fuel imports had declined by about $ 100 million per month by January this year. With the expansion of the economy, this number is expected to slowly grow. Prices can bring imports down without import bans or tariffs.

Another way to reduce fuel imports is by improving public transport. Most of our fuel is wasted in traffic jams as a result of our poor public transportation infrastructure. If we invest in public transport, not only will it reduce fuel imports, but it will also uplift many Sri Lankans and provide significant relief in terms of their purchasing power. Many middle class Sri Lankans pay a 200% tariff to buy a second-hand vehicle at an interest rate of above 12% because they have no other choice but to commute.

Saving foreign exchange

Sri Lanka has been offered many grants, including for the Light Rail Transit (LRT) project, which we turned down on numerous occasions, leading to geopolitical tensions. When people spend less money on commuting and waste less time in traffic congestion, it will not only improve productivity but also their purchasing power, creating many jobs and generating income.

It is an inalienable truth that we need more food imports with different varieties of protein sources for the benefit of the impoverished. Foreign exchange has to be earned through exports, tourism, and remittances.

Saving foreign exchange is a function of the monetary policy or the supply of the Sri Lankan Rupee to the financial system rather than a function of imports and exports. When the rupee becomes expensive, the US Dollar demand decreases automatically because people buy the latter using rupees that they could have used in an alternative manner.

Asking the public to cut down on food imports, which are mainly consumed by the poor, at the expense of allowing the use of more fuel-driven vehicles cannot be justified and borders on cruelty.