Sri Lanka drops plan to relax forex rules
By Feizal Samath
COLOMBO - Under pressure over accusations that ill-gotten money would be
siphoned out, Sri Lanka's central bank has put the lid on a plan to allow a
free flow of foreign currency in and out of the country.
In a move that was welcomed mostly by the business community, the central bank
on January 4 said it planned to allow the unhindered flow of foreign exchange,
which would enable anyone to open bank accounts abroad or send money out
freely.
That, however, triggered an uproar among the supporters of General Sarath
Fonseka, the main opposition candidate in the January 26 presidential poll.
They claimed the move was designed to allow the administration's officials,
anticipating defeat in the
elections, to move tainted or ill-gotten money out of the country.
The central bank governor, Ajith Nivard Cabraal, told Inter Press Service over
the weekend that due to the political furor, the plan had been put on hold
until the elections were over.
"There was an unnecessary political uproar over the relaxation of foreign
exchange rules, which has been happening over the years," said Cabraal. He said
banks and big businesses welcomed the move, saying it was good for investment
purposes and those who regularly traveled abroad.
President Mahinda Rajapaksa, who is seeking a second term in office, has called
a poll two years before the end of his six-year term, which began in 2005. The
decision was prompted by his soaring popularity in the immediate aftermath of
the defeat in May 2009 of Tamil rebels, who had been fighting for independence
and self-rule for nearly 30 years.
However, the president's former army commander, Fonseka, who led the troops to
victory, turned against him over many disagreements and was thrust into the
hustings as a presidential candidate.
Backed by several opposition parties and, unofficially, sections of the
military, Fonseka has become the president's nightmare, with support for the
former commander swelling in the past few weeks, threatening the latter's
chances.
While Rajapaksa banks on winning the war as his trump card to secure a second
term, Fonseka is also claiming success in the war while accusing the incumbent
president and his family of corruption. He has vowed that if elected, he will
bring down the high cost of living and set up an anti-corruption body with
broad powers.
The move to liberalize foreign exchange controls follows an improvement in Sri
Lanka's foreign exchange reserves in recent times, from a dismal position in
late 2008 to early 2009, which saw huge outflows due to the global financial
crisis.
Some US$600 million was withdrawn by foreigners who had bought Treasury bonds
from the central bank, sending reserves sliding to just enough to finance 1.7
months of imports, compared with an average six months of imports in previous
years.
Sri Lanka is self-sufficient in rice, the staple food, but depends on imports
for fuel, wheat flour and sugar, among other essentials.
Subsequently, through a series of measures, including curbs on imports and
increased remittances from Sri Lankan migrant workers in the Middle East, the
sale of Treasury bonds and the grant of an International Monetary Fund (IMF)
bailout package worth $2.6 billion, foreign reserves have gradually improved to
$5.2 billion, translating into 6.3 months of import cover by the end of
November 2009.
Over the past three decades, the country has been moving on the path of a
gradual relaxation of controls on the outflow of foreign exchange, while
caution has been exercised when it comes to full liberalization.
Sarath Fernando, a veteran campaigner for the rights of peasants and convenor
of the non-governmental organization Movement for National Land and Agriculture
Reform, said Sri Lanka must exercise restraint in freeing the foreign exchange
market.
"When the East Asian crisis happened some years back, Sri Lanka escaped the
impact because of our controls. By allowing a free flow of currency, there is a
danger of a lot of money going out," he said. If that happened, he said, "There
was a possibility of many people losing jobs because investors will take the
money out when they want and as they like."
Other experts have also cautioned the central bank against the free flow of
foreign exchange, saying it should be done only after a comprehensive study is
undertaken.
W A Wijewardene, a recently retired deputy governor of the central bank, said
that while the dismantling of barriers to the free flow of foreign exchange had
been a gradual process and needed to be done, more discussion was needed.
"There is no fiscal discipline in the government, which has a huge budget
deficit, and traders import all kinds of luxury goods [which are unnecessary],
and that could drain the reserves," he said in an interview with IPS.
Relaxation of foreign exchange regulations has always been in the cards under
successive governments since Sri Lanka's shift to an open market economy in
1978. But the biggest concern in opening the doors to an unrestricted flow of
foreign exchange is the likelihood that fund outflows would be far greater than
the inflows.
A senior economist attached to a local think-tank, who declined to be named,
said the concern was essentially in the context of the fundamentals of the
economy.
Budget deficits, estimated at 7% to 8% of gross domestic product, are still
unmanageable and foreign reserves are mostly from "hot" capital, or foreign
speculative funds that go into the Treasury bond and Colombo stock markets, and
other "borrowed" sources, which can be quickly repatriated, as happened in
early 2009, when foreign investors took out their money invested in Treasury
bills.
The economist explained that the problem in Sri Lanka was that government
spending was dictated by politics and not by economic considerations. "The
moment you have a kind of structure where politics dictates what you do, then
nothing is certain, and in this case, the free movement of foreign capital can
be a negative development," he said.
The IMF's representative in Sri Lanka, Koshy Mathai, welcomed the central
bank's initial plan to ease the rules on foreign exchange, saying it was a good
idea to streamline the exchange control regime to facilitate both outward and
inward capital flows and boost investor confidence.
On the concern about huge outflows of foreign exchange, "It is intrinsically
difficult to predict the impact of such measures on reserves, and it thus seems
sensible to attempt these reforms at a time when reserves are healthy," Mathai
told IPS.
However, in November last year, when newspaper reports hinted of a possible
dismantling of the foreign exchange rules, the local office of international
governance watchdog, Transparency International (TI), urged Rajapaksa to ensure
that proper governance mechanisms were in place to forestall capital flight or
large-scale outflows.
TI Sri Lanka executive director, JC Weliamuna, raised the concern in the
context of large-scale scams in the financial sector between late 2008 and
mid-2009, when some financial services companies that collected millions of
rupees in deposits from the public at high interest rates collapsed, prompting
their owners to flee abroad with the money.
A string of other finance companies connected to the Ceylinco Group, one of Sri
Lanka's largest conglomerates, also crashed when depositors began pulling out
money, fearing similar collapses. The group's chairman was placed on remand for
several months for alleged mismanagement as the organization struggled to
return the money of some 30,000 depositors.
The beleaguered chairman's wife, who was deputy chair of the group, fled abroad
and is being sought by police.
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