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SRI LANKA: Amid Furore, Central Bank Drops Plan to Relax Forex Rules

Feizal Samath

COLOMBO, Jan 19 2010 (IPS) - 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 Jan. 4 said it planned to allow 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 Jan. 26 presidential polls. They claimed the move was designed to allow the administration’s officials to move tainted or ill-gotten money out of the country, anticipating defeat in the elections.

Central Bank Governor Ajith Nivard Cabraal told IPS over the weekend that due to the political furore, the plan has been put on hold until the elections are over.

“There was an unnecessary political uproar over the relaxation of foreign exchange rules, which has been happening over the years,” said Cabraal. He added 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 his six-year term, which began in 2005, ends. 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 Gen. 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 of winning the election.

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 to bring down the high cost of living in Sri Lanka and set up an anti-corruption body with broad powers once he is elected.

The move to liberalise 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 600 million U.S. dollars were 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 to 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, sale of Treasury bonds and the grant of an International Monetary Fund (IMF) bailout package worth 2.6 billion dollars, foreign reserves gradually improved to 5.2 billion dollars, translating to 6.3 months’ worth of imports 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 exchanges, caution has been exercised when it comes to full liberalisation.

Sarath Fernando, a veteran campaigner for the rights of peasants and convenor of the non-governmental organisation 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 has been a gradual process and needs to be done, more discussion is 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 on the cards by successive governments since Sri Lanka’s shift to an open market economy in 1978. It was just a matter of time before full liberalisation would happen. But the biggest concern in opening the doors to an unrestricted flow of foreign exchange is the likelihood that fund outflows would far exceed the inflows.

A senior economist attached to a local think tank, who declined to be named, said the concern is essentially in the context of the fundamentals of the economy.

Budget deficits, estimated at 7 to 8 percent of the 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 like what happened in early 2009, when foreign investors took out their money invested in Treasury bills.

The economist explained that the problem in Sri Lanka is that government spending is 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.

IMF Representative in Sri Lanka Koshy Mathai has welcomed the Central Bank’s initial plan to ease the rules on foreign exchange, saying it is 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, international governance watchdog Transparency International (TI)’s local office urged President Rajapaksa to ensure that there were proper governance mechanisms in place to forestall capital flight or large-scale outflows.

TI Sri Lanka executive director J.C. Weliamuna raised the concerns in the context of large-scale scams that occurred 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 organisation 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 hunted by Interpol, the world’s largest international police organisation, and Sri Lankan sleuths.

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