Severe shortages of external finances leading to economic deprivations

The country is moving rapidly closer towards mass deprivation of food, petrol, gas, medicines and bare necessities owing to a severe shortage of foreign currency and inappropriate policies. A worsening of the current crisis is inevitable unless foreign assistance is secured immediately.

Rapid deterioration

The rapidity of the deteriorating external finances was such that last Sunday’s discussion of it in this column was outdated by the news report in the same paper that consignments of food and other essentials could not be released from the port owing to banks being unable to give foreign exchange to importers.

Critically low

The depletion in external finances reached such critically low levels that large amounts of essential imports were stuck at the port as banks did not release foreign currency to honour the letters of credit (LCs). Such is the severity of this financial crunch.

Ominous

Even more ominous was the report that “overseas corresponding banks are refusing letters of credit from local banks.” This in effect means that the country is unable to import. An early resolution of this problem is of utmost importance.

Puzzle

Even though foreign reserves have dipped to as low as about US$ 2.5 billion, it is difficult to understand why a relatively small amount of about US$ 25 or even 50 million could not have been released.The only plausible explanation is that banks did not want to sell foreign exchange at the low official rate when the market rate was much higher--nearly 50 rupees or 25 percent more.

Serious implication

The serious implication of this situation is that the country is unable to import essential food items and much needed raw materials for industry. This would create severe shortages of food, medicines, petroleum, gas and other essential imports.

Releasing exchange

The government has now decided to release foreign currency to meet this immediate crisis. The Central Bank of Sri Lanka ( CBSL) released US$ 50 million to the two state banks to clear containers with essential goods that were stuck at the Colombo Port for weeks.

Prime Minister Mahinda Rajapaksa instructed the Controller General of Imports and Exports and the CustomsDirector General to immediately release 800 containers of essential food items which are stuck at the Colombo

Port due to the failure by banks to release foreign exchange to importers. It is understood that the CBSL funds released yesterday could clear 400 such containers.

There are about another 400 such containers of essential commodities to clear. CBSL, it is understood, will release more funds, if needed, to clear more containers containing essential imports.

The available food stocks are estimated to be adequate only till the end of October. May be we can stretch it a little further towards the end of the year. With a lower Maha harvest early next year owing to the lack of fertiliser, insecticides and fungicides, food availability could be a grave problem.

The current problem

While the underlying reasons for the depletion of foreign reserves is well known, the cause for the current unavailability of foreign exchange is the wide gap between the official exchange rate imposed by the Central Bank and the market or black market rate. While the official exchange rate is around Rs. 205 for a US$, the market determined exchange rate is around Rs. 245 for a US dollar.

Export earnings and remittances

This has led to several problems like non remittance of export proceeds, reduced foreign remittances and the unavailability of funds to clear cargo or open letters of credit for imports.We are not receiving export proceeds, remittances are declining and the black market in foreign currencies is thriving.

Impact

The inability to import raw materials will decrease our export capacity and earnings. Moreover, tea and rubber production would fall appreciably owing to the ban on fertiliser, weedicides and fungicides, causing a severe drop in their exports and manufactured rubber exports.

Remittances

Remittances, that rose till June has dipped since then owing to persons remitting dollars through informal sources that pay as much as forty to fifty rupees more for a US dollar. This decrease has been erroneously attributed to lesser workers in the Middle East. The actual reason is that those remitting money from all around the world are not remitting officially. They are remitting their dollars through informal sources that pay as much more for a US dollar.

The crisis

The consequences of the emerging crisis in external finances are horrendous. Are we heading to a Lebanon type catastrophe?

Overcoming the crisis

The resolution of the fundamental problem in the external finances has to be addressed in the manner discussed last week. At this critical juncture we must address the immediate crisis first.The immediate task is to obtain international assistance to augment the reserves adequately to remove the stranglehold on imports. This requires to be addressed in three ways.

The first step

The first step is to abandon the administered exchange rate and allow the market rate to prevail. Such an exchange rate policy will likely sky rocket the exchange rate to much above the official exchange rate and perhaps, even the current black market rate. This can only be found out after the change. There are also possibilities of it being lower than the market rate, but higher than the official rate if there are foreign currency inflows.

The second step

The second step is to seek emergency foreign assistance from friendly countries. The Government has taken steps in this direction already. The Foreign Minister has approached the UAE and Iran for oil on credit. The Government has also requested another currency swap arrangement of US$ 500 million from India. There may be similar overtures to other countries. What success these have met with is still unknown. Their success is of immediate importance.

The third step

The third move is to ask for emergency balance of payments support from the International Monetary Fund (IMF). This is the best option, but one that requires a reversal of the Government’s obstinate and impractical position that it will not go to the IMF.As discussed last Sunday, this is the best and least costly and most beneficial policy option both for the resolution of the immediate and long term problem.

Concluding reflections

The severity of the crisis is not only what it is today, but what it will be tomorrow. Soon there would be severe shortages and restrictions in the availability of petrol, gas, basic foods, and medicines as foreign exchange dips to lower levels.

The severity of the foreign currency crisis demands wiser counsel than prevails. There are signs that such pragmatism prevails in a pivotal position and that the government is moving in such a direction. It is a Hobson’s choice.