ECONOMYNEXT – Sri Lankan authorities are targeting and blaming workers in the Middle East for not sending money through the formal banking system, widening the blame game of the usual scapegoats for currency shortages stemming from monetary and exchange rate policies contradictory.
Undiyal transfers take place because the central bank creates currency shortages and dollars are not available to people armed with excessive rupees created by a loosely pegged central bank.
Expatriate workers added to list of usual suspects in current crisis
Soft-peggers in Sri Lanka on a deep descent into commercialism usually blame imports, trade deficit, oil, current account deficit, foreign exchange problems instead of themselves and the domestic operations department that creates liquidity and generates outflows.
Exporters are also accused of ‘withholding dollars’, importers are accused of ‘non-essential imports’, but the note-issuing bank’s issuing service, which creates a ‘super abundance of paper money’ as the classical economists said, gets away with it for free.
In this crisis where monetary and exchange rate policy conflicts have escalated to a degree never seen in the past due to a repurchase obligation and the currency has collapsed from 180 to 360 to the US dollar, imports in open account and foreign workers are blamed.
Food importers are still able to import on an open account due to long-standing relationships when oil importers, for example, are unwilling to ship goods without prepayment due to credit being taken to perpetuate the trade. flexible anchorage in the past.
Open account imports also do not create any problems. This is simply a priority allocation method.
There is a real transfer of goods into the country through open account imports if financed through Undiyal/Hawala as claimed.
Whether the settlement is net via Undiya/Hawala or gross via the SWIFT system does not matter.
Even if the dollars went through the banks and were given to food importers or other importers, the result is the same.
However, the banking system has no method of prioritizing cash for food, with new money printed to pay state employees and/or for other reasons (crazy sterilization interventions with ACU money) creating a shortage of foreign exchange.
Most of the old trading system – and the less ancient trading system of the British period – operated through a series of trade credits and bills of exchange.
State Bank of India’s US$1 trillion Indian credit also works like Undiyal.
Here is the operational detail of the Indian line of credit.
Sri Lankan importers pay the treasury in rupees based on business documentation including invoice and shipping documents, like someone trying to send a child’s school fees through Undiyal.
Sri Lanka will then owe an amount in US dollars to India.
At the other end, the Indian importer will be paid in Indian Rupees by the State Bank of India.
A Foreign Remittance Certificate (FIRC) will be issued to the Indian exporter to enable him to claim the Indian Rupees as export earnings.
This is exactly what happens in an Undiyal/Hawala settlement system.
In all cases, family members of foreign workers who receive money in US dollars also convert it into rupees (unless it was a Vostro transfer).
This money is used to import food or other items. Whether the Middle Eastern worker sends the money in US dollars or dirhams and is given to food importers by the banks is irrelevant if the food comes into the country through imports open account.
What is different is that the Indian line of credit is the time of settlement of the other leg of the transaction.
Unlike Undiyal, where family members send money into the country, Sri Lanka will owe the money to India under a loan denominated in the currency of a third country, the US Fed , and it will not be settled immediately.
Sri Lankan rupees paid to the treasury by importers will be used by the treasury to finance its deficit. The Treasury will settle the money later and the national debt would increase in the meantime.
In Undiyal, the national debt would not increase.
There is a real transfer of wealth and a real transfer of property in both cases. If open account importers do not use Hawala, the same pressure would be exerted on the official banking circuit.
But if the food really comes from open-account imports, as officials claim, then a priority need of the people is being met.
Sterilized vs Unsterilized Interventions
For a pegged exchange rate to work, say, 360 degrees against the US dollar, the central bank must be prepared to supply dollars in unlimited supply. If dollars are rationed – as now – there are currency shortages at the fixed exchange rate.
In a fixed exchange rate unlike a float, dollars cannot be allocated to different users via price.
In a fixed exchange rate, the rationing of dollars goes through the rationing of credit and the rationing of rupees. For a fixed exchange rate to work, interventions must change the reserve currency.
This is why, when the interventions in the form of dollar sales are sterilized, the soft anchors break down. The reverse – input sterilization – works however, since the national currency is undersupplied. Most East Asian nations with excessive foreign exchange reserves do.
Currency boards where interventions are not sterilized, neither oversupply nor undersupply of money or credit.
This is why the sterling area survived for a century without the International Monetary Fund, but Bretton Woods collapsed in 1971 in about a quarter of a century despite the IMF.
Sri Lanka, the former “first world” countries of Latin America and the ever-developing countries of Africa suffer from the rejection of classical economics and the adoption of Latin America/Cambridge/salt water which claimed that flexible anchoring was possible.
Soft anchoring is inherently flawed and unhealthy
The soft anchor failed in the US and UK. The UK tried a second time with the ERM and again failed.
IMF programs will restore soft pegs and achieve a functioning monetary regime by sterilizing inflows (under a net international reserve target) after destroying the economy to kill private credit.
When money is printed to suppress rates and the peg collapses, interest rates skyrocket. To stabilize and lower rates, the credibility of parity must be restored.
The IMF will generally not disburse money until exchange rate policy conflicts are eliminated.
However, in any case, an IMF program does not reform the central bank to rein in its domestic operations or eliminate its ability to create monetary and exchange rate policy conflicts in the future by applying a single peg regime as a currency board or a floating rate.
In fact, the opposite is happening with flexible inflation targeting.
To have a true inflation target, a proper floating regime is needed, without a NIR target.
That’s why Washington hasn’t been able to address Latin America’s failures despite promoting depreciation, the banking plan, Brady bonds or other policy permutations, which are unfortunately imposed on many countries. other nations as well.
This is why central banks that are clients of the IMF repeatedly come to the agency after printing money to sterilize outflows in a clear rejection of the great classics and the embrace of post-depression mercantilists – mainly English speakers – who integrated what were fringe ideas into classical liberalism.
Sri Lanka has experienced monetary instability and political upheaval beyond the usual strikes seen in Western countries when the central bank creates excessive inflation due to a loose peg.
Rejecting classical economics, rejecting sound money, and embracing unsound soft money with dual peg conflicts has consequences.