Business
Currency Board: A solution to Sri Lanka’s economic crisis?
By Dr Asanka Wijesinghe
On 08 March, Sri Lanka devalued the rupee against the US dollar, entering into a floating exchange rate regime. The Central Bank of Sri Lanka had to abandon the pegged exchange rate as defending the rupee with dwindling reserves was impossible. The inter-bank exchange rate shot up once the banks were assured that the exchange rate was floated. The initial shoot-up was followed by further rallying of the US dollar reaching close to Rs. 300 per USD. With the gradually weakening rupee, inflation is also ascending to worrisome levels calling for radical changes, including adopting a currency board. This article discusses the effectiveness and suitability of a currency board for Sri Lanka in the current macroeconomic context.
Weakening Rupee, Rising inflation, and the
Currency Board Solution
A currency board is a system that issues domestic banknotes in exchange for specific foreign currency – anchor currency like the USD which is used for trade with partner countries – at a constant rate. A cornerstone of the currency board mechanism is the authority’s ability to meet all demand for foreign currency by the holders of the domestic currency.
In Sri Lanka, even after the rupee was floated, reports suggest that an active kerb market with a significant premium above the inter-bank rate exists. While such market behaviour indicates an acute dollar shortage in the market and the equilibrium rate is further away, no official data exists on the kerb market money exchange. However, cryptocurrency platforms provide some critical insights. The Tether coin (USDT), which is closely pegged to the US dollar on a one-to-one basis, is traded for rupees on peer-to-peer (P2P) platforms as USDT is used as a medium to purchase other cryptocurrencies, including Bitcoin.
Data extracted from the P2P platform medium of Binance – a popular cryptocurrency exchange among Sri Lankans – show some supporting evidence for the continually widening gap between official and informal rates again. Significantly, the premium over the official rate plummeted once the rupee was floated, but it gradually recovered to the pre-floated period (A and B panels of Figure 1). The number of sellers and the USDT volume available for sale also went up but riveted back to the levels of the pre-floated period (C and D panels of Figure 1).
The inflationary pressure also does not show any unwinding signs, further eroding people’s purchasing power. These developments encourage the adoption of a currency board as a currency board is believed to be a solution for rising inflation. By the inner mechanics of the currency boards, the independence of discretionary monetary policy is taken away, substituting a disciplined monetary policy – a gold standard without gold – which eliminates the inflationary bias. Indeed, empirical evidence exists in favour of the anti-inflationary effect of currency boards. The inflation rate is lower under currency boards than in pegged or floating rate regimes. Moreover, economies under currency boards grew faster than the average of countries with pegged regimes. However, empirically disentangling multiple influences to pinpoint the low inflation on the currency board is an excruciating task.
Another selling point of the currency board is the fiscal discipline, as currency board regulations prohibit direct monetary financing of government expenditures. A high budget deficit in Sri Lanka and excessive government borrowings from the Central Bank make the fiscal-discipline effect of currency boards much more appealing. Empirical evidence points to low fiscal deficits or larger surpluses under currency board regimes.
Source: Author’s illustration using Binance data
Challenges in Adopting a Currency Board
A significant drawback of a currency board is the need to surrender the monetary policy independence required for managing asymmetric shocks. Such loss is costly when the anchor currency country responds to cyclical conditions, which are different from the prevailing conditions in the country operating the currency board. For example, Hong Kong’s currency board imported low-interest rates from the US in the early 1990s. Such monetary easing was appropriate for the US, but Hong Kong faced an asset price boom that called for monetary tightening. A counterargument against the negative impact of losing monetary policy is the availability of fiscal policy at the operating country’s disposal. However, the maneuverability of fiscal policy is determined by the fiscal and debt positions. In Sri Lanka’s context, the high debt to GDP ratio and fiscal deficits might restrict the use of fiscal policy for pump-priming-stimulating the economy in a recessionary period- due to the fear of losing investor confidence in debt sustainability. Thus, international evidence shows that countries with hard pegged exchange rate regimes generally tighten their fiscal policy in a recession. The Argentinian attempts to bring down the deficit in a recession in 2000 proved to be disastrous.
Sri Lanka’s high indebtedness will also challenge installing a currency board. Once a threat of a possible default looms, the interest rates soar, and refinancing debt will be increasingly difficult. In addition, the operating country needs reserves to back the monetary base in a currency board. In a currency board, the board must continually convert domestic currency for the anchor currency at a constant rate. It should be noted that the reserve level of Sri Lanka has dwindled over time in the recent past. Another drawback of currency boards is the requirement of real sector changes to compensate for the exchange rate deviations. For example, if the anchor currency appreciates against Sri Lanka’s main trading partners, wages should fall to compensate for the increase in foreign consumer prices, restoring competitiveness. Such an exercise needs greater flexibility in the labour markets. Thus, the flexibility of labour markets is a key to the sustainability of currency boards. The political feasibility of the institutional attempts to ease labour market regulations is highly doubtful.
Against this backdrop, the decision to install a currency board should be taken after a careful cost-benefit analysis. A currency board will be helpful to stabilise inflation in the short run but in the long run, Sri Lanka will be better off with a more flexible exchange rate regime. In addition, the benefits of a currency board are not exclusive. For example, fiscal discipline should be stronger in flexible exchange rate regimes as fiscal policy effects are reflected immediately and more transparently. Thus, if Sri Lanka enters into a currency board to stabilise inflation and domestic currency, it needs to contemplate an exit strategy. Generally, it is advisable to leave a currency board when the economy recovers. The requirement to surrender monetary independence and the inability to finance government expenditure under a currency board might reduce the political preference for such a system.
Govt agrees to safeguard and build on hard-won gains
President keen on alleviating burdens on the people
A date to be set for 3rd review of the IMF programme
By Sanath Nanayakkare
An International Monetary Fund (IMF) team led by Krishna Srinivasan, Director for the Asia Pacific Department, visited Colombo October 2-4, 2024. During the visit, Krishna Srinivasan met with President Anura Kumara Dissanayake, Prime Minister Harini Amarasuriya, Minister Vijitha Herath, Central Bank Governor Dr. Nandalal Weerasinghe, Secretary to the Treasury Mahinda Siriwardena, and other stakeholders.
At the end of the visit, Srinivasan issued the following statement:
“We held productive discussions with President Dissanayake and Sri Lanka’s economic team on the economic and financial challenges facing the Sri Lankan economy. We agreed on the importance of continuing to safeguard and build on the hard-won gains that have helped put Sri Lanka on a path to economic recovery since entering one of its worst economic crises in 2022.
“We are encouraged by the authorities’ commitment to continue the reform efforts. The IMF remains a steadfast partner in supporting Sri Lanka and its people and stands ready to assist the country achieve its economic reform goals. The IMF team will continue its close engagement with Sri Lanka’s economic team to set a date for the third review of the IMF-supported program.”
Meanwhile, the President’s Media Division stated that President Anura Kumara Dissanayake engaged in a discussion with the IMF at the Presidential Secretariat on Oct. 4, marking the second day of talks with the President.
Following up on Oct. 3 discussion, the two parties discussed the way forward and measures to overcome delays pertaining to the third review.
At the meeting on the second day with the IMF delegation, President Dissanayake had expressed his government’s intention to provide relief for people while broadly agreeing with the objectives of the IMF programme.
President Dissanayake aims to achieve the objectives of the program in partnership with the IMF, seeking alternative approaches that will alleviate the burden on the citizens.
A constructive and cordial environment was effectively established between both parties during these discussions. The three-day series of talks concluded successfully, marking the end of the IMF delegation’s visit to Sri Lanka.
Director of the IMF’s Asia Pacific Department Krishna Srinivasan, Senior Mission Chief Dr. Peter Breuer, along with other senior IMF representatives and the Sri Lankan delegation attended the discussions.
The following are some comments made by key figures regarding the IMF framework, last week.
Former state minister of finance, Shehan Semasinghe: It is great to note the successful completion of the OCC and IMF consultation process and the formal confirmation that the terms of the agreement in principle are compatible with the comparability of treatment principle, following the agreement in principle reached with international and local holders of international sovereign bonds on 19th Sep. 2024. The achievement is a testament to the teamwork and dedication required to steer Sri Lanka out of bankruptcy under the leadership of former president Ranil Wickremesinghe. I am extremely proud to have led the negotiating team on behalf of Sri Lanka in my then capacity as state minister of finance.
Dr Harsha de Silva: The government is not making any attempts to change the Debt Stationarity Analysis of the IMF programme as they pledged the people to do during the election campaign. They have not and will not hold a single discussion with the IMF or the international creditors to alter any of the existing parameters or debt treatment principles. They lied to the people. We told the truth as to how it could be and people didn’t believe us.
Dr Anil Jayantha, head of the government’s economic council:
We have been able to finalize the agreement in principle in an accelerated manner with greater efficiency and achieve more in two weeks than the previous government did within two years.
The rise of Hemas Consumer Brands (HCB) is a success story in the home and personal care segment in Sri Lanka. Its powerful local brands have repeatedly proven themselves to be the proverbial ‘David’, standing up fearlessly against the ‘Goliath’ of multinational FMCG companies. HCB’s brands have not only competed successfully but also captured competitors’ market share from global brands. Its ability to dominate in such a fiercely competitive arena rests squarely on its capacity for innovation. Bringing the full power of its innovation to the fore, HCB held an ‘Innovation Day’ which showcased every aspect of its innovation journey by organizing an international-level event attended by all its internal and external stakeholders to engender a strategic springboard for innovation and big ideas.
The objective of the ‘Innovation Day’, held at Trace City was to showcase the Company’s innovative culture, the talents of the R&D Team and to reveal the sheer volume of effort behind the scenes for each product. The event featured a variety of stalls, several webinars and live interactive sessions that showcased and exhibited over 150 products and packaging formats. Global reputed supply partners known for their product innovation which mirrors HCB’s journey participated at the Innovation Day, joining in from various parts of the world. Wayamba University also sent a team to showcase the power of natural ingredients and held a discussion booth at the venue. Collaboration has been key to HCB’s success. Impressed by the power of the ideas showcased at the event, HCB’s senior management selected several innovations to be fast tracked and launched. This inclusive approach to innovation has been transformative for HCB’s brands.
The ‘Diva Dathata Diriyak Entrepreneurial Skills Programme’ is a transformative collaboration between Diva, the flagship laundry care brand of Hemas Consumer Brands and Women in Management (WIM) to support women entrepreneurs in the island. This programme has been successfully conducted in 5 provinces and empowered over 275 women entrepreneurs to develop their businesses. By equipping these women with the necessary entrepreneurial skills, the programme not only helps them grow their businesses but also contributes to the general economic development of the country.
The 6th edition of the programme is to be conducted as a one-day seminar on 7th of October 2024 at the Nuwaragam Palatha Central Divisional Secretariat, Anuradhapura from 9.00am onwards. This seminar will be conducted by Dr. Sulochana Sigera, Chairperson, WIM, as part of the ongoing, highly successful series of programmes aimed at equipping women with the skills, knowledge, and confidence to thrive in the extremely challenging entrepreneurial world. The Seminar will be conducted in Sinhala language.
Any women entrepreneur interested in joining the upcoming “Diva Daathata Diriyak” Entrepreneurial Skills Development Seminar in North Central Province, can find more information through the official Facebook page of Diva Sri Lanka. To reserve a seat at the seminar, women entrepreneurs simply need to send a WhatsApp message, SMS, or call the number 076 056 4734.
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