Sri Lanka's forex crisis bodes ill for tottering economy

Low worker remittances and falling tourism revenue as a result of COVID-19 and diminishing export earnings have, among other reasons, triggered a massive foreign exchange shortfall that has aggravated an already precarious economy in Sri Lanka. And there seems to be no end in sight.

A protest outside the Central Bank of Sri Lanka office in Colombo on March 30.

A t 11.20 a.m. on March 30, as the Chennai -Colombo SriLankan Airlines flight began its descent in Colombo, an announcement over the aircraft’s public address system gave out the usual instructions laced with pleasantries, welcoming all passengers to the Bandaranaike International Airport. But it did not stop there. A warning and a threat followed, and they had to do with how the passenger converted the foreign currency he or she was carrying: “If you are a tourist, please retain your travel exchange receipts until your travel is completed. Use only banks or authorised foreign exchange dealers appointed by the Central Bank of Sri Lanka [CBSL] to change your currency.” Then came the threat [paraphrased quote]: “If you change your foreign currency with unauthorised agents, you may be involving yourself in criminal activities.”

The reason for this warning and threat, in a country with a draconian Prevention of Terrorism Act with wide powers to incarcerate anyone without any reason assigned, was not hard to find. It related to the difference in foreign exchange rates between the official channels and the grey market.

All major Sri Lankan banks had counters outside the airport where the buying rate of foreign currencies was displayed. A U.S. dollar, the most sought-after currency in Sri Lanka, that morning equalled Sri Lankan Rupees (LKR) 289. Except for those who are new to Sri Lanka, no one uses these counters any longer because the rates are much lower than what the local currency market offers. This was the reason for the announcement on the flight.

To check the rate in the open market, this correspondent asked an acquaintance to convert some dollars into LKR in the local market. In some time the acquaintance called to announce a conversion rate of LKR 385 to a dollar. Even as one came to terms with the gap in this market reality, Ranga Srilal, a journalist, tweeted at 4 p.m.: “U.S. dollar clears the 400 barrier. The grey market offered 410 rupees (LKR) to the dollar in response to CBSL warnings that money dealers quoting better than commercial bank rates will be prosecuted. Traders have told @an_cabraal [CBSL Governor] where he can put his lame threats.”

The Indian rupee is welcome too. A google search will give you the INR (Indian currency) to LKR rate at 3.87 per rupee. The grey market offers significantly more; depending on the day, the conversion rate can be up to LKR 5 per INR.

Central Bank’s role

CBSL Governor Ajith Nivard Cabraal did act on his threats. On March 31, he tweeted: “The suspension of the money changing license of the first errant money changer has just been announced by the CBSL.” A CBSL press release issued the same day read out the riot act to money changers: “The Central Bank has intensified its on-site investigations at Authorised Money Changing outlets and will stand ready to suspend/revoke permits of Authorised Money Changers who do not adhere to the Directions issued under the Foreign Exchange Act.”

Cabraal does not appear to realise what the problem is. One response to his triumphant tweet read: “If the government banks are capable of releasing required $ [USD] at a proper rate, demand for these places will go down rapidly. As of now, it is close to impossible to get $ released for critical activities such as foreign travel or educational payments.”

“Fix the root cause and not the symptoms,” the tweeter added.

Several upper middle class families in Colombo and elsewhere are worried about the higher education of their children. In Sri Lanka, education is free and students are taught in the mother tongue from Class 1 to 12 (A level). (There is also a parallel international school system where students have to pay to learn in the English medium.) Thereafter, undergraduate education is governed by a complicated system of reservation.

Seats in undergraduate courses are limited, hence many parents who can afford it send their children abroad to study. This has now given rise to a new problem because banks are refusing to release the foreign exchange needed to pay fees for the new term.

In one case, a local businessman instructed his bank to send his son’s term fees to an educational institution in Australia. At the then prevailing exchange rate, the bank calculated the amount to be nearly LKR 20 lakh. The bank later informed the businessman that the money would be sent as soon as adequate foreign exchange was available at the bank and taking into consideration the various priority categories the bank had been asked to follow.

A few days later, the businessman received a call from the bank informing him that his turn for accessing foreign exchange had come and that he would have to pay an additional LKR 10 lakh because the value of the Sri Lankan rupee had dropped. Obviously, he had no choice.

Not just education, entertainment too suffers. PeoTV, operated by SLTMobitel (Sri Lanka Telecom and a private firm MobiTel), had to discontinue some channels, aired from abroad, because of the foreign exchange crisis. As one switches on any of these channels, a message plays out to the accompaniment of music: “The Channel Partner [in this particular case] (Star Sports) has temporarily stopped its transmission owing to the difficulties faced by us in making outward remittances due to reasons beyond our control. We apologise for the inconvenience caused and we are making our best efforts to restore the services as soon as possible.”

Getting around the problem

As always, people find ways to work around any problem. An employee of a multinational company spoke about the difficulties of staying in Colombo as inflation spirals. Asked about his salary, he said he brought into Sri Lanka only 30 per cent of his salary. “My company remits 70 per cent of my salary into an account abroad and sends me the rest…. If all the money is brought here, I will not be able to repatriate when I leave or when I travel abroad. It is too much of a risk,” he said.

One exporter highlighted the difficulty of doing business because of the exchange rate. “When the payment comes in for my exports [after taking the credit period into account], it is far lower than the market rate. How can I manage?” he asked.

An importer said there was no way he would be able to predict the price of a product in the market, or even the landed cost. “I state a price today for a shipment of say, steel, which I will get delivery in about three or four months’ time. Usually, we consider the market of the product, factor in our mark up, and then quote. Now, because of the galloping rupee, all predictions have been thrown out. I have no idea what to quote as a selling price for a product that I have imported,” he said.

Big companies, including those dealing with specialised equipment such as elevators, pass on the cost to their customers. “Customers are unhappy. But we are helpless too,” said a dealer.

Exporters get around the problem in multiple ways. One way is to incorporate an importing firm and insist that the foreign exchange it earns be used to finance these imports. Another is to direct the bank to use the foreign exchange to be used for another company with which the exporter has made a deal. A third involves a complicated formula of booking losses in your exports and getting the foreign buyer to pay much less than what was agreed on paper. (The rest is paid in a foreign bank account.)

The bottom line is clear: placing too many restrictions on people does not work. But that is a lesson that neither the Central Bank nor the Finance Ministry seems to understand. “There are ways to get out of this self-made crisis,” said a top management professional. “But the question is: who will listen now? The crisis is so all-engulfing, what’s happening is hourly firefighting only.”

It was only early this month that the CBSL decided to allow “greater flexibility in exchange rates”. A March 7 press release stated: “The Central Bank is of the view that forex transactions would take place at a level which are not more than Rs [LKR]. 230 per US dollar.” On March 24, the CBSL and the Ministry of Finance assured people that “the banking system is stable, and that the operations of the State Banks are being carried out smoothly, contrary to statements made otherwise”.

Glossing over reality

This seems to be an attempt to gloss over reality. The Sri Lankan government has borrowed heavily from banks, and there seems to be no end in sight. For instance, one government official said that the government’s overdraft with just one bank, the Bank of Ceylon, is “in the range of 500 billion” LKR.

A senior official explained the problem in simple terms: Sri Lanka has an annual import bill of about $20 to $23 billion. It has exports worth $13-$15 billion. The remaining foreign exchange shortfall is made up by worker remittances and tourism. During COVID, remittances went down drastically because of job losses in West Asia, and tourism revenue was nil. But the government was forced to spend because of the COVID crisis. This aggravated an already precarious economy, which was treading a fine line between disaster and default.

Add to this the fact that the government has to pay back International Sovereign Bonds (ISB) as they mature. Another $1 billion worth ISB (according to a government official; outsiders put it at much more) has to be paid back in June. “If you default today, you are gone. No one will lend to you,” Nalaka Godahewa, State Minister for Urban Development, told a local cable TV station. In his view, all governments borrowed to pay interest. That route should be followed now too.

This is where the aid that India and China and others offer falls short, because the money that is given or promised is much less than what Sri Lanka requires. Unless Sri Lanka bridges the shortfall in foreign currency (between exports and imports) the problem will not go away. “Imagine the gap as a wound. Is there a point in treating one part of the wound while leaving the rest unattended?” asked an official, who has a role to play in the current crisis.

One official who has deals with the Finance Ministry said that he was not even sure whether the top officials in the Ministry or those in the Central Bank understood the enormity of the problem. As an example, he pointed out the post-COVID situation on worker remittances.

Worker remittances did pick up post-COVID because of the CBSL’s policies. The exchange rate offered was at least LKR 20 less than what was on offer in the grey market in January. Many chose the grey market not merely because the rates were higher but also because of other facilities—money would be picked up from their places of work or home in West Asia, and hawala routes delivered the money to the person’s residence in Sri Lanka. “I am not even sure if the entire finance management team in the country is capable of asking what is needed for the country at this juncture. One possible solution is for India to stand guarantee in the range of the shortfall, about $5 billion,” he said.

But even this has not been requested from the Sri Lankan side. In his view, there is no point in giving money to Sri Lanka because there seems to be no plan on how to deploy the money effectively. It has to be in the form of aid that can reach the people, he said.

While tourist arrivals in the country are increasing (96,507 in February 2022; a 2,700 per cent plus jump compared with February 2021), there is no guarantee that this trend will last if the unrest in Sri Lanka continues. On the night of March 31, police used tear-gas on protesters in front of the presidential residence after a police bus was set on fire. If the social unrest is not curbed, tourism income can as well be forgotten.

This is the chicken-and-egg situation. The unrest cannot be tackled without ‘hard’ decisions. But people have had enough of hard decisions. Going by the sentiment on the street, they want the current administration to step down. They believe that is the first step towards a solution. Therein lies Sri Lanka’s greatest problem. The Rajapaksas, after all, enjoy a good majority in parliament.