An elusive Belgian investor to rescue the rupee
According to Reuters, Finance Minister Ravi Karunanayake is reported to have disclosed that an unidentified Belgian investor has promised to give Sri Lanka $ 1 billion by way of a deposit carrying an interest rate of 2%.
The minister has opined that it would boost the value of the Sri Lanka rupee which is under pressure for depreciation quite for some time (available at: http://www.ft.lk/article/518680/--1-billion-mystery-investor-boosts-rupee). Without disclosing the full facts, several features relating to the transaction in question have also been revealed by the minister.
Accordingly, there is a local partner to the Belgian investor, it is a kind of a demand deposit from which the investor could take his money out at any time, the first tranche of the deposit amounting to $ 500 million has already been received and the balance will come shortly. The minister has said that if anyone suspecting potential money laundering in the transaction in question can seek the courts’ intervention for a determination as to whether it would violate existing laws.
But an officer of the ministry, according to the Reuters report, appears to have given a firm judgment on the issue obviating the necessity for even seeking legal intervention. He is reported to have opined that it is the responsibility of the money-remitting bank to check on the credentials of the investor in question. The money receiving bank in Sri Lanka or, by implication, the Sri Lankan authorities have nothing to do with that issue.
This is an awkward legal opinion because it discharges, contrary to the common banking and legal practices, a third party from liability if he has accepted a stolen property – say a cheque – on the basis of a certificate issued by the second party about its genuineness.
Hence, it is a transaction that has been sealed by a sovereign government. Strangely, the Central Bank has so far maintained stoic silence on it implying that it too has concurred with the seemingly out of the box move to build up the reserves of the country.
An unconventional move by the Finance Ministry to rescue the rupee
Getting a single party to rescue its currency is an unconventional move by any government. But it has also served a good purpose here. That is, it has been tantamount to admitting in public the gravity of the foreign exchange crisis facing the country today. Resorting to an unconventional move of this nature is similar to a drowning man hanging onto even a floating thread of straw in a last attempt at saving his life.
Of course, countries have resorted to even worse options when they have been faced with such grave foreign exchange crises.
For instance, India in 1991 airlifted 67 tonnes of gold to London and Zurich to get an urgent credit line from the IMF to avert a possible foreign debt default (available at: https://en.wikipedia.org/wiki/1991_Indian_economic_crisis).
Pledging gold for a loan facility is a loss of face for India which had proudly maintained that it could solve its problems without external assistance. But economic circumstances had forced India to backtrack on its earlier heroic statements. Sri Lanka does not have gold to sell and therefore has to get even the devil to come and rescue its currency.
Crisis is a creation of the previous administration
Of course, the foreign exchange crisis is not a creation of this government and it has inherited it from the previous administration. Adopting a domestic economy-based economic policy, the previous administration sowed the seeds of the crisis a long time ago. The signs of the oncoming crisis were evident as far back as 2012.
IPS has warned of the impending crisis since 2011
When the independent analysts and think-tanks drew the attention of the previous administration to the crisis, they were simply ignored these warnings at first and later even rebuked. The Institute of Policy Studies, commonly known as IPS, in its State of the Economy 2011 report warned the Government of the myth of boasting of a foreign reserve base adequate for 5.9 months of imports.
Said IPS: “Sri Lanka’s accumulation of reserves, however, is not the result of the surpluses in the current account of its BOP, but rather the result largely of foreign investments in Treasury bills and bonds, government foreign borrowing, etc. Thus, the country’s medium term exposure to external shocks cannot be discounted. Indeed, a weakening of macroeconomic fundamentals could lead to a swift outflow of funds in government debt instruments.” (P 19).
Sri Lanka had been claiming that its poor performance in exports has been due to unfavourable global developments. But the IPS Report on the State of the Economy 2013 had countered that claim by pointing out that countries Bangladesh and Vietnam had increased their exports in the recent few years. Thus, opined the IPS: “So, clearly only a part of Sri Lanka’s export performance can be attributed to the weak global economic climate and depressed demand in key Sri Lanka’s markets. The other half of the story is more ominous. Sri Lanka has not been successful in expanding its export markets through both bilateral and regional trading arrangements, as well as through enhanced competitiveness.” (P 5).
The charge here is about Sri Lanka’s failure to win back GSP + from the EU and drive Sri Lanka’s economy for greater integration with the large economy to the north, India, via CEPA.
Since the previous administration had been complacent about the rising remittances flows and postponing the critical economic reforms, IPS had warned that increases in foreign exchange outflows need the country to adopt “a focus beyond remittance inflows to the critical role that export earnings play.”
Continuing its warning that the foreign reserve build-up has been through external borrowings and not through earnings, IPS had in its State of the Economy 2014 highlighted that “stability on the external sector is needed to retain foreign investor confidence”.
It added: “This is all the more important in view of Sri Lanka’s rising exposure to external sector developments on multiple fronts as direct government borrowing is increasingly accompanied by indirect government foreign borrowing and private sector borrowing.” (P 3).
This writer too through a number of previous articles in this series drew the attention of the previous administration to the emerging foreign exchange crisis in the country to no avail (available at: http://www.ft.lk/article/332124/A--Child-s-Guide--to-the-IMF-s-press-release-on-Sri-Lanka ; http://www.ft.lk/article/297680/Sri-Lanka-s-external-debt-sustainability--Complacency-based-on-incomplete-analysis-may-be-the-worst-enemy; http://www.ft.lk/article/155713/Fixing-Sri-Lanka-s-gaping-trade-deficit).
However, the country is now in the midst of this crisis as revealed by this writer during an address at the Sunday Times Business Club just before the presentation of Budget 2016 in November last year (available at: https://www.youtube.com/watch?v=MkS7blKFJPk&feature=youtu.be) and in the keynote address on the occasion of the release of the State of the Economy report by IPS for 2015 (available at: https://www.youtube.com/watch?v=igsAaLP2wBY&feature=youtu.be).
The fault with the present administration is its failure to learn from the mistakes of the previous administration by regarding the emerging foreign exchange crisis as a trivial matter. Now the crisis has hit it on the head, prompting it to opt for even unconventional solutions.
A sovereign government cannot act like an underworld criminal
But how prudent is it for a sovereign government to get an elusive investor to come and rescue its currency? A sovereign government is different from an underworld operator and fully committed to principles of good governance, disclosure and transparency. This is all the more important in an era where there is growing global concern about money laundering and the financing of terrorist activities.
The US and the UK authorities have fined several banks for failing to exercise due diligence and prevent money laundering when they undertook certain questionable transactions with customers. Some banks have reached out of court settlements to avoid litigation by authorities, consequential embarrassment and the loss of face. One such big bank so fined has been HSBC, which in a statement apologised for the felony committed due to poor money laundering controls, meaning that the bank had not exercised proper due diligence in handling the transactions (available at: http://www.bbc.com/news/business-20673466).
HSBC can apologise and escape but a sovereign government cannot do so. It is the duty of the country’s central bank to help the government in detecting instances of money laundering and avoid possible subsequent embarrassments which are fatal to its good reputation.
Money launderers lure politicians and bureaucrats with tempting proposals
The money launderers have a common modus operandi in luring public officials and politicians to the felonies they are planning to commit. They engage a local partner, visit the politicians and the central bank and make an unsolicited offer of assistance. They select countries which are vulnerable due to prevailing budgetary or foreign exchange difficulties or in other words drowning countries ready to hang onto even threads of straw for life support.
This writer recalls that when he was in the Central Bank there were one or two such unsolicited offers made every month by numerous people accompanied by their local agents. The amounts so offered had been staggeringly high, ranging from $ 5 to $ 10 billion in one go so that it was difficult to resist the temptation to grab them immediately.
But the Central Bank had a standard procedure to handle such unsolicited offers at that time.
First of all, the promoters were to be told that Sri Lanka was a sovereign country committed to good governance principles and therefore it had to follow due procedures when accepting such offers. That included approval by the Cabinet, appointing the Central Bank as the Government’s agent, calling for public tenders and accepting bids in a transparent manner.
Then, they were to be told, in a bid to dissuade them from further pursuit, that though the country was facing difficulties, the amounts so offered had been too high to be absorbed by the country without overheating its economy. They were, therefore, asked politely to submit their offers through a reputed bank once an announcement was made by the Government.
To be on the safe side, the Central Bank always checked the identity and addresses of the promoters by using the country’s foreign mission network. This was because these alleged promoters had on many occasions been sponsored by leading politicians and the Central Bank had to apprise them of the true situation later.
In all these cases, this writer recalls that they were all fake addresses or when there were identified ones, they had been assigned to basements of unoccupied buildings often earmarked for demolition.
As a part of the modus operandi, they always requested a letter from the Central Bank or the Ministry of Finance appointing them as the government’s agent for raising funds. It was well known that they would use this letter for laundering money across the borders.
More prudent ways for governments to act
Hence, the Central Bank, while declining such unsolicited offers, recommended to the Government to raise a temporary loan through one of the state banks or go for a syndicated loan or issue sovereign bonds in the international markets or as the last resort, go for an arrangement with the IMF.
Even for these measures, due approval should be taken from the Cabinet beforehand since any sovereign borrowing had to be sanctioned by the Cabinet to ensure future payment of interest and repayment of the principal of the loan even when a new government is in power.
The Cabinet, on its part, would seek the opinion of the Attorney General on the legality of the borrowing before it gives its approval. Foreign lenders always insisted on the approval of the Cabinet and clearance by the Attorney General before they lent any money to the country. Any lender who does not ask for these certificates is a person not familiar with these good legal and governance practices.
Risks associated with the elusive investor’s proposal
It is not clear whether the deposit made by the elusive Belgian investor is a loan to the Government or a simple demand deposit made with a local bank at an interest rate of 2% per annum. If it is a deposit made with a local bank, such foreign exchange is not considered a part of the country’s official reserves which include only those balances held by the government and the Central Bank.
Hence, they cannot boost the rupee since they are not available to the Central Bank to protect its external value. If the bank sells such foreign exchange to the Central Bank, it has serious monetary as well as foreign exchange consequences. The monetary consequence is that when the Central Bank buys $ 1 billion, it has to release Rs. 145 billion to the market adding to the existing excess liquidity. That would increase the country’s reserve money base enabling banks to create more money over a period.
At present, when the Central Bank creates one rupee as reserve money, banks are able to create six rupees as money held by people over a period of 18 months. This is a serious threat to the Central Bank’s inflation fighting objective, known to economists as economic and price stability objective, on the one hand, and to the fragile balance of payments, on the other.
The latter is due to the increased import bill due to the higher money balances held by people. Hence, to avoid this, the Central Bank has to further increase the statutory reserve ratio or SRR from the current level of 7.5%.
The futility of this measure was discussed by this writer in a previous article (available at: http://www.ft.lk/article/515521/Looming-economic-crisis--policy-approaches-are-too-short-and-too-late-while-some-are-unproductive). It would lead to an increase in the interest rate structure of the country. If SRR is not increased, the bank will have to take the excess liquidity out of the system by paying a higher interest rate on such money mobilised under its standing deposit facility. It would cause the bank to incur an interest cost threatening its future profitability.
Danger of Sri Lanka functioning as a money laundering corridor
The foreign exchange consequence arises from the hot nature of the deposit alleged to have been received by the country. It is a demand deposit and, therefore, it could be taken out of the country by the single depositor at any time.
The country faces a foreign exchange risk because it has to be in readiness to allow the investor to take that money out at his will. If the foreign exchange has already been sold in the market to protect the rupee, the country has to meet the investor’s demand by either running down the existing foreign exchange reserves or by raising a new loan from abroad. If the investor chooses to take the money out, Sri Lanka cannot easily counter the allegation that the country has been used as a ‘money laundering corridor’ by an alleged money launderer. These are unnecessary risks the country will have to take.
Yahapalana government on the wrong track?
Given the current circumstances, Sri Lanka should get IMF support to come out of the crisis immediately. Then, it has to adopt a comprehensive economic reform program to restructure its economy so that it can avoid such calamities in the future. In this sense, going for an elusive Belgian investor to boost the rupee is not a viable option.
If the Government still chooses to go behind elusive investors, the Yahapalana Government is surely on the wrong track.
(W.A. Wijewardena, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at email@example.com)