Current & capital account controls aimed at fixing BOP could backfire: ICRA Lanka

The prolonged and recently tightened controls on imports and outward remittances are unlikely improve the country’s Balance of Payment (BOP), instead would backfire by way of commodities shortages and rising prices, hurting the supply chains and denting the overall economic activity, according to ICRA Lanka Limited. 

Authorities slapped a slew of measures during the last couple of weeks to alleviate the mounting pressure on foreign exchange liquidity in the domestic market and thereby the exchange rate including the imposition of 5 percent ceiling rate for dollar deposits, fixing the dollar/rupee exchange rate between Rs.200 and 203, and imposing 100 percent cash margin requirement for some selected 623 consumer goods. But the credit rating agency ICRA Lanka expressed doubts if these measures and the earlier measures taken towards limiting certain outwards remittance would deliver the desired results. “ICRA Lanka maintains that restrictions imposed on the current account and capital account are likely to blowback rather than improve the balance of payment situation,” the rating agency said. 

“The import controls and capital controls may be effective tools in managing short- term volatilities in the exchange rate but it comes at the expense of economic growth, external sector competitiveness, and cost of living of people,” it added in its regular economic update released monthly. 

According to ICRA Lanka, prolonged import controls would also see a push back from foreign trading partners as already seen from the statement made by European Union Mission in Sri Lanka in early August. 

Sri Lanka’s external sector troubles emerged from around July due to depleted reserves from a billion dollar bond settlement amid slowdown in inflows caused by the pandemic which gave rise to heightened speculative activity, leading to withholding of exporter earnings and other inflows and front loading of certain imports, creating an abnormal demand-supply imbalance in the domestic foreign exchange market. 

Besides these restraining measures, the Central Bank also took the receipt of nearly a billion dollar worth inflows from the International Monetary Fund as part of its Special Drawing Rights allocation and from a swap with the Bangladesh Bank to shore up the reserves but ICRA Lanka shrugged them off as inadequate to create a lasting improvement in the external sector.

Referring to the most recent 100 percent cash margin requirement on selected imports, the rating agency cautioned of its potential to create a scarcity in such goods due to tightened liquidity in importers, which will then dent the economic activity. 

However, data released by the Central Bank on these commodities also showed some clear signs of excessive imports in the first 7 months compared to both 2020 and 2019 levels. 

While the margin requirement may not have much of an impact on big importers of these goods who have either already built stocks adequate for the next so many months or have the cash reserves to still import adhering to the new rule, the losers are going to be the small scale importers and the consumers at large who will have to bear the higher prices. 

Further showcasing how the restrictions are biting into the domestic industries, ICRA Lanka said, “Many domestic industries are struggling to meet the demand due to shortages in inputs triggered by the scarcity of forex and import controls”.