Open Capital A/C, Reduce Duties

• Solution To Curb Excess Liquidity

Central Bank of Sri Lanka’s (CBSL’s) “excess” reserves, compounded by high rupee liquidity levels in the market is a clarion call to the Government of Sri Lanka (GoSL) to open up its capital account, market sources told The Sunday Leader.

Hot money, ie investments into Government securities being attracted due to the high yields offered, is the main cause for the swelling up of the country’s reserves, estimated at US$ seven billion, they said.
And, CBSL, to get rid of this excess, was offering the same to the market at Rs. 111/67/72 to the US dollar in two way quotes on Wednesday.
However the best way to reduce this excess is by opening up the capital account, the sources said.
The country’s capital account is partially opened, with bureaucracy playing a “stifling” role on local investors who want to take foreign currency out for investments purposes, for which “laborious” exchange control approval is currently required.
CBSL has been buying foreign exchange inflows (mainly dollars) to prevent the rupee from appreciating, as such will hurt exporters.
With the capital account only partially opened currently, the fear is that if market forces are allowed to determine the exchange rate, it will only result in strengthening the same, to the detriment of exporters, hence the absorption of foreign exchange by CBSL, but at the expense of creating high liquidity in the market.
Excess liquidity has been over Rs. 100 billion, day in day out, these days due to the reluctance of investors to invest in the island’s real economy, preferring instead to park their excess liquidity in CBSL’s overnight repo window, which earns them an interest of 7.25% (CBSL’s policy rate).
“If the capital account is opened that will solve CBSL’s high borrowing costs, in that they will not have to absorb the excess liquidity by paying the market a high interest rate of 7.25% in order to keep inflation down,” the sources said.
But if the island’s Capital Account is opened, capital will flow out, thereby controlling this excess liquidity.
Otherwise there is a danger of creating a black market, it’s like the liquor market, the more GoSL raises taxes on legitimate liquor, the bigger the illicit liquor market will grow, the sources said.
Similarly, if foreign outflows are curbed by not fully opening up the capital account, the market will somehow or another find avenues to circumvent those blocks, they said.
Another way to go is by increasing consumption by reducing duties, the sources said.
That way too excess liquidity in the market could be controlled.
The loss in revenue may be offset by economies of scale.
Otherwise, even after the war having had ended 1½ years ago, the people are still being denied the fruits of peace, with no improvement to their living standards, by being denied consumer goods due to a high taxation regime, they said.
Food for thought for President Mahinda Rajapaksa who, in the capacity of the country’s Finance Minister, is due to present Budget 2011 in Parliament tomorrow?