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Will resuming ban increase food prices?

28 Aug 2022

By Shenal Fernando   The media briefing on the Monetary Policy Review: No.6 of August 2022 by the Central Bank of Sri Lanka (CBSL) held 18 August 2022 revealed that the CBSL and the Ministry of Trade, Commerce, and Food Security are currently at an impasse regarding the future and continued use of the Open Account Payment (OAP) terms for the importation of essential commodities. Previously, Minister of Trade and Food Security Nalin Fernando speaking in Parliament claimed that the relaxation of the restrictions on open account trade had played a role in the decline of prices of essential goods in the market such as dhal. However, this relaxation of restrictions on open account trade for selected essential food commodities is expected to expire on 31 August 2022 and it was reported that the Ministry of Trade was pursuing a further extension of this facility. However, the CBSL Governor Dr. Nandalal Weerasinghe categorically denied the claims that the use of open accounts had contributed to the recent reduction in commodity prices and instead insisted that it was a reflection of the other policy measures introduced in recent months which had helped in maintaining the exchange rate at “some stable level”. “We noticed that there is some level of stability in the foreign exchange rate. As a reflection of imposing certain limitations for the open account activities, the exchange rates offered by informal channels like hawala and undial dropped, which led to the commodity price reduction,” he explained. Explaining further, he stated that contrary to how certain traders may wish to paint the recent decreases in commodity prices as a result of the relaxation of the open account restrictions, in reality it was due to the stabilisation of the exchange rate. Accordingly, the Governor stated that the Ministry of Finance would once again ban the use of open accounts for imports soon, based on a proposal presented by the CBSL.      Background   One of the most painful facets of Sri Lanka’s economic crisis is the crippling foreign exchange liquidity crisis that emerged as a consequence of the decision of the former top management of the CBSL and the Monetary Board to hold exchange rates at around Rs. 201-203. This notably resulted in a significant decrease in foreign worker remittances, as foreign workers turned to the undial/hawala informal money transfer systems which offered a significant premium over the official exchange rate (exceeding 30% at the peak of the crisis).   According to CBSL data, foreign worker remittances fell by over 61.6% Year-on-Year (YoY) in 2021 to $ 5.5 billion from $ 7.1 billion in 2020 and this trend has continued in 2022, as foreign worker remittances are down by 51.6% YoY during the period of January to June 2022 at $ 1.6 billion compared to the equivalent period in 2021, as per CBSL statistics.     At this juncture, former Governor of the CBSL Ajith Nivard Cabraal commenced what at the time appeared to be a losing battle to dismantle these informal money transfer systems, in order to ensure that remittances returned to the official banking channels. The new Governor of the CBSL Dr. Nandalal Weerasinghe from all appearances shares the same disdain for these informal money transfer systems and has made the dismantling of these systems a policy priority.  Furthermore, Weerasinghe has identified the practice of using OAP terms to import goods as one of the main reasons for the rise of the local black market for foreign exchange.  Accordingly, on 29 April 2022, Weerasinghe pre-emptively announced that the Department of Imports and Exports Control of the Finance Ministry would publish new regulations prohibiting the import of goods through Open Account Payment terms, Documents against Payment (DP), or Documents against Acceptance (DA) methods in order to dismantle the undial/hawala money transfer systems and the current burgeoning local black market for foreign exchange.  Consequently, this was implemented by the Ministry of Finance through Import Control Regulations No. 7 of 2022, which restricted the importation of goods under open accounts, DA/DP term methods. However, the Ministry of Trade, Commerce, and Food Security intervened, claiming that this restriction would lead to a significant shortage in essential commodities in the local market and managed to convince the Ministry of Finance to somewhat relax these restrictions through Import Control Regulations No. 10 of 2022.  Accordingly, importers recommended by the Secretary of the Ministry of Trade, Commerce, and Food Security were allowed to continue importing 10 selected commodities described as essential food commodities under OAP terms during the period of 1 July 2022 to 31 August 2022. The selected 10 essential food commodities included rice, wheat flour, sugar, red whole lentils, milk powder, big onions, potatoes, dried chilies, dried sprats, and yellow split peas. However, Weerasinghe was vocal in expressing his displeasure regarding this relaxation of open account restrictions and in July 2022 claimed that the decision to allow open account terms for selected imports had reawakened the local foreign exchange black market. He cautioned that the move would create an unnecessary market which had been curtailed as a result of the measures first introduced by the Central Bank on 29 April 2022.   Reactions of economists   Speaking to The Sunday Morning Business, former Deputy Governor of the CBSL Dr. W.A. Wijewardena claimed that the position of the CBSL was misguided because the practice of importation under OAP terms had been vital in ensuring a continuous supply of essential food commodities to the country. “One reason why food inflation has not risen to the high levels anticipated and why we have managed to have a continuous supply of essential food commodities without any shortages is due to the use of the open account terms. Therefore, I believe what the Ministry of Trade is saying is correct and thus the position of the CBSL needs to be reviewed,” he explained. Elaborating further, he pointed out that in the absence of open account trade, importers would be able to import only by opening Letters of Credit (LCs). He added, however, that even the Government was currently struggling to open LCs because foreign banks were hesitant to accept LCs issued by local banks even when they had been guaranteed by a third party.   Wijewardena claimed that if the Government wished to stop the importing of goods through open accounts, it must first ensure that there existed an unlimited supply of US Dollars within the formal banking system. In the absence of an adequate supply of foreign exchange within the formal banking system as is currently the case, the restriction on imports through open accounts can lead to shortages in medicine and imported food items such as dhal, sugar, and big onions. “Most essential items are currently being imported through this open accounts system, which is similar to getting goods on credit from the supplier. If goods are imported under the open accounts system, the goods are released immediately by the Customs and the local importer will have to pay the foreign supplier using informal money transfer channels due to the absence of foreign exchange within the formal banking system. If there is an adequate supply of foreign exchange within the formal banking system, there is no rationale for importers to buy US Dollars at a higher rate from the informal market and pay their obligations to the foreign supplier,” Wijewardena said. Speaking to The Sunday Morning Business, University of Colombo Faculty of Arts Department of Economics Senior Lecturer Dr. Shanuka Senarath too agreed that the CBSL’s stance to ban open accounts in order to limit the demand for the local foreign exchange black market was faulty. “This definition of foreign exchange which has not been sent through the official channels recognised by the CBSL as black money is improper, because black currency is the gain of corruption and other criminal action, whereas the foreign exchange black market is created because people cannot trade through the official channels indicated by the CBSL.  “Moreover, the official channels are offering a lower exchange rate and banks are also forcibly converting foreign exchange. To term foreign exchange that is circulating and which doesn’t comply with these unreasonable restrictions of the Government as black money is not proper,” he explained. He criticised the Government’s failure to consider the primary reasons why people were moving away from the formal banking system and relying on these riskier informal money transfer systems. He claimed that in the absence of adequate foreign exchange in the formal system, importers had no option but to turn to the informal system to meet their forex requirements. However, he also pointed out that the ease with which importers would be able to import under OAP terms would lead to an undesirable situation where there would be a greater flow of foreign exchange out of the country.   Importers’ perspective   Speaking to The Sunday Morning Business on the condition of anonymity, a leading player within the import sector claimed that the Governor of the CBSL appeared to be unaware of the true practicalities of the trade practice and had erred in painting all importers using open accounts as users of undial. Elaborating further, he stated: “The Trade Minister is right to campaign to allow open account operations. Allowing open account trade doesn’t mean anyone can import whatever they want. When the open account shipment comes, it has to be endorsed by a bank declaring that the payment will be made by them. The CBSL appears to be unaware of these trade practices. There were sufficient control mechanisms built in to ensure that the open account process was legal. This trading method wasn’t used to smuggle goods into the country as they imply.”  He further pointed out that open account trade was used for most essential commodities exposed to high price volatility and that in the event the prices fell in the global market, the importers would be able to pass it on to the local consumer when the goods were imported through the open account method.  He noted that following the short-sighted decision to ban open account trade, this was no longer possible. Therefore, he claimed that this situation and the resulting commodity shortage might have played a role in aggravating the country’s inflation.    “Open account trade is where a foreign supplier ships goods on open papers without an LC or a guarantee of payment to a known importer. The benefit of this method is that it is not time-consuming like opening an LC, and under this method goods are shipped on trust to a known importer. This is how Pettah and commodity traders carry out their business. While there may be a few importers who abuse this trading method, this is largely used by legal businesses to import goods legally on credit,” he explained. The source stated that considering the Government’s decision to selectively default on its foreign debt, the importers’ ability to open LCs had been severely limited and it had become an incredibly costly method to import due to the high bank charges involved. Since suppliers are insisting on the confirmation of the LC by a third party foreign bank, this involved an additional 6-7% bank charge. Consequently, more US Dollars move out of the country, leading to higher commodity prices. “The Finance Ministry and the CBSL appear to be misguided on trade practices and seem to be operating on the false assumption that businessmen are rogues and that open accounts equate to the hawala system. We understand there is a huge problem with foreign exchange and that tough actions need to be taken, but stopping open account transactions is not the way,” he said.           


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