By Uditha Jayasinghe

COLOMBO, (Reuters) – Sri Lankan authorities are expected to clamp down on inflows of informal remittances in order to increase its reserve to pay more than $4.5billion in debt repayments next year.

Ajith Nivard, central bank governor said that he had seen $300 million in remittances drop within the past month. He also pledged to apply anti-money laundering laws in order to prevent informal channels of transferring millions of dollars worth of critical foreign currency reserves to the banking system.

Below are the details about Sri Lanka’s forex situation and reasons why it attempts to stop flows through informal channels.

WHY WOULD SRI LANKA WANT BOLSTER REMITTANCES VIA FORMAL CHANNELS

The pandemic has had a devastating effect on tourism and remittances, which were traditionally the largest sources of foreign currency earnings. The first nine months of 2020 saw tourism revenues drop to $92.5M from $4.3B in 2018 and fell to $92.5M in 2021.

While they had been strong in 2020 but fell 9.3% by Sept. 30, to $4.5billion, from $5.1billion in the same period of 2020. The declines are even more rapid since October.

In recent months, major rating agencies downgraded Sri Lankan sovereign ratings several times. This is due to the country’s low public revenues and slow growth. It also has a dearth of reserves at $2.3 billion.

In 2022, the country will have to pay $4.5 billion in interest and debt payments. This includes servicing an international bond maturity of $500 million in January. Its trade deficit increased to $6Billion in nine months, compared with $4.3B in the same period last.

WHY HAS REMITTANCE FLOWS INTO SRI LANKA VIA FORMAL CHANNELS SLUMPED

As the Sri Lankan rupee was weakening rapidly in early September, the central bank ordered banks to fix the unofficial rate between 200-203 Sri Lankan Rs to one dollar.

The rupee has fluctuated between 255 to 265 rupees per dollar through informal channels due to currency pressure, a growing trade deficit and limited foreign earnings. Workers from migrants sent money through the informal “hawala” network, while official channels remitted $353 million to September. This is down from $703 millions in September last year.

Although the central bank offers migrant workers an additional 10 rupees for each dollar that they send via official channels, there is doubt this will be effective given the attractive unofficial exchange rate.

WHAT IS THE WORK OF INFORMAL CHANNELS?

Migrant workers can use the “hawala” (or “undiyal”) transfer system to send money to Sri Lanka. Usually, the cash is in currency. The middleman then ensures that Sri Lankan family receives an equivalent amount of rupees.

Now, the central bank threatens to block accounts receiving any unexplained cash transfer or deposit.

WHY SRI LANKA DOES NOT WANT TO LET THE RUPEE DEPRECIATE FURTHER?

Sri Lanka’s retail inflation rate has reached 9.9% in November. This is almost a decade high, and well beyond the central bank’s target of 4% to 6%.

The largely import-dependent island economy could see inflation rise if it allows the rupee to freely float.

HOW WILL THE CENTRAL BANK FIX ITS FEW FINANCES?

The central bank hopes to raise reserves by increasing remittances inflows. It also expects a rebound in tourism.

A greater proportion of remittances flows is essential as the country plans to securitise part of them and then use that as collateral to lend additional money. Swap deals are being explored with central banks to facilitate imports of vital goods like fuel and medicines.