A situational analysis of the current foreign Exchange crisis.

A situational analysis of the current foreign Exchange crisis.

The depleting foreign reserves in the Central bank and the deepening deficits in the Net Foreign assets of the commercial banks are the resultant effects of a consistently mismanaged national economy. The origin of this problem goes back to 1957 when the country began recording negative trade surplus and has been so up to now barring 1977. Since independence up to 1956 were days of plenty with trade surplus, excepting the years 1952 and 1953. Such trade deficits gave way to Balance of Payment deficits which was bridged by foreign loans year after year. These loans have been from multilateral, bilateral as well as expensive ISBs. All successive Governments focussed on consumption and not on economic productivity which required hard work leading to increased exports and agricultural self-sufficiency. Obviously, the Governmental efforts were to harness votes for the next elections and not economic wellbeing unlike all our neighbours. Hence what we are experiencing today in the form of a foreign exchange crunch should have been seen many years ago, as the writing on the wall was most evident.

 

Graph 1 – Exports, Imports & Trade Deficits since 1950

What we now have (today) is a negative Net Foreign Asset Position of the commercial banks at $2.8 Bn, having ballooned from a break-even level in 2006. The Central Bank has not fared any better with the depleting reserves coming down from a high of $ 8.2 bn in 2014 to $ 2.3 Bn accompanied by a first in its history of a negative Net Foreign Assets of $ 400 mn  in August this year. What does all this mean?

 

“An import-based economy is fully deprived of its lifeline – the all-important dollars”.

 

Our annual import is about $ 22 bn. Applications for Letters of credit to feed the factories with raw material are gathering dust in the banks – some are lying there for over 80 days. Not because of the inefficiency of the banks.  They are certainly far from it. The banks are faced with twin problems. The first being quite evident from the graph which shows their declining NFA leaving their coffers with no dollars. Quite a few banks, especially small to medium sized ones, as a risk management practice, on a day-to-day basis adopt a very conservative practice of “closing” their foreign exchange exposure at the end of each day. This means every time an import LC is established the bank ensures that they   have sufficient dollars to meet that contract at the LC maturity period. This ensures that the bank’s foreign exchange liability is adequately covered with a forward exchange contract to purchase those dollars to meet the import contract. If it does not do so, it leaves the bank with an open position. The larger banks do not do so on a day-to-day basis because of their continuous inward flow and the availability of a forex market. A continuing expansion of this open position due to the low inflow of dollars and the lack of a forex market has now plunged the banks into this situation of a large Negative Foreign Asset position.

 

Graph 2 – Net Asset Position of the Banking Sector

The banks are painfully forecasting their inflow of dollars from exports and remittances to space out opening the LC’s. If you approach a bank today, they will never accept a sight LC or an LC on DA terms.  A sight LC can become due for payment as early as a month and they will not touch DA terms as they cannot give you an assurance as to when the remittance can be done. Based on their inward flow of dollars, they request a 90-to-120-day usance terms so that they can fit you in to their expected inflow. The period could even go up to 180 days. In the current context of global shortages and shipment problems importers find it difficult to accept this offer from banks as they cannot find suppliers who will extend this much of credit. So, it is back to square one for the importer.

 

The second problem faced by most banks is issue of confirmation of the letters of credit. Even if the importer is lucky enough to get these usance terms from the bank and even luckier to find a supplier to give   this amount of credit in the current context, the question of confirmation of the LC arises. The overseas supplier banks now insist on the LC to be confirmed by the local banks’ correspondent bank. With the downgrading of the country’s credit rating, the limit now offered by the correspondent banks to the local banks for confirmation has been reduced. Hence the importer now having gone through the gigantic task of opening the LC is now faced with the lack of confirmation of the LC, a problem no one can solve.

 

Adding fuel to the fire, the importer now by some chance clears all the above hurdles is faced with the problem of cost of import. Suppliers credit certainly does not come cheap now. Hence a 90 or 120-day LC which the bank insists on comes at a premium price. Having imported at the premium dollar price, the importer now awaits a possible further disaster at the time of clearing. Will the exchange rate hold ?? and how does he take a price revision of his finished product.

 

All the problems above led the importers to explore all possible avenues for import and they finally reached out to the always available but never used UPAS scheme (Usance Paid At Sight). This is operated through the correspondent bank of the local bank. This comes at even higher cost (that is why it was never used). But beggars can’t be choosy. In this scheme, say, a supplier who normally offers you a 90 credit will get paid immediately. Notwithstanding this benefit he will not lower his price which already includes his 90-day interest. What choice does the importer have during times of material shortage and shipping constraint. The banks commissions in this transaction does not come cheap either.

 

The corporate performance up to the end of the end of September was based on stocks of raw materials available in the factories due to LC’s opened in around June this year at which time the above problems were there but at a much-reduced scale. The challenge now is to keep the factories working in January/February as the LC’s required to import the raw materials to feed the machines in January/February are gathering dust in the banks.   Hence, we are bound to see the factories putting up the shutters in early next year, not due to the pandemic but because of the dollar crisis.

 

With the trade deficit on a continuing trend of ballooning accompanied by a drastic reduction in worker remittances and tourism resurgence being only in its infancy, there does not seem to be any hope in the  dollar availability improving specially so with a debt service  of 6.7 bn looming in front of the Government in the next 12 months. This reiterates the fact the country is urgently in need of a large inflow of Billions of dollars (not just Millions) as reliance on the routine cash flow is of no avail.