Ban on forward contracts of foreign exchange leads to commodity price hike

In view of the need to avoid excess volatility in the foreign exchange market and the impact on banks  risk management, licensed commercial banks have been directed to refrain from  entering into forward contracts of foreign exchange for a period of three months with immediate effect.

Sri Lanka has barred commercial banks from trading foreign exchange forward for three months as the currency came under pressure amid high levels of excess liquidity.

This will result in the price hike in essential commodities and other imported goods creating shortage in the local market as importers will curtail their business due to heavy losses., they said.  

The forward booking of foreign exchange is the normal practice being carried out by importers to sell their imported goods at a stable price and to recover the loss arising out of severe depreciation of rupee in relation to relevant foreign currency, economic analysts said.

The importation of many items including essential commodities such sugar, food items, coconut oil and related products is being carried out on the basis of making payments exporters or suppliers in relevant foreign countries on 90 to 180 day credit basis in accordance with the government’s new import policy.

Under the present setup, there was no possibility to pay the relevant foreign banks on the very first day of receiving the imported goods at the foreign exchange rate prevailing on that date, they claimed.

For example, if the goods were to be received today, the payment for the relevant transaction would be made in July or August 2021.

At this instance, the commercial banks have earlier agreed to estimate the payment at the US dollar rate equivalent to rupee value estimated at the previous exchange rate on the date of receiving goods (July or August).

This practice was not possible with the imposing of ban forward booking by the Central Bank in view of the need to avoid excess volatility in the foreign exchange market and the impact on banks’ risk management, licensed commercial banks.

Sri Lanka rupee has fallen from around 185 to close to 200 to the US dollar over the past month and forward premiums have inverted as dollar yields overtook rupee yields.

Forward rate agreements are commonly used derivative instruments in financial markets to hedge one’s possible losses from foreign exchange transactions.

Importers hedge against possible further depreciation of the rupee against the US dollar and exporters enter into such agreements to minimise their exposure from the appreciation of the rupee.

These are over-the-counter instruments, where either an importer or an exporter can get into with a bank for a fee.