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Sunday June 23rd, 2024

A COVID-19 Recession and Debt Shock in Asia and Sri Lanka: scenario analysis

VIRUS HOSPITAL: A South Korean health official sprays disinfectant in front of a hospital where a total of 16 infections have now been identified with the COVID-19 coronavirus, in Cheongdo county near the southeastern city of Daegu on February 21, 2020.

This scenario analysis is by Ganeshan Wignaraja is the Executive Director of the Lakshman Kadirgamar Institute of International Relations and Strategic Studies (LKI) in Sri Lanka. He says South Asia’s government debt to GDP ratio of 66.5 percent in 2019 also exceeded IMF benchmarks with outliers Pakistan and Sri Lanka at about 80 percent. As the pandemic is fast moving with the epicentre spreading from China to Europe, an shaped Scenario 2 seems more likely than V-shaped Scenario, he says

MARCH 2020 – Developing Asia is famous for engineering V-shaped recoveries following the 1997 Asian financial crisis and the 2008 global financial crisis as well as emerging as a key engine of global growth. The severity of the COVID-19 pandemic has sparked concerns about whether global growth will be V, U, L or I shaped and what it means for Asia.

China, the initial epicentre of COVID-19, accounts for 17.3% of global cases while lagging South Asia has 0.5% (26 March 2020).The rapid transmission of the infectionis linked to globalization of the world economy and the advent of global travel. It has triggered a public health emergency and an unexpected economic shock. Stock markets across Asia have tumbled and China-centred global supply chains are collapsing. Travel bans and lockdownshave disrupted daily life. Unemployment and income inequality are rising.

Asia grew at 5.6% in 2019 and in January 2020 the IMF projected that this figure would uptick to 5.8% in 2020. It is premature to assess the full economic impact of COVID-19 on Asia as economic data is lacking and forecasting models are not adequately specified to analyse the disruption from the pandemic. The IMF will update its forecasts during the virtually held Spring Meetings in mid-April 2020.

Projections made in astudy on the medium-term outlook on Asia’s growth and the prospects for middle income countries are being updated using leading indicators (e.g. the manufacturing purchasing managers index) in an attempt to predict significant changes in economic activity. Preliminary research suggests two economic scenarios for Asia and world with the depth of downturn depending on the effectiveness in containing the pandemic.

Scenario 1: a short outbreak and a limited economic impact on Asia. The spread of COVID-19 in Asia is checked within a few months through lockdowns, social distancing, virus testing, quarantine and medical treatment. A vaccine is available ahead of schedule. Asia’s growth could be in the range of 4.0-4.5% in 2020. This is above expected global growth of 2.3-2.5%. An upturn in Asia could be likely in 2021. Nonetheless, Asia would fall into recession as defined as two consecutive quarters of decline in a country’s real gross domestic product (GDP).

Scenario 2: A long outbreak and a prolonged economic impacton Asia. COVID-19 continues to spread rapidly in Asia, the interventions are partially successful in containing the infection, another virus season could start with new mutationsand vaccine development takes longer than expected. The decline in Asia’s growth may be in the range of 2.0-2.5% in 2020 and remain sluggish in 2021. This is worse than the bottoming of Asian growth to 2.8% in 1997 during the global financial crisis. Meanwhile, global growth could slip to 1.0-1.5% in 2020.This would constitute a lengthy recession.

As the pandemic is fast moving with the epicentre spreading from China to Europe, an L-shaped Scenario 2 seems more likely than V-shaped Scenario 1. Amid such a bleak outlook, central banks in Asia have cut interest rates and are buying assets to support financial markets.Governments are also undertaking fiscal stimulus and welfare measures.

Looking at Asian debt dynamics helps to grasp why they are intervening.IMF technical work in the early 2000s conservatively suggested prudential benchmarks on public debt of a debt to GDP ratio of 60% for developed economies and a debt to GDP ratio of 40% for developing economies. While not officially endorsed by the IMF, it was thought that breaching these benchmarks would threaten fiscal sustainability.

With a government debt to GDP ratio of 58.8% in 2019, Asia has exceeded the benchmark for developing countries and is approaching that for developed economies. China’s government debt to GDPratio of 60.9% in 2019 is argued to significantly understate the total debt to GDP ratio of 303% when corporate and household debt are included.

The pandemic has led toconcerns about high debt in state-owned enterprises and corporates held in a fragile shadow banking system. South Asia’s government debt to GDP ratio of 66.5% in 2019 also exceeded IMF benchmarks with outliers Pakistan and Sri Lanka at about 80%.

Interestingly, there is little evidence of a Chinese ‘debt trap’ due to commercial borrowing for infrastructure projects at least in the case of Sri Lanka. Graduation from concessional aid has left Sri Lanka more dependent on commercial borrowing from international capital markets. The pandemic has left indebted South Asian economies facing a triple whammy of rising borrowing costs, falling commodity prices and declining tourism receipts. This has put pressure on limited foreign exchange reserves and increased the risk of debt distress in South Asia.

The current COVID-19 trajectory points to ascenario of a long outbreak and a prolonged economic impact on Asia. Policy makers should upscale health interventions as well as loosen monetary and fiscal policyto save lives and mitigate a deep recession.In doing so, the risk of a debt shock needs to be factored into the policy calculus.

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Sri Lanka central bank appoints two Deputy Governors

ECONOMYNEXT – Sri Lanka’s central bank said Assistant Governors A A M Thassim and J P R Karunaratne were promoted to the post of Deputy Governor.

The full statement is reproduced below:

APPOINTMENT OF NEW DEPUTY GOVERNORS OF THE CENTRAL BANK OF SRI LANKA

In terms of the provisions in the Central Bank of Sri Lanka Act, No. 16 of 2023, Hon. Minister of Finance, as recommended by the Governing Board, has appointed Mr. A A M Thassim, Assistant Governor and Secretary to the Governing Board, and Mr. J P R Karunaratne, Assistant Governor, as Deputy Governors of the Central Bank of Sri Lanka with effect from 20.06.2024 and 24.06.2024, respectively.

Mr. A A M Thassim

Mr. A.A.M. Thassim has over 31 years of service at Central Bank of Sri Lanka (CBSL) in different capacities in the areas of Supervision and Regulation of Banking Institutions, International Operations, Communication, Payments and Settlements, Employees Provident Fund, Finance, Risk Management, Deposit Insurance, Security Services and Information Technology.

He has served as the Director of Bank Supervision (DBS), Director of International Operation (DIO) and Director of Communications (DCM) and has contributed towards strengthening the legal framework, governance, implementation the Basel 3 international guidelines for capital and liquidity and adoption of International Financial Reporting Standards (IFRS) 9 to the banking sector, thereby strengthening the resilience of the Financial Sector.

Further, as the DIO, Mr. Thassim was responsible for the investments and management of foreign reserves of the country and exchange rate management. Mr. Thassim has also gained experience and knowledge in the field of payment systems and was involved in the implementation of the Cheque Imaging and Truncation System. In addition, he has also served on several high-level internal committees including in the areas of monetary policy, financial system stability and international reserves.

Prior to the appointment as the Deputy Governor, Mr. Thassim held the position of Assistant Governor and was in charge of several key departments including the Bank Supervision Department. He also served as the Secretary to the Governing Board, Monetary Policy Board, Audit Committee, Board Risk Oversight Committee, Ethics Committee and Financial Sector Crisis Management Committee.

At present, Mr. Thassim is a board member of the Sri Lanka Export Credit Insurance Corporation and the Vice Chairman of the Institute of Bankers of Sri Lanka (IBSL). Further, he has also served as a board member of the Credit Information Bureau of Sri Lanka and LankaClear (Pvt) Ltd.,

Mr. Thassim is an Associate member of the Chartered Institute of Management Accountants (ACMA) United Kingdom and possesses a Masters in Business Administration (MBA) from the Postgraduate Institute of Management (PIM), University of Sri Jayewardenepura (USJ). He has also completed a programme on Gold Reserves Management from Hass School of Business, University of California, Berkeley, USA.

He is also an Alumni of Harvard University, USA having successfully completed the executive programme on Leaders in Development conducted by the John F. Kennedy School of Government.

Mr. J P R Karunaratne

Mr. J P R Karunaratne has over 33 years of service at the Central Bank of Sri Lanka in different capacities in the areas of supervision and regulation of Banks and Non-Bank financial institutions, Currency management, public debt, Secretariat, Finance, policy review and monitoring. He has served as the Director of Supervision of Non-Bank Financial Institutions (DSNBFI) and the Superintendent of Currency (SC) and has contributed towards strengthening the legal and regulatory framework in the Non-Bank Financial Institutions sector and has played a prominent role in the consolidation of the Non-Bank Financial Institutions sector. Prior to the appointment as a Deputy Governor, Mr. J P R Karunaratne held the position of Assistant Governor and was in-charge of the Department of Supervision of Non-Bank Financial Institutions, Finance Department and the Facilities Management Department.

As an Assistant Governor Mr. Karunaratne has previously overseen several other departments namely, Macroprudential Surveillance, Resolution and Enforcement, Foreign Exchange, Currency, Regional Development, Legal and Compliance, Risk Management, Center for Banking Studies, Security Services and Staff Services Management.

He has also served as the Secretary to the Monetary Board, Secretary to the Board Risk Oversight Committee, Monetary Board Advisory Audit Committee and the Ethics Committee. Further, He was on release to the Ministry of Defence, where he served as a Financial Advisor. He was also appointed as the Chief Operating Officer for the Secretariat of Committee of Chartered Accountants appointed by the Supreme Court in 2009.

He has served as the Chairman of the Sri Lanka Accounting and Auditing Standards Monitoring Board and has been a Council Member of the Certified Management Accountants (CMA) of Sri Lanka. Mr. Karunaratne was awarded the CMA Sri Lanka Business Excellence Award at the CMA Sri Lanka National Management Accounting Conference 2023 in recognition of his service to the profession. He has also received “Long Service Award” of the IBSL in 2019 in recognition of his long career and contribution as a resource person at IBSL.

He was the Project Team Leader of the South East Asian Central Banks (SEACEN) Malaysia, research project on “Implementation of Basel III Challenges and Opportunities in SEACEN Countries” and SEACEN published the research in 2013. He serves as a member of several internal and external committees at present.

Mr. Karunaratne holds a Master of Commerce Degree in Finance from the University of New South Wales, Australia and a Postgraduate Diploma in Applied Statistics and a Bachelor of Science (Physical Science) Degree with a First class from the University of Colombo. He is a Fellow Member of the Chartered Institute of Management Accountants (CIMA), UK and a Chartered Global Management Accountant (CGMA). Further, he is an Associate Member of the CMA Sri Lanka.

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Sri Lanka opposition questions claims that IMF housing tax is only for kulaks

ECONOMYNEXT – Sri Lanka’s opposition has questioned claims made by government spokesmen that a tax on housing proposed in an International Monetary Fund deal is only limited to rich people but if as promised by President one house is exempt, it is welcome, legislator Harsha de Silva said.

Sri Lanka President Ranil Wickremesinghe made a promise in parliament that the first house of a citizen will be excluded from the property tax.

Related Sri Lanka to exempt one house from imputed rent wealth tax: President

But opposition legislator Harsha de Silva pointed out that the IMF program documents clearly says taxes will be levied on owner occupied houses on ‘imputed taxes’, not second houses.

Under current inland revenue laws, actual rent income from a second house is already captured as part of taxable income.

The IMF document mentions a threshold value from which taxes will be exempt but not that a whole owner-occupied primary residence will be exempt.

“The tax is imposed on the income of individuals (rather than real property itself) and thus raises central government revenue in accordance with the constitution,” IMF staff said in their report.

“A similar tax was previously included in the Inland Revenue Act. No. 10 of 2006.

“Under this regime, primary residences were exempt and the assessed values for rating purposes were used to determine the base.

“Given the broad exemption and the use of outdated and downward biased annual values, the tax generated hardly any revenue.”

Meanwhile Sri Lanka has promised to impose the housing tax from April 01, 2025.

“…[W]e will introduce an imputed rental income tax on owner-occupied and vacant residential properties before the beginning of the tax year on April 1st, 2025,” the memorandum of economic policies agreed with the IMF said.

“An exemption threshold and a graduated tax rate schedule would make this tax highly progressive.

“The full revenue yield from this tax is estimated at 0.4 percent and would materialize in 2026 (with a partial yield of 0.15 percent in 2025).

“This yield would still fall short by 1 percent of GDP relative to the expected yield of 1.2 percent of GDP from the property tax envisaged for 2025 onwards.”

Presidential Undertaking

“Whatever the President said the IMF agreement says owner occupied house,” De Silva told in parliament.

“It is not the second house that is mentioned in the agreement.

“But there is one thing. I am happy as Samagi Jana Balawegaya, that we have been able to save the middle class in society from a massive tax that was to be imposed.”

In Sri Lanka there is a belief that the most productive citizens are fair game for excessive or expropriationary taxation, just like kulaks were targeted in the Soviet Union for actual expropriation, critics say.

Wealth taxes have had disastrous effects on some US cities like Baltimore, leading to falling populations and dilapidated houses.

Sri Lanka is currently facing a brain drain due to high income tax after on top of depreciation from severe monetary debasement from a flexible exchange rate, which is neither a hard peg nor a clean float.

Sri Lanka has imposed a wide range of taxes on the people to maintain a bloated state, after inflationists engaged in extreme macro-economic policy (tax and rate cuts) glorified in Saltwater-Cambridge doctrine to boost growth, throwing classical economic principles and monetary stability to the winds and driving the country into external default.

The IMF itself gave technical assistance the central bank to calculate potential output inviting the agency to cut rates to close the perceived econometric ‘output gap’.

In the run up to the default, rate cuts triggered multiple external crises, leading to output shocks as stabilization programs were implemented.

Macro-economic Policy

Macro-economic policy as known now was devised by Cambridge academic J M Keynes in the wake of the Great Depression triggered by the Federal Reserve after it invented open market operations and policy rates in the 1920s and also popularized by Harvard academic Alvin Hansen among others.

Macro-economic policy started to de-stabilize countries in peacetime in the interwar years and after World War II it led to the collapse of the Bretton Woods system.

The Great Depression was also a peacetime collapse of what was later known as the roaring 20s’ monetary bubble.

“They have blithely ignored the warnings of economists,” classical economist Ludwig von Mises wrote of European nations which got into trouble from rate cuts and Keynesian stimulus, which brought currency depreciation and protectionism in its wake from the 1930s.

“They have erected trade barriers, they have fostered credit expansion and an easy money policy, they have taken recourse to price control, to minimum wage rates, and to subsidies.

“They have transformed taxation into confiscation and expropriation; they have proclaimed heedless spending as the best method to increase wealth and welfare.

“But when the inevitable consequences of such policies, long before predicted by the economists, became more and more obvious, public opinion did not place the blame on these cherished policies…”

Who….?

In Sri Lanka however there is some understanding of the role played by macro-economists in the most recent crisis.

There are rumblings of unhappiness about ‘central bank independence’ given to an agency to create 5 to 7 percent inflation and currency debasement under a flexible exchange rate and its constitutional status relating to parliamentary control of public finances.

Sri Lanka’s central bank’s current flexible inflation targeting (inflation targeting without a floating rate) regime as well as its 1980s money supply targeting without floating rate has busted the national currency for decades and made it impossible to run budgets, made it difficult for people build houses which are now to be taxed, and also for millions to live and work in the country of their birth.

Fiscal metrics deteriorate each time rate cuts drive the country into currency crises and new taxes are brought in stabilization programs, ousting reformist governments and leading to policy reversals.

Sri Lanka’s citizens have suffered for decades from the privilege given to a few macroeconomists to print money to cut rates with inflationary open market operations and trigger forex shortages.

Related How Sri Lanka’s elections are decided by macro-economists and the IMF: Bellwether

Critics have pointed out that since 1954 in particular, central bank rates cuts which drive the country into external crises and the stabilization programs that follow, have been the main determinant of elections in the country and election of fringe political parties. (Colombo/June13/2024)

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India supports Sri Lanka Coast Guard to boost maritime security

ECONOMYNEXT – India has given 1.2 million US dollars’ worth spare parts to Sri Lanka’s Coast Guard to be used in a vessel also gifted to the Indian Ocean Island on an earlier occasion, the Indian High Commission in Colombo said.

“Handing over of the large consignment of spares symbolizes India’s commitment to support capability building towards addressing the shared challenges of Maritime Security in the region,” the Indian High Commission said

The spare parts were brought to Sri Lanka on the Indian Coast Guard Ship Sachet, an offshore patrol vessel that was on a two-day visit to the island.

The spares were formally handed over to the Sri Lanka Coast Guard Ship Suraksha which was gifted to Sri Lanka in October 2017 by India.

India has gifted spare parts for the ship in June 2021 and April 2022 and also provided assistance in refilling of Halon cylinders in January 2024. (Colombo/June23/2024)

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