IMF keeps Sri Lanka forecasts amid growth risk, import collapse
ECONOMYNEXT – The International Monetary Fund will maintain its projections on economic growth, state revenues and deficits until more data is available, an official said as early 2019 data showed a collapse in domestic credit, imports and a spike in bad loans from prolonged monetary instability.
The IMF is projecting growth will be 3.6 percent in 2019, up from 3.2 percent in 2018, with domestic private credit forecast to grow 12.8 percent, while the government is targeting a budget deficit of 4.5 percent of gross domestic product with ambitious revenue gains.
In April Islamist bombers hit three hotels and Churches and the government has cut value added tax, and banks are also expected to give a debt moratorium. Tourism revenues could fall by a third or 1.5 billion US dollars, officials have said.
"It is too early to revise our assessment on the outlook," Manuela Goretti said in a video conference with reporters in Colombo.
"There will be a small revenue impact from the recent tax policy package that the authorities have approved (for tourism)".
"But of course if growth were to be revised downwards, which is a risk, there might be some additional revenue impact.
"We hope that ongoing reforms both in terms of the tax policy reforms introduced by the authorities last year but also the efforts to strengthen revenue administration will provide some additional buffers that might offset some of these revenue shortfalls."
Credit collapse, bad loans
Sri Lanka’s private credit from commercial banks grew by 26.3 billion rupees in the first three months of 2018 compared to 222.1 billion rupees in the first quarter of 2018, when there was a strong economic recovery from balance of payments crisis in 2015 and 2016.
"Overall credit conditions remain robust well above its nominal GDP growth rate there was inflation at the beginning of the year, which was also partly seasonal," IMF Mission chief
"I think we would like to wait to see more data points before we revise our program assessment on credit and liquidity conditions."
Sri Lanka is prone to balance of payments trouble and currency collapses due to a the operation of a highly unstable non-credible soft-pegged exchange rate regime, where the central bank tries to control both the exchange rate and interest rates by printing money and fails, leading to currency collapses and output shocks.
In the first four month of 2018, as private credit surged 222.1 billion rupees the central bank printed 36.8 billion rupees official data shows.
Printed money or cash injections into the banking system generate cascading expansions in credit, which then hits the balance of payments, generating reserve losses if the currency is not floated.
Analysts who study the central bank’s policy errors closely have highlighted the termination of term repo deals in the first quarter, somewhat similar to the way Argentina’s central bank repurchased its Leliq sterilization securities to generate balance of payments trouble.
In April critics also pointed to a so-called ‘buffer strategy’ involving repaying maturing bonds with bank overdrafts re-financed with central bank credit as well as reckless cash injections through a variety of overnight and term lender of last resort operations for generating a liquidity shock.
The currency collapsing from 153 to 182 in 2018, following a second liquidity shock in August, followed by a political crisis which worsened capital flight, generating liquidity shortages and as multiple convertibility undertakings were deployed.
In the first quarter private credit was negative at the largest banks in the country and bad spiked almost one percent in several larger banks.
Sri Lanka’s currency has depreciated steadily from 131 to 182 to the US dollar, killing domestic purchasing power, partly due to targeting a real effective exchange rate index, in perhaps the worst monetary instability seen since the 1980s.
In 2017 and 2018 in particular, the finance ministry cut taxes and market priced fuel reducing deficits, showing clearly that there was no fiscal dominance of monetary policy.
The budget deficit was brought down to 5.3 percent of GDP in 2018 from 7.6 percent in 2015.
Lost Generation Economics
Analysts have blamed so-called ‘lost generation economics’ and the failure to place strict monetary rules for the monetary instability.
Similar policies involving trying to close a perceived output gap with printed money while targeting the exchange rate, triggered Sterling crises and stagflation in the UK in the 1960s and 1970s and led to the final collapse of Bretton Woods system of soft-pegs as the US Fed lifted its convertibility undertaking to gold.
Predictably as money was printed the central bank lost the ability to collect forex reserves, and the country found was on the verge of sovereign default.
In the first quarter of 2019, with private credit collapsing there is no danger of dollar default and the central bank is well placed to collect reserves.
However a collapse in imports may lead to revenue losses and the overshooting of the deficit target.
Attacks on churches and hotels by Islamist suicide bombers have hit tourism hard and may have cascading shocks banking sector, retail and transport sectors, reducing tax revenues and economic output.
The government has already announced a debt moratorium for hotels and a cut it value added taxes.
As credit contracted imports collapsed 27.6 percent in February, with the cumulative fall of 22.7 percent in the first two months, some of the sharpest falls in economic activity seen for decades, and pointing to possible revenue slippages.
The central bank, in monetary dominance of fiscal policy, place import curbs especially on cars, which give high volume of revenue per dollar spent.
The IMF has asked the central bank not to control trade for balance of payments purposes. BOP deficits are function of money and credit and the soft-pegs and not trade, as Mercantilists believe.
The import collapse occurred well before the April attacks. (Colombo/May16/2019)