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Tuesday August 16th, 2022

IMF slashes global growth after monetary stimulus as Sri Lanka reels

ECONOMYNEXT – The International Monetary Fund has slashed global growth in 2022 by 0.4 percent to 3.2, emerging and developing Asia by 0.8 percent to 4.6 percent and advanced economies also by 0.8 percent to 2.5 percent, as inflation from two years of stimulus began to bite.

Sri Lanka is experiencing over 50 percent inflation by June 2020 and its economy may contract 6.9 percent leaders have warned as the country pays the price for two years of monetary and fiscal stimulus on top of earlier failed stimulus under output gap targeting.

Related Sri Lanka economy may contract 6.9-pct in 2022 PM says after soft-peg collapse

The IMF said the unemployment from the current episode of dis-inflation may be higher than experienced at the end of the Great inflation of the 1970s.

“If the evolution of these factors surprises policymakers, or if they misjudge the appropriate policy stance––including the level of neutral interest rates––the coming disinflation adjustment could be more disruptive than currently expected,” the IMF said in its global economic update.

“Past disinflation episodes associated with monetary policy tightening, such as those experienced by advanced economies in the early 1980s, were often costly, with high unemployment the price of taming inflation.”

The Federal Reserve, the ECB and copying them also countries like Sri Lanka printed vast amounts of money to create jobs and economic growth and are now paying the price.

Classical economics have long pointed out that unemployment is not a result of dis-inflation policies as claimed by Washington-based and other academic economists but an inevitable consequence of expansionary policies.

The biggest culprit in modern-day monetary instability and unemployment is the Federal Reserve which by law is tasked with generating employment (the so-called dual mandate) and usually does the opposite.

“The truth is that by a mistaken theoretical view we have been led into a precarious position in which we cannot prevent substantial unemployment from re-appearing,” classical economist Friedrich Hayek said in his Nobel speech in 1974 as the world was gripped by high inflation and the Bretton Woods soft-pegs in shambles.

“Not because my view is sometimes misrepresented, this employment is deliberately brought about as a means to combat inflation, but because it is now bound to appear as a deeply regrettable but inescapable consequence of the mistaken policies of the past as soon as inflation ceases to accelerated.

“The manufacture of unemployment by what are called ‘full employment policies is a complex process. In essence it operates by temporary changes in the distribution of demand, drawing both unemployed and already employed workers into jobs which disappear with the end of inflation.”

As the Fed ratcheted up money printing and inflation was blamed on supply constraints and Fed chief Jerome Powell claimed it to be ‘transient’ and the link between money supply and the economy was ‘something we have to unlearn I guess” he was cheered on.

Only a few, including some politicians in the US Congress, challenged the Fed, though reality is now hitting the world.

Related

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Fed to end injections sooner, ‘retire’ transitory, Powell says as inflation rages in Sri Lanka

“It was John Maynard Keynes, a man of great intellect by limited knowledge of economic theory, who ultimately succeeded in rehabilitating a view long the preserve of cranks with whom he openly sympathized,” Hayek wrote.

“The claim of an eminent public figure and brilliant polemicist to provide a cheap and easy means of permanently preventing serious unemployment conquered public opinion and after his death, professional opinion too.”

Global inflation is now at 40 years high at levels when Paul Volcker took over the Fed after the Great Inflation of the 1970s created by Arthur Burns who among other things claimed that there was two types of inflation, demand driven and non-demand driven.

“There is a need to realize the fact that he present state of the world and especially the present state of monetary affairs are the necessary consequences of the application of the doctrines that have got hold of the minds of our contemporaries,” another classical economist Ludwig von Mises said in 1952 as his book The Theory of Money and Credit written 40 year earlier in German was republished.

“The great inflation of our age are not acts of God. They are man-made or to say bluntly, government made. They are the off-shoots of doctrines that ascribe to governments the magic power of creating wealth out of nothing and making people happy by raising the ‘national income.’

“One of the main tasks of economics is to explode the basic inflationary fallacy that confused the thinking of authors and statesmen from the days of John Law down to those of Lord Keynes.

“There cannot be any question of monetary reconstruction and economic recovery as long as such fables as that of the blessing of “expansionism” form an integral part of official doctrine and guide the economic policies of the nations.”

At the time the US Fed has tightened policy following a battle with the Treasury under then Fed Chief Thomas McCabe guided by Mariner Eccles and Sri Lanka was experiencing its first currency crisis under the newly set up Latin America style central bank.

“The baseline projection for global inflation is also more pessimistic, having been revised up to 8.3 percent in 2022 on a fourth-quarter-over-fourth-quarter basis, from 6.9 percent in the April 2022 World Economic Outlook,” the IMF said.

“The upside inflation revision in 2022 is larger for advanced economies, where it is expected to reach 6.3 percent from 4.8 percent projected in the April 2022.

“For emerging market and developing economies, inflation in 2022 is expected to reach 10.0 percent on a fourth-quarter-over-fourth-quarter basis.”

The IMF in line with the political orthodoxy of the West blamed the war in Ukraine for higher fuel and food prices rather than the Fed and reserve currency central banks.

In 1951/2 as Sri Lanka was hit by its first BOP crisis and reserves amassed during the currency board period started to deplete amid monetary financing of imports (sterilization of reserves given for imports) the Korean War was blamed for global inflation.

Related Sri Lanka, world’s poor suffers from Fed’s accidental discovery: Bellwether

However the Fed raised rates, with Fed Governor Eccles pointing out that the inflation came from money injected the purchase of Liberty Bonds, a World War I debt, to keep its yield down. (Colombo/July26/2022)

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Sri Lanka sovereign rating at SD but ISBs downgraded to ‘D’ by S&P

ECONOMYNEXT – Sri Lanka’s sovereign rating remains at Selective Default (SD), but the country’s sovereign bonds were downgraded to ‘D’ after missed interest payments, Standard and Poor’s, a rating agency said.

“The Sri Lanka government remains in default on some foreign currency obligations, including international sovereign bonds (ISBs),” the S&P said.

“We do not expect the government to make the payments within 30 calendar days after their due dates.

“We lowered the ratings on the affected bonds to ‘D’, following missed interest payments due on June 3, June 28, and July 18, and a missed principal payment due July 25.”

Sri Lanka is still paying senior creditors with money coming from deferred payments from the Asian Clearing Union.

Sri Lanka started to borrow heavily in foreign bond markets from 2015 after battering its currency peg with extraordinary liquidity injections under ‘flexible inflation targeting and the country lost the ability to roll-over maturing rupee bonds at gross financing level.

From 2015 to 2019, the country had monetary stability only in 2017 and 2019 as the pegged exchange rate regime was shattered with liquidity injections to target an ‘output gap’.

However the targeting the output gap led to currency crises (balance of payment deficit) and growth fell as stabilization measures were slammed.

From 2020 to 2022 even more aggressive liquidity injections were made and taxes were also cut saying there was a ‘persistent output gap’ until all foreign reserves including borrowed reserves were lost and the the country defaulted in peacetime.

The International Monetary Fund gave technical assistance to Sri Lanka to calculate the output gap and also endorsed ‘flexible inflation targeting’, with overnight repo injections, term repo injections, outright purchase of bond, despite having a reserve collecting peg.

On April 12, 2022 Sri Lanka defaulted despite being at peace.

The full statement is reproduced below:

Sri Lanka Bonds Downgraded To ‘D’ After Missed Payments; Sovereign Ratings Affirmed

Overview

The Sri Lanka government remains in default on some foreign currency obligations, including international sovereign bonds (ISBs).

We do not expect the government to make the payments within 30 calendar days after their due dates.

We lowered the ratings on the affected bonds to ‘D’, following missed interest payments due on June 3, June 28, and July 18, and a missed principal payment due July 25.

We affirmed our ‘SD/SD’ foreign currency and ‘CCC-/C’ local currency ratings on Sri Lanka. The outlook on the long-term local currency rating is negative.

Rating Action

On Aug. 15, 2022, S&P Global Ratings affirmed its ‘SD’ long-term and ‘SD’ short-term foreign currency sovereign ratings on Sri Lanka. At the same time, we affirmed our ‘CCC-‘ long-term and ‘C’ short-term local currency sovereign ratings. The outlook on the long-term local currency rating remains negative.

In addition, we lowered to ‘D’ from ‘CC’ the issue ratings on the following bonds with missed coupon or principal payments:

US$650 million, 6.125% bonds due June 3, 2025.

US$1.0 billion, 6.825% bonds due July 18, 2026.

US$1.0 billion, 5.875% bonds due July 25, 2022.

US$500 million, 6.35% bonds due June 28, 2024.

Our transfer and convertibility assessment at ‘CC’ is unchanged.

Outlook

Our foreign currency rating on Sri Lanka is ‘SD’ (selective default). We do not assign outlooks to ‘SD’ ratings because they express a condition and not a forward-looking opinion of default probability.

The negative outlook on the local currency rating reflects the high risk to commercial debt repayments over the next 12 months in the context of Sri Lanka’s economic, external, and fiscal pressures.

Downside scenario

We could lower the local currency ratings if there are indications of nonpayment or restructuring of Sri Lankan rupee-denominated obligations.

Upside scenario

We could revise the outlook to stable or raise the local currency ratings if we perceive that the likelihood of the government’s local currency debt being excluded from any debt restructuring has increased. This could be the case if, for example, the government receives significant donor funding, which gives it some time to implement immediate and transformative reforms.

We would raise our long-term foreign currency sovereign credit rating upon completion of the government’s bond restructuring. The rating would reflect Sri Lanka’s post-restructuring creditworthiness. Our post-restructuring ratings tend to be in the ‘CCC’ or low ‘B’ categories, depending on the sovereign’s new debt structure and capacity to support that debt.

Rationale

Sri Lanka’s external public debt moratorium prevents payment of interest and principal obligations due on the government’s ISBs. As such, interest payments due June 3, June 28, and July 18 on its ISBs maturing 2024, 2025, and 2026, and the principal payment on its July 25, 2022, ISB, would have been affected. Following the missed payments, and given our expectation that payment will not be made within 30 calendar days of the due date, we have lowered the issue ratings on these bonds to ‘D’ (default).

Overdue payments now include the following bonds:

US$1.0 billion, 5.875% bonds due 2022.

US$1.25 billion, 5.75% bonds due 2023.

US$500 million, 6.35% bonds due 2024.

US$1.5 billion, 6.85% bonds due 2025.

US$650 million, 6.125% bonds due 2025.

US$1.0 billion, 6.825% bonds due 2026.

US$1.5 billion, 6.20% bonds due 2027.

US$1.25 billion, 6.75% bonds due 2028.

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Sri Lanka rupee guidance peg edges up; market sees dull trade in govt securities 

ECONOMYNEXT – Sri Lanka’s rupee guidance peg on interbank spot trading strengthened by seven cents while yields on Treasury bills and bonds remained dull on Monday (15) with only a handful of maturities quoted ahead of the central bank’s monetary policy rates later this week, dealers said.

“There was nothing in the market. It was dull today,” a market dealer said.

The central bank will announce its latest key monetary policy rates on Thursday, August 18.

A bond maturing on 01. 06. 2025 closed at at 27.50/28.50 percent on Monday, slightly down from 27.30/28.30 percent on Friday.

The three-month T-bill closed flat at 26.00/27.00 percent on Monday.

Sri Lanka’s central bank announced a guidance peg for interbank transactions strengthened by 7 cents to 360.92 rupees against the US dollar on Monday from 360.85 rupees.

Data showed that commercial banks offered dollars for telegraphic transfers between 369.70 and 370.00 for small transactions. (Colombo/ Aug 15/2022)

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Sri Lanka stocks rally continues for 12th straight session on political stability hopes 

The main index fell for the 4th consecutive session

ECONOMYNEXT – Sri Lanka stocks gained for the 12th consecutive session on Monday (15) ending at their highest in more than four months pushed by retail shares amid signs of political stability after months of protests, dealers said.

The market generated 5.8 billion rupees in turnover, nearly twice of this year’s average daily turnover of 3.11 billion rupees.

The main All Share Price Index (ASPI) rose 1.82% or 164.04 points to 9,191.52, its highest since March 30. The index has risen 19.6% in the last 12 sessions.

“We are seeing a lot of volatility in the market today due to profit taking in the key shares that gained in the last 11 sessions,” a market analyst said.

“Profit-taking also returned after the CSE (Colombo Stock Exchange) published the last set of June reports that showed some counters having done very while some not so much, therefore, there is a significant reaction for that.”

In the last few sessions, the market was mostly driven by Lanka IOC and the plantation sector.

However, ahead of the fuel price revision, LIOC moved to red.

“There was a bit of profit taking on anticipation of price cuts. However, unless fuel prices are cut sharply, LIOC will continue to move,” the analyst said.

At the start of the month, CPC cut fuel prices by 10 rupees based on the price formula.

Globally, crude oil prices have dropped hence there is strong speculation that fuel prices will be cut further.

Last week, Sri Lanka announced a 75 percent electricity tariff hike.

Investors previously feared the move would drag the market down due to possible higher costs for manufacturing firms.

However, the political stability after four months of protest is seen as the catalyst for the market gain, dealers said.

The government also tabled an interim budget last week, revising the budget presented last year as the country is going through an unprecedented economic crisis amid plans on a four-year IMF loan programme, debt restructuring, fiscal reforms, and dealing with loss-making state-owned enterprises.

Sri Lanka already declared sovereign debt default on April 12 this year and failed to pay its first sovereign debt in May amid a deepening economic crisis which later turned into a political crisis and led to a change in the president, cabinet, and government.

The more liquid S&P SL20 index moved up, closing at 0.82% or 25.28 points stronger at 3,097.30.

Sri Lanka is facing its worst fuel and economic crisis in its post-independence era and the economy is expected to contract 7 percent this year.

The main ASPI gained 18.8 percent in August so far after gaining 5.3 percent in July. It lost 9.3 percent in June, 23 percent in April, and 14.5 percent in March.

The market index has lost 24.8 percent so far this year after being one of the world’s best stock markets with an 80 percent return last year when large volumes of money were printed.

Sri Lanka’s sovereign debt default on April 12 has already led the country to be rated with restricted/selective default rating by rating agencies, which has weighed on investor sentiment.

Net foreign outflow was 117 million rupees on Monday while the total net foreign outflow so far this year is 1.3 billion rupees.

Investors are also concerned over the steep fall of the rupee from 203 to 370 levels so far in 2022.

Ceylinco Insurance which pushed the ASPI, closed 11.9 percent up at 2,143.2 rupees a share. Browns Investment closed 8.5 percent up at 8.9 rupees a share, and John Keells Holdings gained 2.5 percent to 129.7 rupees. (Colombo/Aug15/2022)

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