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Wednesday June 7th, 2023

Sri Lanka 2020 budget deficit could rise to 7.9-pct of GDP amid tax cuts: IMF

ECONOMYNEXT – Sri Lanka’s 2020 budget deficit could rise to 7.9 percent of gross domestic product from an earlier forecast 5.3 percent and 6.2 percent in 2019, the International Monetary Fund has said, the highest since 2015, when a so-called 100 day program of a newly elected administration de-stabilized state finances.

The IMF said the primary deficit of the budget – a measure that removes the effect of rate hikes giving the central bank a free hand allow rates to move up and avoid printing money maintain monetary stability – would rise to 1.9 percent from an project 0.7 percent surplus.

Sri Lanka has slashed value added tax, and a series of direct taxes, in a bid to ‘stimulate’ the economy, which was hit by the after effects of a currency collapse in 2018, coming from the island’s highly unstable soft-peg with the US dollar.

Spiking Deficit

Sri Lanka has a habit of running payment arrears during the last few weeks of the year in a bid to understate the deficit and repaying them early next year, sometimes with foreign market borrowings or printed money (provisional advances).

“Under current policies, as discussed with the authorities during the visit, the primary deficit could widen further to 1.9 percent of GDP in 2020, due to newly implemented tax cuts and exemptions, clearance of domestic arrears, and backloaded capital spending from 2019,” IMF mission chief Manuela Goretti said in a statement.

“Given risks to debt sustainability and large refinancing needs over the medium term, renewed efforts to advance fiscal consolidation will be essential for macroeconomic stability.”

Sri Lanka has not presented a formal budget for 2020, but is operating on a vote-on-account limited to the first four months of the year, when general elections are expected to bring in a new parliament.

Finance ministry has asked parliament to support a supplementary estimate of 155 billion rupees to support payment arrears amid the tax cuts. There were also foreign debt projects which were not provided for, parliament was told.

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By cutting taxes Sri Lanka has effectively jettisoned a policy plank of a three year IMF program that is now drawing to a close, based on so-called ‘revenue based fiscal consolidation, where many new taxes were imposed private citizens and the proceeds were given mostly as salary hike to state workers.

The projected deficit for 2020 at 7.9 percent would be the worst since 2015, when a newly elected administration ratcheted up subsidies, and hiked state salaries driving the deficit to 7.6 percent of GDP.

The central bank then cut rates and injected large volumes of money to keep overnight rates down, terminating term repo contracts triggering a currency crisis amid a strong recovery in domestic credit from an earlier collapse of the soft peg.

In 2018, the central bank cut rate and injected printed money to keep overnight rates down triggering monetary instability, despite new taxes bringing in more money and a freeze on state salaries, helping bring down the deficit steadily over two years to 5.3 percent of GDP.

The rupee then collapsed to 182 to the US dollar, triggering involuntary rate hikes and an output shock.

Economic output and revenues then fell, and election spending also went up. The IMF has said the 2019 budget deficit could rise to an estimated 6.2 percent of GDP, from a revised target of 5.7 percent, busting the final targets in a three year program.

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The central bank cut rates on January 30, to 7.5 percent from 8.0 percent, despite inflation hitting 5.4 percent, saying inflation will fall later.

Under a so-called highly discretionary ‘flexible’ inflation targeting’ framework the central banks cuts rates when inflation is low or high, but is then forced into involuntary rate hikes when the currency peg collapses.

State Credit

Private credit has so far been weak since the collapse of the soft-peg in 2018 from 153 to 182 to the US dollar, though a recovery is being seen.

Analysts have said that the economy tends to recover on its own about 18 month after each currency crises triggered by the soft-peg.

Sri Lanka’s Ceylon Electricity Board is going through a financial crisis, accommodating growing new demand with expensive thermal power, adding to losses at state enterprises.

President Gotabaya Rajapaksa has said he wants to make SOEs more efficient.

“The team welcomed the authorities’ plans to enhance the efficiency of state-owned enterprises, enabling them to operate on a sound commercial basis,” Goretti said.

“These plans would need to be supported by a visible commitment to strengthen governance and transparency, notably in the energy sector, and renewed efforts to tackle corruption.” (Colombo/Feb08/2020)

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Sri Lanka’s shares slip on profit taking and selling pressure

ECONOMYNEXT – Sri Lanka’s shares closed lower on Wednesday after four consecutive gains in previous sessions spiraled into selling interest and profit taking, an analyst said.

The main All Share Price Index was down 0.28 percent or 24.39 points to 8,722.06, this is the lowest the index has been since May 02, while the most liquid index S&P SL20 was down 0.40 percent or 9.92 points to 2,468.44.

“The market was gaining in the previous sessions and there is selling and profit taking present today, due to continuously being on green,” an analyst said.

In the previous sessions the market was seeing gains, due to lowered policy rates and low inflation stimulating buying interest and driving the sentiment up, an analyst said.

Sri Lanka’s inflation in the 12-months to May 2023 has eased to 25.2 percent from 35.3 percent a month earlier according to a revised Colombo Consumer Price Index calculated by the state statistics office.

The central bank cut the key policy rates by 250 basis points to spur a faltering economic growth as inflation was decelerating faster than it projected.

“There are gradual improvements in the market sentiment, with positive sentiments coming in from lowered policy rates and inflation,” an analyst said.

The market generated foreign inflows of 12 million rupees and received a net foreign inflow of 18 million rupees, due to low share prices and discounted shares followed by a dividend announcement.

The market generated a revenue of 554 million rupees, this is the lowest the turnover has been since May 10, while the daily turnover average was 1 billion rupees. From the total generated revenue, the banking sector contributed 120 million rupees, Diversified Banks contributed 115 million rupees and the Capital Goods Industry generated 78 million rupees.

Top losers during trade were Sampath Bank, Commercial Bank and Aitken Spence. (Colombo/June06/2023)

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Sri Lanka Treasuries yields plunge, 12-month down 318bp

ECONOMYNEXT – Sri Lanka’s Treasuries yields plunged across maturities at Wednesday’s auction with the 12-month yield falling 318 basis points, in one of the biggest one day falls, data from the state debt office showed.

The 3-month yield fell 244 basis points to 23.21 percent.

The 6-mont yield fell 339 basis points to 21.90 percent, along with the 12 months to 19.10 percent.

The short-term yield curve is inverted.

The central bank last week cut its policy rate 250 basis points in a signaling move but is not printing money to enforce the rate cut.

The debt office sold all 140 billion rupees of offered securities. (Colombo/June07/2023)

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Sri Lanka forex reserves rise US$722mn in May 2023

ECONOMYNEXT – Sri Lanka’s foreign reserves grew 722 million US dollars to 3,483 million US dollars in May 2023 from 2,761 million US dollars in April, official data showed amid weak credit and better inflows.

Sri Lanka lost almost all its reserve in over two years as the central bank sold reserves and printed money to keep rates down (sterilized reserves sales) including borrowed dollars from India.

Gross official reserves fell to a low of 1,705 million US dollars in September 2022.

Sri Lanka’s central bank hiked rates in April 2022 to slow credit and also stopped printing money after it ran out of borrowed Asian Clearing Union dollars from India.

Sri Lanka’s gross official reserves are made up of both monetary reserves of the central bank and any balances of the Treasury account from loans or grants it gets.

The central bank’s net foreign reserves are still negative after busting up borrowed reserves to suppress rates. By April (before the collection of reserves in May) the central bank’s net reserves were negative by 3.7 billion US dollars.

In May alone 662 million US dollars were bought from the market, Central Bank Governor Nandalal Weerasinghe said.


No pre-determined level to stop Sri Lanka rupee appreciation: CB Governor

Borrowing dollars through swaps and busting them up, was invented by the US Federal Reserve as it was printing money and breaking the Bretton Woods system in the early 1970s.

Sri Lanka received a 350 million US dollar tranche from the Asian Development Bank and 331 million US dollars from the IMF to the Treasury for budget support.

The loans can be sold to the central bank by the government to generate rupees and spend. However, since credit is weak, not all the inflows go out of the country particularly as the central bank is conducting deflationary open market operations on a net basis.

By allowing the rupee to appreciate unlike in previous episodes of recovery in an IMF program, after a bout of money printing, the central bank is bringing down inflation – in some cases absolute prices – and restoring confidence and easing the ‘pain’ of ‘monetary policy’ or stimulus.


Why is Sri Lanka’s rupee appreciating?

Though exports are falling, tourism revenues are also picking up.

The budget support loans, tourism receipts less the reserve collected will widen the trade deficit. Building foreign reserves involves lending money to the US or other western nations and is similar to repaying foreign debt. (Colombo/June07/2023)

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