ECONOMYNEXT – Sri Lanka’s banks have sharply cut foreign borrowings over the past year, official data show as the country ran out of rating space after seven years of state expansion and monetary indiscipline.
State and private commercial bank borrowing heavily to abroad to buy dollar denominated Sri Lanka Development Bonds, give offshore banking unit loans to the government after 2015 which expanded from 17 to 20 percent of GDP over 5 years.
State-run Ceylon Petroleum Corporation also borrowed each time money was printed to suppress rates, under ‘flexible inflation targeting’.
Meanwhile some banks also bought discounted international sovereign bonds as foreign investors dumped them.
As downgrades came swiftly in 2020 towards CCC with money printing ratcheted up, banks lost the ability to borrow abroad. They also could not renew maturing loans as counterparty funding limits were cut.
Short term foreign currency borrowings of banks had peaked at 4.6 billion US dollars in the third quarter of 2020, central bank data show and had fallen to 1,442 billion US dollars by the first quarter of 2021 in a steep correction.
Long term loans which were around 1.5 billion US dollars in the first quarter of 2020 fell to 1,072 million by the first quarter of 2021.
Short term currency and deposits of commercial banks went up from about billion US dollars in the first quarter of 2020 to around 4.3 billion US dollars by the first quarter of 2022.
Sri Lanka in 2020 introduced special deposit schemes also to draw foreign funds.
Meanwhile some who had invested in SLDBs had also started to pull out fearing a hair-cut.
Data show that foreign borrowings of banks ratcheted up in the 2015/2016 and 2018 currency crises which were triggered money printed to suppress interest rates under ‘flexible’ inflation targeting, a highly unstable monetary regime peddled by Western Mercantilists to third world countries with ‘fear of floating’.
Sri Lanka also has a fear of hard-pegging.
Sri Lanka expanded the state from 2015 to 20 percent of GDP from 2017 after abandoning spending based consolidation (cost cutting) under revenue based consolidation despite having a bloated state and an oversized military.
Revenue based consolidation (expanding the state with a higher level of taxes) as well as borrowings have long been advocated by the Janatha Vimukthi Peramuna and is also generally followed by other leftists and American progressives.
During repeated currency crises under ‘flexible’ inflation targeting up to 2019, Sri Lanka also borrowed heavily through International Sovereign bonds as the country lost the ability to repay maturing debt in rupees, forcing foreign borrowings to go up at the gross financing level.
State-run Ceylon Petroleum Corporation also borrowed from commercial banks and suppliers as forex shortages from liquidity injections made under flexible inflation targeting created forex shortages making difficult for the CPC to convert rupees to dollars.
Flexible inflation targeting was coupled with deliberate money printing to target an output gap. The International Monetary Fund gave technical advice to calculate the output gap and target it with printed money.
After two currency crises depressed output Sri Lanka cut taxes in December 2019 saying there was a ‘persistent output gap’ and printed even more money than before. (Sri Lanka fiscal stimulus to close output gap)
In 2019 as the impact of state expansion under revenue based fiscal consolation and the foreign borrowings under flexible monetary policy became clear, analysts warned that the country would soon run out rating space and to discontinue unrestrained monetary policy.
“Sri Lanka is a country that had mostly kept monetary stability in the worst years of the war with the help of the ideology then prevailing,” EN’s economic columnist Bellwether warned in December 2019 as money printing began around August in a sign of things to come.
“But now each new episode of monetary indiscipline is costing the country one notch in the rating scale.
“Sri Lanka will soon run out of rating space to tap capital markets if the flexible exchange rate/call money rate targeting continues in the next recovery space.
“Sri Lanka will face credit downgrades and possible sovereign default of dollar debt unless the highly unstable discretionary ‘flexible exchange rate’ is restrained and some monetary discipline is brought in.
“Pakistan, whose central bank also prints money with a peg, and frequently runs to the IMF now has a B- rating. But B- is barely above CCC.
“From two levels below investment grade in 2005, Sri Lanka is now a little above CCC, which is a distressed debt level. It is not a place to take monetary risks in particular.
“The central bank and others are talking about the need to get down interest rates,” the column which was written before the 2019 elections but money printing through outright purchases had started around August of the year said.
“That is not re-asssuring.
“It is doubtful whether China will give loans like earlier to boost growth as it is having its own troubles. China’s flexible exchange rate is taking a toll, as are state owned enterprises. However China may give debt relief to Sri Lanka.
“If rates are cut further and money is printed, the recovery in 2020 will be short-lived or not at all, and another currency crisis will be generated and downgrades will follow.”