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Thursday February 22nd, 2024

Sri Lanka central bank deep in debt, dollar shortages at ‘guidance’ rate : Wijewardena

ECONOMYNEXT – A guidance rate mandated by Sri Lanka’s central bank is not found in the real world and the monetary authority has no ability enforce a managed float (soft-peg), with negative reserves, a top economist and ex-Central Bank Deputy Governor W A Wijewardena has said.

Sri Lanka’s central bank started quoting a guidance rate for interbank market at around 360 to the US dollar in May, about 20 to 30 rupees below the market rate at the time where a higher level of middle remittances were also starting to come from exchange houses.

Banks are quoting telegraphic transfers around 365 rupees to the dollar.

The guidance seems to be an attempt to do officially what was done unofficially earlier.

No clean float, no credible peg

“I speak to importers everyday and they tell me that when they go to banks to buy dollar at 365 they are told to wait at least one to two months,” W A Wijewardena, Former Deputy Governor, Central Bank of Sri Lank told a Central bank forum in Sri Lanka’s latest currency crisis.

“They have to wait in a queue.”

“In my view the present exchange rate policy to fix the exchange rate at middle rate officially, what was done unofficially earlier.

“You can’t do it without having a sufficient stock of exchange.”

Foreign exchange shortages happens in a non-credible or soft-peg (also called a managed float or flexible exchange rate) which collapses whenever the central bank injects money to mis-target interest rates.

A pegged central bank runs out of reserves when money is injected to enforce the artificial policy rate and dollars are sold to mop up the rupees hold the exchange rate, in self-feeding spiral when domestic credit is strong either due to a deficit or a recovery in private credit.

A central bank then gets into a sterilization trap where liquidity shortages coming from dollars sold to defend the exchange rate (reserves for imports or to provide ‘convertibility’ to the newly created money) are sterilized (offset) with new money, preventing reserve money and credit from slowing.

Import re-finance

A central bank which steadily continues to provide reserves for imports then ends up financing the private sector with central bank credit, by injecting money into banks through open market operations to cover the liquidity shortage from dollar sale, preventing a contraction of reserve money and credit.

In a sterilized intervention cycle (reserves for imports) the soft-pegged central bank then loses control of reserve money in the process of trying to enforce a policy rate after the intervention.

Later the injected money shows up as deficit finance because Treasury bills or bonds (sometimes issued to cover past deficits) end up in the central bank balance sheet, altering the loans to deposit ratio of banks.

At the moment state banks in particular have large volumes of overnight borrowings from the central bank from sterilizing dollars given for imports and debt repayments, creating severe asset liability mis-matches.

The private sector re-finance by bank credit, is then classified as deficit finance because the instrument used to inject money is a government security.

In the days of the classical economists of UK for example this error was not made as bankers’ acceptances were used for open market operations and central bankers could not get away blaming the deficit instead of their fixation with interest rates, as they started to do after World War II, analysts say.

When dollar shortages emerge and exchange and other controls are imposed, market participants who fear a currency collapse, then hold back dollars and try to take counter measures to protect their savings from the central bank leading to a loss of credibility of the peg.

Economy Smashed

To restore the credibility of the peg domestic credit and economic activities have to be smashed to make outflows fall below inflows.

If the deficit is high, private sector credit has to be smashed to a greater degree and de-leveraging has to take place in a typical IMF style ‘stabilization measure’.

Sri Lanka’s central bank has raised rates and market rates have moved up in the first step towards reducing private credit and outflows.

The government has also announced some tax measures.

India is giving credit lines which when given the private sector, or fuel is market priced, also generates rupees for the deficit.

Negative Reserves

However in this cycle of money printing to fix interest rates, Sri Lanka’s central bank has not only lost its reserves but also lost borrowed money leaving it about 4 billion US dollars in debt by March 2022.

Wijewardena said the central bank’s gross debt was in the region of about 6 billion US dollars while the net debt was over 4.0 billion dollars.

“The central bank debt is 6 billion dollars while the reserves are minus 4.4 billion dollars,” he said.

“So putting money in central bank is like sinking well. No matter how much water you put, it won’t fill.”

At the moment the central bank is accumulating more debt from Asian Clearing Union payment arrears to India.

A central bank that runs out of reserves and cannot exchange dollars for rupees (provide convertibility and enforce an external anchor) can then float the currency (suspend convertibility) and shift the regime to a float.

The currency then stabilizes after a fall, and forex shortages disappear as long as new money is not created to generate excess liquidity in money markets.

“For a central bank to hold on to an exchange rate at a given level, it should have reserves to do so,” Wijewardena said.

“If we don’t have reserves then we are holding on to a kite that this floating freely without any direction by the person who is holding the thread.”

“So when you have a negative foreign exchange position, central bank cannot fix the rate. We have lost the battle already with the exchange rate.”

“What we have to do now is to allow the exchange rate to fall to whatever the realistic level the rate would take.”

In a float reserve money is no longer altered by forex interventions ending the need to sterilize any liquidity shortages with new printed money.

The central bank then regains the ability to enforce both a policy rate and control the reserve money.

The central bank can then peg reserve money to a single domestic anchor (inflation target) instead of an external anchor (the convertibility rate) via its policy rate.

Dual anchor intermediate regimes

However Sri Lanka’s central bank attempted to float with a surrender requirement (forced sales of dollars to the central bank for new money) the rupee fell steeply. The surrender requirement is still in place and interventions are made in both directions of the peg.

Soft-pegs or managed floats collapse when domestic credit picks up because an intermediate regime central bank tries to enforce two monetary anchors (domestic and external) simultaneously (anchor conflict), eventually losing control of the policy rate, reserve money, broad money and also inflation.

Dual anchor regimes (which violate the concept of impossible trinity of monetary policy objectives) were promoted by the US before especially after World War II in the course of setting up the Bretton Woods system of failed soft-pegs.

Among its advocates was US economist John H Williams. (Sri Lanka use of reserves for imports is a deadly false choice: Bellwether).

Under an IMF program the currency is re-pegged after a float (usually a prior action) to prevent its loans being used for imports, and inflows sterilized to re-build reserves after credit is compressed.

IMF programs usually advocate structural reforms.

IMF Recidivism

However the IMF reforms do not advocate the ending of the soft-peg or managed floats towards a single anchor regime (clean float or hard peg) and the anchor conflict comes up again to trip the managed float when the economy recovers in a few years.

Instead IMF gives clues to developing country central banks to ‘modernize monetary policy’ further towards those operated by clean floating central banks which do not collect any forex reserves and gives zero forex reserves for imports.

The anchor conflicts are worsened by monetary policy modernization (the latest permutation being flexible inflation targeting/flexible inflation targeting) and all interest rate mis-targeting of the monetary policy committee is compensated for by currency depreciation and social unrest in some cases.

The dual anchor almost guarantees that the country will go to the IMF again, a phenomenon labelled ‘IMF recidivism’ or sometimes ‘Many Happy Returns’.

Sri Lanka has gone to the IMF 16 times.

The trips to the IMF ends when either a clean float where reserve money is pegged to an inflation index with suitable accountability imposed on the central bank governor who fails to hikes rates on time is set up or a currency board (hard peg) linked to an external anchor is set up, ending dual anchor conflicts.

A currency board blocks both types of central bank credit: deficit finance (monetization of the deficit) and also private sector finance by re-purchasing bonds from banks after giving reserves for imports with unsterilized interventions.

Wijewardena said Goh Keng Swee, Singapore’s economic architect, who maintained a currency board to give monetary stability and block central bank credit, said hard work made countries prosper and not central bank credit.


Why Singapore chose a currency board over a central bank

The decision to end trips to the IMF and move to a single anchor regime can be made by the people who are hurt most by the soft-pegging and also politicians who are kicked out of power when soft-pegs collapse. (Colombo/June03/2022)

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Sri Lanka parliament appoints members to committees including COPE, COPA

ECONOMYNEXT — Sri Lanka’s parliament has announced the names of legislators appointed to a number of committees, including the Committee on Public Enterprises (COPE) and the Committee on Public Accounts (COPA).

A statement from parliament citing Deputy Speaker Ajith Rajapakse said on Thursday February 22 that 19 members have been appointed to COPE.

These are, namely: Jagath Pushpakumara, Janaka Wakkumbura, Lohan Ratwatte,  Indika Anuruddha Herath,  Shantha Bandara,  Mahindananda Aluthgamage,  Duminda Dissanayake,  Rohitha Abegunawardhana,  Nimal Lanza,  U K Sumith Udukumbura,  Sanjeeva Edirimanna,  Jagath Kumara Sumithraarachchi,  (Major) Sudarshana Denipitiya,  Premnath C Dolawatte,  Upul Mahendra Rajapaksha,  M Rameshwaran,  (Mrs) Rajika Wickramasinghe,  Madhura Withanage, and  (Prof) Ranjith Bandara.

Members nominated for COPA are Mohan Priyadarshana De Silva,  Lasantha Alagiyawanna,  Prasanna Ranaweera,  K Kader Masthan,  (Mrs) Diana Gamage,  Chamara Sampath Dasanayake,  Wajira Abeywardana,  A L M Athaullah,  Wimalaweera Dissanayake,  Jayantha Ketagoda,  (Dr) Major Pradeep Undugoda,  Karunadasa Kodithuwakku,  Isuru Dodangoda,  Premnath C Dolawatte,  (Mrs) Muditha Prishanthi,  M W D Sahan Pradeep Withana,  Madhura Withanage,  D Weerasingha,  and (Mrs) Manjula Dissanayake.

The rest of the committees are as follows:

Committee on Ethics and Privileges
(Mrs.) Pavithradevi Wanniarachchi,  (Dr.) Wijeyadasa Rajapakshe, PC,  Vijitha Berugoda,  Tharaka Balasuriya,  Anuradha Jayaratne,  Chamal Rajapaksa,  Johnston Fernando,  Mahindananda Aluthgamage,  Jayantha Ketagoda,  Madhura Withanage, and  Samanpriya Herath

Committee on Public Petitions
Jagath Pushpakumara,  S. Viyalanderan,  Ashoka Priyantha,  A. Aravindh Kumar,  (Mrs.) Geetha Samanmale Kumarasinghe,  Gamini Lokuge,  Wajira Abeywardana,  (Dr.) Gayashan Nawananda,  Jayantha Ketagoda,  U. K. Sumith Udukumbura,  Mayadunna Chinthaka Amal,  Nipuna Ranawaka,  (Mrs.) Rajika Wickramasinghe,  M. W. D. Sahan Pradeep Withana,  and Yadamini Gunawardena

Ministerial Consultative Committee on Defence
Chamal Rajapaksa,  (Dr.) Sarath Weerasekera, and (Dr.) Major Pradeep Undugoda

Ministerial Consultative Committee on Finance, Economic Stabilization and National Policies
Mahindananda Aluthgamage,  M. W. D. Sahan Pradeep Withana, and (Prof.) Ranjith Bandara

Ministerial Consultative Committee on Women, Child Affairs and Social Empowerment
Jagath Kumara Sumithraarachchi,  (Mrs.) Rajika Wickramasinghe,  and (Mrs.) Manjula Dissanayake

Ministerial Consultative Committee on Investment Promotion
A. Aravindh Kumar,  Dhammika Perera, and Yadamini Gunawardena

Ministerial Consultative Committee on Education
Anupa Pasqual,  Wimalaweera Dissanayake, and Gunathilaka Rajapaksha

Ministerial Consultative Committee on Mass Media
S. M. M. Muszhaaraff,  Jayantha Ketagoda,  and Sanjeeva Edirimanna

Ministerial Consultative Committee on Health
Kanaka Herath,  (Dr.) Gayashan Nawananda, and (Dr.) Major Pradeep Undugoda

Ministerial Consultative Committee on Agriculture and Plantation Industries
Udayakantha Gunathilaka,  Kulasingam Dhileeban,  and Upul Mahendra Rajapaksha

Ministerial Consultative Committee on Wildlife and Forest Resources Conservation
Chamara Sampath Dasanayake,  Kapila Athukorala, and Kumarasiri Rathnayaka

Ministerial Consultative Committee on Justice, Prisons Affairs and Constitutional Reforms
Sisira Jayakody,  Premnath C. Dolawatte, and Sagara Kariyawasam

Ministerial Consultative Committee on Industries
Premalal Jayasekara,  U. K. Sumith Udukumbura, and Lalith Varna Kumara

Ministerial Consultative Committee on Urban Development and Housing
(Mrs.) Kokila Gunawardene,  Milan Jayathilake, and Madhura Withanage

Ministerial Consultative Committee on Foreign Affairs
S. B. Dissanayake,  Namal Rajapaksa,  and (Major) Sudarshana Denipitiya

Ministerial Consultative Committee on Buddhasasana, Religious and Cultural Affairs
H. Nandasena,  Gunathilaka Rajapaksha, and Samanpriya Herath

Ministerial Consultative Committee on Power and Energy
Gamini Lokuge,  Duminda Dissanayake, and Nalaka Bandara Kottegoda

Ministerial Consultative Committee on Environment
S. M. Chandrasena,  Isuru Dodangoda, and (Mrs.) Muditha Prishanthi Ministerial

Ministerial Consultative Committee on Sports and Youth Affairs
Premitha Bandara Tennakoon,  Milan Jayathilake, and D. Weerasingha

Ministerial Consultative Committee on Irrigation
D. Weerasingha,  Yadamini Gunawardena, and Jagath Samarawickrama

Ministerial Consultative Committee on Labour and Foreign Employment
D. B. Herath,  W. D. J. Seneviratne, and Jayantha Weerasinghe, P.C

Ministerial Consultative Committee on State Plantation Enterprises Reforms
Sampath Athukorala,  Thisakutti Arachchi, and M. Rameshwaran


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Sri Lanka, Vietnam to cooperate on agriculture

ECONOMYNEXT – Sri Lanka and Vietnam have signed an agreement to develop the agricultural sector in the island.

The agreement will include the exchange of agricultural technology, studies and research, expertise, production of advanced seeds, application of fertilizers and pesticides, and training of farmers and officials to increase harvests.

Sri Lanka’s Minister of Agriculture and Plantation Industry Mahinda Amaraweera and Minister of Agriculture and Rural Development of Vietnam Minh Hoan Le signed a memorandum of understanding on Wednesday, a statement by the Government Information Department said.

Bilateral discussions between the two countries were held in conjunction with the 37th Asia Pacific Conference of the United Nations Food and Agriculture Organization. (Colombo/Feb22/2024)

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Merchant Bank of Sri Lanka and Finance given ‘BBB+(lka)’ rating by Fitch

ECONOMYNEXT – Fitch Ratings said it assigned Merchant Bank of Sri Lanka and Finance Plc (MBSL) a first-time national long-term rating of ‘BBB+(lka)’.

“MBSL’s rating is driven by our view that the parent, BOC, would provide extraordinary support to MBSL, if required,” the rating agency said.

“We assess MBSL’s standalone credit profile as being weaker than its support-driven rating because of its small franchise with 1.8% market share of sector loans, evolving business model, and weak financial profile, which is reflected in its poor asset-quality metrics, weak profitability and high leverage.”

The full statement is reproduced below:

Fitch Ratings – Mumbai – 22 Feb 2024: Fitch Ratings has assigned Merchant Bank of Sri Lanka & Finance PLC (MBSL) a first-time National Long-Term Rating of ‘BBB+(lka)’.
The Outlook is Stable.

MBSL is 84.5% owned by Bank of Ceylon (BOC, A(lka)/Stable) and other BOC group entities. BOC is the largest banking group in the country.

Key Rating Drivers

Shareholder Support Drives Ratings: MBSL’s rating is driven by our view that the parent, BOC, would provide extraordinary support to MBSL, if required. BOC’s ability to support MBSL is reflected in its credit profile, which is underpinned by its standalone strength. We believe that any required support for MBSL would be manageable relative to BOC’s financial capacity.

Our support assessment also takes into consideration BOC’s majority shareholding in MBSL, increasing product offerings by MBSL that are complementary to those provided by BOC, the parent’s oversight of MBSL’s policies and strategy through board representation, and the usage of the BOC brand by MBSL in its business operations, which raises reputational risk for BOC should MBSL default.

Limited Importance to Parent: MBSL is rated two notches below BOC due to its limited importance to the group. MBSL mainly serves high-yielding, under-banked segments that have limited overlap with BOC’s core customer base, but this is partly offset by BOC’s focus on increasing merchant banking via MBSL to strengthen group feebased revenue. MBSL made up 0.8% of BOC’s consolidated assets at end-September 2023, and makes negligible contribution to group profitability. MBSL also has considerable management independence and there is limited operational integration between the entities.

Weak Standalone Profile: We assess MBSL’s standalone credit profile as being weaker than its support-driven rating because of its small franchise with 1.8% market share of sector loans, evolving business model, and weak financial profile, which is reflected in its poor asset-quality metrics, weak profitability and high leverage. MBSL focuses on vehicle leasing, and gold- and property-backed loans. It has a high risk profile stemming from its significant exposure to borrower segments that are highly susceptible to economic and interest rate cycles.

Stabilising Economic Outlook: We expect the operating environment for Sri Lankan finance and leasing companies (FLCs) to continue to stabilise following the inflation and interest-rate shocks over the past two years. Easing inflation and interest-rate pressures should provide steadier conditions for FLC sector performance. Some headwinds linger, as higher taxes will continue to weigh on household finances in 2024. Investor confidence will also take time to recover. Nonetheless, we expect economic activity in Sri Lanka to improve in the financial year ending March 2025 as GDP growth recovers.

Asset Quality Pressure: The company’s loans that are more than three months past due were high at 25.3% of total loans at end-September 2023 (end-2022: 24.3%) due to its high risk profile. Nonetheless, MBSL’s focus on bad debt recovery has resulted in a decline in the non-performing loan ratio from a much higher level in previous years. We expect a pick-up in borrowers’ business activity and declining interest rates to aid loan collections in the medium term.

Weaker Profitability: MBSL’s pre-tax profit/average asset ratio was low at 0.9% in 9M23 and -0.9% in 2022, primarily due to the sharp reduction in its net interest margin and increase in operating costs on lower business volumes. We expect MBSL’s profitability to improve in the near to medium term, though it will likely remain weaker than that of peers, as its lending operations pick up, borrowing costs decline, and bad debt recovery improves.

History of Capital Shortfalls: MBSL’s capital adequacy ratio (CAR) rose to 16.9% (equity Tier 1 ratio at 13.4%) by end-September 2023 from 12.3% (11.7%) at end-2022, and against the regulatory minimum CAR of 12.5%. MBSL suffered significant capital shortfalls in 2020, with CAR at end-2020 of 5.6% below the minimum required 10.5% due to losses. BOC injected equity into MBSL in 2021 to improve its capitalisation. The breaches resulted in the regulator limiting MBSL’s deposit and lending balances, which affected its business franchise. The caps were removed after its capital ratios increased.

The recent improvement in CAR was due to significant reduction in total gross loans, an increase in gold loans, which carry lower risk weights, in the lending mix, and an increase in Tier 2 capital. We expect capitalisation pressure to ease in the medium term due to improved profitability prospects.

Rating Sensitivities

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

MBSL’s rating is sensitive to changes in BOC’s credit profile, as reflected in BOC’s National Long-Term Rating, as well as Fitch’s opinion around BOC’s ability and propensity to extend timely extraordinary support. Developments that could lead to a downgrade include:

– meaningful reduction in the parent’s ownership, control or influence that could weaken its propensity to support the subsidiary

– notable decline in MBSL’s capital buffers, indicating reduced timeliness in financial support to back growth or meet regulatory norms

– insufficient or delayed liquidity support from the parent relative to MBSL’s needs, which hinders MBSL’s ability to meet its obligations in a timely manner

– sustained weak performance of MBSL that we believe will weaken the parent’s propensity to support the subsidiary

– a material increase in size relative to the parent that makes extraordinary support more onerous for the parent.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

An upgrade is less likely in the near term. However, a significantly greater strategic role for MBSL within the BOC group, along with closer integration with BOC across broader functional areas and greater sharing of the BOC brand name besides the operational usage of brand, could be positive for the rating in the long term.

Date of Relevant Committee
19 February 2024

References For Substantially Material Source Cited As Key Driver Of Rating
The principal sources of information used in the analysis are described in the Applicable Criteria.

Public Ratings With Credit Linkage To Other Ratings
The rating is linked to rating on the parent, BOC.

This report was prepared by Fitch in English only. The company may prepare or arrange for translated versions of this report. In the event of any inconsistency between the English version and any translated version, the former shall always prevail. Fitch is not responsible for any translated version of this report.

Additional information is available on

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