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Tuesday February 7th, 2023

Sri Lanka central bank holds policy corridor, expects market rates to fall

PROBABILITY: Sri Lanka’s central bank expects inflation to fall to mid single digits by end 2023 and remain there. However in the past about 15 months after a currency crisis ends and inflation goes to near zero, liquidity injections begin and another currency crisis is triggered during the year.

ECONOMYNEXT – Sri Lanka’s central bank is holding its policy corridor at between rate at 15.5 percent but is expecting market rates to fall further and the economy to start recovering in the second half.

The rate setting Monetary Board said its was “of the view that the maintenance of the prevailing tight monetary policy stance is imperative to ensure that monetary conditions remain sufficiently tight to rein in inflationary pressures.”

“Such tight monetary conditions, together with the tight fiscal policy, are expected to adjust inflation expectations downward, enabling the Central Bank to bring inflation rates towards the desired levels by end 2023, thereby restoring economic and price stability over the medium term,” the statement said.

The central bank has stabilized the exchange rate around 360/370 to the US dollar and is pegging by buying dollars through a surrender rule and releasing the same dollars for imports, with private credit in negative territory.

A soft-pegged or flexible exchange rate central bank triggers forex shortages by selling dollars and sterilizing the intervention with new money, triggering excess credit effectively re-financing private sector activity.

Sri Lanka’s 12-month inflation – as well as some absolute prices – have started to come down rapidly as a result. The widely watched Colombo Consumer Price Index ended 2022 at up 57.2 percent after peaking at 69.8 percent in September.

Sri Lanka’s GDP was estimated to have contracted by 7.1 percent in the 9 months to September.

“With tighter monetary and fiscal policies in place, along with disruptions to domestic supply conditions, real activity in the final quarter of 2022 is also expected to have remained subdued,” the central bank said.

“The economy is expected to make a gradual recovery during the year supported by the expected improvements in domestic supply conditions, underpinned by the timely implementation of corrective policy measures.

“Meanwhile, the anticipated improvements in foreign exchange flows and the resultant enhancement in business and investor sentiment are expected to reinforce the expected recovery in the period ahead.”

A fan chart published with the monetary policy statement shows a high probability of inflation falling close to zero by the end of 2023 and remaining at the levels thereafter.

In recent years, Sri Lanka’s inflation has tended to fall to near zero about 18 to 22 months after a currency crises ends, however at that time the central bank starts to dump large volumes of money into the credit system under ‘flexible inflation targeting’, triggering a currency crisis in that year.

The exchange rate the rupee then collapses under ‘exchange rate as the first line of defence’ instead of running complementary monetary policy. After the currency collapses, interest rates are then hiked and inflation moves up and growth slows.

Sri Lanka’s banking system had large liquidity shortages from from overnight sterilized interventions from the 2020-2022 currency crisis.

The central bank has injected over 300 billion rupees in term auctions in January largely replacing overnight borrowings easing maturity mis-matches in the banking sector and also cheaper funds at 15.5 percent.

The central bank also restricted access to its overnight window for excess liqudity at 14.5 percent in a bid to encourage interbank call market lending.

“Recent measures adopted by the Central Bank to reduce the overreliance of licensed commercial banks on the standing facilities of the Central Bank and the concurrent conduct of open market operations helped improve liquidity in the domestic money market,” the central bank said.

“This prompted activity in the interbank money market.

Interbank transactions which were only 1.4 billion rupees on January 01 went up to 11.9 billion rupees on January 23. The call market, which lends without collateral, operates at a much lower rate of around 15.5 percent compare to over 20 percent for the market.

However after the liquidity injections, slowing domestic credit and expectations of re-structuring assurances from creditors to unlock and IMF program, market rates have slowed.

“Improved liquidity conditions, along with improved investor sentiment on the anticipation of “financing assurances” from official creditors, led to a notable moderation in the yields on government securities recently, reflecting the easing of the high risk premia attached to government securities,” the central bank said.

Central Bank officials have said earlier that the regulator is in discussions with banks on deposit rates.

“Meanwhile, the market deposit rates have also shown a notable moderation, benefiting from improved liquidity conditions,” the statement said.

“These developments are expected to pave the way for an easing of excessive market interest rates in
the period ahead.

“Nevertheless, outstanding credit extended to the private sector by commercial banks continued to contract in response to the tight monetary conditions and the moderation in economic activity. Monetary expansion also moderated from peak levels, albeit at a slower pace.”

The central bank hinted at further measures to take market interest rates down.

Sri Lanka’s gilt yields are high due to a flaw in the IMF’s debt re-structuring framework where a cut off date for domestic – or foreign – re-structuring is not announced.

“While some downward adjustment in market interest rates has been observed lately, the Monetary Board is of the view that there is sufficient space for excessive market interest rates, including lending interest rates to Small and Medium Sized Enterprises (SMEs), to adjust downwards considering the recent
improvements in domestic money market conditions and sentiments along with the moderation
in the yields on government securities,” the statement said.

“However, the Board was also of the view that the anticipated further decline in the yields on government securities due to the narrowing of risk premia is unlikely to result in a significant improvement in underlying monetary conditions. The Central Bank will continue to closely monitor monetary conditions in the period ahead and will remain prepared to take swift and proactive measures, as appropriate.”

Read the full statement here.

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Sri Lanka Railways to seek PPPs to boost revenue streams

CURFEW RUSH: Commuters scrambling to get home after curfew was declared in Sri Lanka on March 20, 2020.

ECONOMYNEXT – Sri Lanka Railway department hopes to expand Public Private Partnerships and earn more non-passenger revenues to offset recurring operational costs, an official said.

“For the past 10 years, except the last few years, the Railway operational income only covers around 50 percent of the operational expense of the Department,” the General Manager of the Railway, D.S. Gunasinghe told EconomyNext.

“Our plan is to increase the non-passenger revenue of the Railway department.

“And we cannot expect and do not hope for money from the government.”

Sri Lanka Railways already has agreements with Prima, a food firm, and Insee Cement, which is bringing in additional income, Gunasinghe said.

“We had agreements for material transportation such as sand in the past, however it was canceled but we hope to start it again” he said.

The department will rent out its storage facilities and circuit bungalows for the tourism sector to create additional revenue streams.

Sri Lanka Railways recorded an operating loss of 10.3 billion rupees during 2021, compared to a loss of 10.1 billion rupees in 2020, the Central Bank 2021 annual report showed.

The total revenue of the SLR stood at 2.7 billion rupees, a 41.3 percent drop from a year ago.

(Colombo/ Feb 06/2023)

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Sri Lanka’s doctors distribute anti-tax hike leaflets to train commuters

ECONOMYNEXT – Doctors representing Sri Lanka’s Government Medical Officers Association (GMOA) distributed leaflets outside the Colombo Fort railway station against a progressive tax hike, threatening to address the government in a “language it speaks”.

GMOA Secretary Haritha Aluthge told reporters outside the busy Fort railway station Monday February 06 afternoon that all professional associations have collectively agreed to oppose the personal income tax hike.

“The government is taking a lethargic approach. They cannot keep doing this. They have a responsibility towards the citizens, the country and society,” said Aluthge.

The medical officer claimed that the government was acting arbitrarily (අත්තනෝමතික).

“If it cannot understand the language they’ve been speaking, if the government’s plan is to put all professionals out on the street, if it doesn’t present a solution, all professional unions have decided unanimously to address the government in a language it speaks, ,” he said.

Aluthge and other GMOA members were seen distributing leaflets to commuters leaving the railway station. Doctors in Sri Lanka in general are likely to earn higher salaries than the average train commuter, and a vast majority of Sri Lanka’s population, most of whom take public transport, don’t fall into the government’s new tax bracket. Many doctors, though certainly not all, collect substantial sums of money at the end of every month as doctor’s fees in private consultations.

About two miles away from the doctors, the Ceylon Blank Employees’ Union, too, engaged in a similar distribution leaflet campaign on Monday at the Maradana railway station. A spokesman promised “tough trade union” action if there was no solution offered by next week.

Sri Lanka’s cash-strapped government has imposed a Pay As You Earn (PAYE) tax on all Sri Lankans who earn an income above 100,000 rupees monthly, with the tax rate progressively increasing for higher earners, from 6 percent to 36 percent.

A person who paid a tax of 9,000 rupees on a 400,000 rupee monthly income will now have to pay 70,500 rupees as income tax, the latest data showed. This has triggered a growing wave of anti-government protests mostly organised by public sector trade unions and professional associations.

Even employees of Sri Lanka’s Central Bank recently joined a week-long “black protest” campaign organised by state sector unions against the sharp hike in personal income tax, even as Central Bank Governor Nandalal Weerasinghe said painful measures were needed for the country to recover from its worst currency crisis in decades.

The government, however, defends the tax hike arguing that it is starved for cash as Sri Lanka, still far from a complete recovery, is struggling to make even the most basic payments, to say nothing of the billions needed for public sector salaries.

Economists say Sri Lanka’s bloated public service is a burden for taxpayers in the best of times, and under the present circumstances, it is getting harder and harder to pay salaries and benefits.

Sri Lanka’s new tax regime has both its defenders and detractors. Critics who are opposed to progressive taxation say it serves as a disincentive to industry and capital which can otherwise be invested in growth and employment-generating business ventures. Instead, they call for a flat rate of taxation where everyone is taxed at the same rate, irrespective of income.

Others, however, contend that the new taxes only affect some 10-12 percent of the population and, given the country’s economic situation, is necessary, if not vital, at least for a year or two.

Critics of the protesting workers argue that most of the workers earn high salaries that most ordinary people can only dream of, and, they argue, though there may be some cases where breadwinners could be taxed more equitably, overall, Sri Lanka’s tax rates remain low and are not unfair.  (Colombo/Feb06/2023)

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Sri Lanka bond Yields end steady

ECONOMYNEXT – Sri Lanka’s bond yields closed steady on Monday, dealers said while a guidance peg for interbank transactions remained unchanged.

A bond maturing on 01.07.2025 closed at 32.15/30 percent, steady from Friday’s 32.05/10 percent.

A bond maturing on 01.05.2027 closed at 28.90/29.10, steady from Friday’s 28.90/20.05 percent.

The Central Bank’s guidance peg for interbank US dollar transactions appreciated by one cent to 361.96 rupees against the US dollar.

Commercial banks offered dollars for telegraphic transfers at 370.35 rupees on Monday, data showed. (Colombo/Feb 06/2023)

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