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Wednesday December 7th, 2022

Sri Lanka central bank may use controls despite negative real rates

ECONOMYNEXT – Sri Lanka’s central bank said it is holding policy rate at which money is injected to the market at 15.50 percent, but said it may use administrative controls to bring down rates as inflation comes down.

Market rates are now about double that of policy rates. But they are half the historical inflation and have been negative in real terms for several months.

“The Central Bank would expect a moderation of excessive market interest rates, in line with the prevailing policy interest rates,” the monetary authority said in its November policy statement.

“If an appropriate downward adjustment in the market interest rates would not take place in line with the envisaged disinflation path, the Central Bank will be compelled to impose administrative measures to prevent any undue movements in market interest rates.”

The central bank has in the past enforced its policy rates when domestic credit picked up by printing large volumes of money through its policy rates and triggering forex shortages and currency crises by de-stabilizing the reserve collecting peg.

However when the breaks are put on the crisis after the credibility of the peg (and reserves) are lost, rates tend to shoot up.

High nominal rates are a generally found in monetary regimes with anchor conflicts (neither a hard peg or clean floats) analysts have said.

Sri Lanka’s central bank had imposed deposit controls after a currency crisis in 2018.

“…[T]he Board noted with concern the anomalous rise in market interest rates, particularly deposit interest rates and short-term lending interest rates, despite the recent improvements inoverall money market conditions and the adverse implications on business and economic activity,” the agency said.

Sri Lanka’ gilt yields are also high due to fears of a second real hair cut on rupee government securities.

In the past the central bank has been forced to float the currency to restore confidence in the currency after rate hikes and tax hikes reduce domestic credit, and inflows resume, helping loosen the credit system.

Analysts had warned that without a float, restoring confidence in the currency takes much higher rates.

Related Why the Sri Lanka rupee is depreciating creating currency crises

A float isolates reserve money from the balance of payments and gives control back to the central bank and allows it to enforce a policy rate without money leaking through interventions (no reserve pass-through) or having to inject large volumes of money to enforce the policy rate, creating conflicts between money and exchange rate policy.

At the moment the central bank is intervening in both directions in a peg set at around 360 to the US dollar with a surrender rule and sales for oil and other imports.

At a basic level, a pegged exchange rate central bank which intervenes in the forex market loses control of reserve money (monetary policy independence so-called) and triggers a currency crisis when attempts are made to stop the reserve money from shrinking after forex sales.

However pegged central bank can consistently keep rates slightly higher than market, under supply reserve money and credit to build forex reserves above the monetary base (most East Asia central banks).

But enforcing a below-market policy rate with open market rates leads to forex shortages and a currency crisis if domestic credit demand is strong (most Latin America central banks).

Forex shortages and currency crises are a problem associated with reserve collecting central banks that attempt to enforce a policy rate.

The full statement is reproduced below:

The Central Bank of Sri Lanka maintains policy interest rates at their current levels

The Monetary Board of the Central Bank of Sri Lanka, at its meeting held on 23 November 2022, decided to maintain the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank at their current levels of 14.50 per cent and 15.50 per cent, respectively, after considering the recent and expected developments in the domestic and global economy and macroeconomic projections. The Board noted that the maintenance of tight monetary policy stance is necessary to contain any demand driven inflationary pressures in the economy, while helping to further strengthen disinflation expectations, thus enabling to steer headline inflation towards the targeted level of 4-6 per cent over the medium term.

Headline inflation marked a turnaround as expected

Supported by favourable supply side developments and tight monetary policy measures, headline inflation pivoted towards the envisaged disinflation path in October 2022, after passing the peak in September 2022. Accordingly, headline inflation, based on both the Colombo Consumer Price Index (CCPI) and the National Consumer Price Index (NCPI), decelerated, while a deceleration was observed in core inflation.

The deceleration in inflation is expected to continue in the ensuing period, supported by subdued aggregate demand pressures, expected improvements in domestic supply conditions, normalisation in global commodity prices, and the timely passthrough of such reductions to domestic prices, along with the favourable statistical base effect. Global as well as domestic risks to the inflation outlook in the near term are tilted to the downside, thereby supporting the disinflation path (Figure 01) and stabilising inflation at the desired levels towards the end of 2023.

Domestic economic activity is expected to remain tepid during 2022

The real economy is expected to contract in 2022 impacted by the stability-oriented policy measures that led to tightened monetary and fiscal conditions, along with supply side constraints and prevailing uncertainties, among others. Nevertheless, economic activity is expected to make a gradual, yet sustainable recovery, supported by envisaged improvements in supply conditions, improved market confidence, and the impact of corrective policy measures being implemented to stabilise the economic conditions.

Tight monetary and liquidity conditions have slowed the expansion of money and credit

Outstanding credit extended to the private sector by commercial banks is expected to have contracted for the fifth consecutive month in October 2022, reflecting the impact of increased market lending interest rates and the moderation in economic activity. Market deposit interest rates have also risen notably disproportionate to the adjustment in the policy interest rates. The continued excessive upward adjustment in market interest rates, despite the improvements indomestic money market liquidity and the deceleration of inflation, has resulted in persistent anomalies in the interest rate structure.

Meanwhile, yields on government securities are showing some signs of easing recently, and are expected to moderate further. Going forward, the anomaly in market interest rates is expected to be rectified, benefiting mainly from the notable reduction in the overall money market liquidity deficit and the anchoring of inflation expectations in line with the envisaged disinflation path. Further, the high risk premia attached to the yields on government securities are expected to shrink in the period ahead as the debt restructuring process progresses and fiscal sector performance improves with the consolidation measures in place.

The external sector remains resilient despite the heightened balance of payments

The merchandise trade deficit for the ten months ending October 2022 contracted significantly owing to the robust export earnings and a substantial decline in import expenditure due to policy measures taken to curtail demand for imports, amidst the shortage in foreign exchange.

Workers’ remittances are expected to improve in the period ahead with rising departures for foreign employment, while the tourism sector is set to mark an improvement in view of the upcoming season for tourist arrivals. Amidst the improvements observed in liquidity in the domestic foreign exchange market, the Central Bank continued to facilitate the import of essential goods to ensure the availability of energy, power and other supplies necessary for uninterrupted economic activity.

Meanwhile, the exchange rate remained broadly stable. The gross official reserves were estimated at US dollars 1.7 billion as of end October 2022, including the swap facility from the People’s Bank of China, equivalent to around US dollars 1.4 billion, which has certain conditionalities on usability. Risks to external demand could emerge amidst moderating global growth prospects in the near term, however, rising prospects of the tourism sector and workers’ remittances would help offset any negative spillovers to a large extent.

Policy interest rates are maintained at current levels as conditions are sufficiently tight

In consideration of the current and expected developments, both locally and globally, as indicated above, the Monetary Board of the Central Bank of Sri Lanka, at its meeting held on 23 November 2022, decided to maintain the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank at their current levels of 14.50 per cent and 15.50 per cent, respectively. The Board was of the view that the prevailing tight monetary policy stance is necessary to rein in any underlying demand pressures in the economy.

However, the Board noted with concern the anomalous rise in market interest rates, particularly
deposit interest rates and short-term lending interest rates, despite the recent improvements inoverall money market conditions and the adverse implications on business and economic activity.

The Central Bank would expect a moderation of excessive market interest rates, in line with the prevailing policy interest rates. If an appropriate downward adjustment in the market interest rates would not take place in line with the envisaged disinflation path, the Central Bank will be compelled to impose administrative measures to prevent any undue movements in market interest rates.

At the same time, the Board reiterates its continued commitment to restoring price stability and ensuring financial system stability, and remains confident that inflation would follow the projected disinflation path underpinned by the prevailing monetary policy stance, while supporting the economy to reach its potential over the medium term.

Further, the Board remains ready to react appropriately to any materialisation of risks to the forecast

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Crisis-hit Sri Lanka sees recovery in cruise ship tourism from zero

ECONOMYNEXT – Seventeen cruise ships are scheduled to arrive in Sri Lanka next year with
Queen Mary 2, one of the largest and popular ships, Colombo’s harbor master said, as the island nation is looking for alternative avenues to boost its faltered tourism sector.

The rise is expected to bring thousands of high end tourists with higher spending capacity after two years. The island nation saw a record high 54 ships in 2019, rising from the previous year’s 42, Nimal Silva, Colombo Port Harbor Master said.

“The 2019 was one of the best years and in 2020 there were more than 60 scheduled vessels to
call but with COVID pandemic all hell broke loose,” Silva told EconomyNext.

Fourteen cruise ships are scheduled to call from January-May next year and another three are scheduled to arrive in Colombo in November, when the peak tourism season begins.

Cruise tourism cycle begins in Sri Lanka from October to May with a dip during the monsoon

Sri Lanka welcomed two cruise ships in November after almost two years.

Three ships are scheduled to arrive in December and Azamara Quest, carrying at least 722 tourists, arrived in Colombo on December 3 and is now heading to Hambantota.

On December 18, Le Champion carrying 264 will arrive in Colombo and depart to Mumbai and the third vessel, Silver Spirit will arrive in Colombo on December 23 carrying up to 648 passengers.

There are two scheduled in January, one in February, and four in March next year, according to the harbormaster.

“Next year more ships could schedule, so far these are the confirmed ones now,” he said.

This also generates income for the port and the prices are charged according to the size of the

Silva said the first medium sized-cruise vessel, 229 meters long, generated about 14,000 dollars
for docking in the port for a day.

He said Queen Mary 2, a 325 meter long ship and one of the largest cruise ships in the world, is also
scheduled to call at Colombo in February. It can carry up to 3200 passengers.

Silva said almost all the ships that were scheduled have arrived on the island and therefore, he is
confident all the ships including Queen Mary 2 will arrive in Sri Lanka.

“Only one ship has been canceled thus far. There are no last minute cancellations if there were some they would have informed us by now,” Silva said. (Colombo/Dec07/2022)

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Sri Lanka President says 2015-2019 policy struggle was ‘warfare’

ECONOMYNEXT – Sri Lanka President Ranil Wickremesinghe said his attempts to reverse the inward-looking protectionist policies and fix state finances during his last term as Prime Minister was opposed both by politicians and business interests.

“In the 4.5 years as prime minister it was an effort to take this economy out in a different direction,” President Wickremesinghe told an economic forum organized by Sri Lanka’s Ceylon Chamber of Commerce.

“We were able to get a surplus in the primary budget. But it was warfare.

“Politicians wanted to protect their power, businessmen wanted to protect their profits and many others wanted to see what the country would provide them free of charge.”

Wickremesinghe was unable to bring private investment to the port under apparent internal political opposition. Relations with President Maithripala Sirisena also soured and he appointed his own economic advisors.

Meanwhile Wickremesinghe’s free trade agenda was hit by monetary instability as the central bank printed money under flexible inflation targeting and triggered forex shortages which were followed by trade controls.


Sri Lanka controls imports in ‘Nixon-shock’ move to protect soft-pegged rupee

Sri Lanka President calls to expand Nixon shock as rupee falls

Wickremesinghe’s ‘Yahapalana’ administration also went on a spending spree called ‘100-day program’ in 2015 triggering a currency crisis in 2015/2016 as the central bank printed money to suppress rates.

The central bank however had already started injecting liquidity and losing reserves (by terminating term repo deals) from the fourth quarter of 2014 as domestic credit recovered from a 2012 currency crisis before his administration came to power.

The rupee fell from 131 to 152 and stabilization policies led to an output shock. The International Monetary Fund then taught the agency which had already depreciated the currency from 4.70 to 152 to the dollars seeking bailouts 16 times, how to calculate an output target.

Under Finance Minister Mangala Samaraweera taxes were raised and budget were fixed in 2018 to bring deficits back to pre-2015 levels, though state spending went up from 17 to around 20 percent of GDP under the spendthrift ‘revenue based fiscal consolidation’ where cost cutting was dropped.

The central bank then printed money by purchasing bonds from banks to target the yield curve, jettisoning a bills only policy established by ex-Central Bank Governor A S Jayewardena, through term reverse repo and overnight injections taking the rupee from 151 to 162 to the US dollar.

The central bank also created money by entering into a swap with the Treasury in 2018, a type of strategy used by speculators to bring down East Asian pegs putting, further pressure on the currency from around July 2018 onwards.


What went wrong; Sri Lanka’s illiberal economics and unsound money : Bellwether

Stabilization policies then led to another output shock. As forex shortages came Sri Lanka resorted to heavy external borrowing as it was unable to settle maturing loans with domestic borrowings.

After two currency crises and output shocks, macro-economists of the new administration cut taxes saying there was a ‘persistent output gap’ and printed even more money for stimulus (close the output gap). (Colombo/Dec07/2022)

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China calls for joint effort to ease Sri Lanka’s debt burden, no mention of restructure

ECONOMYNEXT — A top Chinese official has expressed hope that countries and multilaterals like the International Monetary Fund (IMF) work with Beijing to play a constructive role in easing Sri Lanka’s debt burden, stopping short of an assurance on debt restructuring.

Chinese Foreign Ministry spokesperson Mao Ning was quoted by international media as saying on Monday December 05 that China attaches high importance to Sri Lanka’s difficulties and challenges.

She was responding to a question on media reports that an IMF team will be in China this week to discuss faster progress on debt restructuring for countries including Sri Lanka, which is negotiating for an IMF bailout.

“On Sri Lanka’s debt issue, I’d like to stress that we support the financial institutions in working out ways with Sri Lanka to properly solve the issue,” said Ning.

“We also hope relevant countries and international financial institutions will work with China and continue to play a constructive role in helping Sri Lanka overcome the current difficulties, ease its debt burden and realise sustainable development,” she added.

She said China has long-standing sound cooperation with the IMF and other international economic and financial institutions.

The spokesperson avoided any mention of debt restructuring, a prerequisite for the IMF extended fund facility (EFF).

Nearly a fifth of Sri Lanka’s public external debt is held by China, according to one calculation. The emerging superpower has been generous in Sri Lanka’s time of need, extending much needed assistance in the form of rice, medicine and other commodities.

The latest arrival in the Colombo port from China was 2 billion Sri Lankan rupees worth of essential medicines and medical supplies, delivered on Tuesday.

However, critics say China is doing everything but what Sri Lanka really needs: agreeing to restructure its outstanding debt.

At least one Sri Lankan opposition MP has demanded that China agree to a restructure.


Sri Lanka debt restructuring: opposition MP warns of “China go home” protests

Tamil National Alliance (TNA) legislator Shanakiyan Rasamanickam, who had been on the warpath with Beijing over an apparent lethargy in helping the crisis-hit island nation restructure its debt, recently warned of a “China, go home” protest campaign similar to the “Gota, go home” protests that unseated the country’s powerful former president in July.

The MP told parliament last Friday December 02 that Sri Lanka owes 7.4 billion dollars to China, a nearly 20-trillion dollar economy, and if the latter was was a true friend, it would agree to either write off this debt or at least help restructure it.

Colombo has been vague at best on the status of ongoing restructure talks with Sri Lanka’s creditors, and opposition lawmakers and others have expressed concern over what seems to be a worrying delay. Rasamanickam and others have claimed that China, Sri Lanka’s largest bilateral creditor, is the reason for the apparent standstill. (Colombo/Dec06/2022)

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