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Sunday May 19th, 2024

Sri Lanka central bank to price control lending rates, policy rate unchanged

ECONOMYNEXT – Sri Lanka’s central bank said it was holding policy rates, but will direct banks to cut lending rates, as they were too far above the policy rate.

“The Monetary Board took note of the downward adjustment of market interest rates in response to monetary policy easing measures implemented thus far and the need to allow space for further adjustment of market interest rates swiftly,” the central bank said in its August monetary policy statement.

“However, the Board observed that market interest rates of certain lending products remain excessive and are not in line with the current monetary policy stance.

“Moreover, the Board anticipates a faster reduction in overall market lending interest rates in line with the recent monetary policy easing measures.

“Accordingly, the Board decided to adopt targeted administrative measures to reduce specific lending interest rates that it considered to be excessive and direct the licensed banks to reduce overall rupee lending interest rates by an appropriate margin in the period ahead.”

Analysts have pointed out that reserve collecting central banks have no real control over interest rates and any artificial policy rate cuts enforced with open market operations will lead to reserve losses and currency depreciation, with consequent negative effects on energy SOEs, budget deficits and debt.

Under an IMF reserve target interest rates have to be higher than required to keep the external sector in balance (Balance of payments neither in surplus or deficit).

RELATED Sri Lanka interest rates are dictated by the IMF reserve target, not inflation

All central banks that violate the rule, which are most central banks in Latin America and Africa and in South Asia and a few remaining ones in East Asia like Laos, will experience balance of payments trouble and will go the IMF again and again, analysts say.

Meanwhile the central bank said bank lending rates were also not in line with falling deposit rates.

..[T]he downward adjustment in market lending interest rates has been disproportionate to the reduction effected in market deposit interest rates.

A cut in the reserve ratio has also allowed banks to lend more money and improved their margins, the central bank said.

The liquidity released has been already mopped up through sell-downs of central bank held securities, giving profits to banks (in Sri Lanka statutory reserve ratio money is unremunerated) and not triggering any forex shortages as credit recovers.

Banks however has large volumes of bad loans, where the deposits concerned have to be financed with remaining performing loans.

Unlike in past currency crises, banks bought Treasury bills did not buy heaving into bonds, due to domestic re-structure fears, denying some of the capital gains that offsets the bad loans coming in the wake of the currency crisis and also pushing up bond yields to high levels.

Authorities by avoiding a broader DDR have sharply improved confidence in government securities, allowing yields to fall. Inflation has virtually stopped in its tracks, supported by broadly deflationary open market operations, a currency appreciation and US monetary tightening.

There was still no ‘sustained recovery in private credit’ yet the central bank said.

In the past, the central bank has missed IMF reserve targets with rates cuts enforced by open market operations, claiming that inflation is low even as budget deficits are cut and fuel is market priced.

RELATED Sri Lanka to miss IMF forex reserve target; seek waiver

As stabilization policies are re-imposed to stop balance of payments crisis, the resulting output shock reduces tax revenues and the country misses the fiscal target in the next year. The debt to GDP ratio and net debt after reserves also tends to go up.

RELATED Sri Lanka misses 2019 budget deficit, forex reserve targets in IMF program

The full statement is reproduced below:

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

The Monetary Board of the Central Bank of Sri Lanka, at its meeting held on 23 August 2023, 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 11.00 per cent and 12.00 per cent, respectively. The Board arrived at this decision following a careful analysis of current and expected developments in the domestic as well as the global economy, while noting the significant easing of monetary conditions effected since June 2023.

The Monetary Board took note of the downward adjustment of market interest rates in response to monetary policy easing measures implemented thus far and the need to allow space for further adjustment of market interest rates swiftly. However, the Board observed that market interest rates of certain lending products remain excessive and are not in line with the current monetary policy stance. Moreover, the Board anticipates a faster reduction in overall market lending interest rates in line with the recent monetary policy easing measures. Accordingly, the Board decided to adopt targeted administrative measures to reduce specific lending interest rates that it considered to be excessive and direct the licensed banks to reduce overall rupee lending interest rates by an appropriate margin in the period ahead.

The disinflation trend continues, with headline inflation reaching single digit levels

Headline inflation, measured by the year-on-year change in the Colombo Consumer Price Index (CCPI, 2021=100), decelerated to 6.3 per cent in July 2023, reaching single digit levels for the first time since November 2021. Following a similar trend, headline inflation, based on the National Consumer Price Index (NCPI, 2021=100), also decelerated to 4.6 per cent in July 2023 (year-on-year). The moderation in headline inflation was mainly driven by the softening of energy and food inflation, along with the favourable statistical base effect. Meanwhile, CCPI and NCPI based core inflation, which reflects underlying demand pressures in the economy, moderated to 6.1 per cent and 6.3 per cent, respectively, in July 2023 (year-on-year). Headline inflation is expected to moderate further over the next few months and stabilise around mid-single digit levels over the medium term.

Domestic economic activity is expected to recover in the second half of 2023 and gradually reach the potential level of economic growth over the medium term

Economic activity is projected to recover gradually during the second half of 2023 and reach its potential level thereafter, supported by the normalisation of monetary conditions, improvements in business confidence, enhancements in supply conditions and the relaxation of import restrictions, and the impact of growth promoting structural reforms. Leading indicators of economic activity point to a lower contraction in GDP in the second quarter of 2023, compared to the previous projections, while the second half of 2023 is expected to record a positive growth, compared to the same period in 2022. However, the impact of weather related disruptions and modest external demand conditions could weigh on expected growth in the near term.

The external sector remains resilient, allowing a gradual relaxation of balance of payments restrictions

The trade deficit decreased notably during the seven months ending July 2023 with a significant decrease in merchandise imports, despite the decrease in merchandise exports. Earnings from tourism and workers’ remittances, which improved considerably from January to July 2023, in comparison to the corresponding period in the previous year, are expected to improve further in the period ahead.

Despite some recent outflows from the government securities market, net foreign investment inflows remained positive during the seven months ending July 2023. In view of the improvements in the balance of payments conditions and the need to support the recovery of activity, the Government relaxed import restrictions related to 638 HS codes, including those of commercial vehicles, since June 2023.

Although a significant share of import restrictions has already been relaxed, demand for imports continued to remain subdued, reflecting the tight financial conditions. The Sri Lanka rupee recorded an appreciation of around 12 per cent against the US dollar thus far during the year. The level of gross official reserves was estimated at around US dollars 3.8 billion as at end July 2023, including the swap facility from the People’s Bank of China, while measures were also taken to repay a part of the swap facility with Bangladesh Bank, in addition to the repayment of maturing debt of multilateral lending agencies.

Market interest rates continue to adjust downward, although disparities in adjustments remain

Reflecting the impact of monetary policy easing measures effected since June 2023 as well as the decline in the risk premia with the announcement of the domestic debt optimisation (DDO) operation, market interest rates have declined to a certain extent. A notable reduction was also observed in the yields on government securities.

However, the downward adjustment in market lending interest rates has been disproportionate to the reduction effected in market deposit interest rates. Furthermore, despite the considerable easing of monetary conditions, interest rates on certain lending products of some financial institutions continue to remain excessively high posing hardships for individuals and businesses, particularly small and medium scale enterprises.

The reduction in the Statutory Reserve Ratio (SRR) from mid-August 2023 is expected to have eased liquidity strains of licensed commercial banks (LCBs) and lowered their cost of funds, facilitating a further downward adjustment in lending interest rates. Meanwhile, based on data available until July 2023, a sustained recovery in credit extended to the private sector by LCBs is yet to be observed.

Therefore, it is essential that market lending interest rates are lowered by financial institutions in line with the eased monetary policy stance of the Central Bank, thereby boosting credit flows to the economy, which in turn would help the revival of economic activity.

Policy interest rates are maintained at their current levels, while measures are introduced to accelerate the reduction of market lending interest rates

In consideration of the current and expected macroeconomic developments highlighted above, the Monetary Board of the Central Bank of Sri Lanka, at its meeting held on 23 August 2023, was of the view that it is appropriate to maintain the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank at their current levels of 11.00 per cent and 12.00 per cent, respectively.

The Members noted that the Central Bank has eased its monetary policy stance considerably since early June 2023 by reducing its key policy interest rates by 450 basis points, while reducing SRR by 2.0 percentage points to inject additional liquidity into the financial markets. Further, the announcement of the DDO strategy also helped reduce the risk premium of yields on government securities, with spillovers to other market interest rates. However, considering the presence of excessive interest rates on certain lending products and the inadequate downward adjustment in market lending interest rates relative to that of deposits, the Board was of the view that the downward rigidity in lending interest rates of certain financial institutions needs to be addressed through administrative measures. Such administrative measures would also ensure the swift transmission of previous monetary policy easing measures to all sectors of the economy.

Accordingly, the Board decided to impose caps on interest rates on pawning facilities at 18 per cent, per annum; on pre-arranged temporary overdrafts at 23 per cent, per annum; and on credit cards at 28 per cent, per annum, for all licensed banks.

Further, the Board was of the view that penal interest rates need to be capped at 2 percentage points over the regular interest rates charged on the relevant credit facility. In addition to the above, the Board noted that other market lending interest rates on rupee loans and advances should also adjust downwards further, in line with the relaxed monetary policy

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Sri Lanka may have to depend on India or nuclear to reach low carbon target: researcher

DOUBLE WHAMMY: In Sri Lanka’s driest period, wind potential also goes down, a researcher and policy advocate says

ECONOMYNEXT – Sri Lanka will need to either connect to India or set up a nuclear power plant if the country is to reach its renewable energy targets due the country’s weather patterns, a researcher and policy advocate has said.

Sri Lanka has set ambitious goals for renewable electricity generation by 2030, apparently without much prior study or any costs being revealed when the target was set by President Gotabaya Rajapaksa.

Rohan Pethiyagoda, a taxonomist and researcher who had also been senior state officials involved in policy at one time said overall Sri Lanka used a large volume of biomass (firewood) for cooking.

“We need to recognize, of course, that about 60 percent of Sri Lankan households still use firewood as their primary fuel,” Pethiyagoda told a climate forum organized by Sri Lanka’s Ceylon Chamber of Commerce.

“Bless them, because they reduce our dependence on fossil fuels for cooking. Even the tea industry, one of our largest exports, uses biomass as its primary fuel for about 90 percent of its production.”

In the electricity sector, where the renewable lobby and other activists oppose coal on the basis of carbon emissions based on international trends, as well as dust, base load still has to be generated if thermal generators are replaced.

Solar power is available only for a few hours in daytime and it can also vary depending on cloud cover.

Hydro power (run of the river plants) is more stable but is dependent on rain. Large hydros with storage can be used for peaks, industry analysts say.

Wind is available throughout the day but can also be unstable. The problem of variability (non-firm energy) can be solved to some extent through ramping and battery storage at additional cost, analysts say.

A renewable plant in Poonakary with battery storage was priced at around 48 to 49 rupees (about 15 US cents) based on public statements.

Meanwhile Pethiyagoda said Sri Lanka’s weather patterns created an additional problem.

“We have this unusual thing for our renewable energy in Sri Lanka, that at the tail end of the northeast monsoon, from about December to April, we have a dry period in this country, which means that our hydro potential during those months goes down,” Pethiyagoda said.

“Now, as luck would have it, our wind potential goes down at the same time.”

As a result, Sri Lanka needs a reliable alternative to the current coal baseload.

“So for that reason especially, we need to look at either connecting to India’s grid in the long term or having a nuclear facility in Sri Lanka if we want to be low carbon. And of course, we need to replace our vehicle fleet.”

“And our base load can probably come from nuclear,” Pethiyagoda said.

“But whichever way we do it, the cheaper way would be for us to connect to India’s grid.

“Whichever way we do it, we’re looking at an investment of about 40 billion dollars. And then we have the problem of looking at how wind and solar will behave.”

It was not clear what the 40 billion dollar investments would be made up of.

Sri Lanka’s external debt as at December 2024, including unpaid principal after default was 37.3 billion US dollars.

In 2021 when the 70 percent target was unveiled in President Gotabaya Rajapaksa’s election manifesto power engineers said a 53 percent energy share planned for 2030 in a general plan at the time was was equal to that of Germany.

Pushing up the share to 70 percent would require billions of dollars of extra investments, they said.

Related

Sri Lanka generation plan renewable power share for 2030 equal to Germany: CEB engineers

After the central bank cut rates and triggered an external default however, Sri Lanka growth, and power demand in the next few years is expected to be lower than before extreme macro-economic policy.

Related Sri Lanka to invest US$11bn by 2030 to meet renewable target

In 2023, the CEB said about 11 billion US dollars would be needed to meet the 70 percent target. (Colombo/June19/2024)

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Sri Lanka President discusses Starlink with Elon Musk

ECONOMYNEXT – Sri Lanka President Ranil Wickremesinghe has discussed connecting the island to the Starlink satellite system with its founder Elon Musk, his office said in a statement.

President Wickremesinghe has met Musk at a World Water Forum High-Level Meeting in Indonesia.

President Wickremesinghe discussed “the implementation of Starlink in Sri Lanka & committed to fast-tracking the application process to connect SL with the global Starlink network,” the statement said.

Starlink is a low earth orbit satellite network, connected to Musk’s SpaceX group. (Colombo/Jun19/2024)

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Sri Lanka’s CEB March 2024 profits Rs84bn with capital gain, fx strength

ECONOMYNEXT – Sri Lanka’s state-run Ceylon Electricity Board group has reported profits of 86 billion rupees with the help of 25.9 billion rupees of capital gains from a transfer of shares, interim accounts show.

The rupee also appreciated in the quarter which keeps imported fuel prices low.

As a standalone entity, the Ceylon Electricity Board, made profits of 84.6 billion rupees in the March quarter.

CEB’s revenues rose 38.5 percent to 167 billion rupees in the March 2024 quarter, while cost of sales fell 26.1 percent to 105.0 billion rupees giving gross profits of 62.7 billion rupees.

The CEB also reported 30.6 billion rupees of other incomes and gains in the March quarter, up from 3.1 billion rupees last year.

Other Income and Gains

The utility said it made a 25.9 billion rupee capital gain from transferring LTL Holdings shares to West Coast Power an IPP in which other entities have a majority holding.

In the quarter the rupee also appreciated.

A rupee appreciation will help reduce the carrying cost of dollar loans and also reduce the cost of imported thermal fuels and maintenance costs of spares.

The central bank allowed Sri Lanka’s exchange rate to appreciate from 324.40 rupees in December 2023 to 300.17 on March 2024 amid deflationary policy and weak private credit allowing imported fuel costs also to fall.

Especially after 1978, after rate cuts drove the country into balance of payments crises, the central bank had collected reserves with free market interest rates, but has not usually allowed the exchange rate to re-appreciate despite generating a BOP surplus with deflationary policy.

Un-anchored Bad Money

Before 1978, when an apparently doctrinally foxed International Monetary Fund abandoned both external and specie anchors simultaneously after the Fed closed its gold window triggering the Great Inflation period, Sri Lanka also did not depreciate its currency, analysts have pointed out.

Related Why the IMF is hated now and is backing bad money in Sri Lanka and Latin America

Since it was set up in 1951, the central bank has printed money under various dual anchor conflicting Saltwater-Cambridge ideologies (re-financing rural credit, sterilizing outflows, potential output targeting, yield curve targeting) to create forex shortages and currency crises and started to go the IMF from the mid-1960s.

From 1978, after the IMF’s second amendment to its Articles denied the central bank a credible external and domestic anchor simultaneously, the currency stated to depreciate steeply.

The government was therefore unable to balance its budget and state enterprises were also unable to balance their budgets running large losses whenever the rupee fell and energy prices went up.

After abandoning its external and specie anchor the central bank followed a anchor conflicting regime involving money supply targeting without a floating exchange rate in the 1980s.

The ideology was rejected in toto by Singapore, Malaysia, Hong Kong, Thailand and China.

Since the end of a civil war macro-economists have followed inflation targeting without a floating exchange combined with extreme macro-economic policy to target potential output, eventually driving the country into external default.

Budgets went haywire in the early 1980s as the rupee fell, despite then President JR Jayawardene cutting subsidies and ending price controls (administered prices) two years earlier, in reforms that Singapore’s economic architect and one-time Finance Minister Goh Keng Swee said were “economic reforms which most people had considered politically impossible.”

Goh who set up a currency board in Singapore rejecting Cambridge-Saltwater ideology, warned JR not to destroy the rupee.

“Exchange rate policies involve many complicated technical issues which I do want to discuss here,” he said.

“On balance, the disadvantage of a depreciating rupee will, I believe, outweigh the advantages. Most of the products whose prices are administered are ether wholly imported or contain a high import content. About a quarter of rice consumption is imported.

“All wheat from which four and bread are produced is imported. The same holds true of kerosene and milk powder.

“Bus fares ware largely determined by the rupee price of imported oil and spare parts. Fertilizers are also mostly imported.”

At the time Sri Lanka had hydro-electricity.

Capital Injections

Some of the CEB’s dollar loans were been taken over by the central government after the steepest currency collapse in the history of the central bank in 2022 and external default.

The CEB’s contributed capital as at end March 2024 was 991.4 billion rupees up from 865.1 billion rupees.

With the March quarter profits with some financial engineering involving the asset sale and the government equity injection, the CEB’s group accumulated losses reduced to 456 billion rupees from 575 billion rupees.

The CEB ran large losses as the regulator failed to raise tariffs as macro-economists printed money to target potential output over the past decade.

From 2011 to 2022 the rupee fell from 113 to 370 to the US dollars as the central bank ran un-anchored monetary policy the regulator only raised prices in 2022.

Energy Minister Kanchana Wijesekera said the last price cut was also made possible due to rupee appreciation.

With no potential output targeting (no inflationary open market operations), the country has started to recover from the stability that has been provided up to now amid weak private investment credit.

Sri Lanka’s private credit is now starting to recover.

Based on past trends of using statistics instead of classical economic principles (cutting current current interest rates with inflationary open market operations of a money monopoly based on historical inflation rates under ‘data driven monetary policy’ without regard to domestic credit) analysts have warned of a return to monetary instability under potential output targeting. (Colombo/May19/2024)

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