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Thursday August 18th, 2022

Sri Lanka debt unsustainable, should stop printing money, hike rates, taxes: IMF

ECONOMYNEXT – Sri Lanka’s public debt is unsustainable and the country should stop printing money, hike rates and taxes to prevent monetary instability from taking hold, the International Monetary Fund has warned.

Debt Unsustainable

The IMF Executive Directors after an annual article IV consultations said “the country faces mounting challenges, including public debt that has risen to unsustainable levels, low international reserves, and persistently large financing needs in the coming years.”

“Against this backdrop, they stressed the urgency of implementing a credible and coherent strategy to restore macroeconomic stability and debt sustainability, while protecting vulnerable groups and reducing poverty through strengthened, well-targeted social safety nets,” the statement said.

A country’s debt is usually deemed unsustainable based on a politically feasible monetary (interest rates) and fiscal (taxes and and spending cuts) framework, and requires debt re-structuring of some kind to keep interest rates at a manageable level.

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Sri Lanka 2020 deal talks hit a snag on debt sustainability: IMF spokesman

The current crisis may result in more monetary instability, the IMF said, after country cut taxes in 2019 and engaged record money printing to create a ‘production economy.’

“Unless the fiscal and balance-of-payments financing needs are met, the country could experience significant contractions in imports and private credit growth, or monetary instability in case of further central bank financing of fiscal deficits,” the IMF said.

Analysts had warned that under current monetary policy and deficits, with negative foreign assets of the central bank, Sri Lanka may lose control of reserve money and end up in market dollarization (Sri Lanka’s monetary meltdown will accelerate unless quick action is taken).

Printing Money

The IMF staff after annual Article IV consultations (report not published) said there had been a large amount of “central bank direct financing of the budget,” an euphemism for printing money.

Sri Lanka printed 1.2 trillion rupees in 2021, in part due to reserve appropriations and price controls on bond yield that led to auction failures.

However after October 2021 money is printed to sterilize reserve sales for imports to maintain a 200 rupee to the US dollar peg as well as a quasi-fiscal activity involving giving subsidies through printed money to expatriate workers.

Inflation has started to soar after two years of money printing which sent broad money up 40 percent in the period.

“Directors agreed that a tighter monetary policy stance is needed to contain rising inflationary pressures, while phasing out the central bank’s direct financing of budget deficits,” the IMF’s executive directors concurring with a staff assessment said.

Sri Lanka started to print money extensively in February 2020 to keep interest rates down, after cutting taxes in December 2019, ostensibly to kick start a ‘production economy,’ based on post-Keynesian principles.

In 2020 after a severe flexible exchange rate episode in March (a rapid shifting between pegged and floating regimes, with partial interventions that sends the rupee sliding) on top of tax cuts, new downgrades cut off Sri Lanka’s access to capital markets.

A downgrade also came in 2018 also after ‘flexible exchange rate’ episode. The downgrade via the flexible exchange rate and money printed to target ‘an output gap’ or a type of Keynesian stimulus, came despite a hike income and value added tax that brought the deficit now.

The IMF also urged tax hikes through both value added and income taxes.

IMF directors also called for the current 200 to the US dollar peg to be dropped in favour or a “gradual return to a market-determined and flexible exchange rate to facilitate external adjustment and rebuild international reserves.”

Monetary Reforms

Analysts and classical economists have called for reforms to central bank’s governing law to block non-rule based discretionary (flexible) policy and commit the agency to a rule of law involving one monetary anchor.

One option is a clean floating rate (no reserve building, no interventions in the fx market for imports or any other purpose) with a low inflation target not higher than 2 percent, (domestic anchor only) like most low inflation developed nations.

The second, more simpler option is a reserve building peg and no policy rate (unsterilized interventions) involving one external anchor, also known as a hard peg or curency, like Hong Kong and some East Asian nations to stop trade controls, exchange controls, currency collapses, high inflation and social unrest.

A third option is a similar arrangement with a wide policy corridor, and policy rate linked to the anchor currency – usually the Federal Reserves such as in the GCC areas and some other East Asian nations (currency-board-like-system), where the rate also changes.

A hard peg, which outlaws central bank financing of the budget, which led to the current crisis, is an automatic hard budget constraint. A hard peg – which Sri Lanka had from 1885 to 1950 would also stop the country from going to the IMF with external trouble.

Analysts have have pointed out that the ‘flexible exchange rate’ with dual anchors is a fancy name for an inconsistent, permanently depreciating crawling peg (or bbc peg) that has resulted in severe trade and exchange controls in Sri Lanka and elsewhere.

In Latin America such dual anchor regimes with reserve collecting flexible regimes, lead to severe currency collapses and repeated defaults including when there is a budget surplus, when the the US Fed starts to tightens monetary policy.

The IMF also called for current exchange controls to be lifted. IMF directors said Sri Lanka “to gradually unwind capital flow management measures as conditions permit.”

The exchange controls and liquidity injections had triggered parallel exchange rate or around 245 to 250 to the US dollar.

Bad weather and a resurgence of Covid-19 could also compound economic woes contribute and raise bad loans.

IMF Concludes 2021 Article IV Consultation with Sri Lanka

Washington, DC – March 2, 2022: The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with Sri Lanka on February 25, 2022.

Sri Lanka has been hit hard by COVID-19. On the eve of the pandemic, the country was highly vulnerable to external shocks owing to inadequate external buffers and high risks to public debt sustainability, exacerbated by the Easter Sunday terrorist attacks in 2019 and major policy changes including large tax cuts at late 2019. Real GDP contracted by 3.6 percent in 2020, due to a loss of tourism receipts and necessary lockdown measures. Sri Lanka lost access to international sovereign bond market at the onset of the pandemic.

The authorities deployed a prompt and broad-based set of relief measures to cope with the impact of the pandemic, including macroeconomic policy stimulus, an increase in social safety net spending, and loan repayment moratoria for affected businesses. These measures were complemented by a strong vaccination drive. GDP growth is projected to have recovered to 3.6 percent in 2021, with mobility indicators largely back to their pre-pandemic levels and tourist arrivals starting to recover in late 2021.

Nonetheless, annual fiscal deficits exceeded 10 percent of GDP in 2020 and 2021, due to the pre-pandemic tax cuts, weak revenue performance in the wake of the pandemic, and expenditure measures to combat the pandemic. Limited availability of external financing for the government has resulted in a large amount of central bank direct financing of the budget. Public debt2 is projected to have risen from 94 percent of GDP in 2019 to 119 percent of GDP in 2021. Large foreign exchange (FX) debt service payments by the government and a wider current account deficit have led to a significant FX shortage in the economy. The official exchange rate has been effectively pegged to the U.S. dollar since April 2021.

The economic outlook is constrained by Sri Lanka’s debt overhang as well as persistently large fiscal and balance-of-payments financing needs. GDP growth is projected to be negatively affected by the impact of the FX shortage and macroeconomic imbalances on economic activities and business confidence. Inflation recently accelerated to 14 percent (y/y) in January 20223 and is projected to remain double-digit in the coming quarters, exceeding the target band of 4–6 percent, as strong inflationary pressures have built up from both supply and demand sides since mid-2021. Under current policies and the authorities’ commitment to preserve the tax cuts, fiscal deficit is projected to remain large over 2022–26, raising public debt further over the medium term. Due to persistent external debt service burden,

International reserves would remain inadequate, despite the authorities’ ongoing efforts to secure FX financing from external sources.

The outlook is subject to large uncertainties with risks tilted to the downside. Unless the fiscal and balance-of-payments financing needs are met, the country could experience significant contractions in imports and private credit growth, or monetary instability in case of further central bank financing of fiscal deficits. Additional downside risks include a COVID-19 resurgence, rising commodity prices, worse-than-expected agricultural production, a potential deterioration in banks’ asset quality, and extreme weather events. Upside risks include a faster-than-expected tourism recovery and stronger-than-projected FDI inflows.
Executive Board Assessment

Executive Directors commended the Sri Lankan authorities for the prompt policy response and successful vaccination drive, which have cushioned the impact of the pandemic. Despite the ongoing economic recovery, Directors noted that the country faces mounting challenges, including public debt that has risen to unsustainable levels, low international reserves, and persistently large financing needs in the coming years. Against this backdrop, they stressed the urgency of implementing a credible and coherent strategy to restore macroeconomic stability and debt sustainability, while protecting vulnerable groups and reducing poverty through strengthened, well-targeted social safety nets.

Directors emphasized the need for an ambitious fiscal consolidation that is based on high-quality revenue measures. Noting Sri Lanka’s low tax-to-GDP ratio, they saw scope for raising income tax and VAT rates and minimizing exemptions, complemented with revenue administration reform. Directors encouraged continued improvements to expenditure rationalization, budget formulation and execution, and the fiscal rule. They also encouraged the authorities to reform state-owned enterprises and adopt cost-recovery energy pricing.

Directors agreed that a tighter monetary policy stance is needed to contain rising inflationary pressures, while phasing out the central bank’s direct financing of budget deficits. They also recommended a gradual return to a market-determined and flexible exchange rate to facilitate external adjustment and rebuild international reserves. Directors called on the authorities to gradually unwind capital flow management measures as conditions permit.

Directors welcomed the policy actions that helped mitigate the impact of the pandemic on the financial sector. Noting financial stability risks from the public debt overhang and sovereign-bank nexus, they recommended close monitoring of underlying asset quality and identifying vulnerabilities through stress testing. Directors welcomed ongoing legislative reforms to strengthen the regulatory, supervisory, and resolution frameworks.

Directors called for renewed efforts on growth-enhancing structural reforms. They stressed the importance of increasing female labor force participation and reducing youth unemployment. Further efforts are needed to diversify the economy, phase out import restrictions, and improve the business and investment climate in general. Directors also called for a prudent management of the Colombo Port City project, and continued efforts to strengthen governance and fight corruption. They noted the country’s vulnerability to climate change and welcomed efforts to increase resilience.

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Sri Lanka rupee, yields in govt securities slightly changed

ECONOMYNEXT – Sri Lanka Central Bank’s guidance peg for interbank transactions weakened on Thursday (18) and yields in Treasury bonds picked up slightly while in T-bill edged down in dull trade after the central bank kept key monetary policy rates steady, dealers said.

On Thursday, before the market opened, the central bank held its key policy rates steady at 15.50 percent, while data showed market interest rates are close to twice the rate of them while private credit and imports falling as a consequence.

The central bank is injecting 740 billion rupees of overnight money to banks at 15.50 percent, which were originally injected mostly after reserves were sold for imports (or debt repayments) to artificially keep down rates (sterilized interventions), effectively engaging in monetary financing of imports.

The injections (sterilizing outflows) prevent the credit system from adjusting to the outflows and encourage unsustainable credit without deposits, which is the core problem with soft-pegged central banks, triggering a high rate and an economic slowdown later.

A bond maturing on 01. 06. 2025 closed at 27.90/28.00 percent, slightly up from 27.75/90 percent on Wednesday.

The three-months bill closed at 28.30/29.25 percent, down from 29.25/30 percent on Wednesday.

Sri Lanka’s central bank announced a guidance peg for interbank transactions weakened by one cent to 360.97 rupees against the US dollar on Thursday from 360.96 rupees.

Data showed that commercial banks offered dollars for telegraphic transfers between 367.97 and 370.00 for small transactions.  (Colombo/ Aug 18/2022)

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Japan grants medical equipment worth 500-mn yen to Sri Lanka govt hospital

ECONOMYNEXT –  The  Japanese government has granted medical equipment worth 500 million Japanese yen to the Sri Jayawardenepura government hospital to improve the hospital’s treatment facilities under Japan’s Non-Project Grant Aid Programme.

A statement by the Department of External Resources said the grant was given in response to a request by Sri Lanka’s government.

Under the 500 million Japanese yen (approximately 1,265 million rupees) grant assistance, angio-CT machine, other radiology equipment, ophthalmic instruments, surgical instrument sets (stainless steel with satin finish), 15 dental units with accessories, liver transplant instrument sets, and a cardiac catheterization laboratory will be provided, a statement said on Thursday August 18.

Sri Lanka due to its worst economic crisis in its post-independence history is currently facing shortages of essential medicine, non-essential and lifesaving medicines pressuring the health sector to only attend to emergency cases to preserve available limited medicine stocks.

On Thursday at the policy rate announcement media briefing by the Central Bank of Sri Lanka (CBSL), Governor Nandalal Weerasinghe said, with the strict measures taken in the recent past, Sri Lanka is currently managing the limited forex income coming into the country to purchase essential goods such as fuel and medicine.

Sri Lanka has received various grants from several countries including China and India which gave a 200 million US dollar credit line to purchase medicine from India.

In June, Minister of Health Keheliya Rambukwella said there is no shortage of vital medicines in the country and all medicines will be restocked by August 2022. However, shortages of medicine aer still being reported in various hospitals islandwide.

“This improvement at the hospital will facilitate the enhancement of the quality of the care provided especially to the patients with non-communicable diseases while enabling high quality medical professional training to medical undergraduates and postgraduates from the National School of Nursing at the aculty of Medical Sciences of the University of Sri Jayawardenepura,” the External Resources Department statement said.

“This project will eventually assist the development of human resources of the health sector in Sri Lanka,” it said. (Colombo/Aug18/2022)

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Sri Lanka immigration on the hunt for Scotswoman who documented protests

Kayleigh Fraser via @kayzfraser Instagram

ECONOMYNEXT – Sri Lanka’s Immigration and Emigration Department is attempting to track down Kayleigh Fraser, the Scotswoman who documented the country’s anti government protests.

Fraser was ordered to leave the island on or before Monday August 15 after officials cancelled her visa. She and her lawyer had filed a writ petition against her deportation with the Supreme Court, which was dismissed on the grounds that she was not being deported deported, only had her visa cancelled.

“The learned State Council submits that the impugned document ‘X4’ is not a deportation order as claimed by the petitioner and she confirmed that no deportation order has been made up to date by the authorities against the petitioner,” a court document shared by Fraser said.

Immigration officials stated that the police and SSD were on the lookout for Fraser.

“Her visa was cancelled on August 15, so we are looking to put her in a detention camp until she can get a ticket to leave the country,” the official told EconomyNext, confirming that Fraser was not getting deported but that her visa was cancelled.

“Legally we cannot give her a grace period, but on a humanitarian basis, we can give her the time to get a ticket,” the official said.

Fraser had used her social media to share pictures and videos of the anti-government protests in front of the Presidential Secretariat, and has been vocal against state sanctioned violence against protestors.

“Given what I have witnessed here in Colombo – the chemical weapons attacks on protestors, the government instructing the military to beat and torture protestors, the arbitrary arrests and blackmailing of prominent faces from the protests, intimidation tactics and threats etc – I should not be surprised at what has happened today,” she said, speaking to the Daily Record, a Scottish tabloid.

There were no reports of chemical weapons being used against any protestors in Sri Lanka, and it is unclear whether Fraser was erroneously referring to tear gas which was used to disperse crowds.

Fraser also called out media channels who she claimed had attempted to misrepresent peaceful protests as violent.

“It became very clear to me early on that this was not being reported. There was no international coverage on what was happening, and the media here were very much trying to say that it was violent, but that is the absolute opposite of what I saw,” she said over social media.

“What I saw was a beautiful union [of people] coming together in absolute unity. It was a beautiful movement and I’ve never seen anything like that in my life and that kept me coming back.”

However, Sri Lanka’s authorities maintain that the arrests so far have been legal and that violence did occur on the part of some protestors, though activists and some civil society groups disagree. On May 09, after supporters of then Prime Minister Mahinda Rajapaksa launched an unprovoked attack on peaceful protestors in Colombo, a wave of retaliatory mob-violence erupted across the country which saw the residences of some parliamentarians torched to the ground. One government MP was killed.

Authorities say many of the arrests so far have been of protestors who had violated court orders or had illegally occupied government buildings.

Fraser continues to post on her social media. (Colombo/Aug18/2022)

 

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