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Friday December 9th, 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 bond yields end higher, kerb dollar Rs370/371

ECONOMYNEXT – Sri Lanka bonds yields ended up and the T-bills eased on active trade on Friday, dealers said.

The US dollar was 370/371 rupees in the kerb.

“The bond rates went up, however more interest was seen in the short term bills by the investors” dealers said.

A bond maturing on 01.05.2024 closed at 31.90/32.20 percent on Friday, up from 31.25/70 percent at Thursday’s close.

A bond maturing on 15.05.2026 closed at 30.30/31.30 percent steady from 30.30/31.00 percent.

The three-month T-bills closed at 30.75/31.30 percent, down from 32.00/32.25 percent.

The Central Bank’s guidance peg for interbank transactions was at 363.18 rupees against the US dollar unchanged.

Commercial banks offered dollars for telegraphic transfers between 371.78 and 372.00 for small transactions, data showed.

Buying rates are between 361.78 – 362.00 rupees. (Colombo/Dec 09/2022)

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Foreign minister, US ambassador discuss future assistance to crisis-hit Sri Lanka

ECONOMYNEXT — In a meeting in Colombo, Sri Lanka Foreign Minister Ali Sabry and US Ambassador to Sri Lanka Julie Chung discussed ways in which the United States can continue to support Sri Lanka going forward, the Ambassador said.

Chung tweeted Friday December 09 afternoon that the two officials had reflected on the “twists and turns” of 2022, at the meeting.

Minister Sabry was recently in Washington D.C. where he US Secretary of State Antony Blinken.

A foreign ministry statement said the two officials held productive discussions at the Department of State on December 02 on further elevating bilateral relations in diverse spheres, including the 75th anniversary of diplomatic relations which will be marked in 2023.

Incidentally, Sri Lanka also celebrates the 75th anniversary of its independence from the British in 2023, and President Ranil Wickremesinghe has given himself and all parties that represent parliament a deadline to find a permanent solution to Sri Lanka’s decades-long ethnic issue.

The US has been vocal about Sri Lanka addressing concerns about its human rights record since the end of the civil war in 2009 and was a sponsor of the latest resolution on Sri Lanka passed by the United Nations Human Rights Council. Unlike previous resolutions, this year’s iteration makes specific reference to the country’s prevailing currency crisis and calls for investigations on corruption allegations.

In the lead up to the UNHRC sessions in Geneva, Minister Sabry Sri Lanka’s government under then new president Wickremesinghe does not want any confrontation with any international partner but will oppose any anti-constitutional move forced upon the country.

On the eve of the sessions on October 06, Sabry said countries such as the United States and the United Kingdom, who led the UNHRC core group on Sri Lanka, are greatly influenced by domestic-level lobbying by pressure groups from the Sri Lankan Tamil diaspora.

These pronouncements notwithstanding, the Wickremesnghe government has been making inroads to the West as well as India and Japan, eager to obtain their assistance in seeing Sri Lanka through the ongoing crisis.

The island nation has entered into a preliminary agreement with the International Monetary Fund (IMF) for an extended fund facility of 2.9 billion dollars to be disbursed over a period of four years, subject to a successful debt restructure programme and structural reforms.

Much depends on whether or not China agrees to restructure Sri Lanka’s 7.4 billion dollar outstanding debt to the emerging superpower. Beijing’s apparent hesitance to go for a swift restructure prompted Tamil National Alliance MP Shanakiyan Rasamanickam to warn of possible “go home, China” protests in Colombo, similar to the wave of protests that forced the exit of former pro-China President Gotabaya Rajapaksa.

The TNA will be a key player in upcoming talks with the Wickremesinghe government on a solution to Sri Lanka’s ethnic issue. (Colombo/Dec09/2022)

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India smogs out Sri Lanka’s China tower observers

 

ECONOMYNEXT – Sri Lanka’s Chinese-built Lotus Tower has halved visitors to its observation deck an official said as dirty air flowing from India triggered air quality warnings and schools in the capital closed.

“Masks are mandatory at the observation deck and roughly around 50 to 60 can go up to the observation deck at a time, time limits have not been altered and still persists at 20 minutes for observation,” the official told EconomyNext.

Prior to the smog, 120 observers were permitted at once to the deck.

However, even after limitations the Lotus Tower has continued to draw visitors, and revenues are coming in, the official said.

The tower built with a Chinese loan by the cash rich Telecom Regulatory Commission has been described by critics as a white elephant that eats the money earned from telecom operators mainly as spectrum fees.

Sri Lanka’s National Building Research Organization (NBRO) said India air heavily polluted with particulate matter was flowing across the island into a depression in the South West Bengal Bay. (Colombo/Dec09/2022)

 

 

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