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Sunday May 22nd, 2022

Sri Lanka Finance Minister says country facing twin external and domestic crises

ECONOMYNEXT – Sri Lanka is facing severe external crisis as well as a domestic crisis with revenues falling and expenses continuing to rise, Finance Minister Basil Rajapaksa said, amid Coronavirus pandemic and unprecedented money printing which has triggered a plethora of economic controls.

“Our country is facing a severe foreign exchange crisis,” Minister Rajapaksa told the parliament in his debut speech on Tuesday (07).

“Due to Covid this year, the government’s revenue so far for this year has fallen between 1500-1600 billion rupees from the estimated amount.”

Basil, the younger brother of both President Gotabaya Rajapaksa and Prime Minister Mahinda Rajapaksa, made his maiden speech after being appointed to the post in July through the non-elected national list.

The 69-year old key strategist behind the current administration used words carefully not to attack the opposition, unlike his loose-tongued fellow legislators of the ruling Sri Lanka Podujana Peramuna (SLPP) and called for a collective effort to tackle the country’s problems.

Accumulation of State Failures

“I am not blaming any political group, but what is happening now is a culmination of events that has taken place over a long period,” Rajapaksa said.

“We admit that there has been unnecessary spending, waste, and corruption in the past, not only limited to a certain period but for a long period,” Basil Rajapaksa said.

Data from the central bank shows the country’s net foreign exchange reserves are close to zero, which means almost of all of its reserves are borrowed.

Money has been printed to keep interest rates near historic low; despite a budget deficits in excess of 10 percent of gross domestic product had triggered forex shortages as soon as private credit recovered.

In a Mercantilist knee jerk reaction, authorities banned vehicle imports, which are taxed between 200 to 300 percent and can bring up to 3 dollars in tax revenues for every dollar spent.

In Sri Lanka there is little understanding that it is liquidity injections and credit that makes outflow of forex higher than inflows.

Banning high tax imports and driving credit to imports of low taxed items such as capital goods has long been a part of the island’s cascading policy errors that intensify currency crises regardless of who is in power, critics have said.

Revenues from Customs had fallen sharply Rajapaksa said.

“The main source of government income has been from vehicle imports,” Rajapaksa said. “We have banned importing vehicles for the past one and half years.

“Because of difficulties in finding foreign exchange (to import). So the revenue from the customs dropped to low level this year.”


Sri Lanka 2021 budget deficit 4.7-pct of GDP up to June, debt grows faster

Revenue Crunch

He also said the lockdown has reduced Excise Department and Value Added Tax from the Department of Inland Revenue, the other two main revenue agencies.

“When there is a lockdown, the revenue from direct and indirect taxes reduced by 75-80 percent on a daily basis,” the finance minister said.

“From the expenditure side, the government spending has increased because we did not cut any allowances or salaries of state sector employees. In some areas like health we had to pay extra allowances.

“So, we definitely need to look for new ways,” he said.

A circular issued to government agencies ahead of a November budget said there will be a hiring freeze; all new projects will be halted and overtime halted.


Sri Lanka to freeze hiring, halt new projects, target subsidies

A key factor behind Sri Lanka’s parlous state finances is giving ‘jobs for the boys’ pumped full of supporters and unemployed graduates. In the first four months of the year 84 cents out of every tax rupee went to pay state salaries and pensions.

External Sector

Minister Rajapaksa said the external sector is “also facing a similar crisis”.

He blamed the lack of tourism revenues which could be between 4 to 5 billion US dollars for the external problems.

Sri Lanka’s rupee had fallen sharply to around 230 to the US dollar from 185 at the end of 2019 as money was printed.

Economic analysts have said that a fall in tourism revenues simply reduces incomes to tourism sector business and workers and therefore imports fall as had happened in other countries such as Maldives.

A fall in tourism revenues or a ‘real shock’ cannot affect the parity of a paper issued by a note-issuing bank with a foreign currency or the overall balance of payments.

The parity can change only worsen when excess notes issued without foreign reserve backing come up for redemption in forex markets and the central bank denies convertibility.

If convertibility is provided for notes issued without reserve backing (a peg is defended with dollar reserves against rupees issued for Treasury bills), existing forex reserves fall.

Meanwhile remittances, another a key source of foreign exchange for domestic economic activity and the main driver of the country’s trade deficit, had started to fall over the past few months.

“Remittances increased last year, but during the last three months they are on a decline,” he said.

“There has been a decline of 30-35 percent in the past three months.”

Analysts blame parallel exchange rates and a high grey market exchange rate for leakage of foreign exchange to unofficial channels.

Sri Lanka’s exports have bounced back to a pre-pandemic level, thanks to allowing export factories to operate under lockdown period.

Sovereign Default Risk?

Sri Lanka successfully repaid 1 billion US dollar sovereign bond on July 27 amid speculation of possible debt default like Lebanon.

Sri Lanka has been progressively downgraded from a tax cut in December 2019 and the country was locked out of capital markets when the rating fell to CCC.

Sri Lanka’s gross official reserves fell to 3.8 billion US dollars in July.

The central bank has revealed plans to replenish the reserves with swaps, loans as well as an 800 million US dollar special drawing rights allocation from the IMF.

The country has so far received around 1.3 billion out of the planned swaps and borrowings.

Sri Lanka has to repay 6.9 billion dollars in debt in the next 12 months.

If bond auctions fail and money is printed to keep rates down Sri Lanka will not be able to finance the payments out of inflows and foreign reserves will continue to take up the slack, analysts have warned.

Amid the pandemic concessionary finance has reduced, he said.

The World Bank and Asian Development Bank have been particularly helpful, the government will continue to borrow from them, he said.

The ADB and World Bank has been building hospitals, ICUs and financing vaccine purchases.

“We are implementing a policy of using limited foreign loans sparingly,” he said. “We will borrow loans only for essential projects or the projects which will give benefits to the country.”

“We will be borrowing loans from these institutions next year for the projects that will benefit the people,” he said.

Sri Lanka has borrowed heavily from China in recent years for some projects which are not bringing returns, critics have said.

From 2015 to 2019 Sri Lanka’s sovereign bonds also soared from 5 billion US dollars to 15 billion as money was printed to target a call money rate and an output gap and there was monetary stability only in 2017 and 2019, to allow foreign debt to be paid back.

A Liability Management Law also replaced new borrowings with new loans instead of squeezing the current account backed by neutral or deflationary policy from the central bank.

“Earlier what we did was extend the loans with an additional interest rate,” Rajapaksa said. “Instead of an effort like that, we expect to reduce the loans to make a debt-free country.

“Our policy is to borrow loans with simple and concessionary terms and without any conditions that will harm the country’s independence and sovereignty.”

Analysts have warned that it is imperative to get bond auctions to raise real money and maintain domestic solvency if authorities want to repay foreign debt.

If money is printed and swaps are taken, debt will shift from the central government to the central bank.

Sri Lanka has also refused to go for an IMF bailout and said there would be no default. (Colombo/Sept08/2021)

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