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Tuesday March 28th, 2023

Sri Lanka following John Law, rupee debauched in MMT: legislator

ECONOMYNEXT – Sri Lanka is treading on the path of John Law, an 18 century French Mercantilist who drove France to a monetary meltdown with an early central bank, in implementing so-called Modern Monetary Theory debauching the currency, an opposition legislator has charged.

Sri Lanka cut taxes sharply in December 2019 in a fiscal ‘stimulus’ and started printing in large quantities following several rate cuts in early 2020 in a monetary ‘stimulus’.

John Law Returns

“Look at the problems in fiscal policy. What was the benefit of cutting taxes?” opposition legislator Kabir Hashim questioned in parliament.

“Government revenues fell and prices of goods went up. Look at monetary policy. In 1700s in Britain there was a man called John Law. It is his policies we are following now, printing money and calling it MMT.”

Law fled his native Scotland to France over an incident in a duel, but had tried interest Scottish leaders in setting up a central bank and a national paper money.

Scotland had a series of free banks where a type of short term advances of printed money similar to ‘provisional advances’ found in Sri Lanka’s central bank law, called the ‘real bills doctrine’ which was in use to various degrees.

However he failed to persuade Scottish leaders including the Duke of Argyle of his scheme. Following his flight to France, Law cultivated a friendship with the Duke of Orleans, who was regent to King Louis of France.

In 1720 Law was appointed Controller General of Finance. A private bank set up by Law (Banque Générale Privée) was nationalized as Banque Royale and it bought government debt.

“He (Law) bankrupted France,” Hashim said. “The same thing is happening in Sri Lanka.”

Mississipi Stocks

Placing restrictions on free trade, Law created several companies with crony-Mercantilist monopoly powers including the Mississippi Company, driving up stock market prices with excess profits.

In Sri Lanka import restrictions are also driving up stock market profits of some so-called crony import-substitution companies, which exploit people with high prices benefiting from import duties and import controls.

However inflation soon followed and stock markets collapsed as people demanded gold in return for the paper money, in a similar way people demand dollars in return for printed money in a pegged exchange rate central bank.

Hashim said hundreds of billions of rupees had been printed in 2020.

“Where had his money gone?” he questioned. “There should be lots of money. Why is the government saying there is no money now?”

The money left country as a balance of payments deficit as the new money was redeemed for foreign reserves for trade transactions and for dollar debt repayment through the ‘convertibility undertaking’ of the peg.


Sri Lanka’s central bank buys bonds in new money printing phase

Sri Lanka sells US$76mn in August after liquidity injections

The BOP deficit started in late 2019 as the Yahapalana central bank bought bonds to target an output gap and lower interest rates artificially again ending a policy of mopping up inflows.

Excess Money Redeemed for Reserves

The BOP deficit in 2020 was 2.3 billion US dollars. In 2021 up to April the BOP deficit was over 900 million dollars.

“The rupee had been severely debauched (mus-ther barl-doo),” Hashim said. “Mahinda Rajapaksa hit the rupee over 100 to the US dollar in 2005. Gotabaya Rajapaksa hit it over 200 to the US dollar in 2020/2021.”

However the central bank in the administration in which Hashim was a cabinet minister also followed a milder version of MMT called ‘output gap targeting’, triggering currency crises.

Ironically the International Monetary Fund gave technical support to calculate a supposedly existing ‘output gap’.

Hashim’s administration also followed a more non-credible peg called the ‘flexible exchange rate’ involving vicious dual anchor conflitcs, which switched between floating and fixed rapidly, sometimes within the same day, due to refusal to convert to dollars very much smaller volumes of printed money and went sliding down.

The administration also made an attempt to institutionalize dual anchor conflicts by writing the ‘flexible exchange rate’ into the monetary law.

Printing money to target an output gap created a currency crisis in 2018 driving the rupee down from 153 to 182 to the US dollar forcing corrective policies to be implemented as the balance of payments was blown apart, in a so-called ‘stop-go’ policy. (Stop-Go policies of the political business cycle)

The central bank also jettisoned a ‘bills only policy’ trying to control long term yield curve, going beyond a short term ‘real bills doctrine’ to longer term permanent injections of money in the style of Banque Royale.

It was claimed that ‘inflation targeting’ was followed, despite operating the highly unstable pegged exchange rate called ‘flexible exchange rate’ with a foreign reserve target, which analysts warned would end in disaster.

The 2018 debacle was also significant since money was printed despite tax hikes and market pricing of oil, showing there was no fiscal dominance of monetary policy.


Sri Lanka may be heading for a triple anchor, ‘inflation targeting’ oxymoron: Bellwether

However the country does not have a floating rate to avoid a currency collapse when money is printed through open market operations.

Deteriorating Policy

After busting the rupee the central bank also controlled deposit rates, in an unprecedented double expropriation of the small man in favor of leveraged businesses and the state in another Mercantilist intervention.

The central bank also engaged in real effective exchange rate targeting resisting an appreciation of the currency in 2017 while buying up over a billion US dollars in reserves and also undoing dangerous swap deals.

Instead of letting the currency appreciate like in 2010 and 2011, the rupee was further depreciated by 3 rupees in 2017.

The then administration gave ‘central bank independence’ and allowed REER targeting, a blatantly Mercantilist strategy aimed at getting a short term trade advantage by destroying real wages of export workers.

The then-cabinet also did not objects to ‘output gap targeting’ to be implemented though no cabinet sanction had been given for such an action which went against the stability objective of the central bank.

A policy rate corridor was also narrowed from 150 to 100 basis points, and no action was taken.

MLA mandate for stability

Call money rate targeting was then started where large volumes of money was printed to target a rate below the ceiling of the corridor making nonsense of the idea of having a policy corridor in the first place which is to allow rates to go up automatically when a peg is defended.

Critics have pointed that the central bank only has a stability mandate and no growth mandate for any John Law type activity other than provisional advances for six months, and both output gap targeting and MMT violates Section 05 of the constitution of the central bank.

However even in 1950, an economist writing in The Banker magazine warned that the six-month limit was no protection as long at the CB could buy Treasuries and had many tools used in Latin America.

Sri Lanka’s central bank was one of several set up by the Fed in Latin America and Asia in the style of Argentina’s central bank.

In 2015 large volumes of money was injected initially to keep call money rates at the bottom of the corridor eventually driving the rupee from 131 to 151 to the US dollar by early 2017 in the first currency crisis in the last administration.

Analysts warned that the call money rate targeting would be a death-knell for the rupee and REER targeting would, trigger monetary instability and political unrest.

However MMT is much more dangerous.

Analysts have warned that MMT combined with swap deals could make the central bank insolvent, in addition to possible sovereign default and could trigger a monetary meltdown unless corrective action was taken to stop printing money.

History Repeats
The 2020 MMT exercise was done despite the experience of 2015 and 2018, where growth collapsed after the liquidity injections triggered currency crises.

In France, despite the experience of the John Law’s paper money, a currency called Assignat was printed after the French revolution. The assignat was printed not against Treasury bills but land seized mostly from the Church and ‘assigned’ against paper livres.

The currency soon lost value and trading restrictions and exchange controls were brought to maintain its value.


Sri Lanka tightens capital controls, outflows from forex accounts capped

In August, 1793, a law was passed punishing any person who sold assignats at less than their nominal value with imprisonment for twenty years in chains, and later a law making investments in foreign countries by Frenchmen punishable with death.

“On whom did this vast depreciation mainly fall at last?”,” questioned Andrew Dickson White in his work Fiat Money Inflation in France.

“When this currency had sunk to about one three-hundredth part of its nominal value and, after that, to nothing, in whose hands was the bulk of it?

“The answer is simple.

I shall give it in the exact words of that thoughtful historian from whom I have already quoted: “Before the end of the year 1795 the paper money was almost exclusively in the hands of the working classes, employees and men of small means, whose property was not large enough to invest in stores of goods or national lands.

“Financiers and men of large means were shrewd enough to put as much of their property as possible into objects of permanent value.

“The working classes had no such foresight or skill or means. On them finally came the great crushing weight of the loss. After the first collapse came up the cries of the starving.” (Colombo/July02/2021)

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Sri Lanka stocks weaken for the second session on profit taking

ECONOMYNEXT – Sri Lanka’s stocks closed weaker on Tuesday for the second consecutive session mainly driven by month-end profit-taking by investors, according to brokers.

The main All Share Price Index (ASPI) closed down 0.56 percent or 51.81 points to 9,233.40.

The market has been on a downward trend since last week as investors are adopting a wait-and-see approach until more clarity is given regarding local debt restructuring after the International Monetary Fund approved the extended loan facility.

“The market is down as the selling trend continues,” said Ranjan Ranatunga of First Capital Holdings, speaking to EconomyNext.

“As there is a price decline in all shares across the board, combined with the month ending followed by margin calls, the market continued on a downward trend.”

The market generated a slow and thin turnover of 860 million rupees.

The main contributor to the turnover is Lanka IOC, following news that the Sri Lanka cabinet has granted approval for three oil companies from China, the United States, and Australia in collaboration with Shell Pl to lease 150 fuel stations for each company to operate in the local market.

The fears of debt restructuring mainly affected the banking and financial sectors, which dragged the index down for the day.

The market saw a net foreign inflow of 30.9 million rupees, and the total offshore inflows recorded so far in 2023 are 1.01 billion rupees.

The most liquid index, S&P SL20, closed 0.81 percent or 21.68 points down at 2,656.30.

The market saw a turnover of 860 million on Tuesday, below this year’s daily average of 1.8 billion rupees.

Top losers were Vallibel One, John Keells Holdings, and Hatton National Bank.

Analysts said the downward trend is expected to continue for the rest of the week as profit-taking is expected to continue. (Colombo/March28/2023)

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Sri Lanka rupee closes weaker at 325/328 to dollar, bond yields up

ECONOMYNEXT – Sri Lanka’s treasury bond yields were up at close on Tuesday and the rupee closed weaker in the spot market, dealers said.

A 01.07.2025 bond was quoted at 31.20/60 percent on Tuesday, up from 30.75/31.00 percent on Monday.

A 15.09.2027 bond was quoted at 28.25/29.00 percent, up from 28.10/60 percent from Monday.

Sri Lanka rupee opened at 325/328 against the US dollar steady, from 322/325 from a day earlier. (Colombo/ March28/2023)

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Sri Lanka Telecom on track rating upgrade track on planned stake sale: Fitch

ECONOMYNEXT – Sri Lanka Telecom has been place on watch for a possible rating upgrade after the government, which has defaulted on its sovereign debt said it will sell down its majority stake.

“The rating reflects the potential rating upside due to weakening linkages with SLT’s parent, the government of Sri Lanka (Long-Term Local-Currency Issuer Default Rating: CC), due to the government’s plan to sell its 49.5 percent stake in the company,” the rating agency said.

“Fitch will resolve the RWP when the proposed disposal becomes practically unconditional, which
may take more than six months.”

The agency said it expect SLT’s revenue growth to slow to a low single-digit percentage in 2023 amid weakening consumer spending due to consumers increasingly prioritising essential needs, such as food and medicine, as real income has fallen significantly following the currency depreciation and unprecedently high inflation.

The full statement is reproduced below;

Fitch Places Sri Lanka Telecom’s ‘A(lka)’ Rating on Watch Positive

Fitch Ratings – Colombo – 27 Mar 2023: Fitch Ratings has placed Sri Lanka Telecom PLC’s (SLT) National Long-Term Rating of ‘A(lka)’ on Rating Watch Positive (RWP).

The RWP reflects the potential rating upside due to weakening linkages with SLT’s parent, the government of Sri Lanka (Long-Term Local-Currency Issuer Default Rating: CC), due to the government’s plan to sell its 49.5% stake in the company. Fitch will resolve the RWP when the proposed disposal becomes practically unconditional, which may take more than six months.

SLT’s ratings are currently constrained by its parent’s weak credit profile under Fitch’s Parent and Subsidiary Linkage (PSL) Rating Criteria. SLT’s Standalone Credit Profile (SCP) is stronger than that of the state, reflecting the company’s market leadership in fixed-line services, second-largest share in mobile, ownership of an extensive optical fibre network and a strong financial profile. The extent of SLT’s rating upside, following the proposed disposal, will depend on the credit profile of its new parent, the linkage strength with SLT according to our PSL criteria, and the proposed funding structure.


Disposal Plan: SLT announced on 20 March 2023 that the Sri Lankan cabinet has granted in-principle approval to sell the 49.5% stake in SLT held by the state. The disposal is part of a plan to restructure state-owned entities (SOEs) to improve the state’s financial position. SLT said steps have yet to be taken to identify potential buyers and it will take at least eight to 12 months to finalise the transaction. We believe the government will push through the disposal as SOE restructuring is an integral part of the IMF’s financial support to Sri Lanka.

Sovereign Ownership Pressures Rating: We assess the legal ring-fencing and access and control between SLT and the state as ‘Open’ under the PSL criteria, given the absence of regulatory or self-imposed ring-fencing of SLT’s cash flow and the government’s significant influence over the subsidiary’s operating and financial profile. SLT’s second- biggest shareholder, Malaysia-based Usaha Tegas Sdn Bhd with a 44.9% stake, has no special provisions in its shareholder agreement to dilute the government’s influence over SLT.

Higher Rating: However, the PSL criteria allows for a stronger subsidiary to be notched above the weaker parent’s consolidated profile in extreme situations, such as when a parent is in financial distress but the subsidiary continues to operate independently and its banking access appears unaffected. We do not believe SLT is at risk of default in the next 12 months, as it has sufficient liquidity and its debt does not carry cross-default clauses that can be triggered by the parent’s distress.

SLT’s ‘A(lka)’ rating therefore reflects its relativities with national peers, but is still below its SCP due to the drag from state ownership. We apply our PSL criteria because our Government-Related Entities (GRE) Rating Criteria states that in cases where the SCP of the GRE is higher than the government’s IDR, the relevant considerations of the PSL criteria will be applied to determine whether the IDR of the GRE is constrained or capped at the government’s rating level.

Weak Demand in 2023: We expect SLT’s revenue growth to slow to a low single-digit percentage in 2023 amid weakening consumer spending. Consumers are increasingly prioritising essential needs, such as food and medicine, as real income has fallen significantly following the currency depreciation and unprecedently high inflation. SLT’s subscriber numbers and minutes of usage have already fallen in 2022. Competition has also intensified, especially in the mobile segment, leading to lower realisation of recently introduced tariff hikes.

Weak demand should be offset to an extent by increased migration to SLT’s fibre-to-the- home (FTTH) network, from its own copper network, and subscriber additions. FTTH carries higher revenue per user than the copper network. SLT had 475,000 FTTH connections, a 35% increase yoy, by end-2022.

Weakening Profitability: We expect SLT’s EBITDA margin to narrow to around 34% in 2023 (2022: 35.6%) amid lower demand and ongoing cost escalations. All telecom operators increased tariffs by 20%-25% in late 2022 to tackle falling margins. However, the realisation into revenue remains weak, especially in the mobile segment, due to deep price cuts by one of the smaller operators and falling demand. SLT’s fixed-line business is able to maintain stable EBITDA margins due to the recent tariff hike and the FTTH segment’s higher revenue per user.

Leverage to Stabilise: We expect SLT’s EBITDA net leverage to remain around 1.3x in 2023 (2021: 0.9x, 2022: 1.3x) amid falling profitability. However, its leverage is strong for the rating. We expect capex of around LKR25.0 billion annually over 2023-2024 on network upgrades and expanding its fibre infrastructure.

Interest-Rate Hikes, Currency Depreciation Manageable: We expect SLT to maintain its EBITDA interest coverage closer to 4.0x over 2023-2024 (2022: 4.4x) despite interest rates rising almost threefold. Most of SLT’s debt is on variable interest rates, which will raise costs. SLT’s foreign-currency revenue, which accounts for 10%-12% of group revenue, is more than sufficient to meet the group’s foreign-currency operating expenses and interest costs. SLT had around USD10 million in foreign-currency debt at end-
December 2022, compared with USD40 million in foreign-currency cash deposits.

Sector Outlook Deteriorating: Fitch expects the average 2023 net debt/EBITDA ratio for SLT and mobile leader Dialog Axiata PLC (AAA(lka)/Stable) to remain around 1.3x (2022: 1.3x) amid weak margins and high capex. We expect sector revenue growth to slow to 8% in 2023 (2022: 15%), while the average 2023 EBITDA margin for SLT and Dialog should narrow to 31% (2022: 32%) amid low usage and high costs.

SLT’s SCP benefits from market leadership in fixed-line services and the second-largest position in mobile, along with ownership of an extensive optical fibre network. SLT has lower exposure to the crowded mobile market and has more diverse service platforms than Dialog. However, Dialog has a larger revenue base, lower forecast EBITDA net leverage and a better free cash flow (FCF) profile than SLT. Dialog is rated at ‘AAA(lka)’, while SLT’s rating is under pressure because of the state’s weak credit profile.

SLT has a larger operating scale than leading alcoholic-beverage manufacturer Melstacorp PLC (AAA(lka)/Stable), which distributes spirits in Sri Lanka through its subsidiary, Distilleries Company of Sri Lanka PLC (AAA(lka)/Stable). Melstacorp is exposed to more regulatory risk in its spirits business because of increases in the excise tax, but this is counterbalanced by its entrenched market position and high entry barriers.

Consequently, the company can pass on cost inflation and maintain its operating EBITDA margin, supporting substantially stronger FCF generation than SLT.


Fitch’s Key Assumptions within Our Rating Case for the Issuer:

– Revenue growth to slow to 4% in 2023 amid falling subscriber numbers and lower usage due to weakening consumer spending;

– Operating EBITDA margin to narrow by 150bp to 34% in 2023 due to higher costs and lower volume;

– SLT to continue capex on expanding its fibre and 4G network with LKR25 billion spent annually in 2023 and 2024;

– Effective tax rate of 28% from 2023;

– Dividend payout of 33% of net income over 2024-2025


Factors that could, individually or collectively, lead to positive rating action/upgrade:

– Fitch will resolve the RWP when the proposed disposal becomes practically unconditional, which may take more than six months, and once Fitch has sufficient information on the new majority shareholder’s credit profile and linkages with SLT and the proposed funding structure.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

– Fitch would remove the RWP and affirm the National Long-Term Rating at ‘A(lka)’ with a Stable Outlook if the proposed disposal does not proceed and the linkages with the state remain intact.


Manageable Liquidity: SLT’s unrestricted cash balance of LKR14 billion at end- December 2022 was sufficient to redeem its contractual maturities of around LKR11 billion. SLT’s short-term working-capital debt amounted to another LKR10.0 billion and we expect the company to roll over the facilities given its solid access to local banks.

Liquidity is further enhanced by about LKR15 billion in undrawn bank credit facilities, although these are uncommitted. SLT typically does not pay commitment fees on its undrawn lines, although we believe most banks will allow the company to draw down the funds because of its healthy credit profile.

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