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Sunday January 29th, 2023

Sri Lanka foreign exchange swap discounts widen, fears of underworld grabbing kerb market

ECONOMYNEXT – Upside down rates in Sri Lanka’s rupee-dollar swap discounts continued to widen this week and market participants lamented the movement of a higher share of kerb market foreign exchange to the underworld, after a crackdown on authorized money changers.

In the official foreign exchange market swap discounts continued to widen, reflecting low rupee yields and low dollar availability for funding purposes, market participants said.

The spot/1 month was quoted -170/-150 cents this week.

The spot two months was -325/-275 cents

The spot/3 months was -500/-450 cents

The spot/6 months was -800/-750 cents

A swap discount of 750 indicates that market participants who sell dollars today at (say) 200 rupees in the swap market will get it back roughly for 192.50 (a discount) in six months, despite continued reserve losses indicating that the peg is under pressure.

The central bank has also forced dollar earnings of exporters and service providers to be converted, indicating that dollar deposit growth will slowdown further, hurting the funding books of banks, analysts warn.

Sri Lanka’s state banks had been among key borrowers in the swap market. State banks have large dollar loans to state-run CPC in particular.

The CPC had been forced to borrow dollars when the central bank printed money to target a call money rate in the past as well as creating forex shortages. Attempts are underway to get credit lines and further expand dollar borrowings of the CPC.

This week the central bank raided several authorized money changers who have been exchanging dollars at above the official non-credible peg of 200 to the US dollar.

Sri Lanka’s authorized money changers are mostly long-standing businesses that have operated across generations. Many belong to the Tamil and Muslim communities.

The communities had been engaged in cross-border trade from the British period and beyond.

“Most of my business is going to the underworld,” a traditional kerb market merchant lamented earlier this week after the first raids of authorized money changers took place.

Hawala operators may also get additional business discouraging people from bringing notes to the country, another said.

There was also a possibility of forged dollar notes being circulated as the underworld expands the business, market participants warned.

Sri Lanka is a country where there was hardly any forged dollar notes due to the screening done by the longstanding kerb market community which included authorized money changers.

Though international card fraudsters targeted credit cards and ATMs in Sri Lanka, forged dollar note operators could not target Sri Lanka due to the business practices of the domestic kerb market, those familiar with the practice say.

Forged foreign currency notes operators are active in countries like Indonesia.

Exchange controls and other controls come when legislators fail to introduce sufficiently tight laws on central banks that try to control interest rates by printing money.

Even behind the Iron curtain money printing made smugglers and black-market

the biggest private sector run business, leading to the Russian mafia and others in the communist bloc.

Forex and balance of payments problems spread like an epidemic after World War II, as central banks earlier run by bankers were nationalized and they came under the control of so-called ‘lost generation economists’ who were spewed out of Anglo-American universities after the Keynesian revolution.

After Hitler was defeated, Germany by Ordoliberals had one of the strongest currencies during the Bretton Woods era, while the UK and the US were hit by inflation and many newly independent countries which printed money for ‘development economics’ became miserable developing countries.

“The root of our present monetary troubles is, of course, the sanction of scientific authority which Lord Keynes and his disciples have given to the age-old superstition that by increasing the aggregate money expenditure, we can lastingly ensure prosperity and full employment,” explained Friedrich Hayek, a classical economist, after the Bretton Woods collapsed.

“Sir John Hicks has even proposed that we call the third quarter of this century, 1950 to 1975, the age of Keynes, as the second quarter was the age of Hitler. I do not feel the harm that Keynes did is really so much as to justify that description.”

The Fed, in the 1960s, as money was printed to target an ‘output gap” also started central bank swaps.

Then the head of the Federal Reserve Bank of New York’s FX desk Charles Coombs went around begging for swaps from prudent European banks, such as the Bundesbank and the Swiss central bank.

They were used in part to stop prudent European central banks from demanding gold (reserves) of the Fed for excess money printed to maintain low rates and delay the inevitable.

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Sri Lanka operators seek higher renewable tariffs, amid exchange rate expectations

ECONOMYNEXT – Sri Lanka’s renewable companies say they need tariff of 40 to 45 rupees a unit to sell power to the Ceylon Electricity Board and the agency owes them tens of billions of rupees for power sold in the past.

The association has strong exchange rate expectations based on the country’s dual anchor conflicting monetary regimes involving flexible inflation targeting with a reserve collecting target.

“In the coming year of course because of the rupee devaluation, I think the solar energy sector might require tariffs closer to RS 40 or RS 45, hydropower will also require tariffs on that scale,” Prabath Wickremasinghe President of the Small hydropower Developers Association told reporters.

“I think right now what they pay us is averaging around RS 15 to RS 20.”

Some of the earlier plants are paid only 9 rupees a unit, he said. The association there is potential to develop around 200 Mega Watts of mini hydros, 700 to 1000MW of ground mounted soar and about 1,000 rooftop solar.

In addition to the rupee collapse, global renewable energy costs are also up, in the wake of higher oil prices in the recent past and energy disruption in Europe.

The US Fed and the ECB have tightened monetary policy and global energy and food commodity price are now easing.

However in a few years the 40 to 45 rupee tariffs will look cheap, Wickremesinghe pointed out, given the country’s monetary policy involving steep depreciation.

From 2012 to 2015 the rupee collapsed from 113 to 131 to the US dollar. From 2015 to 2019 the rupee collapsed from 131 to 182 under flexible inflation targeting cum exchange rate as the first line of defence where the currency is deprecated instead of hiking rates and halting liquidity injections.

From 2020 to 2022 the rupee collapsed from 182 to 360 under output gap targeting (over stimulus) and exchange rate as the first line of defence.

“The tariffs are paid in rupees,” Wickremasinghe said. With the rupee continuing to devalue in other 5 years 40 rupees will look like 20 rupees.”

Sri Lanka has the worst central bank in South Asia after Pakistan. Both central banks started with the rupee at 4.70 to the US dollars, derived from the Reserve Bank of India, which was set up as a private bank like the Bank of England.

India started to run into forex shortages after the RBI was nationalized and interventionist economic bureaucrats started to run the agency. Sri Lanka’s and Pakistan’s central bank were run on discretionary principles by economic bureaucrats from the beginning.

The Central Bank of Sri Lanka was set up with a peg with gold acting as the final restraint on economic bureaucrats, but it started to depreciated steeply from 1980 as the restraint was taken away.

Now under so-called ‘exchange rate as the first line of defence’ whenever the currency comes under pressure due to inflationary policy (liquidity injections to target an artificially low policy rate or Treasuries yields) the currency is depreciated instead of allowing rates to normalize.

Eventually rates also shoot up, as attempts are made to stabilize the currency which collapses from ‘first line of defence’ triggering downgrades along the way.

After the currency collapse, the Ceylon Electricity Board, finances are shattered and it is unable to pay renewable operators.

Unlike the petroleum, which has to stop delivery as it runs out of power, renewable operators continue to deliver as their domestic value added is higher.

However they also have expenses including salaries of staff to pay.

The CEB which is also running higher losses after the central bank printed money and triggered a currency collapse, has not settled renewable producers.

“In the meantime, we have financial issues with the investors and CEB owns more than 45 million rupees in the industry,” Warna Dahanayaka, Secretary of Mini Hydro Association, said at the conference.

“We can’t sustain because we can’t pay the salaries and we can’t sustain also because of the bank loans. Therefore, we are requesting the government to take the appropriate action for this matter.”

Sri Lanka and Pakistan have identical issues in the power sector including large losses, circular debt, subsidies due to depreciating currencies.

In Sri Lanka there is strong support from the economists outside government for inflationary policy and monetary instability.

The country’s exporters, expatriate workers, users of unofficial gross settlement systems, budget deficits and interbank forex dealers in previous crises have been blamed for monetary instability rather than the unworkable impossible trinity regime involving conflicting domestic (inflation target) and external targets (foreign reserves).

The country has no doctrinal foundation in sound money and there is both fear of floating and hard peg phobia among opinion leaders on both sides of the spectrum regardless of whether they are state or private sector like any Latin American country, critics say.


South Asia, Sri Lanka currency crises; only 2-pct know monetary cause: World Bank survey

A World Bank survey last year found that only 2 percent of ‘experts’ surveyed by the agency knew that external monetary instability was generated by the central bank. Most blamed trade in severe knee jerk reaction. (Colombo/Jan29/2023)

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Sri Lanka top chamber less pessimistic on 2023 GDP contraction

ECONOMYNEXT – Sri Lanka’s top business chamber said it was expecting an economic contraction of up to 2 percent in 2023, which is much lower than projected by international agencies.

“The forecast of 2023 is quite negative in terms of the international forecasters,” Shiran Fernando Chief Economist of Ceylon Chamber of Commerce told a business forum in Colombo.

“Our view is that there will be some level of contraction, may be zero to two percent. But I think as the year progresses in particular the second half, we will see consumption picking up.”

The World Bank is projecting a 4.2 percent contraction in 2023.

In 2022 Sri Lanka’s economy is expected to contract around 8 to 9 percent with gross domestic product shrinking 7.1 percent up to September.

Most businesses have seen a consumption hit, but not as much as indicated, Fernando said.

“Consumption is not falling as much as GDP in sense and we are seeing much more resilient consumer,” he said.

Sri Lanka’s economy usually starts to recover around 15 to 20 months after each currency crisis triggered by the island’s soft-pegged central bank in its oft repeated action of mis-targeting rates through aggressive open market operation or rejecting real bids at Treasuries auctions. (Colombo/Jan28/2023)

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Acuity Knowledge Partners with Sri Lanka office to be bought by Permira

ECONOMYNEXT – Permira, an investment fund with operations in Europe, US and Asia is buying a majority stake in Acuity Knowledge Partners, which has a 500 seat center in Sri Lanka for a undisclosed sum.

Equistone Partners Europe, from which Permira is buying the stake will remain a minority investor, the statement said.

In 2019, Equistone backed a management buyout of Acuity from Moody’s Corporation.

Acuity Knowledge Partners says it serves a global client base of over 500 financial services firms, including banks, asset managers, advisory firms, private equity houses and consultants.

“Despite the current challenges for the financial services sector, we have experienced continued growth and a strong demand for our solutions and services,” Robert King, CEO of Acuity Knowledge Partners, said.

“Given the significant demand within the financial services sector for value-added research and analytics, and the need for operational efficiency, with Permira’s deep experience in tech-enabled services and its global network, I am confident the business will continue to flourish.”

London headquartered Acuity has offices in the UK, USA, India, Sri Lanka, Costa Rica, China and Dubai, UAE.

Equistone was advised on the transaction by Rothschild & Co and DC Advisory, and Latham & Watkins acted as legal counsel. Robert W. Baird Limited served as financial advisers to Permira, and Clifford Chance is acting as legal counsel.

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