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Sunday April 14th, 2024

Sri Lanka has to work fast to contain multiple defaults as Tanzi bites: Bellwether

ECONOMYNEXT – Sri Lanka has to work quickly to establish a clean float and contain defaults on multiple fronts that can be triggered if foreign exchange shortages persist from low policy rates and a deadly surrender requirement.

Sri Lanka’s economic crisis involving foreign exchange shortages, like in Latin America comes primarily from its central bank which is operating an unworkable intermediate regime peg called a ‘flexible exchange rate’, which is neither a clean float nor a hard peg.

A flexible exchange rate fails because it is not rule-bound and it can trigger defaults on multiple fronts by encouraging fiscal excesses (either tax cuts or higher spending or both) because state economists falsely believe that the interest rate can be controlled by printing money.

The unstable peg that brought forex troubles to Sri Lanka was set up in 1950 in the style of a Latin American central bank and its underlying law was changed several times to weaken its anchor further. It was originally set up with a gold anchor targeted at 2.88 grains of gold.

But the anchor was changed after the Fed became a floating rate after the collapse of the Bretton Woods system, creating further instability making it the worst central bank in South Asia, overtaking Pakistan.

After 2015, very aggressive open market operations in the form of call money rate targeting and the post-2020 price ceiling on bond auctions were the final nails in the coffin.


Soft-pegged central banks, through years of forex shortages, have also lobbied and received extensive powers from parliaments to impose controls on the people and avoid raising rates.

However, the controls make the crisis worse as the underlying anchor conflict is not dealt with.

Exchange controls are one. When a central bank restricts dollar sales, importers who have to pay demurrage or fear further depreciation are willing to buy dollars at high rates in unofficial markets.

When money is printed to maintain low interest rates or to give salaries to state workers, excess demand for goods is created and inflows of dollars are no longer enough to match the supply.

The central bank was earlier printing money to pay premiums to export workers in a parallel exchange rate, which worsened forex shortages.

The outward pressure and high prices allow Undiyal counterparties in the Middle East or Italy to offer similar high premiums.

The various controls by the central bank and other authorities prevent the market from adapting and lead to a worsening of the exchange rate crisis.

The most damaging control now imposed is a surrender requirement where banks are forced to give 50 percent of the dollars they get from exporters and ex-pat workers to the central bank.

A dollar purchase by the central bank can only be made when a peg is strong, and if the rupee is facing upward pressure due to weak domestic credit. But now the peg has lost credibility. It is a suicidal move to impose a surrender requirement on a peg that has lost credibility.

That is why the float has not taken place. Without a float and further tightening of policy, Sri Lanka’s monetary meltdown will accelerate.

If legislators and others want to turn Sri Lanka into an East Asia, these powers have to be removed and the monetary law changed, to radically curb open market operations in the future.

It can be done through a currency board.


With greater reliance on bullet repayment sovereign bonds by the government, cross-border and interbank loans, swaps by commercial banks and swaps by the central bank, three types of defaults could happen when forex shortages worsen.

There have been extensive warnings of sovereign default in the belief that the problem is caused by the lack of taxes and a failure to roll over debt as in Ecuador.

If that was the case the problem will be limited only to sovereign debt and can be easily solved by a re-structuring to reduce the gross financing need (GFN) in the near term.

But Sri Lanka is not Ecuador which was dollarized at 25,000 Sucre many years ago and no longer suffers peg conflicts. Neither is Sri Lanka Greece which was in a monetary union. Sri Lanka is a Latin America style pre-dollarized flexible exchange rate Ecuador.
That is why fuel and power shortages happen. (Sri Lanka is not Greece, it is a Latin America style soft-peg: Bellwether)

Foreign exchange shortages are a result of a lack of a working monetary regime, either a working peg or a working floating rate.

Without a working monetary regime several types of defaults can happen and it is not limited to sovereign default.

a) Sovereign debt repayment is at risk as long as foreign exchange shortages (excess rupee creation) persist.

b) The central bank debt repayment is at risk as long as foreign exchange shortages (excess rupee creation) persist.

This column warned about this before and the IMF has now also made the same warnings in its Article IV report.


Sri Lanka’s central bank should guard against bankruptcy as Fed lights commodity fires

Sri Lanka central bank repayment capacity to IMF under scrutiny

c) State banks are at risk due to debt taken to finance Ceylon Petroleum Corporation as money was printed to trigger currency crises in quick succession over a few years as well as dollar loans.

This column has generally avoided talking about banks but rating agencies have already warned about the sovereign link earlier.

All banks have been struggling due to rating cuts that came as money was printed. Tightening limits are a problem for all banks.

d) SOEs and also private firms who are solvent may find it difficult to find dollars to repay dollar loans even if they are solvent and have rupees.

Rating agencies generally talk about the sovereign ceiling.

If a float is quickly re-established, some of the fallouts could be contained. Alternately fast-track dollarization could be allowed by allowing dollar recipients to make payments in foreign currency and denominating contracts in dollars.


The inability to buy dollars is a problem of jumping from the rupee monetary base of the Central Bank of Sri Lanka to the Federal Reserve’s US dollar monetary base.

Let’s say the CPC needs dollars. A dollar has to be sold by an exporter for a rupee (wealth jumps from the US to Sri Lanka monetary base) and the exporters pay the CPC in rupees.

CPC now has to jump back from the rupee monetary base into the US monetary base with US dollars.

Hence the exporter dollar conversion rule makes the problem worse because a given transfer of wealth has to jump from US monetary base to rupees and back again to dollars.

It can be done easily if the peg is credible or if there is a floating exchange rate. When it is dysfunctional it cannot be done.

The shortcut is to allow dollarization, also known as a hard exit from a broken flexible exchange rate.

Then the government can also charge taxes and fees in rupees first from hotels and exporters.


Sri Lanka should prepare to float, and promote parallel dollarization: Bellwether

An earlier column has explained how dollarization can be allowed.

Depreciation and Tanzi effect

The ability to repay maturing debt is primarily a matter of available savings. But when the currency depreciates the value of savings evaporates.

New savings also reduce as prices go up.

Economists talk about the Tanzi effect. The Tanzi effect refers to the fall in the real value of taxes in a hyperinflating economy from the time the taxes fall due and the time the payment is made.

However, savings and debt have a similar problem. A fall in currency inflates away real wealth. Economist Steve Hanke has already calculated a higher level of inflation implied by exchange rate movements.

When the currency falls, the ability to repay reduces. That is partly why countries that practice ‘competitive exchange rates’ and depreciate their currencies end up importing capital.

The revenue-based fiscal consolidation exercise by rejecting spending-based consolidation failed to arrest deficits. This was predicted in the 1960s by classical economist B R Shenoy when revenues were over 20 percent of GDP.

When government spending goes up from 17 to 20 percent of GDP under revenue-based fiscal consolidation but the deficit does not come down, total consumption goes up leaving fewer savings available to repay domestic or foreign borrowings.

To contain cascading defaults it is essential to end the surrender rule, curtail access to open market operations perhaps by placing quantity limits of access to the central bank window and managing government spending.

When money is printed to maintain low interest rates or to give salaries to state workers, excess demand for goods is created and inflows of dollars are no longer enough to match the supply.

The government giving handouts at this time will not help the poor.

Any handouts must be given only after a working exchange rate regime is established. The float has to succeed or dollarization has to be allowed.

Why default now?

Why is Sri Lanka close to default now if a Latin America style central bank was always there?

Sri Lanka has faced currency crises in the past but no default because there was not much commercial debt. Bi-lateral lenders continue to fund the country in a crisis and did not demand their money back in a crisis.

Latin American nations, which were basically first world nations before soft pegs were set up in the 20th century and faced severe uncertainty from the 1980s after the Fed floated, had always borrowed from commercial markets.

Sri Lanka also started to borrow in commercial markets with a similar soft-peg from around 2005 onwards.

But policy deteriorated rapidly from around 2015. A key deterioration was call-money rate targeting.

Sri Lanka was on track downward spiral when call money rate targeting came with excess liquidity was started.

In 2018 Sri Lanka suffered a currency crisis despite budget deficits being brought down.

In 2019 this column warned that Sri Lanka was running out of rating space to print money and operate a flexible exchange rate regime and further downgrades would occur.


Sri Lanka needs monetary discipline to avoid further downgrades: Bellwether

Sri Lanka’s Weimar Republic factor is inviting dollar sovereign default: Bellwether

Single Anchor Regimes

In order to have a strong exchange rate, a monetary regime must have one anchor only.

A single anchor monetary regime involving a clean floating exchange rate is used by all developed nations.

Successful East Asian nations like Hong Kong use a single external anchor or exchange rate target, and interest rates float.

Depreciating or failing regimes like in Sri Lanka, Latin America and Africa try to juggle with both domestic and external anchors (flexible exchange rates or dual anchor conflicting regimes) and collapse because neither the exchange rate nor interest rates truly float.

A flexible exchange rate can collapse and trigger independent defaults of financing fiscal excesses such as in the case of many Latin American defaults.

In countries with failing exchange rate regimes, there is almost a religious fear of hard pegs and also true floats. Economists have labelled this ‘fear of floating’.

The experience of the Russian Ruble is a case in point. As this columnist said at the time the ban on the use of forex reserves by the West in their ignorance was a lifeline. And the lady is a champ.


Sri Lanka rupee appreciates against Ruble, Bank of Russia may clean float

Intermediate regime countries keep going back to IMF. That is because the IMF programs do not end in a hard peg or a true float but yet another permutation of an unstable intermediate regime. (Colombo/Apr01/2022)

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Sri Lanka undershoots inflation target in first quarter despite VAT hike

Sri Lanka undershoots inflation target in first quarter despite VAT hike

ECONOMYNEXT – Sri Lanka’s inflation is expected to lower than initially projected in 2024, despite a value added tax hike, Central Bank Governor Nandalal Weerasinghe has said

“When we looked at the last two monetary policy reviews… we had an inflation path a little elevated to what was realized, ” he told reporters following a March 50 basis point rate cut.

“Mainly because our projection factored in the VAT increase in January and some of the short-term food price increases, we have seen in December and January.

But what we have seen the actual inflation realization, is that the impact of VAT has not been that much and also the reduction in electricity prices also has helped, as well as the supply conditions, especially food supplies has been better.

“As a result, inflation outcome has been much lower than we expected.”

Sri Lanka’s central bank has been conducting broadly deflationary policy, except perhaps in December 2024, when a private credit spike appears to have been accommodated by standing facilities on top a seasonal real demand for cash.

The central bank has also allowed the currency to re-appreciate departing inflationist policy generally seen since 1978, analysts say.

“In our projections, we see in the next 12 to 18 months, inflation will remain well below our target range between 4-6. In our expectation it will remain around 4-5 percent in the next 12 to 18 months.

“That is one of the reasons we saw we had some pace to reduce our policy rate.”

The central bank cut its policy corridor 50 basis points to 8.50 and 9.50 percent, and has allowed excess liquidity to build up in money markets from a balance of payments deficit (net dollar purchases) at the current market interest rate structure.

Though money is being injected through various tools allowing some banks to trade without deposits, overall, there is a sell down of its domestic securities holdings.

Sri Lanka has a reserve collecting central bank currently subject to IMF forex reserve targets and domestic asset sell down target (which are essentially complementary), an inflation target of up to 7 percent and an implicit potential output (printing money for growth) target.

The central bank currently providing exceptionally monetary stability not for many years, and cautiously lowering rates, as well as reversing some of the inflation it has created in the past in food prices and energy.

Since September 2022, when deflationary policy started to show up in the balance of payments, the central bank has only created 3.9 percent inflation according to the widely watched Colombo Consumer Price Index.

However, analysts have warned that in the past, deeply flawed operational frameworks involving multiple and contradictory anchors have tended to trip up when private credit recovered when rates are cut claiming inflation is low.

Sri Lanka also does not have a penalty rate for standing facilities, unlike countries with tighter operational frameworks, which are less prone to crises. (Colombo/Apr14/2024)

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Sri Lanka eyes on speedy debt resolution at IMF/WB Spring Meetings: State Finmin

ECONOMYNEXT – Sri Lanka is looking forward to have discussions for a speedy debt resolution and restore debt sustainability at the Spring Meetings of the International Monetary Fund (IMF) and World Bank (WB) starting on Monday (15) in Washington, State Finance Minister Shehan Semasinghe said.

Minister Semasinghe is leading the Sri Lankas delegation for this year’s IMF/WB Spring Meetings that includes Central Bank Governor Nandalal Weerasinghe and Treasury Secretary Mahinda Siriwardana.

The island nation expects to conclude the debt restructuring negotiation with its private creditors and sovereign bond holders and formalize the already agreed deal with bilateral creditors by end of the first half of this year, government sources have told EconomyNext.

Sri Lanka also expects to receive the third tranche of the IMF by mid this year after the completion of the second review of a $3 billion loan program last month.

“We expect fruitful engagements that will pave the way for unlocking the next tranche of essential funding and a speedy debt resolution which will enhance economic stability, confidence, sustainable growth, restore debt sustainability and ultimately, improving the welfare of every Sri Lankan citizen,” the Minister said in his X (Twitter) platform.

“Sri Lanka’s journey to its current state of stability and progress is due to the invaluable support provided by the IMF, World Bank and international partners during the most severe economic crisis we faced since 2022. “

“As we navigate the complexities of global economic challenges, we will engage closely with the IMF and aim to contribute to broader international economic cooperation with our partners.”

“Through dialogue, partnership, and concerted efforts, we are confident that we will achieve brighter economic future for Sri Lanka,” Semasinghe said.

The Monday’s Spring Meetings come as President Ranil Wickremesinghe government is facing a presidential election after long delayed local government and provincial polls.

Some government officials have said there could be likely slippages in the IMF targets during the election period as majority of Sri Lankans feel their struggling has risen due the implementation of IMF conditions including increased taxes.

The government has already started to relax some of the tough conditions it has maintained to boost the state revenue amid an increase in the tax revenue.

However, President Wickremesinghe has vowed to continue the IMF-led reforms as they are citing they are the only solution to come out of the current unprecedented economic crisis. (Colombo/April 14/2024)

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LGBTQIA+ Rights: Europe and South Asia See Similar Discriminatory Practices

ECONOMYNEXT – The rights and protections of the LGBTQIA+ community have been fraught with challenges and continue to be so, despite the many gains achieved in recent years.

Nor are those handful of rights universally applied, a recent discussion which looked at the European and South Asian perspectives on same-sex rights and unions revealed. Most developed nations have introduced protections for those identifying as LGBTQIA+, and a view from a distant lens paints a picture of tolerance. Yet, a closer look at the European arena throws up the many gaps that are evident in the application of the law.

In the so-called conservative South Asian nations, changes to legislation are slow to be implemented. That may come as a surprise, for, contrary to popular belief, same-sex relationships were culturally acceptable in the South Asian region and is not a Western concept points out Ruhaan Joshi, a Public Policy Practitioner from India.

Society’s view on same-sex relationships dimmed with the imposition of Western values and the criminalisation of such relationships with the advent of colonial rule.

While the LGBTQIA+ communities in South Asian countries currently battle to have same-sex relationships decriminalised and their unions legally accepted, the irony is that countries that first made such relationships punishable by law have moved on to be more welcoming, though some discriminatory practices continue.

Joshi was part of a discussion themed ‘On Being Queer and LGBTQIA+ in South Asia and Europe, held in Germany on April 9 this year. The discussion which included the release of two papers which examined the rights and protections of the LGBTQIA+ community in Europe and South Asia, respectively, was organised by the Friedrich Naumann Foundation for Freedom.

Joining Joshi in the discussion were lawyer and parliamentarian Premnath C Dolawatte from Sri Lanka, Milosz Hodun, President, Projekt Polska Foundation, Poland, Michael Kauch, a Member of the European Parliament and RENEW Europe Group and Inaya Zarakhel, a Dutch-Pakistani actress and an activist on Queer Rights, who moderated the discussion. The two papers were presented by Hodun and Joshi, respectively.

In his opening remarks, Kauch pointed out that while the view of the liberals is that the rights recognized in one member nation of the EU must be accepted by all member countries, that is not the ground reality, the issue of Rainbow families being a case in point.

In the context of the European Union, though the Court of Justice has ruled on the freedom of movement of those in same-sex partnerships and their families, the ruling is not universally applied by member nations.

In Italy, and some European nations, surrogacy which helps childless couples to become parents is illegal. In other situations where same-sex parents are of different nationalities a child in that union faces restriction of movement or the possibility of being stateless if one parent hails from a country where such parental rights are not recognised.

Hodun meanwhile stated that in Poland transgender persons must first sue their parents for the gender assigned to them at birth, to have their gender marker changed on documents.

Some countries such as Russia and Azerbaijan resort to State-sponsored homophobia, and in many instances politicians and political parties promote such biases to boost their voter base it was pointed out. Even where laws are in place for the protection of LGBTQIA+ rights, there is no political will to implement them.

In Europe where migrants arrive in droves seeking asylum, and are frowned upon by many of those countries, LGBTQIA+ members face even more discrimination Hodun says, both by other refugees and governments, where most often the state ignores the situation despite the guidelines issued by the UN and the European Court of Justice. Hate speech and hate crimes too are on the rise he adds stating that at least 80 per cent go unreported.

Increasingly the LGBTQIA+ community has experienced a diminishing of their safe spaces as right-wing and populist governments are elected across the globe. Taking a dig at feminism, meanwhile, Kauch states that though feminists uphold a woman’s right to opt for an abortion, they take a different approach on the topic of surrogacy.

Dolawatte who waded into unchartered waters when he presented a Private Member’s Bill to decriminalise same-sex relationships through an amendment to section 365 of the Penal Code and the repealing of section 365A in its totality, is hopeful that the Bill will pass its third reading. It’s been an uphill battle he says, referring to the case filed in the Supreme Court against the Bill. The court ruled in his favour.

He had little or no support from his own party members, but says the President of the country, and younger party members are with him on this issue. Apart from making Sri Lanka a safe space, it would encourage foreign nationals identifying as LGBTQIA+ to visit without fear, and thus boost tourism he opines.

As Joshi states society has come a long way from when LGBTQIA+ were made fun of and were subject to violence to the positive portrayal in movies. Such movies are also well-received by society. Transgender identity has a distinct recognition in South Asian religious beliefs. Hijra, Khwaja Sara or Kinnar are some names given to transgender folk and they have, since ancient times been an accepted group in society. On the one hand, there’s Afghanistan and the Maldives which make no allowances for the LGBTQIA+ community, while Nepal became the first South Asian nation in 2023, to register a same-sex marriage, Joshi states. In most South Asian nations, the courts have ruled in favour of relaxing the rules against this community, and, like in Europe, it is the governments that drag their feet.

For governments to change their stance, society must take the lead in fighting for the unconditional dignity of the individual, freedom of movement, and safeguarding the tenets of democracy, he says adding that it must also run parallel with the LGBTQIA+ community looking beyond themselves at issues that impact democratic values, and the societal restrictions non-LGBTIQIA+ groups face, such as opposition to inter-caste marriage and the right to adopt outside their caste systems and equal access to many other privileges.

While the panellists advocated working together across the global divide as a step towards achieving equal rights for all, Dolawatte also called for caution; too much pressure on such issues from Europe he said may not be welcome, and must be handled with care.

With right-wing and populist governments getting elected across the globe, Kauch claims the forthcoming EU elections will prove crucial in deciding how future and current governments ensure tolerance and diversity amongst their citizenry.

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