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Sri Lanka heading for uncertainty with low rate obsession: Bellwether

ECONOMYNEXT – Sri Lanka is heading into uncertain territory with an obsession on interest rates, a trigger happy central bank which tends to deliver liquidity shocks through open market operations, which now buys bonds to create money, and the budgets deteriorating on top of all that.

In 2018 the central bank triggered two runs on the currency with a combination of a buffer strategy (where maturing bonds were repaid with a central bank re-financed overdrafts), overnight and term reverse repo injections and rupee/dollar swaps of a type used by hedge funds to generate domestic currency to hit currency pegs.

If the central bank generated currency crises through open market operations in 2018 when budgets were tight, and there was a fuel price formula, what are the odds on it keeping the exchange rate steady when budgets deteriorate?

There have been claims made that in 2005, Sri Lanka had similar economic troubles, but the country managed to overcome them, despite a war.

But many countries which had no war had been brought down by money printing central banks and soft pegs of the type Sri Lanka has now, when private credit picks up and budget deficits widen.

Countries like Argentina, Ecuador, Mexico, Turkey had been repeatedly brought down by similar central banks.


2020 is not 2005 for several reasons. The 2002 to 2004 United National Party administration fixed many of the problems with the economy that came with the peg collapse in 1999/2000.

The currency was, actually, appreciating in 2004, bad loans were coming down, inflation was near zero when the ministries were taken over by Chandrika Kumaratunga in the last quarter of 2003, triggering a run on the rupee.

Most of the ‘circular debt’ in Petroleum and Ceylon Electricity Board and the banks were cleared. Tight fiscal policies and moderate state expenditure, wage restraints and a hiring freeze, allowed the private sector to expand.

Several agencies were privatised, which brought an immediate transformation of the economy. The administration followed clear classical economic policies the central bank under A S Jayewardene was for sound money.


But the last UNP administration followed loosely socialist policies based on price controls, taxing private citizens and companies to give high salaries to state workers, under an International Monetary Fund program of ‘revenue based fiscal consolidation’ with a highly unstable peg. (What went wrong; Sri Lanka’s illiberal economics and unsound money : Bellwether)

CPC was heavily mis-managed despite a price formula by restricting its ability to buy foreign exchange and forcing it to borrow dollars, despite having cash surpluses, based on Mercantilist false doctrine. This strategy – pioneered by Mercantilists many years ago – will continue to harm the country into the future. (Nick Leeson-style losses at Sri Lanka’s CPC raise big questions)

The central bank also followed un-interrupted Mercantilist monetary policy, targeting the real effective exchange rate (an external anchor) along with other domestic anchors, while the IMF stayed silent and/or added fuel to the fire with different types of ‘overvaluation’ calculations. (Sri Lanka may be heading for a triple anchor, ‘inflation targeting’ oxymoron: Bellwether)

The central bank based on public pronouncements also targeted core inflation, and under an IMF program, a high headline inflation of eight percent (domestic anchors) which gave enough rope to the monetary authority to generate balance of payments troubles. ((Sri Lanka needs a narrower inflation target to stop stagflation, BOP crises: Bellwether)

The IMF also taught the central bank to target an output gap, essentially a variation of so-called full employment policies that led to the collapse of the US dollar, and the Bretton Woods system itself.

Similar full employment policies also led to the Sterling Crises and made the UK a shadow of its former self. It also made the Bank of England a client of the IMF.

Collapsing exchange rates pushed up nominal interest rates to high levels in both the US and the UK and triggered stagflation.

As predicted, the UNP administration paid the price for REER targeting and currency depreciation and the monetary indiscipline of the central bank in the electorate.

You may also read

Sri Lanka’s UNP pays the price for currency depreciation, REER targeting: Bellwether

Sri Lanka’s path to debt and destruction paved by currency collapse, REER targeting: Bellwether

Monetary Mess

After generating structurally high interest rates with monetary instability and dual anchor conflicts Sri Lanka’s central bank also slapped price controls, on lending and deposits of banks, invoking a blunt instrument it had not used before.

“The Monetary Law also seeks to give the Central Bank of Ceylon, powers of control over the direction as well as over the quantity of bank finance in Ceylon,” an analyst wrote in the 1951 August issue of The Banker Magazine in London as Sri Lanka’s money printing central bank was established.

“Although this is intended primarily as an anti-inflation regulation it is obvious that it can be used to slow down or prevent the increase of any particular type of credit which the Monetary Board regards as undesirable,” the Banker Magazine warned.

The central bank could slap portfolio ceilings, prescribe minimum capital and minimum cash margins as cover for any letters of credit they open.

“One other control granted to the central bank, that of limiting the interest paid by commercial banks on deposits or changes on loans, is apparently intended to be used only sparingly,” The Banker noted.

“It will be obvious from this summary that the new Monetary Board is going to be given almost unlimited power of control over the banking system of Ceylon, – a power which, if misused could do irreparable harm to the island’s economy.”

In Sri Lanka and elsewhere deposit rates do not fall quickly after a ‘flexible exchange rate’ collapse partly due to competition and also because bad loans squeeze inflows to banks.

By trying to resist market rates, the central bank had denied resources to banks to lend in the recovery period. A strengthening exchange rate, after an initial fall in consumption, would have led to a V-shaped recovery.

In another severe deterioration of policy under Governor Indrajit Coomaraswamy, the central bank had broken the rule on only buying Treasury bills and has started buying bonds.

By breaking the restraints, Governor Coomaraswamy had opened the doors for the central bank to manipulate rates far down into the yield curve and undermine stability.

As a basic principle, a central bank should sell long term sterilisation securities and build up reserves when private credit is weak, and rates are low, not buy them. Later, at the top of the credit cycle if necessary short term securities can be sold when they come up for maturity.

Either way to keep the peg and preserves reserves, all sterilisation securities have to be rolled over, preferably to the same buyer.

IMF Adds to Instability

In addition to powers contained in the monetary law, that allows the central bank to control rates and generate instability, the IMF program now in force, itself intensified the problems.

One was the lack of a ceiling on domestic assets of the central bank, which would have put the central bank’s domestic operations in a straight jacket immediately and provided stability to the currency, the country, the people and energy prices.

The disorderly market condition rule, to defend the rupee (delaying interventions to stop the fall of the rupee from excess liquidity until the currency fell sharply), further undermined the credibility of the rupee and generated panic.

In Pakistan, specific ceiling were set on domestic assets of the central bank.

The State Bank of Pakistan was banned from sterilising interventions with new money, unlike Sri Lanka’s program, which left everything open-ended with an upper-level inflation target big enough to sink Sri Lanka.

“Going forward, the SBP might intervene to prevent a possible overshooting or disorderly market conditions (DMCs), while at the same time not suppressing an underlying trend and in a manner consistent with rebuilding reserves,” the IMF program in Pakistan read.

“These sales will not be sterilised, such that the stance of monetary policy will be correspondingly tightened if intervention is needed.”

Though Pakistan programs (and Argentina’s), which through the sterilisation block, tries to prevent the central bank from targeting a call money/overnight rate with liquidity injections, nevertheless has a ‘disorderly’ undertaking that triggers panic in forex markets.

The DMC is downwardly skewed.

While selling dollars is delayed, which can trigger panic in forex markets, there is no corresponding DMC before buying dollars, giving rise to convertibility undertakings which are skewed towards depreciation.

No Excess Demand from Deficits

There is a belief in Sri Lanka articulated by policymakers and central bankers in particular that budget deficits generate excess demand.

They don’t.

Deficits transfer money from savers and bond holders into government spending.

Excess demand comes if the central bank prints money by purchasing bonds or through open market operations to accommodate the deficit.

“No additions to the money supply take place when the savings of the people are claimed by the government to finance its outlays; such operations merely shift moneys from the pockets of the savers into the pockets of the recipients of government disbursements,” explained B R Shenoy a classical economist who correctly identified the problems in the island and the solutions in Economic Situation and Trends in Ceylon – A Program of Reform as far back as 1966.

However if deficits are financed by the central bank it expands the money supply, creating excess demand.

“The same and result emerges when Public Debt is sold to commercial banks,” and are paid for by central bank money, he said.

This was seen in the ‘buffer strategy’ fiasco and term repo injections which generated instability in 2018.

In the final analysis there is not much difference whether cash injections are used for private credit by banks or the Treasury for the deficit. That is why in 2018, there was currency crises despite a very good budget

That budget deficits cause inflation was also an idea propagated by Arthur Burns around the time the US dollar and the Bretton Woods collapsed. Classical economists have pointed out that especially in 1973 and 1974 he went around spreading this idea.

To boost his argument he made deficits look larger by adding the borrowings of the Federal National Mortgage Association.

Deficits – if no money is printed – simply crowds out private investment or consumption. Currencies fall because deficits are accommodated by the central bank.

The cut in taxes if implemented in December could lead to Rs30 or 40 billion revenue loss a month. This is a considerable shock. But if it is accommodated by foreign borrowings, or through domestic borrowings at a higher interest rate, it may be possible to maintain stability.

However, December is a month where money is printed to accommodate festival demand. In January provisional advances are given, and salary hikes of state workers take effect.

If rates are controlled through liquidity injections, and the DMC is deployed, the grounds will be set for instability and capital flight.

In 1994, A S Jayewardene as central bank Governor, who was an LSE graduate, inherited an awful budget from the UNP election promises.

The budget deficit was 10.5 percent of GDP in 1994 and 10.1 percent of GDP in 1995. He was able to weather the shock with high call money rates.

Now deficits are much lower though there are doubts about the size of the GDP itself.

It must be borne in mind that Argentina frequently collapses because of the BCRA, not the budget. It was very clearly evident in the latest crisis.

Before the latest currency collapse, the central government deficit was a little over 5 percent, and the overall public sector deficit was over 6 percent.

When a deficit deteriorates by one percent the central bank resists rate hike with injections, and all hell breaks loose.

Argentina’s foreign debt was only 37 percent in 2017. Then foreign debt ballooned to nearly 52 percent of GDP as the BCRA printed money, and the peso collapsed.

John Exter, in fact, is said to have used one of the provisions in Sri Lanka’s central bank which is credited with being invented by Raúl Prebisch, who helped design the BCRA and started the beginning of the end of Argentina.

The Confluence of Factors

Sri Lanka is now seeing the confluence of three deadly monetary regressions, with the restraints set by A S Jayewardene also being casually broken by Governor Coomaraswamy.

The first is the ‘flexible exchange rate’ involving call money rate targeting with excess liquidity which removes the protection the rupee gets from the policy corridor. The one-sided ‘DMC’ convertibility undertaking with the foreign reserve target is the second.

The third is the newly given license to repress of the long term bond yield curve with central bank bond purchases.

To this monetary witches’ brew has now been added a spiking fiscal deficit with the possibility of a boost in consumption and private credit.

Usually ‘stimulus’ packages are temporary, which will expire when private credit and consumption picks up. Capital spending projects stop when the projects end. Tax cuts expire. But we know of no such limits.

This column is based on ‘The Price Signal by Bellwetherpublished in the December 2019 issue of the Echelon Magazine. To read Bellwether columns as soon as they are published, subscribe to Echelon Magazine at this link. The i-tunes app can be downloaded from here.

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  1. Badee says:

    Do you advocating higher interest rates, when budget deficit is high? Although there is room to conduct loose Monetary policy? . We would like to know your thoughts on how the economy could stimulate , without doing any fiscal or monetary stimulus???

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  1. Badee says:

    Do you advocating higher interest rates, when budget deficit is high? Although there is room to conduct loose Monetary policy? . We would like to know your thoughts on how the economy could stimulate , without doing any fiscal or monetary stimulus???

Melco’s Nuwa hotel to open in Sri Lanka in mid-2025

ECONOMYNEXT – A Nuwa branded hotel run by Melco Resorts and Entertainment linked to their gaming operation in Colombo will open in mid 2025, its Sri Lanka partner John Keells Holdings said.

The group’s integrated resort is being re-branded as a ‘City of Dreams’, a brand of Melco.

The resort will have a 687-room Cinnamon Life hotel and the Nuwa hotel described as “ultra-high end”.

“The 113-key exclusive hotel, situated on the top five floors of the integrated resort, will be managed by Melco under its ultra high-end luxury-standard hotel brand ‘Nuwa’, which has presence in Macau and the Philippines,” JKH told shareholders in the annual report.

“Melco’s ultra high-end luxury-standard hotel and casino, together with its global brand and footprint, will strongly complement the MICE, entertainment, shopping, dining and leisure offerings in the ‘City of Dreams Sri Lanka’ integrated resort, establishing it as a one-of-a-kind destination in South Asia and the region.”

Melco is investing 125 million dollars in fitting out its casino.

“The collaboration with Melco, including access to the technical, marketing, branding and loyalty programmes, expertise and governance structures, will be a boost for not only the integrated resort of the Group but a strong show of confidence in the tourism potential of the country,” JKH said.

The Cinnamon Life hotel has already started marketing.

Related Sri Lanka’s Cinnamon Life begins marketing, accepts bookings


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Sri Lanka to find investors by ‘competitive system’ after revoking plantations privatizations

ECONOMYNEXT – Sri Lanka will revoke the privatization of plantation companies that do not pay government dictated wages, by cancelling land leases and find new investors under a ‘competitive system’, State Minister for Finance Ranjith Siyambalapitiya has said.

Sri Lanka privatized the ownership of 22 plantations companies in the 1990s through long term leases after initially giving only management to private firms.

Management companies that made profits (mostly those with more rubber) were given the firms under a valuation and those that made losses (mostly ones with more tea) were sold on the stock market.

The privatized firms then made annual lease payments and paid taxes when profits were made.

In 2024 the government decreed a wage hike announced a mandated wage after President Ranil Wickremesinghe made the announcement in the presence of several politicians representing plantations workers.

The land leases of privatized plantations, which do not pay the mandated wages would be cancelled, Minister Siyambalapitiya was quoted as saying at a ceremony in Deraniyagala.

The re-expropriated plantations would be given to new investors through “special transparency”

The new ‘privatization’ will be done in a ‘competitive process’ taking into account export orientation, worker welfare, infrastructure, new technology, Minister Siyambalapitiya said.

It is not clear whether paying government-dictated wages was a clause in the privatization agreement.

Then President J R Jayewardene put constitutional guarantee against expropriation as the original nationalization of foreign and domestic owned companies were blamed for Sri Lanka becoming a backward nation after getting independence with indicators ‘only behind Japan’ according to many commentators.

However, in 2011 a series of companies were expropriation without recourse to judicial review, again delivering a blow to the country’s investment framework.

Ironically plantations that were privatized in the 1990s were in the original wave of nationalizations.

Minister Bandula Gunawardana said the cabinet approval had been given to set up a committee to examine wage and cancel the leases of plantations that were unable to pay the dictated wages.


Sri Lanka state interference in plantation wages escalates into land grab threat

From the time the firms were privatized unions and the companies had bargained through collective agreements, striking in some cases as macro-economists printed money and triggered high inflation.

Under President Gotabaya, mandating wages through gazettes began in January 2020, and the wage bargaining process was put aside.

Sri Lanka’s macro-economists advising President Rajapaksa the printed money and triggered a collapse of the rupee from 184 to 370 to the US dollar from 2020 to 2020 in the course of targeting ‘potential output’ which was taught by the International Monetary Fund.

In 2024, the current central bank governor had allowed the exchange rate to appreciate to 300 to the US dollar, amid deflationary policy, recouping some of the lost wages of plantations workers.

The plantations have not given an official increase to account for what macro-economists did to the unit of account of their wages. With salaries under ‘wages boards’ from the 2020 through gazettes, neither employees not workers have engaged in the traditional wage negotiations.

The threat to re-exproriate plantations is coming as the government is trying to privatize several state enterprises, including SriLankan Airlines.

It is not clear now the impending reversal of plantations privatization will affect the prices of bids by investors for upcoming privatizations.

The firms were privatized to stop monthly transfers from the Treasury to pay salaries under state ownership. (Colombo/May25/2024)

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300 out of 1,200 Sri Lanka central bank staff works on EPF: CB Governor

ECONOMYNEXT – About 300 central bank staff out of 1,200 are employed in the Employees Provident Fund and related work, Governor Nandalal Weerasinghe said, with the function due to be transferred to a separate agency after a revamp of its governing law.

“When it comes to the EPF there is an obvious conflict of interest. We are very happy to take that function out,” Governor Weerasinghe told a forum organized by Colombo-based Advocata Institute.

“We have about 300 staff out of 1,200 including contract staff, almost 150 of permanent staff is employed to run this huge operation. I don’t think the central bank should be doing this business,”

The EPF had come under fire in the past over questionable investments in stocks and also bonds.

In addition, the central bank also faced a conflict of interest because it had another agency function to sell bonds for the Treasury at the lowest possible price, not to mention its monetary policy functions.

“There has been a lot of allegations on the management of this fund. This is the biggest fund of the private sector; about 2.6 million active, I think about 10 million accounts.

“When it comes to EPF, obviously there’s another thing. We obviously have, in terms of resources, on the Central Bank, that has a clear conflict because we are responsible for the members.

“We have to give them a, as a custodian of the fund, we have to give them a maximum return for the members.

“For us to get the maximum return, on one hand, we determine the interest rates as multi-policy. On the other hand, we are managing public debt as a, raising funds for the government.

“And on the third hand, this EPF is investing 90 percent in government securities. And also, interest rates we determine, and they want to get the maximum interest. That’s a clear conflict, obviously, there’s no question.”

A separate agency is to be set up, he said.

“It’s up to the government or the members to determine to establish a new institution that has a trust and credibility and confidence of the members that this institution will be able to manage and secure an interest and give them a reasonable return, good return for their lifetime savings,” Governor Weerasinghe said.

“The question is that how whether we have whether we can develop that institution, whether we have the strong institution with accountability and the proper governance for this thing.

“I don’t think it should be given completely to a private sector business to run that. Because one is that here we have no regulatory institution. Pension funds are not a regulated business.

“First one is we need to establish, government should establish a regulatory agency to regulate not only the EPF business fund, there are several other similar funds are not properly regulated.

“Once we have proper regulations like we regulate banks, then we can have a can ensure proper practices are basically adopted by all these institutions.

“Then you can develop an institution that we who can run this and can be taken back by the Labour Department. I’m not sure Labour Department has the capacity to do all these things.”

While some EPF managers had come under scrutiny during the bondscam and for questionable stock investments, in recent years, it had earned better returns under the central bank management than some private funds that underwent debt restructuring according to capital market analysts with knowledge of he matter. (Colombo/May24/2024)

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