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Sri Lanka hikes policy rate 50bp, SRR up 200bp as forex reserves run low

MONETARY DIRECTION: This graph was published before the rate hike.

ECONOMYNEXT – Sri Lanka’s central bank has raised an overnight rate by 50 basis points to 6.0 percent at its monetary policy meeting in August, as it runs out of foreign reserves due to liquidity injected through ceiling Treasuries yields which act as a de facto policy rate.

The statutory reserve ratio has also been raised by 2.00 percent to 4.00 percent from September 01.

The interbank market is already short due to reserve outflows.

Sri Lanka’s central bank is running a pegged exchange rate (called flexible exchange rate) collecting foreign reserves but operates as if it was running floating regime, targeting a domestic anchor (an inflation index) creating frequent currency crises, high inflation and output shocks, due to the conflict in anchors, classical economists have shown.

While the rate hike is a good move, unless the ceiling rate on bill auctions are taken off and injections halted, any overnight rate hikes will not be able to stem reserve losses.

Large volumes of money injected after failed Treasuries auctions have depleted gross reserves to 1.8 months of imports by July.

Analysts have warned that net reserves, after deducting an International Monetary Fund loan and swaps, and a balance on the Asian Clearing Union, are even lower and injecting money through failed Treasuries auctions are unsustainable.

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“The Board expects these monetary policy decisions to iron out the prevailing imbalances in the domestic financial markets and the external sector of the economy, while preempting the buildup of any excessive inflationary pressures over the medium term, thereby supporting greater macroeconomic stability,” the central bank said.

“The upward adjustments in market interest rates and the expected liquidity deficit in the domestic money market would also help the economy to absorb the large amount of currency held by the public observed since the onset of the pandemic in early 2020.”

The SRR requirement is likely to be met by overnight borrowings analysts say.

Overnight borrowings have already risen to 113 billion rupees and the market was short 32 billion rupees on August 18 due to reserve outflows. The SRR could however absorb around 150 billion rupees of failed bond auctions.

Sri Lanka’s economic troubles involving currency troubles and output shocks intensified during the past few years with call money target targeting and so called ‘Stage III’ Treasuries auctions before the de facto ceiling rate, critics have said.

The central bank is also expecting the rate hikes to reduce the gap between US dollar and rupee deposit rates and also parallel exchange rates in the grey market.

Higher grey market rates have driven remittances off the official market.

The full statement is reproduced below.

The Central Bank of Sri Lanka tightens its Monetary Policy Stance

The Monetary Board of the Central Bank of Sri Lanka, at its meeting held on 18 August 2021, decided to increase the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) of the Central Bank by 50 basis points each, to 5.00 per cent and 6.00 per cent, respectively. In addition, the Monetary Board decided to increase the Statutory Reserve Ratio (SRR) applicable on all rupee deposit liabilities of licensed commercial banks (LCBs) by 2.0 percentage points to 4.00 per cent, with effect from the reserve maintenance period commencing on 01 September 2021. These decisions were made with a view to addressing the imbalances on the external sector of the economy and to preempt the buildup of any excessive inflationary pressures over the medium term, amidst improved growth prospects.

The global economy is set to make a gradual recovery in 2021, although normalisation of economic activity would largely be uneven across regions

As per the July 2021 update to the World Economic Outlook (WEO) of the International Monetary Fund (IMF), the global economy is projected to grow by 6.0 per cent in 2021 and 4.9 per cent in 2022. Economic prospects have diverged across regions and access to COVID-19 vaccines has emerged as the principal factor that drives the global economic recovery in the period ahead. Most countries have experienced transitory price pressures due to supply-demand mismatches amidst the pandemic. Such transitory pressures could become more persistent, thereby warranting preemptive action by central banks in order to ensure stability in the period ahead. Accordingly, some central banks have already commenced tightening monetary policy while several others have signalled a possible tightening of monetary policy in the period ahead.

The Sri Lankan economy is on a recovery path despite the pandemic related disruptions

Supported by fiscal and monetary stimulus measures, the Sri Lankan economy is gradually making headway following the setback in 2020. As per the estimates published by the Department of Census and Statistics (DCS), the economy witnessed a stronger than expected recovery during the first quarter of 2021, recording a real growth of 4.3 per cent, year-on-year. The economy is poised to record a higher growth rate during the second quarter of 2021, partly due to the sharp contraction observed in the corresponding quarter of the previous year. Possible disruptions to domestic economic activity from the re-emergence of the COVID-19 pandemic and related preventive measures could weaken the recovery to some extent during the second half of 2021. Nevertheless, with the successful rolling out of the national COVID-19 vaccination programme and the Government’s strategy to impose only selective mobility restrictions, the momentum of activity is expected to sustain in the period ahead. Available indicators and projections suggest that the real economy would grow over 5 per cent in 2021, and this momentum would be sustained over the medium term. 2

Most market interest rates have reached low levels resulting in the expected acceleration in credit flows to the private sector

With the gradual transmission of accommodative monetary policy measures, most market deposit and lending interest rates declined to their historic low levels. Supported by the low interest rate environment, credit to the private sector expanded notably during the first half of 2021, surpassing the annual expansion of credit observed in 2019 and 2020. The momentum of credit expansion is expected to continue in the period ahead, with increased credit flows to productive and needy sectors of the economy. Meanwhile, credit obtained by the public sector from the banking system, particularly net credit to the Government, also increased notably thus far during the year, amidst the impact of the pandemic on government revenue and recurrent expenditure. Reflecting the impact of increased domestic credit, the growth of broad money (M2b) continued to remain elevated.

The external sector continued to face a multitude of challenges requiring coordinated measures

The implementation of the essential growth-conducive stimulus measures, which resulted in the availability of low cost credit to the private sector, led to a sustained increase in the demand for merchandise imports since mid-2020. With the increase in import expenditure outweighing the improvements observed in earnings from exports, the trade deficit continued to widen during the first half of 2021 over the corresponding period of last year.

Moreover, the expected recovery in the tourism industry could be further delayed due to uncertainties associated with the resurgence of the pandemic globally. Workers’ remittances, which recorded a significant growth in 2020 as well as in the first few months of 2021, have also displayed some deceleration. Limited conversion by exporters and the advancing of imports together with some speculative activity, prompted by anomalies between interest rates on the rupee and foreign currency products in the financial market, exerted undue pressure on the exchange rate in the domestic market. Amidst these developments, all debt service obligations of the Government, including the settlement of the International Sovereign Bond (ISB) of US dollars 1 billion in late July 2021, have been duly met thus far in 2021.

Gross official reserves were estimated at US dollars 2.8 billion with an import cover of 1.8 months by end July 2021. This, however, does not include the bilateral currency swap facility with the People’s Bank of China (PBoC) of CNY 10 billion (equivalent to approximately US dollars 1.5 billion). Measures are being taken by the Government and the Central Bank to secure foreign financing from several sources in order to reinforce the level of official reserves in the near future. Meanwhile, the Government continued to aggressively explore avenues to enhance non-debt creating foreign inflows, by strengthening the domestic production economy, which would help strengthen the external sector in the period ahead.

Possible upside pressures on inflation are being addressed through preemptive policy measures

Inflation, which remained moderate during early 2021, accelerated somewhat in recent months due to high food inflation and some acceleration in non-food inflation. Inflation is projected to hover around the upper bound of the desired 4-6 per cent target range in the near term. The envisaged improvements in aggregate demand conditions and the likely increases in global energy and other commodity prices may generate some inflationary pressures in 2022, requiring preemptive policy measures to ensure the maintenance of inflation in mid-single digit levels over the medium term.

Tightening of monetary policy stance is expected to support greater economic stability In consideration of the current and expected macroeconomic developments as highlighted above, the Monetary Board decided to rollback some extraordinary support provided to the economy at the onset of the COVID-19 pandemic.

Accordingly, with effect from 19 August 2021, the Board decided to increase the policy interest rates, i.e., the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR), of the Central Bank by 50 basis points each, to 5.00 per cent and 6.00 per cent, respectively. This would also result in the Bank Rate, which is linked to the SLFR with a margin of +300 basis points, automatically adjusting to 9.00 per cent.

In order to induce a faster response of the market to these adjustments, the Monetary Board also decided to increase the Statutory Reserve Ratio (SRR) applicable on all rupee deposit liabilities of licensed commercial banks (LCBs) by 2.0 percentage points to 4.00 per cent, with effect from the reserve maintenance period commencing on 01 September 2021.

The Board expects these monetary policy decisions to iron out the prevailing imbalances in the domestic financial markets and the external sector of the economy, while preempting the buildup of any excessive inflationary pressures over the medium term, thereby supporting greater macroeconomic stability.

The upward adjustments in market interest rates and the expected liquidity deficit in the domestic money market would also help the economy to absorb the large amount of currency held by the public observed since the onset of the pandemic in early 2020. The Central Bank will continue to monitor domestic and global macroeconomic and financial market developments and take appropriate measures to ensure that the economy reverts to its potential, while maintaining inflation in the targeted 4-6 per cent range under its flexible inflation targeting framework.

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Sri Lanka power outages from falling trees worsened by unfilled vacancies: CEB union

HEAVY WINDS: Heavy rains and gusting winds have brought down trees on many location in Sri Lanka.

ECONOMYNEXT – Sri Lanka’s power grid has been hit by 300,000 outages as heavy winds brought down trees, restoring supply has been delayed by unfilled vacancies of breakdown staff, a union statement said.

Despite electricity being declared an essential service, vacancies have not been filled, the CEB Engineers Union said.

“In this already challenging situation, the Acting General Manager of CEB issued a circular on May 21, 2024, abolishing several essential service positions, including the Maintenance Electrical Engineer in the Area Engineer Offices, Construction Units, and Distribution Maintenance Units,” the Union said.

“This decision, made without any scientific basis, significantly reduces our capacity to provide adequate services to the public during this emergency.

“On behalf of all the staff of CEB, we express our deep regret for the inconvenience caused to our valued customers.”

High winds had rains have brought down trees across power lines and transformers, the statement said.

In the past few day over 300,000 power outages have been reported nationwide, with some areas experiencing over 30,000 outages within an hour.

“Our limited technical staff at the Ceylon Electricity Board (CEB) are making extraordinary efforts to restore power as quickly as possible,” the union said.

“We deeply regret that due to the high volume of calls, there are times when we are unable to respond to all customer inquiries.

“We kindly ask consumers to support our restoration teams and to report any fallen live electrical wires or devices to the Electricity Board immediately without attempting to handle them.

The union said there were not enough workers to restore power quickly when such a large volume of breakdowns happens.

“We want to clarify that the additional groups mentioned by the minister have not yet been received by the CEB,” the union said.

“Despite the government’s designation of electricity as an essential service, neither the government, the minister in charge, nor the CEB board of directors have taken adequate steps to fill the relevant vacancies or retain current employees.

“We believe they should be held directly responsible for the delays in addressing the power outages due to the shortage of staff.”

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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

(Colombo/May25/2024)

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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.

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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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