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Thursday February 9th, 2023

Sri Lanka in stagflation after flexible exchange rate collapse

STAGFLATION: Sri Lanka’s growth usually falls and inflation picks up after a currency collapse.

ECONOMNEXT – Sri Lanka is going through a period of stagflation involving low growth and higher inflation for the second time in less than five years after the repeated collapses of a highly unstable soft-peg called the ‘flexible exchange rate’.

Sri Lanka ran into a balance of payments crisis in 2015 as rates were cut and tens of billions of rupees tied up in term repo deals with the central banks was dumped into the banking system to keep rates down, on the argument that inflation was low.

At the time the credit system was recovering from a 2012 balance of payments crisis which was followed by a period of monetary discipline. The liquidity releases had however begun by the fourth quarter of 2014, data show.

By the time the crisis ended the rupee had fallen from 131 to 150 to the US dollar. During 2017, there was no monetary indiscipline, the credit system stabilized, but inflation spiked as the prices adjusted to lagged effects of the previous collapse.

The rupee was weakened to 153 to the US dollar apparently to target a Real Effective Exchange Rate Index, though private credit was wake and money and exchange policies were not in conflict.

Base money injections made through a strong side convertibility of a peg (dollar purchase) were mopped up by sell-downs of central bank held securities during the period, keeping the exchange rate strong.

In 2018, the economy and credit system was starting to recover and inflation was just starting to go down when the central bank again injected large volumes of liquidity through multiple liquidity windows to generate another run on the rupee.

Rates were cut despite inflation being relatively high.

Analysts had warned that an inflation ceiling of 7.8 percent set under a deal with the International Monetary Fund was too high and would lead to instability and stagflation.

Argentina’s central bank – which also pegs – had set itself a 17 percent inflation target before the most recent currency collapse.

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Base money was also injected through unsterilized dollar purchases and rupee dollar swaps in 2018, of a style used by speculators to generate liquidity and attack pegs during the East Asian crises, to target a call money rate and enforce a rate cut.

In the 2018 crisis, where confidence was worsened by a political crisis in October the rupee fell from 153 to 182 to the US dollar.

Sri Lanka has to operate a peg to build a forex reserve buffer, but there has been no ceiling on central bank domestic assets to halt monetary indiscipline.

Sri Lanka is now targeting a ‘flexible exchange rate’ (external anchor) while building a forex reserve buffer, while also operating a ‘flexible; inflation targeting arrangement (targeting a wide domestic anchor).

Rates may have been cut and liquidity injected, despite higher inflation to target a gap between actual and ‘potential’ output with printed money.

Developed nations also went through a period of stagflation in the 1970s when the Bretton Woods system of soft-peg broke and there were no rules to discipline central banks, without a peg to gold.

Floating rate central banks eventually came up with an inflation rule and no pegging.

In Sri Lanka growth fell to 1.6 percent in the June quarter, partly due to attacks on hotels on Easter Sunday. In October inflation had topped 5 percent.

Rates were cut in 2019 despite higher inflation and liquidity was injected to depress the call money rates, weakening the rupee.

Analysts have pointed out that the rupee slides whenever liquidity shocks are given despite generally weaker credit, because of skewed convertibility undertakings.

When the rupee comes under pressure from excess liquidity the central bank waits until ‘disorderly fall’ before deploying a weak-side convertibility undertaking to defend the peg.

Even after the undertaking is deployed, liquidity is injected instantly to stop overnight rates from moving up to stabilize the currency.

However there is no similar strong side convertibility undertaking to wait until a ‘disorderly’ appreciation has taken place to buy dollars and inject base money.

Large volumes of dollar are bought specially from the Treasury to inject base money at market rates.  Such purchases are also made in the throes of a currency crisis. (Colombo/Nov04/2019-SB)

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Thousands of Sri Lankans protest against tax hike

ECONOMYNEXT – Thousands of Sri Lanka’s highly paid state workers protested against tax hikes, citing it as ‘unfair’ with most of them have been caught into the tax brackets for the first time.

The tax hike protest also saw hundreds of private sector workers also gathered in Colombo Fort, demanding a downward revision of the newly implemented taxes.

The protesters later went to a central Colombo Hyde Park to continue their agitation after a court order issued them to clear the area.

Under a theme of ‘Repeal Oppressive Tax Refers’, workers representing 40 trade unions including all private and public sector banks, university lecturers, Port Authority, Ceylon Electricity Board (CEB), Government Medical Officers of Health participated in the protest.

“We don’t mind paying taxes, we know we have to contribute to government revenue,” K L Chandana, representing CEB Engineer’s Union told EconomyNext.

“Moving from one tax bracket to a higher tax bracket is unrealistic, especially with the inflation and global factors. Earlier we were in the green to pay taxes because the country wasn’t in hyperinflation and we had a better quality of life, but our income don’t match with inflation. So there’s no way we can squeeze another expense.”

The ongoing economic crisis has forced President Ranil Wickremesinghe’s government to impose high PAYE and personal income taxes up to maximum 36 percent depending on their income.

A person who paid a tax of 9,000 rupees on a 400,000-rupee monthly income will now have to pay 70,500 rupees as income tax, the latest data showed.

The government took a step back to exempt some allowances partially including for fuel, driver, and vehicle, a government document showed.

“We don’t mind paying fair taxes, we paid them earlier,” Udaya Ekanayake, an Administrative officer from Anuradhapura told Economynext.

“We are opposed to taxation because it is not in line with the economic crisis, inflation is exceeding 50 percent and we are being taxed by 32 percent.”

Meanwhile, the Government Medical Officers Association Media Spokesman, Chamil Wijesinghe said, the protest was the first warning and that if the government fails to respond, the unions will bring the country to a standstill.

“If the government still can’t understand, we are ready to take further actions and we will make the country come to a standstill,” Wijesinghe said.

A renowned actor and a new member of the Ceylon Mercantile Industrial Union Peter d’ Almeida told EconomyNext that the government should bring in higher corporate taxes and taxes on the super-rich reducing the burden on the general public.

“These people had enough of the burden which has been placed on people, with the so-called tax reforms and increased price in utilities, and the general increase in the cost of living,” Almeida told EconomyNext.

“And the sad part is people who ruined this country are still in power and it is people who have nothing to do with this facing the burden of rebuilding the country.
That is unacceptable.”

“A very high cooperate tax and taxes on super rich including wealth and capital gains should be in order.”  (Colombo/ Feb 08/2023)

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Sri Lanka stocks edge up after President’s policy statement amid protests 

ECONOMYNEXT – Sri Lanka shares edged up on Wednesday on dull sentiments over rising protests against tax hikes, which is also expected to hit corporate earnings in the face of reduced consumption, analysts said.

“The President’s address in Parliament assured that the country would be seeing tough times in the road to recovery and that taxes are here to stay,” an analyst said.

Protests were staged against the tax hikes on Wednesday in capital Colombo citing it is “unfair” and does not comply with cost of living especially since income has not reflected inflationary hikes.

If protests resurface, investors could pull down investor momentum towards shares, the analyst said.

“The investors are looking at a positivity towards the IMF, there is no concrete confirmation on that but they are looking at a positive direction with the IMF,” the analyst said.

All Share Price Index (ASPI) edged up by 0.13% or 11.59 points 8,987.45

“Investors are willing to invest if macroeconomic conditions come into place and there are further developments to an assured IMF deal,” an analyst said.

President Wickremesinghe said that Sri Lanka had reached the final stage of negotiations with the International Monetary Fund and that a basic agreement last September was agreed for and now there is the debt sustainability program.

The Central Bank expects the IMF deal to be finalized by the end of the first quarter or fist month of second quarter.

Sri Lanka got assurances from India, Paris Club and China towards debt restructuring in order to secure 2.9 billion dollars for an IMF loan.

The IMF has so far only accepted the letter of debt re-structuring sent by India.

However, the IMF has still not approved restructuring assurances from Paris Club and China.

China’s Exim Bank has given Sri Lanka a two-year moratorium on its defaulted loans and will discuss additional re-structuring within the ‘window’, the Chinese Foreign Ministry spokesperson Mao Ning said last week,

“The international support demonstrates that we are on the right path,” President Wickremesinghe said.

John Keells Holdings has been receiving high amounts of foreign buying after announcements with regard to the opening of Cinnamon Life in 2025.

The most liquid index S&P SL20 closed down at 0.09 percent or 2.63 points to 2,782.56.

The market saw a turnover of 1.1 billion rupees today, comparatively lower to the year’s daily average of 1.9 billion rupees, and significantly lower than the 2022 average turnover of 2.9 billion rupees.

The bourse saw a net foreign inflow (NFI) of 291 million rupees.

Top losers during the closure was HNB, LOLC, DFCC.

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Sri Lanka opposition mum as monks burn India-backed constitutional amendment

ECONOMYNEXT – As sections of Sri Lanka’s Buddhist clergy took to the streets against a proposed full implementation of an India-backed constitutional amendment to resolve Sri Lanka’s ethnic issue, the country’s opposition parties remained mum on the protests and on their own stance on devolution.

Opposition National People’s Power (NPP) leader Anura Kumara Dissanayake when asked by a journalist about the monks’ protest on Wednesday February 08 claimed that President Ranil Wickremesinghe had set a trap.

“I ask the people of this country to not get caught in this trap. What Wickremesinghe wants is to brush the real problems aside and bring out other problems to create a disturbance in society,” said Dissanayake.

The NPP leader said President Wickremesinghe will not fully implement the 13th amendment to the constitution as repeatedly assured by him.

“He won’t bring it. He plays this game every time. He wants to set fire to this country and protect his power,” he said.

Dissanayake did not elaborate on his party’s position on the 13th amendment.

A group of Buddhist monks staged a protest against the amendment near the parliament complex Wednesday morning as President Wickreemsinghe told MPs that he is committed to devolving power within a unitary state as a permanent solution to the island nation’s decades-long ethnic issue.

Tensions rose at the protest as police tried to block the monks who only dispersed after an official from the presidential secretariat spoke to them and assured a response from the president.

Some of the monks set fire to a copy of the 13th amendment in full view of the media and police personnel in a scene that was eerily reminiscent of Wickremesinghe’s United National Party (UNP) burning a draft bill of a new constitution presented to parliament by former President Chandrika Bandaranaike Kumaratunga’s government in 2000 also a solution to the conflict.

Meanwhile Sri Lanka’s main opposition the Samagi Jana Balawegaya (SJB) has yet to make its views known on the rising opposition to the 13th amendment from nationalist quarters.

A small number of MPs on both sides of the aisle have expressed their opposition, but the president has said he will go ahead with full implementation.

The SJB boycotted a recent all-party conference (APC) on the ethnic issue but said it supports devolution of power, though the party has yet to articulate its position on the amendment’s full implementation.

Wickremesinghe told parliament on Wednesday that there will be no division of the country, contrary to fears expressed by some Buddhist monks.

Related:

Sri Lanka president reiterates commitment to devolution within unitary state

The 13th amendment to Sri Lanka’s constitution emerged from the controversial Indo-Lanka Accord of 1987 as a purported solution to the worsening ethnic conflict, four years after war broke out. Provincial councils came in the wake of this amendment, though land and police powers have yet to be devolved to the provinces as originally envisioned. Both Sinhalese and Tamil nationalists have historically opposed the amendment, the former claiming it devolved too much, the latter complaining it didn’t devolve enough.

A full implementation of the amendment would see land and police powers devolved to the provinces, a development that is not likely to garner support from Sri Lanka’s more nationalist-oriented parties including sections of the ruling Sri Lanka Podujana Peramuna (SLPP).

Meanwhile, India has expressed its support for Wickremesinghe’s assurances that the amendment will be fully implemented. India’s support is crucial to the cash-strapped island nation as it struggles to recover from its worst currency crisis in decades. India has officially communicated to the International Monetary Fund (IMF) that it will support Sri Lakna’s debt restructuring process, which is a prerequisite for a desperately needed 2.9 billion dollar IMF bailout.

The leftist Janatha Vimukthi Peramuna (JVP), which controls the NPP, staged a violent insurrection in the late 1980s in opposition to the Indo-Lanka Accord. Former President Ranasinghe Premadasa also opposed the accord signed by his predecessor President J R Jayawardena.

Meanwhile, Jaffna district MP an former Northern Province Chief Minister C V Vigenswaran on Wednesday welcomed the president’s decision, while noting however that the 13th amendment falls short of the aspirations of the Tamil people.

Related:

Sri Lanka reconciliation: Vigneswaran backs president, wants monks not to interfere

(Colombo/Feb08/2023)

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