ECONOMYNEXT – Sri Lanka may need a new International Monetary Fund bailout, an economist said as a consumption bubble fired by a state spending spree, worsened by low interest rates and outright money printing, continues to pressure the balance of payments.
Dushni Weerakoon, Deputy Director, Institute of Policy Studies to an economic forum organized by DFCC Bank in Colombo that Sri Lanka could opt to for an IMF program or alternative means of raising capital including a sovereign bond.
"The IMF option seems more prudent, because even if you want to tap the sovereign market, having an IMF program also lends some confidence.
"The sovereign raters will also look at it as bringing some medium term stability."
Weerakoon said there were sharp currency adjustments and abrupt hard landings in quick succession, with the most recent in 2009 and 2012.
She said the IMF appeared to be expecting a ‘decent budget’ for a program.
Conditions in external credit markets were also tightening she said.
Sri Lanka’s rulers gave a 40 percent salary hike to public servants and pensions needing large volumes of resources to be transferred from private citizens and their workplaces to state workers.
But the Central Bank did not allow rates to go up despite higher domestic state borrowings and instead released by 300 billion rupees of liquidity collected from earlier dollar inflows in a quantity easing manoeuvre and outright monetization of a further 170 billion rupees over the past year.
The liquidity released through domestic operations came up for redemption in forex markets, through imports.
Private credit also picked up at the same time, and state workers who got higher salaries also had no incentive to save due to historically low interest rates.
Sri Lanka tried to float the currency on September 04, but outright monetization of large volumes of debt continues to pressure the currency.
Unless the central bank sells its forex reserves to ‘redeem’ the rupee the currency will continue to fall.
Analyst say state foreign borrowings can reduce the pressure on domestic credit markets and the pressure to monetize more debt.
Some analyst warn that some rating agencies may also be concerned about the serial inability of Sri Lanka’s authorities to analyse and deal with credit imbalances early as policy in Sri Lanka has tended to precipitate and worsen credit and consumption bubbles.
They also say is important to take action before outlook or credit downgrades come.
The 2011/2012 crisis was largely caused by a credit funded energy subsidies which were ultimately accommodated by sterilized foreign exchange sales by the Central Bank.
Some analysts have also called for the Central Bank to be abolished and a Hong Kong style currency board to be put in place so that monetization and currency depreciation cannot happen in the future. (Colombo/Oct25/2015)