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Friday July 30th, 2021
Economy

Sri Lanka minister warns of financial terror, mystery deepens over fuel stabilization fund

ECONOMYNEXT – Sri Lanka’s Energy Minister Udaya Gammanpila said there was no fuel stabilization fund, a key strategy of the current administration which rejected market pricing of fuel while in opposition.

Sri Lanka last week raised fuel prices in move that the International Monetary Fund usually asks countries with soft-pegged exchange rate regimes, which print money and gets into toubles to do.

Minister Gammanpila had likened the fuel sector losses and debt was dangerous challenge which was worse than Tamil Tiger terrorism.

“When I was not a minister, the cabinet on March 30, 2020, decided to establish a fuel stabilization fund,” he told reporters in Colombo.

“Even though it was said that the fuel stabilization fund would be established, such a fund did not operate (kri-yarth-mer-ker) as an unexpected thing happen in the month of March,”

“Due to the fast spread of the pandemic, the government lost revenue from tourism, lost foreign investments, lost remittances sent by migrant workers and lost the tax revenue from import of motor vehicles,” he said.

“At last, the government had to rely on tax revenue from imports and fuel.”

Neither remittances nor export revenues belong to the government. The government gets taxes when remittances and exports are spent on imports or domestic products.

Mystery Gap

Finance Ministry reports showed that the Fuel Stabilization Fund was set up in 2020 but contributions stopped as prices started to pick up and a tax surcharge on fuel was removed.

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Deepening the mystery further, official data showed that the underlying account of the Fuel Price Stabilization Fund was in fact 26 billion rupees negative by end 2020.

Sri Lanka’s external sector was thrown into a crisis as taxes were cut in December 2019 in a “fiscal stimulus” and money was printed in 2020 to make up for revenue shortfalls and also to depress interest rates.

Fuel, particularly petrol, is a key source of ‘carbon’ taxes for the government, though carcinogenic diesel used to power the SUVs of most members of parliament is taxed lightly.

Successive administrations led have carried on a fiction of ‘government bearing the burden’ in fixing fuel prices with the exception of a 2001-2004 and 2015-2019 administration, though the practice tends to create forex shortages as money is printed to replace lost taxes from fuel sales as global petroleum prices go up.

Even before the petrol price hike the landed cost of petrol was less than 70 rupees a litre though it was retailed at 137.00.

The ruling Sri Lanka Podujana Party while in opposition severely criticized a fuel pricing formula of the then administration and promised to fix prices, in what critics say was a deadly economic strategy.

Analysts had warned that with the Federal Reserve printing money energy prices were going to be shock to Sri Lanka’s economy in 2021 due to the price fixing strategy.

Money printed to fix energy prices had contributed to currency crises in 2000/2001, 2004, 2008, and 2012.

Money is printed either to cover lost taxes (2004), or to keep interest rates down as state-run Ceylon Petroleum Corporation borrows money from state banks to subsidize fuel outside the budget (2008/9 and 2011).

Unhedged Exposure

In an unusual strategy, Keynesian policymakers also pressures the CPC to take dollar debt instead of paying fuel bills using dollars purchased from the market, whenever central bank money printing triggers forex shortages.

In 2018, the CPC was forced to take dollar loans, as money was printed by the central bank to target an output gap under Keynesianism, even as the Federal Reserve tightened monetary policy, in a remarkable move which analysts dubbed a Nick Leeson style action.

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Analysts consider it remarkable since the then administration had raised a series of taxes to reduce the budget deficit and also market price fuel.

But the CPC which had built cash reserves to crowd out non-oil imports was not allowed to use them to buy dollars as the currency came under pressure from liquidity injections.

The Bank of Ceylon, which had already loaned 200 million dollars loaned another 700 million under a sovereign guarantee, in what was name a ‘cover up loan’ while the People’s Bank loaned 900 million.

The loans are by the CPC when the central bank prints money and creates forex shortages to satisfy a Keynesian ideology, known as the ‘transfer problem’, which is based on a mis-understanding of the link between domestic credit and international trade.

In 2018, despite market pricing fuel, the CPC ran a 104 billion rupee loss, of which 82.7 billion was a ‘Nike Leeson’ or forex losses on unhedged loans taken from state banks.

As a result, the firm owed over 1.8 billion US dollars to the Bank of Ceylon and People’s Bank by end 2018. It is not clear whether new dollar loans were taken by the utility in 2020 also.

Fuel Subsidy Financial Terror

The CPC also buys fuel on suppliers’ credit with repayments terms of 6 months or more, exposing it to further forex losses.

In another twist the Fuel Price Stabilization Fund itself was set up with 50 billion rupees in printed money, which would create over 275 million dollars of forex shortages when loaned out of banks to the economy at March 2020 exchange rate of around 180 to 190 to the US dollar.

Minister Gammanpila said the Sri Lanka was now facing a bigger challenge than the Tamil Tiger terrorists.

“Instead of lying (un-der-ner-war) to the people I like to tell them the truth. The truth is bitter. We only have three months of (import) reserves,” Minister Gammanpila told reporters.

“The central bank advised (maha bankuwer upadesak denawa) The rupee can fall further and the prices of all goods can go up and to immediately go for a price revision.”

“More than the loss to the CPC it is the effect on the entire economy. We have to decide whether we stand up as a nation or is buried. We are in an economic challenge which is more dangerous than Tiger terrorism.”

The banking system which had loaned over 600 billion to the Ceylon Petroleum Corporation was in danger of collapse, he said.

State run banks have been borrowing dollars in the interbank forex markets, including through swaps paying effectives rates over of 10 percent, driving effective forward rates down. (Colombo/June17/2021 – Corrected banking system debt)

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