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Sri Lanka money printing, deficits could lead to economic implosion: IMF report

ECONOMYNEXT – Further money printing to finance deficits could lead to monetary instability while trade and private credit could eventually shrink, an International Monetary Fund assessment has warned, as the country reels from tax cuts and liquidity injections made to keep interest rates down.

Sri Lanka had large uncertainties which were tilted to the downside, an IMF public information notice quoting a staff assessment made after annual rticle IV consultations said.

Deficit spending

The budget deficit in 2022 was also expected at 10.7 percent of gross domestic product after an 8.9 percent of GDP deficit in 2021.

Sri Lanka has been printing large volumes of money under the so called Modern Monetary Theory (MMT) to keep rates down and finance the deficit. Deficits were also kept large under an anti-austerity ideology.

Related

Sri Lanka to cut foreign debt, ride Modern Monetary Theory: CB Governor

Money printing however, creates forex shortages as the new money is spent by their recipients (usually state workers and government contractors) and the money ends up as imports.

Former owners of maturing treasury bills which are bought by the central bank and are not rolled over could also end up with printed money as could banks, when reserve sales are sterilised.

Imports soared in 2021 to 20.4 billion US dollars. In January the government announced a billion dollars of handouts including more state salary hikes.

If the budget deficit and money printing (central finance of the deficit) is not contained, the economy could implode with private credit and imports collapsing, the IMF said.

Trade and private credit implosion, monetary instability

“The outlook is subject to large uncertainties with risks tilted to the downside,” an IMF staff assessment said.

“Unless the fiscal and balance-of-payments financing needs are met, the country could experience significant contractions in imports and private credit growth, or monetary instability in case of further central bank financing of fiscal deficits.”

Sri Lanka’s inflation was already at 14.1 percent by January 2021 (risen to 15.1 percent by February after the report).

Parallel exchange rates were around 248 rupees, significantly above the 200 to the US dollar official exchange rate which is undermined by the policy rate.

The policy rate 6.5 percent was far below inflation, which had risen to 15.1 percent since the IMF’s staff report which went to its Executive Directors on February 25.

Sri Lanka’s government debt including treasury guarantees and foreign debt of the central bank had risen to 118.9 percent by end 2021 from 110 percent a year earlier, and 94 percent in 2019, when tax cuts and money printing began.

“Under current policies and the authorities’ commitment to preserve the tax cuts, fiscal deficit is projected to remain large over 2022–26, raising public debt further over the medium term,” the assessment said.

Public debt was unsustainable, and a credible economic programme was needed to address the problem, the IMF said. Unsustainable debt usually also requires debt re-structuring.

Related:

Sri Lanka debt unsustainable, should stop printing money, hike rates, taxes: IMF

Sterilised forex sales

Money is being printed over the past quarter to offset the impact of reserve sales for imports (to sterilise interventions) effectively financing the private banks, with treasury bill auctions mostly successful after price controls on bond auctions were ended.

Sri Lanka has a Latin America style central bank with extensive powers to print money to finance the government, or private sector through re-finance schemes and also open market operations to sterilise reserve sales for imports or any other purpose.

Though forex reserves sales for imports should contract reserve money, push short term rates up, stabilising the exchange rate, the central bank’s commitment to a 6.5 percent policy rate was making it print money to sterilise interventions re-expanding reserve money.

In a quasi-fiscal activity, the central bank was also providing subsidies to remittances amounting to at least 8 rupees per US dollar, further undermining its ability to control reserve money.

The central bank was also engaging in a quasi-fiscal activity giving a premium for foreign remittances coming through the official banking system after parallel exchange rates were triggered by money printing and exchange controls.

Sri Lanka also faced risks of rising bad loans, rising commodity prices, bad harvests, or a COVID-19 spike though the government has taken effective action on that front.

Sri Lanka could grow 2.6 percent in 2022, the IMF said.

The IMF does not usually project what are called ‘disaster scenarios’ but gives advice on how it can be avoided, analysts familiar with the agency’s practices said.

Money printing, taxes

IMF executive directors urged Sri Lanka to stop printing money, hike interest rates and raise taxes and cut spending.

“Directors agreed that a tighter monetary policy stance is needed to contain rising inflationary pressures, while phasing out the central bank’s direct financing of budget deficits,” an Executive Directors assessment said.

“Directors emphasised the need for an ambitious fiscal consolidation that is based on high-quality revenue measures.

“Noting Sri Lanka’s low tax-to-GDP ratio, they saw scope for raising income tax and VAT rates and minimising exemptions, complemented with revenue administration reform.

“Directors encouraged continued improvements to expenditure rationalisation, budget formulation and execution, and the fiscal rule.

“They also encouraged the authorities to reform state-owned enterprises and adopt cost-recovery energy pricing.” (Colombo/Mar04/2022)

Comments (2)

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  1. Edie says:

    There has been NO ONE WITH a ABRAIN RESPONSIBLE TO SECURE DISASTER working at the CENTRAL BANK to prevent the economy down fall.

  2. Dimitri Ganegoda says:

    All the facts are not true.

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Your email address will not be published. Required fields are marked *

  1. Edie says:

    There has been NO ONE WITH a ABRAIN RESPONSIBLE TO SECURE DISASTER working at the CENTRAL BANK to prevent the economy down fall.

  2. Dimitri Ganegoda says:

    All the facts are not true.

Sri Lanka may have to depend on India or nuclear to reach low carbon target: researcher

DOUBLE WHAMMY: In Sri Lanka’s driest period, wind potential also goes down, a researcher and policy advocate says

ECONOMYNEXT – Sri Lanka will need to either connect to India or set up a nuclear power plant if the country is to reach its renewable energy targets due the country’s weather patterns, a researcher and policy advocate has said.

Sri Lanka has set ambitious goals for renewable electricity generation by 2030, apparently without much prior study or any costs being revealed when the target was set by President Gotabaya Rajapaksa.

Rohan Pethiyagoda, a taxonomist and researcher who had also been senior state officials involved in policy at one time said overall Sri Lanka used a large volume of biomass (firewood) for cooking.

“We need to recognize, of course, that about 60 percent of Sri Lankan households still use firewood as their primary fuel,” Pethiyagoda told a climate forum organized by Sri Lanka’s Ceylon Chamber of Commerce.

“Bless them, because they reduce our dependence on fossil fuels for cooking. Even the tea industry, one of our largest exports, uses biomass as its primary fuel for about 90 percent of its production.”

In the electricity sector, where the renewable lobby and other activists oppose coal on the basis of carbon emissions based on international trends, as well as dust, base load still has to be generated if thermal generators are replaced.

Solar power is available only for a few hours in daytime and it can also vary depending on cloud cover.

Hydro power (run of the river plants) is more stable but is dependent on rain. Large hydros with storage can be used for peaks, industry analysts say.

Wind is available throughout the day but can also be unstable. The problem of variability (non-firm energy) can be solved to some extent through ramping and battery storage at additional cost, analysts say.

A renewable plant in Poonakary with battery storage was priced at around 48 to 49 rupees (about 15 US cents) based on public statements.

Meanwhile Pethiyagoda said Sri Lanka’s weather patterns created an additional problem.

“We have this unusual thing for our renewable energy in Sri Lanka, that at the tail end of the northeast monsoon, from about December to April, we have a dry period in this country, which means that our hydro potential during those months goes down,” Pethiyagoda said.

“Now, as luck would have it, our wind potential goes down at the same time.”

As a result, Sri Lanka needs a reliable alternative to the current coal baseload.

“So for that reason especially, we need to look at either connecting to India’s grid in the long term or having a nuclear facility in Sri Lanka if we want to be low carbon. And of course, we need to replace our vehicle fleet.”

“And our base load can probably come from nuclear,” Pethiyagoda said.

“But whichever way we do it, the cheaper way would be for us to connect to India’s grid.

“Whichever way we do it, we’re looking at an investment of about 40 billion dollars. And then we have the problem of looking at how wind and solar will behave.”

It was not clear what the 40 billion dollar investments would be made up of.

Sri Lanka’s external debt as at December 2024, including unpaid principal after default was 37.3 billion US dollars.

In 2021 when the 70 percent target was unveiled in President Gotabaya Rajapaksa’s election manifesto power engineers said a 53 percent energy share planned for 2030 in a general plan at the time was was equal to that of Germany.

Pushing up the share to 70 percent would require billions of dollars of extra investments, they said.

Related

Sri Lanka generation plan renewable power share for 2030 equal to Germany: CEB engineers

After the central bank cut rates and triggered an external default however, Sri Lanka growth, and power demand in the next few years is expected to be lower than before extreme macro-economic policy.

Related Sri Lanka to invest US$11bn by 2030 to meet renewable target

In 2023, the CEB said about 11 billion US dollars would be needed to meet the 70 percent target. (Colombo/June19/2024)

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Sri Lanka President discusses Starlink with Elon Musk

ECONOMYNEXT – Sri Lanka President Ranil Wickremesinghe has discussed connecting the island to the Starlink satellite system with its founder Elon Musk, his office said in a statement.

President Wickremesinghe has met Musk at a World Water Forum High-Level Meeting in Indonesia.

President Wickremesinghe discussed “the implementation of Starlink in Sri Lanka & committed to fast-tracking the application process to connect SL with the global Starlink network,” the statement said.

Starlink is a low earth orbit satellite network, connected to Musk’s SpaceX group. (Colombo/Jun19/2024)

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Sri Lanka’s CEB March 2024 profits Rs84bn with capital gain, fx strength

ECONOMYNEXT – Sri Lanka’s state-run Ceylon Electricity Board group has reported profits of 86 billion rupees with the help of 25.9 billion rupees of capital gains from a transfer of shares, interim accounts show.

The rupee also appreciated in the quarter which keeps imported fuel prices low.

As a standalone entity, the Ceylon Electricity Board, made profits of 84.6 billion rupees in the March quarter.

CEB’s revenues rose 38.5 percent to 167 billion rupees in the March 2024 quarter, while cost of sales fell 26.1 percent to 105.0 billion rupees giving gross profits of 62.7 billion rupees.

The CEB also reported 30.6 billion rupees of other incomes and gains in the March quarter, up from 3.1 billion rupees last year.

Other Income and Gains

The utility said it made a 25.9 billion rupee capital gain from transferring LTL Holdings shares to West Coast Power an IPP in which other entities have a majority holding.

In the quarter the rupee also appreciated.

A rupee appreciation will help reduce the carrying cost of dollar loans and also reduce the cost of imported thermal fuels and maintenance costs of spares.

The central bank allowed Sri Lanka’s exchange rate to appreciate from 324.40 rupees in December 2023 to 300.17 on March 2024 amid deflationary policy and weak private credit allowing imported fuel costs also to fall.

Especially after 1978, after rate cuts drove the country into balance of payments crises, the central bank had collected reserves with free market interest rates, but has not usually allowed the exchange rate to re-appreciate despite generating a BOP surplus with deflationary policy.

Un-anchored Bad Money

Before 1978, when an apparently doctrinally foxed International Monetary Fund abandoned both external and specie anchors simultaneously after the Fed closed its gold window triggering the Great Inflation period, Sri Lanka also did not depreciate its currency, analysts have pointed out.

Related Why the IMF is hated now and is backing bad money in Sri Lanka and Latin America

Since it was set up in 1951, the central bank has printed money under various dual anchor conflicting Saltwater-Cambridge ideologies (re-financing rural credit, sterilizing outflows, potential output targeting, yield curve targeting) to create forex shortages and currency crises and started to go the IMF from the mid-1960s.

From 1978, after the IMF’s second amendment to its Articles denied the central bank a credible external and domestic anchor simultaneously, the currency stated to depreciate steeply.

The government was therefore unable to balance its budget and state enterprises were also unable to balance their budgets running large losses whenever the rupee fell and energy prices went up.

After abandoning its external and specie anchor the central bank followed a anchor conflicting regime involving money supply targeting without a floating exchange rate in the 1980s.

The ideology was rejected in toto by Singapore, Malaysia, Hong Kong, Thailand and China.

Since the end of a civil war macro-economists have followed inflation targeting without a floating exchange combined with extreme macro-economic policy to target potential output, eventually driving the country into external default.

Budgets went haywire in the early 1980s as the rupee fell, despite then President JR Jayawardene cutting subsidies and ending price controls (administered prices) two years earlier, in reforms that Singapore’s economic architect and one-time Finance Minister Goh Keng Swee said were “economic reforms which most people had considered politically impossible.”

Goh who set up a currency board in Singapore rejecting Cambridge-Saltwater ideology, warned JR not to destroy the rupee.

“Exchange rate policies involve many complicated technical issues which I do want to discuss here,” he said.

“On balance, the disadvantage of a depreciating rupee will, I believe, outweigh the advantages. Most of the products whose prices are administered are ether wholly imported or contain a high import content. About a quarter of rice consumption is imported.

“All wheat from which four and bread are produced is imported. The same holds true of kerosene and milk powder.

“Bus fares ware largely determined by the rupee price of imported oil and spare parts. Fertilizers are also mostly imported.”

At the time Sri Lanka had hydro-electricity.

Capital Injections

Some of the CEB’s dollar loans were been taken over by the central government after the steepest currency collapse in the history of the central bank in 2022 and external default.

The CEB’s contributed capital as at end March 2024 was 991.4 billion rupees up from 865.1 billion rupees.

With the March quarter profits with some financial engineering involving the asset sale and the government equity injection, the CEB’s group accumulated losses reduced to 456 billion rupees from 575 billion rupees.

The CEB ran large losses as the regulator failed to raise tariffs as macro-economists printed money to target potential output over the past decade.

From 2011 to 2022 the rupee fell from 113 to 370 to the US dollars as the central bank ran un-anchored monetary policy the regulator only raised prices in 2022.

Energy Minister Kanchana Wijesekera said the last price cut was also made possible due to rupee appreciation.

With no potential output targeting (no inflationary open market operations), the country has started to recover from the stability that has been provided up to now amid weak private investment credit.

Sri Lanka’s private credit is now starting to recover.

Based on past trends of using statistics instead of classical economic principles (cutting current current interest rates with inflationary open market operations of a money monopoly based on historical inflation rates under ‘data driven monetary policy’ without regard to domestic credit) analysts have warned of a return to monetary instability under potential output targeting. (Colombo/May19/2024)

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