ECONOMYNEXT – Sri Lanka needs a corrective economic package to put the economy on a stable path top economist WA Wijewardena said as foreign exchange shortages continued to dog the country amid low interest rates and a high budget deficit.
“We need a corrective policy package,” Wijewardena, who is an ex-Deputy Governor of the central bank said. “Sri Lanka has to take the bitter pill.”
There have been calls for Sri Lanka not to pay an upcoming loan and use the money for imports.
“That is a choice among alternatives,” Wijewardena said. “You need to look at it and carefully and analyze it.”
Unlike in the past currency crises, Sri Lanka’s credit has now been downgraded to ‘CCC’ and ‘CC’ levels by rating agencies and the country has been locked out commercial debt markets.
Sri Lanka’s finance ministry last week raised salaries and pensions and other subsidies which would cost 227 billion rupees. Sri Lanka has 6.0 percent policy rate now and inflation of 12.1 percent by December.
Many economic players are feeling the effects of the controls and forex shortages.
One example was of a factory which was operating at 50 percent because there were no raw materials indicating that firm catering to the doemestic market was also in trouble.
Though the materials were in the port, the manufacture could not access because dollars were not released.
He said a comprehensive economic package was needed to fix the problem.
“Unless the bitter pill is taken Sri Lanka has no future,” Wijewardena warned.
His comments came as foreign banks tightened lines to Sri Lanka and restricted packing credit for shipment to Sri Lanka even without a default.
Wijewardena had several times advocated a program with the International Monetary Fund as the most practicable way out of the current problem. Many have also suggested debt restructuring.
However authorities have so far resisted going to the IMF.
The first step in an IMF program is usually tightening of monetary policy and a float of the currency, which stops reserves from being used for imports, analysts say.
Unless a working exchange rate regime is re-established and reserves are stopped from being used for imports, any money disbursed by the IMF will also be used for imports.
In a pegged exchange rate regime with a policy rate, any reserve sale for imports is offset by an injection of liquidity (sterilization) preventing the monetary base from contracting.
In effect the central bank sells both dollars and rupees to the banking system simultaneously preventing a contraction in domestic credit and demand while facilitating and outflow of real resources. To rebuild foreign reserves the opposite has to be done.
Pegged central banks continue to intervene for imports and other payments until they run out of reserves and then float. Sometimes central banks themselves go down and a new currency is issued or the country is dollarized.
IMF’s general advice to pegged exchange rate central bank to run a ‘flexible exchange rate’ is also made to stop using ‘reserves for imports’ or for any other inflows on a sustained basis and avoid getting into a sterilized forex sale spiral. (Colombo/Jan09/2021)