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Sri Lanka policy incoherence hurting rating, potential lenders: Fitch

ECONOMYNEXT – The lack of a coherent policy framework is hurting the sovereign rating and also potential lenders who may want to finance the country, an analyst at Fitch Ratings which downgraded the country to a ‘B-‘ a notch above CCC has said.

The outlook is also negative at the lower level.

Sri Lanka has about 4 to 4.5 billion US dollars in foreign loans to pay in the next few years and this year about 3.2 billion US dollars remain to be paid.

Sri Lanka cut rates and started injecting liquidity from the last week of February 2020, just before a Coronavirus crisis hit and ratcheted up money printing to unprecedented levels as the crisis hit, sending the rupee crashing down to 200 and earning a downgrade.

When money is printed, a country with a pegged exchange rate regime runs out of foreign exchange raising doubts about the ability of a country to repay foreign loans.

Sri Lanka has said it is talking with the Asian Development Bank, the AIIB, and AFD to raise budget support loans.

Sri Lanka is also talking to the International Monetary Fund for an 800 million US dollar facility.

“The government is trying to reach out to meet the funding gap that we have,” Associate Director Asia Pacific Sovereign Ratings Sagarika Chandra told an online forum.

“Whether these loans will materialize is a big question because a lot of it also depends on Sri Lanka’s ability to come up with some kind of coherent policy framework which these multi-lateral bodies can rely on.”

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“So there is this policy uncertainly in Sri Lanka.

Sri Lanka was steadily raising taxes from 2017 to fix state revenues but suddenly slashed value-added tax in January 2020, without a passing any of the taxes in parliament expanding the deficit just as the private credit was set to recover from a currency collapse in 2018.

The central bank also cut rates on January 30, despite the budget set to worsen. In February and March, more liquidity was injected de-stabilizing the rupee.

Chandra said there was also uncertainty about how long the Coronavirus pandemic will last.

Sri Lanka however has been aggressively contact tracing and is ahead of many countries in the world in containing the epidemic despite a few miss-steps due to a reluctance to random testing high-risk sectors and frontline workers.

The only gap now remaining is voluntary testing-in-the-workplace, observers say.

Sri Lanka’s debt to GDP ratio was now set to reach 100 percent by 2023 under a Fitch baseline case.

Sri Lanka’s debt is about 900 percent of revenue, compared to about 300 percent for other countries rated at B, Chandra said.

Other analysts have however said the biggest danger to Sri Lanka’s foreign debt repayment like Argentina’s come from the central bank.

It was widely expected that the central would cut rates and print money to trigger monetary instability as soon as private credit recovered in 2020. In March 2020 there was a pick up in private credit.

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Argentina’s debt to GDP ratio was a little over 80 percent and revenue to GDP was over 20 percent in the last collapse.

However, the central bank generates excess liquidity when private credit picks up mainly by targeting the interest rates of its sterilization securities, sending the peso crashing down forex shortages and the government into default.

Sri Lanka’s central bank generates excess liquidity mainly by targeting the middle of its policy corridor instead of the top, though cutting the ceiling rate when domestic credit picks up also contributes to forex shortages.

In 2020 the central bank resumed targeting the 3, 6 and 12 moth bill yield in the same lines as LELIQ securities are targeted by Banco Central de la República Argentina to create monetary instability in that country.

Most of Sri Lanka’s balance of payments crises before the 2018 crisis had been triggered by targeting the 3, 6, and 12 moth bills yields, long time watchers of the country’s monetary policy errors say.

In the 2018 crisis, liquidity was injected by targeting a series of short term rates through overnight and term reverse repo auctions and engaging in dollar-rupee swaps of the type used by speculators to hit pegged exchange rates.

In another monetary policy deteriorating the central also resumed purchases of long bonds into its portfolio giving it the power to repress rates deeper into the yield curve. (Colombo/May18/2020-sb)

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