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Monday February 6th, 2023

Sri Lanka President calls to expand Nixon shock as rupee falls

ECONOMYNEXT – Sri Lanka’s President Maithripala Sirisena has called for more trade controls and import substitution as the rupee fell amid policy errors in operating a soft-peg with the US dollar.

President Sirisena has asked a National Economic Commission to prepare a list of non-essential goods that can be stopped and had it over the Finance Ministry in a week, a statement from his office said.

The goods will be temporarily controlled and attention will be focused on producing import substitution products domestically, President Sirisena has said.

Sri Lanka operates a non-credible foreign reserve collecting soft-peg with the US dollar, involving a de facto external anchor with an undefined convertibility undertaking, which shifts suddenly to a floating rate with a domestic anchor made up of a wide near double digit inflation target with the unsterilized excess liquidity collected during the pegging period intact, sending the rupee crashing down.

This is called a ‘flexible exchange rate’.

The finance ministry has already slapped controls on cars, footware and perfumes in recalling moves by President Richard Nixon as the US dollar’s soft peg with gold failed in 1971, driving the dollar above 86 dollars an ounce from 35.

"I am taking one further step to protect the dollar, to improve our balance of payments, and to increase jobs for Americans," Nixon said at the time.

"As a temporary measure, I am today imposing an additional tax of 10 percent on goods imported into the United States. This is a better solution for international trade than direct controls on the amount of imports.

"This import tax is a temporary action. It isn’t directed against any other country. It is an action to make certain that American products will not be at a disadvantage because of unfair exchange rates. When the unfair treatment is ended, the import tax will end as well."

The US dollar then floated.

Sri Lanka closed the entire economy at the time and people ate ‘sakkara’ for sugar, wore kerosene smelling cloth which were rationed and draconian exchange controls were also imposed.

However, when the economy was re-opened in 1978, no substantial reforms were done to the central bank, and the rupee continued to fall.

The finance ministry has already slapped controls on cars, footware and perfumes, opening a pandora’s box for more controls, and leaving egg in the face of free trade advocates and the main free trade plank of the administration in tatters.

Analysts however had already warned that unless the central bank was reformed or at least it operating procedures overhauled free trade will not be possible. (Sri Lanka’s central bank has to be restrained for free trade to succeed)

In addition liquidity injections will also make it impossible to service foreign debt leading to dollar sovereign default (Sri Lanka’s Weimar Republic factor is inviting dollar sovereign default).

Sri Lanka’s current troubles stem from the first quarter of 2018, when mopping up of dollar inflows suddenly stopped (sterilized foreign exchange purchases), according to analysts who closely study its operations.

There were calls to start issuing central bank securities to permanently mop up inflow purchases, but in the first quarter sterilization suddenly failed amid a series of failed term repo auctions.

Monetary policy is now more pro-rupee with overnight rates near ceiling 8.50 percent policy rate and not all outflows permanently filled with permanently printed money. (Colombo/Oct16/2018)

 

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Sri Lanka’s banks may have to re-structure loans caught in progressive tax

ECONOMYNEXT – Sri Lanka’s banks should explore restructuring loans of salaried employees hit by progressive tax, Central Bank Governor Nandalal Weerasinghe said as progressive income taxes were imposed at lower thresholds amid high inflation following a sovereign default.

There have been complaints mainly by picketing state enterprise executives and also other workers of such agencies such Sri Lanka Port Authority that high progressive taxes were putting their bank accounts into overdraft after loan installments were cut.

“Yes, they have mentioned that,” Governor Weerasinghe said responding to questions from reporters.

“We have told the banks earlier as well. Because the interest rates are high and their business being reduced, the SME sector, the repaying capability has reduced.

“We have told them to explore their repaying capabilities and restructure their loans in order to safe guard both sides. At this time also we are asking the banks to do that.”

In the case of some state enterprises, the Pay-As-You-Earn tax, through which income tax is deducted from salaried employees in the past was not paid by the employee but the SOE.

Bad loans of the banking system overall had risen after the rupee collapsed, reducing the spending power in the economy, while rates also went up as money printing was scaled back, foreign funding stopped and the budget deficit widened.

The rate hike has prevented possible hyperinflation and a bigger implosion of the economy by stabilizing the external sector in the wake of previous mis-targeting of interest rates.

In the current currency crisis a delay in an IMF program due to China not giving debt assurances as well as fears of domestic debt re-structure has kept interest rates elevated.

Sri Lanka’s economic bureaucrats in 2020 cut taxes and also printed money, in a classic ‘Barber Boom’ style tactic implemented by UK economists and Chancellor Anthony Barber in 1971 to boost growth and employment.

The ‘Barber Boom’ ended in a currency crisis (at the time the UK did not have a floating rate and the Bretton Woods system was just starting to collapse under policies of Fed economists) and inflation of around 25 percent in the UK.

The UK implemented a three-day working week to conserve energy after stimulus while Sri Lanka saw widespread power cuts as forex shortages hit.

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Anthony Barber budget of 1971

Anthony Barber budget of 1972

Similar policies saw a worldwide revival as the US Fed economists injected money during the Covid crisis mis-using monetary policy to counter a real economic shock and boost employment while the government gave stimulus checques.

Now the world is facing an output shock as a hangover the Covid pandemic recedes.

The re-introduction of progressive tax at a maximum rate of 36 percent while tax brackets high jumped with the rupee collapsing from 200 to 360 to the US dollar had reduced disposable incomes further.

Salaries employees were encouraged to get loans in 2020 with the central bank mandating a 7 percent ceiling rate for five years.

However, any borrower who got loans on floating rates long before the scheme are now facing higher rates. (Colombo/Feb06/2023)

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Sri Lanka to address SME tax problems at first opportunity: State Minister

ECONOMYNEXT – Problems faced by Sri Lanka’s small and medium enterprises from recent tax changes will be addressed at the first opportunity, State Minister for Finance Ranjith Siyambalapitiya said.

Business chambers had raised questions about hikes in Value Added Tax, Corporate Income Tax and the Social Security Contribution Levy (SSCL) that’s been imposed.

It should be explored on how to amend the Inland Revenue Act, Siyamabalapitiya said, adding that the future months should be considered as a period where the country is being stabilized.

Both the VAT and SSCL are effectively paid by customers, but the SSCL is a cascading tax that makes running businesses difficult.

In Sri Lanka SMEs make up a large part of the economy, accounting for 80 per cent of all businesses according to according to the island’s National Human Resources and Employment Policy.

(Colombo/ Feb 05/2023)

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Sri Lanka revenues Rs158.7bn in Jan 2023 up 51-pct

ECONOMYNEXT – Sri Lanka’s government revenues were 158.7 billion rupees in January 2023 but expenditure and debt service remained high, Cabinet spokesman Minister Bandula Gunawardana said.

In January 2022 total revenues were Rs104.5 billion according to central bank data.

Sri Lanka’s tax revenues have risen sharply amid an inflationary blow off which had boosted nominal GDP while President Ranil Wickremesinghe has also raised taxes.

Departing from a previous strategy advocated by the IMF expanding the state and not cutting expenses, called revenue based fiscal consolidation, he is attempting to do classical fiscal consolidation with spending restraint.

President Ranil Wickremesinghe has presented a note to cabinet requesting state expenditure to be controlled, Gunawardana told reporters.

State Salaries cost 87.4 billion rupees.

Pensions and income supplements (Samurdhi program) were29.5 billion rupees.

Other expenses were 10.8 billion rupees.

Capital spending was   21 billion rupees.

Debt service was 377.6 billion rupees for January which has to be done with borrowings from Treasury bills, bonds and a central bank provisional advance of 100 billion rupees, Gunawardana said.

Interest costs were not separately given. (Colombo/Feb05/2023)

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