ECONOMYNEXT- Sri Lanka had recorded a surplus in the external current account in the third quarter of 2020 and is expecting a marginal surplus in 2021, Central Bank Governor W D Lakshman said.
“In 2020, a very rare thing has happened although it was still affected by Covid-19,” Governor Lakshman told reporters.
“This rare thing was that we experienced a decline in the current account deficit, and in one of the quarters, I think quarter three, there was a surplus in the current account – very rare thing in Sri Lanka.”
According to central bank data, Sri Lanka recorded external current account deficit of 792 million dollars in the six month to June 2020, up from 351 million dollars in 2019.
In the nine months to September 2020, the current account deficit had fallen to 630 million dollars, indicating a surplus of around 142 million dollars in the third quarter.
In 2019, the central bank was re-building foreign reserves and selling down its Treasury bill stock to mop up inflows (creating a balance of payments surplus through ‘below the line outflows’ to central bank reserves) amid weak and sometimes negative private credit.
Current Account Surplus
In 2019, there was also a quarterly current account surplus, but amid prudent monetary policy.
“For the first time in 10 years in the first quarter of this year, there was a surplus in the current account of the balance of payments,” then Governor Indrajit Coomaraswamy told reporters in 2019.
“That is the first time that has happened since 2009,” he said. “Of course it’s only one quarter, but still it’s a positive development.”
Analysts had pointed out that ‘stimulus’ oriented imprudent policy to target an output gap began largely after July 2019 ending monetary stability and the BOP turned, despite very weak credit.
Sri Lanka’s credit again collapsed in the second quarter of 2020 amid lockdown, and started to pick up from around August.
Though the central bank was printing money and injecting liquidity 2020, most of it flowed out as foreign reserve sell-downs to repay debt, as ‘above the line’ outflows or a balance of payments deficit.
“If you go through past data, current account surpluses were observed in Sri Lanka 1950/51, 1954/55 and then 1977 and nothing after that,” Governor Lakshman said.
“All throughout the period after 1977 has been negative current account deficits. These deficits became very very large in more recent times.”
“So this rare thing we hope to able to achieve again, during this year, or at least by next year.”
In 1950 Sri Lanka had just set up a money printing central bank, abolishing a currency board that had kept the exchange rate fixed to the Indian rupee one to one (4.76 to the US dollar and 13.33 to the sterling at the time) from 1885 and money printing had not started.
In the first year the central bank Governor was John Exter, who analysts say set up Latin America style central bank in Sri Lanka but did not use it tools to de-stabilize the country. The peg was written into the law as a tool of monetary discipline.
A current account deficit (or a trade deficit) is an outcome of savings behaviour and is usually driven in Sri Lanka due to domestic spending of financial sector inflows, such as foreign financing of budget deficits and foreign direct investment (foreign savings).
Money printing by the central bank can create spikes in the current account deficit above financial account inflows through import surges when domestic credit is driven to unsustainable levels with central bank liquidity injections.
In 1952 the central bank printed money and ran down forex reserves from 216.4 million dollars (9.6 months of imports at the time) to 164.8 million dollars.
The soft-pegged central bank then enacted a new exchange control law, instead of halting money printing.
The exchange control law stopped financial and capital account outflows, making it impossible for domestic savings to be invested outside and tilting the playing field towards current account deficits analysts say.
In 1953, forex reserves were run down to 114.3 million dollars. In 1954 and 1955 the then government implemented corrective measures including budget surpluses of 0.5 percent of GDP and 2.2 percent of GDP and rebuilt foreign reserves back to 210 million dollars by the end of 1955.
In 1977 Sri Lanka’s economy re-opened and there was also a balance of payments deficit and the budget deficit 4.5 percent of GDP from 8.4 percent a year earlier.
Deficit spending went in to full gear from 1978, and monetary instability worsened.
The central bank’s law was also changed to take the restraint of the peg out plunging the country into continuous depreciations and 20 percent inflation until a central bank governor who knew monetary policy came in form of A S Jayewardene to stem the slide in 1995.
In 2020 the current account surplus in the third quarter came in year of balance of payments deficits and outflows through the financial account due to inability to raise foreign debt due to loss of confidence due to previous money printing and tax cuts.
Governor Lakshman said Sri Lanka was expecting a current account surplus in 2021 as well.
“And we are indeed expecting a marginal current account surplus this year,” he said. Marginal, but the conditions will further improve in the medium term.”
It is not clear whether the ‘current account surplus’ in 2021 would be created with a balance of payments surplus (central bank ending money printing and re-building forex reserves) or continued financial sector outflows. (Colombo/Feb15/2021)