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Wednesday December 7th, 2022

Sri Lanka rupee debt in US$20bn IFR hair cut as economy inflates

ECONOMYNEXT – Sri Lanka government and government guaranteed domestic currency debt broadly considered in debt review has shrunk by a 19.6 billion US dollar equivalent as the economy inflated in the worst currency crisis in the history of the island’s intermediate regime central bank.

Sri Lanka’s central government rupee debt fell to the equivalent of 32.4 billion dollars from 50.5 billion dollars, a phenomenon labeled High Inflation and Financial Repression (IFR).

Sri Lanka had rupee debt of 53.5 billion US dollar equivalent by end December 2021, made up of 50.5 billion US dollars of central government debt and 3.1 billion SOE guaranteed debt, included in an update to creditors on data up to December 2021.

Sri Lanka had 47.3 billion US dollars of central government forex debt with 5.4 billion US dollars of guaranteed state enterprise debt and 3.0 billion dollars of central bank debt included.

In the next six months the rupee collapsed from around 200 to 360 to the US dollar in a float botched with a surrender rule (forced dollar sales to the central bank), sterilized interventions and too low policy rates amid raging domestic credit.

By end June 2022, rupee debt had shrunk to 34.0 billion US dollars equivalent from 53.6 billion US dollars equivalent by end December 2021 in a severe High Inflation and Financial Repression (IFR) event or real ‘haircut’ according to the latest update to creditors.

Sri Lanka’s dollar debt considered in the update had also fallen marginally to 46.6 billion US dollars by end June 2022 from 47.3 billion US dollars in December 2021 made up of 5.5 billion US dollars of SOE guaranteed debt and 3.2 billion US dollars of central bank debt.

The monetary authority however has more forex debt than included in the update according to other data. Considered in the update were 1.1 billion US dollars owed to the International Monetary Fund (negative SDR position excluded) and 2.0 billion dollars in external swaps only.

The treatment of Asian Clearing Union deferred liabilities and domestic swaps are not immediately clear.

The wiping out of the rupee debt to 34.5 billion US dollars by June 2022 from 53.6 billion US dollars six months earlier reduced total public sector debt considered in the compilation to 80.5 billion US dollars from 100.9 billion US dollars over the six months.

There appears to be classification differences between the two updates.

The new update said forex debt was 70 percent out of public debt of 122 percent of GDP in June 2022 compared to 27 percent of 114 percent of GDP public debt in 2020 before the currency collapse.

Sri Lanka’s economy is expected to inflate to at least 23.8 trillion rupees in 2022 from 16.8 trillion rupees in one of the biggest inflationary blow offs since the 1980s when rupee began to be rapidly depreciated in response to money printing, triggering high inflation and social unrest.

An inflating rupee economy boosts nominal tax revenues, bringing automatic ‘debt sustainability’ through IFR as long as the public sector is not expanded and there is wage restraint.

Tax revenues were up 25 percent in the six months to June 2022.

Related Sri Lanka budget 2022, tax revenues surge 25-pct up to June in inflation

On top of the usual flexible exchange rate IFR there are now fears that a domestic debt re-structure (DDR) would also take place.

A DDR will hurt banks, Sri Lanka authorities have said.

In addition pension funds and other debt holders who will in any case pay more tax under contemplated reforms will also be hit on a second hair cut on top of IFR.


Sri Lanka has no final decision yet on domestic debt re-structuring

Sri Lanka rates elevated amid failed float and DDR fears

Sri Lanka’s rupee collapses repeatedly due to the country’s intermediate regime central bank which does not have a consistent monetary anchor but practices discretionary and conflicting policy in line with what is generally known as the ‘impossible trinity’.

Over the past 7 years highly discretionary policy was operated under ‘flexible inflation targeting’ where floating rate monetary tools (open market operations for stimulus) were applied to a reserve collecting peg, in policy comparable or worse than the 1980s, according to critics.

However in the last decade Sri Lanka had become a market access country unlike in the 1980s and the country defaulted in April 2022 after running out of reserves.

In all previous currency crises coming from flexible monetary policy, debt sustainability was reached with High Inflation and Financial Repression. At the moment government rupee debt yields are around 30 percent with historical inflation running close to 70 percent.

But in this currency crisis a debt re-structure is required after the country was locked out of markets by sovereign bond holders from around 2020 and downgrades later in the year.

A new monetary law which will allow discretion to override rules as in the past seven years, legalizing both a ‘flexible’ exchange rate and ‘flexible’ inflation targeting (a modernized version of attempting to defy the impossible trinity of monetary policy objectives with policy errors compensated by depreciation) is to be enacted as a prior action in a deal with the IMF according to critics. (Sri Lanka’s central bank needs accountability and restraint, not independence: Bellwether)

Due to the promotion of flexible policy pegs, a central bank that goes to the IMF keeps going to the Fund again and again in a phenomenon classical economists call recidivism – or in jest, ‘many happy returns’. Sri Lanka is going to the IMF for the 17th time.

Flexible or discretionary policy is a doctrinal foundation of classical Mercantilism (John Law, James Steuart as well as Anti-Bullionists and the Banking School) which was given a new lease of life under Keynesianism and forms the foundation of non-credible soft-pegs (intermediate regimes).

Washington based promoters of neo-Mercantilism including Robert Triffin (propagation of Argentina style Prebisch-Triffin central banks), John H Williams (key currency), and later John Williamson (basket band crawl/REER targeting) peddled impossible trinity flexible regimes to hapless third world nations that did not have a strong domestic classical economic doctrinal foundation.

Flexible monetary policy rejects the rule based principles advocated by classical economists like David Hume, David Ricardo outright as well as Henry Thornton.

Flexible exchange rates – which are neither clean floats nor hard pegs – also reject more modern classicals like F A Hayek, Ludwig von Mises and Wilhelm Ropke whose ideas drove the Federal Republic and Japan from 1948 and later East Asia firm and hard pegs (Why Singapore chose a currency board over a central bank), GCC firm pegs and also ideas of others like Milton Friedman and Bertil Ohlin.

Their ideas drove monetary policy in the US, UK and Sweden in the ‘Great Moderation’ period from the early 1980s until around 2001, and still drive policy in several countries with German speakers including Switzerland.

Germany itself is now under the European Central Bank which printed money to boost jobs riding the ‘supply bottleneck/transient inflation’ bandwagon, taking refuge in non-monetary explanations, along with the US and is now suffering the effects of the Powell Bubble.

In Sri Lanka, there is a strong belief among policymakers that a part of the inflation in a country is non-monetary and the claim is used to delay rate hikes, unleash open market operations to suppress market rates and drive up credit, triggering currency crises.

That inflation is non-monetary (wage-spiral, interest rates, forward market speculation, hoarding) stem from ideas of classical Mercantilists like James Steuart.

That inflation comes from a monetary and non-monetary soup is an idea articulated by talking heads in popular financial media, and persons like Fed Chief Arthur Burns who broke a centuries old gold standard in 1971-73, creating fiat money.

Broadly speaking, cost-push theory argues that prices or costs drive money supply changes, not that there is a causal soup involving an x percent of cost push inflation and y percent of monetary inflation.

In a country with a flexible-policy-reserve-collecting peg, nominal interest rates are high and long term real growth is low due to trade and exchange controls imposed by the soft-pegged central bank which curtail economic freedoms, as well as output shocks that follow currency crises.

In an IMF or other Debt Sustainability analysis, low growth and generally higher nominal interest rates have to be assumed with no exit from anchor conflicting flexible policy that has prevailed from 1950 compounded by depreciation from BBC policy from 1980s and market access over the past decade.

In a four to five year Federal Reserve cycle, a flexible policy soft-pegged country will lose about two years of growth due to monetary instability. The compounding effects of low growth (output shocks) have severe impacts on long term growth and prosperity.

In Sri Lanka’s current currency crisis which led to sovereign default, growth is to become positive in 2024 and remain about 3.0 percent until 2027 according to the update creditors. (Colombo/Sept25/2022 – Update II)

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Sri Lanka may see rates falling next year: President

ECONOMYNEXT – Sri Lanka’s interest rates are high and hurting small businesses in particular but interest rates are required to maintain stability, President Ranil Wickremesinghe said.

“One is, all of you want to know what’s going to happen to the interest rates?,” President Wickremesinghe told an economic policy forum organized by the Ceylon Chamber of Commerce.

“I wish I know. The governor has told me that the inflation has peaked. It’s coming down. You all understandably want some relief with the interest rates to carry business on.”

“I understand that and appreciate the viewpoint. It’s not easy to carry business on with such high interest rates. On the other hand, the Central Bank also has to handle the economy. So maybe sometimes early next year we will have a meeting of minds of both these propositions.”

Sri Lanka’s interest rates are currently at around 30 percent but not because the central bank is keeping it up. The central bank’s overnight policy rate is only 15.5 percent but the requirement to finance the budget deficit and roll over debt is keeping rates up.

Rates are also high due to a flaw in the International Monetary Fund’s debt workout framework where there is no early clarity on a whether or not domestic debt will be re-structured.

After previous currency crises, rates come down after an IMF deal is approved and foreign loans resume and confidence in the currency is re-stabilished following a float.

This time however there has been no clear float, though the external sector is largely stable and foreign funding is delayed until a debt re-structure deal is made.

Sri Lanka’s external troubles usually come because the bureaucrats do not believe market rates are correct when credit demand picks up and mis-uses monetary tools given in 1950 by the parliament to suppress rates, blowing the balance of payments apart.

The result of suppressed rates by the central bank are steep spikes in rates to stop the resulting currency crisis.

A reserve collecting central bank has little or no leeway to control interest rates (monetary policy independence) without creating external troubles, which is generally expressed as the ‘impossible trinity of monetary policy objectives’.

However, it has not prevented officials from trying repeatedly to suppress rates, perhaps expecting different results.

After suppressed rates – supposedly to help businesses – trigger currency crises, the normalization combined with a currency collapse leads to impoverishment of the population.

The impoverishment through depreciation leads to a consumption shock, which also leads to revenue losses in businesses.

The suppressed rates then lead to bad loans.

In the 2020/2022 currency crisis the sovereign default has also led to more problems at banks. Several state enterprises also cannot pay back loans.

“…[T]he bad debt that is being carried by the banks is mainly from the private sector or the government sector,” President Wickremesinghe said.

“Keep the government sector aside. We’re dealing with it. How do you handle it? Look, one of our major areas of are the small and medium industries. You can’t allow them to collapse, but they’re in a bad way.”

Classical economists and analysts have called for new laws to block the ability to central bank to suppress rates in the first place so that currency crises and depreciation does not take place in the first place.

Then politicians like Wickremesinghe do not have to take drastic and unpopular measures to fix crises and there will be stability like in East Asia.

Sri Lanka had stability until 1950 when the central bank was created by abolishing an East Asia style currency board. The currency board kept the country relatively stable through two World Wars and a Great Depression.

In 1948 after the war (WWII) was over “we stood second to Japan” Wickremesinghe said.

“But we started destroying it from the sixties and the seventies,” he said. :We started rebuilding an economy, which was affected by a (civil) war, and thereafter the way we went, is best not described here.”

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Crisis-hit Sri Lanka sees recovery in cruise ship tourism from zero

ECONOMYNEXT – Seventeen cruise ships are scheduled to arrive in Sri Lanka next year with
Queen Mary 2, one of the largest and popular ships, Colombo’s harbor master said, as the island nation is looking for alternative avenues to boost its faltered tourism sector.

The rise is expected to bring thousands of high end tourists with higher spending capacity after two years. The island nation saw a record high 54 ships in 2019, rising from the previous year’s 42, Nimal Silva, Colombo Port Harbor Master said.

“The 2019 was one of the best years and in 2020 there were more than 60 scheduled vessels to
call but with COVID pandemic all hell broke loose,” Silva told EconomyNext.

Fourteen cruise ships are scheduled to call from January-May next year and another three are scheduled to arrive in Colombo in November, when the peak tourism season begins.

Cruise tourism cycle begins in Sri Lanka from October to May with a dip during the monsoon

Sri Lanka welcomed two cruise ships in November after almost two years.

Three ships are scheduled to arrive in December and Azamara Quest, carrying at least 722 tourists, arrived in Colombo on December 3 and is now heading to Hambantota.

On December 18, Le Champion carrying 264 will arrive in Colombo and depart to Mumbai and the third vessel, Silver Spirit will arrive in Colombo on December 23 carrying up to 648 passengers.

There are two scheduled in January, one in February, and four in March next year, according to the harbormaster.

“Next year more ships could schedule, so far these are the confirmed ones now,” he said.

This also generates income for the port and the prices are charged according to the size of the

Silva said the first medium sized-cruise vessel, 229 meters long, generated about 14,000 dollars
for docking in the port for a day.

He said Queen Mary 2, a 325 meter long ship and one of the largest cruise ships in the world, is also
scheduled to call at Colombo in February. It can carry up to 3200 passengers.

Silva said almost all the ships that were scheduled have arrived on the island and therefore, he is
confident all the ships including Queen Mary 2 will arrive in Sri Lanka.

“Only one ship has been canceled thus far. There are no last minute cancellations if there were some they would have informed us by now,” Silva said. (Colombo/Dec07/2022)

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Sri Lanka President says 2015-2019 policy struggle was ‘warfare’

ECONOMYNEXT – Sri Lanka President Ranil Wickremesinghe said his attempts to reverse the inward-looking protectionist policies and fix state finances during his last term as Prime Minister was opposed both by politicians and business interests.

“In the 4.5 years as prime minister it was an effort to take this economy out in a different direction,” President Wickremesinghe told an economic forum organized by Sri Lanka’s Ceylon Chamber of Commerce.

“We were able to get a surplus in the primary budget. But it was warfare.

“Politicians wanted to protect their power, businessmen wanted to protect their profits and many others wanted to see what the country would provide them free of charge.”

Wickremesinghe was unable to bring private investment to the port under apparent internal political opposition. Relations with President Maithripala Sirisena also soured and he appointed his own economic advisors.

Meanwhile Wickremesinghe’s free trade agenda was hit by monetary instability as the central bank printed money under flexible inflation targeting and triggered forex shortages which were followed by trade controls.


Sri Lanka controls imports in ‘Nixon-shock’ move to protect soft-pegged rupee

Sri Lanka President calls to expand Nixon shock as rupee falls

Wickremesinghe’s ‘Yahapalana’ administration also went on a spending spree called ‘100-day program’ in 2015 triggering a currency crisis in 2015/2016 as the central bank printed money to suppress rates.

The central bank however had already started injecting liquidity and losing reserves (by terminating term repo deals) from the fourth quarter of 2014 as domestic credit recovered from a 2012 currency crisis before his administration came to power.

The rupee fell from 131 to 152 and stabilization policies led to an output shock. The International Monetary Fund then taught the agency which had already depreciated the currency from 4.70 to 152 to the dollars seeking bailouts 16 times, how to calculate an output target.

Under Finance Minister Mangala Samaraweera taxes were raised and budget were fixed in 2018 to bring deficits back to pre-2015 levels, though state spending went up from 17 to around 20 percent of GDP under the spendthrift ‘revenue based fiscal consolidation’ where cost cutting was dropped.

The central bank then printed money by purchasing bonds from banks to target the yield curve, jettisoning a bills only policy established by ex-Central Bank Governor A S Jayewardena, through term reverse repo and overnight injections taking the rupee from 151 to 162 to the US dollar.

The central bank also created money by entering into a swap with the Treasury in 2018, a type of strategy used by speculators to bring down East Asian pegs putting, further pressure on the currency from around July 2018 onwards.


What went wrong; Sri Lanka’s illiberal economics and unsound money : Bellwether

Stabilization policies then led to another output shock. As forex shortages came Sri Lanka resorted to heavy external borrowing as it was unable to settle maturing loans with domestic borrowings.

After two currency crises and output shocks, macro-economists of the new administration cut taxes saying there was a ‘persistent output gap’ and printed even more money for stimulus (close the output gap). (Colombo/Dec07/2022)

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