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Sunday January 29th, 2023

Sri Lanka rupee, forex markets in pickle as LC rationing froths

ECONOMYNEXT – Sri Lanka’s forex markets are mired in tight trading restrictions and banks found it increasingly difficult to accommodate customer requests for letters of credit market participants said, as money printing and excess liquidity continue to pressure the rupee.

Sri Lanka’s rupee is now in a non-credible peg at 200 to the US dollar with over 100 billion rupees (about 500 million US dollars) in excess liquidity pressuring the peg via potential new credit.

Last week another 22 billion rupees (about 100 million US dollars) were printed to keep Treasury bill yields below 5.21 percent, which is functioning as a de facto ceiling policy rate.


Sri Lanka prints Rs22bn after failing to sell bills at ceiling rate

LC Rationing

With interbank forex trading coming to a virtual standstill banks are finding it difficult to cover letters of credit obligations in time, forcing them to ration LCs to customers who have access to printed money from the central bank to do business with.

“We cannot accommodate the requests for LCs so we have to ration them,” a banker said. “There is no regulation to say to ration them, but we are forced to do it.”

Bank NOPs were slashed in April as credit demand picked up and printed money hit forex markets.

Then a non-credible peg was imposed at around 200 to the US dollar, making it difficult for banks to cover their positions after providing dollars for customers to cover bills and LCs.

Problems with LCs began to emerge shortly after but has now intensified.


Sri Lanka forex market caught between moral suasion and slashed NOPs

Sri Lanka’s non-credible peg to US dollar devalued to 202 amid LC struggle

Several banks are now running short (negative) net open positions.

This week isolated forward transactions took at 200 to the US dollar as some banks tried to reduce their negative NOPs, market participants said.

Forward legs at discount in swap market

In the swap market one year forwards are quoted at discounts with domestic dollar yields overtaking the rupee rates kept down by money printing.

The year was quoted this week at 1700/2200 levels or a discount of around 17 rupees.

Banks are mandated to sell to importers around 200 to the US dollar.

However it is not clear whether a similar restriction applies to capital outflows with foreign investors in particular selling out of stocks in bid to protect their money.

Sri Lanka has been following excessively loose monetary policy associated with Sterling crises in the late 1960 and the collapse of the US dollar and the Bretton Woods soft-peg system in 1971, which worsened after 2015.

During the recent past a highly unstable and discretionary external anchor called a ‘flexible exchange rate’ which had zero credibility in the market was coupled with discretionary domestic anchor called the ‘flexible exchange rate’ with predictable consequences.

In 2020, unprecedented liquidity injections were made under so-called Modern Monetary Theory, with pegged exchange rate regime.

Though the peg is now enforced at 200 to the US dollar with multiple controls, there is no monetary policy to back it analysts say as long liquidity is injected.

A US money-doctor set up Sri Lanka’s soft-pegged central bank in 1950 in the style of several set up in Latin America abolishing a currency board that had kept the exchange rate and free trade since 1885.

A false promise was made that that the agency will be able to engage in discretionary credit policy (print money) and also supply foreign exchange in unlimited quantities as the currency board had done since 1885.

Economists and analysts have been calling for the central bank’s open market operations to be restrained, and if not for it to be abolished altogether so that resident of Sri Lanka can get on with their lives without monetary instability.

From 2015 large volumes of liquidity has been released into banks to keep call money rates at the middle or bottom of the policy corridor in a steep regression of policy.

The China-backed Colombo Port City is to be protected from the soft-pegged central bank through multiple currency dollarization.


Sri Lanka Port City dollarization upheld, constitution violation from depreciation: SC

Sri Lanka’s Supreme Court has upheld the right of Port City residents to be protected from depreciation.


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Sri Lanka operators seek higher renewable tariffs, amid exchange rate expectations

ECONOMYNEXT – Sri Lanka’s renewable companies say they need tariff of 40 to 45 rupees a unit to sell power to the Ceylon Electricity Board and the agency owes them tens of billions of rupees for power sold in the past.

The association has strong exchange rate expectations based on the country’s dual anchor conflicting monetary regimes involving flexible inflation targeting with a reserve collecting target.

“In the coming year of course because of the rupee devaluation, I think the solar energy sector might require tariffs closer to RS 40 or RS 45, hydropower will also require tariffs on that scale,” Prabath Wickremasinghe President of the Small hydropower Developers Association told reporters.

“I think right now what they pay us is averaging around RS 15 to RS 20.”

Some of the earlier plants are paid only 9 rupees a unit, he said. The association there is potential to develop around 200 Mega Watts of mini hydros, 700 to 1000MW of ground mounted soar and about 1,000 rooftop solar.

In addition to the rupee collapse, global renewable energy costs are also up, in the wake of higher oil prices in the recent past and energy disruption in Europe.

The US Fed and the ECB have tightened monetary policy and global energy and food commodity price are now easing.

However in a few years the 40 to 45 rupee tariffs will look cheap, Wickremesinghe pointed out, given the country’s monetary policy involving steep depreciation.

From 2012 to 2015 the rupee collapsed from 113 to 131 to the US dollar. From 2015 to 2019 the rupee collapsed from 131 to 182 under flexible inflation targeting cum exchange rate as the first line of defence where the currency is deprecated instead of hiking rates and halting liquidity injections.

From 2020 to 2022 the rupee collapsed from 182 to 360 under output gap targeting (over stimulus) and exchange rate as the first line of defence.

“The tariffs are paid in rupees,” Wickremasinghe said. With the rupee continuing to devalue in other 5 years 40 rupees will look like 20 rupees.”

Sri Lanka has the worst central bank in South Asia after Pakistan. Both central banks started with the rupee at 4.70 to the US dollars, derived from the Reserve Bank of India, which was set up as a private bank like the Bank of England.

India started to run into forex shortages after the RBI was nationalized and interventionist economic bureaucrats started to run the agency. Sri Lanka’s and Pakistan’s central bank were run on discretionary principles by economic bureaucrats from the beginning.

The Central Bank of Sri Lanka was set up with a peg with gold acting as the final restraint on economic bureaucrats, but it started to depreciated steeply from 1980 as the restraint was taken away.

Now under so-called ‘exchange rate as the first line of defence’ whenever the currency comes under pressure due to inflationary policy (liquidity injections to target an artificially low policy rate or Treasuries yields) the currency is depreciated instead of allowing rates to normalize.

Eventually rates also shoot up, as attempts are made to stabilize the currency which collapses from ‘first line of defence’ triggering downgrades along the way.

After the currency collapse, the Ceylon Electricity Board, finances are shattered and it is unable to pay renewable operators.

Unlike the petroleum, which has to stop delivery as it runs out of power, renewable operators continue to deliver as their domestic value added is higher.

However they also have expenses including salaries of staff to pay.

The CEB which is also running higher losses after the central bank printed money and triggered a currency collapse, has not settled renewable producers.

“In the meantime, we have financial issues with the investors and CEB owns more than 45 million rupees in the industry,” Warna Dahanayaka, Secretary of Mini Hydro Association, said at the conference.

“We can’t sustain because we can’t pay the salaries and we can’t sustain also because of the bank loans. Therefore, we are requesting the government to take the appropriate action for this matter.”

Sri Lanka and Pakistan have identical issues in the power sector including large losses, circular debt, subsidies due to depreciating currencies.

In Sri Lanka there is strong support from the economists outside government for inflationary policy and monetary instability.

The country’s exporters, expatriate workers, users of unofficial gross settlement systems, budget deficits and interbank forex dealers in previous crises have been blamed for monetary instability rather than the unworkable impossible trinity regime involving conflicting domestic (inflation target) and external targets (foreign reserves).

The country has no doctrinal foundation in sound money and there is both fear of floating and hard peg phobia among opinion leaders on both sides of the spectrum regardless of whether they are state or private sector like any Latin American country, critics say.


South Asia, Sri Lanka currency crises; only 2-pct know monetary cause: World Bank survey

A World Bank survey last year found that only 2 percent of ‘experts’ surveyed by the agency knew that external monetary instability was generated by the central bank. Most blamed trade in severe knee jerk reaction. (Colombo/Jan29/2023)

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Sri Lanka top chamber less pessimistic on 2023 GDP contraction

ECONOMYNEXT – Sri Lanka’s top business chamber said it was expecting an economic contraction of up to 2 percent in 2023, which is much lower than projected by international agencies.

“The forecast of 2023 is quite negative in terms of the international forecasters,” Shiran Fernando Chief Economist of Ceylon Chamber of Commerce told a business forum in Colombo.

“Our view is that there will be some level of contraction, may be zero to two percent. But I think as the year progresses in particular the second half, we will see consumption picking up.”

The World Bank is projecting a 4.2 percent contraction in 2023.

In 2022 Sri Lanka’s economy is expected to contract around 8 to 9 percent with gross domestic product shrinking 7.1 percent up to September.

Most businesses have seen a consumption hit, but not as much as indicated, Fernando said.

“Consumption is not falling as much as GDP in sense and we are seeing much more resilient consumer,” he said.

Sri Lanka’s economy usually starts to recover around 15 to 20 months after each currency crisis triggered by the island’s soft-pegged central bank in its oft repeated action of mis-targeting rates through aggressive open market operation or rejecting real bids at Treasuries auctions. (Colombo/Jan28/2023)

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Acuity Knowledge Partners with Sri Lanka office to be bought by Permira

ECONOMYNEXT – Permira, an investment fund with operations in Europe, US and Asia is buying a majority stake in Acuity Knowledge Partners, which has a 500 seat center in Sri Lanka for a undisclosed sum.

Equistone Partners Europe, from which Permira is buying the stake will remain a minority investor, the statement said.

In 2019, Equistone backed a management buyout of Acuity from Moody’s Corporation.

Acuity Knowledge Partners says it serves a global client base of over 500 financial services firms, including banks, asset managers, advisory firms, private equity houses and consultants.

“Despite the current challenges for the financial services sector, we have experienced continued growth and a strong demand for our solutions and services,” Robert King, CEO of Acuity Knowledge Partners, said.

“Given the significant demand within the financial services sector for value-added research and analytics, and the need for operational efficiency, with Permira’s deep experience in tech-enabled services and its global network, I am confident the business will continue to flourish.”

London headquartered Acuity has offices in the UK, USA, India, Sri Lanka, Costa Rica, China and Dubai, UAE.

Equistone was advised on the transaction by Rothschild & Co and DC Advisory, and Latham & Watkins acted as legal counsel. Robert W. Baird Limited served as financial advisers to Permira, and Clifford Chance is acting as legal counsel.

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