An Echelon Media Company
Friday June 21st, 2024

Sri Lanka rupee non-credible peg at 203 to dollar drives dollar rationing, rates rise

ECONOMYNEXT – Sri Lanka’s non-credible peg with the US dollar at 203 is driving dollar rationing, market participants said, as an attempt to ration rupee production by the monetary authority is driving market rates up, but is yet to be fully successful.

Banks prioritized the supply of dollars to food imports in recent days especially items like milk where the Consumer Affairs Authority created a shortage with its price control gazettes.

Importers including LP Gas and some building materials are crying for dollars and banks are trying to help, market participants say.

Sri Lanka’s central bank has been printing large volumes of money, triggering credit and driving outflows above the total inflows to the country and shattering the credibility of a dollar peg. In August private credit on the rupee books of banks was 104 billion rupees.


Sri Lanka private, state credit surge in August, CB credit up 187-pct

There had been the off-market settlement of dollars at rates up to 230 to the US dollar, but the activity reduced following a central bank order which led to more intensive dollar rationing.

However some off-market settlements are taking place among friendly parties, at around 215 to 220 to the US dollar, trading sources say with the central bank not providing full convertibility for the rupees it is creating, despite wanting to maintain the parity at 203 to the US dollar.

A surrender rule further undermines the peg which is weakened by liquidity with negative convertibility creating more liquidity, analysts say. However many third world central banks with unstable currencies including that of Zimbabwe has done it, analysts say.

Partial Convertibility

A central bank cannot maintain a peg without providing convertibility to the currency it creates. However, some convertibility had been provided, to importers of food over the past week following an order by Prime Minister Mahinda Rajapaksa.

Sri Lanka has had external problems ever since a Latin America style central bank was set up in 1950, abolishing a credible peg that had kept the country stable through two World Wars and a Great Depression.

Sri Lanka (then Ceylon) had some trouble with depreciation (against the gold Sterling) only when the silver price started to fall from the ‘panic of 1893’ but the peg still held, analysts say.

When the credibility of the peg is undermined by artificially low-interest rates, steep spikes are required to restore confidence in the soft-pegged currency. The ‘better’ the economy is doing (stronger private credit) the more difficult it is to restore credibility.

Central banks that operate credible pegs are able to provide stability to those who use the currency which eventually results in low inflation (capital preservation) and low-interest rates.

Sri Lanka current troubles and loss of credibility of the rupee came from extreme stimulus and suppression of rates throughout the yield curve through price controls, despite the widening of the budget deficit through tax cuts and unemployed graduate hires in the midst of a pandemic.

As long as money is printed to buy bonds from failed auctions, problems with the rupee will persist, analysts have warned.

“A partially failed bond auction is as good as a fully failed bond auction because both result in liquidity injections which undermine the peg,” EN’s economics columnist Bellwether says.

“Failed auctions will also lead to a sterilization trap where the central bank is forced to mop up through repo auctions that it creates through failed auctions.

“However a float (full suspension of convertibility) also will not work if bond auctions fail or the Treasury borrows from state bank overdrafts which are re-financed with window money.”

On Tuesday bond yields spiked as the government tried to roll-over maturing bonds and meet a coupon payment in an auction of 100 billion rupees.

A 2023 bond that was auctioned at an average yield of 9.36 percent is estimated to have a cutoff of 9.80 percent. The bond was quoted at 9.50/10.00 levels on Wednesday.

A 2017 bond that had an auction average of 11.14 percent and a 2030 bond which hand an auction average of 11.23 percent are estimated to have cutoffs of around 11.90 percent.

An 86 billion rupee Treasury bill auction is due on Wednesday. Market rates are catching up to the budget deficit but deposit rates also have to rise.

To make investors comfortable with holding bonds, rates have to rise to levels that allow any policy rate hikes to catch up.

But partially failed bond auctions that inject liquidity may lead to excessive rises in rates even as monetary instability continues, analysts say.

A monetary policy decision is due to be made public on October 14.


Sri Lanka bond auction yields rise around 100bp across maturities

Sri Lanka’s bond auctions have failed ever since domestic economic activity improved and the country’s note issue bank started over-issuing notes to keep rates down.

Failed domestic bond auctions whose price is artificially propped up by central bank purchases (effectively an inability of the government itself to service domestic debt) leads to an inability of the government to service external debt.

In Latin American countries like Argentina where government budgets are much better, external default comes from the loss of credibility coming from the failure to roll-over sterilization securities at auctions.

Aggregate Demand Bubble

The US Fed is printing money despite a post-Covid recovery creating all kinds of distortions across the globe including a commodity bubble.

Sri Lanka’s policymakers last year pointed to Jerome Powell’s money printing to justify domestic policy errors.

The International Monetary Fund says the post-Covid recovery was unusual and has features not seen in the past.

“There are labour shortages and unemployment at the same time,” IMF’s Chief economist Gita Gopinath said in October 2021 releasing the agency’s World Economic Outlook report.

Related Sri Lanka 2021 GDP growth downgraded to 3.6-pct by IMF, global growth lowered

Critics say economic disruptions are one outcome of firing indiscriminate aggregate demand bubbles also known as the Keynesian stimulus or John Law policies.

Nobelist Friederick Hayek had explained how it happens.

“Just as there cannot be a uniform price for all kinds of labour, an equality of demand and supply for labour, in general, cannot be secured by managing aggregate demand,” he wrote.

“The volume of employment depends on the correspondence of demand and supply in each sector of the economy, therefore on the wage structure and demand between the sector.”

Eventually, as inflation stops accelerating higher unemployment than earlier is the result. (Colombo/Oct14/2021)

Leave a Comment

Your email address will not be published. Required fields are marked *

Leave a Comment

Leave a Comment

Cancel reply

Your email address will not be published. Required fields are marked *

Indian FM meets Sri Lanka political leaders; focuses on committed deals

ECONOMYNEXT – Indian External Affairs Minister (EAM) S. Jaishankar met President Ranil Wickremesinghe and a range of political leaders during his visit to Sri Lanka, focusing on commitments made by Sri Lanka to India, including land and energy pipeline connectivity.

Sri Lanka has committed to renewable energy deals for the Indian Adani group, Trincomalee port development, an investment zone around the port, a bridge between the island nation’s Northern Mannar and South India’s Rameshwaram, a power grid, and an oil and gas pipeline between the two nations.

Though most of the committed projects have been discussed and some already signed, they face delays amid public protests, court cases on environmental concerns, anti-Indian sentiments triggered by high prices of renewable projects, local politicians as well as perceived Chinese influence, analysts say.

India has been pushing Sri Lanka to fast-track these deals under Prime Minister Narendra Modi.Jaishankar’s visit also comes ahead of Sri Lanka’s presidential polls later this year.

Jaishankar met President Wickremesinghe in a one-on-one meeting, Prime Minister Dinesh Gunawardena, and Foreign Minister Ali Sabry before delegation-level talks with Ports, Shipping and Aviation Minister Nimal Siripala de Silva, Agriculture and Plantation Industries Minister Mahinda Amaraweera, and Power and Energy Minister Kanchana Wijesekera.

“Appreciated the progress made on various bilateral projects and initiatives. Under President Ranil Wickremesinghe’s guidance, we discussed the way forward for India-Sri Lanka cooperation, especially in power, energy, connectivity, port infrastructure, aviation, digital, health, food security, education, and tourism sectors,” Jaishankar said on his official Twitter platform.

He also met former President Mahinda Rajapaksa, opposition leader Sajith Premadasa, and leaders of various political parties from the North, East, and the upcountry region.

“Interaction of EAM with the leadership of the Government of Sri Lanka provided an opportunity to review and accelerate progress in the multifaceted India-Sri Lanka partnership,” the Indian External Affairs Ministry said in a statement.

One of the key focus areas of discussion was the Vision Document adopted by President Wickremesinghe and Prime Minister Modi during the Sri Lankan leader’s visit to India in July 2023.

“Discussions added momentum to the ongoing projects as well as initiatives for promoting connectivity in all its dimensions, particularly in domains of energy, physical infrastructure as well as economic and people-to-people ties.”

Jaishankar also met leaders of Sri Lanka’s upcountry Tamils, who originally came from India as plantation workers. He discussed development and devolution of power with an eight-member delegation of Tamil leaders from the Northern and Eastern provinces, including Shanakiyan Rasamanikkam and M. A. Sumanthiran.

India helped Sri Lanka with financial and humanitarian aid when the island nation faced an unprecedented economic crisis amid delays by the International Monetary Fund loan to rescue Sri Lanka.

“Following Sri Lanka’s economic recovery and stabilization, forging deeper long-term economic cooperation was underlined as a priority for sustainable and equitable growth of Sri Lanka, and mutual prosperity in the Indian Ocean Region,” the Indian External Affairs Ministry said.

Though the Sri Lankan government has claimed that Jaishankar’s visit was a precursor to Indian Prime Minister’s visit, the Indian External Affairs Ministry did not mention anything about a possible Modi visit.

This visit is Jaishankar’s first bilateral visit after the formation of the new government.

The Adani wind power project in the Northern district of Mannar has seen some public protests over environmental concerns after some experts said the project has failed to conduct a proper Environmental Impact Assessment (EIA). Critics also protest against its transparency.

President Wickremesinghe, opposition leader Premadasa, and Marxist Janatha Vimukthi Peramuna (JVP) leader Anura Kumara Dissanayaka are expected to contest in the election to choose the island nation’s 8th leader.

Sri Lankan leaders have been under pressure from India in the past two decades amid increasing Chinese influence in the island nation, seen as a security threat to India, analysts say.

The docking of a Chinese nuclear submarine in 2014 led to a dramatic government change in the 2015 presidential poll with the ousting of former leader Mahinda Rajapaksa, who later accused India of orchestrating his defeat.

Rajapaksa’s brother Gotabaya in 2021 unilaterally canceled a key port terminal project given to India’s Adani group after promising Jaishankar to sign the deal.

Gotabaya Rajapaksa was later forced to flee the country in 2022 after mass protests due to his economic policies. (Colombo/June 21/2024)

Continue Reading

Sri Lanka car permit tax losses Rs14bn in two years of partial disclosure

ECONOMYNEXT – Sri Lanka has lost 14.3 billion rupees in taxes from car permits given to public servants, including doctors, military officers, central bankers, finance ministry and tax officials, in 2019 and 2020 information disclosed by the finance ministry shows.

Inclusive of some 2021 tax losses when imports were banned for the rest of the year, 14.4 billion rupees of foregone revenue from a waived luxury tax is shown.

The list only shows waivers of a so-called ‘luxury tax’ imposed on larger vehicles above a certain value and size.

The list does not show other vehicles imported under car permits such as double cabs or cars below a certain size.

The list also does not seem to include tax free cars imported by politicians.

In 2019, Sri Lanka has lost 8.3 billion rupees from the luxury tax on car permits and in 2019 the loss 5.92 billion rupees.

In 2021 when car imports were stopped as the central bank started printing money to cut rates and target ‘potential output’ only 85.6 million rupees were lost.

Among the biggest tax waivers of over 10 million rupees went to some doctors and military officers. Doctors were among the biggest users of tax slashed car permits in the list.

Sri Lanka at one time did not allow cars imported by state workers to be transferred for many years.

But reportedly after Customs raided a finance company involving a fleet of vehicles, the rule was relaxed by the then President.

Among the largest tax waivers listed were given to Rolls Royce and Maclaren assigned to Melwire Rolling (Pvt) Ltd.

The 45.6 million rupee Rolls Royce was given a 42.1 million rupee tax waiver.

The 41.46 million McLaren was given a 37.9 million tax waiver.

There were also a large number of Audi A5 and Q2 vehicles listed at prices over 80 million rupee. It is not clear whether the disclosure is an error. The market value of the A5 and Q2 are much lower.

Up to end 2023, 138 cars imported under a migrant worker remittance scheme was listed to lose 436 million rupees in luxury taxes.
The total for the three years was listed at 14.86 billion rupees, involving 2,034 cars in 2019 and 1,470 cars in 2020.

It is not known how much the total tax losses or total vehicle imported through ‘car permits’ is. (Colombo/June20/2024)

Continue Reading

Construction of Sampur solar power plant to begin mid-July

ECONOMYNEXT – Joint energy projects between India and Sri Lanka, including the Sampur solar power plant due to begin next month, took centre stage during bilateral discussions between president Ranil Wickremesinghe and visiting Indian External Affairs Minister S Jaishankar on Thursday.

Wickremesinghe and Jaishankar discussed initiatives aimed at enhancing energy connectivity and developing the renewable energy sector, a statement by his media division said.

“Significant attention was given to plans for an LNG supply, a proposed petroleum pipeline linking the two countries, and advancing oil and gas exploration projects. Additionally, it was announced that construction of the Sampur Solar Power Plant is set to commence in July 2024.”

The visit comes amid delays in key Indian projects including land, oil and gas pipe, and grid connectivity deals, Adani’s wind power plant deals which are facing a legal battle, and port and investment zone projects in the Eastern port district of Trincomalee.

Indian supported projects for developing Trincomalee and expanding the Kankasanthurai port, the ongoing development of Jaffna Airport and Colombo Airport, and the expediting the unique digital identity card project were discussed.

The efficiency of projects supported by the Indian government aimed at bolstering Sri Lanka’s liquid milk industry and fertilizer production, were also examined.

Sri Lankan leaders have been under pressure from India in the past two decades amid increasing Chinese influence in the island nation as the move is seen as a security threat to India, analysts say. (Colombo/Jun20/2024)

Continue Reading