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Thursday December 1st, 2022

Sri Lanka rupee plunges amid money printing as car imports collapse

ECONOMYNEXT – Sri Lanka’s rupee has plunged to 199 to the US dollar in March as vehicle imports collapsed to almost nothing, official data showed as domestic credit driven by printed money, recovered.

Sri Lanka’s vehicle registrations fell to 3,556 units in March 2021 down from 13,219 units in March 2020 when a lockdown started and down from 34,475 units in January 2020.

Motor car registrations fell to just 149 units in March 2020, down from 1,165 units a year earlier and 2,526 units in January 2020, an analysis of vehicle registry data by JB Securities, a Colombo-based brokerage shows.

Only 11 three wheelers were registered in March down from 762 in March 2020.

However 250 medium trucks were registered up from 95 units a year earlier.

Sri Lanka banned car imports in 2020 as a tax cut in December 2019 followed by unprecedented money printing triggered forex shortages.

There is a strong Mercantilist belief in Sri Lanka that monetary instability involving currency collapses and balance payments deficits are not due to money printing and credit but is due to trade.

Analysts had warned that banning imports does not work in countries because, credit will flow into other permitted sectors and imports will recover. If the credit is financed with printed money outflows will exceed inflows, creating forex shortage and currency pressure.

Sri Lanka had also slapped import controls in past episodes of money printing.

In 2018 Sri Lanka printed money to target a call money rate and an output gap and controlled vehicle imports and gold through taxes and credit restrictions.

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Sri Lanka rupee collapses as gold imports end

DUAL ANCHOR CONFLICT: In 2018 Sri Lanka triggered a currency crisis by targeting an ‘output gap’ with printing money to keep call money rates down just after halting gold imports.

Sri Lanka has been following a highly discretionary or corrupted version of inflation targeting and printed money to keep rates down, despite the existence of a pegged exchange rate, triggering economic instability and balance of payments crises.

The central bank has no growth mandate and printing money to push growth and creating monetary and economic instability is not in line with the main objectives in the monetary authority’s law, economists have said.

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The International Monetary Fund may also have been complicit in giving technical assistance to calculate an output gap and which led to monetary instability.

The 2018 monetary instability from the ‘flexible inflation targeting/call money rate targeting’, came despite large tax hikes and market pricing of fuel.

Analysts have pointed out that Sri Lanka’s beliefs that imports cause monetary instability is linked to a Keynesian confusion dating back to the 1920s, known as the ‘transfer problem’.

Keynes believed that a trade (or current account surplus) was required to make foreign repayments, and was unable to grasp that that it was a consequence of financial outflows. To make outward payments and create a current surplus the government had to raise taxes or borrow at market rates.

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In 1929 several classical economists tried to explain to Keynes that foreign borrowings made imports overtake exports and loan repayments or loans made to foreigners, reduced imports.

Similarly oney printing (inflationary policy) also boosted imports, while deflationary policy (inflow sterilization reduced) imports.

“Foreign borrowing, however, increases and loans (to foreigners) reduce buying power,” Swedish economist Bertil Ohlin wrote in 1929.

“Similarly, inflationary credit policy (central bank purchases of Treasury bills) and deflationary policy (CB securities sales) reduces it.

“In the former case new buying power is created by the banks; in the latter, money which is earned and save is not lent by the banks to others, – it vanishes (is sterilized) and buying power falls off.”

Since he could not grasp idea, those who are schooled in Keynesian economics cannot grasp the concept that money printing creates forex shortages and the reverse ‘generates’ dollars.

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Sri Lanka’s shares gain in mid market trade

EXONOMYNEXT- Sri Lanka’s shares gained in mid market trade on Thursday (1), pushed up by strong positive sentiments on interest rates easing in line with inflation and speculation on government to hold talks with multilateral creditors ADB and World Bank for a possible loan facility.

Market has continued to gain for the past four sessions.

“Shares were moving on positive strong sentiments flowing in from yesterday (30), we are seeing a rally in the hotels, while the retail favorites such as LIOC and Expolanka,” analysts said.

Positive investor sentiments have been established, from positive comments from the Governor of the Central Bank over market rates eventually seeing an ease despite the fears of a domestic debt restructuring as inflation falls, increased liquidity in dollar markets, and the inter-bank liquidity improves.

Analysts further stated that, Treasury related stocks are also activated due to downward movements in yield.

All Share Price Index (ASPI) gained by 1.4 percent or 123.41 points to 8,774.64, while the most liquid share gained by 1.31% or 35.68 points to 2,765.

The market generated a turnover of 1.6 billion rupees at 1130 hours. (Colombo/Dec1/2022)

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Sri Lanka electricity losses from overpriced fuel, no tariff hike considered: regulator

ECONOMYNEXT – Sri Lanka’s state-run Ceylon Electricity Board’s high operating costs are partly due to excessive prices paid for fuel and no tariff hike is being considered, Chairman of the Public Utilities Commission of Sri Lanka, Janaka Ratnayake said.

The CEB itself does not buy fuel but depends on state-run Ceylon Petroleum Corporation and Lanka Coal, another state firm to buy fuel. Both firms are periodically caught in procurement scandals.

“They are paying about 385 plus rupees per litre for furnace oil,” Ratnayaka told EconomyNext.

“That is too much. From the global market we can buy it to much lower price. It can be imported below 200 rupees,”

“I ask the government to take the necessary steps to create a system to import furnace oil, like they did for fuel, to be imported at the lower price levels. If that happens, we can go without going for a price hike.”

Sri Lanka’s CEB generally gets furnace oil and residual oil from the domestic refinery and usually do not import furnace oil.

The refinery however is not regularly operating due to inability to get crude amidst the worst currency crisis in the history of the island’s intermediate regime central bank.

Ratnayake had earlier brought to light import costs of the CPC.

Pushing for operations efficiency of the CEB is a role of the regulator. Regulating costs based on global benchmark prices to push for procurement efficiencies is a standard practice. However the PUCSL is not the official regulator of the petroleum sector.

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Sri Lanka power tariff revisions sought in Jan and July: Minister

Power and Energy Minister Kanchana Wijesekera told parliament that cabinet approval was sought to twice yearly tariff hikes in January and July of each year.

No Electricity tariff hikes are being considered yet, Ratnayake said.

Wijesekera blamed the regulator as well as successive administrations for not regularly revising power prices and pushing the sector into crisis.

In Sri Lanka activists had also blocked cheap coal power. (Colombo/Dec01/2022)

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Sri Lanka banks may need more regulatory, accounting forbearance: Coomaraswamy

ECONOMYNEXT – Sri Lanka’s banks may need more regulatory forbearance ex-Central Bank Governor Indrajit Coomaraswamy said as the country imposes stabilization measures after the worst currency crisis since independence.

“We need to look at regulatory forbearance,” Coomaraswamy told a forum organized by CT CLSA Securities, a Colombo based brokerage.

“For CA Sri Lanka to do some more accounting forbearance. They have given some already.”

Sri Lanka’s central bank has given some regulatory loosening in the mark to market losses and also in liquidity ratios.

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Sri Lanka relaxes bank capital rules to cushion bond losses as rates spike

Sri Lanka’s banks are seeing higher levels of bad loans after the latest currency crisis as well as mark-to-market losses, and the impact of dollar sovereign bonds in default.

Sri Lanka’s stage 3 loans were 7.9 percent of total advances (net 8.7) by the end of the second quarter of 2022.

It compares with a 6.6 percent NPL ratio in the first quarter of 2020 as the Coronavirus pandemic started, which also triggered bad loans just as the roots of the current currency crises started.

In a currency crisis, a soft-pegged or reserve collecting (flexible exchange rate) central bank will inject liquidity to either monetize mostly maturing Treasuries from past deficits (in Latin America mainly failure to roll-over sterilization securities) to suppress rates.

When forex shortages begin to emerge from the excess credit, the flexible exchange rate central bank will intervene and sterilize the dollar sales to keep suppressing rates and prevent reserve money from contracting. Both moves allow banks to give credit without deposits, worsening their loan to deposit ratios and blowing a hole in the balance of payments.

When interest rates correct to stabilize the currency crisis and injections end, bad loans pile up. During the Coronavirus crises however economic activity was muted, compared to previous credit cycles and large volume of injected liquidity piled up in the banking system.

Before the twin crises, the central bank had earlier made banks boost capital.

Coomaraswamy who was Central Bank Governor until the beginning of 2020 said the then head of bank supervision A Thassim had insisted that banks comply with the Basle III capital standards as early as possible, when he himself was prepared to give some more time.

As a result, Sri Lanka banks were well capitalized at the start of the crisis, he said.

In the crisis with government finances already weakened, the banks were made to give relief and took the pressure, Coomaraswamy said.

After Sri Lanka default in April and interest rates were normalized to stop the currency crisis, banks were now facing pressure.

CA Sri Lanka, the island’s accounting body had already given some leeway to re-classify trading portfolios of securities to reduce the impact of mark-to-market losses.

In previous currency crisis, the IMF makes the briefly float the currency to establish confidence in the exchange rate after raising rates to curb domestic credit. This time rates were raised after a float failed by a surrender rule.

A successful float leads to early exporter conversions and a resumption of delayed import settlements which leads to a gradual fall of interest rates. Fixes to the budget and utilities also help.

The falling rates help boost capital gains of banks, offsetting some of the loan loss provisions.

This time however though external stability has large been reached, there has been no successful float to convince the market but taxes have been raised and utility prices adjusted to reduce domestic credit.

Lack of clarity over domestic debt re-structuring has also kept rates elevated. But long term rates have now started to ease.

Meanwhile President Ranil Wickremesinghe had already proposed an asset management company to take-over bad loans. (Colombo/Dec01/2022)

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