Sri Lanka slams Nomura report again; says not worse than Argentina and Turkey

ECONOMYNEXT – Sri Lanka’ central bank which operates a non-credible crawling peg with the US dollar has slammed a report by Nomura, an investment bank, that appeared to exaggerate the island’s vulnerability to a currency crisis.

Sri Lanka cannot be worse than Turkey and Argentina, the central bank said. Sri Lanka has been vulnerable to currency collapses since 1951 when a central bank with money printing powers was created to join the Bretton-Woods system of failed soft-pegs.

From 1885 Sri Lanka had a currency board under the sterling area with exchange rate stability and low inflation.

"Nomura has computed Sri Lanka’s score at 175, while assigning lower values to countries that are currently facing severe economic and financial strains," the Central Bank said in a statement Monday as the rupee breached 164 to the US dollar.

"Any methodology that yields outcomes whereby Sri Lanka’s score is substantially worse than countries like Argentina, Turkey, and South Africa does not appear to be sufficiently nuanced to capture market realities and dynamics."

The rupee has come under pressure after the central bank injected liquidity into money markets through a swap, and had continued to pump money through term repo auctions below the ceiling policy rate of 8.50 percent, and the Nomura report (Not carried on EconomyNext) has contributed undermining the credibility of the peg among some market participants.

The central bank also cut net open dollar positions of banks, which analysts had warned will increase volatility and require more central bank intervention to keep the currency stable.

"A closer look at Nomura’s ‘Damocles score’ for Sri Lanka shows that it has remained above the 100 continuously since 2012 except for a few months in 2013/14," the central bank said.

"At times, the ‘score’ has even hit the upper bound of 200. Therefore, it is evident that in the case of Sri Lanka, this rudimentary index cannot be considered an indicator/predictor of crisis."

"It is because the score does neither consider a particular country’s distance from threshold values nor the country-specific circumstances, that Sri Lanka is listed as a country that is at greater risk of crisis than countries like Argentina and Turkey."

Advertisement

 

 

 

Analysts have warned the central bank not to purchase Treasury bills and inject money permanently into the banking system, not to inject new money through term reverse repos in times of currency pressure but give only overnight money at the ceiling policy rate and not to make unsterilized dollar purchases from the Treasury or engage is swaps.

All dollars from the Treasury or other market participants should be sold in the market without expanding money and not to the central bank.

If unsterilized dollar purchases are made (or when unsterilized currency swaps and made) when there is no pressure, it should be followed up with unsterilized dollar sales.

However Sri Lanka’s overall credit conditions are moderate, and are not at levels seen in years like 2015 and 2011, when domestic analysts correctly predicted currency crises. Overall market rates are also higher, making it easier to emerge out of crisis as long as prudent policy is followed.

EN’s economics analyst Bellwether who correctly called the 2015/2016 crisis as early at late 2014 (Sri Lanka may lose forex reserve beauty contest amid ultra-low interest rates: Bellwether), has suggested a number of measures to improve the credibility of the Sri Lanka’s soft-peg after the fist episode of currency panic which started around May when the central bank failed to engage in unsterilized defence after injecting liquidity in March and April 2018.

Sri Lanka’s soft-peg is variously called a ‘crawling arrangement’ by the International Monetary Fund and also a somewhat misleadingly called ‘a flexible exchange rate’, which however only goes down.

17 September 2018
12-12-2012

The full statement of the central bank is reproduced below:-

Clarification on the Erroneous Report regarding Sri Lanka issued by Nomura Holdings Inc

Several international media sites have recently quoted an analysis by Nomura Holdings Inc., which shows that seven emerging economies including Sri Lanka are at risk of an exchange rate crisis.

The said media sites further quoted the report as saying Sri Lanka’s short term external debt is as high as US dollars 160 billion. As Sri Lanka’s short term external debt is nowhere near this figure, the Central Bank of Sri Lanka requested Nomura to correct the errors in their computations.1

In response, according to Bloomberg, Nomura has “corrected their ‘Damocles’ report to fix Sri Lanka’s short term debt figure to be US dollars 7.5 billion” in an emailed statement to media. Nomura has, however, kept the ‘Damocles score’ for Sri Lanka unchanged. 2

The Central Bank wishes to point out that the ‘Damocles score’ published by Nomura is a rudimentary attempt to build an index based on eight indicators and threshold values for the selected indicators.

The score is then used to show the likelihood of crisis in a country in the period ahead. A score of above 100, according to Nomura, suggests a country is vulnerable to an exchange rate crisis in the next 12 months, while a reading above 150 signals that a crisis could erupt at any time.

Nomura has computed Sri Lanka’s score at 175, while assigning lower values to countries that are currently facing severe economic and financial strains. Any methodology that yields outcomes whereby Sri Lanka’s score is substantially worse than countries like Argentina, Turkey, and South Africa does not appear to be sufficiently nuanced to capture market realities and dynamics.

A closer look at Nomura’s ‘Damocles score’ for Sri Lanka shows that it has remained above the 100 continuously since 2012 except for a few months in 2013/14. At times, the ‘score’ has even hit the upper bound of 200. Therefore, it is evident that in the case of Sri Lanka, this rudimentary index cannot be considered an indicator/predictor of crisis.

It is because the score does neither consider a particular country’s distance from threshold values nor the country-specific circumstances, that Sri Lanka is listed as a country that is at greater risk of crisis than countries like Argentina and Turkey.

For example, in the Nomura analysis, the short term external debt to exports ratio includes goods only. Services, including tourism, and remittances are excluded. By not focusing on all current account flows, the ‘score’ exaggerates the country’s vulnerability. Moreover, the broad money to foreign reserves ratio does not properly interpret the cause of the increase in the former. The recent increase in broad money was due to an increase in the net foreign assets (NFA) of the banking system, which has, in fact, reduced the country’s external vulnerability.

The real short-term interest rate indicator for Sri Lanka is also marginally above Nomura’s threshold. This has been caused by a reduction in inflation rather than an increase in interest rates. These examples demonstrate how the binary methodology used by Nomura could be misleading.

Nomura’s error in relation to Sri Lanka’s short term external debt figure itself shows that the said report has not undergone a thorough review before publication. Indeed, the rigourousness of any analysis based on the predictive power of an index, which cannot differentiate between short term debt of US dollars 7.5 billion and US dollars 160 billion, in an economy with a GDP of around US dollars 90 billion and gross official reserves of around US dollars 8.6 billion, is questionable.

Therefore, the investors and the general public are advised to form their own informed opinion with regard to Sri Lanka’s macroeconomic conditions and potential.

Note

1. Sri Lanka’s short term external debt and liabilities, based on the general definition that uses original maturity, are currently estimated at around US dollars 7.7 billion, while these liabilities are estimated at around US dollars 14.3 billion under the broadest definition that includes long term debt falling due in the next one year period and the total foreign holding of rupee denominated long term Government bonds

Latest Comments

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