ECONOMYNEXT – Sri Lanka has transferred the balance remaining of Ceylon Petroleum Corporation bank debt to the central government, official data shows, as part of restructuring state enterprise balance sheets under an International Monetary Fund program
State-run banks gave over loans to the Ceylon Petroleum Corporation as forex shortages emerged from inflationary rate cuts (rates suppressed with reverse repo operations or sterilized dollar sales interventions).
In December 2023 credit to state corporations went down by 350 billion rupees to 769.8 billion rupees (about a billion US dollars) while credit to government, which includes new debt taken (mostly to roll over interest), went up 562.5 billion rupees to 8,285 million dollars, central bank data showed.
In April 2023 SOE credits went down by 516 billion rupees.
State banks gave loans to the CPC when rates were cut with printed money under a flexible inflation targeting framework, including when fuel was market priced under as formula by then Finance Minister Mangala Samaraweera under the nose of an IMF program.
Under flexible inflation targeting cum potential output targeting, money is printed to cut rates as soon as inflation falls to near zero, which coincides with a recovery in private credit from the previous crisis, leading to a fresh round of forex shortages.
The CPC is then made to borrow first through dollar supplier credits, though the agency has miniscule dollar revenues (mostly aviation fuel) which are then converted to state bank loans, usually after the currency collapses, triggering large losses to the entity.
When fuel is market priced, CPC’s own cash balances end up as deposits including repo transactions in state banks which are loaned to private creditors, to make investments and more imports, nullifying any benefits from market pricing fuel.
In the absence of central bank inflationary monetary operations, non-oil imports should fall to match the real incomes of the country. The borrowings on the other hand also widens the current account deficit.
Analysts have pointed out that inflation targeting with a de facto pegged exchange rate (a central bank in which net foreign assets go up and down with corresponding changes in net domestic assets), and the belief that rates can be cut when inflation falls, is a fundamental flaw in recent IMF programs, which shunts countries into repeated cycles of external crises.
CPC borrowings after rate suppression (macro-economic policy) has been a recurring policy error in the country.
Before 2018 foreign loans partly or fully financed CPC losses. CPC losses and borrowings should lead to a rise in market rates, but due to a fixed policy rate, liquidity is injected to suppress rates. Under a fixed policy rate, a drought which leads to fuel imports financed by bank credit, without a hike in tariffs, can lead to forex shortages.
Loans it was made to take from Iran in a currency crisis around 2000 is still outstanding.
In that crisis, Sri Lanka’ economy also contracted.
When rates are cut with reverse repo injections or standing facilities, central government net foreign debt also soars in the same way as the CPC, reserves being run down to repay installments or new debt taken to pay up maturing debt, outside of the annual deficit financing requirement.
As rates are hiked to stabilize the external sector and restore the lost confidence in the money of the state central bank, the deficit and debt to GDP ratio goes up, tax revenues get hit and the incumbent government usually loses office in the stabilization period.
Budget deficits in the stabilization year are usually higher than the year in which the crisis was triggered, with nominal interest rates also soaring, though ‘deficits’ are eventually blamed for the problem.
After several cycles of flexible inflation targeting and potential output targeting (printing money to push growth), which led to a rapid rise in net foreign debt Sri Lanka defaulted in 2022 after running out of reserves.
Countries with reserve-collecting central banks that do not try to cut rates with reverse repo injections but allows rates to market-price, end up with low nominal interest rates comparable to developed nations, as well as steady growth without frequent external crises or currency depreciation.
At the moment rate cuts have been ‘paused’ by central bank governor Nandalal Weerasinghe and monetary policy has been largely deflationary, except for several outright purchases of longer term bonds. (Colombo/Feb05/2024)