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Tuesday May 28th, 2024

Sri Lanka’s central bank makes more than Rs500bn in profits to June 2023: analysis

ECONOMYNEXT – Sri Lanka’s central bank has made profits of around half a trillion rupees, helped by foreign exchange gains on a negative net open position as well as profits on domestic assets in the six months to June, an analysis of official data showed.

The central bank’s equity, which is roughly a measure of profits, grew by 575 billion rupees from December 2022 to June 2023.

The profit measured in the profit and loss account may differ due to adjustments to other comprehensive income or other items, including profit transfers.

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The central bank’s net foreign assets which were negative fell from 1.6 trillion rupees in December 2022 to 963 billion rupees in June based on monetary survey data.

Sri Lanka’s central bank in the course of cutting rates in 2020-2021 borrowed dollars from the Reserve Bank India, Bangladesh Bank and the International Monetary Fund (it already had a negative position on an IMF loan) to target an output gap.

In 2022 the central bank also borrowed money from India through the Asian Clearing Union, which was busted and sterilized with new domestic money, widening a balance of payments deficit, not necessarily to target an output gap, but because they were available.

As a result, the central bank ended up with negative net open position of about 4.4 billion US dollars by December 2023 or 1.6 trillion rupees and forex losses of 788 billion rupees.

RELATED Sri Lanka central bank makes Rs788bn forex loss in 2022, net loss Rs374bn

Swap Hazard

Central banks which do not have access to swaps are forced to make interest rate corrections earlier. However after the US Fed invented swaps in the money printing bout that killed the Bretton Woods system, other central banks started to do the same.

Central banks which mis-target rates may also engage in swaps with domestic agents, or foreign funds and create money.

In the course of the East Asian crisis, central banks which do not usually cut rates to boost growth and had no domestic assets in the balance sheet (including Bank of Thailand) were brought down with liquidity created through swaps with hedge funds.

Before swaps, Sri Lanka’s central bank which usually had some reserves left used to make profits in a currency collapse from both domestic assets (interest earnings) and residual reserves (unrealized exchange gains).

In a new central bank law legislators have not barred inflationist macro-economists from borrowing through swaps, creating money and running large losses in the course of targeting an output gap or engaging in open market operations in the future.

Latin America style central banks whose currencies collapse due to mis-targeting rates (inflationary open market operations or liquidity injections made to cut rates against domestic credit and balance of payments developments) and borrow money through swaps or from the IMF rarely see currency appreciation.

The IMF also advocates monetary debasement in the hope of cutting real wages of workers and boosting temporary profits of export firms (competitive exchange rates) at the cost of falling living standards, social and political unrest and losses to energy SOEs.

However, under Governor Nandalal Weerasinghe, the rupee was allowed to strengthen. The REER index is also below 100 due to a very fast fall in the currency in March.

With negative private credit and an appreciation of the currency, index measured price-inflation was stopped in its tracks from around September 2023, in the style of countries that dollarized after severe macro-economic policy.

Sri Lanka’s rupee appreciated from 363 to 308 to the US dollar from December to June.

The rupee has since fallen back to 324 to the US dollar, taking away some of the profits.

Profits from Inflation

A central bank which has printed money also makes profits on its domestic asset book, from interest earned from the government securities.

A central bank is fully owned by the government and its profits can be transferred or cancelled against government liabilities, which has important implications on budget deficits, net foreign debt, net domestic debt and IMF assumptions on debt to GDP ratios.

A central bank balance sheet, appropriately restrained by law, can result in a swifter fall in foreign and domestic debt based on IMF calculations in a debt sustainability analysis.

Rejecting Classical Economics

Countries started to suffer balance of payments deficits from the 1920 due to mistaken ideas about monetary systems that emerged among Anglo-American academics who increasingly had influence over central banks which were previously run by banking practitioners, analysts say.

Private central banks like the Bank of England and Reserve Bank of India were restrained restrained through the customers (convertibility undertaking) as well as by laws like the Peel Act, before nationalization based on laws of nature discovered by classical economists which restricted the activities of the issue department (now called domestic operations or open market operations).

Widespread defaults started from the 1980s among countries which did not float or hard peg and had intermediate regimes with conflicting anchors (what are now called flexible exchange rates) and engaged in aggressive open market operations in failed attempts to run credit cycles independent of the Federal Reserve.

A central bank whose open market operations are adequately controlled by the parliament can prevent a future default, depreciation, inflation and social unrest, by bringing back sound money and defeating the inflationism of 20th century Anglo-American macro-economic policy, analysts say.

In a planned domestic debt restructuring plan authorities have cut interest coupons on some central bank held government securities (large volumes of which were acquired to prevent the roll-over of Treasury securities issued to finance past deficits or to sterilize interventions and finance unsustainable private sector credit and imports) effectively transferring profits to the government if market rates are higher.

Under the old central bank law, profits cannot be transferred if large volumes of money were printed in the past year, even if there were no accounting losses from dollar borrowings due to safeguards put in place by the architect of its constitution, John Exter, who was skeptical of macro-economic policy despite studying at Harvard University.

Any central bank profit transfers made as liquidity will result in forex losses and monetary instability. In countries like Singapore such reserve money altering transactions are prohibited. (Colombo/Aug29/2023)

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Sri Lanka risks foreign retaliation over VFS visa deal

ECONOMYNEXT – The Maldives could take reciprocal action after Sri Lanka’s new system of outsourcing its visas, which requires the payment of “processing” and “convenience” charges of 26 dollars, even though the government does not collect any fees.

Maldivian authorities have reminded Sri Lanka of the long-standing bilateral agreement under which their citizens could travel freely between the two neighbours without any charges or bureaucratic barriers.

A one month stay is available without a fee.

Maldivians, who consider Sri Lanka their second home, often spend more than a month in the larger country, but are now required to pay 26 dollars to VFS Global, which has controversially been contracted to handle Sri Lankan visas.

“The Sri Lankan government will not charge a fee, but Maldivians still have to pay VFS after applying online for a visa,” a Maldivian government official said in the capital, Male. “This violates the spirit of our agreement.”

He said the new administration of President Mohamed Muizzu was taking up the issue with Sri Lankan authorities in both Male and Colombo.

In a worst-case scenario, the Maldives will be compelled to reciprocate the new cost of a Sri Lankan visa and charge Sri Lankans traveling to the archipelago. There are also expat Sri Lankans in the Maldives.

There are only a handful of countries to which Sri Lankan passport holders can travel without any visa restrictions.

Singapore is another country which could take action against Sri Lanka if the bilateral deal is found to be violated, according a source said.

Opposition parties have said in parliament that outsourcing the visa handling to VFS Global and their partners was a bigger corruption scandal than the bond scam of 2015 and 2016, when billions of rupees were stolen through insider deals. (COLOMBO/May 28, 2024)

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Sri Lanka’s WindForce Plc rated ‘BBB+(lka) with stable outlook: Fitch

ECONOMYNEXT – WindForce Plc said Fitch Ratings Lanka Ltd had assigned a ‘BBB+(lka)’ rating for the company with stable outlook.

“The rating reflects WindForce’s large exposure to Ceylon Electricity Board (CEB, BB+(1ka)/Stable) as the key offtaker. The Stable Outlook reflects Fitch Ratings’ view that risks of significant payment delays from CEB to WindForce has decreased, easing liquidity pressure,” the company said in a stock exchange filing.

The full Rating Action Commentary by Fitch Ratings Lanka Ltd:

Fitch Publishes Sri Lanka’s WindForce’s ‘BBB+(Ika)’ National Rating; Outlook Stable.

Fitch Ratings – Colombo – 22 May 2024: Fitch Ratings has published Sri Lanka-based independent power producer WindForce PLC’s ‘BBB+(Ika}’ National Long-Term Rating. The Outlook is Stable.

The rating reflects WindForce’s large exposure to Ceylon Electricity Board (CEB, BB+ (Ika)/Stable) as the key offtaker. The Stable Outlook reflects our view that risks of significant payment delays from CEB to WindForce has decreased, easing liquidity pressure. However, Fitch believes medium-term risks to weaker collections of CEB’s dues
remain, and this is subject to the consistent implementation of CEB’s cost-reflective tariff mechanism.

Key rating drivers

Improving Receivables Collection: We expect WindForce’s receivable days to remain at around 80 in next 12 months. This is based on our expectation that CEB will continue to settle its payables, following improvement in its financial profile from cost-reflective tariff revisions. WindForce’s receivable days fell to around 198 days by December 2023, from 348 days at the end of the financial year 31 March 2023 (FY23). The company says it received further payments in 1Q24 that improved its receivables materially.

Weak Counterparty Profile: WindForce’s rating is constrained by the weak credit profile of its key offtaker CEB, the sole electricity transmitter and distributor in Sri Lanka, despite CEB’s improved financial performance. CEB’s rating is ultimately contingent upon support from the Sri Lankan sovereign (Long-Term Local-Currency Issuer Default Rating (IDR): CCC-; Long-Term Foreign-Currency IDR: Restricted Default) and its weak credit profile.

WindForce derived an average 80% of its EBIT from CEB in FY23-9MFY 724, with balance coming from its Ugandan operations. We expect WindForce’s cash flow exposure to CEB to increase further in FY25-FY27 with the commissioning of a 1OMW solar project in Kebithigollewa and a 1OOMW solar power plant in Hambantota in Sri Lanka.

Risks to Cost-Reflective Tariffs: Fitch believes there are risks to consistent implementation of cost-reflective tariffs, affecting the credit profile of domestic power generation companies. This is because of the government’s competing priorities: managing inflation, CEB’s financial health and the state’s own finances. We have assumed WindForce’s receivables days will deteriorate to 100 by FY27 as a result, but a longer record of consistent implementation could support a moderation of these risks.

The Sri Lankan government has implemented a cost-reflective tariff mechanism since mid-2022, to ensure CEB’s operating costs and interest obligations are covered. The new mechanism supports break-even operating cash flow for CEB, as of its latest financial year. This has enabled CEB to clear part of its overdue payments to trade creditors over the past 12 months. The tariff regulator – the Public Utilities Commission of Sri Lanka – approved lower tariffs by an average of 21.9% in its March 2024 review, which is a greater decrease than CEB’s proposal, reflecting the risks.

Investments Weigh on Free Cashflow: We estimate negative free cash flow (FCF) in FY25-FY27, due mainly to high capex and investments. This is despite improving operating cash flow from a shorter working capital cycle and newly commissioned projects. WindForce expects to invest USD12 million for the 30% stake in a LOOMW solar project in Hambantota in FY25-FY27.

Moderate Leverage; Adequate Coverage:
We forecast WindForce’s EBITDA net leverage to rise to 2.5x in FY25 (QMFY24: 2.0x) and 4.2x in FY26 on higher capex. However, interest coverage should strengthen to 3.7x in FY25 (9YMFY24: 3.1x) due to falling domestic interest rates even as debt increases. Sri Lanka’s monthly Average Weighted Prime Lending Rate fell to 10% by end-April 2024, from the peak of 28% in December 2022. Around 70% of
WindForce’s loans carried variable rates as of end-2023.

Steady EBITDA Margin: We expect the EBITDA margin to remain around 70% in FY25-FY27. WindForce’s power purchase agreements (PPA) offer long-term cash flow visibility, with a weighted-average remaining contract life of around 12 years, but production volume is affected by seasonal and climatic patterns. This is mitigated by its diversified portfolio, comprising wind (74MW), solar (38MW) and hydro (15MW) power plants, totalling to 127MW excluding associates and joint ventures.

Derivation Summary

WindForce is rated two notches below domestic power producer and engineering, procurement and construction contractor Lakdhanavi Limited (‘‘A(Ika)/Stable). The difference is on account of Lakdhanavi’s larger operating scale, and geographic and business diversification.

Both Lakdhanavi and WindForce have significant exposure to CEB. However, Lakdhanavi has operations and maintenance (O&M) services, manufactures transformers and switchgears, and offers galvanizing services. We also believe CEB is likely to prioritise payments to Lakdhanavi in a stress scenario, given Lakdhanavi provides O&M services to one of Sri Lanka’s largest power plants, and is investing in a large liquefied natural gas power plant, both of which are critical to CEB’s future strategy.

Resus Energy PLC (BBB(Ika)/Stable), a domestic power producer, is rated one notch below WindForce. WindForce’s higher rating is driven by a comparatively better liquidity position with sufficient cash flow to cover near-term maturities and better diversification in power generation sources and geographies.

Vidullanka PLC (A+(Ika)/Stable) is a renewable power producer with operations in Sri Lanka (35MW) and Uganda (13MW). WindForce is rated three notches below Vidullanka, despite the latter’s smaller scale. Vidullanka has lower counterparty risk and lower exposure to CEB, as 80% of its EBIT came from its Uganda projects in FY23.

Key assumptions

Fitch’s Key Assumptions Within the Rating Case for WindForce:

– Revenue to increase by 14% in FY25, mainly driven by commissioning of 1OMW Kebithigollewa power plant and 15MW Hiruras power plant’s first full year of operation;

– EBITDA margin of around 70% in FY25 and FY26;

– Receivable days at 80 in FY25;

– Capex of LKR2.5 billion in FY25 and LKR6.0 billion in FY26;

– Investments of around LKR2.0 billion a year in FY25 and FY26 in associate companies;

– Dividend payout of 80% of prior year profit.

Rating sensitivities

Factors that could, individually or collectively, lead to positive rating action/upgrade

-A sustained and substantial reduction in counterparty risk, as reflected in a significant improvement in CEB’s credit profile.

Factors that could, individually or collectively, lead to negative rating action/downgrade

-Deterioration in liquidity, including due to delayed receivables collection or challenges in refinancing;

-EBITDA net leverage above 5.5x for a sustained period;

-EBITDA interest coverage below 1.5x for a sustained period.

Liquidity and debt structure

Liquidity Subject to Counterparty Health: WindForce’s liquidity is subject to timely collections of dues from CEB. It had around LKR2.9 billion readily available cash and cash equivalents as of end-2023, with around LKR6.3 billion of unused but uncommitted credit lines from domestic banks, against LKR2.2 billion of debt maturing in the next 12 months. Maturing debt mainly comprises the current portion of long-term debt obtained to fund the investments in its power plants.

We expect the company to generate negative FCF in the near-to-medium term due to high capex. However, WindForce has adequate access to domestic banks, as most banks are willing to provide longer-tenured facilities for the company’s operating power plants that have more than 10 years remaining under their PPAs.

Issuer profile

WindForce is a leading renewable power producer in Sri Lanka, with total installed power generation capacity of about 163MW (including its share of associates and joint ventures) as of end-March 2024.

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Sri Lanka rupee opens broadly stable at 300.50/90 to US dollar

ECONOMYNEXT – Sri Lanka’s rupee opened broadly stable at 300.50/90 to the US dollar on Tuesday, from 300.50/70 the previous day, dealers said. Bond yields were steady.

A bond maturing on 15.12.2026 was quoted at 9.95/10.00 percent from 9.90/10.05 percent.

A bond maturing on 15.09.2027 was quoted up at 10.35/40 percent from 10.30/40 percent.

A bond maturing on 01.07.2028 was quoted up at 10.90/95 percent from 10.80/95 percent.

A bond maturing on 15.01.2030 was quoted stable at 11.60/80 percent.

The Colombo Stock Exchange opened down. The All Share Price Index was down 0.06 percent at 12,303, the S&P SL20 was down 0.06 percent at 3,649. (Colombo/May28/2024)

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