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Thursday February 9th, 2023

Sri Lanka’s problem linked to insolvency, not liquidity: Harsha

THE SLIDE: Sri Lanka current BOP slide began with a policy reversal around August 2019.

ECONOMYNEXT – Sri Lanka’s external problem is linked to medium and long term solvency requiring debt restructuring and is not a short term liquidity problem that can be solved by swaps, Harsha de Silva, an opposition legislator said.

Sri Lanka’s 2022 sovereign bond, which was issued at 5.75 percent was now trading at 46 percent, and Sri Lanka could no longer to go international markets to borrow, he said.

“That is the confidence the international markets have in us,” he said. “Then how can we go and take a loan from the international market to fulfill our requirements?”

Despite import controls, Sri Lanka’s imports were continuing, with some imports higher than last year, he said.

Long Term

Foreign reserves were falling. The solution put forward was to get central bank swaps.

“So there is a problem, but the government has analysed this problem as a problem in liquidity,” de Silva said.

“They said that they will solve this problem through a swap of 1.5 b dollars from and another one billion dollar swap from India and another loan of 700 million from China,” he said.

But the problem was not a short term liquidity problem that that could be solved by swaps, he said.

“I see this not as a liquidity problem but as an insolvency problem, whether we can fulfill the medium and long term financial responsibilities of the country,” he said.

There was a gap between reality and the picture painted by government spokesmen, he said.

If solutions are delayed, the blow on the people would be harder, he warned.

“We should restructure our debts, if the government do that then they will be able to find a medium-term solution to this problem,” he said.

Sri Lanka’s gross official reserves were down to 4,557 million US dollars by 2021 was barely enough for about three months of imports at around 1,500 US dollar a month, he said.

“This is a very dangerous situation, generally in economics, we measure the reserves to how many import months is it enough,” de Silva told reporters in Colombo.

Describing reserves in terms of foreign reserves is a yardstick used by some analysts to measure ‘reserve adequacy’.

Before Keynesian interventionism involving ‘flexible’ policy led to frequent currency collapses, the reserve backing of a currency issue – like the gold standard – was a tool to maintain monetary stability and served as a check against central bank excesses.

Pegged central banks do not use foreign reserves to pay for imports for months on end in practice, unless money is steadily printed (liquidity injections made) and there is an ongoing currency crisis where forex sales are sterilized with new liquidity injections.

Peg

In a consistent pegged regime, the monetary authority supplies an unlimited amount of foreign exchange to maintain a fixed exchange rate, triggering contraction in reserve money (reduction in bank rupee reserves) and a spike in short term rates, forcing bank credit to be sequenced and rationed at the margin.

Rupee reserves in banks may be used for import generating credit, credit to buy dollars to repay foreign debt, or to buy assets from fleeing foreign investors, any of which will crowd out other credit, as long as no new liquidity injections are made.

Imports and other forex outflows are therefore matched and sequenced to inflows in a consistent peg with no additional injections.

In practice, in a working pegged system with high credibility, forex losses to trigger a reserve money contraction and tighten liquidity may be measured in weeks (or days) rather than months, analysts say.

A forex sale by the monetary authority to maintain a peg will ration credit below the available new deposits and loan repayment inflows in banks. A forex purchase which injects new liquidity will enable credit over and above deposits and loans repayments in to the banking system, matching outflows of forex to inflows through the credit system.

Therefore there is no depreciation and the peg (external anchor) is kept.

Floating

In a true floating regime the central bank does not supply a single dollar to the forex market.

Therefore the monetary base and interest rates are unchanged by foreign exchange flows and credit is automatically rationed to the available deposits and loan repayments in the banking system.

A floating regime matches outflows to the inflows by not altering the monetary base for all intents and purposes, because liquidity is trapped within the domestic credit system even if there is an increase in cash use, unless currency is physically exported.

As part of measures during the East Asian crisis – mis-reported in international financial media as ‘exchange controls’ – Bank Negara Malaysia slapped limits on the export of ringgit notes.

Related

Solving Sri Lanka’s debt and monetary crisis sans the IMF, like Japan, Malaysia: Bellwether

However the exchange rate may change in the short term (float) due to timing differences in inflows, credit and outflows. The day to day differences are smoothed out by bank net open positions and buyers and sellers who may delay transactions for few days for a better rate. Such currencies do not depreciate and tend to be strong.

The strength of the exchange rate (and real changes in reserve money) is based on the inflation target (domestic anchor) and how successfully the target is reached.

Most floating exchange rates with a low inflation target (below 2 percent) are strong and are usually referred to by Mercantilists as ‘hard currencies’ analysts say.

Since a floating regime matches outflows of dollars to inflows by not changing reserve money and a pegged exchange regime matches inflows to outflows by changing the reserve money in-step on a daily basis, the systems operate in diametrically opposite ways.

Countries get into trouble when intermediate regimes which are neither true (hard) pegs nor true floats are operated.

They may also flip regimes back and forth suddenly and rapidly (flexible exchange rate) dooming them to regime conflict, triggering monetary instability involving currency crises, low growth and eventually default, analysts say.

Many East Asian pegs have kept rates slightly above the required rate to match forex reserves to domestic money supply, rationed credit in excess and built up large forex reserves exceeding the domestic money supply by selling central bank securities to the banking system and exporting savings below-the-line to an extent more than a neutral hard peg (currency board) would have done.

Latin American nations and Sri Lanka sometimes over-rations credit selling central bank (or CB held) securities to banks, keeping rates above what is required to keep the peg, building forex reserves, and then buys back securities keeping rates lower than required, injects liquidity and loses reserves triggering collapses.

Beginning of the end

Sri Lanka’s current monetary instability began on or around August 2019, when prudent policy ended and output-targeting-with-a-peg began, analysts who closely follow the country’s monetary policy errors and currency crises say.

Sri Lanka was withdrawing excess liquidity from the banking system until July 17, and selling down the central bank’s securities holdings to the banking system, keeping rates slightly higher than required for a neutral peg.

Related

Sri Lanka’s central bank buys US$129mn to peg rupee in July

However by August 07 policy reversed.

At the time the central bank was given full independence by political authority to target an output gap, despite its monetary law having a mandate only for ‘economic and price stability’.

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Sri Lanka prints Rs2.2bn 10-month money below overnight policy rate

Sri Lanka’s killer ‘flexible exchange rate’ strikes again: Bellwether

Monetary instability and capital flight then followed.

Related

Foreign investors exit Sri Lanka rupee bonds for second week

Sri Lanka rupee closes below 181 to US dollar in ‘flexible exchange rate’ policy

In August 2019 when monetary policy reversed and money printing to target an output gap started, Sri Lanka’s gross official reserves made up of the central bank’s monetary reserves linked to reserve money and finance ministry dollar balances were 8.5 billion US dollars.

Up to July 2019, the central bank had collected 354 million US dollars from forex markets and steadily mopped up liquidity. Te central bank was buying dollars on a net basis every month.

After policy reversed only 32 million US dollars were collected on a net basis for the rest of the 2019.

In 2020 unprecedented money printing started under so-called Modern Monetary Theory after tax cuts in December 2019 further eroded state revenues putting more pressure on the domestic credit system and triggering downgrades.

Related

Sri Lanka posts record US$2.32bn BOP deficit in 2020 with MMT

In 2020 Sri Lanka ran a balance of payments deficit of 2.3 billion US dollars. (Colombo/Mar09/2021)

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Thousands of Sri Lankans protest against tax hike

ECONOMYNEXT – Thousands of Sri Lanka’s highly paid state workers protested against tax hikes, citing it as ‘unfair’ with most of them have been caught into the tax brackets for the first time.

The tax hike protest also saw hundreds of private sector workers also gathered in Colombo Fort, demanding a downward revision of the newly implemented taxes.

The protesters later went to a central Colombo Hyde Park to continue their agitation after a court order issued them to clear the area.

Under a theme of ‘Repeal Oppressive Tax Refers’, workers representing 40 trade unions including all private and public sector banks, university lecturers, Port Authority, Ceylon Electricity Board (CEB), Government Medical Officers of Health participated in the protest.

“We don’t mind paying taxes, we know we have to contribute to government revenue,” K L Chandana, representing CEB Engineer’s Union told EconomyNext.

“Moving from one tax bracket to a higher tax bracket is unrealistic, especially with the inflation and global factors. Earlier we were in the green to pay taxes because the country wasn’t in hyperinflation and we had a better quality of life, but our income don’t match with inflation. So there’s no way we can squeeze another expense.”

The ongoing economic crisis has forced President Ranil Wickremesinghe’s government to impose high PAYE and personal income taxes up to maximum 36 percent depending on their income.

A person who paid a tax of 9,000 rupees on a 400,000-rupee monthly income will now have to pay 70,500 rupees as income tax, the latest data showed.

The government took a step back to exempt some allowances partially including for fuel, driver, and vehicle, a government document showed.

“We don’t mind paying fair taxes, we paid them earlier,” Udaya Ekanayake, an Administrative officer from Anuradhapura told Economynext.

“We are opposed to taxation because it is not in line with the economic crisis, inflation is exceeding 50 percent and we are being taxed by 32 percent.”

Meanwhile, the Government Medical Officers Association Media Spokesman, Chamil Wijesinghe said, the protest was the first warning and that if the government fails to respond, the unions will bring the country to a standstill.

“If the government still can’t understand, we are ready to take further actions and we will make the country come to a standstill,” Wijesinghe said.

A renowned actor and a new member of the Ceylon Mercantile Industrial Union Peter d’ Almeida told EconomyNext that the government should bring in higher corporate taxes and taxes on the super-rich reducing the burden on the general public.

“These people had enough of the burden which has been placed on people, with the so-called tax reforms and increased price in utilities, and the general increase in the cost of living,” Almeida told EconomyNext.

“And the sad part is people who ruined this country are still in power and it is people who have nothing to do with this facing the burden of rebuilding the country.
That is unacceptable.”

“A very high cooperate tax and taxes on super rich including wealth and capital gains should be in order.”  (Colombo/ Feb 08/2023)

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Sri Lanka stocks edge up after President’s policy statement amid protests 

ECONOMYNEXT – Sri Lanka shares edged up on Wednesday on dull sentiments over rising protests against tax hikes, which is also expected to hit corporate earnings in the face of reduced consumption, analysts said.

“The President’s address in Parliament assured that the country would be seeing tough times in the road to recovery and that taxes are here to stay,” an analyst said.

Protests were staged against the tax hikes on Wednesday in capital Colombo citing it is “unfair” and does not comply with cost of living especially since income has not reflected inflationary hikes.

If protests resurface, investors could pull down investor momentum towards shares, the analyst said.

“The investors are looking at a positivity towards the IMF, there is no concrete confirmation on that but they are looking at a positive direction with the IMF,” the analyst said.

All Share Price Index (ASPI) edged up by 0.13% or 11.59 points 8,987.45

“Investors are willing to invest if macroeconomic conditions come into place and there are further developments to an assured IMF deal,” an analyst said.

President Wickremesinghe said that Sri Lanka had reached the final stage of negotiations with the International Monetary Fund and that a basic agreement last September was agreed for and now there is the debt sustainability program.

The Central Bank expects the IMF deal to be finalized by the end of the first quarter or fist month of second quarter.

Sri Lanka got assurances from India, Paris Club and China towards debt restructuring in order to secure 2.9 billion dollars for an IMF loan.

The IMF has so far only accepted the letter of debt re-structuring sent by India.

However, the IMF has still not approved restructuring assurances from Paris Club and China.

China’s Exim Bank has given Sri Lanka a two-year moratorium on its defaulted loans and will discuss additional re-structuring within the ‘window’, the Chinese Foreign Ministry spokesperson Mao Ning said last week,

“The international support demonstrates that we are on the right path,” President Wickremesinghe said.

John Keells Holdings has been receiving high amounts of foreign buying after announcements with regard to the opening of Cinnamon Life in 2025.

The most liquid index S&P SL20 closed down at 0.09 percent or 2.63 points to 2,782.56.

The market saw a turnover of 1.1 billion rupees today, comparatively lower to the year’s daily average of 1.9 billion rupees, and significantly lower than the 2022 average turnover of 2.9 billion rupees.

The bourse saw a net foreign inflow (NFI) of 291 million rupees.

Top losers during the closure was HNB, LOLC, DFCC.

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Sri Lanka opposition mum as monks burn India-backed constitutional amendment

ECONOMYNEXT – As sections of Sri Lanka’s Buddhist clergy took to the streets against a proposed full implementation of an India-backed constitutional amendment to resolve Sri Lanka’s ethnic issue, the country’s opposition parties remained mum on the protests and on their own stance on devolution.

Opposition National People’s Power (NPP) leader Anura Kumara Dissanayake when asked by a journalist about the monks’ protest on Wednesday February 08 claimed that President Ranil Wickremesinghe had set a trap.

“I ask the people of this country to not get caught in this trap. What Wickremesinghe wants is to brush the real problems aside and bring out other problems to create a disturbance in society,” said Dissanayake.

The NPP leader said President Wickremesinghe will not fully implement the 13th amendment to the constitution as repeatedly assured by him.

“He won’t bring it. He plays this game every time. He wants to set fire to this country and protect his power,” he said.

Dissanayake did not elaborate on his party’s position on the 13th amendment.

A group of Buddhist monks staged a protest against the amendment near the parliament complex Wednesday morning as President Wickreemsinghe told MPs that he is committed to devolving power within a unitary state as a permanent solution to the island nation’s decades-long ethnic issue.

Tensions rose at the protest as police tried to block the monks who only dispersed after an official from the presidential secretariat spoke to them and assured a response from the president.

Some of the monks set fire to a copy of the 13th amendment in full view of the media and police personnel in a scene that was eerily reminiscent of Wickremesinghe’s United National Party (UNP) burning a draft bill of a new constitution presented to parliament by former President Chandrika Bandaranaike Kumaratunga’s government in 2000 also a solution to the conflict.

Meanwhile Sri Lanka’s main opposition the Samagi Jana Balawegaya (SJB) has yet to make its views known on the rising opposition to the 13th amendment from nationalist quarters.

A small number of MPs on both sides of the aisle have expressed their opposition, but the president has said he will go ahead with full implementation.

The SJB boycotted a recent all-party conference (APC) on the ethnic issue but said it supports devolution of power, though the party has yet to articulate its position on the amendment’s full implementation.

Wickremesinghe told parliament on Wednesday that there will be no division of the country, contrary to fears expressed by some Buddhist monks.

Related:

Sri Lanka president reiterates commitment to devolution within unitary state

The 13th amendment to Sri Lanka’s constitution emerged from the controversial Indo-Lanka Accord of 1987 as a purported solution to the worsening ethnic conflict, four years after war broke out. Provincial councils came in the wake of this amendment, though land and police powers have yet to be devolved to the provinces as originally envisioned. Both Sinhalese and Tamil nationalists have historically opposed the amendment, the former claiming it devolved too much, the latter complaining it didn’t devolve enough.

A full implementation of the amendment would see land and police powers devolved to the provinces, a development that is not likely to garner support from Sri Lanka’s more nationalist-oriented parties including sections of the ruling Sri Lanka Podujana Peramuna (SLPP).

Meanwhile, India has expressed its support for Wickremesinghe’s assurances that the amendment will be fully implemented. India’s support is crucial to the cash-strapped island nation as it struggles to recover from its worst currency crisis in decades. India has officially communicated to the International Monetary Fund (IMF) that it will support Sri Lakna’s debt restructuring process, which is a prerequisite for a desperately needed 2.9 billion dollar IMF bailout.

The leftist Janatha Vimukthi Peramuna (JVP), which controls the NPP, staged a violent insurrection in the late 1980s in opposition to the Indo-Lanka Accord. Former President Ranasinghe Premadasa also opposed the accord signed by his predecessor President J R Jayawardena.

Meanwhile, Jaffna district MP an former Northern Province Chief Minister C V Vigenswaran on Wednesday welcomed the president’s decision, while noting however that the 13th amendment falls short of the aspirations of the Tamil people.

Related:

Sri Lanka reconciliation: Vigneswaran backs president, wants monks not to interfere

(Colombo/Feb08/2023)

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