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Saturday May 25th, 2024

Sri Lanka’s rupee depreciation and economic crises; the deficit lie

DEFICIT NARRATIVE: In Sri Lanka the fiscal deficit rises in the stabilization year. The deficit barely rises in the year the forex crisis is triggered by targeting the call money rate, and in some cases it has remained flat in nominal terms as well.

ECONOMYNEXT – In Sri Lanka and in other countries with bad central banks like in Latin America, inflation and currency shortages are perpetuated by a series of false narratives repeated ad nauseum by the perpetrators until the public accepts them as true.

By these actions, inflationists escape accountability for money printing or the deployment of inflationary policy to trigger monetary instability by cleverly transferring the blame to the victims, which include not only the general public but also politicians who lose office.

In order to escape Sri Lanka’s 73 years of monetary instability which started with the setting up of the central bank and frequent trips to the IMF, it is important to examine the truth or otherwise of these claims.

This is the first of a series that will attempt to show how countries suddenly started to experience balance of payment deficits in the last century in peacetime and various narratives stopped any correction.

These red herrings were not developed in Sri Lanka, but by Western inflationists as ‘macro-economic policy’ advocated by US post-Keynesians in particular, undermined the Bretton Woods soft-peg system and the last vestiges of the gold standard were shattered.

The mis-labelling of monetary instability as macro-economic instability was also one of the ways the victims of central banks were misled.

But the most enduring and oft-repeated false excuse given by these inflationalist working within and without what were effectively ‘independent’ central banks of the West was that the budget deficit was the cause of forex shortages and inflation.

In Sri lanka in the year the central bank triggers the currency crisis, deficits have been stable or barely grown nominally, indicating that very small rises in rates early under a wide policy corridor would have prevented a currency crisis.

On the other hand, deficits tend to grow steeply in the year the balance of payments was brought back into surplus through a stabilization program, which tends to slow growth, push up rates, and the debt to GDP ratio.

In the next currency crisis, especially if there is commercial debt, the country tends to default.

The Deficit Lie/Fiscal Dominance

The false narrative around deficits goes like this: politicians expand the budget deficit and the central bank is subject to de facto (by the large deficit by itself) and de jure fiscal dominance through operational dominance by politicians or Treasury officials blocking rate hikes.

There are two problems with this claim. One is that there is no data to support this claim, especially in Sri Lanka, especially after the end of the civil war.

The other is that Treasury Secretaries in Sri Lanka have almost always been ex-central bankers, therefore, it is a problem of economists and not politicians or the general public anyway. Politicians are clueless in third world countries and when they had a clue, they did not interfere.

A close examination of recent currency crises shows these trends. Some of these trends are also present in older crises before the civil war started as well as in many countries including Latin America that experience peacetime currency collapses and default.

Trend One: the deficit expands in the stabilization year when currency crises are eliminated and the BOP returns to surplus. This deficit apparently is not subject to ‘fiscal dominance’ either de facto or de jure.

Trend Two: In the year the currency crisis is triggered and money printing suddenly expands, the deficit to GDP sometimes falls and nominally the increase is small.

Trend Three: The money printed in the year that the central bank triggers crises is disproportionately higher than any nominal increase in the deficit, compared to the previous year when there was monetary instability. This is because central banks trigger BOP deficits not by printing money for the current year deficit, but by printing money to buy back government debt held by banks from deficits decades ago to target the call money rate initially and then sterilize outflows as panic sets in.

The Recent Crises

In the 2008 crisis, which happened in the middle of an intensified war and the Great Financial Crisis, some of these factors were present, but it was also driven by capital flight within a stable exchange rate, but monetary policy was tight.

In the 2001 crises, which also took place in the middle of a war also some of the characteristics can be seen, though the currency collapse was steeper.

This column is prepared to make some allowances for war, since, even in classical liberal days, private central banks like the Bank of England got into trouble in wartime. It also must be kept in mind that the country that did not print money or printed the least was usually the victor. But there can be no excuse for peacetime monetary instability.

The trend of expanding deficits in stabilization years holds true even in war years. In 2001 for example, when monetary stability was restored and reserves were re-built with a BOP surplus of 219.8 million US dollars, the deficit went up steeply from 9.5 to 10.4 percent of GDP.

The nominal deficit went up from 119.4 billion rupees to 146.7 billion rupees, yet money printing was reversed by 5.7 billion US dollars.

In 2009, a stabilization year, the budget deficit went up from 309.6 billion rupees to 476.4 billion rupees, yet the BOP was in surplus with higher interest rates.

In peacetime currency crises came in rapid succession as money was printed to keep rates down as the economy recovered.

The Crisis year

In the 2011/12 currency crises the central bank triggered a BOP deficit of 1,059.4 billion rupees without a war as the economy strongly recovered and private credit recovered. The deficit in the crisis year of 2011 went up only by 5.2 billion rupees from 445 billion rupees to 450 billion rupees.

This deficit could have been easily managed if interest rates were allowed to move up a little. But the central bank printed 184.6 billion rupees that year to keep rates down and effectively finance the private sector.

In 2015, however there was a substantial increase in the deficit due to Yahapalana salary and subsidy hikes, where an excuse can be made that there was de facto or otherwise fiscal dominance.

However, the central bank started injecting money from the third quarter of 2014 before that government even came to office to suppress rates. As the deficit went up by 238.3 billion rupees the central bank printed 80.4 billion rupees, according to the rise in credit to the government, which however did not tell the whole story.

In 2016, when the deficit was reduced by 189.2 billion rupees to 640.3 billion rupees, the central bank printed 183.0 billion rupees.

Then, in 2017, the stabilization year, the deficit went back up to 733 billion rupees or 93.2 billion rupees and the central bank reduced its credit to the government by 188 billion rupees. In terms of GDP also the deficit fell marginally.

In 2018, in another currency crisis year, the budget deficit went up by only 27.3 billion rupees but the central bank printed 247.7 billion rupees as massive amounts of money was injected to target the call money rate and then sterilize interventions when foreigners fled re-financing the private banks to buy the debt.

In 2018 as well as in other crisis years, the budget deficit could have been easily bridged by a 100 or 200 basis point rate hike and reducing private credit or boosting savings, as the difference in deficits of the two years show.

Instead of which rates were cut in that year, just like in earlier crisis years. As a share of GDP, the deficit fell from 5.5 to 5.3 percent of GDP in 2018.

In 2019, the stabilization year, the budget deficit went up to 6.8 percent of GDP but the BOP came back into surplus. In rupee terms the deficit went up to 1,016 billion rupees from 760 billion rupees, but 109.6 billion rupees in central bank credit was reduced.

It can be very clearly seen that the budget deficit was not the problem, for the external deficit in the previous year as it was lower.

No Escape under Data Driven Monetary Policy

Then what is the problem?

The problem is data driven monetary policy, or the belief that rates can be cut with printed money to get easy growth, when inflation falls.

In 2015 when the deficit went up, the central bank had no business cutting rates. The central bank was already printing money from the third quarter of 2014 and running forex shortages.

Yet the agency cut rates in April 2015 suicidally and injected money to target the call money rate claiming inflation was low.

Based on this argument it was justified in doing so under data driven monetary policy, where econometrics triumphed over laws of nature.

In 2018 it cut rates while the deficit was down. The excuse at the time was that fiscal policy was tight, therefore monetary policy must be loose to boost growth.

That is the time it was quite evident that Sri Lanka had no future. The central bank would print money whether the deficit expanded or narrowed. The people and the economy had no escape from monetary instability.

To suggest that Mangala Samaraweera or Eran Wickremeratne was putting pressure on the central bank to print money does not hold water. Harsha de Silva publicly asked rates to be raised.

Whatever the fiscal authorities did was not relevant, the central bank would cut rates and trigger currency crises as soon as private credit recovered.

And post the currency crises, 12-month inflation tends to fall around the same time as private credit recovers, giving excuses for a fresh round of money printing.

Why does all this matter?

There is a further complication for a reserve collecting central bank. To collect reserves, a country must finance the deficit of a third party reserve currency country.

If Sri Lanka buys US securities, then the American deficit is financed. Raising taxes and reducing the deficit domestically is not enough, domestic investment must be curtailed sufficiently to build reserves (finance a reserve currency country deficit).

So why does all this matter?

This matters because it shows why deficits and debt go sharply up in countries with bad central banks. The deficit and debt (including the rupee value foreign debt) go up for reasons that have nothing to do with fiscal policy.

While good fiscal policy is important, no amount of fiscal fixing will help if the central bank is triggering monetary instability and depreciating the currency, because repeated stabilization cycles will destroy growth and fiscal metrics.

The reason for spikes in bad loans in the private sector and bad fiscal metrics is virtually the same – it is bad money.

This is also important for another reason, which these columns have explained before.

Mistargeting of rates is the reason IMF programs fail in the second year. It is important because Sri Lanka is now about to make the same mistake again under data driven monetary policy.

This is what happens in peaceful Latin American countries and it is what happens in Sri Lanka and in all IMF countries.

Politicians in particular must take note.  Ranil Wickremesinghe and his ministers must not put pressure on the central bank to cut rates.

Already the writing is on the wall. Noises are coming about ‘high real interest rates’.

It is when private credit gains momentum that the real problems will begin. Under a flexible exchange rate, even a small pick up like in 2018 can create havoc.

The IMF itself has warned that the pace of reserve collection has slowed. And no wonder. The central bank started injecting money on a gross basis in May. From June the external sector started showing signs of instability.

But the IMF warning about reserve collections is disingenuous.

The IMF itself is at Fault

It is the IMF that promotes econometrics (data driven monetary policy and the monetary consultation clause that promotes money printing as soon as inflation falls) that go against laws of nature well described by classical economists to avoid balance of payments troubles.

The IMF suggests there is monetary financing. There was minimal monetary financing of the deficit, except after 2020. There is however ‘monetary financing’ of banks consistently (by repurchasing old bonds from prior year deficits), which is way higher than the deficit.

This mistake did not happen in classical days. Financing of banks (or discount houses initially) was through bills of exchange and it was clearly visible.

Hence classical economists, some of whom got themselves elected to parliament to bring laws against central banks, easily made the distinction between financing of ‘merchants’ and the ‘government or the King.’

Unlike the IMF or present-day economists of third world central banks that go for bailouts frequently, classicals had a deep knowledge of note issue banking operations.

As the data shows above, in the crisis year, the reason large volumes of money – much higher than the increase in the deficit is printed – is because the central bank is actually financing the private sector.

In Argentina for example crises are driven by the failure to roll-over BCRA’s own sterilization securities like (Leliqs).

In Sri Lanka it is the re-financing of banks by either outright, term or overnight purchase of securities from banks, through inflationary open market operations claiming inflation is low.

That is why IMF programs are destined to fail and second or third defaults happen in many cases.

4-6 pct inflation targeting is an invitation to disaster

All this matters because of a third reason.

An examination of the data table in Sri Lanka shows that all post war currency crises had taken place by targeting a 4-6 percent inflation range.

What the numbers show is that targeting 4-6 percent failed to stop currency crises, which eventually led to growth shocks and spikes in debts as the monetary brakes were hit.

The post-2020 “macro-economic policy” deployed had tax cuts on top of money printing. During that crisis also inflation was relatively low initially despite large volumes of money being printed.

Sri Lanka’s problem and that of other African and Latin American countries is that monetary regimes are fundamentally flawed.

There is a propensity to deploy macro-economic policy despite the existence of a reserve collecting central bank in the legal and operational frameworks themselves, despite such actions defying laws of nature.

Sri Lanka, Africa and Latin America and unstable countries in East Asia like Laos are in the same universe as stable countries with 2 percent targets and subject to the same laws of nature described by classical economists when BOP deficits and monetary instability were absent.

No amount of reforms in other sectors, including in budgets which are undoubtedly required, can help a country, if monetary stability is denied by targeting 5 percent inflation and failing to defy laws of nature, repeatedly. (Colombo/Oct23/2023)

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Sri Lanka to find investors by ‘competitive system’ after revoking plantations privatizations

ECONOMYNEXT – Sri Lanka will revoke the privatization of plantation companies that do not pay government dictated wages, by cancelling land leases and find new investors under a ‘competitive system’, State Minister for Finance Ranjith Siyambalapitiya has said.

Sri Lanka privatized the ownership of 22 plantations companies in the 1990s through long term leases after initially giving only management to private firms.

Management companies that made profits (mostly those with more rubber) were given the firms under a valuation and those that made losses (mostly ones with more tea) were sold on the stock market.

The privatized firms then made annual lease payments and paid taxes when profits were made.

In 2024 the government decreed a wage hike announced a mandated wage after President Ranil Wickremesinghe made the announcement in the presence of several politicians representing plantations workers.

The land leases of privatized plantations, which do not pay the mandated wages would be cancelled, Minister Siyambalapitiya was quoted as saying at a ceremony in Deraniyagala.

The re-expropriated plantations would be given to new investors through “special transparency”

The new ‘privatization’ will be done in a ‘competitive process’ taking into account export orientation, worker welfare, infrastructure, new technology, Minister Siyambalapitiya said.

It is not clear whether paying government-dictated wages was a clause in the privatization agreement.

Then President J R Jayewardene put constitutional guarantee against expropriation as the original nationalization of foreign and domestic owned companies were blamed for Sri Lanka becoming a backward nation after getting independence with indicators ‘only behind Japan’ according to many commentators.

However, in 2011 a series of companies were expropriation without recourse to judicial review, again delivering a blow to the country’s investment framework.

Ironically plantations that were privatized in the 1990s were in the original wave of nationalizations.

Minister Bandula Gunawardana said the cabinet approval had been given to set up a committee to examine wage and cancel the leases of plantations that were unable to pay the dictated wages.


Sri Lanka state interference in plantation wages escalates into land grab threat

From the time the firms were privatized unions and the companies had bargained through collective agreements, striking in some cases as macro-economists printed money and triggered high inflation.

Under President Gotabaya, mandating wages through gazettes began in January 2020, and the wage bargaining process was put aside.

Sri Lanka’s macro-economists advising President Rajapaksa the printed money and triggered a collapse of the rupee from 184 to 370 to the US dollar from 2020 to 2020 in the course of targeting ‘potential output’ which was taught by the International Monetary Fund.

In 2024, the current central bank governor had allowed the exchange rate to appreciate to 300 to the US dollar, amid deflationary policy, recouping some of the lost wages of plantations workers.

The plantations have not given an official increase to account for what macro-economists did to the unit of account of their wages. With salaries under ‘wages boards’ from the 2020 through gazettes, neither employees not workers have engaged in the traditional wage negotiations.

The threat to re-exproriate plantations is coming as the government is trying to privatize several state enterprises, including SriLankan Airlines.

It is not clear now the impending reversal of plantations privatization will affect the prices of bids by investors for upcoming privatizations.

The firms were privatized to stop monthly transfers from the Treasury to pay salaries under state ownership. (Colombo/May25/2024)

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300 out of 1,200 Sri Lanka central bank staff works on EPF: CB Governor

ECONOMYNEXT – About 300 central bank staff out of 1,200 are employed in the Employees Provident Fund and related work, Governor Nandalal Weerasinghe said, with the function due to be transferred to a separate agency after a revamp of its governing law.

“When it comes to the EPF there is an obvious conflict of interest. We are very happy to take that function out,” Governor Weerasinghe told a forum organized by Colombo-based Advocata Institute.

“We have about 300 staff out of 1,200 including contract staff, almost 150 of permanent staff is employed to run this huge operation. I don’t think the central bank should be doing this business,”

The EPF had come under fire in the past over questionable investments in stocks and also bonds.

In addition, the central bank also faced a conflict of interest because it had another agency function to sell bonds for the Treasury at the lowest possible price, not to mention its monetary policy functions.

“There has been a lot of allegations on the management of this fund. This is the biggest fund of the private sector; about 2.6 million active, I think about 10 million accounts.

“When it comes to EPF, obviously there’s another thing. We obviously have, in terms of resources, on the Central Bank, that has a clear conflict because we are responsible for the members.

“We have to give them a, as a custodian of the fund, we have to give them a maximum return for the members.

“For us to get the maximum return, on one hand, we determine the interest rates as multi-policy. On the other hand, we are managing public debt as a, raising funds for the government.

“And on the third hand, this EPF is investing 90 percent in government securities. And also, interest rates we determine, and they want to get the maximum interest. That’s a clear conflict, obviously, there’s no question.”

A separate agency is to be set up, he said.

“It’s up to the government or the members to determine to establish a new institution that has a trust and credibility and confidence of the members that this institution will be able to manage and secure an interest and give them a reasonable return, good return for their lifetime savings,” Governor Weerasinghe said.

“The question is that how whether we have whether we can develop that institution, whether we have the strong institution with accountability and the proper governance for this thing.

“I don’t think it should be given completely to a private sector business to run that. Because one is that here we have no regulatory institution. Pension funds are not a regulated business.

“First one is we need to establish, government should establish a regulatory agency to regulate not only the EPF business fund, there are several other similar funds are not properly regulated.

“Once we have proper regulations like we regulate banks, then we can have a can ensure proper practices are basically adopted by all these institutions.

“Then you can develop an institution that we who can run this and can be taken back by the Labour Department. I’m not sure Labour Department has the capacity to do all these things.”

While some EPF managers had come under scrutiny during the bondscam and for questionable stock investments, in recent years, it had earned better returns under the central bank management than some private funds that underwent debt restructuring according to capital market analysts with knowledge of he matter. (Colombo/May24/2024)

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Desperate Sri Lankans seek risky foreign jobs amid tough IMF reforms

ECONOMYNEXT – After working 11 years in Saudi Arabia as a driver, Sanath returned to Sri Lanka with dreams of starting a transport service company, buoyed by Gotabaya Rajapaksa’s 2019 presidential victory.

However, the COVID-19 pandemic in 2020 and an unprecedented economic crisis in 2022 shattered his dreams. Once an aspiring entrepreneur, he became a bank defaulter.

Facing hyperinflation, an unbearable cost of living, and his family’s daily struggles, Sanath sought greener pastures again—this time in the United Arab Emirates (UAE).

“I had to pay 900,000 rupees ($3,000) to secure a driving job here,” Sanath (45), a father of two, told EconomyNext while having a cup of tea and a parotta for dinner near Khalifa University in Abu Dhabi.

Working for a reputed taxi company in the UAE, Sanath’s modest meal cost only 3 UAE dirhams (243 Sri Lankan rupees). Despite a monthly salary of around 3,000 dirhams, he limits his spending to save as much as possible.

Sanath has been in Abu Dhabi for 13 months but had to wait six months before driving a taxi and receiving no salary.


“I had to get my UAE driving license. I failed the first trial, and the company paid 6,500 dirhams on my behalf, agreeing to deduct 500 dirhams monthly from my salary,” he explained.

“So far, I have repaid only 3,000 dirhams.”

To raise the 900,000 rupees for the job, Sanath borrowed money from friends and pawned jewelry.

“I don’t know if I was cheated by the agent, but I must repay that money and also send money for my family’s expenses,” he said, glancing at a photograph of his family in a Colombo suburb.

Working night shifts in busy Abu Dhabi, Sanath said, “If I can secure 9,000 dirhams monthly through taxi driving, I will earn 3,000 dirhams in the month after deductions for the license fee and any traffic fines.”

Sanath came to Abu Dhabi with seven other Sri Lankan men through an employment agency in the Northwestern town of Kurunegala.

“Only two of us have withstood the tough traffic rules and payment deductions for offenses,” he said. Some of his colleagues are still job-hunting, while others have returned to Sri Lanka.

Sanath is one of around 700,000 Sri Lankans who have left the island in the last two years due to the economic crisis that forced the country to adopt difficult fiscal and monetary policies, including higher taxes and costly borrowing, exacerbating the cost of living.


From January 2022 to the end of March 2024, at least 683,118 Sri Lankans migrated for foreign employment through legal channels, according to the Sri Lanka Foreign Employment Bureau.

They have sent $11.31 billion in remittances through official banking channels during the same period, central bank data shows.

Many Sri Lankans leave on visit visas, hoping to find jobs later, often guided by friends already working abroad. The economic crisis has pushed them to seek better opportunities abroad, despite the risks.

Sri Lankan authorities struggle to stop such risk-takers, who sometimes resort to illegal migration, despite warnings about human trafficking.

In Myanmar, 56 Sri Lankans caught in an IT job scam were detained earlier this year, and the government is still repatriating them.

At least 16 retired Sri Lankan military personnel have been killed in the Russia-Ukraine war after being misled by unscrupulous recruiters. Officials estimate that over 400 retired military officers may have left for similar reasons.


In March, Foreign Minister Ali Sabry warned against visiting any nation on open visas, urging Sri Lankans to emigrate only through registered agencies.

Despite the risks, many Sri Lankans are desperate to leave.

Abu Salim, a 32-year-old former rugby player, came to Dubai on a visit visa hoping for a banking job, which he never got.

Now freelancing in an insurance firm, he said, “I survive, and my relatives don’t see my struggle. It’s stressful, but still better than Sri Lanka right now.”

Suneth, a former top garment merchandiser, is also job-hunting in Sharjah after quitting his initial job in Sharjah.

“My worry is the visa. I must find a new job before it expires,” he said.

Many Sri Lankans in the UAE work multiple jobs, compromising their sleep and health to make ends meet. (Abu Dhabi/May 24/2024)

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