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Thursday December 8th, 2022

Why Sri Lanka is having power cuts, fuel shortages as forex crisis worsens – Explained

ECONOMYNEXT – Sri Lanka on Wednesday made a 35.3 million US dollar payment to release a 37,500 metric tonne diesel shipment and President Gotabaya Rajapaksa has also asked authorities to give priority for fuel as power cuts became bigger.

Energy Minister Udaya Gammanpila who had earlier warned of four hour power cuts when daily power cuts were denied to the CEB after a coal plant broke down, forex shortages disrupted imports and the utility was running down hydro storage too fast.

Gammanpila has also warned of fuel shortages if the CPC is not allowed a price increase to generate rupees to buy dollars as it can no longer borrow from banks.

Here are some key questions and answers on the fuel crisis in Sri Lanka:

Why is Sri Lanka facing a fuel shortage?

Sri Lanka’s state-run fuel retailer Ceylon Petroleum Corporation (CPC) cannot buy enough dollars in the market at the current 200 to the US dollar rate due to foreign exchange shortages. The shortages come from rupees injected into the banking system to maintain low interest rates which it has pushed up credit and demand for all imports.

Unlike other import bills, which are small, fuel bills are among the biggest, and therefore whenever money is printed to keep rates down, fuel bills stand out as the most difficult to fill. Unlike other importers the CPC also does not pay higher rates to buy dollars at higher rates any longer.

On top of that, the CPC says it is losing 551 million rupees a day due to rising fuel prices in February. Unless prices are increased it cannot find the rupees to buy dollars. In the past losses were covered by tax cuts and loans from state banks.

Now the government is short of tax revenues, especially after a salary increase, and the CPC is indebted to the hilt to state banks from past wrong practices. The CPC owes banks over 3.5 billion dollars.

What is the fuel supply outlook in the near future?

Officials at CPC say five oil tankers are scheduled to arrive in the island this week. However, if the CPC is unable to find dollars, the shortages are likely to continue with delays to clear the oil tankers.

Why doesn’t CPC have a buffer stock?

In the past, CPC has borrowed dollars or used suppliers’ credit to import oil without making immediate payments when money was printed to keep rates down, creating forex shortages. Now suppliers are no longer giving credit to the CPC. As a result, the CPC has to find dollars upfront to pay suppliers when there are forex shortages.

Earlier CPC used to have stocks of 2 to 3 weeks. Now the stocks are down to 5 or 6 days.

Though ships are coming on time as ordered, a delay in unloading triggers shortages across the distribution network leading to stock outs.

Minister Gammanpila has said in April in an Indian credit line may be activated allowing more imports to be made.

Is there an increase in Sri Lanka’s fuel demand?

Yes. According to statements by Energy Ministry officials, daily demand for diesel has risen sharply to about 9000 metric tonnes a day, from an earlier 6,000 a day. The increase is mostly from the power sector with some power plants that used to run on furnace oil also using diesel. The 270 MW West Coast combined cycle plant uses 1,000 MT day.

People are also using generators. Industries and people may also be stocking up and running with full tanks. Petrol use has also increased with more people avoiding public transport due to Covid.

In addition, when economic activity recovers, there is generally an increase in energy use. Electricity demand growth slowed during the Covid pandemic in 2020. Growing exports also increase the demand for power. A recovery in tourism can lead to more energy for transport and electricity use in hotels and restaurants.

Energy sector analysts had warned of power cuts from 2018, when a coal plant was cancelled and later a combined cycle plant was delayed due to capacity shortages not keeping up with economic growth. However without fuel now, existing capacity also cannot be run.

Why does fuel demand increase up to April?

The first quarter is the driest months of the year. Until April showers start and monsoons in May, the CEB has to carefully use stored fuel to generate power and also ramp up fuel based generation.

That is why, as soon as the coal plant broke down, the CEB wanted to have one hour power cuts to save water.

In addition the heat may push up air-condition use and export industries generally work at full tilt in March and early April before the New Year holidays, further boosting energy demand.

That is also why economic analysts said rates should be raised and the currency floated before the dry season set in February.

Will a price hike or price formula reduce fuel demand?

Going by past trends, not much. But as people and companies put money into fuel, they have to cut down on non-oil spending. Or they have to reduce savings which in turn will reduce the resources to give credit to other borrowers and therefore imports. The adjustment comes through a fall in non-oil spending, credit and imports in the total economy as the CPC extracts rupees from customers.

However if new money is injected to the banking system for whatever reason, or salaries of state workers are paid with printed money, the required correction will not happen, even if prices are hiked and dollar demand will continue with unsustainable non-oil imports.

If the CPC is forced to borrow dollars despite having rupees taken from the economy as happened in the past, the correction will also not happen as its rupee deposits in the bank are loaned to other customers to trigger non-oil imports, as happened in 2018 despite the price formula.

What will be the impact on the people due to the current fuel crisis?

Fuel shortages can reduce economic activities by disrupting production and transport.

If the central bank uses reserves to import fuel and maintain the 200 the US dollar peg, under the monetary regime currently in operation, more money is printed to offset the transaction, an activity known as sterilization.

The action prevents the banking system from adjusting to the reserve sale through an increase in interest rates, creating further pressure on the currency.

There has been talk of rationing by Minister Vasudeva Nanayakkara among others. Rationing will further disrupt people’s lives without solving the problem. Rationing or price controls have not solved either inflation or foreign exchange in Sri Lanka in the past.

When will the fuel crisis end?

April rains can reduce the demand for electricity from imported oil. The Indian credit line can help bring fuel for some time and leave the country or CPC with another 500 million dollars in debt just as previous currency crises left it with 3.5 billion US dollars in debt.

Sri Lanka has a large stock of coal which may last up to July. After that, more coal will have to be imported.

Foreign exchange shortages are a monetary phenomenon found only in flawed or soft pegged exchange rate systems, triggered by rupee reserves injected to the banking system to maintain artificially low rates. Forex shortage gets worse as economic activity and credit demand (such as loan-funded losses in fuel or electricity companies) or deficit spending go up. Countries that did not have forex problems during Covid can experience currency pressure when the economy re-opens if rates which were cut during the lockdowns are not allowed to go back up. This is happening to both Pakistan and Bangladesh.

Central banks with floating exchange rate regimes, that do not sterilize interventions after giving reserves for imports (usually because there are not much reserves to give in any case), do not suffer foreign exchange shortages. The UK had also experienced forex shortages (Sterling crises) when the Bank of England operated a flawed pegged regime driven by Keynesian dogma. The Bretton Woods system also collapsed the dollar was floated in 1971 for similar reasons.

Forex shortages can be ended by tightening monetary policy. Raising taxes to reduce the budget deficit and therefore domestic credit will also help. Pegged central banks usually float when they run out of reserves after one or more hikes in the policy rate.

Why does a float help?

When a central bank gives reserves for imports by defending a pegged exchange rate, it triggers a liquidity shortage in the banking system and the rupee monetary base or reserve money shrinks by the rupees paid into the central bank by an importer. The action will push up interbank rates in a hard peg where interventions are unsterilized and interest rates float up. However a soft-pegged central bank will re-inject the lost money back into bans via open market operations to offset the reserve sale (sterilize the intervention) to stop the interest rate from floating up, and pressure the currency.

A float stops the cycle of reserve sales for imports (stops defending the peg at 200) and simultaneously ends the need to re-inject money, which the central bank sucked out from the dollar sale to prevent rates from going up. In addition to imports for consumption, Sri Lanka is also experiencing capital flight and pressure on debt repayments, all of which require higher interest rates to generate savings to meet such payments.

When Sri Lanka’s interventions were unsterilized and interest rates were allowed to be floated, and the hard peg was broken in 1950 to set up a central bank the country had foreign reserves worth 11 months of imports. (Colombo/Feb23/2022)

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Sri Lanka in deep talent drain in latest currency crisis

ECONOMYNEXT – Sri Lanka businesses are facing a drain of talent, top business executives said as the country suffers the worst flexible exchange rate crisis in the history of its intermediate regime central bank and people lose hope.

“We are seeing a trend towards migrating,” Krishan Balendra, Chairman of Sri Lanka’s John Keells Holdings told an economic policy forum organized by the Ceylon Chamber of Commerce.

“We have seen an impact mainly on the tourist hotels side, quite an exodus of staff (migrating) to countries we have not seen in the past. 

“We have seen people go to Scotland, Ireland. It has usually been the Middle East and Maldives. Australia seems like a red hot labor market at the moment.”

Sri Lanka’s rupee collapsed from 200 to 360 to the US dollar after macro-economists printed money to suppress rates.

Sri Lanka operates a ‘flexible exchange rate’ where errors in targeting interest rates are compensated by currency depreciation especially after the 1980s.

Classical economists and analysts have called for the power to mis-target rates and operate dual anchor conflicting monetary regimes should be taken away to prevent future crisis.

Currency crises are problems associated with flexible exchange rate central banks which are absent in hard pegs and clean floats.

“Something new we are seeing is that older people, even those in their 50s, which was a surprise, are looking at migrating,” Balendra said.

Businesses are trying to retain talent as real wages collapse.

Balendra said as businesses they see some stability returning and based on past experience growth is likely to resume, and they were communicating with the workers.

“We have a degree of conviction that the economy should get better, its the stability phase now and it will get better going forward so without the way our businesses are placed we should see good growth,” Balendra said.

“We can’t chase compensation that’s just not practical and we are not trying to do that especially if people are looking to immigrate but what we can do is show the career opportunities in the backdrop of the situation that people would rather stay here because its home.” 

Sri Lanka unit of Heineken says it is also trying to convince workers not to leave, with more success.

“We are all facing the effects of brain drain and it’s not just the lower levels… What we are doing is a balance of daring and caring,” Maud Meijboom-van Wel – Managing Director / CEO, Heineken Lanka Ltd told the forum.

“Why I say daring is, you have to be clear in what you can promise people, when you make promises you have to walk the talk. So with the key talents and everyone you need to have the career and talent conversations.

“I am a bit lucky because I am running a multinational company so my career path goes beyond Sri Lanka so I can say if you acquire certain skills here, then you can move out of here and then come back too, that is a bit easier for me but it starts with having a real open conversation with walking the talk – dare and care.” (Colombo/Dec7/2022)

 

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Despite losses, Sri Lanka to resume “park & ride” transport after complaints  

ECONOMYNEXT –  Sri Lanka’s state-run Transport Board will resume its loss-making City Bus service from January 15, 2022 Cabinet Spokesman Bandula Gunawardena said, after the service abruptly discontinued with the state-run firm’s director board citing losses.

The City Bus service was introduced in 2021, under the government of former President Gotabaya Rajapaksa, from Makubura to Pettah and Bambalapitiya.

The service was started to reduce the number of automobiles travelling to and from Colombo and suburbs by providing a comfortable, convenient and safe public bus transportation for passengers and riders who use cars and motorcycles as their means of transportation.

During the time period in which the service was initiated, there were 800 hundred vehicles that would be parked and would use the system, Gunawardena, who is also the Transport Minister, said.

The service was later collapsed due to inconsistencies in scheduling and it was completely stopped after

“Without informing the Secretary or the Minister of the relevant Ministry, the Board of Directors have come to a conclusion that this is loss making route and must be halted,” Gunawardena said.

“The users of the City Bus service brought to our notice and therefore I gave the Secretary to the Ministry of Transport the approval to start the City Bus service from January 15.”

“If we stop all loss making transport services then massive inconveniences will occur to the people in far parts of the island.”

The chairman of the state run Ceylon Transport Board has been asked to handover the resignation letter by the Minister Gunawardana citing that the head has failed to implement a policy decision approved by the government. (Colombo/ Dec 06/2022)

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Sri Lanka may see rates falling next year: President

ECONOMYNEXT – Sri Lanka’s interest rates are high and hurting small businesses in particular but interest rates are required to maintain stability, President Ranil Wickremesinghe said.

“One is, all of you want to know what’s going to happen to the interest rates?,” President Wickremesinghe told an economic policy forum organized by the Ceylon Chamber of Commerce.

“I wish I know. The governor has told me that the inflation has peaked. It’s coming down. You all understandably want some relief with the interest rates to carry business on.”

“I understand that and appreciate the viewpoint. It’s not easy to carry business on with such high interest rates. On the other hand, the Central Bank also has to handle the economy. So maybe sometimes early next year we will have a meeting of minds of both these propositions.”

Sri Lanka’s interest rates are currently at around 30 percent but not because the central bank is keeping it up. The central bank’s overnight policy rate is only 15.5 percent but the requirement to finance the budget deficit and roll over debt is keeping rates up.

Rates are also high due to a flaw in the International Monetary Fund’s debt workout framework where there is no early clarity on a whether or not domestic debt will be re-structured.

After previous currency crises, rates come down after an IMF deal is approved and foreign loans resume and confidence in the currency is re-stabilished following a float.

This time however there has been no clear float, though the external sector is largely stable and foreign funding is delayed until a debt re-structure deal is made.

Sri Lanka’s external troubles usually come because the bureaucrats do not believe market rates are correct when credit demand picks up and mis-uses monetary tools given in 1950 by the parliament to suppress rates, blowing the balance of payments apart.

The result of suppressed rates by the central bank are steep spikes in rates to stop the resulting currency crisis.

A reserve collecting central bank has little or no leeway to control interest rates (monetary policy independence) without creating external troubles, which is generally expressed as the ‘impossible trinity of monetary policy objectives’.

However, it has not prevented officials from trying repeatedly to suppress rates, perhaps expecting different results.

After suppressed rates – supposedly to help businesses – trigger currency crises, the normalization combined with a currency collapse leads to impoverishment of the population.

The impoverishment through depreciation leads to a consumption shock, which also leads to revenue losses in businesses.

The suppressed rates then lead to bad loans.

In the 2020/2022 currency crisis the sovereign default has also led to more problems at banks. Several state enterprises also cannot pay back loans.

“…[T]he bad debt that is being carried by the banks is mainly from the private sector or the government sector,” President Wickremesinghe said.

“Keep the government sector aside. We’re dealing with it. How do you handle it? Look, one of our major areas of are the small and medium industries. You can’t allow them to collapse, but they’re in a bad way.”

Classical economists and analysts have called for new laws to block the ability to central bank to suppress rates in the first place so that currency crises and depreciation does not take place in the first place.

Then politicians like Wickremesinghe do not have to take drastic and unpopular measures to fix crises and there will be stability like in East Asia.

Sri Lanka had stability until 1950 when the central bank was created by abolishing an East Asia style currency board. The currency board kept the country relatively stable through two World Wars and a Great Depression.

In 1948 after the war (WWII) was over “we stood second to Japan” Wickremesinghe said.

“But we started destroying it from the sixties and the seventies,” he said. :We started rebuilding an economy, which was affected by a (civil) war, and thereafter the way we went, is best not described here.”

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