Sri Lanka’s debt dilemma and recurring BoP crisis | Sunday Observer

Sri Lanka’s debt dilemma and recurring BoP crisis

24 June, 2018

The Governor of the Central Bank of Sri Lanka, Dr.Indrajit Coomaraswamy says, the current arrangement with the International Monetary Fund (IMF)is critical for Sri Lanka to enable the raising of money to service the huge outstanding debt over the next four years. Addressing the inaugural Cambridge Knowledge lecture organized by the Cambridge Alumni Society of Sri Lanka on the topic, ‘China - One Belt One Road: Threat or Opportunity for Sri Lanka’, the Governor pointed out that Sri Lanka’s decision to seek IMF intervention was of its own making as the authorities had heavily mismanaged economic affairs in the past.

“We have an average of about US$ 3.9 billion that we have to pay every year for the next four years. To do that, we have to borrow on average, about US$ 2.5 billion dollars every year from international capital markets,” explained Dr. Coomaraswamy, addressing a packed audience at the SSC Pavilion in Colombo.

He noted that the IMF arrangement while ensuring good housekeeping will help Sri Lanka to protect the rating of the country. This in turn will help the island to gain access to international capital markets to raise funds at reasonable terms at a time when international interest rates are going up.

“We have very little room to manoeuvre and if we lose fiscal discipline and we lose the IMF programme, we get downgraded by the rating agencies. Thereafter, we will not be able to borrow the money we need to repay the money we have already borrowed,” he said, cautioning that it would lead to the kind of scenario that countries in the Asian crisis, such as Greece had experienced.

However, Dr. Coomaraswamy said, if government authorities are ready to maintain fiscal discipline, he is very confident that the Central Bank will be able to manage the debt situation so that the economy does not spill over into crisis. Apart from Mongolia, Sri Lanka is the only country in the whole of Asia Pacific which currently has an arrangement with the IMF.

“One of the things that have happened in the past is that we have handed over much of our economic sovereignty to outsiders.You can’t blame others or anybody else, it’s really the fact that we mismanaged our affairs, and we had to go to the IMF,” Dr. Coomaraswamy, an Alumni of the University of Cambridge, acknowledged.

Meanwhile, Dr. Coomaraswamy said, Sri Lanka is making some progress on financial stability but to persist, to consolidate and build on the progress, it is vital that the government’s fiscal policy remains on track.

“The Central Bank has to have prudent monetary policy and manage the exchange rate well, but most importantly the government has to maintain fiscal discipline.

If in the run-up to the elections, fiscal discipline is lost, then all bets are off because our debt dynamics are such that we have very little room to manoeuvre,” he said.

Speaking on the exchange rate management policy, the Governor said, Sri Lanka had in the past depleted a lot of its scarce external reserves by trying to defend the exchange rate and bitterly failing afterwards.

“That actually is a lose-lose situation. For instance, in 2011-12, we spent almost US$ 3 billion to defend the rate. We couldn’t do it and in the end, the currency depreciated by almost 15%. In 2015, we spent over US$1 billion and then in the end we had to depreciate by almost 10%. So it’s a no-brainer, that we have to avoid it,” the Governor justified.

While noting that the Central Bank is presently trying to have a flexible exchange rate policy, he however outlined that the Bank will avoid too much volatility to make sure that the exchange rate reflects underlying fundamentals.

The Central Bank has purchased USD 246.4 mn on a net basis from the foreign exchange market in 2018 (up to June 20) while in 2017, the country’s monetary authority had purchased Rs. 1.664 billion on a net basis from the forex market, official data showed.

“It is possible that some people are speculating too much with the Rupee. Because, if you look at the Real Effective Exchange Rate, the Central Bank feels that the Rupee is fairly valued and we also have a healthy level of reserves. In these circumstances, the rate of depreciation has been more than warranted,” Dr. Coomaraswamy said, indicating the main reason for the sharp depreciation of the currency.

According to recent statistics, the Sri Lankan Rupee has depreciated by 4.5% against the US Dollar from the beginning of this year up to June 21. The Japanese Yen on the other hand has appreciated by a sharp 6.3% against the Sri Lankan Rupee during the same period.

“Most emerging market currencies are under pressure because the US dollar is very strong, oil prices are high and interest rates in the US are also going up.

For these reasons, there is pressure on a number of currencies. But we feel the rate at which the Rupee has depreciated has been unwarranted,” Dr. Coomaraswamy highlighted.

Elaborating that it is crucial for Sri Lanka to have a competitive exchange rate, the Governor lamented that for many years, by having an overvalued exchange rate, Sri Lanka has however subsidized foreign producers at the expense of domestic producers.

“If you have an overvalued exchange rate, you are asking the exporters to run 110 metres in a 100 metre race. They are not getting full value for their produce. On the other hand, with an overvalued currency, people who are producing import competing goods are also disadvantaged,” the Governor explained.

He said, the main reason the governments in the past were in favour of an overvalued exchange rate was because it subsidized the consumers which is understandably a political aspect. However, if you keep penalizing or dis-incentivizing producers, at some point the government will not have the money for imports.

“That is what keeps happening to us because every so often, we have a Balance of Payments crisis. One of the reasons for this BoP crisis is because we don’t manage the exchange rate so that we have a competitive exchange rate which benefits our exporters and producers of import-competing goods,” Dr. Coomaraswamy emphasized.