BiZnomics Research Team, being a body of professional Economic and business researches, felt it opportune to discuss national economic conditions including the country’s total debt stock (domestic and foreign borrowings), and the revenue-generating solutions including Hambantota port as an asset in stimulating economic growth takes the opportunity to speak to Dr. Kenneth De Zilwa, a business Cycle Analyst who has over 17 years of experience at all functional levels in senior management positions at banking and a senior consultant at the China Harbor Engineering as the subjects are very current and relevant to the ongoing discussions on the objective making the general public aware.
What is Sri Lanka’s economic condition?
To answer this we need to understand the models of development used by the two governments. Sri Lanka has witnessed two economic models in the past 10 years, namely, investment driven, local supply based and local enterprise driven economic model of 2010-2014 and a more liberal, external supply based consumption model ushered during 2015 to 2019. The resultant outcomes of these two are now in the public domain and could be compared and contrasted. In the 2010-2014 period the average GDP growth rate, which is the approximation used to indicate overall expansion of the country’s production, was at 6.78pct. The average growth rate in 2015-2019 was 3.70pct; indicating a 45pct decline from the earlier period. This implied a significant slowdown of real economic activity in the country. To put this in context we have to understand that the 2010-2014 growth was achieved despite the many global shocks, namely, we witnessed the food crisis, the second great depression of 2008 (second since the Grest Depression of the 1930s) which saw the global financial system collapse and the global oil crisis. In contrast, in the past 5 years we had not witnessed any external shocks, apart from the depreciation of the Turkish Lira and its aberrations on global markets.
Similarly, we find price volatility in interest rates and exchange rates. The commodity volatility had been passed on to the real economy, making input cost of production and consumables more expensive despite the dramatic fall in global crude oil prices. In fact it was observed by the Central Bank of Sri Lanka that the rupee depreciation by 18pct in 2018 viz a viz the US Dollar brought about a LKR 1,000 billion loss to the economy during 2014 to 2019 i.e. while during the last 5 year period, the total depreciation cost to the country was LKR 1,780.0 billion incremental debt servicing cost to the country. The erratic behavior of markets can thus be costly for the development agenda. Therefore we can argue that the free markets based model adopted in 2015-2019 was
not conducive for the real sector development and economic growth. Going forward we envisage that a new business model will be introduced for Sri Lanka to kick start the economy with an emphasis on properly aligned macroeconomic policies which will stimulate local Agro-Industrialization and unleash the entrepreneurial activity across multiple sectors. This will lift the GDP growth rate to well above its historic average of 4.75pct.
How much is Sri Lanka in debt and what is the solution for this?
Sri Lanka debt has been a talking point since 2014 and the reason for that was the rapid development that was undertaken during the 4-year period after the war. This clearly brought about an increase in the national debt stock. The country’s total debt stock (domestic and foreign borrowings) increased from LKR 4,590 million to LKR 7,390 million with significant amounts of funds utilized in the creation of balance revenue asset and capacity building, for the country needed to be integrated and the journey towards industrialization undertaken . Many of such capital intensive projects have a long term payback period and the cash flow from such projects was gradually building up, with less stress on the fiscal front of government business. In 2015 however, the new government moved away from adding capital assets to the country’s economy and was focused on shifting economic policy towards less state led investment capital. They therefore, commenced disposing of already created assets via long term lease agreements to various foreign countries. Hambantota port is a classic example where the port’s revenue-generating business venture was leased back to the construction company at the cost of construction and not based on the discounted future cash flow method. The argument was that asset disposing was necessary given the country’s debt burden.
Similarly, we find price volatility in interest rates and exchange rates. The commodity volatility had been passed on to the real economy, making input cost of production and consumables more expensive despite the dramatic fall in global crude oil prices. In fact it was observed by the Central Bank of Sri Lanka that the rupee depreciation by 18pct in 2018 viz a viz the US Dollar brought about a LKR 1,000 billion loss to the economy. In fact during 2010-14 i.e.last 5 year period, the total depreciation cost to the country was LKR 1,780.0 billion adding to the incremental debt servicing cost and debt stock of the country.
The decision of 29 October 2019 by the outgoing Cabinet to sign a compact with the Millennium Challenge Corporation (MCC) has given rise to extensive public discussion and debate. A new President has been elected on November 16, 2019, with a new Prime Minister and a new Cabinet sworn in soon after. The new government is bound to reconsider its predecessor’s decision to sign the MCC agreement.
The proposed MCC compact, once signed, would make a US government grant of USD 480 million available for expenditure in two Sri Lankan projects – a transport development project (costing $400 million) and a land project (costing $80 million). These two projects are supposed to address two binding growth constraints in the country: inadequate infrastructure of transport logistics and restricted access to land for investment purposes. The MCC grant funds will be disbursed in stages over a period of five years. Unlike other official grants, the MCC grant will not be disbursed to the Sri Lankan government. Instead, these funds will be channelled into a Sri Lankan private company specially set up in Colombo for this purpose by the MCC to be used in the implementation of the two accepted projects. This company will monitor the progress achieved in the projects concerned and grant funds will be released step by step if progress achieved in each stage is judged satisfactory. The US government reserves the right to terminate the operation of the project at any time if the MCC is not satisfied with project implementation progress.
It is good to begin this brief article about the desirability or otherwise of signing the MCC compact by placing the MCC in its proper global perspective. The “Western development establishment” led by the US has dragged increasing numbers of developing countries into the net of neoliberalism since the 1970s and 1980s. Sri Lanka has the dubious reputation of having been a pioneer to be so dragged into a neoliberal policy framework. The use of foreign aid conditionality has been the mechanism widely used by the Western development establishment to neo-liberalise developing countries.
The IMF and the World Bank have formed the institutional mechanism used in the process. Under conditionality, the countries receiving grants and loans on concessionary terms were required to gradually meet the laid down policy conditions after loans were authorized and dispensation commenced
in tranches. The grant “assistance” to a developing country1 through Millennium Challenge account of the US signifies a different way of converting the developing country victims into a neo-liberal policy framework. This method has been described as “preemptive” development assistance. It entails refusal and withholding of funds until demands made by the donor country are met.
The conditions to be met are listed under three broad headings, namely
1) ruling justly (good governance);
2) investing in people (health and education for all);
3) “economic freedom” (sound economic policies that foster enterprise and entrepreneurship)
The Monetary Policy dilemma is nothing new as we have seen US, Japan and other developed economies question the monetary policy tools used to stimulate or contract the economic activity. The US president recently blamed the Federal Reserve Bank that its action of raising interest rates has slowed the US economy. A similar trend has also been seen in India in that the Reserve Bank has reduced its policy rate in the eye of national elections. The Reserve Bank of India Monterey policy cuts its benchmark repo rates to 6.25 percent citing slow economic growth and sharply lower inflation. The committee also change its monetary policy stance ‘Neutral” from the previous outlook of policy tightening. Monetary neutrality comes just a few months after Urjit Patel the former governor resigned amid widening differences with the government over various economic and regulatory issues including the government perception that monetary policy was too tight.
The new governor Shaktikantha Das said that after the announcement on the rate cut the slowing down in the economy and sharply lower inflation opened up for policy action. The need in his view is to stimulate private investment and consumption to address growth, given that the inflation target had been met. India’s inflation rate has been fallen from an annual average of about 10 percent to 3.6 percent in the 2018/2019 financial year. The phase of price increase is now below the target set in the reserve bank inflation targeting framework of 4 percent with a range of 2 – 6 percent plus or minus. In January Indian industrialists met the Governor of the Reserve Bank and appealed for a 50 percent rate cut and reduction in bank’s capital ratio to facilitate the flow of credit to industries to reduce their cost.
Sri Lanka Prime Minister has also appointed a committee to examine why banks have not reduced lending rates in spite of the fact that the Central Bank has reduced rates on two consequent sessions.
The recent announcements by Monetary Board of the Central Bank of Sri Lanka that the reduction of the Reserve Ratio on all deposits of commercial banks from 6 percent to 5 percent from March 1st 2019 following a reduction in the reserve ratio from 7.5 percent to 6 percent in mid-November 2018 comes in at a time when Sri Lanka is facing an daunting task to stimulate the economy given its below potential growth rate achieved over the past three years .Bank maintained their policy rates on deposits and lending facilities unchanged at 8 and 9 percent respectively on both occasions. The reduction in the reserve ratio in February 2019 is justified on the ground that some policy intervention by the Bank is warranted to address the large and persistent liquidity deficit in the money market although is natural on the change of policy rates.
Monetary Policy review by the Monetary Board in February and March have noted the following;
The real economic growth remained subdued at 3.2 percent during 2018, compared to a growth of 3.4 percent in 2017. The growth of industry activities slowed down significantly to 0.9 per cent during 2018, mainly as a result of the contraction in construction.
Real GDP growth will remain moderate in 2019 as well. The continued low growth emphasizes the need for implementing growth enhancing structural reforms expeditiously.
The deficit in the trade account contracted with the continued growth of exports alongside a decline in imports in response to the policy measures to curtail non-essential imports. Increased tourist arrivals in the first quarter of 2019, improved earnings, although workers’ remittances moderated during the first two months of 2019.
Proceeds from the issuance of the International Sovereign Bonds (ISB) helped increase gross official reserves to an estimated US dollar 7.6 billion by end March 2019.
Noticeable growth of earnings from tourism continued to support the current account although worker remittances marginally declined in 2018.
The recent uptick in inflation was driven by the upward revisions mainly to prices of fuel but inflation expectations indicate that it is likely to remain within the desired range of 4-6 percent in 2019 and beyond, with appropriate policy adjustments.
Credit extended to the private sector decelerated to 13.6 percent during the first two months of 2019, from 15.9 percent in December 2018. broad money (M2b) also slowed down during the first two months to 14.4 percent in February 2019 from 13 percent in January 2018 of the year. A growth of around 13.5 percent is expected in private sector credit in 2019, while broad money (M2b) is expected to grow at around 12.0 percent in 2019.
The Monetary Board views that broad money (M2b) growth is likely to support economic activity adequately without creating excessive demand driven inflationary pressures.
The domestic money market has improved reflecting Call Money Rate declining by 45 basis points so far during 2019, however other market interest rates continued to remain at high levels thus far in 2019. The Central Bank may implement mechanisms for more effective downward adjustments in market interest rates.
At present there is a slowdown in private sector credit. A Working Committee appointed on the directions of Prime Minister Ranil Wickremesinghe is expected to submit a report recommending necessary actions to reduce the private credit interest margin.
The Central Bank Governor Dr. Indrajit Coommaraswamy explained at the press conference in February 2019 that the policy intervention to inject LKR 60 bn was to ease liquidity shortage. This liquidity shortage continued to prevail despite the liquidity injection of LKR 90 bn in November 2018 through a reduction in reserve requirements. The Governor indicated that liquidity shortage in the market is around LKR 100 bn and expects that the market to find the balance in the shortfall of around LKR 40 bn. He also hinted that large liquidity injections could spill into more imports, thereby adversely affecting foreign reserves and the exchange rate. The governor’s view was that the lower interest rates encourage consumption related loans, with the public opting to import cars or to invest in construction industry that has a significant import content. The Governor’s dilemma is how growth could be fostered without undue pressure on external reserves.
International Reserves of Sri Lanka declined to USD 6.2 bn against predetermined short term (less than 1 year) liabilities which stood at USD 6.5 bn placing the Central Bank on a negative reserve position. The reserve position was USD 6.9 bn in December 2018, down from USD 07 bn in November 2018. The reserves are partly protected with 200 percent cash deposit margins on import of motor vehicles and 100 percent cash margins on consumer durables. These policy actions have substantially reduced imports in recent months. The test is whether the exchange rate will remain stabilized once these direct controls on imports are removed.
Source: Central Bank of Sri Lanka
As shown in the chart, nominal interest rates have moved steadily in an upward direction although the differences between them and the NCPI Core Inflation Rate have narrowed owing to a steep increase in the core inflation rate. The core inflation rate which has been well below the target range of 4 – 6 percent has entered in to inflation target range in January – March 2019. It is likely that this trend may continue with seasonal demand and the fuel price revisions that have already taken place.
Expressing optimism on the inflation outlook, Governor Coomaraswamy forecasted that inflation would remain in the range of 4 -6 percent although it is volatile to fuel price adjustments and other administrative price revisions. He explained that the uptick in inflation rate in January to March 2019 was due to non-food inflation driven by education and house rentals. A further upward pressure is expected from fuel price adjustments and likely administrative price revisions on cement, milk powder and LP gas.
The monetary policy review underpins the underlying risks of a ballooning trade deficit. Export growth remains modest. Import growth currently remains subdued due to credit restrictions on imports. The removal of such restrictions may require to let market fundamentals to work in terms of the Government policy framework particularly in the context of the ongoing IMF extended fund facility to improve the overall macro-economic conditions. But such relaxation remains a challenge in the context of slippages in government budget and recovery in imports following the removal of deposit margins of imports. The exchange rate appreciation may short live, once imports picked up in the second quarter and outflow on oil imports at high prices and values due to prevailing electricity shortfall. But it is doubtful whether in an election year imports growth could be kept under policy control for long. Reserves are kept stable and exchange rates allowed appreciating in the backdrop of short term inflows from external borrowings and subdued imports in tourism and remittances are perhaps the only supporting elements from the 1st quarter 2019 particularly, motor vehicles, milk powder and consumer durables.
Tourism and remittances are perhaps the only supporting elements from the point of view of the stabilizing balance of payments but remittance inflows of around USD 07 bn too have slowed down. The flexibility available to the Central Bank to conduct market based monetary policy in election times (2019 May) remain illusory as pressure is building from the fiscal slippages, recovery in imports and private sector for low interest rates. Exchange rate may remain vulnerable and deficits in market liquidity are likely to persist. Bank though, have reported large profits also subject to rising non-performing loans, accounting requirements, higher capital requirements and taxes. Excessively high real interest rates may be a reality with modest growth in GDP as Governor anticipated in February, 2019.
The Monetary Policy Review announcement on 10th April 2019, came at a time that the 2018 economic growth data pointed to a further slowedown in GDP growth of 3.2 percent and also following the fiscal policy stance announced in the 2019 National Budget. It will also provide the Central Bank to respond through its policy stance to the 2019 National Budget. Yet the Central Bank did not change its position on the policy rates expressing downside risks and concerns over inflation and external stability. The concerns have risen as to whether current monetary policy stance is appropriate for the country’s tumbling economy. Some also anticipate monetary policy easing in view of continued slowdown in economic growth.
However, the recent staff review by the IMF advised the Central Bank of Sri Lanka to continue to maintain a prudent and data dependent monetary policy standing ready to tightened policy rate should inflationary pressers re-emerged.