Sri Lanka’s finance minister says country faces dual external and internal crisis
ECONOMYNEXT – Sri Lanka faces a severe external crisis as well as a domestic crisis with declining income and spending continuing to rise, said Finance Minister Basil Rajapaksa, amid the coronavirus pandemic and unprecedented money printing that triggered a plethora of economic controls.
“Our country is facing a serious currency crisis,” Minister Rajapaksa told parliament in his first speech on Tuesday (07).
“As a result of Covid this year, government revenue so far for this year has dropped to between 1.5 trillion and 1.6 trillion rupees from the estimated amount.”
Basil, the younger brother of President Gotabaya Rajapaksa and Prime Minister Mahinda Rajapaksa, delivered his first speech after being appointed to the post in July on the unelected national list.
The 69-year-old key strategist behind the current administration used words cautiously not to attack the opposition, unlike his fellow Sri Lankan lawmakers Podujana Peramuna (SLPP) in power and called for a collective effort to s tackle the country’s problems.
Accumulation of state failures
“I don’t blame any political group, but what is happening now is the culmination of events that have taken place over a long period,” Rajapaksa said.
“We admit that there has been unnecessary spending, waste and corruption in the past, not only limited to a certain period but for a long time,” said Basil Rajapaksa.
Data from the central bank shows that the country’s net foreign exchange reserves are close to zero, meaning that almost all of its reserves are borrowed.
Money was printed to keep interest rates historically low; despite a budget deficit of more than 10 percent of gross domestic product had triggered foreign exchange shortages as soon as private credit resumed.
In a knee-jerk mercantilist reaction, authorities have banned vehicle imports, which are taxed between 200 and 300 percent and can bring in up to $ 3 in tax revenue for every dollar spent.
In Sri Lanka, it is little understood that it is the injections of liquidity and credit that make the outflows of foreign currency greater than the inflows.
The ban on high-tax imports and the granting of credits for imports of low-taxed items such as capital goods have long been part of the island’s cascading policy mistakes that intensify currency crises no matter what. power, critics said.
Customs revenues have fallen sharply, Rajapaksa said.
“The main source of government revenue comes from vehicle imports,” Rajapaksa said. “We have banned the importation of vehicles for a year and a half.
“Because of the difficulties in finding foreign currency (to import). Customs revenue has therefore fallen to a low level this year.
He also said the lockdown reduced the excise department and the value-added tax of the domestic revenue department, the other two major tax agencies.
“When there is a foreclosure, direct and indirect tax revenues are reduced by 75-80% per day,” the finance minister said.
“On the expenditure side, government spending has increased because we have not reduced the allowances or salaries of public sector employees. In certain areas such as health, we had to pay additional indemnities.
“So we absolutely have to look for new ways,” he said.
A circular issued to government agencies ahead of a November budget said there would be a hiring freeze; all new projects will be stopped and overtime stopped.
A key factor behind Sri Lanka’s precarious state finances is providing “jobs for the boys” filled with jobless supporters and graduates. In the first four months of the year, 84 cents of each fiscal rupee was used to pay state salaries and pensions.
Minister Rajapaksa said the external sector “is also facing a similar crisis”.
He blamed the lack of tourism revenue which could be between US $ 4 billion and US $ 5 billion for external problems.
The Sri Lankan rupee had fallen sharply to around 230 per US dollar, down from 185 at the end of 2019 as the silver was printed.
Economic analysts have said that a decline in tourism income simply reduces the income of businesses and workers in the tourism sector and as a result imports fall as has happened in other countries like the Maldives.
A drop in tourism receipts or a “real shock” cannot affect the parity of a paper issued by a bank issuing notes with a foreign currency or the global balance of payments.
Parity can only change to worsen when excess banknotes issued without currency reserves are redeemed in the foreign exchange markets and the central bank denies convertibility.
If convertibility is ensured for banknotes issued without reserve backing (an anchor is defended with dollar reserves against rupees issued for treasury bills), existing foreign exchange reserves decline.
Meanwhile, remittances, another key source of foreign exchange for national economic activity and the main driver of the country’s trade deficit, had started to decline in recent months.
“Remittances increased last year, but over the past three months they are down,” he said.
“There has been a drop of 30 to 35% in the last three months. “
Analysts blame parallel exchange rates and a high gray market exchange rate for currency leaks to unofficial channels.
Sri Lanka’s exports rebounded to pre-pandemic levels, thanks to the authorization of export factories to operate during the lockdown period.
Risk of sovereign default?
Sri Lanka successfully repaid $ 1 billion in sovereign bonds on July 27 amid speculation about a possible default like Lebanon.
Sri Lanka was gradually lowered from a tax cut in December 2019 and the country was excluded from capital markets when the rating fell to CCC.
Sri Lanka’s gross official reserves fell to US $ 3.8 billion in July.
The central bank has revealed its intention to replenish reserves with swaps, loans as well as an allocation of special drawing rights of US $ 800 million from the IMF.
The country has so far received around 1.3 billion of the planned swaps and borrowings.
Sri Lanka is due to repay $ 6.9 billion in debt over the next 12 months.
If bond auctions fail and money is printed to keep rates low, Sri Lanka will not be able to fund payments from inflows and foreign exchange reserves will continue to take over, warned. analysts.
Amid the pandemic, concessional financing declined, he said.
The World Bank and the Asian Development Bank have been particularly helpful, the government will continue to borrow from them, he said.
The AfDB and the World Bank have built hospitals, intensive care units and financed the purchase of vaccines.
“We are implementing a policy of using limited foreign loans sparingly,” he said. “We will only borrow loans for essential projects or projects that will bring benefits to the country.”
“We will borrow from these institutions next year for projects that will benefit the people,” he said.
Sri Lanka has borrowed heavily from China in recent years for some projects that don’t pay off, critics said.
From 2015 to 2019, Sri Lanka sovereign bonds also fell from US $ 5 billion to US $ 15 billion as money was printed to target a call rate and an output gap and there is no had monetary stability only in 2017 and 2019, to allow the payment of foreign debt. back.
A liability management law also replaced new borrowing with new loans instead of squeezing the current account backed by a neutral or deflationary central bank policy.
“Previously, we extended the loans with an additional interest rate,” Rajapaksa said. “Instead of such an effort, we plan to cut lending to make a country debt free.
“Our policy is to borrow loans on simple and concessional terms and without any conditions that will undermine the independence and sovereignty of the country.”
Analysts have warned that securing bond auctions is imperative to raising real money and maintaining domestic creditworthiness if authorities are to repay foreign debt.
If money is printed and swaps are taken, the debt will flow from the central government to the central bank.
Sri Lanka has also refused to ask for an IMF bailout and said there will be no default. (Colombo / Sep08 / 2021)