“The session will evaluate Sri Lanka’s economic policies and reform progress,” State Minister for Finance Shehan Semasinghe said.

“We look forward for continued support of all countries for a successful review to unlock the third tranche, which will further enhance economic stability, growth, and reform efforts.”

The Article IV consultation and second review under the Extended Fund Facility (EFF) for Sri Lanka are on the IMF Board meeting agenda for June 12. The session will evaluate Sri Lanka's economic policies and reform progress. We look forward for continued support of all countries… pic.twitter.com/EGE4UfWgcO

— Shehan Semasinghe (@ShehanSema) June 3, 2024

Sri Lanka is currently finalizing MOUs with official creditors and are also in talks with the IMF.

The Executive Board will consider both the program review and Article IV consultation. (Colombo/June04/2024)

Stability

“The objective of monetary policy is not to promote growth, but to stabilize and facilitate for the country to achieve potential growth, whatever the levels,” Governor Weerasinghe told reporters in Colombo, after keeping rates unchanged.

“A lot of other policies will have to take place to enhance growth in the medium to long term.”

Critics have complained that Sri Lanka’s central bank has in the past tried to push growth by cutting rates by printing money through liquidity tools and denied monetary stability to the people and businesses by trying to close a potential ‘output gap’.

Sri Lanka has exchange controls due to successive deeply flawed monetary operational frameworks which intensify and also leads to trade controls, whenever attempts are made to boost growth by inflationary rate cuts involving reverse repo injections or standing facilities.

In the last century there has been a growing belief under Keynesian or post-Keynesian doctrines that rate cuts could boost growth or unemployment, (the non-neutrality of money) leading to the eventual collapse of the Bretton Woods, the emergence of floating rates, high levels of inflation, asset price bubbles like the housing bubble in floating regimes and steep depreciation and default in reserve collecting ones.

Some critics say money is indeed ‘non-neutral’ in that monetary instability, negative confidence shocks and the inability to conduct normal economic activities that come from forex shortages or defaults in the wake of inflationary rate cuts, leads to below average growth or economic contractions. Others – including monetarists – believe money may not be neutral in the short-term.

Before open market operations proper, were devised in the 1990s, leading to deliberate inflationary rate cuts, forex shortages seem to have come from rural credit re-finance, deficit financing as well as sudden sterilization of forex market interventions in Sri Lanka.

Sri Lanka’s economy grew 4.5 percent in the last quarter, after negative growth from the most aggressive ‘macro-economic policies’ deployed since the setting up of the central bank in 1950 and joining the International Monetary Fund.

For 2024, the central bank is making a cautious projection of around 3.0 percent, amid domestic elections, a debt restructure that is yet to be completed and an uncertain external environment.

Output Gap

At the moment there is a potential output gap based on the central bank’s model, Governor Weerasinghe said.

The potential output is a statistical estimation which is based in part on historical trends.

“Potential output is not a fixed one,” Governor Weerasinghe explained. “It is a dynamic variable, depending on historical data. As everyone knows potential output is what has happened in the
past and that will generate the potential output.”

“On that basis what we are seeing is the potential output is higher than what we think now.

He declined to publicly share the output gap estimated by the central bank. The potential output has been as high as 5.25 percent when it begun to be estimated.

“I don’t think we can share that kind of information in the model,” Governor Weerasinghe said. “That’s a complicated one. What we see is there is still a gap, a negative output gap is there.

“The central bank’s objectives in monetary policy decisions; the first one is to look at the inflation outlook, and then at whether there is a slack in the economy or whether there is a space for the economy to catch up and reach the potential.”

Rates

The central bank has been cautious in cutting rates, and held the policy corridor at 8.5 percent and 9.50 percent this, maintaining a balance of payments surplus, a strong exchange rate, allowing the agency to maintain monetary stability.

The central bank has maintained low inflation of around 2.5 percent for around 18 months, providing stability for economic activities to normalize.

At the moment so-called statistical ‘real’ short term rates based on historical inflation are positive.

Inflation would continue to be below 5 percent for 2024 based on their statistical model, Director of Economic Research S Jegajeevan said, though there may be a pick up from current levels.

Inflation may edge higher in the latter part of 2025.

“I can see there is a space (to cut rates),” Governor Weerasinghe said. “Inflation we think we can maintain at 5.0 percent. Policy rates are at 8.5 percent. I think real natural rates can be much lower going forward.”

At the moment with excess liquidity from dollar purchases interbank rates have hit the bottom of the policy corridor of 8.5 percent preventing short term rates from falling.

Recent lowering of the policy corridor, have also not been enforced by any printing of money.

The willingness to invest savings longer term, may depend not only on the availability of real savings but how confident savers are about future stability of the country including the exchange rate, analysts say. (Colombo/May31/2024)

Though private credit is positive it is still ‘sluggish’ , the central bank said.

At the moment working capital is being borrowed.

Credit Demand

Businesses are trying to de-leverage after a currency crisis, and also re-negotiate old loans with lower interest rates as complaints from the SME sector shows.

De-leveraging is part of a credit cycle that improves the balance sheets of business across the board and leaves them in a stronger position to expand in the future.

To expand however retail sales have to pick up. Capital investments then start as existing capacity or slack runs out and there is more confidence in the future.

“We have seen retail sales picking up in the recent past,” Governor Weerasinghe said. “I think that will push up some of the SME borrowings in the coming months.”

Early indications show that credit has not moved fast in April, which was a holiday month, he said.

“Hopefully in the months of May and June credit will pick up.”

The Prime Lending Rate has started to fall, indicating the risk appetite.

“Volumes are also rising,” Governor Weerasinghe told reporters after the latest monetary policy decision to hold rates.

“But businesses are still not willing to borrow for a longer term.”

Sri Lanka’s central bank has kept inflation low and allowed the exchange rate to appreciate in the first quarter which had brought down the price of many imported goods which could also help drive up retail sales.

A stronger exchange rate would also reduce building material prices, which may reduce the overall need for capital investments or allow bigger projects in the future, compared to a 370 to the dollar exchange rate that was seen in 2022.

Sri Lanka periodically hikes rates steeply to avert currency crises, which are usually triggered by cutting rates with inflationary open market operations and standing facilities on the basis of 12-month historical inflation data without regard to current credit conditions at the time, critics say.

This year rates have fallen due to weaker private credit, strong finances of the state enterprises, which allows debt repayments, a flattening state deficit by tax hikes as well as confidence and stability created by the central bank which halted capital flight.

But there is also reserve collection (financing the budget deficits of foreign countries) under an IMF program and repaying central bank swaps.

A slower fall in rates has been observed compared to an initial response to hikes in earlier cycles as well, Governor Weerasinge said.

Abnormal Cycle

“If you look at the charts it has been coming down significantly, but still not aligned with policy rates, under normal monetary policy cycles,” Governor Weerasinghe told reporters.

“In a cycle of policy easing transmission happens with a time lag.”

This time is not a normal cycle with debt restructuring added to the mix.

In Ghana which also has a flexible inflation target at 8.0 percent, an inflation target so deadly and could amount to un-anchored money, a default, depreciation and debt restructuring has seen instability continue with a gilt market shock from wide domestic debt restructuring.

In Ghana the policy rate is 29 percent, inflation 25 percent and the 3-month bill 23 percent in May.

Sri Lanka has also hiked income taxes.

Unlike value added tax, where money is collected after transactions, including retail sales, income tax kills the disposal income required to make transactions happen.

Legislators led by the Justice Minister Wijedasa Rajapaksa lifted the parate execution, or foreclosure by board decision, in a sudden state intervention, which banks had already warned would make them more cautious in lending to good customers and keep rates up.

Related

Sri Lanka parate suspension increases risk premium, endangers deposits, banks say

It is not clear to what extent the parate execution suspension is contributing to sticky new lending rates and delaying an economic recovery, but the central bank has earlier urged banks to cut rates for SMEs despite the problem with parate execution.

Sri Lanka CB urging banks to lower rates for SMEs despite parate suspension

Classical economists refer to such shocks as ‘regime uncertainty’. In the US during the extension of the Great Depression and delay in investment spending was directly attributed to state interventions especially under the New Deal, which spooked investors.

READ MORE: Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed after the War

Confidence created by the central bank through recent exchange stability and virtually no inflation amid falling import prices, which could trigger a similar fall in domestic substitutes, may also increase disposable income, initially allowing more reserves to be collected and deposit rates to fall.

The latest dollar purchases however have been left mostly unsterilized, allowing excess liquidity build up, which analysts say may push rates down, particularly deposit rates, but may pressure the exchange rate unless mopped up to some extent or the exchange rate defended to lose the liquidity and reserves as credit demand resumes.

Governor Weerasinghe said there was a claim that banks had raised deposit rates (most fixed deposits are up to one year in Sri Lanka) but that re-pricing had now largely happened.

New lending

Though negotiations for old loans may be going on, which also depends on bargaining between banks and customers, Governor Weerasinghe said he would like to see new lending rates falling faster.

“We are monitoring the new lending rates, which are around 12.5 percent. It is still the highest,” Governor Weerasinghe said.

“We are emphasizing that new lending should happen at closer to the other market rates.”

There are some new apartment projects and land sales are also being advertised.

Credit growth depends on actual credit demand which has factors other than interest rates.

Governor Weerasinghe pointed out that the ban on car imports could also contribute to a slower credit.

Vehicles are financed by both banks and leasing companies. Leasing companies themselves have credit lines with banks.

Banks are also trying to raise equity to gear up for new lending after capital ratios were hit by bad loans and defaults in dollar bonds.

Commercial Bank on May 28 announced a 22 billion rupee rights issue. (Colombo/May29/2024)

Maldivian authorities have reminded Sri Lanka of the long-standing bilateral agreement under which their citizens could travel freely between the two neighbours without any charges or bureaucratic barriers.

A one month stay is available without a fee.

Maldivians, who consider Sri Lanka their second home, often spend more than a month in the larger country, but are now required to pay 26 dollars to VFS Global, which has controversially been contracted to handle Sri Lankan visas.

“The Sri Lankan government will not charge a fee, but Maldivians still have to pay VFS after applying online for a visa,” a Maldivian government official said in the capital, Male. “This violates the spirit of our agreement.”

He said the new administration of President Mohamed Muizzu was taking up the issue with Sri Lankan authorities in both Male and Colombo.

In a worst-case scenario, the Maldives will be compelled to reciprocate the new cost of a Sri Lankan visa and charge Sri Lankans traveling to the archipelago. There are also expat Sri Lankans in the Maldives.

There are only a handful of countries to which Sri Lankan passport holders can travel without any visa restrictions.

Singapore is another country which could take action against Sri Lanka if the bilateral deal is found to be violated, according a source said.

Opposition parties have said in parliament that outsourcing the visa handling to VFS Global and their partners was a bigger corruption scandal than the bond scam of 2015 and 2016, when billions of rupees were stolen through insider deals.

VFS has sent this response in relation to visas to Maldivians

We want to clarify that no visa or service fee is levied to Maldivian nationals who wish to visit Sri Lanka for a period of six months. Fees are applicable for all other categories.

For additional information on visa exemptions please check https://www.srilankaevisa.lk/information

We have also attached a screenshot of the page which states that Maldivians do not have to obtain an e-Visa for six months stay.

All applicable visa fees and charges are as per the directions of the Department of Immigration and Emigration (DI&E), Sri Lanka. (COLOMBO/May 28, 2024)

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.

Related

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)

“Supreme Global has identified MAC as the ideal partner to guide and support this acquisition, based on MAC’s expertise and recent contracts secured from major carriers like MasKargo and Teleport by AirAsia,” the company said in a statement.

Under the terms of the agreement, MAC will provide freighter aircraft and operational support to establish a cargo feeder network for SriLankan Airlines if Supreme Global and its partners win the bid.

Supreme Global was pre-qualified to conduct due diligence and eventually bid for SriLankan Airlines by Sri Lanka’s State Owned Enterprises Restructuring Unit.

MAC will support Supreme Global and its partner in restructuring efforts post-acquisition, as well as assist in launching a cargo network leveraging the geographic position of Sri Lanka to enhance its capacity as a strategic hub, Supreme Holdings said.

Related story
Supreme Global Holdings with Qatar, India investors, bids for SriLankan

“There can be any number of laws in the country but it will be useless if consumers aren’t aware of the legal recourse,” Janaka Prasad, Assistant Director of the Consumer Affairs Authority said.

The methods of consumers purchasing goods and services have evolving faster than a country can enact laws, Prasad told reporters Friday, adding that this was a global challenge.

“The consumer plays and important role in navigating a fast evolving marketplace.”

“We have a literacy rate of 90-95 percent, but this is not enough. The ability to read is not sufficient. Consumers have to be able to comprehend. That cognizance is lacking in Sri Lankan consumers when you compare with the rest of the world.”

Sri Lanka’s consumers must make sure to protect their money. “Most of the complaints we receive are not about essential items. People scrolling on their phones decide impulsively that they want to buy something.”

“Consumers have to do due diligence of what they buy, consider the specifications, the country of manufacture, the product’s history, read reviews (of course some companies pay for reviews), so consumers must consider all of this.”

Laws are enacted over time in response to various challenges presented at various times, the CAA official pointed out. “We cannot change the law daily or weekly in pace with the changing marketplace.

“If you look at the 19th and 20th centuries the pace of change was slow. But in the last 20 years alone things have changed drastically. A phone you buy today could be outdated in a week. 20 years ago a tv would last you some time, but now LED and LCD tvs don’t last that long.

“Quality, durability and technological use of goods have evolved. So consumer demand must be aware of these, factor in these considerations.”

The CAA receives a lot of complaints Prasad said. “There are actions we can take within the legal framework we have now. But we have to amend and bring the law up-to-date with the changes in the online purchasing, then we can ensure a far safer online marketplace.”

“We have to develop consumer awareness. Only then we can reduce this problem.” (Colombo/May17/2024)

It will examine finding of an IMF Governance Diagnostics Assessment and will “engage in critical discussions surrounding the challenges and opportunities inherent in contemporary governance frameworks.”

“We are at a crucial juncture where effective governance is paramount for economic prosperity and societal well-being,” Murtaza Jafferjee, Chair of the Advocata Institute said in a statement.

“This conference provides a unique opportunity for stakeholders to come together, share insights, and chart a path forward towards more resilient and equitable governance structures.”

Governor of the Central Bank Nandalal Weerasinghe, Treasury Secretary Mahinda Siriwardena, Sarath Jayamanne PC, Advocata Chairman Murtaza Jafferjee, Radika Coomaraswamy, Justice Aluwihare, Sharmini Cooray, Rohan Samarajiva are among the key speakers.

It will be held on Saturday, May 18, 2024, at the Galle Face Hotel, Colombo from 8.30am onwards.

Register by visiting here to attend the conference in person

Link for virtual registration here.

“The investment promotion ministry was given a target of billion US dollars of FDI for 2024,” Minister Amunugama said.

“Though the final contracts have not been signed I am pleased to say even now discussions are steadily progressing to exceed that number.

“By the second quarter we are likely to be able to double it and by the end of the year may be triple it.”

A renewable energy project by India’s Adani group for which a power purchase agreement was approved by the cabinet this week was valued at 800 million US dollars.

The first phase of an oil refinery in Hambantota by China’s Sinopec group will be around 2.8 billion US dollars.

There were also a number of other projects which were on track.

China’s refinery is to be a 5.0 billion US dollar in three phases with the first phase valued at 2.8 billion dollars.

In 2024, in the UK, Canada, France, Italy and Germany the Board of Investment has appointed investment agents and country representatives on an honorary basis from business persons of sri Lanka origins and started investment forums.

“Instead of waiting for investors to come, we are now directly approaching them,” Minister Amunugama said.

Sri Lanka’s investment environment has got better compared to last year.

“Whatever anyone says, I can as the Investment Promotion Minister say that the environment has got better,” Minister Amunumgam said.

“Firstly, there should be political stability, there should be monetary stability and confidence in monetary stability (mool-yer sthaver-bar-wa-yer).

“Then there has to be some predictability about the future.”

Sri Lanka operates a flexible inflation targeting framework (trying to target a domestic anchor without  a clean float) and also targets potential output (print money and cut rates to promote growth), and ends up in the arms of the International Monetary Fund after running out of foreign exchange. (Colombo/May12/2024)

The industrial park will be built on 700 acres by a defunct state-run cement factory.

The investors will invest 500 million dollars to build infrastructure in the land given by the Board of Investment under a private public partnership model.

The Canadian entrepreneurs will build roads and other infrastructure and will attract investors into the zone to recover their costs.

The zone operators have the choice of also constructing buildings and offering plug-and-play factories.

“It is entirely up to them,” Minister Amunugama said. “They can build factories or offer bare land.”

The defunct cement factory only has limestone in about 100 acres which will not be sufficient to sustain a cement factory for a long time, he said.

There was at one time about 500 acres of limestone but now settlements have come up and it was not practical to move people out of the area.

However, if an investor was willing to revive the factory with a smaller extent of limestone, the choice was left to them, Minister Amunugama said.

The industrial park could also build links with the KKS harbour, he said.

Investments zones as public private partnerships are planned in Trincomalee, Mankulam and Paranthan. (Colombo/May10/2024)

“In 2023 there were greater outflows,” Fernando explained. “Sometime people who retired did not immediately take out their funds. But there were more outflows last year.

“But in 2024 contributions are positive.”

In 2024 some private firms have raised salaries after inflation spiked last year. Some companies have also raised executive salaries to defray an income tax hike.

Demographers have been warning for years that EPF contributions would eventually turn negative, though the original deadline had passed. (Colombo/May07/2024)

The government has decided to pay the return from the earnings the fund made in 2023, he said.

It was higher than the 9.0 percent return the EPF had paid in recent years, Minister Siyambalapitiya said.

Sri Lanka re-structured the debt of the EPF, extending maturities and initially raising the coupon the 12 percent, after the central bank busted the currency from 200 to 370 destroying its real value and pushing inflation to 70 percent.

However, over the past year, the central bank has appreciated the currency, recouping the fund some of its losses.

According the Central Bank, the inflation generating state enterprise that manages the fund, liability to members went up by 12.9 percent to 3,817.9 billion rupees in 2023, while the total value of the fund went up 11.5 percent to 3,857.4 billion rupees.

There has been hardly any inflation (as measured by the most widely watched Colombo Consumer Prince Index) since September 2022, when monetary stability was restored. (Colombo/Apr29/2024)

Exports are projected at 12.9 billion US dollars from 11.9 billion dollars.

Imports are expected to recover to 20 billion dollars in 2024 from 16.8 billion in 2023.

Sri Lanka earns foreign exchange from remittances and also tourism to pay for imports and also repay debt or build reserves as long as the central bank does not cut rates with inflationary open market operations and easy standing facilities to trigger balance of payments crises.

Sri Lanka does not have a penalty rate for standing liquidity facilities.

The central bank is projecting 3.4 months of gross official reserves or about 5.6 billion dollars based on the 20 billion in imports.

The central bank is also projecting a 5 percent of GDP external current account surplus, compared to a 3.1 percent surplus in 2023, when foreign aid dried up after a default.

Related

Sri Lanka current account in US$1.6bn surplus in 2023

Sri Lanka financial account turns $1.3bn in to deficit in 2023 amid heavy repayments

Sri Lanka had to repay multi-lateral lenders and private banks also repaid credit lines and balance their open positions with dollar collections when foreign debt was repaid in dollars.

It is easy to build reserves when private credit is weak. However, in the past the central bank had cut rates claiming inflation was low, under so-called flexible inflation targeting and ‘data driven’ monetary policy.

Sri Lanka ran headlong into serial currency crises after the end of a civil war, by trying to target 5 percent inflation while operating a reserve collecting central bank.

Critics say using spurious monetary doctrines involving targeting output and inflation based on what some classical economists call ‘reality-detached’ statistical models (econometrics) while rejecting classical economic principles, macro-economists drove a country at peace into default in 2022.

The International Monetary Fund itself taught the central bank to calculate ‘potential output’ giving incentives to print money including though targeting the medium term yield curve through the purchase of bonds, jettisoning a ‘bills only’ policy.

A monetary law giving effect to the same the same doctrines have been now passed in parliament.

In the last quarter of 2023, economic growth revived to 4.5 percent, amid largely deflationary policy and almost no inflation.

Sri Lanka has a history of strongly recovering from currency crises triggered by rate cuts, but inflationism has tended to resume quickly, especially after the end of a civil war, triggering external instability.

Concerns have been raised that monetary instability will return with inflationary open market operations and non-penal rate standing facilities when private credit picks up, as it happened in 2011/12, 2015/16, 2018 and 2020.

A wide variety of scapegoats are then blamed by macro-economists, including politicians (deficits), some private citizens (vehicle imports, fuel), the public at large (current account deficits) and acts of god (weather for cost-push inflation). (Colombo/April29/2024)

President Raisi will inaugurate a 514 million dollar irrigation and hydropower project that was designed and built by Iranian engineering firm and was also initially financed before international sanctions hit the project.

The Uma Oya multi-purpose project is expected to generate 290 GigaWatt hours of energy, irrigate 6,000 hectares of agricultural land and provide drinking and industrial water.

It was designed and built by Iran’s Farab Engineering group.

Sri Lanka and Iran are also expected to sign five agreements during the visit. (Colombo/Apr24/2024)

Most of these new laws focus on structural changes of the existing executive and administrative structures, Siriwardana was quoted as saying in a speech to ministry officials on April 08.

The laws related to public finance, procurement, public private partnerships, state enterprises and also a law on the offshore economy.

The following new laws are being made:

a. Public Financial Management Bill
b. Public Debt Management Bill
c. Economic Transformation Bill
d. Management of State Owned Enterprises Law
e. Public Private Partnership (PPP) Law
f. Investment Law
g. Public Procurement Bill
h. Unified Labor Law Bill
i. Food Security Bill
j. Public Asset Management Bill
k. Microfinance and Credit Regulatory Authority Bill
l. Secured Transaction Bill
m.Offshore Economic Management Bill
n. New law for facilitating proposed agricultural land lease programme
Public Service Employment Bill
o. Sri Lanka Accounting and Standard Monitoring Act

Changes are planned to the following laws

a. Amendments to Agrarian Development Act
b. Amendments to Excise Ordinance
c. Amendments to Customs Ordinance
d. Amendments to Finance Act
e. Amendments to Foreign Exchange Act. Colombo/Apr15/2024)

Sri Lanka’s currency collapsed in 2022 after two years of aggressive macro-economic policy where money was printed to boost growth and taxes were also cut, throwing large section of the population into poverty and pushing up inflation.

“In Sri Lanka, growth will rebound to 1.9 percent in 2024 and 2.5 percent in 2025 from the 2.3 percent contraction in 2023,” the ADB said in its Asian Development Outlook report.

“This will be driven by rising output in services, resumption in industrial projects, and continuous reform aimed at improving the business climate.

“Still, tax increases will dampen the recovery in private consumption and investment.”

Sri Lanka’s central bank restored monetary stability by September 2022 and the economy started to show positive growth officially from the third quarter of 2023. In the fourth quarter the economy was estimated to have grown 4.5 percent.

Sri Lanka has a history of recovering from severe monetary shocks and the island has one of the worst central banks in the region, along with Pakistan, analysts have said.

In addition to the usual currency crises generated by the central bank which does not have a credible single anchor monetary regime, Sri Lanka also defaulted on its external debt and was also faced by capital flight from banks.

Both Sri Lanka’s and Pakistan rupee is derived from the Indian currency at 4.70 to the US dollar at independence.

Pakistan’s growth for the year to June 2024, will also recover to 1.9 percent, and 2.8 percent in 2025, the Asian Development Bank said from a contraction last year.

Sri Lanka’s rupee fell to 360 to the US dollar and has been allowed to appreciate to 298 amid deflationary open market operations (sell-downs of domestic assets of the central bank against dollar purchase), which is making traded commodities cheaper and boosting disposable incomes.

The central bank also has to collect foreign reserves under an IMF program, which requires dampening domestic investments, at least by an equal amount. However countries with monetary stability generally attract foreign capital while also preserving the real value of domestic savings.

The ADB has been funding Sri Lanka after an IMF deal was struck.

Sri Lanka is expected to wrap up re-structuring debt by June 2025, which will also open bilateral lending taps. (Colombo/Apr12/2024)

“The government’s weak fiscal position has resulted in fewer new construction contracts, the suspension of existing projects and payment delays to contractors. This has affected CGF through a drop in premium income,” Fitch said.

“Premium income plummeted by 87% in 2023 to LKR13 million on low guarantee volume amid a sluggish local construction sector.” (Colombo/Apr11/2024)

The full report:

Fitch Affirms Construction Guarantee Fund’s ‘BB(lka)’ National IFS Rating; Outlook Stable

Fitch Ratings has affirmed Sri Lankabased Construction Guarantee Fund’s (CGF) National Insurer Financial Strength (IFS) Rating of ‘BB(lka)’. The Outlook is Stable.

KEY RATING DRIVERS

Weak Operating Conditions: CGF’s performance exhibits a strong correlation with government construction activity, as the company offers guarantees and related services to small- and medium-sized contractors involved in government projects. The government’s weak fiscal position has resulted in fewer new construction contracts, the suspension of existing projects and payment delays to contractors. This has affected CGF through a drop in premium income and a higher risk of claims by employers.

Underwriting Pressure: We expect underwiring performance to remain weak over 2024-2025 on low business volume.

Premium income plummeted by 87% in 2023 to LKR13 million on low guarantee volume amid a sluggish local construction sector, while claim costs increased by 10% and administration costs rose by 38% on investment-related withholding tax hikes. Consequently, Fitch calculates CGF to have incurred an underwriting loss of LKR107 million in 2023, from a profit of LKR16 million in 2022.

The company says the majority of outstanding guarantees do not carry claim risk, as they are extensions of existing guarantees granted for administrative purposes. Meanwhile, earnings were buoyed by a 61% rise in investment income on higher interest rates, with net profit reaching LKR333 million (2022: LKR285 million). Return on equity was 16%
and averaged 17% in the last three years.

Eased Investment and Liquidity Risks: Fitch believes investment and liquidity risks have eased following the positive rating action on the Sri Lankan sovereign’s Local Currency IDRs as well as on Fitch-rated Sri Lankan bank and non-banking financial institutions; see Fitch Upgrades Sri Lanka’s Long-Term Local-Currency IDR to ‘CCC-‘ and Fitch Affirms Ratings on 15 Sri Lankan Banks; Removes Watch Negative; CBL on Negative Outlook.

CGF adopts a conservative investment mix, with around 78% of invested assets held in cash and term deposits at state-owned Bank of Ceylon (Long-Term Foreign-Currency IDR: CC, National Long-Term Rating: A(lka)/Stable) at end-2023. Treasury bills accounted for the remainder.

Adequate Capital: Net guarantee risk exposure/total capital was 0.5x at end-2023 (2022:0.4x). CGF’s gross guarantee liabilities have fallen to LKR1.5 billion, from a peak of LKR12.0 billion in 2020, due to lower volume of new guarantees and a discontinuation of some projects. Total claim initiations since inception have been low, at LKR150 million, or 7.2% of end-2023 equity. Capital is supported entirely by internally generated net
surplus.

Moderate Company Profile: We rank CGF’s company profile as ‘Moderate’ compared with that of other insurers in Sri Lanka, reflecting its ‘Moderate’ business profile and ‘Neutral’ corporate governance. CGF is fully owned by the state, with the secretary to the treasury functioning as the trust’s settlor. Its competitive position is strengthened by the expertise of its trustees, which comprise both public- and private-sector institutions. It has a small operating scale, with total assets and equity of LKR2.9 billion and LKR2.1 billion, respectively, at end-2023.

High Risk Appetite: We regard the fund’s risk appetite as high, as it provides guarantees to high-risk contractors, particularly small- and medium-scale contractors registered under the Construction Industry Development Authority’s National Registration Scheme, without requiring collateral. CGF attempts to mitigate this risk by conducting comprehensive screening of the contractors’ technical and financial capabilities. The board of trustees has set a cash collateral requirement of 20% for advance payment bonds.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade:

– Rising investment and asset risk, including a downgrade of the ratings of financial
institutions or the sovereign ;

– Sustained weakness in financial performance or weaker risk management practices;

– A deterioration in the company profile, for instance, due to significant weakening in CGF’s association with the government, or a deterioration in its business risk profile, due to a decline in the country’s economic conditions that affects the domestic construction sector.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade:

– Sustained improvement in the company profile in terms of a larger operating scale as
well as successful diversification into profitable and stable business lines.

The monthly salary bill is about 93 billion rupees, but it has gone up by about 13 billion rupees due to the 10,000 rupee allowance, he said.

Usually the monthly salaries are paid starting from the 16 and 17. First teachers are paid, then the military the next day, followed by provincial councils, he said.

But for April money is paid before the New Year.

“But for April we paid before the New Year,” Minister Siyambalapitiya said. “So today the Treasury released the funds to all state institutions.”

“Tomorrow everyone should get their salaries, to their accounts or otherwise”.

Colombo-based Verite Research analysis of expenditure found that 32 percent of the salaries go to the military and another 16 percent went to the public security ministry.

The health salary bill was only 17 percent of the total, and education only 9 percent.

President Ranil Wcikremesinghe’s budget speech for 2024 outlined that the cost of living allowance which sat at 7,800 rupees, was to be increased by 10,000 rupees to 17,800 rupees in January 2024. (Colombo/Apr9/2024)

Remittances were up from 476.2 million in February 2024.

Related Sri Lankans migrating for foreign employment drops 4.2-pct in 2023

Sri Lanka’s remittances dropped to around 275 million US dollars in 2022 as money was printed to mis-target rates creating forex shortages driving foreign exchange into unofficial channels.

Monetary stability was restored in the last quarter of 2022, improving the credibility of the exchange rate.

Monthly remittances have been above 475 million US dollars from May 2023.

Remittances generally rise in March ahead of traditional New Year holidays and also in December. (Colombo/Apr07/2024)

Remittances for 2024 end are targeted to increase by 17 percent, from the recorded 5969 million dollars of 2023 to 7000 million dollars, the Bureau Publicity Manager Manjula Kularatne told Economy Next.

Sri Lanka’s workers leaving for work abroad dropped to around 203,087 by 2019, with economic growth low or through still positive.

In 2022 official worker migration rebounded above 300,000 with the worst currency crisis in the history of the island’s soft-pegged central bank.

Sri Lanka last saw 300,703 workers migrating in 2014.

Sri Lanka has network of employment agencies which have been built up over decades of monetary instability and currency depreciation that had destroyed real wages in the island.

After the 2022 currency crisis, a sharp increase in personal income tax maintain the country’s bloated state under revenue based fiscal consolidation (encouragement to abandon cost-cutting as a method of reducing the budget deficit) professionals also started to migrate with the twin hit of monetary debasement and a hike in income tax which reduced disposable incomes.

Sri Lanka cut taxes in December 2019 to target potential output after two currency crises from money printed (inflationary rate cuts) to target potential output reduced growth. (Colombo/Apr05/2024)