Jonathan Alles, Managing Director and Chief Executive Officer of HNB, one of the leading private banks in Sri Lanka, weighs in on the unfolding economic crisis and its impact on the banking sector. He offers suggestions on what Sri Lanka can do to enable its banks to become more effective in driving the economic revival as myriad challenges and looming haircuts from debt restructuring cause difficulties for banks.

HNB has one of the larger balance sheets in the financial sector in Sri Lanka. Whatever happens in the economy will impact your balance sheet, so what do you anticipate will happen with the economy looking forward?

The banking sector has a role in stabilizing the economy and reviving growth, as it has often done during past crises. HNB is a bank with the scale to make a significant impact. As such, we remain committed to securing the future of this country. But let us look at the immediate challenges confronting the banking sector.

The country is contending with a debilitating forex issue that is unprecedented in scale. The shortage of foreign exchange is so severe, that it is becoming increasingly challenging for banks to support imports. While the export sector has to be commended for its resilience, it is not generating sufficient forex inflows into the system.

Several measures have been adopted to contain the outflow, including delaying payments for non-critical imports and curtailing foreign transactions on credit cards. Each month the country raises approximately $1 billion from exports, whereas imports amount to nearly $2 billion despite the various import controls. In 2021, the annual import bill was about $20 billion, while exports were approximately $12 billion.

The halving in worker remittances – another vital source of foreign exchange – and earnings from tourism going into freefall have only compounded the forex shortage leading to shortages for essentials like food, medicine, gas and fuel. Some exporters and migrant workers may be holding on to their earnings overseas as they lack confidence, or resort to grey market channels to convert their forex earnings at a higher exchange rate for a few more rupees. This is the reality. We have to work with what we have, and without inflows into the system, banks have very little to work with to stabilize or fuel the engines of the economy.

The spate of downgrades of the sovereign rating and the announcement of the suspension of external debt has had a knock-on effect, cancelling our foreign exchange and swap limits in total. As a result, we are delaying disbursing forex to import clients, many of whom have been with us for 3-4 decades. These deep exclusive relationships stand on decades of reliability and trust, but that can only take us so far. This is the most serious structural challenge that has to be resolved.

And it is the result of the country having defended the currency for too long by sacrificing its forex reserves. Alternatively, the grip should have been gradually eased, avoiding the steep overnight depreciation from Rs 200 against the US dollar to Rs 390, compounding the stress on the economy and the people of Sri Lanka as price adjustments overshot.

However, we are hopeful the exchange rate will correct itself, easing significantly to more appropriate levels once an IMF programme is in place. Had we gradually let go of the exchange rate three months ago, as most reputable experts had called for, we believe the US dollar would be range-bound at Rs 250-260 today instead of Rs 370! What the country needs right now is for an IMF programme to come through fast, and we are made to understand that discussions with the IMF are progressing well.

The IMF Board will need reassurances from the government concerning debt sustainability and that creditors are satisfied with the repayment plans. We are hopeful the IMF Board will approve a programme for Sri Lanka by this October or November at the earliest, mapping the disbursement of agreed-upon funds over the next few years. Parallel to these efforts, the Government will need to have a focused budget for the short term to deal with some of the immediate issues, and a clear roadmap and plan for economic revival and sustainable growth. In the interim, the country will have to secure bridging finance from supporting nations and multilateral agencies to deal with the shortages of essentials like food, gas, fuel and pharmaceuticals.

How is the banking sector geared to deal with these challenges and enable the rest of the economy?

It is going to be a difficult task, especially given that dwindling foreign exchange reserves and external borrowing lines mean the sector is dependent on deposits. At present, inflows into foreign currency deposits are also weak, which in turn constricts foreign currency lending. We understand that foreign currency borrowers are struggling, but banks may likely have to encourage them to start repaying. In the absence of deposits, the loan repayments can generate some forex liquidity into the banking system to support export finance at least, if not more.

On the Sri Lanka Development Bonds, domestic investors are getting rupees instead of the US dollars they invested and now have to build their forex reserves from scratch. Given how dire the situation is, no one is complaining because we all understand the need to work together to reset the economy, starting with the long-overdue exchange rate and interest rate adjustments. We now see efforts to correct interest rates from the disparity and arbitrage between interbank rates and the Treasury bill bond rates. Policy rates increased by about 700 basis points, but that had a knock-on effect. Today, Treasury securities are around 25-28%, which is phenomenally high. The authorities are also keen not to add further inflationary pressure by printing any more money.

Today the country is in hyperinflation territory, with inflation rising to 54.6% in June, and this is from an economy that once prided itself on maintaining inflation at 4-6%. Clearly, something has gone wrong with our fundamental, fiscal and economic management.

Interest rates have followed inflation to some extent. We cannot continue to sustain high expenditures by printing money because that money would end up in the economy. When there are fewer goods and services available due to supply constraints, price inflation takes over. In that aspect, we are happy to see some fiscal adjustments taking shape in the form of tax increases.

As borrowers, both individuals and businesses, contend with elevated interest rates and low debt servicing capability due to the impacts on earnings from the economic crisis, banks are likely to see loan repayments shrink, even as COVID-era moratoriums come to an end. Banks are looking at deteriorating asset quality and higher impairment costs. The more we impair, the more the P&L gets impacted, leading to challenges around capital and liquidity.

Thankfully, most banks are well-capitalized and have the buffers to surmount the challenges. Few anticipated the scale and impact of the current external debt crisis. Now, with banks exposed to Sri Lankan ISBs and SLDBs at varying degrees, any proposed haircut would impact their capital very significantly.

If you had some recommendations for policymakers, what would those be?

Banks would like to get involved and drive the economic revival. After all, that is what we are there to do. However, to be effective, policymakers must firmly commit to structural reforms, including fiscal and monetary policy, and formulate plans with adequate accountability and review processes in place to take the economy forward. From what we have seen over the last few years, we have resorted to short-term fixes and postponing the inevitable in some cases. The government and people of this country cannot expect the banking sector to solve fundamental problems with the economy, nor should they expect banks to resuscitate state institutions and every failing industry. We pride ourselves on building a resilient banking sector for the country with solid KPIs, capital buffers and profitability. But beneath all that are some ill-advised ventures such as investments in loss-making SOEs or even the extensive moratorium programme post-COVID, which the banking sector is exposed to that could lead to significant stresses.

We need to brace ourselves for that. There must be some focus to protect and strengthen the banking industry. Given its essential role in facilitating exports, SMEs and other critical sectors, if there is an industry that needs a national fund to support it right now, it would be banking. We need some amount of liquidity in dollars to restore confidence in our ability to execute international transactions and honour external payments. The entire economy stands to benefit.

Repaying any dollar liquidity support over a short to medium-term period is possible, but the challenge remains about sourcing such funds in the first place.

That is where investors come in. They can add their support to the banking sector, and in the process, buy into the underlying spirit of the remarkable changes that we have seen in Sri Lanka over these past months, namely: the belief that we can, and will turn this economy around. It will take time, but we will come through in the end.

That is where investors come in. They can add their support to the banking sector, and in the process, buy into the underlying spirit of the remarkable changes that we have seen in Sri Lanka over these past months, namely: the belief that we can, and will turn this economy around. It will take time, but we will come through in the end.

While painful, it created greater resilience because there were tight controls, as well as monitoring, to ensure that banks built in greater stability. That checked the insanity, and now banks are more accountable to investors and public depositors because they cannot do anything and everything. Banks are merely the custodians of shareholder and depositor funds. As such, we are accountable for every single rupee. That is the level of care in which we run banking operations and manage this business.

With export revenue and inward remittances deteriorating, we also have to surrender 25% of forex inflows to the Central Bank, making it harder for us to service our customers. With potential haircuts from restructuring ISBs and SLDBs, the banking sector is constricting further. Moving forward, the banking sector needs greater flexibility to support our customers, and at this stage, we only want dollars for essentials like food and fuel. While it may complicate negotiations with some foreign creditors, I believe that local government debt i.e. Treasury Bills and Sri Lanka Development Bonds should remain out of any debt restructuring agreement, since the impact on domestic banks, and by extension, the grassroots of the economy and the average Sri Lankan will be severe. In addition, authorities need to pay more attention and have stricter controls in tracking export revenues and import outflows to avoid any leakages, and in addition, introduce new measures to encourage remittances into the country, while tracking and identifying some of the big illegal market activists and take appropriate action. We only have difficult choices ahead, but with the right balance of policies, there is still a narrow path for progress to be made.

We have a complex problem comprising myriad complex issues with no easy solutions, so what would you like to fix if you could?

In a word: leadership. This is the moment to bring in real experts in their respective fields to lead the development of policies that will secure this country’s future. We have always had such people, but they have never been allowed to do their jobs. We need economists and experts in banking and finance to set macro-economic policy, and align it with the requirements, and objectives of the real economy.

There are many Sri Lankans with impressive achievements and experiences with global and local financial organizations, including the IMF and World Bank, while less qualified people were allowed to run the economy into ruin here. We need to attract Sri Lankan professionals on the ascendency or pinnacle of their careers to take up the mantle of leadership, and help reset the course and steer the economy out of this crisis. We need sweeping education reforms to foster entrepreneurship, build and nurture future-ready talent, and improve access to finance for sustainable growth and elevated livelihoods from the grassroots upwards.

We need to drive sustainable sources of generating the most important foreign exchange – exports. This means strategic import substitution and modernization of agriculture. It means supporting technopreneurs, and Sri Lankan professionals to export their services. It requires an urgent restarting of tourism, remittances inflows, and the promotion of Sri Lanka as an education hub to retain foreign currency in Sri Lanka while generating additional earnings through foreign students.

In addition to urgently expanding our export capacity, we need to simultaneously curtail all wasteful expenditure. Sri Lanka cannot afford a single white elephant. All of the existing investments in non-productive assets need to be re-evaluated and repurposed for a productive purpose or be liquidated. Underperforming sectors – including the public and private sectors and SOEs, need to either be reformed or shut down so that their labour can be redirected into the parts of the economy capable of generating foreign exchange or providing essential products or services. Sri Lanka has no choice left but to transform into a productivity-obsessed nation.

Most importantly, Sri Lanka needs leaders with integrity who can end the culture of corruption, cronyism, and welfare entitlement once and for all. We need disciplined and principled leaders who lead by example at all times. As individuals, we must also set the example ourselves, wherever we are and whatever we do. Let’s wake up and do the right thing for our country and our people. Everybody is watching us. Let’s not embarrass ourselves further. We are made of better stock and capable of so much better. Whatever it takes, we must unite to help our country and our people out of this crisis and towards prosperity.