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This is a report produced by Bloomberg. Bloomberg: Sri Lankan President Gotabaya Rajapaksa vowed to finish the remaining two years in his term despite months long street protests calling for his ouster, but won’t stand for re-election as he focuses on fixing a financial mess that tipped Sri Lanka into its worst-ever economic crisis. “I “I can’t go as a failed president,” – Sri Lankan President Rajapaksa Vows to Finish Term, Won’t Run for Re-Election

ECONOMYNEXT – Sri Lanka’s central bank has explained its exchange rate regime, which is still creating forex shortages amid a failed attempt to float the currency after mis-targeting interest rates for two years.

Sri Lanka has a soft-peg or intermediate regime (now called a flexible exchange rate) which loses credibility quickly and collapses frequently when liquidity is injected as money and exchange policies conflict.

The rupee collapsed steeply after March 2022, as an attempt was made to float the currency with a surrender requirement (forced dollars sales to the central bank) making the regime a peg and forcing the currency down, critics have said.

The central bank is now intervening in the market with surrendered and borrowed dollars, preventing a clean float from taking place.

Sri Lanka’s rupee has fallen from 4.70 to the US dollar to 365 to the US dollar since the soft-peg was set up in 1950.

The central bank introduced a ‘guidance rate’ last month saying transactions were taking place at different rates and there was no price transparency.

Later open account imports were also banned, raising fears over food imports if the banks do not allocate dollars for food quickly.

In 2022 Sri Lanka is suffering the worst currency crises in the history of the intermediate regime central bank.

However the central bank has taken the key step of raising rates which will reduce domestic credit, private investments and therefore imports, drive more money to the deficit, and reduce money printing which is creating forex shortages.

Sri Lanka’s public are generally net savers, cannot print money, and are incapable for creating balance of payment problems, either through imports, undiyal transactions, holding foreign currency in hand or maintaining dollar deposits, unless such transactions are directly or indirectly re-financed by central bank credit and open market operations.

Forex shortages are a problem associated with soft-pegs where outflows exceed inflows through the credit system when money is printed and rupee reserves of individual banks change when interventions are sterilized.

Clean floats also do not have forex shortages. Both clean floats and hard pegs match inflows to outflows at all times.

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Monetary regimes that are do not have conflicts involve targeting one anchor (keeping one variable constant like the exchange rate or inflation or until 1971 price of gold) and allow or change monetary policy to maintain it.

The full statement is reproduced below:

06 June 2022
Communications Department

The Current Exchange Rate Arrangement: Background, Positive Impact thus far, and Expected Outcomes

This note is intended to explain to the general public the background to the current exchange rate arrangement, and the positive impact it has already made, and expected outcomes in the period ahead.

The country is facing extremely challenging economic circumstances at present while it is going through the worst balance of payments crisis in history. The Sri Lanka rupee was subject to tremendous depreciation pressure, amidst the shortage of foreign exchange liquidity in the domestic foreign exchange market, warranting a measured adjustment in the determination of the exchange rate in early March 2022, compared to the level that prevailed in the market amidst concerns about the adverse impact of any large depreciation of the exchange rate on the society.

However, the outcome of the exchange rate flexibility that was thereafter allowed following the initial measured adjustment fell short of expectations due to the large overshooting by market forces, reflecting the significant liquidity pressures that prevailed in the domestic foreign exchange market as well as the delay in market correction. This behaviour of exchange rate since allowing more flexibility in March 2022 suggests the need for careful sequencing of measures when allowing flexibility in exchange rate under balance of payments crisis conditions.

Following the excessive depreciation, inflation accelerated significantly through imported prices, while second-round effects of such excessive depreciation on other goods and services were also observed subsequently. Moreover, due to the acute shortage of foreign exchange in the domestic foreign exchange market, along with continuous depreciation of exchange rate, the conversions of foreign exchange by the foreign exchange holders delayed due to expectation of further depreciation and high premium offered in the grey market, thus adding further pressures on the currency.

Meanwhile, the demand for foreign exchange in the grey market thrived to part finance rising import demand outside the banking system, causing further pressures on the currency as well as heightening stresses in the banking system. This significant volatility of the exchange rates drove up the interbank exchange rates as well as customer buying and selling rates in an abrupt nature, causing undue speculation on the currency.

Against this backdrop, limiting the extent of depreciation and excessive volatility became necessary. If remained unresolved, such boundless rate of depreciation of the exchange rate could have led to extremely detrimental impact on overall macroeconomic stability, given the severity of the balance of payment crisis that the country is going through at the moment. Further, during the discussions with the Heads of Treasuries of licensed commercial banks, the need for some guidance to the market from the Central Bank on the degree of volatility of the exchange rate movements was emphasized, while the commercial banks have the prerogative to determine the interbank spot market exchange rate.

In consultation with the market players, the Central Bank commenced providing daily guidance on the degree of volatility (with an allowable two-sided variation margin) to all licensed commercial banks from 13 May 2022 based on exchange rate determined in the interbank market on the preceding day. Although this arrangement is often misinterpreted as ‘pegged exchange rate’ regime, there are clear distinctions between the current transitory arrangement and the pegged exchange rate system. Under the pegged exchange rate regime a fixed middle rate is usually dictated by a central bank, while market driven variable spot rate being considered as the middle rate under the current arrangement.

The implementation of this arrangement has brought in a greater stability in the exchange rate determination in both formal market and grey market thus far, while also minimizing excessive margins prevailed in both markets, and the effects of the same are expected to reflect in the exchange rates used for customer transactions. According to the feedback received from the stakeholders, there exists broader consensus on the current arrangement of the exchange rate, which is market driven with less volatility and more predictability, compared to the earlier arrangement, which experienced excessively volatile of the exchange rate driven more by speculation rather than market forces and economic fundamentals.

The Government and the Central Bank implemented several complementary measures, alongside the current exchange rate arrangement, to correct some of the imbalances observed in the external sector, thereby bringing about stability in the domestic foreign exchange market. Restrictions imposed on open accounts and consignment payments terms have helped curtail activity in the grey market, thereby narrowing the gap between the official exchange rate and the grey market rate. Accordingly, the current exchange rate arrangement is viewed as a more credible mechanism, vis-a-vis an arrangement where grey market activity could operate freely.

Consequently, inflows on account of workers’ remittances to the banking system have gathered pace since the introduction of the new exchange rate arrangement, while conversions have improved. Import expenditure has declined notably in May 2022, compared to April 2022, according to provisional data from Sri Lanka Customs.

Despite the reduction in import expenditure, all possible measures would be taken to secure availability of essential commodities with the expected inflows from multilateral and bilateral sources to the banking system in the period ahead. Given the degree of overshooting of the exchange rate in March 2022, a further market based correction is expected with the deceleration of non urgent import expenditure, alongside increasing inflows to the banking system in terms of workers’ remittances and export proceeds on goods and services, among others.

This improved momentum in the domestic foreign exchange market is expected to consolidate with the progress being made towards reaching the staff level agreement with the International Monetary Fund (IMF) on a funding arrangement, along with the negotiations for bridging finance from other multilateral and bilateral partners.

The Central Bank would like to reiterate that the current arrangement of exchange rate would be reviewed from time to time, and further flexibility would be allowed if need be, once market confidence is restored, supported by envisaged foreign exchange inflows to the country.

Sri Lanka was, – for a short while, measured in months – the world’s first and only all-organic farming nation. This came about when the country’s former military strongman virtually in disguise as the nation’s de facto Defence Minister, now President, Gotabaya Rajapaksa announced an immediate overnight ban on the importation of all pesticides and Sri Lanka nosedives into an abyss of despair

COLOMBO (News 1st); Former General Secretary of the Communist Party of Sri Lanka, D. E. W. Gunasekera alleged that there are hidden forces in operation behind the detaining of the Russian ‘Aeroflot’ aircraft. He also urged the Government to probe further into the matter, and to not to pick sides in fear of diplomatic relations with India D. E. W. Gunasekera alleges hidden forces behind Aeroflot issue

COLOMBO (News 1st); What caused the country to come to its current state within two years was the bad management of the economy, says Prime Minister Ranil Wickremesinghe in an interview with NDTV. Prime Minister Wickremesinghe also said while thanking India for their assistance that, unfortunately, Sri Lanka has come to its worst situation in Post of PM, Youth in Politics, Economic Crisis : PM’s stance

ECONOMYNEXT – Sri Lanka’s China-backed Port City Project has faced a setback as due to the unstable situation in the country a top official said after two years of money printing to keep rates down triggered currency collapse and social unrest.

The Port City is a 1.4 billion US dollar sea reclamation project by unit China Communications Construction Company Limited, in partnership with the government of Sri Lanka which will sell a share of land to get revenue. Already 1.2 billion had been spent.

“We had a huge plan to aggressively market and sell Port City from this year but we have been challenged by the country situation,” Assistant Managing Director of CHEC Port City, Thulci Aluwihare told an online forum on May 28 by the Sri Lanka Economics Association.

Sri Lanka has seen progressive downgrades as money was printed to keep rates down and boost growth (stimulus or output gap targeting) under flexible inflation targeting triggering three currency crises in seven years as open market operations became increasingly aggressive.

In the latest crisis, the rupee collapsed to 366 to the US dollars from 200, in a botched float with a surrender requirement after a global pandemic which also delayed the project.

Monetary stability has still not been restored with money printing continuing and shortages seen in energy and medicines.

The Port City’s first large project, a 250,000 square metre office and retail development called the International Financial Centre are due to break ground in the third quarter of 2022, Aluwihare said.

The billion-dollar IFC’s first phase will see 500 million US dollars invested.

A Duty-free Store in association with two international operators, which is currently under construction, will be opened in the fourth quarter of 2022.

Utility connections to the periphery are to be completed by June 2023, he said.

Of the 100 hectares of land ready for development, 4.4 hectares by the Marina were sold for 200 million US dollars to predominantly local investors.

The Marina will be utilised for the development of an international luxury yacht marina and a five-star city hotel, which is also generating interest for residential development, he said.

Investors who get the land will then construct buildings, and permanent economic activities will then begin as businesses and residents occupy the buildings.

The project is slated to generate 143,400 direct jobs, and add 24 billion US dollars in economic value from reclamation and development. It is expected to generate 13 billion US dollars of gross domestic product a year when fully operational. (Colombo/June05/2022)

ECONOMYNEXT – Sri Lanka is urging citizens to grow vegetables in flower pots after the country’s economists mistargeted interest rates triggering a currency collapse and forex shortages continue amid money printing at higher interest rates.

After a partially failed main (Maha) cropping season and under-cultivation in the current Yala (minor) season due to fertilizer and fuel shortages, Sri Lanka is expecting record falls in food production.

Global commodity prices including foods and energy have risen in the so-called ‘Powell Bubble’ fired by US Federal Reserves, which also initially lied and blamed rising foods on ‘supply chain shortfalls’ but has since raised interest rates to stop money printing.

“If you have twenty flowerpots, and you grow food in at least ten of them, then we can get out of this crisis,” Agriculture Minister Mahinda Amaraweera told a reporter in Colombo.

“There are so many types of Yams that can be grown. If we do that we can successfully get out of this global crisis.”

Sri Lanka has imported more rice with crop shortfalls. Agriculture experts say about 5 months’ worth of rice (about a million metric tonnes) may need to be imported.

Minister Amaraweera says already about 338,000 Metric tonnes of rice have been imported and the government wants to import more rice before prices go up further.

Sri Lanka would need about 400 million US dollars to import a million tonnes (about two months’ worth of dollars coming through the Undiyal system). However, there are warnings that all food imports may be hit after open account imports were banned by the state.

After printing money to mis-target interest rates, Sri Lanka usually imposes various controls in cascading policy errors which worsens the fallout of central bank action.

After two years of money printing by the country’s Keynesian economists who favour an unstable peg (flexible exchange rate) with discretionary monetary policy (flexible inflation targeting) and output gap targeting (printing money to push up growth) inflation is soaring.

In May, has already hit 39 percent. Food prices have risen 57.4 percent in the 12-months leading up to May.

There have been calls to reform the central bank and hold it accountable so that it can no longer practice ‘flexible’ or discretionary policy.

Under the current law which binds the agency to economic and price stability, generating monetary stability and targeting output through ‘flexible policy’ is a violation of its basic goals.

However a draft law to legalize flexible policy and allow officials to escape accountability, and also give legal assistance is in existence, critics have said. (Colombo/June05/2022)

COLOMBO (News 1st); The Ministry of Agriculture states that paddy cultivation in the Yala season is facing a serious crisis. Accordingly, a senior official of the Ministry stated that the crisis situation has arisen due to the non-avalibility of the required stocks of fertilizer for the Yala season. The official pointed out that paddy cultivation in Yala harvest in crisis due to non-availability of fertilizer

ECONOMYNEXT – State-run SriLankan Airlines had lost 170 billion rupees in 2021 and its accumulated losses had risen to 542 billion rupees, a Finance Ministry report said despite the national career improving its performance in the last quarter.

SriLankan Airline’s revenue fell to 71 billion rupees in 2020 in the Coronavirus pandemic triggering a 45 billion rupee loss.

In 2021 revenues grew to 134.6 billion rupees as foreign travel was gradually relaxed.

But the airline had been hit by high finance costs and currency depreciation as the island’s soft-pegged central bank triggered the worst currency crises in its history.

In the year to March 2022 finance costs went up to 122.5 billion rupees from 35.6 billion rupees and unrealized forex losses were 47.7 billion rupees, up from 6.8 billion rupees a year earlier.

SriLanka’s intermediate regime central bank created the worst currency crisis in its history in 2022 after two years of money printing and a botched float with a surrender requirement.

The government has re-issued letters of comfort of 205.4 million US dollars and 27.6 billion rupees to state banks for loans given to SriLankan Airlines.

The airline had trade creditors of 183 billion rupees including 89 billion rupees owed to state-run Ceylon Petroleum Corporation.

SriLankan Airlines had interest bearing liabilities of 372 billion rupees, the report said.

“This scenario has had a significant impact to the banking sector and the CPC,” the Finance Ministry said.

“Furthermore, the capital erosion of Sri Lankan Airlines has been aggravated by the massive loss experienced in 2021/22, throwing further doubt on SLA’s going concern in light of the government’s fiscal restricted fiscal space and the financial environment of the state banking sector.”

“..[U]under the prevailing economic conditions, the Government is no longer in a position to finance SLA’s losses and therefore SLA requires an immediate transformation to clear up their liabilities through a proper business restructuring by selecting a suitable
business partner.

SriLankan Airlines has lost money since ex-President Mahinda Rajapaksa ousted Emirates Airlines as managing shareholder an re-nationalized the airline.

ECONOMYNEXT – Sri Lanka President Gotabaya Rajapaksa has instructed to identify all underutilized lands owned by plantation companies and prepare an expeditious programme to cultivate food crops, his media division said on Saturday as the crisis-hit island nation is facing a food shortage in the near future.

“Plantation companies own more than 9,000 hectares of uncultivated land. The President pointed out the need to identify suitable crops for cultivation in respective estates owned by 23 companies,” the President’s Media Division (PMD) said in a statement citing Rajapaksa made the remarks at a discussion held at the President’s House, o Friday (03).

The president’s instructions come as the island nation’s agricultural experts have warned of a possible shortage of rice and other essential foods possibly in September because of lower production due to the impacts of chemical fertilizer ban last year and inability to import amid dollar shortage.

Prime Minister Ranil Wickremesinghe has already warned of an acute food shortage by August and said the island nation would require $600 million to import fertilizer amid Sri Lanka’s near zero foreign currency reserves.

Crop scientists have warned that Sri Lanka could produce enough rice only for seven months of this year due to the fertilizer ban. Before the fertilizer ban, Sri Lanka had self sufficiency in rice production.