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ECONOMYNEXT – Sri Lanka has no food shortages at the moment except milk which are imported by a few large companies, but drugs and medical items are facing deadly shortages after the central bank created dollar shortages with money printing.

Sri Lanka is estimated to import around 200 million US dollars of foods a month including onions, potatoes, sprats, lentils and cereals and some types of rice from time to time.

Sri Lanka’s drug shortages are primarily created by the National Medical Regulatory Authority ,a deadly price control agency created by the ousted Yahapalana administration along with the central bank which is running the flexible exchange rate.

When the NMRA imposes price controls importers cannot sell at the current costs with the central bank depreciating the currency with money printing and a surrender rule. Therefore there are shortages.

They also cannot open Letters of Credit at banks due to dollar shortages created by money printing and the surrender rule.

The easiest way to create food shortages is to clampdown on the Undiyal/Hawala markets, open account food imports and force Pettah traders to open LCs or set Customs authorities on food importers who do not fully settle bills through official channels.

The Consumer Affairs Authority can also contribute to food shortages with price controls.

Starting NMRA without ending flexible inflation cum output gap targeting

This column warned as far back as 2015 when the then Monetary Board was printing money claiming inflation was low as commodity prices collapsed that restraining by law the central bank’s flexible policy was the answer not the NMRA. (Sri Lanka’s pharma control Neros fiddling while Colombo burns with falling rupee)

In 2018 when the outcome of the flexible inflation targeting cum output gap targeting gap become clearer, pointed out that Sri Lanka was not Greece where the currency was stable but a Latin America style central bank where the rupee collapses very steeply hitting consumer prices.

Flexible exchange rates or soft-pegs are the most dangerous monetary regime ever cooked up by economists or mercantilists.

This is what the column said at the time in (Sri Lanka is not Greece, it is a Latin America style soft-peg: Bellwether)

“Under Euro a local company can still repay foreign loans. They can also borrow domestically or use their bank deposits to repay foreign loans. There is no problem with importing goods as the Euro is accepted abroad.

“The prices of fuel or electricity did not go up steeply. They were same as any stable country in the Euro area like Germany or France. As there was no explosion in inflation the value of bank deposits were intact. While there is sovereign default and possible hair cuts on state debt there is no private default or haircut.

“But a falling currency imposes a hair cut on all state and private debt including bank deposits in solvent banks. Pensions are made worthless hitting old people the hardest.

“A collapsing soft-pegged currency will put all citizens other than the very rich, in severe difficulties unlike a strong floating exchange rate like the Euro.

Three sins and a currency collapse

“In a soft-pegged monetary regime like in Sri Lanka, the currency continues to fall each time the central bank intervenes in forex markets and then prints money to keep interest rates down.

“As long as the currency is not floated, there is no end in sight for exchange rate depreciation, especially if interest rates are not raised and credit does not slow. What usually happens in Sri Lanka and other soft-pegs is that in the end rates have to be hiked and the currency floated. This is the phenomenon been referred to as ‘rawulath ne kendeth ne’ in this column.

“In Latin America – unlike Greece – when the currency falls steeply, prices go up, and people ‘s living standards melt as most of the money goes to food and medicines. This makes the many businesses fail as demand collapses.

“Then banks have bad loans and suffer losses.

“Unlike in Greece, the government of a soft-pegged country cannot raise money from domestic markets and repay foreign loans even at prohibitive interest rates. The government may default. Downgrades will compound the problem, pushing interest rates up.

“As prices move up with currency depreciation the value of bank deposits evaporates. If the currency falls by 50 percent, local companies will now have to borrow more to repay foreign loans, making massive holes in their balance sheets even if forex was available to buy.

“If exchange controls come, there will be no dollars to buy with the domestic money they have borrowed.
“It is not possible to import goods freely when a soft-peg collapses because there will be forex shortages due to sterilized intervention. Import controls may also come.

“As the cost of fuel or electricity goes up (oil prices are now falling and there is rain in Sri Lanka) if prices are not raised, more money will be printed to subsidize energy, pushing the currency down.
“In Latin America, energy price controls have led to money printing and rationing. There can be power cuts and fuel shortages.

“In Sri Lanka because of price controls of the National Medicines Regulatory Authority medicines, drugs can go off the shelves.

“In Latin American soft-pegs many price controls were imposed. Instantly goods go off the shelves and black markets appear.

“With import controls more businesses will fail. People will be laid off as revenues fall. Banks will make more losses. Rates will rise eventually. More businesses can fail.

“If this situation continues for several months, there may be runs on banks. If money is printed to bail them out, the currency falls even more. This phenomenon was seen in many Latin American soft-pegs and also Indonesia during the East Asian crisis.

“Debt to GDP will explode until inflation catches up. The share of foreign debt will also increase. This is what happens in Latin America. It is not Greece.

Monetary Meltdown

In 2021 when bad central bank policy continued this column warned that if a float was botched running out of reserves due to ‘fear of floating’ that is found in flexible exchange rate central banks, default and a meltdown was likely.

Soft-peggers do not float in one go but tries to adjust the currency little by little. However it can backfire. The IMF also advised the central bank to adjust little by little. It was done. Two months after the float the rupee is still adjusting little by little.

This column warned against this type of half-hearted floating and half-hearted bond auctions. It is extremely disappointing to this columnist to see these warnings coming true.

This column has said in the past that dire warnings are made in the hope that the central bank’s usually flexible policies would be abandoned.

This is what was said in 2021 when the central bank continued with trying to target an output gap with the peg already broken in Sri Lanka’s monetary meltdown will accelerate unless quick action is taken: Bellwether

“The central bank itself is likely to be insolvent on its dollar liabilities before the end of the year unless money printing is halted.

“However any kind of half-hearted Treasury bill and bond auctions, partially failed bond or bill auctions with some volumes of printed money will lead to progressively higher interest rates but the reserve losses and currency depreciation will continue.

“Soft-peggers are not good at floating. Partial interventions (flexible exchange rate) will lead to even higher interest rates and more losses of confidence.

“In Argentina, short term rates went up to 60 percent due to the ‘flexible exchange rate’ (which is neither floating nor pegged) that had caused so much damage to Sri Lanka since 2015 coupled with an unsterilized disorderly market conditions (DMC) rule, which also lacks credibility.

“The high interest rates can kill many businesses. The high rates from partial floating can kill finance companies and banks.

“When dying banks are bailed out with printed money, it is generally even more difficult to control the exchange rate.

“Inflation and cash shortages will lead to a consumption collapse which will also destroy businesses. Low reserves will lead to a default on foreign debt as happened to the Weimar Republic.

CAA, NMRA a big threat

“When the rupee starts to fall, the price controls will come. The Consumer Affairs Authority (CAA) had already stopped Laugfs Gas.

“It will impose many more price controls. Many more shortages will occur. It will be a big threat to the ordinary people. People will be branded ‘black marketers’.

“The money printers are already getting ready to hike the fine on those who break price controls by 100 times.

“The National Medicinal Drugs Authority (NMRA) could be an even bigger threat. NMRA price controls will make it impossible for drug importers to operate. There may be shortages of some types of medicines.

“The import substitution firms, also called ‘cronies’ will manage.

“It is even possible that oil imports will have to be curtailed, if more money is printed to pay state “workers and meet other expenses.

“What happens to soft-pegs countries is that eventually the currency is floated when it becomes apparent to the Keynesians driving policy, that there is no way to rebuild reserves. When the rupee is floated price controls may again cause havoc.

Avoiding Worst Case Scenario – Monetary Meltdown

“So what is the worst case scenario?

“The worst case scenario is that the nothing will be done and the central bank will continue to print money to keep the ceiling yield on Treasury bill yields.

“Whatever Keynesian or post – Keynesian economist, have been taught at university, reality always hits eventually. Keynesian models are fine in theory, but they do not exist in the real world. The Hicks-Hansen model (IS-LM) was dismissed by Hicks himself later.

“The central bank itself is likely to be insolvent on its dollar liabilities before the end of the year unless money printing is halted.

“However any kind of half-hearted Treasury bill and bond auctions, partially failed bond or bill auctions with some volumes of printed money will lead to progressively higher interest rates but the reserve losses and currency depreciation will continue.

“Soft-peggers are not good at floating. Partial interventions (flexible exchange rate) will lead to even higher interest rates and more losses of confidence.

“In Argentina, short term rates went up to 60 percent due to the ‘flexible exchange rate’ (which is neither floating nor pegged) that had caused so much damage to Sri Lanka since 2015 coupled with an unsterilized disorderly market conditions (DMC) rule, which also lacks credibility.

“The high interest rates can kill many businesses.

“The high rates from partial floating can kill finance companies and banks. When dying banks are bailed out with printed money, it is generally even more difficult to control the exchange rate.

“Inflation and cash shortages will lead to a consumption collapse which will also destroy businesses. Low reserves will lead to a default on foreign debt as happened to the Weimar Republic.

Food Heroes

When a country defaults trade takes a big hit because foreign suppliers refused to accept Letters of Credit. But in Sri Lanka’s case this happened in incremental steps from around late 2020 when the country was downgraded to CCC.

First some suppliers stopped accepting LCs of local banks which were not counter signed by an international bank. Suppliers need LCs to get packing credit. Then banks in Japan and Western countries stopped counter signing them. For a while Indian banks did it at a high premium.

The Indian banks also stopped counter signing. They also stopped giving supplier credit against Sri Lanka LCs.

Then as the central bank tightened controls, surrender rules and so on, without halting money printing banks stopped giving LCs because they could not find dollars to settle them on time.

However Sri Lanka’s Pettah traders, like a mother hen feeding her chicks under the greatest challenges continued to import food using traditional relationships, sometimes running back several generations, with suppliers sending goods on open papers.

Farmers are also doing it despite the lack of fertilizer. Some fertilizer is smuggled from India to feed the people (boat urea).

Suppliers in South Asia and Dubai are familiar with Undiya/Hawala and are willing to trust personal relationships more than LCs. Their word is their bond.

Food importers will tell that banks only give small amounts of money. They have in fact cleared most of the containers in the port.

That is why there is food. Through the Undiyal/Hawala system they get priority. And they can get a dollar at 20 rupees higher and feed the nation while banks have to listen to various dictates of authorities and powerful suppliers including in building materials.

The Undiyal/Hawala system is not a threat to anyone. It does not create new money and drive up excess liquidity of the good banks, unlike the surrender rule of the ‘official channels’.

It does not reduce the rupee reserves of state banks in particular and lead to printed money borrowing from the SLF window unlike the ‘official channel’.

It is harmless a gross settlement system where the currency floats without influencing reserve money. It is feeding a nation with remittances.

What should be done is not to force food importers to use LCs, but to fix the broken peg (rates have already been raised which will reduce domestic credit and investments and imports in a step in the right direction) or have a clean float so that imports can be done freely.

Forcing food importers to use LCs can create food shortages. Setting the CAA hounds after the food heroes will also create shortages. (Colombo/Apr29/2022)

ECONOMYNEXT – Sri Lanka’s newly appointed cabinet is likely to be dissolved when majority at an all-party meeting with President Gotabaya Rajapaksa agrees on Friday, Cabinet Spokesman and Media Minister Nalaka Godahewa said.

President Rajapaksa, who is under heavy criticism for the current economic crisis, has called for an all-party conference and has pledged to go for an all-party cabinet once the consensus is reached at the meeting which is scheduled to be held Friday morning.

The earlier cabinet resigned on April 3 and a new cabinet has been appointed, aiming to ease some pressure from the protesters.

“My understanding is unless something drastic happens in between, it is very likely that the cabinet will be dissolved and a new cabinet be appointed,” Godahewa told at a meeting with Foreign Correspondents Association (FCA) on Thursday (28).

“I think we are heading towards that direction. If majority of them agree to form a cabinet, definitely current cabinet will be dissolved.

“If the opposition parties don’t come, it boils down to the original team that are there, then the issue will be what is the cabinet? What is the composition? Who’s going to lead? So those things have to be resolved. I don’t know, the final outcome yet.”

The youth-led protesters have been demanding the resignation of President Rajapaksa and Prime Minister Rajapaksa, Both have defied to step down, but agreed to go for constitutional changes to reduce the powers held by the president.

The protesters have been agitating for the 21st consecutive day on Friday (29) near the presidential secretariat in the heart of capital Colombo near a range of luxury hotels.

People across the country have joined the protesters and have been backing them to bring in a new change in the country’s political system in which many have lost confidence.

The protests were started after shortage of essentials including medicines, fuel, and milk powder led people across the country to stay in queues, sometimes for days amid extended power cuts.

Rajapaksa government has so far not found any sustainable solution to shortages of dollars which has resulted in shortages of essentials as the government could not import the essentials.

“It will at least bring stability inside the parliament,” Godahewa said when asked if a new all-party cabinet would help ease shortages. ‘

“Right now even to pass an act or any drastic action that we have to take in this economic crisis, certain drastic decisions will have to be made. So if you can’t pass those in the parliament, nothing can be done.”

“So you need a strong government, first of all, to face this economic crisis. But it will not necessarily solve the mood outside, I think that will continue for a while.”

“But you have no other way to solve that, unless you put the economy back on track. To put the economy back on track, you will need parliamentary democracy established and a strong government. So that’s the first step you’re trying to achieve.” (Colombo/April29/2022)

ECONOMYNEXT – Sri Lanka is hopeful of reaching a staff-level or initial agreement with the International Monetary Fund within two weeks, Ceylon Chamber of Commerce quoted Central Bank Governor Nandalal Weerasinghe as saying.

Governor Weerasinghe had addressed the committee of the Chamber on April 28.

“Noting that encouraging progress had been made towards establishing a macro-fiscal policy framework and initiating structural reforms, he expressed confidence that a staff-level agreement with the IMF is likely to be reached within the next two months,” the Chamber said.

Sri Lanka has a soft-pegged exchange rate regime, which is neither a clean float nor a hard peg and there is a balance of payments deficit and a currency peg collapses whenever the central bank prints money to keep interest rates down artificially.

Unlike clean floats of hard pegs where balance of payments crises are impossible, soft-pegs or flexible exchange rate frequently end up at the IMF usually also with political upheavals and social unrest.

After the end of a 30 -year war monetary policy radically deteriorated with flexible inflation targeting (discretionary policy where money can be printed on multiple excuses) with output gap targeting (printing money for stimulus) triggering a series of currency crises, analysts have said.

In 2018 output gap targeting triggered a currency crisis despite tax hikes and market pricing of oil. During each money printing period – which created forex shortages – the country borrowed heavily abroad including through what was called active liability management and the Ceylon Petroleum Corporation was also made to borrow.

The currency collapsed from 131 to 182 during two soft-peg now called crises

In the 2020-21 crisis the central bank borrowed and it now has net debt.

Eventually Sri Lanka defaulted on its external debt on April 12, despite the country being at peace and the IMF said it will have to re-structure external debt to keep down the gross financing need.

Sri Lanka will not re-structure domestic rupee or dollar debt, Governor Weerasinghe has said.

The staff level agreement has to be approved by the IMF board after all prior actions which are deemed to be absolutely required are completed. A key prior action is debt – restructuring according to what is now known.

The central bank has hiked its artificially low policy rate which hit the rupee and triggered reserve losses from 2020 to 2022 to 14.5 percent after triggering a currency collapse from 182 to 355 so far party accelerated by a surrender rule which was pushing the peg down, analysts have said.

With the peg still broken and generating forex shortages in 2022 Sri Lanka is now on another foreign borrowing spree calling it ‘bridging finance’.

A country also has to end forex shortages and match outflows to available inflows before the first tranche is disbursed, the prevent the IMF money from being frittered away in ‘bridging finance’ style activity. (Colombo/Apr28/2022)

COLOMBO (News 1st); Trade Unions from several areas across the country reached Occupy Galle Face protest site on Thursday (28) afternoon. Many Government, non-Government and private-sector workers from various sectors such as the Management Service Union, Bank Employees Union, the Government’s Exclusive Officers, the Export Development Board, Development Office, and Lawyers took part in the LEAVE! Trade Unions march to Galle Face demanding President step down

ECONOMYNEXT- Sri Lanka is facing its worst performing cultivation season in more than a decade during the ongoing Yala season and there is a possibility of a looming food crisis in the coming months,” a group of Agriculture experts have warned.

President Gotabaya Rajapaksa’s ban on chemical fertilizer a year ago is now taking the toll on the agricultural sector with the paddy production has plummeted nearly by 50 percent.

Rice is Sri Lanka’s staple food and nearly 80 percent of the 2.2 million Sri Lankan farmers cultivate paddy in 800,000 acres of land, the biggest by any crop.

“This season has not yet begun, but it is already finished. There is no hope for it,” K.K.I.U.  c, a crop science professor at University of Ruhunu told reporters on Wednesday (27) in Colombo representing Academics’ Movement to Safeguard Agriculture in Sri Lanka.

“If we cannot get enough seed paddy for next season at least, Sri Lanka will have to depend on imports even in 2023. We cannot see this crisis coming to an end.”

The fertilizer ban has led Sri Lanka to import rice from India, Pakistan, and Myanmar while China has agreed to grant 5,000 metric tons of rice.

Critics say the government’s objective of chemical fertilizer ban is lost because the island nation has to spend more dollars on imports while people are compelled to consume rice grown under agrochemicals in a foreign country instead of Sri Lanka.

The experts also said apart from rice,  yield of corn, a crop largely used for animal feed, went down by over 70 percent. while decline in tea production has led to a fall of 52 million US dollars in the first quarter due to fertilizer ban. They also said vegetable yield also had also gone down by 30 percent.

President Rajapaksa and his cabinet ministers were stubborn on organic fertilizer. The government first imported organic fertilizer from China, but the consignment was rejected because the authorities said the shipment contained harmful bacteria. Later it imported liquid Nitrogen fertilizer, but farmers complained that they do not prefer to use them due to bad odour.

Last week, the President said banning chemical fertilizer was a mistake and he would reverse the decision for the this Yala cultivation season.

Experts said a looming food shortage could be due to farmers temporarily abandoning Agriculture due to the unsustainable costs of the occupation.

“Fertilizer prices have gone up by seven folds, and farmers no longer receive subsidies. A 50kg of fertilizer was 6000 rupees in the past. Now it is over 45,000 rupees. Large commercial farms can cover the costs, but most farmers decided to reduce production area or temporarily stop agriculture,” Academics’ Movement to Safeguard Agriculture in Sri Lanka said.

The initial ban on chemical fertilizer in April last year resulted in widespread protests by the farming community. After the ban is lifted, now fertilizer scarcity is haunting the farming  community hard.

Arunakumara stated that importers were finding it difficult to open letters of credit due to the forex crisis, and that the Russia Ukraine war, as well as China’s export ban on chemical fertilizer was also impacting the scarcity.

Experts noted that the lack of weedicides, pesticides and insecticides also had a huge impact on crops, especially on corn, which is highly affected by growth of weeds.

Professor Saman Dhamakeerthi from University of Peradeniya told Economy Next that the reduction of corn production could have adverse effects on the animal husbandry industry, particularly poultry farms, and that meat prices would also increase as a result.

Experts stated that Sri Lanka was self-sufficient in paddy since 2008, producing on average an excess of 800,000 metric tonnes of paddy per year, except for two years of extreme drought. In contrast, Sri Lanka had to import 650,000 kg of rice since the ban on chemical fertilizer, experts say. (Colombo/Apr27/2022)

ECONOMYNEXT – Sri Lanka has recorded a budget deficit of 12.2 percent of gross domestic product in 2021, with 1,225 billion rupees printed under output gap targeting with flexible inflation targeting, official data show.

The debt ratio with Treasury guarantees and net central bank foreign debt was had risen to 115.9 percent of GDP.

Sri Lanka has raised 1,457 billion rupees in revenues in 2021 or 8.7 percent of GDP, down from 9.1 percent of GDP or 1,373.3 billion rupees in 2020, according to fiscal data released.

Output Gap Targeting

In 2019, the government raised 1,890.9 billion rupees of 12.6 percent of GDP until the country’s economists cut taxes to target an output gap.

“The switching of resources from unproductive public expenditure to the private firms and individuals will be growth friendly in a context where there has been a persistent output gap,” the Finance Ministry said in December 2019. (Sri Lanka fiscal stimulus to close output gap)

“Higher growth will have a positive impact on the overall debt dynamics of the country as well.”

To prevent the extra money in private hands from going back to the budget through bond auctions, the central bank then imposed price controls on bond auctions and bought large volumes of securities with printed money.

There have been claims that 600 billion rupees a year in taxes were lost a year due the tax cuts.

However in 2021, twice the value of the tax cuts or 1,225 billion rupees was printed as the balance of payments was blown wide open, losing the ability to repay foreign loans and an import boom started with the excess money.

The central bank has discretionary independence to whatever it’s Governor and Monetary Board wants going against its mandate of maintaining economic and price stability in Section 5(a) of its governing law using other provisions and its involvement in a Treasury securities auctions committee. (Sri Lanka central bank to work closely with finance ministry in developmental state: Governor)

Ironically the tool to calculate the output gap was given by the International Monetary Fund.

Sri Lanka began ‘flexible inflation targeting with output gap targeting (stimulus with printed money) after 2015 eventually driving a country without a war into default with three currency crises in quick succession.

Flexible policy unconstrained by law

The output gap targeting was done with a flexible exchange rate, which is neither a clean float nor a hard peg leading to anchor conflicts and currency collapses.

The flexible exchange rate or a soft-peg is the third rate unstable intermediate used in many third world countries that go the International Monetary Fund with balance of payments trouble. Balance of payments crises do not take place in hard pegs of clean floats.

From 2015 to 2019 two currency crises were triggered by money printed to target an output gap under ‘flexible inflation targeting.’

At the time money printing was justified on the claim that “output gap stabilization is an important concern in a flexible inflation targeting regime” and that it “argues for a relaxation of monetary policy.”

During the ousted Yahapalana regime a new law was brought to legalize flexible and discretionary policy instead of committing the Monetary Board to a rule of law and reducing its discretionary powers. The law also sought to indemnity staff.

Deficit

As total revenues went up to 6.1 percent to 1,457 billion rupees current spending went up 2.8 percent to 2,747 billion rupees.

The current account deficit or the gap between total revenues and only current spending was 1,290 billion rupees flat from 1,298 billion rupees a year earlier.

Capital spending was 774 billion rupees, down 0.6 percent from 791 billon rupees a year earlier.

The overall budget deficit (after grants) was 2,057 billion rupees or 12.2 percent of GDP compared to 2,085 billion rupees of 13.9 percent of GDP in 2020.

The Finance Ministry had claimed the deficit was 11.1 percent of GDP in 2020 by shifting some arrears to the previous year.

Foreign borrowings were a negative 13.9 billion rupees with the rating steadily downgrade since 2015 under flexible inflation targeting with output gap targeting and eventually being locked out of capital markets in 2020.

Money Printing

In 2021 1,225.2 billion rupees was printed, up from 505.8 billion rupees in 2020.

In the 2018 currency crisis when the then administration gave full independence to the central bank they were unable to stop 247 billion rupees from being printed or to stop output gap targeting.

Then Minister Harsha de Silva pleaded with the central bank to raise rates, but the pleas were ignored.

In 2019, 109 billion rupees in central bank credit was reversed, but output gap targeting began from August ending pushing the balance of payments into negative territory.

The deficits are still continuing with a broken pegged regime.

The central government debt of GDP ratio went up 104.9 percent from 98 percent. With government guaranteed debt it was 113.6 percent of GDP.

The central bank also became a net dollar borrower in 2021. When negative net foreign assets are added, the debt to GDP ratio was up to 115.9 billion rupees.

Analysts and economists have called for legal changes to the central bank’s law and the removal of provisions that allows it to practice flexible inflation targeting, output gap targeting and trigger economic and price instability and commit it to a rule of law.

The output gap targeting under flexible inflation targeting which triggered three currency crises from 2015 to 2022 and brought a country at peace into default and the flexible exchange rate to collapse is likely illegal under section 5 (as) critics say. (Sri Lanka has a corrupted inflation targeting, output gap targeting not in line with monetary law: Wijewardena)

ECONOMYNEXT –  Sri Lanka President Gotabaya Rajapaksa has given his consent “in principle” to an all-party government to be appointed upon the resignation of Prime Minister Mahinda Rajapaksa and the cabinet, a private broadcaster reported on Wednesday (27).

According to the privately owned NewsFirst network, a statement from the president’s office which has yet to be publicised has said the president plans to meet leaders of parties and independent groups that represent parliament on Friday (29) at 10.30am.

“As a solution to the crisis facing the country right now, I agree in principle to an an all-party government representing all parties in parliament be formed,” the statement quoted the president as saying.

The composition of said all-party government, which will be formed after the resignation of Prime Minister Mahinda Rajapaksa and the cabinet, the duration of its term, appointments to be made in that government and other relevant matters need to be decided upon discussion, the statement said.

This is the first time President Rajapaksa has commented on widespread calls for his government’s resignation. However, his statement made no mention of the main demand of protestors islandwide that the president himself step down.

Meanwhile, Sri Lanka’s main opposition Samagi Jana Balavegaya (SJB) is collecting signatures for a no confidence motion against the increasingly unpopular government. Former energy minister and now dissident government MP Udaya Gammanpila claimed 120 MPs will back the motion. The legislature comprises a total of 225.

The island nation is going through the worst economic crisis in the country’s history due to a crippling dollar shortage brought about by, among other things, relentless money printing. Protests have erupted islandwide demanding the resignation of the government and President Gotabaya Rajapaksa.

Some government MPs themselves have called for the resignation of Prime Minister Mahinda Rajapaksa, who has said he has no plans to leave. (Colombo/Ap427/2022)

ECONOMYNEXT – Sri Lanka’s Finance Ministry has ordered capital expenditure cuts in the budget for 2022 to trim spending and imports in a bid to save the rupee which has been hit by money printed to keep interest rate low.

Newly appointed Treasury Secretary Mahinda Siriwardene in a circular to government departments, provincial councils and statutory boards has ordered all new projects and those that have been started and stalled due to lack of raw materials to be suspended.

“Enhancing the government revenue is a crucial requirement to control this challenging situation,” Siriwardene said.

“However as it takes a certain time, public expenditure needs to be well-tightened, making it available only for the most essential services for a certain period.”

In the case of half completed projects, negotiations have to be held with contractors.

Officials have also been asked to stop acquiring lands of other assets.

Requirements which have commenced but where letters have not been issued should be delayed.

Circulars issued earlier on containing current spending would continue.

Sri Lanka’s state finances got into fix from 2015 due to ‘revenue based fiscal consolidation’ where the usual spending based consolidation was abandoned.

Recurrent spending was pushed up from 1.2 trillion rupees in 2014 to 2.4 trillion rupees by 2019 and total spending rising from 17.2 percent of GDP to 19.4 percent by 2019.

As part of the flexible inflation targeting, money was printed output gap targeting was adopted (go policy) leading to revenue falls when the breaks were applied to stop the resulting currency crisis (stop policy).

As currency crises triggered forex shortages sovereign bonds built up at central government levels and dollar borrowings went up at the Ceylon Petroleum Corporation.

From 2020 an large volume of money was printed under an output gap targeting exercise called developmental state/production economy where taxes were also cut, releasing more money into private hands.

To prevent the money from ending up back in the budget via bond markets through slightly higher interest rates (which would have happened under a fixed exchange rate), the central bank ordered price controls on bonds, bought securities with printed money and triggered an external crisis.

Unable to borrow from capital markets due to downgrades, foreign reserves were run down in from 2021 to 2022.

In early 2020 Finance Minister Basil Rajapaksa offered a 20 billion rupee ‘relief package’ in the first quarter which further de-stabilized the budget and put pressure on domestic credit.

The currency has collapsed from 203 to 345 after an attempt was made to float the currency without removing a surrender rule or sharply raising rates to stop private credit and avoid printing money.

Policy rates were hiked to 14.50 percent which will reduce private credit. The capital expenditure cuts or spending based consolidation would also reduce domestic credit.

However on Friday about 18 billion rupees were printed which would make forex shortages persist and rates to be elevated. (Colombo/Apr27/2022)

ECONOMYNEXT – Sri Lanka’s Tamil  National Alliance (TNA) is still undecided on a proposed no confidence motion (NCM) against the government, apprehensive that the premiership will be retained by the ruling Sri Lanka Podujana Peramuna (SLPP) or will otherwise go to a person who supported the 20th amendment to the constitution, an TNA MP said.

TNA parliamentarian M A Sumanthiran told EconomyNext Wednesday (27) morning that the party will arrive at a decision once there is clarity.

“We don’t know what will happen after the NCM. We don’t want to fall from the frying pan to fire. We don’t want anybody from the SLPP or people who voted for the 20th amendment to become the PM. We will decide once we have clarity,” he said.

The main opposition Samagi Jana Balavegaya (SJB) is currently collecting signatures for an NCM against Sri Lanka’s increasingly unpopular government. Former energy minister and now dissident government MP Udaya Gammanpila claimed 120 MPs will back the motion. The legislature comprises a total of 225.

Sri Lanka is going through the worst economic crisis in the country’s history due to a crippling dollar shortage brought about by, among other things, relentless money printing. Protests have erupted islandwide demanding the resignation of the government and President Gotabaya Rajapaksa.

Some government MPs themselves have called for the resignation of Prime Minister Mahinda Rajapaksa, who has said he has no plans to leave. (Colombo/Ap427/2022)

ECONOMYNEXT – A currency board for Sri Lanka would bring immediate confidence to investors and help stop the economic crisis, top emerging market investor Mark Mobius who has experience in investing in stable countries with fixed exchange rates said.

“I like the currency board idea. It has worked around the world. Provided you have a really ethical board of directors of the currency board, to make sure that they do not deviate (from the currency board rules),” Mobius said in an interview in Colombo.

“But that to me is the solution. It will immediately bring confidence.”

Mobius said he had been investing for a long time in Hong Kong which has a currency board.

Hong Kong set up a currency board in 1983 after the currency became unstable and has kept its exchange rate at 7.8 to the US dollar and is a territory which has among the highest economic freedom in the world.

A currency board cannot buy Treasury bills to create forex shortages and the exchange rate is permanently fixed.

As result non-classical economists or mercantilists cannot engage in ‘stimulus’ or output gap targeting to create forex shortages and balance of payments crisis.

Soft-pegged currencies (central banks with foreign reserves) collapse due to liquidity injected through open market operations to keep interest rates down when domestic credit picks up.

They also cannot depreciate the currency in the pursuit of temporary trade gains (mercantilist objectives), give short term zero-sum profits to export firms at the expense of workers and trigger strikes and social unrest.

However the currency board has to have its own law and had to be a “true currency board” not like the case in Argentina where it was claimed to be currency board but operated in a different way Mobius said.

“The law has got to be changed,” he said.

Argentina had a ‘convertibility system’ under the same Latin America central bank law and the exchange rate collapsed in 10 years. Soft-pegs generally collapse in the second Fed cycle as the ceiling rate is brought down.

Mobius said he saw opportunities in Sri Lanka’s equity markets in companies “with strong balance sheets, high returns on equity which can grow profits in dollar terms” which can survive a crisis.

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He had bought an apartment in Sri Lanka and had hired a decorator who had quoted a dollar price because some material had to be imported.

However when he went to the bank to get the money he had been told only rupees would be released. He was wondering what to do and ‘waiting for the answer’ since the rupee was falling and if the money was withdrawn their were doubts whether material could be imported.

However in the case of sovereign bonds, were traded off shore and money did not have to be brought into Sri Lanka, he said.

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Sri Lanka had a currency board from 1885 to 1950 and it was broken legislatively in favour of an intermediate regime. Currency boards are generally set up in crises.

The Ceylon currency board was set up by British colonial administration after the Eastern and Oriental Bank (a note issuing chartered bank failed and closed its doorz leading a 50 percent depreciation of the Ceylon Rupee.)

Singapore also kept is currency board after independence to avoid inflation and balance of payments crises. (Colombo/Apr27/2022)