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Messed up Economy in Sri Lanka


Risky gambling with economic fundamentals is a popular way too. In this way, you can keep rolling out things with massive borrowings and investment in mega projects until things get right. Of course, if you are lucky enough, you will get through.







by Sirimal Abeyratne

( November 25, 2018, Colombo, Sri Lanka Guardian) As I began to write the column, a short text message – a news alert message, on my mobile phone, read: “The Sri Lankan rupee further depreciated against the US dollar…selling rate is 179…” Although it wasn’t any unusual news for a few months now, this time it looked scary to me.

I remembered my comment on this exchange rate issue at a high level meeting held about two months ago and, chaired by the President and, attended by the then Prime Minister as well as many others.

I commented: “Depreciation of the Sri Lankan rupee is not the end of the world. However, it doesn’t mean that there is no problem; in fact, there is and, it is much more than what appears to be. For instance, if a healthy man and a weaker man are both caught up in rain, the result can be different between the two men. While the healthy man might sneeze and get on with his normal work, the weaker man can even end up with pneumonia.”

What I meant by that was that the Sri Lankan rupee has already been weakening for years and decades, when it was knocked by an external shock.

Last week's picture of a tourist couple at the Nuwara Eliya park. Fewer tourists were seen in this holiday town owing to the political crisis.

Nevertheless, when I hear about rupee depreciation now, what I sense is absolutely different.

Credit-worthiness


Before the opening of the current political drama, the sudden depreciation of the rupee was caused by what we call an external shock – tightening monetary policies in the US and other advanced countries resulting in an outflow of financial investments from the stock and government securities markets.

Most of the economic news that we received during the past few weeks indicate squeezing foreign exchange positions and tightening government’s finance position.

This was further reflected through the downgraded credit-worthiness of the country by Moody’s rating agency, although there are differences in opinion over this announcement.

Market sentiments created by downgraded credit-worthiness however show that “credit risk” of the country is now higher than it was. At least as its least possible implication, it would be difficult for Sri Lanka to borrow at lower cost.

Depleting foreign exchange inflows


Although the IMF has concluded the fifth review of its Extended Fund Facility (EFF) of US$1.5 billion for Sri Lanka, the decision to release its sixth tranche of $250 million is on hold now pending clarity on the political situation. Besides, some of the developments that have taken place over the past few weeks seem contradictory to the policy targets that Sri Lanka should have achieved by now.

At the same time, there were reports about frozen foreign grants by the US and Japan amidst the current political situation. The peak tourist season has just begun, enabling Sri Lanka to receive over 2.5 million tourist arrivals this year. But the tourism sector which is more sensitive to internal security conditions than any other has been experiencing cancellations of bookings resulting in a depletion of potential foreign exchange.

Some of the other disturbing news continues to stress the tightening foreign exchange situation of the country. The stock of foreign reserves, according to the Central Bank is about $7 billion which is needed for meeting the forthcoming foreign debt obligations. According to the Central Bank, Sri Lanka has to pay $1 billion in January 2019 and another $500 million in April 2019 for which the stock of foreign reserves has to be maintained.

Tightening government finance


The last few weeks were also marked by wasteful expenses on the one hand and, populist expenses on the other hand. They were going against the government’s medium-term objective of “fiscal consolidation” and, perhaps displeased the IMF as well.

Among these policy measures were, the new tax concessions and, the removal of fuel price formula as well as new borrowings from the Central Bank. The functioning of the public sector as well as the legislature seems to have been paralysed, exerting further pressure on the fiscal management.

On the top of all above, risks and uncertainty is mounting and exerting further pressure on both external and government finance positions.

Economic decisions


Those investors who have been with a “wait and see” attitude should have come to a conclusion now that “it was wise that we didn’t go to invest in Sri Lanka”. Those lenders must have thought that “it is good that we got out of the stock market or bond market and, no need to put our money in risk”. Tourists who intended to visit Sri Lanka must have thought that “it is good we change our plans and, there are enough countries in Asia other than Sri Lanka, to visit”.

Even those who are already in Sri Lanka must be planning along the same lines to leave the country and take away their investments to different locations. Educated youth who have been thinking of migrating must have confirmed their ideas.

Outcome


The economic repercussions of all the above events and circumstances are two-fold as short-term and long-term and, the two sides are inter-related. Short-term repercussions would be further tightening of external and government finance positions.

When foreign exchange inflows fall and outflows rise, the rupee depreciation would be faster. It can be put on hold, not for economic but for populist reasons. This can be done by releasing the foreign reserves of the Central Bank to meet the inflow-outflow gaps in the foreign exchange market.

The foreign exchange reserves are, anyway, needed to repay the forthcoming foreign debt-repaying obligations. This would put the economy in a risky position for not being able to meet the debt obligations.

The second type of short-term economic repercussions is related to government’s finance position. The arrival of populist policy measures and the possibility of their further expansion in the face of an anticipated general election would aggravate the budgetary mismanagement. The government will need more money above the tax revenue in order to meet the budget deficit.

Long-term repercussions


The long-term economic repercussions of the current events and circumstances would be reflected through sluggish growth performance and weak job creation. However, the government would be able to raise growth temporarily through domestic demand and create jobs through expanding the public sector.

Such measures, however, are destined to make matters worse sooner than later. Growth emanating from increased domestic demand is not capable of generating tax revenue, but increasing government spending.

If growth is not accompanied by private investment on the one hand and, export expansion on the other hand, that growth does not last long. Then, it is not capable of generating foreign exchange inflows either.

Therefore, through the inter-relationships between short-term and long-term repercussions, what we could anticipate is a further worsening of the economic status of the country.

Getting the economy on track


Once the economy enters into a self-degenerating spiral bind, getting out of it is a painful process with an uncertain outcome. It is not difficult to find examples from some other countries in the world.

Risky gambling with economic fundamentals is a popular way too. In this way, you can keep rolling out things with massive borrowings and investment in mega projects until things get right. Of course, if you are lucky enough, you will get through.

There are other ways too. Many countries in Africa have gone astray with power and money in wrong hands and, Venezuela collapsed without clear direction and help due to wrong policies. But at the same time there were 18 countries in the Euro Zone to rescue Greece, willingly or unwillingly. Perhaps, a rich friend might come to help Sri Lanka during difficult times.

(The writer is a Professor of Economics at the University of Colombo. He can be reached at sirimal@econ.cmb.ac.lk )

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