With blackouts engulfing at least half of the day, long queues waiting at fuel pumps, and surging inflation driving people to seek refuge in greener pastures beyond the frontiers, Sri Lanka’s economic crisis cannot be brushed under the carpet anymore.
To understand what really precipitated this crisis, Moneycontrol spoke to Dr WA Wijewardena, the former Deputy Governor of the Central Bank of Sri Lanka (CBSL).
Dr Wijewardena, who worked with the Central Bank from 2000 to 2009, has been a vocal critic of the government and the CBSL. While he says that the root of the problem lies in poor policymaking, the crisis worsened because there was no counter-pressure given by the CBSL.
Excerpts from the interview:
While most people have been blaming the Sri Lankan government for the crisis that's unfolding, saying that it is poor public-finance management and policymaking that resulted in the current situation, you have been very critical of the country’s Central Bank.
The root of the crisis can be traced back to income-tax and value added tax concessions that the percent administration announced in November 2019. I have said that the government lost revenue amounting to about SLR 500 billion per annum, or about 4 percent of the GDP. At the same time, the government expenditure went up because of the pandemic, which resulted in a wider Budget deficit.
The Budget deficit went up from 6-7 percent of the GDP to 11-12% of the GDP. Instead of going back to the old tax system, which would have generated at least a part of the revenue needed, the government got the Central Bank to allow the money supply to go up by borrowing from the banking sector, which consists of the Central Bank and commercial banks.That’s how the Central Bank worked as a yielding hand (helping hand) in causing the current economic crisis.
The Central Bank liberally extended credit to the government. Therefore, during the 25-month period beginning January 2020, the government had borrowed from the banking sector to the tune of SLR 42,00 billion, which is an increase of 173 percent over the level at the end of 2019. Because of this rise in government borrowings, the total money stock in the country has increased by SLR 3,000 billion or by 40 percent.
What happened when the money supply went up to such an extent?
This is when the crisis began to manifest itself. When money stock increases by such a magnitude, it increases aggregate demand in the economy. But aggregate supply had been constrained due to pandemic and also due to the imprudent agricultural policy adopted by the government to convert Sri Lanka's agriculture to organic agriculture overnight.
So, there was pressure for the prices to go up.
Normally, the Central Bank keeps money supply growth equal to the real economic growth in the economy, plus another 5-6 percent to facilitate the transactions. So, if the real economic growth is say 5 percent, the Central Bank would allow the money supply to grow by, say, 11 percent. But, in this case, what happened was the real economic growth has been actually close to zero during 2020 and 2021. Because in 2020, it was negative 3.6 percent.
In 2021, it is positive 3.7 percent. When you add up the two growth rates together, it is actually close to zero. But the money supply has increased by 40 percent, which meant there was tremendous inflationary pressure. This (excess money supply coupled with weak goods supply) also depleted the forex because the demand for goods was met through imports.
Then the government had to place import and export controls, which didn’t prove sufficient… the foreign reserves fell from around $7.6 billion at the end of 2019 to $2.3 billion by February 2022. Out of this $2.3 billion, there are certain amounts that the Central Bank cannot use immediately, such as the gold stock, also the position of Sri Lanka with the International Monetary Fund and also 1.6-billion yuan facility that had been granted by the People's Bank of China to Sri Lanka.
So, when you take all these out, the usable foreign reserves as at the end of February was about $400 million, which was not sufficient even to meet imports for one week for the country.
When the country was running short of dollars…
There was a massive shortage of dollars in the former banking sector. There was a queue… If somebody wanted to buy some imports, they had to wait their turn because the Central Bank had fixed the exchange rate at SLR 200 per US dollar and there were no dollars available at that rate. Therefore, those who wanted the dollar had to go to the unofficial market or the black market. The black-market rate was around SLR 250 to 260 per US dollar.
So, the black market started thriving. All the money that should have come into the formal banking sector were actually directed to the black market. As a result, the remittances on which Sri Lanka depends on, largely to finance a part of the trade deficit, started dwindling. Normally, Sri Lanka gets around $650 million by remittances per month, but that had fallen to $200 million by February 2022.
It’s because of all this that I say that the Central Bank had a yielding hand (gave a helping hand to cause the economic crisis).
Is that also the reason why you had said that the Sri Lankan Rupee should have been floated much earlier, and not as late as this March?When the size of this foreign exchange crisis began to reveal, around 2012, we had begun asking the government to allow a flexible exchange rate policy. When the present government came to power in 2019, we had asked the government to seek a funding facility from the International Monetary Fund. Both weren’t accepted by the government.
At one stage, when the Central Bank could no longer supply dollars to the market to meet its requirements, they had to let the exchange rate go. If it had started this gradually, from say around 2020, and sought facility from the International Monetary Fund, we could have avoided the present catastrophe.
Do you think the government’s plans to get out of this crisis by availing government-to-government loans and arranging for foreign currency swaps with the IMF be effective?
The government's strategy has been to raise very short-term cash loans from friendly countries like India, Bangladesh and China. These loans are just three months swap facilities, which have to be either repaid or renewed. For example, recently there was this swap facility that had been obtained from Bangladesh amounted to $150 million.
When it came up for repayment, the government got Bangladesh to extend it for another period. Similarly, there was this 10-billion-yuan currency swap facility obtained from the People's Bank of China, which amounted to $1.5 billion. When it came up for repayment, China extended another loan of $1.5 billion to enable Sri Lanka to settle the earlier loan.
Similar is the loan facility India has given Sri Lanka, and the Indian government has to extend them continuously every three months. What will happen when the countries cannot extend these loans anymore? Then Sri Lanka will either default or borrow from another source at a very high cost. That is the risky position the country is in today.
Is monetising public assets an option?
Yes, it is. Those are the hotels and lands owned by the government in strategic locations, mainly in Colombo which have demand and could be effectively put into money making businesses. But, in the middle of a critical economic crisis, Sri Lanka will not be able to realise the true price for those public assets. It may have to sell its assets at a deep discount.
Both the strategies – of borrowing short-term funds from the friendly countries and friendly Central Banks, and attempting to monetise existing public assets – are not long-term, sustainable strategies for securing enough foreign exchange balance for Sri Lanka. The reliable, long-term strategies are to promote exports of goods and services, and promote foreign direct investments into Sri Lanka. Meanwhile, Sri Lanka should borrow from the IMF.
The cost of borrowing from the IMF is about 3.5 percent, whereas when you get a loan from a friendly country, the cost will be about 14 percent. When borrowing from a friendly country, Sri Lanka will have to pay the swap provider about 2 percent. But there is an additional cost too. If Sri Lanka swaps $1 with India today, India will give $1 and Sri Lanka will have to give SLR300.
The SLR300 belongs to India until the swap facilities reverse, and it can be invested by India in interest receivables in Sri Lanka at 12 percent today. So, 12% receivable earnings plus another 2 percent on the swap facility add up to 14 percent.
If Sri Lanka is to borrow from the IMF, Colombo will have to follow its suggestions. Do you think these suggestions would work and won't fiscal tightening make the country more vulnerable to outside shocks?
Well, whether we go to the IMF or not, in order to come out of the present very acute economic crisis, Sri Lanka has to implement all these painful policies. The advantage of getting into an IMF programme and implementing these policies is that it will give foreign investors more confidence in the country. Sovereign bonds that are being traded now below par value will move up and probably will trade at face value or close to the face value.
Do you think that 5 percent GDP growth for FY22, which the government has projected, could be possible?
No. Even in 2021, the growth rate was 3.7 percent. Now, because of the disruption caused to agriculture and also from lack of raw materials and from the power shortage, industries are not operating at their optimal level. So, most probably the growth rate in 2022 will be less than 2 percent.
The IMF seems to have predicted 2.6 percent in their note on Sri Lanka.
It will be even less than that because you can't even reach that level with the long power cuts, decline in agricultural production and the non-availability of raw materials for industries. Till 2026, the growth is likely to be less than 3 percent, though the government has estimated a GDP growth of 7 percent for the medium term.