ECONOMYNEXT – Sri Lanka’s central government’s net debt fell to 36.3 billion US dollars in 2023, from 37.5 billion dollars in 2022, despite the government borrowing 1.57 billion US dollars to finance the budget deficit, official data shows.
When a reserve collecting central bank does not print money to enforce its policy rate or the average weighted call money rates or the 7 day rate or any other rate targeted by term reverse repo auctions, there are no forex shortages, allowing foreign debt to be repaid with rupee revenues.
In 2023, the government borrowed 1.52 billion US dollars to finance its deficit, mostly supported by loans from the International Monetary Fund and budget support loans from the Asian Development Bank and World Bank.
The government also repaid maturing debt from the same agencies and the central bank also built reserves and repaid some of its own debt, by selling down its domestic asset stock, maintaining an appropriate interest rate and largely operating deflationary policy.
The central bank’s Net International reserves improved by 2.82 billion US dollars from a negative 3.2 billion US dollars in 2023 to a negative 404 million US dollars in 2023.
In the previous three years the central banks lost reserves as money was printed to target a 5 percent inflation and also growth (potential output) denying monetary stability for economic agents to work and grow.
The government borrowed heavily from China and later India, after losing market access.
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Debt From Independence
When Sri Lanka ended a 30-year civil war in 2009, after a currency crisis, the total net debt of the country taken since independence was only 11.2 billion dollars, slightly lower than the currency crisis year of 2008.
In the 2008 crisis, Sri Lanka was trying to borrow from Libya. In a 2000 currency crisis Sri Lanka had borrowed from Iran, and the debt is still outstanding.
After the war money was actively printed to target growth or high inflation triggering serial currency crises within IMF programs, as now happens in Kenya and Bangladesh.
In the 2011 crisis (with an IMF program) net debt jumped to 16.4 billion dollars from 13.17 billion a year earlier, despite only 1.92 billion dollars being borrowed for the budget.
From 2015 the International Monetary Fund taught Sri Lanka to calculate potential output, giving another reason than flexible inflation targeting to print money, analysts have said.
By end 2014 after deflationary policy in 2013 and the first three quarters of 2014, net debt was down to 17.2 billion rupees, despite 958 million dollars and 1.6 billion dollars being borrowed to finance deficits in the two years.
Aggressive Flexible Policy and Repeated Stabilization
By end 2016 net debt jumped to 22.4 billion rupees as flexible inflation targeting was unleashed amid a rise in the budget deficit due to the 100 day program and a recovery in private credit, on the basis that inflation was low.
The stabilization program slowed growth but reduced debt in 2017.
In 2018 net debt rose again as money was printed and excess liquidity boosted to target flexible inflation and potential output, including by swapping Treasury reserves for domestic currency.
Analysts had pointed out that 2018 was emblematic since taxes were hiked to bring down the budget deficit and fuel market prices but money was still printed for flexible inflation targeting, potential output targeting, within an IMF program.
The then administration became unpopular amid currency depreciation, higher food and energy prices.
A law called to borrow dollars in excess of budget – which tends to push down interest rates – was also enacted.
CPC Borrowings
Like the central government borrowed dollars to repay maturing loans due to forex shortages, the Ceylon Petroleum Corporation also borrowed through suppliers’ credit which were later turned into loans from state banks, triggering huge losses, despite market pricing oil.
The CPC was made to borrow from Iran in the 2000 currency crisis, the debt which is still outstanding.
In 2018 there were import controls, which analysts dubbed Nixon’s shock as the IMF backed operational framework made it impossible to have free trade.
In 2019, stabilization policies were followed, again discrediting the economic framework of the administration.
Macro-economists of the new administration followed even more aggressive monetary policy to target potential output cutting rates, the reserve ratio and also taxes, leading to rapid ratcheting up of net debt.
Having lost market access, Sri Lanka then borrowed from China and petroleum suppliers to cover forex shortages. In 2022 India gave loans to the government and the central bank amid some of the most severe forex shortages seen since the 1970s triggering social unrest.
The CPC borrowings (which were reduced in both 2017 and 2019 amid better rates), have since been taken over by the central government.
In 2022 and 2023, interest arrears also accumulated.
Analysts have warned that the cycle would be repeated if rates were cut on inflation (or real interest rates) disregarding external monetary stability and debt repayment needs, crises will emerge as they do in other IMF programs.
In Kenya, riots erupted amid a 7th review of an IMF program, as policy rates were hiked steeply to avert a currency crisis, after operating a flexible inflation targeting regime of 5+/- 2.5 percent, violating the impossible trinity.
Kenya’s currency collapsed from 107 shillings to the US dollar in April 2021 when central bank entered to 161 by January 2024.
EN’s economic columnist Bellwether says the failures of IMF programs seem to be coming from a monetary policy consultation clause, which de-links the program from the balance of payments, as if there was no foreign reserve target and there was a clean float, compared to more successful programs earlier.
Sri Lanka’s program has a ceiling on domestic assets which can somewhat reduce the ability of the central bank to create forex shortages and social unrest, through rate cuts enforced with liquidity tools.
However, as a UK analyst warned in 1950 after reading the safeguards proposed by John Exter in the first central bank law to stop mis-targeting of rates, that as long as open market operations are legal, it is not possible to stop a reserve collecting central bank from money printing or triggering currency instability. (Colombo/July22/2023)