CBSL suggests Nomura has previously forecast ER crises in Sri Lanka which never materialised

The Central Bank of Sri Lanka (CBSL) today pointed out that Nomura Holdings Inc., which recently determined Sri Lanka is in immediate danger of an exchange rate (ER) crisis, had forecast such crises in Sri Lanka over the past few years without any ever materialising.

“A closer look at Nomura’s ‘Damocles score’ for Sri Lanka shows that it has remained above the 100 continuously since 2012 except for a few months in 2013/14. At times, the score has even hit the upper bound of 200. Therefore, it is evident that in the case of Sri Lanka, this rudimentary index cannot be considered an indicator/predictor of crisis.”

In the index published on 10 September, Japanese financial services company Nomura had computed Sri Lanka’s score at 175, while assigning lower values to countries that are currently facing severe economic and financial strains. A score above 150 signals that an exchange rate crisis could erupt at any time, and presumably a score of 200 suggests an even more immediate danger.

As Sri Lanka has not suffered an exchange rate crisis from 2012 onwards, during the run of consecutive 100 plus scores on the Nomura index, it can be ascertained that those predictions of an exchange rate crisis never materialised.

In spite of a clarification by CBSL, Nomura Holdings Inc. is yet to amend the original ‘Damocles score’, although according to Bloomberg news, it has changed Sri Lanka’s short term debt figure to $7.5 billion as requested.

The clarification was issued by CBSL on a day when it also reported that the Sri Lankan Rupee plummetted to a new low as the selling pries reached Rs 165.14 to the US dollar. The buying price of a US dollar is marked at Rs 161.81 and this is the 1st time Sri Lankan Rupee has surpassed these marks.

CBSL pointed out that Sri Lanka’s short term external debt was nowhere near as high as the $ 160 billion indicated in the Nomura analysis, but between $ 7.7 billion and $ 14.3 billion, depending on the definition employed.

Sri Lanka’s short term external debt and liabilities, based on the general definition that uses original maturity, are currently estimated at around $ 7.7 billion. These liabilities are estimated at around $ 14.3 billion under the broadest definition that includes long term debt falling due in the next one year period and the total foreign holding of rupee denominated long term Government bonds.

CBSL advised investors and the general public to form their own informed opinion with regard to Sri Lanka’s macroeconomic conditions and potential, as the Nomura score does not capture market realities and dynamics.

“Any methodology that yields outcomes whereby Sri Lanka’s score is substantially worse than countries like Argentina, Turkey, and South Africa does not appear to be sufficiently nuanced to capture market realities and dynamics.”

The bank called the ‘Damocles score’ a rudimentary attempt to build an index based on eight indicators and threshold values for the selected indicators.

“…. the score does neither consider a particular country’s distance from threshold values nor the country-specific circumstances, that Sri Lanka is listed as a country that is at greater risk of crisis than countries like Argentina and Turkey.”

Breaking down Nomura’s report further, CBSL added that, in the analysis, the short term external debt to exports ratio includes goods only, with services, including tourism and remittances, excluded. By not focusing on all current account flows, the ‘score’ exaggerates the country’s vulnerability.

Moreover, the broad money to foreign reserves ratio does not properly interpret the cause of the increase in the former. The recent increase in broad money was due to an increase in the net foreign assets (NFA) of the banking system, which has, in fact, reduced the country’s external vulnerability.

The real short-term interest rate indicator for Sri Lanka is also marginally above Nomura’s threshold. This has been caused by a reduction in inflation rather than an increase in interest rates.

“These examples demonstrate how the binary methodology used by Nomura could be misleading,” CBSL said.

It went on to say that the report has not been thoroughly reviewed and is therefore questionable.

“Nomura’s error in relation to Sri Lanka’s short term external debt figure itself shows that the said report has not undergone a thorough review before publication. Indeed, the rigourousness of any analysis based on the predictive power of an index, which cannot differentiate between short term debt of $ 7.5 billion and $ 160 billion, in an economy with a GDP of around $ 90 billion and gross official reserves of around $ 8.6 billion, is questionable.”