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CBSL’s economic roadmap: Panacea or a short-sighted move?

09 Oct 2021

  • Doubts over addressing foreign reserves, external debt, and Balance of Payment issues
By Skandha Gunasekara The recently launched roadmap by the Central Bank of Sri Lanka (CBSL), aimed at achieving stability and growth, has drawn criticism for being out of focus and short-sighted. Senior economist and former CBSL Deputy Governor Dr. W.A. Wijewardena stated the roadmap was flawed, as it looked to resolve issues faced by the entire country instead of focusing on addressing the issues faced by the CBSL, adding that it also failed to set out milestones. “When a Central Bank Governor presents a roadmap, it needs to focus on resolving the problems faced by the CBSL, not by the entire country. Firstly, they are facing a foreign exchange problem; secondly, an external debt problem; and thirdly, the Balance of Payments problem. “However, instead of addressing these core problems, the roadmap is trying to address all the problems Sri Lanka is facing, and that too at a very micro level. So, when you have a roadmap like that, you are diluting your strategy, and as a result, you exhaust your resources when you try to attain the goals of other people. “Another important thing that is lacking are milestones, where goals are set to be achieved within certain time frames. It seems like more of a wish list where most of the things are out of the Governor’s control,” said Dr. Wijewardena. Commenting on the recommendation in the roadmap to buy back International Sovereign Bonds (ISBs), Dr. Wijewardena pointed out its impracticality, as the Government was unable to directly carry out a buyback. Additionally, such a buyback through alternative means would not yield any profits. “In terms of the Bank Covenant, it (ISB) cannot be bought by the issuer. Neither the Government of Sri Lanka nor the Central Bank can buy it back. Meanwhile, even though others can buy it, if they go to the market, the prices will increase, and they will have to buy it either at the face value or very close to the face value. As such, whoever buys it will not make any profit. So, it is better to repay it rather than try to buy it through a third party,” he said. He then asserted that the Central Bank’s move to peg the rupee at Rs. 203 against the US dollar would exacerbate the dollar shortage. “Removing the 100% cashback margin on imports is a good thing. But then, at the same time, they fixed the exchange rate. So how can the two policies reconcile? You can’t have a fixed exchange rate at Rs. 203 to a dollar and lift all the other restrictions. There will be no dollars coming into the market,” he explained. Dr. Wijewardena also condemned the move to increase the tax margin on exporters, likening it to a scare tactic, adding: “He (Governor) shouldn’t have frightened the exporters like that because exporters are the most valuable asset we have at this particular juncture in Sri Lanka, and if you try to frighten them, you can’t achieve anything.” He then recommended that the Governor retract the roadmap, do away with all aspects the Central Bank had no control over, and focus on the core issues instead. “The Governor had mentioned towards the end of his presentation that he could change the roadmap at any time, and I think I would advise him to change it and shed all the unnecessary things which are beyond the control of the Central Bank and concentrate on the key issues the Central Bank is currently facing,” he noted. Not a final solution to forex crisis Colombo-based economic policy think tank Advocata Institute Chief Operating Officer (COO) Dhananath Fernando too was adamant that the rupee must not be controlled; instead, it should be allowed to fluctuate naturally against the dollar. He noted that pegging discourages exporters from bringing in dollars to the country. He said: “My concerns would be on trying to keep the exchange rate at Rs. 203 against the US dollar, and thinking that the exporters are the problem projects something different. I think that is something we have to reconsider. I say this because thinking exporters were looking to keep dollars may not be an accurate assumption. “However, even if they were doing so, it would be because they don’t have any incentive to bring it back. When you pay a lower rate for the dollar, there is no real incentive to bring it back. Additionally, repatriating 100% leads to the question of who would be taking the loss of the exchange rate, as they would have to convert it into rupees and then convert it back to dollars. So, I think that the more we try to keep the dollar at Rs. 203, the more we will see dollar shortages.” He said the issue of the rupee being controlled was also resulting in a decrease in foreign remittances to the country, with expat workers opting to transact via the black market to gain better foreign exchange rates. He said that controlling the rupee rate in the long term would impact exports as well. “At the moment, some of the raw materials for our exports cannot be obtained easily because of this dollar shortage. The same thing that happened with milk powder and rice will happen to the US dollar market in Sri Lanka, which will probably cause problems for both importers and exporters. However, I believe it hasn’t impacted the exporters yet,” he noted. Fernando appreciated the Governor’s attempts to address the long-term impact of the forex crisis through the roadmap, but noted that the proposed solutions would only postpone the problem. “The Government has been having a lot of bilateral discussions, trying to open credit lines for fuel supply and more government-to-government (G2G) funding. But what we have to understand is that these measures won’t permanently solve these problems, (except for) just postponing them,” he said. Fernando too was critical of the Central Bank’s proposed policy of increasing taxes for exporters from 14% to 28%, as it would alienate the exporters, result in more dollars being kept outside the country and even result in the downsizing of export businesses. “Exporters are our only saviours at this point. Taxing them at a rate of 28% if they don’t repatriate money doesn’t give the right signal, as these taxes are looked at as a form of punishment. Similar to how rice millers and producers stopped doing business as a result of the price controls, exporters too could look at this tax as a punishment or in a negative light and downscale their business, which will have a negative impact on the overall economy through even more dollar shortages. “The best option, I believe, is to introduce an incentive and allow the dollar rate to increase; it will bring in some money because ultimately, it is governed by demand and supply,” he noted. He also charged that the ongoing quantitative easing via monetary stimulus was in fact causing further dollar outflows instead of having the positive impact that was intended. He said: “For the last 18-20 months, we have increased the money base by around 33% for the purpose of quantitative easing. The Central Bank increased interest rates so that they can absorb the money back, which is a sound approach. However, a second reason for the dollar shortage is quantitative easing, due to which the prices of imports automatically increase. “To control import prices, you need not have import controls. If you tighten the system, the imports will naturally reduce, but when you have more money supplied to the market, all that money will go out of Sri Lanka as dollars. The more you do quantitative easing, the more people tend to spend, as they don’t see a need to save. Looking at these decisions from the perspective of the upcoming elections, bringing in a permanent solution would be better for all parties.” Fernando went on to say that he understood the thinking behind the economic roadmap, but said that it was not a final solution to the major forex crisis the country was facing. He went on to say that he expects the Government would succumb to market pressure and dynamics, and remove its controls on the rupee possibly at the start of 2022. “The Governor noted that they could change this economic plan or parts of it at any given time, and with the budget announcement in November, I think the Government has options to change these regulations. I believe they would gradually let the rupee float in the coming months. They might keep the rupee pegged until the next bullet payment of the ISB in January,” he opined. “The Government has three options: Either it secures a substantial credit line, lets the dollar exchange rate go up, or cuts down all imports and become completely self-sufficient. However, my gut feeling is that the Government was trying to secure as much through credit lines as possible, and based on the outcomes of those discussions, I hope they quickly move onto the next step,” he added.  Misled politicians? Meanwhile, main Opposition party Samagi Jana Balawegaya (SJB) charged that the economic roadmap was a matter of “an accountant misleading politicians”. “It is not a secret that the Government has got its wires crossed. The language and some of the content makes you wonder if the Finance Minister, rather than the Governor of the Central Bank (CBSL), was making a statement,” said SJB MP Eran Wickramaratne, referring to Cabraal’s announcement of the economic roadmap. “Some of the issues that were raised should have been taken up privately with the Finance Minister rather than publicly. The mix-up of roles and responsibilities in this Government is not surprising. The worry here is that an accountant is misleading politicians who appear not to grasp the socioeconomic implications. This is no different to a chemist giving a lecture on chemistry to an audience that does not know chemistry,” Wickramaratne told The Sunday Morning. He too asserted that the tax on exporters would only have a negative outcome and pointed out similarities to a move by the Lebanese Government before its financial collapse. “There were no new strategies to address the debt issue, and the only new plan was to forcibly convert dollar deposits into Sri Lankan rupees. The CBSL is claiming dollar deposits of $ 2 billion, but this has been disputed by the JAAF (Joint Apparel Association Forum Sri Lanka). The strategy is flawed since penalising exporters by forcing conversions will only disincentivise future inward flows. Exporters will under-invoice and keep foreign currency overseas. This is a self-defeating policy. This was also a step taken by Lebanon prior to the final crash,” he explained. Wickremeratne too pointed out that the price of the rupee was being controlled merely for the sake of appearances and did not reap any financial benefits. “It appears the CBSL’s motivation for keeping the dollar at Rs. 203 was because that is the rate at which per capita GDP (gross domestic product) is accounted for and debt-to-GDP ratio is calculated. The Government is using accounting tricks to show the national debt stock is being cleverly managed. Unfortunately, you cannot use accounting tricks to reduce the debt-to-GDP ratio. You need to control the budget deficit and manage growth. In 2020, the budget deficit was 14% of GDP – the highest since 1987. It will be in double digits this year as well, with no clear plans to reduce it,” he emphasised. He said that he was certain the Government would resort to the sale of national assets to raise dollars and questioned the ethics behind the move to grant tax amnesties. He added: “The sale of state-owned assets targeting $ 1 billion (Rs. 200 billion) was discussed. There is no way that non-strategic assets can raise that amount of cash. The Government has to sell strategic assets to achieve this. There has to be a discussion on the process and transparency on the sale of assets and businesses. We must ensure that we do not commit future cash on a non-scientific basis like observed in the recent energy transaction, in order to solve immediate cash flow issues. “Inflows through the tax amnesty, targeting $ 100 million, was also discussed. This is to legitimate black money. Reaching this target may be possible, judging by the recent revelations in the Pandora Papers. The real issue is whether illegal and black money transactions must be legalised or whether those who robbed and broke the law should be held to account.” Wickramaratne then went on to make a number of recommendations including the upholding of the rule of law. “The Government must be committed to the rule of law. Sri Lanka must demonstrate its commitment to international treaty obligations. The big picture needs to be managed so that confidence in the country will be restored to investors,” he said. He also said the Government must free interest rates and also move to restructure debt, possibly with the help of the International Monetary Fund (IMF). “To attract foreign investment, the Government has to free interest rates. A free foreign exchange rate will help in returning the dollar debt. With or without the IMF, fiscal consolidation is a must. With the help of the IMF, a soft restructuring of debt will help improve cash flows and avoid a debt default. “The Government should prioritise fiscal consolidation through raising revenue, lowering the cost of doing business, rationalising expenditure, and investment in human resources (education, training, technology, research, etc.) instead of physical infrastructure (roads and highways), providing technology subsidies to small and medium enterprises (SMEs) to improve quality and for agriculture to improve productivity, and providing incentives for exporters,” he concluded.

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