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2022 Budget may focus on austerity measures: CITI

  • Austerity measures inevitable if SL to secure IMF assistance
  • SL unlikely to repay Jan. 2022 ISB in full if consensus reached on IMF
  • Says Basil may usher in policy pragmatism

BY Cassendra Doole

The 2022 Budget currently under preparation is likely to contain austerity measures as it will be an “important policy document” towards reaching an agreement with the International Monetary Fund (IMF), if local media reports of a new found inclination on the part of the Government to seek the assistance of the global financier are accurate, Citi said in a note yesterday (26).

In the report, Citi said: “We think austerity measures now look inevitable. If the government reaches consensus on approaching the IMF, we think it is unlikely to repay the January 2022 bond in full in order to avoid a significant drain on external reserves as it reassesses the rest of the Eurobond repayments.” Citi added: “Aside from tax and other regulated price increases, private sector involvement (PSI) in a debt restructuring under an IMF programme could be part of the package, with risk of some form of a principal haircut on dollar bonds beyond coupon relief and principal extension.”

Further, Citi also noted that Finance Minister Basil Rajapaksa may help move the policy consensus toward pragmatism, as the protracted debt uncertainty impacts macro stability, adding that the decision to seek IMF will undoubtedly be a political decision when considering the individuals in the current government.

“We change our call and now expect Sri Lanka to suspend debt payments by year end as it finalises an IMF programme (a final deal may spill into 2022), versus our previous base case of still repaying the January 2022 bond in full and then finalising an IMF programme not too long after. We think this was always going to be a political decision as well with some in the Government – State Finance Minister Ajith Cabraal, Presidential Advisor P.B. Jayasundera, and CBSL Governor Lakshman – still publicly opposed to approaching the IMF,” the research document said, adding: “However, the protracted debt uncertainty is now impacting macro-stability, and we think the new Finance Minister Basil Rajapaksa may help move the policy consensus toward pragmatism.”

Earlier reports released by Citi stated multiple times that the government will have to go for an IMF programme as Sri Lanka’s debt is on an unsustainable path even though the government was in denial. 

Citi noted that local media has reported the involvement of Finance Minister Basil Rajapaksa in addition to reports that two monetary board members and the majority of senior CBSL officials are in favour of going to the IMF. 

“If the news reports are correct, the government’s decision to approach the IMF does not surprise us, but the timing isn’t clear. Some senior officials like State Finance Minister Ajith Cabraal and Presidential Adviser P.B. Jayasundera are still publicly opposed to any such move, and an SDR allocation of close to $ 800 million allows further delays in reaching out to the IMF. Our base case prior to this news had been that SL would seek IMF support soon after the January 2022 bond maturity.”

According to Citi, the biggest trigger for approaching the IMF is the country’s external liquidity position which is unraveling faster than expected notwithstanding the one-off SDR allocation and RMB 2 billion CDB loan. “Official reserves fell more sharply than expected to $ 2.8 billion in July, local holdings of matured ISBs have not been adequately recouped into SLDBs in August given protracted FX shortages, the trade deficit has widened 32% year-to-date, and remittances have been losing momentum and declining sharply in recent months (down 27% YoY in June to July 2021), which we think reflects fund flows out of the formal banking sector given a nonmarket aligned FX spot rate,” said Citi, adding that the worsening Covid situation is not helping any matters. 

“We also think a worsening Covid situation has made any meaningful tourism recovery in the next 12 months difficult. We widen our current account deficit forecast for this year to 2.5% of GDP (vs 1.6% of GDP), largely on reported remittance weakness. Capital flows have also been below expectations with little concrete progress in asset sales/privatisation and follow-through flows after the Colombo Port City Economic Commission Bill was passed in May 2021.”

Meanwhile, the FX depreciation and import controls are also a triggering factor contributing to worsening the inflation dynamics warns Citi.

“FX depreciation and import controls are now leading to rising inflation expectations that feed into worsening inflation dynamics. Some of the rupee versus US dollar quotes in the banking system are as much as 10% weaker than those quoted by state-owned banks. We think the former reflect the market better, and fuel inflation expectations, which alongside import controls and loose macro policies (notwithstanding the latest monetary tightening), are worsening inflation dynamics.”

Citi further added “We think expectations of protracted dollar shortages and import controls are fueling speculative hoarding. We raise our forecast for Colombo CPI inflation (currently at 5.8% in July) to 6.6% by year end (vs earlier forecast of 6.3 %), and we maintain our view of another 25-50bp rate hike by year-end and another 100-150bp hike in 2022, but an earlier IMF deal could lead to front loading more rate hikes by year-end.”