‘Swaps, loans only temporary relief’
- ICRA Lanka states Sri Lanka is in crisis mode
- Official reserves at $ 3.5 b in August
- Headline inflation increases to 6%
ICRA Lanka, in its August Monthly Economic Update, declared that Sri Lanka is in crisis mode, and added that swaps and foreign currency loans would provide only temporary relief, and will not be sufficient to generate a lasting improvement in the external sector.
ICRA Lanka stated that restrictions imposed on the current account and capital account are likely to blow back rather than improve the balance of the payment situation. It noted that many domestic industries are struggling to meet the demand due to shortages in inputs triggered by the scarcity of forex and import controls.
“Foreign trading partners may push back as seen from a statement made by the European Union (EU) Mission in Sri Lanka early August. In addition, the CBSL (Central Bank of Sri Lanka) imposed a 100% cash margin deposit requirement against the importation of selected goods which will tighten the liquidity position of the importers. This will further dent economic activity and bring about scarcity in the targeted goods,” ICRA Lanka noted.
The import controls and capital controls may be effective tools in managing short-term volatilities in the exchange rate but it comes at the expense of economic growth, external sector competitiveness, and cost of living for people, they added.
“The current inflation trajectory may breach the CBSL’s inflation target in the medium term. On the global front, prices have retreated but historically domestic prices are relatively downward inelastic. Therefore, it may take a month or two to calm domestic inflation.”
The CBSL tightened its monetary policy stance by 50 bps on 19 August, becoming the first central bank in the region to do so. As a result, the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) increased to 5.00% and 6.00%, respectively. Thus, the Bank Rate, which is automatically adjusted with the SLFR, will stand at 9.00%.
Subsequent to the rate hike and amidst tighter liquidity, the volumes in the call and repo markets surged. The lending through the Standing Lending Facility was seen rising throughout the month, causing overnight liquidity to briefly turn negative several times.
Following S&P Global downgrading the country’s CCC+ sovereign rating outlook to Negative, the yields on international sovereign bonds (ISBs) maturing in 2022-23 shot up, while others declined in the last week of the month.
With regard to the external sector, earnings from merchandise exports increased marginally to around $ 1.1 billion in July 2021. The largest contributors to export earnings were the exports of textiles and garments ($ 454 million) along with tea ($ 115 million).
The trade deficit increased 190% YoY in July due to the 32% YoY increase in import expenditure to $ 1.7 billion in July. Moreover, total remittances decreased during July by 32% YoY, resulting in worsening the current account balance.
The official gross foreign reserves in Sri Lanka fell to around $ 2.8 billion in July 2021, its lowest position since July 2009, due to the settlement of the matured ISBs of $ 1.0 billion by the CBSL on behalf of the Government. However, the foreign reserves were strengthened in August 2021 to $ 3.5 billion due to both the influx of $ 787 million from the International Monetary Fund’s (IMF) special drawing rights (SDR) allocation, and $ 150 million from the Bangladesh Central Bank under the swap arrangement.
Wage growth jumped to 8% in June from its lower base that prevailed around the same time last year due to continued recovery of industry and services sectors. However, overall headline Inflation increased to 6%, driven mainly by a surge in non-food inflation. The increase in non-food inflation is broad based with a notable rise in prices of the transport, restaurants and hotels, and health subgroups.
Due to the worsening food crisis, the Cabinet abolished the import tax of Rs. 175 per kilogramme of milk powder in an attempt to bring down the price. In addition, the Cabinet nod was received to import rice to curb rice prices. The Government declared a food emergency at the end of August amid double-digit food inflation.
In spite of the worsening economic situation, the stock market experienced a sharp uptick during August, as the market closed with the All Share Price Index (ASPI) and S&P SL20 gaining over 10.8% and 10% respectively as investors turned bullish over speculation that the Government was seeking support from the IMF for debt restructuring. However, foreigners remained net sellers.