Sri Lanka will have to make do with available dollar inflows, not bridging funding, says BC Governor

ECONOMYNEXT – Sri Lanka will have to manage imports with available inflows instead of relying on bridge financing, central bank governor Nandalal Weerasinghe said, as rising interest rates and slowing private credit as well as falling disposable income due to inflation slowed down imports.

Sri Lanka hopes to secure an International Monetary Fund program after August that will allow the government to borrow from agencies like the World Bank and Asian Development Bank or Japan. Foreign financing will generally drive up spending and imports unless it is sterilized to build up reserves.

The World Bank and AfDB cannot lend to Sri Lanka until the debt is made sustainable and macro-fiscal approval is complete. Japan also said it would support an agreement with the IMF.

“In the meantime, we will have to make do with the exports and the remittances that we receive from the country’s perspective,” Governor Weerasinghe told reporters in Colombo after July’s monetary policy review.

“That’s how much we can import. This adjustment is in progress. We therefore expect the situation to improve.

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IMF disbursements to a loosely pegged central bank do not stimulate imports because they are credited directly to the central bank and invested in the US (finances the US deficit instead of Sri Lanka).

imf straight jacket

The IMF generally discourages their use for monetary financing of imports (interventions for oil and other imports which are then sterilized with new money), limiting imports to available inputs.

However, IMF funds increase reserves and reduce the immediate need to build up large levels of foreign exchange reserves (sterilization of inflows) and reduce corrective interest rates, indirectly opening up borrowing space to government or industry private.

Foreign reserves are built up over a longer period as part of a net international reserve (NIR) target, usually a performance criterion in the IMF program.

Unlike India’s and China’s lines of credit or “bridge financing”, the IMF programs work because they target domestic credit, including the budget deficit and energy company losses, which when they are refinanced with central bank credit (monetary financing), lead to currency shortages.

Neither India nor China has the skills or the mechanism to guide a country in reducing domestic credit and money printing to restore external sustainability, unlike the IMF.

High interest rates are the key tool to crush private credit and slow economic activity to restore the lost credibility of the soft-peg (flexible exchange rate) that triggers currency shortages and high inflation.

Periodic IMF programs and output shocks are the inevitable consequence of engaging in loosely anchored stimulus measures.

The IMF program however fails to provide permanent solutions to Latin America or Sri Lanka from the soft peg (flexible exchange rate) to which contradictory monetary and exchange rate policies are not addressed.

Sri Lanka is negotiating the 17th IMF program after a collapse of the soft peg and its first default with a 6% inflation target and a collection reserve peg (flexible inflation target) that created three crises money in seven years.

Meanwhile, Sri Lanka received support from Indian credit lines, the Bangladesh swap facility and deferments from the Asian Clearing Union, Governor Weerasinghe said.

“It has helped fill the void so far. So even in the future, we expect this to continue so that we can manage until the IMF (program),” he said .

“Otherwise we will have to adjust and manage with what we get. We have a billion in exports, another 300 to 400 million in remittances. Then if we can reduce imports to around 1.3 billion, then we can manage the balance.

Under Governor Weerasinghe, rates have been raised and attempts are being made to reduce money printing.

But a damaging buy-back rule (forced dollar sales to the central bank) continues and monetary financing of imports also continues largely with ACU credits, perpetuating currency and exchange conflicts and currency shortages, warned the analysts.

The Sri Lankan rupee crashed to 360 from 200 to the US dollar as it attempted to float (suspend convertibility) with a buy-back rule (strong side convertibility rule) and oil financing (convertibility rule on the weak side).

Bridging financing

Sri Lanka has already tried to secure US$6.0 billion in bridging funding, about 3-4 times the usual US$1.5-2.0 billion in foreign budget funding the country receives in normal years. . Sri Lanka could get up to $6 billion from India, talks with Japan

“It depends on imports,” Weerasinghe said. “For example, if we had a two billion (dollar) import bill, we need more bridge financing.

“Now the import bill is down to around US$1.3 billion.”

Refinancing private sector imports with US$6 billion with repaid “bridge financing” would have given the state budget funding of Rs 2.1 trillion (unless the CEB losses had been financed ) at an exchange rate of 360 rupees per US dollar.

However, there are payment arrears to be cleared. The CPC has significant arrears due to suppliers.

“The problem here is that there are legacy payments,” Weerasinghe explained. “These are coming to an end. There are arrears coming due. The banking system has arrears to pay. These are in addition to the daily outings.

“That will have to be taken care of, or we will have to seek an extension of those credits in the future, so that we can manage the situation.”

The banking system also has negative net open positions partly because of honoring letters of credit and partly because of certain practices regarding the repayment of public debt, analysts said. (Colombo/July 17/2022)

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