Stability Policy Cheat by the CB Governor? Let us examine.

The Central Bank Governor after securing his six-year term is now in the constant media talks on the difficulties confronted by the general public in the present currency crisis and the envisaged IMF based bailout plan to resume the economy with essential imports in next six months.

Therefore, this article is intended to establish that the envisaged IMF bailout plan for the stabilization of the economy is nothing but another public cheat by him in trying to revive the failed debt-based import financing model in which he has played the lead role in more than a period of 15 years.

This article is based on views expressed by the Governor at two media interviews, i.e., Hiru Salakuna on 25 July 2022 and the CNBC business media on 21 July 2022, as highlighted below.

Governor’s views expressed at Hiru Salakuna Programme

In response to a question raised at the interview on the allegation that the present foreign debt trap is a result of US$ 10 bn of International Sovereign Bonds (ISBs) raised at a very high interest rate of around 8% in 2018 and 2019 during the term of the Governor Coomaraswamy with him as the Senior Deputy Governor, he rejected it outright. In response, he clarified as follows.

• The foreign reserve of US$ 7.6 bn held at the end of 2019 was the result of the ISB issuance of US$ 4.4 bn in 2019 whereas it is the same reserve that was utilized in 2020 and 2021.

• There was a long-term reserve because the government in that time under the Governor Coomaraswamy had raised US$ 4.4 bn in 2019 and another US$ 2 bn in 2018. After that, nobody gave loans to us.

• If not for that foreign reserve of US$ 7.6 bn, this crisis would have occurred in 2020.

Governor’s views expressed at the CNBC interview

His views with regard to the envisaged IMF programme were as follows.

• Sri Lankan authorities have submitted to the IMF and creditors an overall macroeconomic stabilization programme including monetary policy reform, fiscal policy reform and reform of strategic state enterprises where all these together coming as an overall macroeconomic package which will help the economy to achieve so called macroeconomic balance or stability in going forward once an agreement is reached with the IMF and, therefore, he is confident that economy can be stabilized once funds are received from multilateral donors.

• Sri Lanka is eligible for US$ 3 bn of funds from the IMF Extended Fund Facility over a period of three years and another US$ 4 bn will be supplemented by other institutions such as World Bank and ADB once the IMF begins dispensing funds.

• The current economic crisis is an opportunity for Sri Lankan authorities to learn from past mistakes and not reverse reforms once the IMF program ends. This is, to me, an opportunity for the authorities to learn a lesson and move in the right direction, even beyond the IMF program. That is the key for us to manage this economy on a sustainable basis.

• The new president has been involved in the negotiations with the IMF. “I am hoping that that commitment will continue… the sooner the better, so that we can reduce the time of the pain that we are experiencing now”.

(see https://www.cnbc.com/video/2022/07/21/curtailing-inflation-is-most-important-thing-for-sri-lanka-central-bank.html)

Comments on Huru Salakuna Programme – Foreign Debt Trap

Governor’s views in the hindsight show how the country got into foreign debt trap and resulting bankruptcy at present whereas some of his views are factually incorrect. This position is established from the following comments.

• First, the Central Bank as the public debt manager and fiscal agent and bank had a regular habit of raising foreign loans to the government for the purpose building up and maintaining the foreign currency reserve of the Central Bank. Accordingly, foreign currency received in loans was purchased by the Central Bank while corresponding value of Rupees was credited to the government account at the Central Bank. In the past, foreign loans were arranged by the government itself mostly on long term basis from foreign governments. In contrast, since 2007, the Central Bank has engaged in an aggressive campaign of raising short and medium-term commercial loans from banks and international financial markets. In fact, the Central Bank was seeking a strategy to construct a sovereign yield curve so that there is a ready credit market for Sri Lanka to access international markets for fiscal operations.

• Second, ISBs referred to in the interview became the major source of market borrowing in the last decade. Since 2007, eleven ISB issuances amounting to US$ 17,550 mn were undertaken. Under the Governor Coomaraswamy 2016-2019, US$ 9,900 mn were raised from five ISB issuances which account for 56.4% of total ISB issuances so far. ISB issuances in 2018 and 2019 alone amounted to US$ 6,900 mn. The Governor’s views that these are long-term sources of foreign reserve is factually incorrect as these are medium-term market borrowing sources (as compared to official sources) which are not prudent for a long-term reserve due to high concentration risks. That is why the Central Bank confronted a complete depletion of its foreign reserve in 2020 and 2021 due to running out of market conditions to issue ISBs. While the government had to pay interest half-yearly on outstanding ISBs, two ISBs amounting to US$ 2,000 mn were repaid in 2020 and 2021. While another US$ 500 mn was repaid in January 2022, total outstanding amount of US$ 12,550 mn is now in default since 12 April 2022.

• Third, the Governor’s view that the foreign reserve of US$ 7.6 bn at the end of 2019 was the result of ISBs is factually incorrect as the Sri Lanka Development Bonds, sale of local government securities to foreign investors up to 10%-12% of total securities outstanding and currency swaps were other major sources of market borrowing used to fund the foreign reserve. In addition, sale proceeds of Hambantota port also contributed to the foreign reserve in 2019. As a result of these sources, a total balance of payment surplus of US$ 1,480 mn was achieved in 2018 and 2019 through the net foreign currency inflows.

• Fourth, the currency depreciation also aggravated the foreign debt trap as the depreciation caused the government to collect more local revenue to service foreign currency loans. As the public debt and reserve manager, the Central Bank undertakes debt service out of its foreign reserve whereas the government has to pay the Central Bank equivalent amount of Rupees for the foreign currency under debt service. Therefore, the Central Bank had the practice of debt rollover, i.e., raising new foreign loans to offset the repayment, so that the government fiscal position and foreign reserve are maintained smoothly. As a result, the ratio of foreign debt in the total debt, which had declined from 59% in 1987 to 42% in 2008, rose back to 47%-49% in 2018 and 2019. This ratio rises to 52%-53% when Sri Lanka Development Bonds and ISBs held by domestic investors are included in foreign loans on the ground of foreign currency liabilities.

• Fifth, the Governor’s statement that nobody gave loans to us (the government) is factually incorrect. The government could arrange several foreign currency swaps from Bangladesh, India and China to the foreign reserve of the Central Bank while US$ 4,437 mn of gross inflows to the government from other borrowing sources were arranged in 2020 and 2021 in the middle of the Corona crisis. In addition, US$ 787 mn received from the new SDR allocation of the IMF in August 2021 also helped the foreign reserve. That is why the Central Bank could fund a total BOP deficit of US$ 6,289 mn in the two years. Such inflows helped the Central Bank save its gross foreign reserve at US$ 3,139 mn at the end of 2021 although down from US$ 7,642 mn at the end of 2019 while funding a BOP deficit of US$ 6,289 mn. in 2020 and 2021.

Therefore, it is clear that the government foreign debt trap is a result of the practice of the Central Bank to raise foreign market borrowing to maintain its foreign reserve. The Governor himself explained that the foreign reserve was maintained from ISBs raised by the government in 2018 and 2019 and no loans were received after that to keep the foreign reserve. In fact, the government was not technically aware of this model of foreign reserve and, instead, used rupee proceeds of loans for fiscal operations as the Central Bank as the debt manager handled issuance of government securities for borrowing.

However, the foreign reserve is a statutory duty under the monetary policy of the Central Bank as stipulated in the Monetary Law Act. Therefore, it is the public duty of the Central Bank to use the monetary policy to generate a foreign reserve adequate for the BOP on the strength of the real economy. In contrast, the Central Bank has been using a model of daily inter-bank liquidity and policy interest rates-based monetary policy which is generally used by advanced market economies while its debt manager duty has been used to build and maintain the foreign reserve. As such, the foreign reserve and monetary policy of the Central Bank in fact have been largely a fiscal policy extension as the foreign reserve constituted nearly 70% to 90% of the Central Bank balance sheet and money printing.

As a result, when the Central Bank could not continue the market borrowing monetary model as before since 2020, it had to use the existing foreign reserve which caused the current economic crisis due to acute shortage of foreign currency known as the currency crisis or BOP crisis. It is self-explanatory from the Governor’s statement. Therefore, the present crisis is primarily a financial crisis caused by the fundamental failure of the Central Bank’s monetary policy.

Therefore, above response given by the Governor is simply a political-type micro allegation fingering at others, which is not worth for an independent Central Bank with the statutory duty of economic and price stability and financial system stability of the country.

Comments on CNBC business media interview – IMF bailout to stabilize the economy

The envisaged macroeconomic revival strategy as indicated in the interview is not practical in the present context of the crisis-hit economy as highlighted below.

• First, the Governor’s view that nearly US$ 7 bn of funds planned from the IMF programme and multilateral financial institutions is a part of the old, failed strategy used in the import dependent economy funded through government foreign loans. This strategy is the cash flow management model used to finance and drive the import economy without focusing on the development and sustainability of the real sectors of the economy. Therefore, this US$ 7 bn is to be an extension of the past story of IMF programmes of 16 times amounting to SDR 4,426 mn from 1965 to 2020. Sri Lanka has been in the two largest IMF programmes since 2009 representing 61.5% of the total IMF programs. The present Governor was closely involved in negotiation and implementation of both programmes at a stretch. Therefore, he knows very well that the envisaged IMF programme is unable to bailout or stabilize the economy, especially from the current level of economic crisis.

• Second, the IMF programs in the past were used to protect the foreign reserve of the Central Bank when it confronted with risk of depletion by various shocks while the direct borrowing sources also were in place. Therefore, in those 16 occasions, the economy was functioning quite well unlike the present collapsing/bankrupt economy with a non-exiting foreign reserve, acute shortage of foreign currency inflows and essential imports, persistent long ques for oil and gas, default of foreign debt, soaring inflation above 60%, tight credit/monetary conditions with government securities interest rates around 30% and negative GDP growth of 6.8% (first quarter 2022). In this context, even if the US$ 7 bn is received as envisaged, it will evaporate in few months not being adequate even for essential imports such as oil.

• Third, the overall macroeconomic stabilization programme to which the Governor refers is only a conceptual paperwork. The policy reforms covered in it could be the cutting of the government spending and budget deficit to suit its current revenue stream, further tightening of the monetary policy by raising interest rates to curtail credit expansion and commercialization of state enterprises to reduce their burden on the fiscal front. These are similar policy reforms implemented even under the past IMF programmes. However, the economy has collapsed just in one year after the latest IMF programme of SDR 1,770 mn that ended in 2020. There are many countries including Argentina and Pakistan who have got into the current global waive of currency/BOP crisis caused by the global Corona pandemic and other geopolitical shocks including the Russian invasion in Ukraine while those countries are in the similar IMF stabilization programmes. Bangladesh which was supported by the IMF pandemic programme in April 2020 and lent US$ 200 mn to Sri Lanka in 2021 also has applied for an IMF loan of US$ 4.5 bn last week to boost its foreign reserve. Similarly, many emerging market economies also are in the IMF funding pipeline and stabilization programmes which have not immunized them from the crises.

• Fourth, Governor’s statement that the IMF-based overall macroeconomic package will help the economy to achieve so called macroeconomic balance or stability is a gross exaggeration of textbook version. Macroeconomic balance in textbooks implies a hypothetical situation of the aggregate demand being equal to the aggregate supply of the economy. No country can practically reach that situation and no data is available to find the demand and supply levels separately. Therefore, policymakers and researchers collect data such as inflation and employment based on theoretical grounds to detect whether there is a mismatch between the aggregate demand and aggregate supply. For example, when inflationary pressures are raising, it is argued that the demand is higher than supply causing such inflation or continuous increase in prices in general. The recession is considered as the reverse position. Practically, no economy can be maintained at the balance as demand and supply conditions change frequently due to various factors. Therefore, the view that the IMF package with US$ 3 bn can get Sri Lanka’s collapsed economy back to the demand - supply balance is a baseless hypothesis. Even earlier IMF programs could not bring that balance. Therefore, the stabilization of the economy from the current financial crisis back to pre-Corona level is not a magic that can be achieved through such conceptual IMF paperwork’s.

• Fifth, the economic stability does not mean the macroeconomic balance although the Governor says so. The macroeconomic balance is the demand-supply equality as indicated above. However, the stability generally refers to a condition of the economy moving without significant volatilities in GDP growth, unemployment, inflation, balance of payment, etc., or large booms and downturns. Even many central banks attempt to conduct monetary policies to keep the economy around a targeted inflation of 2% or 5% which shows a situation of an economic imbalance with the demand exceeding the supply at a moderate phase for the dynamism of the economy. Therefore, his economic stability concept is a contradiction to the reality as well as textbooks terminology and, therefore, cannot be applied to Sri Lankan economy suffering from the current crisis.

• Sixth, the World Bank on 28 July has announced that it would not provide financial assistance until Sri Lanka implements an adequate macroeconomic policy framework including deep reform to create economic stability. Therefore, the support from other multilateral institutions is highly doubtful as their lending approaches could be different from the IMF programme.

• Seventh, the President also expressed yesterday at a public gathering that getting funds from the IMF and others would not end the current problem and the debt burden has further increased. The President also stressed the urgent need for modernization of agriculture and creation of export and digital economy in place of presently collapsed import economy. In contrast, the Governor talks about tinkering the collapsed import economy with an IMF bailout which is being dragged on without a timeframe

Therefore, above views expressed by the Governor at the CNBC interview reflect the poor subject knowledge he has acquired for the past 15 years up to the end of 2020 in his involvement in the monetary policy including foreign reserve and exchange rate management carried on government foreign borrowing. 

Therefore, it is clear that the recovery of the economy from the current crisis is not possible by trying to resume with same IMF model which is in long delay.

Overall Comment

The present Governor is largely responsible for the failed macroeconomic management model indicated above for nearly 15 years up to the end of 2020. However, he blames the government and past Governors of the Central Bank for the present crisis as if he is innocent and has come fresh to save the country from the crisis for no personal benefit to him. 

Therefore, he has got a new habit of arranging media interviews almost daily basis and making broad comments as to why the recovery is difficult due to current political instability and what the government should do while he is trying to sell the IMF bailout as the only solution for the recovery. He also issues alerts to the general public as to what will be the catastrophe possible ahead.

However, it is the Central Bank that is statutorily responsible for the economic and price stability and financial system stability of the country, and the political stability is not a precondition for implementation of the policy instruments empowered to the Central Bank with greater policy independence under the Monetary Law Act. It is for this purpose that the regulation of the monetary and financing side of the economy has been entrusted solely with the Central Bank and Monetary Board.

Therefore, the Governor being the Chairman of the Monetary Board and CEO of the Central Bank has the unique authority on the development and stabilization of the economy. Further, the cause for current crisis is the failure of the Central Bank to fulfil its public duties, primarily the foreign reserve and BOP funding with stability in the exchange rate.

However, it is clear that the present Governor is not conversant iĺn both practical approaches to macroeconomic management and policy instruments available to the Central Bank for the recovery from the current crisis. What he understands is the old cash flow management model to finance and drive the import economy without focusing on the development and sustainability of the real sectors of the economy. 

Therefore, since 7 April 2022, he has further aggravated the crisis by arbitrarily defaulting of government foreign loans and raising interest rates causing government interest rates to around 30%. As such, he has failed to show any progress on the resolution of the present financial crisis caused primarily by the depletion of the foreign reserve of the Central Bank. Instead, he keeps on talking on political instability and expanding time targets for getting the IMF loan in the old fashion and acts in the media shows to pretend that the political instability is the only hurdle preventing him from stabilising the economy.

As the Central Bank is now technically and functionally bankrupt, the Governor has ample time to preach economic sermons at media shows as he wishes.

 (This article is released in the interest of participating in the professional dialogue to find out solutions to enormous economic difficulties presently confronted by the general public consequent to the global Corona pandemic and subsequent disruptions and shocks.)

 

P Samarasiri

Former Deputy Governor, Central Bank of Sri Lanka

(Former Director of Bank Supervision, Assistant Governor, Secretary to the Monetary Board and Compliance Officer of the Central Bank, Former Chairman of the Sri Lanka Accounting and Auditing Standards Board and Credit Information Bureau, Former Chairman and Vice Chairman of the Institute of Bankers of Sri Lanka, Former Member of the Securities and Exchange Commission and Insurance Regulatory Commission and the Author of 10 Economics and Banking Books and a large number of articles published)