The Triggers of Deadly Desease of Sri Lankan Bankruptcy - Why could the Monetary Board not detect and prevent the triggers?
Although
there is a lot of post-mortem analyses of the present economic crisis and
resulting bankruptcy of the economy, there is no controversy over the triggers
of the crisis primarily being the deteriorating foreign currency position of
the economy, despite the statutory responsibilities of the Monetary Board (MB)
and the Central Bank (CBSL) since its inception and the vast economic data base and operational
mechanism available with them to detect early warnings and manage macroeconomic
risks.
Further, the
MB is still on the sleepy mode until the crisis is resolved in old
fashion with an IMF bailout supported by the default and restructuring of government
foreign debt, irrespective of the cost to the general public.
Therefore,
the purpose of this short article is to present the set of key monetary related
data that the MB/CBSL could use to detect and derail the path of the economy’s bankruptcy so
far and further ahead.
Economy’s
Operating Structure
We all know activities
on production in modern monetary economies take place fueled by the financial side
of the economy regulated by the MB under its monetary policy mandate. In open
economies, domestic finance and external finance arising from the country’s BOP
transactions are inter-connected. Therefore, changes in assets and liabilities
of the CBSL and resulting impact on domestic money and foreign exchange markets are
nothing but blood test results of the health conditions of the economy.
For example,
when the CBSL acquires a rising volume of foreign assets in excess of its
foreign liabilities, it prints money in exchange of such foreign assets. If the CBSL
does not sterilize this money printing, the domestic currency liquidity in the
money market immediately rises and causes interest rates to fall. Further, the
availability of foreign assets will help the CBSL to control the currency depreciation which will have second round impact on both domestic money and foreign exchange markets that are the backbone of the real economy.
However,
there is no mathematical formula or model to manage the CBSL’s monetary operations
to stabilize and promote the economy for desirable targets. Therefore, the MB must
be guided by a reliable set of data relating to the CBSL’s monetary operations
and their immediate outcomes as early warnings of the performance of the economy.
The core set
of data frequently available with a short time lags are listed as follows.
These data are available to the public through the CBSL daily, weekly and
monthly publications released in its website. Although the MB has the access to
a comprehensive database and early warning indicators frequently compiled and analyzed by the CBSL economists for fortnightly MB meetings, this data set alone is
adequate to understand the health trend of the economy.
Foreign Currency/BOP Conditions
- Daily representative exchange rates of commercial banks for Telegraphic Transfers. This shows the domestic foreign exchange market trend.
- Gross Foreign Reserve/Assets of the CBSL (Official Reserve). This shows a major source of money printing and the CBSL’s ability to meet foreign payments and manage the exchange rate. The CBSL has daily data.
- Monthly BOP Overall Balance. This represents the amount of the BOP financed by the CBSL out of its foreign reserve and the resulting change in its net foreign assets that causes money printing in equivalent amount.
- Monthly trade balance, worker remittance and gross foreign currency inflow to the government that represent major sources of BOP transactions and determine the overall BOP balance, foreign reserve and exchange rate.
Domestic Monetary Conditions
- Policy interest rates (SDFR and SLFR) and daily bank operations with the CBSL at those rates. This shows overnight bank operations to keep the overnight call money rate within the policy rates.
- Daily overnight call money rate and volume. This shows inter-bank liquidity conditions aligned to the monetary policy.
- Weekly Treasury bill auction yield rates (91 days, 182 days and 364 days) and amounts accepted. This represents the short end of the yield curve controlled by the CBSL in line with its monetary policy.
- CBSL holding of Treasury bills volume daily. This shows money printing through direct purchase of Treasury bills by the CBSL.
- Prime lending rates of commercial banks weekly. This represents a conduit of private short-term, low risk credit market.
Accordingly, the Tables 1
and 2 below give the data tabulated on a quarterly basis, i.e., last day, or last week or
cumulative at the end of the quarter (BOP data) as applicable.
What did data state how the crisis triggered in 202-2021
- The BOP or domestic foreign currency conditions deteriorated as shown by the rising BOP deficit caused by worsening trade deficit, worker remittance and capital inflow to the government where the CBSL used its foreign reserve to finance the deficit (goods, services and capital outflow) while appreciating and keeping the exchange rate fixed at Rs 200 level.
- Therefore, the total BOP deficit in 2020 and 2021 was US$ 6,289 mn with the gross inflow to the govt. only of US$ 4,437 mn. while the trade deficit and remittances deteriorated by US$ 3,711 mn in 2021. As a result, the foreign reserve collapsed to US$ 3,139 mn as at the end of 2021. This is the root cause of the foreign currency crisis that eventually led to the country's bankruptcy.
- The monetary policy got tightened since the 3rd quarter 2021 by raising market interest rates. However, the money printing also has risen to fund the banks through SLF and the government through Treasury bill purchase while a gradual reduction in SDF was reported. The end-use of the reduced SDF and increased SLF is not evident from the data and could be mostly for direct advances to the government by the state banks as private sector credit was risky due to the crisis-hit economy. Such advances and CBSL purchase of Treasury bills consisted of the credit creation to fund debt service through the foreign reserve without new foreign debt and debt rollovers.
What does data state how the bankruptcy is worsening in 2022
- The BOP deficit in 2022 has risen further, despite the float of the exchange rate on 7 March 2022, historic increase in policy rates by 8% since 8 April 2022, default of government foreign debt service on 12 April 2022 and various ad-hoc administrative trade and exchange controls, although the trade deficit improved somewhat in the 2nd quarter. As a result, the foreign reserve has further eroded to US$ 1,859 mn.
- However, when the illiquid US$ 1,500 mn of the Chinese currency swap is removed, the foreign reserve in 2022 has declined from US$1,639 at the beginning to US$ 315 mn. at the end of July. Therefore, the BOP deficit of US$ 2,814 mn in the first half of 2022 should have been funded by the foreign grants and Indian credit lines.
- The faster rise in SDR, SLF and CBSL Treasury bill holding while interest rates also are rising reflects the chronic instability in the economy. The idle call money market is a serious concern over the inter-bank market trust. The Treasury bill yield rates reaching at 31% is indicative of the domestic debt unsustainability of both the state sector and private sector.
- High interest rates, default of debt and other administrative market controls have led to further bankruptcy of the economy with an officially projected contraction of the economy by 8%-8.5% with the consumer inflation soaring beyond 65% in 2022.
MB/CBSL Non-Active Policy Stance
- There is no controversy over the failure of the MB to take remedial action to prevent the country’s bankruptcy, despite the availability of the crisis trigger data and policy literature. The data given above are like A, B and C of the English Alphabet to the internationally trained economists in the CBSL.
- The CBSL's internal macroeconomic risk management mechanism supporting the MB consists of Monetary Policy Committee, Monetary Policy Consultative Committee, Financial Stability Committee, Financial Stability Consultative Committee, Foreign Reserve Management Committee, daily Market Operations Committee, Domestic Operations Department, International Operations Department, Macroprudential Surveillance Department, Risk Management Department and bank-wide Risk Management Committee that are monitored and controlled directly by the Governor.
- Further, the present MB also stays relaxed by talking about varying forecasts over inflation peak, IMF bailout and debt restructuring while passing the blame to the government's fiscal and debt management although both state sector and private sector further dig in the tunnel of the bankruptcy. For example, the government struggles with non-availability of bank credit to purchase paddy harvest being a major economic activity while the MB being the national bank credit distribution authority stays deaf and blind. However, not a word is spoken over the failures of the CBSL's statutory mandates as the debt manager, fiscal agent and foreign reserve manager.
Therefore, the worst of the present crisis is seen yet to come in view of above data and current trends of the crisis-hit countries such as Lebanon, Pakistan and Zimbabwe in the middle of global inflation getting out of control to four decades high.
The Queen Elizbeth II who attended a Cambridge University Conference held on the subject of the global financial crisis 2007/09 just asked a blunt question from those eminent Professors after listening to their professional talks "why they didn't see that thing (financial crisis) coming?" As nobody could give a responsible answer to the Queen, they commenced serious research work to find the answer.
(This article is released in the interest of participating in the professional dialogue to find out solutions to present economic crisis confronted by the general public consequent to the global Corona pandemic, subsequent economic disruptions and shocks both local and global and policy failures.)
P Samarasiri
Former Deputy Governor, Central Bank of Sri Lanka
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