Tuesday, 16 October 2018 07:22

Govt. should guard against policy backsliding: IPS

Warns tougher times ahead as SL heads towards higher debt repayments and elections in 2019
Insists best way forward is to remain focused on promoting exports and investments
Cautions of possible “sharp drop” in currency as CB has limited reserve roomto defend rupee
Growth likely to continue around 4%, inflationary pressures show signs of rising
Imperative to retain investor confidence through strong macroeconomic fundamentals
Fiscally-sustainable regime essential for consistent polices and growth

Sri Lanka’s Government should fight against policy backsliding and remain focused on export and investment driven growth strategies as the already beleaguered economy heads towards deepening political and economic challenges next year, hampered by high debt, growing external risks and limited reform implementation, a top think tank said yesterday.

Institute of Policy Studies (IPS) Executive Director Dr. Dushni Weerakoon speaking at the launch of the organisation’s landmark ‘State of the Economy’ publication dwelling on the topics of economic performance, international environment as well as the issues of climate change, food security, and disaster risk management, warned Sri Lanka had little room to substantially change its economic prospects in the short term.

She pointed out that the complex combination of high debt repayments starting in 2019 and likely to continue till 2021, along with an appreciating dollar, rate tightening by the US Federal Reserve, global trade wars and sluggish investment, would continue to pose serious challenges for growth.

“In the near term it is clear that the economic environment is going to be very challenging, more challenging than it has been so far. Global growth outlook is dimming as a result of escalating trade wars, higher debt, climbing oil prices and tightening US policy. For Sri Lanka pressure on the currency is likely to continue and even though there is a rise in exports and investment, there isn’t likely to be a material change enough to make a significant impact on Sri Lanka’s current account. With higher borrowings needed in the next few years and given the tight macroeconomic conditions and limited time to push through structural reforms, growth is likely to continue hovering around 4%,” she said.

Given looming presidential elections in 2019, local policymakers are likely to face pressure to move away from fiscal consolidation and structural reform measures that have been spearheaded by the Government over the past three years, she noted. But since Sri Lanka would have to resort to international capital markets to raise funds for debt repayments, Dr. Weerakoon insisted it remained imperative for the country to retain investor confidence by maintaining strong macroeconomic fundamentals.

“Given this situation, there is likely to be pressure for policy backsliding but Sri Lanka has to ensure that we retain investor confidence, in 2019 in particular, as we go forward to settle our external debt. Foreign investors are likely to scrutinise our economic risks more intensely along with political risks in 2019, and it is unfortunate that all of these are converging next year. Policy predictability and consistency is therefore critical and whatever growth strategy is adopted what we cannot escape from is that Sri Lanka needs to generate dollar revenue to match dollar denominated debt servicing for any strategy to be resilient and sustainable.”

Dr. Weerakoon was positive of the Government’s efforts to improve macroeconomic fundamentals, pointed out that they were on a much sounder footing today than two years ago. The Government has also made strides in reducing budget deficits, with the latest data showing that Sri Lanka is largely on target to meet its deficit goal of about 5% for 2018 and monetary policy has been effective in curbing credit growth and inflation.

“We now have better public finances, more prudent management of monetary and foreign exchange policy within the constraints Sri Lanka currently faces, and in terms of performance outcomes positive growth in exports and Foreign Direct Investment (FDI).

“Management of exchange rate policy has been an area of controversy, but there has been a qualitative improvement in the way Sri Lanka’s reserves have been accumulated. The Central Bank has been a net purchaser for much of 2017 and into the first quarter of this year, building up Sri Lanka’s non-borrowed reserves and allowing the exchange rate to gradually adjust to market fundamentals. Turnaround in exports in continuing in 2018 with growth of about 6.5%. But growth is still coming at under 4% for the sixth consecutive quarter and worryingly Sri Lanka is still increasing its external debt and debt accumulation is accelerating rather than reducing.”

Warnings made by IPS in 2017 have largely become reality, noted Dr. Weerakoon, recalling Sri Lanka’s excessive borrowing spree when global interest rates were low, which has presently ground to a halt as those favourable conditions unwind.

“We are witnessing the disruptions, primarily in the form of a depreciating currency, largely created by the dual problems of increasing imports and higher fuel prices. An appreciating dollar has also contributed. Given that Sri Lanka’s forex markets are thin, anyone of these factors in isolation could have exerted pressure on the currency but in combination all these three have had impact on the rupee.”

Even though several other countries in Sri Lanka’s neighbourhood are seeing similar or higher levels of currency depreciation, the local scenario is made more serious by comparatively higher levels of debt, emphasised Dr. Weerakoon. As much as 27% of Sri Lanka’s foreign debt is held by State-Owned Enterprises and the private sector, resulting in depreciation weakening balance sheets.

“Simply said, depreciation can be limited by using reserves but markets will often force a sharp devaluation. This is almost a foregone conclusion given the limited reserves that we hold. Forced devaluation is often a sharp one and is better avoided. This is what we saw in 2015, 2012, 2008 and 2001. Reserves are down to $7.2 billion with import cover reduced to four months and the danger threshold is about three months of imports. So there is very limited room for the Central Bank to use its reserves to defend the currency even if it wished to do so.”

Attempts to curb imports of non-essential luxury imports, encourage exporters to repatriate their earnings may provide limited relief, acknowledged Dr. Weerakoon, who also touched on the option of temporary controls on capital outflows. However, she conceded that such a measure would be controversial and difficult to implement as it would be seen as detrimental to investor confidence. Since Sri Lanka relies heavily on international capital markets to raise funds for debt repayments and refinancing debt it is imperative to retain investor confidence.

“We must have a fiscally-sustainable regime in place. The rupee depreciation will have fiscal and revenue impact and we are likely to see reduced inflows coming into Treasury bills and bonds to help the Government finance fiscal deficit. Sri Lanka is also likely to face higher interest costs on debt. In the near to medium term fiscal risks mostly come from elections.”

Dr. Weerakoon largely supported the current monetary policy stance by the Government, recognising that balancing controlled demand with fostering growth would be a tough task for the institution.

“In this situation I think it is sensible to keep a lid on interest rates because at this point raising interest rates is not going to slow the exit of foreign investors from Treasury bills and bonds, nor is it likely to lead to fresh inflows of investments and if we are to ensure that growth remains fairly buoyant at the 3.7% reported in the last quarter, then some balance between tight monetary policy and growth needs to be maintained. But the amount of space for that is also narrowing swiftly because inflation is also on the rise, partly because of the increase in fuel prices and rupee depreciation. The Central Bank will have to be watchful on price inflation and then decide on its monetary policy accordingly.”

(FT)

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