Sri Lankan banks reduce foreign borrowing and see more dollarization of deposits

ECONOMYNEXT – Sri Lankan banks have slashed foreign borrowing sharply over the past year, official data shows, as the country ran out of rating space after seven years of state expansion and monetary indiscipline.

Public and private commercial banks borrowing heavily from abroad to buy dollar-denominated Sri Lanka development bonds, lending to offshore banking units in government after 2015, which increased from 17 to 20% of GDP over 5 years .

The state-run Ceylon Petroleum Corporation also borrowed whenever money was printed to suppress rates, as part of “flexible inflation targeting”.

Meanwhile, some banks also bought discounted international sovereign bonds as foreign investors dumped them.

While downgrades came quickly in 2020 towards the CCC with increased money printing, banks lost the ability to borrow overseas. They were also unable to roll over maturing loans as counterparty funding limits were reduced.

Banks’ short-term foreign currency borrowing had peaked at US$4.6 billion in the third quarter of 2020, according to central bank data, and fell to US$1.442 billion in the first quarter of 2021 in a sharp correction. .

Long-term loans, which were around US$1.5 billion in the first quarter of 2020, fell to 1,072 million in the first quarter of 2021.

Short-term money and commercial bank deposits grew from around US$1 billion in the first quarter of 2020 to around US$4.3 billion in the first quarter of 2022.

Sri Lanka introduced in 2020 special deposit systems also to attract foreign funds.

Meanwhile, some of those who had invested in SLDBs had also begun to withdraw, fearing a haircut.

Data shows banks’ foreign borrowing increased during the currency crises of 2015/2016 and 2018, which triggered money printing to suppress interest rates as part of “flexible” inflation targeting. “, a very unstable monetary regime peddled by Western mercantilists to Third World countries with “fear”. to float’.

Sri Lanka is also afraid of a hard anchor.

Sri Lanka expanded the state from 2015 to 20% of GDP from 2017 after abandoning expenditure-based consolidation (cutting costs) under revenue-based consolidation despite a bloated state and military oversized.

Revenue-based consolidation (expanding the state with a higher level of taxes) as well as borrowing has long been advocated by the Janatha Vimukthi Peramuna and is also generally followed by other American leftists and progressives.

During repeated currency crises under ‘flexible’ inflation targeting through 2019, Sri Lanka also borrowed heavily through international sovereign bonds as the country lost the ability to repay its incoming debt. maturing in rupees, forcing foreign borrowing to rise to gross funding level.

The state-owned Ceylon Petroleum Corporation has also borrowed from commercial banks and suppliers as foreign exchange shortages due to liquidity injections made under flexible inflation targeting have created foreign exchange shortages making it difficult for the CPC to convert rupees to dollars.

Flexible inflation targeting has been combined with deliberate money printing to target an output gap. The International Monetary Fund has provided technical guidance for calculating the output gap and targeting it with printed money.

After two currency crises that depressed output, Sri Lanka cut taxes in December 2019, saying there was a “persistent output gap” and printed even more money than before. (Fiscal stimulus in Sri Lanka to close the output gap)

In 2019, as the impact of state expansion under revenue-based fiscal consolation and foreign borrowing under flexible monetary policy became clear, analysts warned that the country would soon run out of rating space and that it would end its rampant monetary policy.

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Sri Lanka needs monetary discipline to avoid further downgrades: Bellwether

“Sri Lanka is a country that mostly maintained monetary stability in the worst years of the war with the help of the prevailing ideology then,” EN economics columnist Bellwether warned in December 2019 as the Money printing was beginning around August in a sign of things to come. .

“But now, each new episode of monetary indiscipline costs the country a notch in the credit rating scale.

“Sri Lanka will soon run out of rating space to tap the capital markets if flexible exchange rate/overnight cash rate targeting continues in the next recovery space.

“Sri Lanka will face credit downgrades and a possible sovereign default of dollar debt unless the highly unstable discretionary ‘flexible exchange rate’ is restrained and some monetary discipline is instituted.

“Pakistan, whose central bank also prints money with a peg and reports frequently to the IMF, now has a B- rating. But B- is barely above CCC.

“From two levels below investment grade in 2005, Sri Lanka is now slightly above CCC, which is a distressed debt level. This is not a place to take particular monetary risks.

“The central bank and others are talking about the need to lower interest rates,” said the column, which was written before the 2019 election, but the printing of money through outright purchases had begun. around August of the year.

“It’s not reassuring.

“It is doubtful that China will provide loans as before to stimulate growth because it has its own problems. China’s flexible exchange rate is taking its toll, as are state-owned enterprises. However, China could provide debt relief. debt in Sri Lanka.

“If rates are cut further and money is printed, the recovery in 2020 will be short-lived or not at all, and another currency crisis will be generated and downgrades will follow.”

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