27 October, 2020

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Budget 2014: No Rupee Devaluation Shocks

By Hema Senanayake – 

Hema Senanayake

Hema Senanayake

If I have any kind of expertise, it is in the subject of economics, especially in macroeconomics. Perhaps some CT readers might want to know my views on the budget 2014. Let me begin with the budget of 2013.  When the 2013 budget was presented, the Central Bank of Sri Lanka (CBSL) forecasted to achieve 7.5% GDP growth. Instead, I suggested that “Sri Lanka will never achieve 7.5% GDP growth” for the year 2013. My claim is on record. Why did I say that?  In the budget for 2013, it was proposed to reduce foreign borrowings dramatically in compared to the previous year. Pointing it out, I categorically said that if the government stick to the limit of foreign borrowings proposed in the budget, the government has to contain the private sector credit growth severely in order to avoid significant rupee depreciation and as a result it would not be able to achieve 7.5% GDP growth in the year 2013. My prediction was well backed by a reason.

The economy is a system; you can’t do whatever you want in one area without having impact in another area. The stability of rupee depends on the balance between the inflow of dollars (or foreign currencies) into the country and the outflow of dollars. And private sector credit growth is important to achieve higher GDP growth; ensuring private sector credit growth is not possible if the balance between inflow and outflow of dollars breaks negatively which means inflow of dollars reduced in compared to outflow. The proposed dramatic reduction of foreign borrowings in the budget of 2013 should have definitely broken the said balance negatively. This was a great mistake and as a result finally the government desperately pushed the National Savings Bank to borrow in dollars.

The said mistake has been avoided in 2014 budget. In this budget it has been proposed to increase foreign borrowings by 34.15% to Rs.331.5 billion; this will roughly amounted to USD 2.5 billion. Quickly you will guess that in the year 2014 there won’t be currency devaluation shocks. That is right. Another positive point is the proposal to reduce domestic borrowings by 22%. The combined effect of both proposals is that it provides a better chance to expand private credit issuances. If credit issuances (or credit growth) are not significant then there are chances to appreciate the value of rupee which is an indication that CBSL has to bring down the interest rates. This means in 2014 we will be able to see more stable currency, low interest rates and private sector credit expansion which combination helps to have a higher GDP.

When I say a higher GDP, it means a GDP value than the budget deficit which is known as deficit spending of the government. If the government’s deficit spending is 8% and the achieved GDP is 8%, I do not consider it as a good GDP value. The reason is that in the GDP calculation we added up basically four parameters, one parameter being the government expenditure. This means if the government borrows and spends Rs.100 then by that amount GDP goes up. Even with higher GDPs, such economies will collapse sooner due to debt crises or due to severe currency depreciations. In 2011, we had around 8% of deficit spending and the GDP grew by 8% and in the second quarter of 2012 there began a shocking currency depreciation. On the contrary, in 2014, we will have a good GDP value exceeding the amount of deficit spending.

However foreign borrowings come with an obligation to pay them back. This necessitates in increasing the inflow of dollars through non-credit sources through the promotion of exports and Foreign Direct Investments (FDIs). In this regard individual entrepreneur’s creative mind set is very important other than economic incentives. They should feel that they can do businesses independently without any fear. Respect for human rights is directly related to the promotion of exports. If human rights are respected now, the country can win back the GSP+; and that helps to promote exports to Europe and will justify the proposed foreign borrowings. Sometimes I tried to figure out the real political reason to impeach former Chief Justice. Whatever the reason was, I think the cost on the country’s democratic image was more than what was achieved politically by the impeachment; in economic terms we say that the comparative advantage of the impeachment of CJ is negative. So was the effect of Expropriation Act; this Act is needed to be repealed. For many countries like Sri Lanka democracy pays the country off.

Economic system is larger than anybody’s conceited thinking or feeling. Thinking high about your own thoughts can be known as conceited thinking. Some “patriots” or even Central Bankers with conceited mindset might have thought that Sri Lanka can do well by itself. This budget surrendered this conceited thinking by proposing to increase foreign borrowings. Economic system proved to be larger than any individual’s vision. This is positive. I think there is only one more step to take; shed the conceited political behaviour. That would pay the country off indirectly and directly on the ruling elite.

In the above we discussed about the increase of inflow of dollars through non-credit sources. Two important sources identified are exports and FDIs. Another two non-credit sources of increasing dollar inflow are the promotion of decent expatriate worker program and the promotion of tourism. Now think from the end. Do the BBS mischief acts help to have a good expatriate worker program or to promote tourism. Do the “rent-a-mob-activities” promote the country’s good image? In one extreme situation the main opposition party decided not to participate in CHOGM. How that decision reflected upon the country’s image? You may think in terms of comparative advantage. The government could have easily stopped the high handed mob activity at the Head Quarters of the main opposition party. Let us assume that it did not happen. In the event the seats reserved for the opposition at CHOGM would have been duly filled. Is that good for the country’s image?

Any proposal to increase foreign borrowings must have a promise to increase the inflow of dollars through non-credit sources. As we saw above, all major four such sources are directly linked to the promotion of country’s good image. In this regard accountability to the rule of law is the most important. Other features of good governance might arise from the rule of law.

Economies do not crash due to low GDP growth but crash suddenly due to monetary disturbances. That was what happened in Argentina in 1999, in the United States and Europe in 2008. That was what was about to happen in Sri Lanka amidst high GDP growth, in the middle of the year 2012, due to severe devaluation of rupee. All out economic crisis was avoided by containing credit growth. However, we will not see any monetary disturbances in the year 2014, if there is not much deferred foreign debt payment obligations for the coming year.

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Latest comments

  • 1
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    Excellent article making the simple point that good governance is good for the economy. But will the powers get the message? Unlikely.

  • 1
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    Only good governance in terms of human rights, rule of law, democracy and independence of the judiciary will promote a steady economic growth in the long run. Why cannot the myopic leaders of the regime understand this simple truth?

    Sengodan. M

  • 0
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    At present we are ranked 69th in the world democracy rankings along with other third world developing countries. http://democracyranking.org/wordpress/?page_id=57

    In the corruption perception index we are at 79 – http://www.transparency.org/cpi2012/results

    In the ease of doing buisness rankings we are at 85 – http://www.doingbusiness.org/rankings

    So it seems that these rankings are fairly interrelated. Govt must realise that we cannot develop in isolation. Our major markets are in the west where democracy, human rights are given premium status. Even Iran has finally come around from being an anti-western intransigent state to building a better understanding with the west. The sooner we face the realities the better for the people. We are an educated society with third rate politicians and leaders.

  • 0
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    One half of Economists predictions are always right. It goes like this. One Economist makes his or her calculations and predicts, say GDP Growth rate for SL for 2013 year to be 7.5% of GDP or more. Then the numbers come out next Economist comes on to the stage and predicts the GDP will be less thaan 7.5 % of GDP.
    Surprise surprise one of the 2 Economists will be proved right when the actual figures are published sometime later…

    Let us get real Mr Senanayaka. Can you predict what the SL Rupee exchange rate against US dollar will be in a couple of month’s time? Give it to the nearest 1 or two cents and the reference date. If you do this I know you are for real.

    • 0
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      if he knew the answer hed be a billionaire .

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      I think your question is honest. Prediction is not the business of economists, instead economists can maintain the value of currency within a beneficial range to promote economic growth. If CB wants to maintain the value of rupee within a certain range then it has to maneuver with the variables that associated with it and CB has the power and authority to do such maneuvers. By end February 2013 CB said foreign reserves are good and a loan from IMF was not necessary but I disagreed. Then government had to push NSB to borrow at a higher rate of interest. When that happened Cabraal was happy and said that it helped to stabilize rupee. Nothing will happen without setting the necessary conditions. When the conditions set are wrong the concerned economists can predict what will happen. Not like in 2012 and 2013, the budget 2014 has set the conditions to keep the rupee stable and to expand private sector credit growth. Still day to day or weekly or monthly maneuvers are necessary. CB can do it, if CB is independent from negative political pressures. If bureaucratic arrogance prevails in CB then legislature can make due interventions. Thanks.
      Hema

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        Thank you for your comprehensive response. It is puzzling though that assuming Cabraal is/was the only non-Economist hence unqualified and incompetent Governor SL had in the history of CB, how can you explain USD exchange rate, for example, falling from about Rs 10 in the 60’s to around Rs 100 during the time qualified and competent Economists were heading this institution?

  • 0
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    No way Hema! You cannot get any investment in here without paying out a hefty 40% to the brothers. Tell me what impact this will have on your macro economics?

    • 0
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      40 % of nothing is still nothing you old fool .

      • 0
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        Thats for those who have nothing to invest and most of those broke cases are already here. The FDIs that the macro economists dream of are not going to put down 40% to get into this hell hole.

  • 0
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    This is strange economics…

    In the year 2014 there won’t be any currency devaluation risks because SL ‘s foreign borrowings are increasing by 34%!

    I do not know of a country that lead to a stronger currency or prosperity through foreign borrowings. It is the foreign investment (specially FDI) that creates stability in a currency not borrowings. Eventually the excessive borrowings of SL that is being deployed into non-productive assets such as ports, airports, money losing airlines will end up in tears.

    SL is using institutions such as National Savings Bank/Bank of Ceylon to borrow money overseas because its own debt
    Ratios are already stretched. Why the largest savings mobilization institution in the country needs FX borrowings is beyond me!

    At present the world financial markets are liquid and the money is cheap. SL is attracting a some of this money into fixed income(now that the markets a partially open) and stock markets. Once the tide turns, it will be the currency that will bare the burden first.

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