15 December, 2017

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The Economic Outlook Remains Uncertain!

By Hema Senanayake

Hema Senanayake

Hema Senanayake

Calendar year 2016 begins today. In this year the government is going to learn an economic lesson which had never been learnt in their first full year in office. They will learn that ultimately both monetary and fiscal policy narrowed down to the management of exchange rate. In 2015 the government did fail to understand it and as a result the rupee depreciated to an unexpected level. According to the Minister of Finance himself, the expected value of the rupee against U.S. dollar was close to 130. However, on the last banking-day of the last year the exchange value of rupee was around Rs.145 per dollar.

For any country which uses some other country’s currency such as dollar, as its international reserve currency and also for any country which has been posting a current account deficit for a significant number of years like Sri Lanka, the both monetary and fiscal policy ultimately narrowed down to the management of exchange rate, if that country did not have enough non-credit based inflow of dollars (foreign exchange) which are not posted in the nation’s “current account.” This is not difficult to understand. For example, if the rupee depreciated from its current value of Rs.145 to Rs.160 or 165 per U.S. dollar in this year, it will bring negative chain effect across all sectors of the economy with little positive effect on exports.

However, some economists who are critical about the depreciation of rupee do blame the Central Bank of Sri Lanka (CBSL) for adopting “floating exchange rate arrangement.” It is true that Sri Lanka has been previously classified as having stabilized or fixed exchange rate arrangement. Usually International Monetary Fund (IMF) publishes a report each year classifying all its member countries (188) in terms of exchange rate arrangements adopted by each country. Accordingly, in 2014 report IMF has classified Sri Lanka as a country which moved to a stabilized arrangement from floating, (refer page 3 of IMF report). When the 2015 report is published by IMF, it will reclassify Sri Lanka as having moved back to floating regime from stabilized arrangement. Can any country like Sri Lanka which continue to meet its Balance of Payment requirements through borrowed money from foreign sources, choose as to what kind of exchange rate arrangement be adopted? My obvious answer is “NO.” It has to adopt “floating regime” under the given circumstances.

Yet, this doesn’t mean that Sri Lankan rupee should continue depreciating. If Sri Lanka is going to have that fate in this year, for that matter the blame should go primarily to CBSL for bad monetary and monetary policy management and to the government as a whole. Why?

Let me explain it by citing a few examples here. It is true that certain consumer imports might have negatively contributed to the current account and as a result to the Balance of Payment of the country. It also can be true that import of cars for personal use might be the significant issue. I think this situation has previously been observed by the Central Bank too.

I guess that could have been the reason to reduce the loan-to-value ratio to 70% by CBSL a couple of months ago. Prior to that, financial institutions had been providing loans amounting to the full value of the vehicle for prospective buyers. After the loan-to-value ratio is reduced, the prospective buyer has to pay 30% of the value upfront when buying a vehicle. This rule could have resulted in reducing car sales resulting lessor number of car imports. The monetary effect is that the issuance of loans would be reduced if vendors did not try to sneak through the administration of the policy by CBSL. Except for a few auto traders, prospective car buyers did not protest for this policy.

However, the Minister of Finance increased the loan to value ratio to 90%. That happened before the budget.

From the budget, the same Minister of Finance lamented saying that 60,000 new cars per month is registered and that is too much for the road net-work. Then he proposed to stop issuing all tax free car permits and further increased taxes on small and medium size electric cars. The objective again was to reduce car imports but not by reducing the issuance of loans but with an administrative rule. But this time around people protested. This is the difference; when the monetary policy tools are used to contain imports people will not resist that much but they will not tolerate when their previously enjoyed privileges are removed by ad-hoc administrative rules.

However, this endeavor has failed now. Prime Minister assured that the car permits will be issued again. President issued a directive saying not to increase the tax on eco-friendly cars. These reversals of budget proposals are not simple measures.

Therefore, the only option available now is to use monetary policy tools to contain imports through the reduction of the issuance of loans because without loans consumer imports cannot rise that much. However the reduction of loan-to-value ratio is not a proper monetary policy tool.

The customary policy tool on the supply-side of money is known as Statutory Reserve Ratio (SRR). By increasing or decreasing this ratio the CBSL can regulate money supply. When the ratio is increased the money supply (i.e. loan issuance) is reduced and when the ratio is decreased relatively money supply is increased. The CBSL used that policy tool a few days ago exactly on 30th December. On that day the Monetary Board decided to raise the SRR by 1.50 percentage points to 7.50 per cent from current 6.0%, effective from 16 January, 2016. Is this good? Yes it is but not much. Why? Let me answer as follows.

People save money in commercial banks. In turn commercial banks issue loans to customers. How much loans can banks issue? You might think that the loanable funds may be equal to savings in the bank. This is true, only in regard to certain saving banks which do not operate “current accounts” for customers. But for designated commercial banks loanable funds are exponentially higher than that of deposits of the bank. The reason is that commercial banks can virtually create monetary substitute known as “credit money.” It is this money that they lend.

Now, I am asking you if the commercial banks are not allowed to create money, will the issuance of loans be reduced. Yes, it is. In such an event, will it be useful to reduce imports. Yes, it is. If this is true, the CBSL must invent a new policy tool which can effectively and quickly regulate the creation of “credit money” in the system because the monetary policy tool call SRR can only reduce a fraction of money which could potentially be created by banks. Also, SRR does not work in short term. This is the reason that I believe that CBSL’s recent action to increase SRR would have very minimal positive effect on an impending Balance of Payment crisis. Sans good policies foreign borrowing is the next and worst option available for the government.

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Latest comments

  • 2
    0

    To make the Sri Lanka economy solvent the PRIORITY should be tracing and recovering the looted billions that the corrupt politicians of the Lanka have in overseas bank accounts. These stolen funds would be more than enough to pay of the gigantic National DEBT.

    If all the billions stolen by the corrupt clowns who sit in the Diyawenna Parliament were traced and used to settle the so-called National Debt which is really the COST of POLITICAL CORRUPTION, the Sri Lankan economy would be solvent.

    The people must demand that all the stolen Rajapaksa and cronies millions in Suiss, UK, Singapore, Dubai, China and Sechelles etc be traced.
    But getting aid from UK to which benefits from the looted funds of third world dictators and politicians, who keep the corrupt British Banks going is useless, because UK is part of the financial crime circuit!

    • 0
      2

      Stop dreaming!

    • 1
      0

      Quite right Don! UK and all the western banks and economies benefit from corrupt politicians in third world having their accounts in western banks!

      Look what happened in Greece where the corrupt politicians caused the economy to default and come under the yoke of the IMF with the people suffering. The IMF and Transparency international never said anything about the CORRUPTION and LOOTING by corrupt Greek Politicians even though they knew what was going on.

      The world financial system is a corrupt cesspool the king of which is the IMF and World Bank. Transparency International is an NGO which tows their party line..

  • 0
    0

    Ministers from the Yahapalana govt says for sometime, Sri lankan Debt paying instalments are twice that of what the revenue is. Only in this December, not even one year left for the govt, how many billions they borrowed through new money printing, Treasure bills, bonds, Currency swaps with India.

    They could not hold on even to the coconut cultivation that British Colonial master grew. Tea cultivation and rubber are still at the same place.

    Because 5 million Sri lankan are living overseas. At least some of these people send money and they live on those remittances. About five hundred women per year come back in coffins. Have they cut down that? NO. How about the destruction of families and children of dysfuncional families ?

    Only thing politicians and the top professionals can not work unless they have the luxury car permit. Right now, roads not enough for the vehicles that Sri lanka has. Imports are still twice that of exports. Does it look like a country that will grow up ?

    Most probably, during the next global event make Sri lanka bankrupt.

    Oil had worsened global warming So the oil use has to go down. Then Arab countries go to austerities. Then Sri lanka also will have problems.

  • 0
    0

    Our problem is the excessively proneness to import. We cannot afford to run a huge trade deficit and depend on the migrants transfers alone to finance them. Already the deficit exceeds the flow of migrants transfers. In a few years we will face the stark economic reality of financial bankruptcy unless we take steps to increase exports and import substitution.

  • 0
    0

    National economy is manipulated by US junta puppets that current regime in center of Colombo of UNP-Ranil; and US -FRD has created new set of links between UNP policy makers and Central Bank of SL to undermined development of commodity production in 2016 Sri lanka.

    Result of that ours per-capita will go down ,we will back to fail-nation will remain as Poverty and Backward country in Global Map.

    This is verbal and unholy alliances between of USA and UNP -Ranil policy of economy of memdordam of understanding-MOU that dismantle National economic foundation was build last 67 years by SLFP led political coalitions since 1956.

    Sri Lankan, the very system foundation has been rerouted by last Budget UNP-2015 set of policies by UNP gang that did not realized by ours so-called pundits of elites that belongs to local thinking thanks.

    So-called left political paries-JVP, LSSP, SLCP sections of elites and Frontline Socialist Party who are backing present UNP puppet regime is playing hands of US and Indian big-bourgeois vital interest in against Nation capitalist Development and Democracy an Island in 21st century.

    This new coloinilaztion of ‘regime change’ by in the US power hand which that installed MS-President UNP-Ranil and CBK regime look after vital interest of monopoly bourgeoisie class in globally .
    That was laid foundation 2015 January 9th save hegemonies interest. Ours economy is fail look in 2106.

    This is political economic agenda of New Economy policy of UNP led by budget 2016.

  • 0
    0

    SL Economic Development and future prosperity entirely depend on the Tourism Industry.

    Good Road and Rail Network,Airports, Harbours and Tourist essentials such as Casinos, and Theme parks are a must if we have to prosper.

    The previous Regime had that worked out to a tee.

    Yahpalanaya changed all that because whisky Madam wanted Revenge,

    And Bodhi Sira couldn’t say to a free ride to heaven,

    That is history.

    Even the once mighty Resource rich countries are going Tourism to solve their unemployment and balance of payments problems, after the ass fell out of commodity prices, when China hit the brake pedal.

    Now these countries are struggling to find the Dosh to build Infrastructure.

    Sweat shops and Batalanada’ assembly lines are just “Pit Stops” for Foreigners who run Designer Clothing and Car Industries.

    When the wages creep, they move on to the next slave labour camp.

    People who are up to scratch with Applied Economics in the West, are aware of how these Industries operate.

    But our Economists seem to wear Yahapalana lenses even when they read and write.

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