It was not too long ago that the powers that be said that the global financial crisis would have no effect on Sri Lanka. The financial system was in their view insulated from the happenings all around us; it was safe and sound. So too it was in respect to the Sri Lankan economy whose resilience was a boast. While all around the world countries were lowering their rate of growth, we were expecting a 6-6.5 percent growth. This has since been revised to 5-5.5 percent, with a proviso that it may be higher if things improve.
Projections for economic growth in the world, in Asia and in South Asia were revised downward at least twice. So was the case with growth predictions for Asia’s awakened economic giants, China and India. It appeared from official pronouncements that the Sri Lankan economy was on an independent high trajectory of growth.
This optimism was despite clear indications that the economic downturn had begun. There were closures of factories; exports were decreasing and the effect of the down turn in agricultural export prices were affecting rubber growers and tea small holders and estates. Even the common man did not believe the official scenario, much less the educated. Economists, except those in official positions and academics turned sycophants, knew the country was in an economic crisis, a crisis that was deepening rather than abating.
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The story is somewhat different today. The global crisis is being blamed for the downturn in the economy. We have a home grown financial crisis and a bail out package rather reminiscent of US actions. And a decline in foreign exchange reserves to one of the lowest that the Central Bank considers quite adequate for the country’s imports. There are such divergent views on the state of the economy between officialdom and independent observers, the business community and even the common man. Most independent observers are of the view that the economy is in a crisis.
The latest bleak assessment of the economy comes from Fitch Ratings. Fitch Ratings have revised Outlook on the country’s long-term foreign and local currency Issuer Default Ratings (IDRs) to Negative from Stable. At the same time, Fitch Ratings has affirmed the Long-term foreign and local currency IDRs and the Country Ceiling at 'B+', and the Short-term IDR at 'B'.
These downgrades are an indication of how outsiders assess the economy on certain objective economic indicators. However the Central Bank is of the view that these assessments are not correct and unwarranted. James McCormack, Head of Asia Sovereign ratings has commented that: "The revision to Sri Lanka's Outlook reflects heightened concern regarding the sovereign's external financial position in light of the marked decline in official foreign exchange reserves,"
There is a divergence in the assessment of the country’s external finances between Fitch and the Central Bank. According to Fitch as at end-December 2008, Sri Lankan official reserves were $1.75 billion, down sharply from a peak of $3.56 billion in July 2008. Fitch said it estimates Sri Lanka's current account deficit widened to $3.6 billion in 2008 (8.8% of GDP) from $1.5 billion in 2007, with most of the deterioration in the trade deficit, which grew to an estimated $4.4 billion from $2.4 billion. The trade deficit was in fact much higher at US$ 5.8 billion according to CBSL statements.
According to Fitch Sri Lanka's reserves at end December 2008, covered just 1.3 months of current external payments (including all debit items in the current account of the balance of payments), one of the lowest coverage ratios of any emerging market. The Central Bank has disputed this assessment vehemently calling the downward revision of Sri Lanka’s Outlook by Fitch Ratings as unwarranted. The Central Bank reaffirmed that the revision of the country’s both long-term and short- term default rating was not justified.
According to the Central Bank although it is true that reserves have declined, it is a reflection of the consequences of global financial crisis which resulted in a global liquidity crisis leading to the drying up credit lines. Besides it says that the Central Bank had to provide foreign exchange to meet the demand arising from withdrawal of foreign investment in government securities and payment of large petroleum bills. It contends that reserves had been built up by the Central Bank to face this type of contingency.
The Central Bank contends that the pessimistic view of Fitch Ratings is reflected in its assessment of the current account deficit of the BOP at 4.9% of GDP in 2009 which is considerably higher than the assessment of Sri Lankan Authorities (2..7%) as well as that of the Economic Intelligence Unit which is 2.1%. A significant decline in trade deficit is expected due to sharp decline in commodity prices, in particular petroleum. Therefore, a current account deficit of relatively small magnitude is estimated by the Central Bank and this is expected to be quite manageable with anticipated financial inflows, especially, the steady flow of remittances. In fact, the remittances during 2009 are expected to remain steady in view of the nature of the Sri Lankan migrant workforce and the steps taken by authorities to direct them through official channels.
There are three ways by which the Central Bank expects to overcome the depleted reserve position. First it expects the trade deficit this year to be much less than last year. We discussed this in this column last week and agree that it would be so, though we would still incur a deficit as export earnings too are likely to dip. Nevertheless, the trade deficit will be a lesser problem. The second expectation is that private remittances would remain high.
This too may be more or less realized, though one cannot be certain as lower incomes and lesser job opportunities may reduce such remittances. There is also the expectation that new incentive measures to increase NRFC deposits would bring in more money. This expectation may be optimistic as the gains may be quite modest.
The third strategy of the government is to woo friendly cash rich regional countries, China and India to invest in financial instruments at attractive rates of return. This is likely to succeed. The disadvantage in this strategy is that the borrowing may be at high interest rates and therefore the debt servicing costs could be high. Would our two friendly countries not exploit the situation and lend at concessionary terms without onerous conditions of repayment? Can they lend at terms similar to the IMF and World Bank without difficult conditions to fulfill?
The danger inherent in the current situation of low external reserves is that the government is likely to borrow on terms that could raise the country’s foreign debt and debt servicing costs. These are already high and an increase in them would be one of passing on the current problem to future governments and future generations. |
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