Forex quagmire
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It was one of those weeks where rapid developments meant a change in focus and strategy.
I had in mind the topic that I was about to focus on in this week’s column but a call on Thursday morning by my jolly-mood economist friend, Sammiya (short for Samson) set me thinking afresh.
“Hello machan, how are you,” asked Sammiya. “Fine, fine,” I replied, hoping this would be a short conversation so that I could go back to my planned topic-of-the-day column.
“Well… have you been following the foreign exchange crisis, the Central Bank response and the information that you had in the Business Times last week on this situation. It seems the crisis is building up,” he said.
“You may be right,” I said, with my mind wandering whether I should change the topic of the day (which was not a very exciting one) to write about the foreign exchange crisis.
“Sri Lanka has huge foreign debt payments to make this year and even though the Government says all debt payments will be honoured – as has been the case in the past and there has been no default – a major foreign exchange crisis will emerge by the end of 2021,” he said.
As we discussed the crisis with more information being exchanged, I realised that this was a bigger issue that needed to be discussed than my first choice of a topic. We ended the discussion hoping to meet socially in the future once the COVID-19 pandemic eases and when socialising is permitted.
Sri Lanka’s foreign exchange reserve position is precarious. Reserves had fallen to US$4 billion by end-May 2021 from $5.7 billion at end-2020 and $8 billion a few years ago. To add to the country’s woes, there is a bunching up of foreign debt payments in the 2-3 years which means that the foreign debt repayment will be $6.3 billion in 2021, $6.5 billion in 2022 and $5 billion in 2023.
In a desperate bid to shore up reserves and meet foreign debt obligations, the Government has been on a borrowing spree through loans and swap arrangements.
Central Bank Governor Prof. W.D. Lakshman, while appealing for calm this week amidst agitated currency markets, said that conditions of foreign currency liquidity observed in Sri Lanka’s domestic market at present are temporary and are driven by excessive speculative activity.
“We request these operators in the market to remain calm and not fuel undue speculation, which is not in the national interest, as the careful management of the situation without undue disruption, will result in a beneficial outcome to the country as a whole,” he said in a statement.
According to him inflows to the Central Bank include the SWAP facility of $250 million from the Bangladesh Bank expected in July 2021, the SAARC Finance SWAP facility from the Reserve Bank of India of $400 million expected in August 2021 and the special SWAP facility of $1 billion being negotiated with the Indian counterpart. In addition to this is also around $800 million under the IMF SDR allocation expected in August 2021.
The NDB Bank’s announcement this week that it was getting a $75 million facility from a US state developing financing institution would be a welcome addition to depleted foreign resources. Sri Lanka was also planning to obtain a loan of $150 million from the Asian Development Bank under a COVID-19 facility.
However, despite the Governor’s assertions of the forex crisis being temporary in nature, the Government announced several Cabinet decisions to tackle the issue.
The ban on non-essential imports (which has led to a lot of confusion in the marketplace) was extended for another six months from July 2021, local companies were permitted to raise foreign funds while stock market-listed companies would be encouraged to raise foreign funds and list shares in foreign currency while an option to borrow overseas is also available to local banks.
Bangladesh, once a country poorer than Sri Lanka, is also lending money to Sri Lanka after showing tremendous growth and flourishing foreign reserves largely due to its successful labour-intensive garments manufacturing and migrant workers’ remittance sectors.
As I continued penning my thoughts (in this case writing on the computer), I could hear the trio engaged in laughter and conversation under the margosa tree.
“Paarawal pirila den sancharana seema nethi nisa (The streets are crowded now that the travel restrictions have ended),” said Kussi Amma Sera.
“Godak denek ihala yana elavalu mila gena thama katha karanne. Aanduwen kiyanawa, haal mila pahalata genna avashyai kiyala (There is a lot of talk about the rising cost of vegetable prices. The government is also saying they want to bring down rice prices),” noted Serapina, wondering aloud how that would be done.
“Dan wath davase padiyata weda kana ayata weda patan ganna puluwan. Egollo hariyata duk vinda lockdown-eka hinda (At least now the daily wage workers can get back to work. They were suffering under the lockdown),” said Mabel Rasthiyadu.
The crux of the crisis is that the country is woefully short of foreign exchange largely because there is a mismatch between export earnings and import costs which are twice that of export earnings.
Furthermore, some exporters are holding onto their dollars even after converting the mandatory 25 percent of foreign earnings to local rupees, as they are able to get a higher interest rate on foreign currency earnings while they borrow local money at cheaper rates to pay wages and other fixed local costs.
Local banks have been told to manage their foreign currency requirements from within the market without seeking funds from Central Bank reserves putting further pressure on the US dollar. The increase in printing money was also said to lead to more consumption patterns which, in turn, result in more imports and a greater need for foreign exchange.
Some analysts argue that the Central Bank is not getting the dynamics right in the printing of new money (largely due to an increase in the Central Bank’s acquisition of government securities) vis-à-vis forex reserves. On the other hand with banks being told to find their own foreign funds to match their individual demand, they (banks) are seen only servicing their best customers’ foreign exchange requirement even after Letters of Credit (LCs) have been opened by other customers. An analyst labelled this practice as ‘rationing of LCs’.
Another problem is confusion as to what essential and non-essential means under the import ban. For example, tea exporters – a critical foreign exchange earner – are unable to import some raw material as it is perceived non-essential by the authorities, putting them in a difficult spot.
There are more and more calls for the Government to structure the foreign debt and phase it out to the ability-to-pay levels in the next three years, an option that the authorities have not used so far.
As I wound up my column, making use of a second mug of tea brought by Kussi Amma Sera, to relax, I was left with the reality that Sri Lanka’s foreign exchange problems are not going away in the short term.