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Rupee falls, recent VAT cuts likely to widen deficit in 2020

Sri Lankan rupee fell 0.22% to 181.25/35 per dollar on Monday, compared to Friday's close of 180.85/181.00, Refinitiv data showed. It is up 0.7% so far this year.

Meanwhile, foreign investors were net buyers of government securities on a net basis for the sixth straight week, purchasing a net 4.3 billion rupees worth of government securities in the week ended Nov. 27.

Total foreign outflows from government securities through Nov. 27 stood at 43.7 billion rupees, according to central bank data.

The government said on Wednesday it had decided to reduce value-added tax (VAT) to 8% from 15% from Dec. 1, and abolish some other taxes as well, in its attempt to boost economic growth that has fallen to a near two-decade low.

Emerging Asia Economics said in a note on Monday that the tax cut decision would provide a significant boost to the economy, but put increased strain on the country's fragile public finances.

“Unless Sri Lanka raises taxes elsewhere or cuts spending, the VAT cuts will lead to around $2 billion in lost revenue (around 2% of GDP) and the deficit is likely to widen to around 6.5% of GDP in 2020," it said.

“This is much larger than the 5.3% deficit target agreed with by the IMF (International Monetary Fund), who could withhold future loan payments unless the government reverses course."

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Central Bank Governor extols the new Monetary Law Act

The Governor of the Central Bank Dr. Indrajit Coomaraswamy says that the proposed Monetary Law Act, will strengthen stability in monetary policy.

Sri Lanka is in the process of introducing a new law governing central banking in the country in place of the current Monetary Law Act.

Amending this 70-year old law is a long-felt need, in order to update its provisions with regard to monetary policy formulation in line with international best practices, and also to introduce a strong macro-prudential policy framework aimed at preserving the stability of the financial system

Dr. Coomaraswamy stated that whenever the Government had fiscal indiscipline and was short of money, it forces the Central Bank to print money noting that effectively printing causes inflation.

He was of the view that the Central Bank should not be involved in print money and buy  treasury bills from the government in the primary auction.

He disclosed that the aim  of the proposed new monetary law act to provide provisions  that the Central Bank by law should be prevented from participating in the primary auction for treasury bills.

“The Central Bank should not print money. It should be prevented from printing money, and this would be a significant improvement in our monetary policy formulation," he emphasized.

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IMF approves disbursement of USD 164 million

The Executive Board of the International Monetary Fund (IMF) has stated that Sri Lanka’s economy is on the road to recovery after the Easter Sunday attacks and approved the disbursement of US$ 164 million as part of the Extended Fund Facility (EFF).

The Executive Board had met on Friday (1) and completed the Sixth Review of Sri Lanka’s economic performance under the programme supported by an extended arrangement under the EFF.

The completion of the Sixth Review, upon the granting of a waiver of non‑observance for the end‑June 2019 performance criterion on the primary balance, enables the disbursement of SDR 118.5 million (about US$ 164 million), bringing the total disbursements under the arrangement to SDR 952.23 million (about US$ 1.31 billion).

Sri Lanka’s extended arrangement was approved on 3 June 2016, in the amount of about SDR 1.1 billion (US$ 1.5 billion), or 185% of quota in the IMF at that time of approval of the arrangement. On 13 May 2019, the Executive Board approved an extension of the arrangement by one additional year, until 2 June 2020, with rephasing of remaining disbursements.

Following the Executive Board’s discussion of the review, Deputy Managing Director and Acting Chair of the Board Mitsuhiro Furusawa said that the Sri Lankan economy was gradually recovering from the impact of the Easter Sunday terrorist attacks.

He said that growth was projected to strengthen to 3.5% in 2020, from 2.7% in 2019, as tourist arrivals and related activities gradually recover.

“Sustained efforts to mobilise revenues will be needed in 2020 to place public debt on a downward path, while preserving space for critical social and investment spending. The new fiscal rule framework and the establishment of an independent public debt management agency over the medium term will help anchor public debt sustainability. Advancing SOE reforms in the electricity sector will also be critical to reduce fiscal risks,” he said.

He also said that the Central Bank of Sri Lanka should maintain a data-dependent monetary policy.

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Economists advocate upcoming government to shift fiscal policy

Several leading economists expressed their dismay on the statement made by a high ranking official of the Central Bank who stressed on the need to maintain the present fiscal policy by the new government which will come in to power next year.

In an interview with Reuters news agency, the Central Bank’s senior deputy Governor, Nandalal Weerasinghe warned that Sri Lanka could lose access to global debt markets if a new government shifts away from the country's current fiscal policy.

"How can Nandalal make such a prediction without knowing the global debt market behavior in 2020 and beyond?," an eminent economist who wished to remain anonymous asked adding that in an ever changing world the upcoming government would be able to change fiscal policies accordingly.

Policymakers should start paying more attention to what’s called structural fiscal policies, that is, changes in both public spending and tax collection to aid the expansion of the productive potential of economies, he said.

“First, cyclical weaknesses should have to be overcome. High government debt and limited fiscal space also call for a change of strategy," he said.

The fiscal efforts over the last decade have done little to address the structural impediments to growth and there has been a slowdown in productivity growth since 2015 under the present regime. he added.

The Central Bank's conduct of monetary policy was questionable during the last couple of decades, especially during the previous Rajapaksa regime under a set of senior officials like Ajith Cabraal, P Samarasiri, Dr. Nandalal Weerasinghe and Ananda Silva whose names were mentioned in the Presidential Commission which had examined the bond issue, another well respected economist said.

Third, inequality has been trending up in many countries, despite much progress in raising living standards across the developing world in the last few decades.

Given this background, one cannot help but wonder whether the statement of Dr. Nandalal Werasinghe is anything more than his arrogant behavior along with an attempt to boost his own image which is already tarnished after the bond scam.

His credibility had been challenged in a motion submitted to the Colombo Magistrate's Court several months ago which named the Senior Deputy Governor of the Central Bank, Dr. Nandalal Weerasinghe and the retired Deputy Governor Ananda Silva as suspects in the Central Bank bond scam.

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Sri Lanka's total debt increase by 71% due to Rajapaksa borrowings

Sri Lanka government’s total debt has increased by a staggering by 71 percent since the taking over of administration in 2015 from previous Rajapaksa regime, official statistics showed.

The present administration has to borrow money since 2016 to repay the massive loans taken by the previous regime, sources from the Treasury said.

The most significant borrowing in 2013 was the US $750 million obtained from international markets at the highest ever interest rate of 8.9 percent at a time when the global benchmark rate for that type of loan was  around 1.3 percent.

According to Finance Ministry data, public debt has increased to over Rs. 8000 billion in 2015 from Rs. 4000 billion in 2009.

While the government went on a borrowing spree on international capital markets, government revenue nose-dived.

In 2005, Sri Lanka's tax-to-GDP ratio was 13.7 percent. By 2014, it was 10.1 percent, one of the lowest in the world.

As a result, expenditure necessary for long-term growth in sectors such as health and education suffered. As a result, Sri Lanka needed to borrow more just to repay the loans of previous regime.

In 2014, interest payments amounted to Rs. 436 billion, approximately 24 percent of government expenditure.

Sri Lanka’s public debt has continued to escalate putting huge pressure on the Government budget as well, official sources said.

External debt in Sri Lanka averaged USD 45.88 billion from 2012 until 2019, reaching an all time high of USD 55.47 billion in the second quarter of 2019 and a record low of USD 37 billion in the fourth quarter of 2012.

To pay interest and principal obligations of the existing stock of foreign debt, Sri Lanka will need $ 5-6 billion in each of the next five years.

Loan repayments between 2019 and 2022 would be around USD 21 billion. The country’s foreign debt is estimated at USD 55 billion.

Sri Lanka’s public debt amounted to Rs. 12 trillion at the end of 2018 .The total debt was Rs. 12.6 trillion as of June 2019. Public debt is 83 percent of the economy (83% GDP)

As of the end of 2018, Rs. 6 trillion of Rs. 12 trillion or 50% of total debt was foreign debt. As of June 2019, Rs. 6.3 trillion of Rs. 12.6 trillion debt is foreign debt. As a result, foreign vs domestic debt is now 50/50.

Foreign debt declined from 37% of the GDP in 2009 to 30% in 2014. Since then, foreign debt-to-GDP ratio has increased by 11% percentage points to 41% as of the end of 2018.

The domestic debt-to-GDP ratio has declined from 50% of the GDP in 2009 to 42% in 2018.

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Foreign investment outflow retards even amidst current volatility

On a cumulative basis, net outflows in the government securities market amounted to US$ 96 million during the first half of the year.

Foreign investments in the CSE, including primary and secondary market transactions, recorded a net inflow of US dollars 10 million during the month of June 2019.

On a cumulative basis, the CSE recorded a net outflow of US$ 10 million in the first half of 2019, including primary and secondary market transactions.

Further, long term loans to the government recorded a net outflow of US$ 99 million during June 2019

Along with the proceeds of the International Sovereign Bond (ISB) of US$ 2 billion, issued in June 2019, the level of gross official reserves of the country increased to US$ 8.9 billion by end June 2019 (equivalent to 5.2 months of imports) from US$ 6.7 billion recorded at end May 2019.

Meanwhile, total foreign assets which consist of gross official reserves and foreign assets of the banking sector, were recorded at US$ 11.5 billion as at end June 2019, which was equivalent to 6.8 months of imports.

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Licensed banks to operate under stringent operational framework

Sri Lanka’s licensed banks are to be operated under more stringent legal and regulatory framework with the implementation of the new Banking Act, Central Bank Governor Dr.Indrajit Coomaraswamy told a media conference recently.     

The Central Bank (CB) is now reviewing the current Banking Act and several amendments will be made to strengthen the Act and one of those amendments is to empower the director of bank supervision of the CB to impose fines on banks for irregularities and malpractices, he disclosed.  

“At present, the Central Bank as the regulator has no way to impose fine on errant banks. It can only restrict their business in certain ways. We can restrict the role of board members etc. But we can’t impose fines so that is what would be introduced,” he said.

The key areas to be included into the proposed new Banking Act are an overall mandate for supervision and regulation, and a differentiated regulatory framework to facilitate proportionality, strengthening corporate governance, and consolidated supervision

A resolution framework, the capacity to impose monetary penalties/fines, ring-fencing of banks to mitigate contagion risk, strengthening provisions for mergers, acquisitions and consolidation of large foreign banks and holding company structure for banks will also be included in the new act.

Bank examination methodology will continue to be enhanced focusing on the efficiency, effectiveness and sustainability of individual banks and the banking sector.

A new supervisory rating model (The Bank Sustainability Rating Indicator-BSRI) is being developed by the Central Bank with a view to facilitating a risk based supervision framework to enable early intervention and prompt corrective action.

A regulatory framework on consolidated supervision will be formulated and provisions in this regard will also be brought into the Banking Act, official sources said.

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Sri Lanka's Market: An Investment Gem Hidden In Too Much Pessimism

Legendary billionaire investor George Soros famously observed that “the most money is made when things go from terribly awful to just awful.” Coincidentally, this is also the time when hardly anyone wants to invest.

Few markets in the region probably embody that adage more than Sri Lanka. Currently classified as an Asian frontier market in the same company as Vietnam, Pakistan, Bangladesh and Kazakhstan among others, the country's political instability grabbed the world's attention on Easter Sunday when suicide bombers attacked three churches and three tourist hotels. While media focus was and still is pessimistic, Sri Lanka is recovering and rebuilding. A great deal of hope is riding on the December 2019 elections and this could indeed be a turning point for the nation.

For investors, Sri Lanka offers a strong diversification benefit in the event that global market volatility increases. The correlation between U.S. equities and India indicate a strong positive correlation based on last five years of market data. Sri Lanka, on the other hand, has a negative correlation with both markets. The correlation between Sri Lanka stocks and India's Nifty 50 and the S&P 500 in the U.S. is negative 0.442 and negative 0.556, respectively, according to Bloomberg data.

Mark Mobius, the veteran investor who earned the moniker as the "father of emerging markets," believes the outlook for both Sri Lanka's bonds and equities, which currently have valuations at 10-year lows, will rise as the political situation improves.

The CSE (Colombo Stock Exchange) is currently trading at 8.3 times earnings and the Sri Lanka Investable Universe of 305 stocks BF (blended forward) is 7.3 times earnings. By comparison, India's stock market is at 27.9 times earnings.

Against this backdrop, there are opportunities for value investing. Colombo's ASPI (All Share Price Index) is trading at 8.3 times current year earnings, a 10% discount to the last 3-year average, and at a 32% discount to the MSCI Frontier Markets Index.

The Central Bank of Sri Lanka on May 31 cut its benchmark interest rate for the first time in more than a year to support the flagging economy, which grew at 3.2% in 2018 amid a protracted political leadership crisis. Then came the terrorist attacks, which killed more than 250 people. As a direct impact of the Easter Sunday tragedy earnings from tourism in May have plunged by –70.8% to $71 million from $243 million a year earlier, according to the Sri Lanka Tourism Office. The tourism industry accounts for 5% of Sri Lanka’s $87 billion economy.

Sri Lanka has been struggling to revive economic growth following a three-decade long civil conflict that ended in 2009 and ongoing political turmoil. Tourism arrivals have increased more than fivefold since the war ended and revenue from the industry is near a record. In order to promote tourism, Sri Lanka will soon offer free visa travel to Indian passport holders beginning August 1. Indians are the largest group of travelers to the country, followed by China, which also included in the visa free policy.

While India's finance minister has ruled out reconsidering a plan to issue foreign currency overseas sovereign bonds, Sri Lanka is marketing dollar-denominated bonds in overseas markets for the second time since March. The country's 7.55% coupon sovereign issue of $1.5 billion was 4 times oversubscribed as the search for yield pushed investors out further out on the risk curve. Dulindra Fernando, the manager of the Ceylon Dollar Bond Fund stated that U.S. dollar returns on Sri Lanka's sovereign debt fund had reached 8.56% during the first six months of this year alone.

The country's borrowers are finding a window for issuance after the Federal Reserve cut interest rates, and the European Central Bank has said that extra monetary stimulus might be needed. And that's because bonds that trade with negative yields have reached $14 trillion, which is equivalent to 25% of the global bond market, according to Deutsche Bank research.

Sri Lanka with its country rating of B has been deemed "speculative" by the rating agencies. Historically, Sri Lanka has traded above both Pakistan and Mongolia in sovereign credit spreads, but this year due to excessive pessimism Sri Lanka is now below both nations in credit quality. As Sri Lank's political stability improves with the new election, we should expect to see its credit spreads narrow.

Since 2014, South Asia has been the fastest growing subregion in the world, with its eight economies collectively boasting average annual growth of 7%. This is even higher than East Asia's 6.2%. But Sri Lanka is still overlooked and under-researched by global investors, which means it might be an attractive opportunity for a limited time.

reiner michael
Rainer Michael Preiss is a portfolio strategist based in Singapore, covering global macro, geopolitics, frontier and emerging markets as well as Blockchain and emerging Tech.

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World Bank calls on Sri Lanka to invest more in human capital

The World Bank called on Sri Lanka to invest in human capital in preparing for new emerging world and gain success in today’s rapidly evolving knowledge economy.

Idah Z. Pswarayi-Riddihough, World Bank County Director for Nepal, Sri Lanka and Maldives when she unveiled the new Sri Lanka Human Capital Development report in Colombo  

She noted that investing in the human capital is going to be the most important decision a country can make to secure its future.

Developing its human capital to a new and higher level will be key for Sri Lanka to become the upper-middle-income economy it seeks to be.

Central Bank looks forward to continuing our work with the Government to realize the country’s full promise and potential, she assured.

“Technology and automation are radically changing the very nature of work and reshaping industry, “she said.

“Children in primary school today are likely to work in jobs that may not even exist right now. Developing its human capital to a new and higher level will be key for Sri Lanka to become an upper-middle-income economy,” she added.

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CSE records a new high in July despite terror attacks

Sri Lankan shares are set to open up next week afresh after ending a record-breaking month of July, stock market analysts said. The improvement of the external sector performance, local exports, lower interest rates and decrease of imports created some positive investment sentiment, they pointed out.

The retail market participation in stock trading has been improved significantly during the month of July, analysts said. Sri Lanka’s All Share Price Index (ASPI) has increased by 620 points for the month of July 2019 taking the ASPI from 5372.28 points to just under 6,000 points, closing on a 6 month high.

Finance Minister Mangala Samaraweera said that growth during this period amounted to 11.6% outperforming all major global stock indices.

stock market

Sri Lanka’s S&P20 Index has performed particularly well during this period growing 22% in the month, taking the index from 2,450 points to 3,051 points.

The market has responded to the improvement in macroeconomic stability as inflation declined to 2.1% in June, interest rates (1 year TB) declined by over 250 basis points this year.

Tourism and consumption is recovering quickly after Easter Sunday attacks, and the Rupee has appreciated 3.7% this year as the trade deficit has declined rapidly. The return of the EPF to the equity market, under prudent governance structures, is another boost to the equity market, stock market analysts said.

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2018 coup and Easter attacks significantly impact fiscal performance: IMF

The International Monetary Fund (IMF) says sustaining prudent policies and implementing institutional reforms remain critical to preserving macroeconomic stability, given the weak global outlook and Sri Lanka’s sizable public debt.

The protracted impact of the 2018 political crisis and the Easter attacks are significantly impacting fiscal performance, the IMF claimed.

The end-June fiscal target was missed by a large margin, due to frontloading of spending from the clearing of arrears and externally-financed capital projects carried over from 2018 as well as a sharp fall in indirect revenues following the terrorist attacks.

A staff team from the IMF led by Manuela Goretti visited Colombo during September 10-25, 2019 to conduct the sixth review and the team had reached understandings at the staff level with the Sri Lankan authorities.

The team reached understandings at the staff level with the Sri Lankan authorities on the sixth review of the EFF-supported program.

The team praised the authorities’ efforts to normalize the security situation in the country after the tragic terrorist attacks in April and mitigate the impact of the shock on the economy.

The new Central Bank Act will be a landmark reform in the roadmap towards flexible inflation targeting by strengthening the CBSL’s mandate, governance, accountability, and transparency, in line with international best practice, the IMF said.

The mission welcomed the authorities’ commitment to advance revenue-based fiscal consolidation in 2020 and over the medium term to preserve the gains achieved under the program.

It has put the high public debt on a downward path, and provide space for better-targeted social and capital spending.

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CBSL to crack down on errant money changers

Sri Lanka’s authorised money changers numbering around 65 in Colombo and suburbs have come under Central Bank scrutiny following allegations that they are siphoning off vast amounts of foreign currency.

Authorised dealers are required to hand over the foreign currency they buy to the Central Bank and obtain proceeds in Sri Lankan Rupees.

As part of the investigations, Central Bank officials in disguise are visiting authorised money changers to check whether they are involved in illegal transactions.

These investigations followed complaints that authorised money changers who were only allowed to buy foreign currency and deposit it with the Central Bank were involved in major rackets and financial misappropriations.

Under existing laws authorised money changers should deposit a minimum of US dollars 1.5 million a year with the Central Bank.

A senior treasury official said it had been revealed that the foreign exchange brought into the country was not being fully contributed to the national reserve as part of the money was smuggled out of the country.

Therefore, the Central Bank will take stern action against unauthorised money changers and errant foreign exchange dealers.

However, Authorised Money Changers Association claimed that they were finding it difficult to continue with the business as there were several unauthorised money changers and no action was being taken against them.

He said there were only 65 authorised money changers, but there were a large number who were operating without a licence.

He denied allegations that the authorised money changers were involved in large scale foreign currency rackets.

The Central Bank annually receives more than Rs. 7 billion from money changers.

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