20% devaluation or IMF bailout

Economists sound warning as reserves plummet to lowest level, but CB confident
By Feizal Samath

Sri Lankan economists say devaluation or a bailout package from the IMF is inevitable to head off a foreign exchange crisis where reserves have fallen to little more than six weeks of imports but the Central Bank (CB) is adamant that it has its own strategies to tackle the situation.

The current reserves position is similar to 1975-76 during the controlled economy of the Sirima Bandaranaike regime, when however there weren’t much imports, according to a retired World Bank economist. Japan is also cutting aid globally to most countries, including Sri Lanka, another economist said.

Asked about the concerns and possible IMF support, CB Governor Ajith Nivard Cabraal said there was no cause for alarm and thus the need for IMF support did not arise.

“The situation is under control. We expect to close 2008 with foreign reserves worth $2.5 billion equivalent to around 2.2 months of imports. We are also hoping to raise upto $500 million from the Sri Lankan diaspora through investment in bonds and treasury bills in a campaign that will start (across the world) on February 4 (when Sri Lanka’s independence is celebrated),” he told The Sunday Times, which sought his reponse to the call by economists for either devaluation or an IMF package to head off a possible foreign cash flow situation.

According to the CB’s November data, gross official reserves by end November 2008 were sufficient to finance around 1.7 months of imports.

Economists say the situation is critical. At a discussion chaired by President Mahinda Rajapaksa this week on economic issues, some respected economists made a presentation and argued that the way out of a foreign exchange crisis was to devalue the rupee. They explained the reasons for this strategy – as anything else is not possible -- saying while it could trigger mild inflation, it was unavoidable but on the long term, beneficial.

However Mr Cabraal, The Sunday Times reliably understands, had opposed this move, which could have an impact on elections this year.

Economists and exporters say the rupee should be depreciated to about Rs 128-130 in relations to a US dollar. It is now around Rs 114, after a marginal float of the rupee some weeks back by the CB.
Mr Cabraal told The Sunday Times that everyone talks of devaluation as the only means to raise export earnings but there were other ways, pointing to a export stimulus package announced by the government last month in addition to cutting interest rates by two percent this week.

“We have put in place an overall package for exporters and in addition to this oil prices are low while power costs will come down. It’s a total package. We have depreciated the rupee against the US dollar to Rs 114 and that’s good enough,” he observed.

But a top Colombo economist, who declined to be named, said foreign reserves of around 1.5 months worth of imports was precarious and immediate solutions needed to be found. “Any level below two months is worrying while three months is the acceptable level,” he said, adding that even if tea prices rise and oil prices continue at low levels, petrol bills have to be paid (at least $2 billion a year) while the CB will be compelled to eat into the depleted foreign resources to defend the rupee in the money markets.

Most economists contend that the government is left with few options – either devalue by 20%, seek an IMF package or enforce import controls similar to the 1970-77 era.

Dr Anura Ekanayake, an economist and Vice Chairman of the Ceylon Chamber of Commerce, agrees there is a balance of payments crisis looming. “If the (migrant) remittances fall and commercial sources of borrowing dry up -- which is very likely due to the global credit crunch and poor ratings of Sri Lanka -- then we would be in some trouble,” he said, speaking in a personal capacity and not as a chamber official.

He said in the short term, a bail-out package from the IMF may be required if and only if ‘we cannot get our act right’, adding that the budget deficit needs to be reduced by increasing tax collection, not by raising taxes.

Dr Muttukrishna Sarvananthan, Principal Researcher of the Point Pedro Institute of Development and currently Fulbright Visiting Research Scholar in the US, said the overall balance-of-payments was negative, which the CB was hiding from the public by not disclosing the (correct) figure.

Compounding these, Sri Lanka’s largest single donor, Japan, is cutting down on aid after a long time, primarily due to bad economic policies pursued by the present government and partly also due to human rights abuses, he said.

Dr Sarvananthan noted that though this fact is still not official, this is reflected by the merger of JICA (Japanese International Cooperation Agency) and JBIC (Japanese Bank for International Cooperation) operations in Sri Lanka, thereby scaling down operations of both.

He however feels a depreciation of the rupee at this moment is too little too late while drastic restrictions on imports would be devastating because it would fuel inflation, which has been declining in the latter half of 2008.

“Perhaps the only low cost option available is to seek IMF assistance but will the government bite the bullet is the moot question at the moment” He said economists have been warning the government about the impending crisis for long, to no avail.

The last time Sri Lanka got an IMF standby credit facility was in 2001 which was required to buy costly military equipment after the Elephant Pass military camp was taken over by the LTTE, and due to high oil prices. Last week Elephant Pass was re-captured by government troops.

Under that IMF facility, Sri Lanka got $150 million in the first tranche and was planning on going up to $450 million when the programme fell through. The IMF closed its Colombo office in 2006 saying there was no funding programme here.

The retired World Bank economist also says the only option left for Sri Lanka is to return to Article 4 consultations (budgetary support) with the IMF. “I may not agree with everything they say but they have the money which we need,” he said adding that an IMF programme will also give some confidence to foreign investors. A university economist said that if commodity prices rose and oil prices went over $75 then there would be a serious foreign exchange problem, though he felt the situation right now was not critical.

“In such a case we may need to get a bailout package from IMF and this would be best for the country though the government is unlikely to opt for one as it would not want to comply with the attached conditions especially with respect to fiscal discipline,” he said.

Sociologist Siri Hettige from the University of Colombo says the growing concern over rights and democracy in Sri Lanka would be exacerbated by the economic crisis if tea incomes and remittances fell, and jobs were lost.

“We have not paid much attention to the looming economic crisis. Tea farmers will be up in arms. If you can’t finance your imports, we may be compelled to seek IMF assistance,” he said, reflecting a public, non-economic viewpoint.

Sarvodaya founder A.T. Ariyaratne said he reckoned Sri Lanka was facing one its worst crises since the political situation would be aggravated by the economic crisis.

Millions of dollars from Lankans across the seas

A mega campaign across the world to attract Sri Lanka’s diaspora of more than one million to invest in treasury bills and bonds will get underway on February 4.

The promotion will be led by messages from President Mahinda Rajapaksa and Central Bank (CB) Governor Ajith Nivard Cabraal – plus promo ‘jingles’ from Sunil Perera, one of the country’s best-known musicians with a wide following amongst Sri Lanka expatriates.

The campaign to raise upto $500 million this year will be launched in North America, Europe, Asia and West Asia. It will be led by CB Deputy Governors, Asst’ Governors and other CB officials along with the six lead banks in roadshows across the world with the initial phase in February.

“The general assessment from our envoys is that with interest rates falling and a patriotic feeling amongst our people, there is a lot of interest to invest. The Tamil diaspora also wants to invest in the north and east,” Mr Cabraal said.

The campaign will take teams to the US and Canada; Qatar & Dubai among others in West Asia; Italy, Germany, Switzerland, Norway, Netherlands and the UK in Europe; Singapore, Malaysia, Korea and Japan in Asia; and Australia and New Zealand.

It’s the government’s biggest campaign ever to seek the support of Sri Lanka’s diaspora in the country’s development.

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