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US interest rate hike will affect Lanka’s economy
View(s):The United States Federal Reserve’s decision to raise interest rates by 0.25 percent on the US dollar, the currency the Sri Lankan rupee is linked to, will have a ripple effect on Sri Lanka’s economy, experts warned yesterday. “What was speculated for many months has happened now and we could see an outflow of foreign funds,” noted W.A. Wijewardena, economist and former Central Bank (CB) Deputy Governor.
The US Federal Reserve on Wednesday raised interest rates by 0.25 percent, the first ever rise in more than nine years, impacting markets and economies across the world. By keeping its interest rates low and unchanged, most US investors have been putting their money in high interest, emerging markets including Sri Lanka.
In recent months, however with speculation, that US rates would rise, US investors have been gradually pulling out funds from countries like Sri Lanka. According to official data, foreign investments in Sri Lankan treasury bills and bonds fell to Rs. 275 billion in October this year from Rs. 475 billion in January 2014. “This would further decrease with the anticipation that US interest rates would further rise,” another top economist, who declined to be named, said.
The local impact and implications from the US Federal Reserve’s move are likely to lead to pressure on the authorities to increase interest rates and thereby reduce consumption-led imports; seek an International Monetary Fund (IMF) stand-by facility or Indian or Chinese financial support; slowdown spending on education and health and put pressure on depreciating the rupee further to reduce import demand among other issues.
Populist measures in the budget and reversing some of the tough measures in the budget, as listed in many other stories in the Sunday Times and the Business Times, would further exacerbate the economy which is grappling with fiscal slippages, dropping tax revenues and rising expenditure. The rupee, currently at Rs. 140 per 1 dollar level, could also rise.
Economists, for several months, have warned of an overheated economy amidst dangerously low foreign reserves. Mr. Wijewardena has repeatedly stated in public forums that according to the CB’s own timetable, repayments on loans and other factors would amount to US$ 4.4 billion in the next 12 months. This would further deplete reserves currently at US$ 6.4 billion. “As we have repeatedly said, Sri Lanka has no option other than going to the IMF,” he said, a view shared by many economists.
However that may not be as simple as it was a few months ago before the budget. In a post-budget statement, the IMF raised serious concerns over the budget and its post-budget populist measures, prompting the Government to frown on IMF criticism as interference in local economic affairs. Economists say ironically it was the now-ruling UNP, when in opposition, that had raised alarm bells over the economy and asked why international agencies like the IMF were not questioning the government’s economic fundamentals.
“It won’t be easy to negotiate with the IMF because the fund will want to ‘put the house in order’ and reduce the populist measures. It is time for the economy to cool down and time to bite the bullet with unpleasant measures. But is the Government up to it,” asked a financial expert.
He said with local council elections likely in the first half next year, the Government is unlikely to accept politically-suicidal conditions for an IMF standby credit facility and may opt for loan support from India (extension of a rupee swap facility of $1 billion) and China (like what the former government relied on). A slowdown in health and education spending is also likely to overcome a growing fiscal deficit.
Exporters to the US say the US interest rate hike is unlikely to affect their competitiveness. “If at all there is an impact, it would be a few thousands of dollars in loan repayments. However if the rate hike increases to the 1 percent and over level then it could create problems,” one garment exporter said adding that there were bigger issues in Sri Lanka with the US developments.
Murtaza Jafferjee, Managing Director/CEO of JB Securities, said the stock market would not be affected in the short term as investors had factored in these expected changes in US interest rates. “We have to wait and see whether interest rates will rise substantially, in which case there could be an impact,” he said.
He pointed out that credit growth in consumer durables (including imports) could slow down next year with the Government restarting infrastructure projects. The Government is seeking Rs. 100 billion from the financial markets over the next three years to fund roads and highways and this could see banks putting a greater emphasis on this sector than consumer lending.