In the above article, your columnist claims that the CBSL assessment on Sri Lanka’s external financial position and the fiscal consolidation in response to Moody’s report, has ‘weaknesses’. In that regard, we wish to respond as follows: (a) The article claims that the recent experiences point to the continued depreciation of the Sri Lanka rupee, [...]


Central Bank rejects dismal picture of the economy

The Central Bank has reacted to last week's economic perspective article by our economics analyst Dr. Nimal Sandaratne. The article was headlined 'External Finance and Fiscal Consolidation: What is the real position?'

In the above article, your columnist claims that the CBSL assessment on Sri Lanka’s external financial position and the fiscal consolidation in response to Moody’s report, has ‘weaknesses’. In that regard, we wish to respond as follows:

(a) The article claims that the recent experiences point to the continued depreciation of the Sri Lanka rupee, poor performance of the stock market, and outflows of funds from the securities market, as factors that reflect ‘perceived weakness’ of the country’s financial position.

It is grossly misleading to highlight the effects of a blip in international financial markets and thereby portray a dismal picture on the performance of the stock market and the government securities market. In this regard, it needs to be clearly understood that an outflow of funds from the securities market that would warrant a claim to the effect that the financial position of Sri Lanka is perceived to be weak did not take place.

As is well known, the developments that occurred in global financial markets recently was due to the announcement by the Chairman of the Federal Reserve of United States (Fed) of possible tapering off of the quantitative easing programme. That statement resulted in some outflow of funds in many emerging markets across the globe. At the same time, the depreciation of the Sri Lankan rupee was due to a somewhat temporary greater-than-expected import demand, rather than a forex demand created by fund outflows. That was also because the effect on Sri Lanka of this Fed move was marginal, as the government securities market continued to record a net foreign inflow position.

In any event, if, as your columnist claimed, the daily performance of the stock market is the indicator of the perception of the financial position of the country, your columnist may now have serious difficulty in explaining as to how the Bourse has risen to a 3-week high with larger foreign investments by 23 July 2013, just three days after his claim on the poor performance of the stock market!

(b) The second claim that your columnist made is that the external reserve position does not take into account the liabilities, especially the debt service payments due in the coming months. Your columnist further claimed that once the debt service payments are taken into account, the reserve position will decline to USD 4.5 billion, which is adequate for about 2.6 months of imports only. A related claim that he made is that the reserves in terms of the number of months of imports is an unsatisfactory measure, as the economy is dependent on capital flows and there are short term contingent liabilities.

It has to be said that these claims indicate that the columnist who was previously a Director of the Economic Research Department of the Central Bank, has now forgotten as to how reserves are calculated, and how their adequacy is measured. It is true that the external reserve position does not take into account, liabilities such as debt service payments, because external reserves are an asset of the Central Bank and the debt service payments are liabilities of the government. But, the claim that the reserve position would drop after adjusting for debt service payments is an amateurish view, since it neglects to consider the regular inflows to the CBSL reserve during the course of the year.

On the reserve adequacy measures, the import cover of international reserves is a well-established norm, in contrast to your columnist’s claim that it is ‘unsatisfactory’. Further, as is well known, capital flows have a maturity profile, ranging from short-term to medium- and long-term. In this context, it will be noted that the major part of the current foreign holdings of government securities is over 1 year with some securities having maturity ranges up to 20 years as well, reflecting the increased investor appetite for long-term investments in Sri Lanka. Further, the threshold imposed on foreign investments in government securities as a prudential measure also helps to lessen any vulnerability against volatile capital flows.

(c) The next claim your columnist makes is on foreign debt, which has been suggested as being on an increasing trend, as at end 2012. It is quite natural for foreign debt levels to rise and for the economy to experience an external current account deficit, when the savings-investment gap has to be financed through foreign sources, either from debt capital or non-debt creating capital flows. However, if the composition of the Financial Account of the Balance of Payments, is carefully assessed, it would be seen that the private sector participation seems to be gaining in terms of financing the external resources gap in Sri Lanka today. Further, as Sri Lanka’s financial markets continue to develop, the use of financial derivatives and debt securities continue to play an increasing role in mobilizing funds, thus moving away from traditional borrowing practices.

Moreover, the enhancement of investor confidence and conducive business environment that has been created in the post-conflict economy has also resulted in a significant growth in foreign direct investment, and, at the same time, it has paved the way for many corporates to raise funds abroad on the merit of their own creditworthiness. In this backdrop, claiming that vulnerabilities are building up, just on the basis of increasing foreign borrowing in aggregate terms, without carefully assessing the composition of such borrowing is clearly simplistic. In this regard, it is also advisable to assess the trend of foreign debt as a percentage of GDP over the past 30 years or so, which exercise, if your columnist has done, he could have realized the relatively sharp deceleration of foreign debt accumulation over the years, from the peak of 62 per cent in 1989 to 36.5 per cent in 2012.

(d) Your columnist claimed that the targets for public finances have not been met and the fiscal deficit is underestimated by some ‘creative accounting’.

In this regard, it must be reiterated that the fiscal policy strategy of the government has been focused towards reducing the budget deficit and debt to GDP ratios. Accordingly, the budget deficit as a per cent of GDP has continuously declined, recording 9.9 per cent in 2009, 8.0 per cent in 2010, and 6.9 per cent in 2011. The budget deficit for 2012 was expected to be reduced to 6.2 per cent of GDP, but, the achievement of such fiscal target in 2012 became challenging due to a combination of factors, including the shortfall of government revenue due to the tight policy measures adopted to strengthen external stability, and increased interest expenditure resulting from comparatively high interest rates. Even, in this challenging environment, the government realized a budget deficit at 6.4 per cent of GDP in 2012. In this regard, your columnist should also be reminded that when he served as the Director of the Economic Research Department of the Central Bank, in 1987, the GDP growth rate was only 1.5 per cent, inflation was over 10 per cent, reserves were a mere three months of imports, and the budget deficit was over 10 per cent of GDP, and the Sri Lanka rupee depreciated by nearly 5 per cent! Be that it may, he must surely be pleased today that all those macro-economic fundamentals are performing at a much better level now, even while a tremendous transformation is taking place in the Sri Lankan economy!

It is also very disappointing to note your columnist’s claim that the fiscal deficit is underestimated by some ‘creative accounting’. Such an allegation is completely groundless, since in Sri Lanka, fiscal sector statistics are compiled according to the Government Financial Statistics 1986 Manual (GFSM 1986), as recommended by the International Monetary Fund (IMF) for its member countries. According to the GFSM 1986, the operational balances of public enterprises are not required to be included in compiling the budget deficit under the central government concept, as mentioned in the article. Therefore, these losses cannot be considered as direct liabilities of the central government as government has not transferred funds to these institutions against these losses. Hence, claiming the budget deficit is underestimated is incorrect.

Your columnist must also be advised that despite a marginal increase of the budget deficit during the first four months of this year to 3.9 per cent of GDP, compared to 3.8 per cent of GDP in the corresponding period in 2012, government revenue is expected to increase during the second half owing to continuous improvement in income taxation, full impact of VAT coverage extension to retail trade, gradual recovery from the impact of adjustment measures, improvement in banking liquidity and lower interest rates. In that background, it is very likely that the government will be able to achieve the fiscal targets for 2013.

(e) The other claim your columnist made is that the trade balance is large and it is extremely unhealthy and a threat to external financial stability. He also asserted that even if the workers’ remittances and earnings from tourism offset much of trade deficit, debt service payments would dip into external reserves of the country during the course of the year.

In this connection, your columnist may perhaps like to refer to a previous prediction he made on 13 May 2012 in your newspaper, where he stated: “The inadequate performance of exports in a context when imports are growing means that the trade gap (in 2012) would increase substantially. If this trend in exports continues, while imports continue at the current pace, then the trade gap this year would exceed the US$10 billion record of last year. It is likely to be in the region of US$ 11 to 12 billion. This is a magnitude that is unlikely to be bridged with capital inflows.”

Subsequent events have made if abundantly clear that his doomsday prediction have not materialized, and while it is noted that he himself has now revised the trade deficit forecasts downward for this year, his past claims confirm that any writer can publish comments on Sri Lankan economy which ultimately turn out to be wild guesses and comments that are based on unrealistic assumptions. In a similar vein, the ‘real position’ that your columnist attempts to portray now in his recent news article, is likely to be way off target, because of the fragility of his assumptions.

Our Economic Analyst Nimal Sandaratne in response to the Central Bank’s lengthy reply says that in the interests of the country he hopes the optimistic scenario of the CBSL would prevail.

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