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With the exchange rate policy currently pursued by the Central Bank heavily criticised by the Treasury and being a major bone of contention with the International Monetary Fund (IMF) which is monitoring the economy under a US$ 2.6 billion standby facility arrangement, the bank’s governor Ajith Nivard Cabraal has said Sri Lanka no longer needed to continue in the programme.
Cabraal says Sri Lanka has a comfortable dollar reserves position therefore the additional US$ 800 million from the IMF as the last tranche would be unnecessary. He also points that drawing this tranche would increase the interest rate from 1.1 percent to 3 percent, but this fact was already known when the agreements were signed in 2009. Also, the government had consistently said it was keen to complete the programme because it would give the economy a degree of credibility in an era where attracting foreign investment was crucial.
Last September, the IMF did not complete its review mission and the disbursement of the last tranche was delayed by the IMF because it was critical of the Central Bank’s policy of defending the exchange rate by selling dollars from the reserves. Not only was the reserve position, with a heavy debt component, eroding but export competitiveness was taking a hit as other regional economies devalued their currencies.
As earlier reported in these pages, despite severe import demand, the Central Bank has continued to keep the exchange rate stable by selling millions of dollars on a daily basis and the Treasury is exerting pressure on the bank to allow a degree of flexibility. But the Central Bank has refused to budge.
US$ 1.56 billion was used up from the reserves to artificially prop up the rupee during the four month period July to October 2011. According to dealers, a further US$ 1 billion has been sold to-date since the rupee was depreciated by 3 percent in November 21.
According to our calculations, for the past one and a half months, the Central Bank has pumped in a total of almost Rs. 300 billion to ease the rupee liquidity tightening which was caused by the dollar sales. The drain on rupee liquidity has resulted in some banks finding it difficult to maintain favourable overnight balances.
By end November 2011 reserves stood at US$ 6.2 billion, down 30.6 percent from US$ 8.1 billion in July, with the borrowed component now becoming more significant as the reserves diminish, shrinking the comfort zone.
As reported last week, a special economic report prepared for the government last year said Sri Lanka ought to manage its economy so as to avoid seeking IMF assistance in future. But by continuing to defend the exchange rate, Sri Lanka is risking a balance of payments crisis, unless the desired inflows materialised.
"The Central Bank is now trying to save face by saying it would not be necessary to continue with the IMF programme, well knowing that the IMF was unlikely to budge on the exchange rate issue. Remember, the bank’s Governor Ajith Nivard Cabraal did admit there was pressure on the balance of payments and that expected foreign currency inflows would help ease these pressures, so these inflows are yet to materialise, and until they do we are not out of the woods," a money market dealer told The Island Financial Review.
"That we would have to pay the IMF an additional 2 percent interest on the US$ 2.6 billion standby facility arrangement, increasing from 1.1 percent to 3.1 percent, is a lame excuse for not wanting to continue with the programme. It was he who said that negotiations were ongoing for a follow-up surveillance programme once the current programme was over, and the interest rate on these what? Also, the government has borrowed at more than 6 percent from international markets, so clearly the Central Bank is trying to save face over its exchange rate stance," another dealer said.
Speaking to our sister paper Divaina Cabraal said: "According to the Letter of Intent that was signed with the IMF by the Government and the Central Bank in July 2009, the objective of the Standby Facility Arrangement (SBA) was to cushion the impact of the global financials crisis on the Sri Lankan economy, and in particular, its adverse effects on the most vulnerable in the society. The SBA was also intended to help Sri Lanka to bring down inflation and place the country on a strong path of economic growth. Further, the programme envisaged the rebuilding of the country’s external reserves to about US$ 3.5 billion (or the equivalent to 3.5 months of imports), and the strengthening of the fiscal position. In addition, the programme contemplated the strengthening of the domestic financial system and the maintenances of monetary stability."
"Today, if one were to take a close look at the Sri Lanka economy, it is very clear that the broad objectives of the IMF programme have been achieved, and those achievements must surely be seen as a credit to both the IMF and the Sri Lankan authorities. Overall, the programme can also be said to have helped the establishment of a sound platform for the future growth momentum and stability of the Sri Lanka economy in the face of the global turmoil.
"With regard to the disbursements, it will be seen that Sri Lanka was originally working towards raising a sum of US$ 1.9 billion from the IMF in order to buttress its reserves to meet the external shocks due to the global financial crisis. So far, under the SBA programme, Sri Lanka has received disbursements amounting to US$ 1.7 billion, and also another US$ 0.5ibillion as an additional SDR, allocation.
"On that basis a sum of over US$ 2.2 billion has been received up to now, which is substantially higher than the original sum that was ear-marked. In the view of the Sri Lankan authorities, this sum of US$ 2.2 billion will adequately cover the country’s requirements and hence there may not be a need for further funds. Further, as of now, the interest applicable on the SBA outstanding amount of US$ 1.7 billion is very reasonable at around 1.1 per cent per annum. However, if further tranches were to be obtained under the current IMF SBA, the entire loan will attract as interest rate of an additional 2 per cent, which will make the loan a lot more expensive. Naturally, all these matters will be given careful consideration by the Sri Lankan authorities, in its decision as to whether or not further tranches are to be requested," Cabraal said.
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