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Sri Lanka’s debt poses near-term risks, state-owned enterprise borrowing could deepen crisis: IMF report

ECONOMYNEXT – Sri Lanka’s public debt is unsustainable under possible fiscal improvements and contingent liabilities from state-owned enterprises could add to the burden the International Monetary Fund has reduced as money printed to maintain Low interest rates created currency shortages.

If money printing continues, Sri Lanka could default in the near term, the IMF warned in a report released after the annual Article IV consultations, as well as an economic shock. The Sri Lankan authorities had pinned their hopes on foreign flows.

The D-word

“Unless fiscal and balance of payments financing needs are met, the country could experience significant contractions in imports and private credit growth, or monetary instability if additional financing of fiscal deficits by the central bank (printing money),” reports the IMF. warned.

“If unidentified external financing is not available, the country could experience a disorderly adjustment through a sharp compression of imports and potentially short-term external arrears.

Sri Lanka has a soft peg or flexible exchange with conflicting domestic and external pegs that create periodic balance of payments crises, but this time the problem has been complicated by a sharp rise in international sovereign bonds in recent years. years.

Sovereign bonds and the dollar debt of state-owned Ceylon Petroleum Corporation rose as money was printed in 2015, 2016 and 2018, triggering currency shortages that were met by borrowing, despite increases taxes and a fuel pricing formula in 2018.

Analysts had warned that the country had been following an unanchored monetary policy for several years under a discretionary “flexible inflation targeting regime” that allowed the central bank to print money and create currency crises at will, including during an IMF program in 2018.

In 2019, tax increases were canceled (state salaries were increased in 2015).

Failure of Treasury bill auctions

As of 2020, money printing increased and the redemption of printed money against reserves to maintain a pegged exchange rate depleted reserves using price controls in auctions. Unsold bonds were purchased by the central bank with printed money.

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“Authorities temporarily imposed hard caps on interest rates at Treasury auctions, which led to large auction shortfalls and primary purchases of Treasury bills by the CBSL,” the official said. IMF.

“To help finance the government, CBSL provided 3.5% of GDP in direct financing in 2020 and about 5% of GDP in the first 3 quarters of 2021.”

Sri Lanka’s gross financing needs were high, with market access interrupted by downgrades and high and impossible with just a reduction in the fiscal deficit, indicating debt restructuring.

“Based on staff analysis, the fiscal consolidation needed to bring debt down to safe levels would require excessive adjustment over the next few years, indicating a clear solvency problem,” the report said.

The raw financialability index was 23.8, which was high.

“The staff believe that Sri Lanka’s public debt is unsustainable. If left unaddressed, persistent deficits in fiscal financing and the BoP (balance of payments) will limit growth and jeopardize macroeconomic stability in the short to medium term.

The government’s gross public debt was estimated at 118.9% of gross domestic product at the end of 2021 and gross financing needs were 30.1% of GDP. But it could reach more than 50% depending on the short-term risks.

Public enterprise debt amounted to 15.8% of GDP and 6.6% of GDP was covered by explicit guarantees.

Sri Lanka halted the reform and privatization of state enterprises under a policy articulated by Janatha Vimuthi Peramuna of Sri Lanka (sale of national assets) which was adopted by the Rajapaksa administration.

Successive administrations then stopped market pricing of energy, also following a policy championed by the JVP called “removing the plug”.

The central bank was also in debt.

The report indicates that Sri Lanka is at risk of experiencing a depreciation of the exchange rate. At the time the projections were made, the rupee had not started to fall sharply. (Colombo/March 26, 2022)