Impact of forex crisis and solutions for national economy

• Global and local experts share key insights at Daily FT-ICC Sri Lanka webinar

Daily FT and ICC SL in association with Colombo University MBA Association, ACCA and CA Sri Lanka recently hosted a webinar to identify ‘solutions’ to the forex crisis, which is clearly a confusing and vexing issue for experts, policymakers, decision-makers and citizens alike.

An opening clip, previously broadcast on an international TV News channel, established the point of view as held by Central Bank Governor Ajith Nivard Cabraal, that World Bank as well as other ‘rating agencies’ are projecting an image of Sri Lanka that was not only unflattering, but was ‘myopic’ – suggesting that these overseas agencies are not fully aware of the capacity that Sri Lanka has to be able to travel through this period of ‘difficulty’. He was the voice of confidence, that there will be growth beyond mere recovery in the time ahead, and that such growth as his expectation of 5%, will enable to effectively meet the existing ‘threat’ of commitments. ‘Working hard on the tourism numbers’, and also the expected remittances from overseas, he said, would ensure this positive turnaround.

One of the keynote speakers, Dr. Shekhar Shah, Former Director General of NCAER and a former World Bank Regional Economic Adviser for South Asia, was of the opinion that the Governor of the Central Bank, not being a novice in this position, would have a grasp of the dynamics that are in play, even though there is a ‘crisis’. He alluded to the 6-month Roadmap introduced by the Central Bank last year, which is a response to the need for macro-economic growth and financial stability. 

There are two deficits that challenge Sri Lanka, the external debt and the internal or fiscal deficit. Dr. Shah selected to focus on the former. There have been 16 IMF programs that Sri Lanka’s Central Bank has previously conducted, and that experience would be useful in the current handling of the external debt with lenders and creditors, whether bilateral or multilateral. The fundamental factor is to arrive at understanding whether Sri Lanka faces a liquidity issue or a debt problem. Is the debt sustainable, and are the cash flows adequate to service such ‘debt stock’?

Delicate balancing acts needed by policymakers and decision makers, given the compound issues of political pressure and rising inflation. Risk of not having access to international markets and capital markets. Reputational aspects are also involved. The repayment of $ 500 million in January was most likely to instil confidence among the foreign markets. 

A ‘signal’ that liquidity was being managed well, despite the serious issues confronted. The efforts to conserve foreign currency reserves are also manifest, and this shows that the CBSL has taken a judgment call. Reference to the 2019 Debt Sustainability analysis that was undertaken jointly by CBSL experts and their IMF counterparts. That published document noted that there were risks to be faced, even though the debt both domestic and external was seen to be manageable or sustainable, with lowering public debt as a whole and raising revenue substantially. 

Notable though is that the pandemic hit after this assessment was made. In the current context, one of the assumptions made is that the pandemic could see a tapering off in the world scene. With that possible scenario, tourism will resume to levels that were obtained before the pandemic. In a few years this upturn could provide $ 5 billion into the reserves. 

Another assumption is that the SL Rupee will remain stable. And so too with levels of inflation being kept in check. This could lead to consolidation of the fiscal strength in the economy. Foreign remittances might also regain their momentum. These assumptions cannot be seen as certain. 

Dr. Shah noted that the IMF has sent a message to countries that are facing high dollar debt, that they need to “act now”, and if there is the possibility of ‘extending maturities’ then there is need to do so. In his concluding remarks, Dr. Shah indicated that the changed ‘attitude’ among the international agencies is not anymore operating from the standpoint of the Washington controlled technicians, but that they are taking a more pragmatic approach as would support economies such as Sri Lanka. 

The webinar included a panel discussion featuring, former Minister of Economic Reforms and Public Distribution Dr. Harsha de Silva, MP; Verité Research Executive Director Dr. Nishan de Mel; HNB, NDB and Cargills Bank former Managing Director and CEO Rajendra Theagarajah; The World Bank, Washington DC Senior Economist Sibel Kulaksiz; Oxford Political Review Founder Brian Wong; Entrepreneurship Specialist and World Economic Forum Experts Network Member Talal Rafi; United Nations ESCAP Economist Dr. Alberto Isgut; and Ceylon Chamber of Commerce and the Employers’ Federation of Ceylon Past Chairman Suresh Shah

Independent Central Bank

Dr. Harsha de Silva noted the forex crisis was more than a liquidity problem, it was a solvency issue, and was of the view that the CBSL and the Government did not have a handle on it. He felt that the proposals that are being offered are ‘wrong’. He did not feel that the CBSL was sufficiently independent of the Government’s political positions (as the experts therein need to be). He chose to provide context to the aforementioned 2019 IMF Staff report, by reminding that that was formulated following the outcomes from the April 2019 multiple bomb blasts, and presented facts and figures that were pertinent to that crisis. But following the issue of the IMF report the introduction of the tax relief measures ran contrary to any ‘sustainability’ that was foreseen and planned for. The pandemic exacerbated the issues.

Recovery strategies

Dr. Nishan de Mel offering an analysis said regaining access to capital markets and returning to the level where remittances are forthcoming; will be the path to ‘recovery’. This is a necessary assumption. Referred to the most critical downgrading by rating agencies, which occurred in April 2020. This signal was triggered on account of the foreign reserves also seeing a rapid reduction, and locked Sri Lanka’s economy out of the international capital markets. Ratings are mostly about what can happen in the future, and are not providing a backward review. This system, then, indicates that there is a perspective arising that Sri Lanka might not be able to meet its commitments, even though ISB payments have been consistently made on due dates from October 2020 until January 2022. 

The presumed risk alerts international lenders, and borrowing becomes less possible. In 2009, the same Governor did take Sri Lanka out of the brink by very successfully working with the IMF in making provisions for the economy to bounce back. Sri Lanka saw commendable growth because of following that IMF program. But the same confidence cannot be had now, the reserves have gone below what is optimum. In addition, the internal debt has been too rapidly on the rise. 120% of GDP. Remarkable escalation. Sri Lanka’s Interest to Revenue Ratio is the highest among countries in the world with large debt levels. This then adds to the ‘cost’ of funding. Borrowing to pay interest is not anymore a viable option.

The Ecuador case study was offered. They chose to follow ‘pre-emptive restructuring’. The idea of ‘sharing the pain’ with the creditors in order to allow the economy to survive and overcome the serious issues faced and also will prevent social upheaval within, where the population is forced into very serious deprivation of simple provisions and commodities for their daily living. That country, within six months of negotiation, were able to regain their stature and also benefit from re-entering the capital markets, and also receive a B+ rating by the end of the program. 

Debt restructuring

Dr. Alberto Isgut referred to the Sovereign Debt Restructuring mechanism introduced by the IMF in the 1990s. The value of this provision can best be secured by acting ahead of the very serious deterioration that could occur in a particular economy. Ecuador and Argentina too, were able to come through their crises by entering into such a program, embarked on in a timely manner. UNESCAP does not usually enter into direct negotiations in such issues and cases. But the Secretary General has issued a special notice in the context of the present global crisis spurred by the pandemic, that those nations that are under pressure on account of the economic downturn should be considered in the schedule of UNESCAP. 

A three-phase approach has been recommended, and includes the seeking of more time to be able to solve the issues of debt and currency outflows from developing countries. The provision also encompasses debt relief. It is worth exploring the possibility that Sri Lanka could be in this framework for receiving the ‘assistance’ as proposed in December 2021.

Brian Wong separated the issues confronting Sri Lanka and proposed some ‘possible’ responses toward solutions with regard to the main theme of the “Forex Crisis”. 

Currency swaps, as already been secured through India and China. There are possible negative consequences, not least the political fallout. Yet, there is the benefit that accrues in the short to medium term in bridging the foreign currency shortfall. Another option: making certain that there will be generous inflows of foreign currency. This would include opening the borders and pushing the numbers of tourist arrivals. Question remains whether such inflows of foreign funds will in fact be directed toward the national economy. 

Given that these two options might not provide the needed and sustainable solution, then the third option includes turning to the IMF or China or some other unnamed ‘source’ for the needed forex funding to be able to mitigate the crisis. IMF’s operational attitude has changed from the dour, austerity focused approaches that it was reputed for in the past. That factor weighs in favour of working on a program with the IMF. He recognised, though, that the political ideology stands against the Government turning to this source.

Sibel Kulaksiz referred to the possibilities that do exist within the framework of provisions in the World Bank, for debt restructure. There are newer responses that have been set up in the past year. These are taking into account the debt that many economies are having to grapple with, and which have been exacerbated with the pandemic’s impact as well on revenue generation.

Role of the private sector

Suresh Shah noted the business community has been vocal about the issues that are being faced, well before the crisis has mounted to this serious level. Important to consider the reasons why these deficits and poor consolidation of foreign reserves have occurred, before trying to find a way out of the crisis. For 70 of the many years since 1948 successive governments have been content to allow a fiscal deficit to continue, both internally and in the external accounts. This is the fundamental reason for these regimes having had to resort to borrowings. Repaying debt by incurring ‘new debt’. Unsustainable. 70% of revenue is going toward servicing interest on borrowings. 

As for a solution, reducing expenditure is not feasible in the short term, even though the sensible approach will be to reduce the deficit in the two accounts. Compounding the issue is that raising revenue is not possible in a year. Realistically, these achievements in solving the two accounts’ deficit will take several years, even though attempts can be made to increase export revenue and for inflows from revived tourism to accrue. Therefore, what Sri Lanka needs is the ‘space’ to get these reforms done. 

The important question is ‘where do we get the money?’ to be able to secure this space for recovery, in the next 4-5 years needed for the reforms to kick in with bringing benefits. Poor ratings have impacted the ability for the country to go to the bond market; bi-lateral borrowing is possible but those measures of support from friendly countries are at best only of value for a few months, not years. Option is to go to the multilateral agencies. But this will certainly require restructure. 

Rajendra Theagarajah noted that restructuring is already an aspect that is being mulled over, and there are conversations that are ongoing within the banking sphere. Seems logical to actually go in for a program that has the support and involvement of the multi-laterals. Such an approach cannot be a negotiation by experts in the CBSL in isolation, rather, there has to be a consensus among all political parties and stakeholders in the economic machinery, and they all need to be involved in a transparent process. It implies a majority consensus arrived at, at the level of the Parliament. A five-year-plus commitment is needed from all political parties, so as to avoid another ‘flip’ in policy when there is a change of regime which will lead to a disastrous fall. Containing non-essential expenditure is vital, and not pander to populist trends.

Talal Rafi noted that there is no short-term solution to the debt issues, and it is not possible to benefit from an increase in trade in sorting the forex crisis. Lessons to be derived from the experience of Vietnam. From initiating certain industries such as garment manufacture, they have moved along the road of innovation and brought in other technological aspects of industries and electronics, and these have helped in generating reserves via such enhanced trade. More FDIs are needed, since there is no way that the domestic economy can generate the capacity.

Governor Ajith Cabraal

Gov. Cabral – in a recorded video message to the webinar, also suggested that looking into the past will help to understand how and why this crisis emerged. In the period 2019 it was seen that the percentage of ISBs vis a vis the GDP had risen to a very high level. The strain on the economy was much greater than before, and combined with the pandemic the inflows of foreign exchange was depleted. Despite the strain, Sri Lanka has been able to settle the debt. If you don’t have reserves, you cannot pay the debt, he said, is a fallacy. The country has been able to meet its requirements from the inflows that did accrue even though there has been a reduction in inflows. 

He disagreed with the prediction of a state of bankruptcy occurring. He remains critical of those that advocate that Sri Lanka should not pay the debt (which was paid on time on 18 January 2022) citing that a serious depletion of foreign reserves will place the country in greater jeopardy. On the contrary, the country now is in a stable situation, having met that financial commitment on time. Tourism should come back to normal, and so too with remittances which should increase. Exports are taking place. Several proposals are already being actioned to repay the debts, such as monetising assets.

IMF is not the only option available. Sri Lanka is able to restructure on its own. Swap arrangements are helping with meeting those commitments. Other inflows will enable retiring of those swaps, which are short term at best. There is transparency and the plan is on the CBSL website. Sri Lanka is no different from many other countries that are facing huge inflationary rates. We are on the road to recovery, and there will be 5% growth, even though the turmoil of the present will be weighing in for the short term.

Conclusions

Theagarajah indicated that there was no sense of criticising the payment of $ 500 million in January, rather, the concern of those who represent the Chambers and the private sector was about the longer term, and the ability to successfully establish a sustainable mechanism for the next five years at least. This includes resolving some of the serious issues faced by the citizenry of the country. While the prerogative remains with the policymakers, those of the concerned business community will continue to articulate alternative courses, which the decision makers can consider. 

Suresh Shah echoed the same thoughts and added that the common people cannot be made to pay for lapses in policy. Should the businesses have to take the brunt? Rather, it is important that there is a clear definition of the way forward so that there is no interruption in the commodities that people have to access and for the opportunities for business to thrive. Raw materials have to be able to get their raw materials in, if the private sector is to actually drive the growth of 5%.

Dr. Shekhar Shah suggests that no advice is needed from outsiders. The talent and capacity of the people within, and the comprehension of the various issues, be it political or fiscal frameworks, and the social implications of all these factors are well comprehended are being communicated. 

However, there is a need for a disciplining factor to be installed. Perhaps the outside creditors need to be involved in instilling this urgent disciplinary element. Long-term commitment needed. Politicians need to educate themselves and the public to be able to avoid any pushback from the reforms and adjustments that are on cards. 

Dr. Harsha was asked about his recommendations for recovery in the event that tourism receipts do not flow in. Replying, he chose to briefly contest some of the figures and payments made and the reasons for them, relating to reserves that had been forwarded by the Governor. In the present increasing interest rates is needed. Get to a point of equilibrium. Ensure that the country can then be assured of inflows. Address the value of the currency being stabilised. Take on depreciation to be able to deal with the international market. The World Bank and IMF have forgiven debt before. Can they do so in this time of greater crisis? 

Kulaksiz responded that discussions are pertinent in this context. But such issues are also to be brought to the table with an accompanying commitment to protecting the vulnerable and provisions for preventing social upheaval resulting from serious indebtedness facing some poorer countries. Brian Wong commented on China’s ability to step in. He indicated that there is a trend to look to China. However, China also needs to make some adjustments and changes with regard to its own diplomacy and improve on the ability to work with nations. He also felt that there could be more store on tech collaboration with China, which could contribute to better growth prospects for a country like Lanka.

Suresh Shah reiterated that there are six areas of urgent reform and those have to be brought into a credible plan in the next six months. Dr. Harsha de Silva drove the further point that there needs to be a collaborative effort from all parties beyond the limiting-frame of political expediency.

Theagarajah also underscored the need for the ratings of the banking system needing to be addressed to benefit from the international market. The stature of the economy has to be recognised internationally as prudent and credible and not have a reputation as liable to default. Many noted the current forex problems need serious fixing before the crisis gets Sri Lanka on a path of no return. 

The session was moderated by Daily FT Editor Nisthar Cassim and ICCSL past Chairman Dinesh Weerakkody.