Sri Lanka will take steps to directly communicate with potential investors and stakeholders the emerging trends of the country’s economy after international rating agency Standard and Poor’s (S&P)upset authorities with their latest review, where the country’s outlook was downgraded to ‘negative’ from ‘stable’.

The Central Bank said it would take this step as it is compelled to review its relationship with S&P. It accused the rating agency of bias and questioned its professional judgment.

S&P’s argument for the country’s negative outlook is based on two concerns.

It says the pressure on Sri Lanka’s external liquidity position has intensified with reserves eroding and the delay in the IMF standby facility with which the country would try to right its balance of payments crisis is one concern.

The other concern is with regard to the fiscal imbalances (with revenues expected to slump further while expenditure increases) and the debt position of the government.

"Information on foreign exchange reserves at the end of March showed a 26.8% decline in gross official reserves since the beginning of the year, even as the trade deficit narrowed significantly in the quarter," S&P said.

"This implies further deterioration in Sri Lanka’s ratio of foreign debt service to reserves (foreign currency debt service payments to official reserves), which rose to 39.8% in 2008 from 29.4% in 2007, and its ratio of commercial foreign currency debt to reserves, which rose to 95% from 68%.

"Notwithstanding the expected moderation of the current account deficit from a record 9.3% of GDP in 2008 to our projected 5.8% this year, Sri Lanka’s gross external financing needs are likely to remain high at about 130% of current account receipts plus usable reserves—above the ‘B’ median and all peers.

"In addition to the immediate concern over external liquidity, sovereign creditworthiness continues to be constrained by ongoing large fiscal deficits, which in our view, are due to an inadequate revenue base and inflexible expenditure structure.

"The 2008 fiscal deficit of 8% of GDP is a reversal of modest consolidation over the recent years. In addition, revenue growth of an estimated 14.6% against nominal GDP growth of a reported 23.2% underscores the weak revenue generation.

"Standard & Poor’s believes that unless strong policy measures are applied on the expenditure and revenue front, the general government fiscal deficit will remain high at 7%-8% of GDP in the foreseeable future.

"This, combined with positive real interest rates as inflation falls, and the potential continued depreciation of the Sri Lankan rupee, are expected to negatively affect the country’s debt dynamics. Notably, Sri Lanka’s public and external leverage already well exceed those of similarly rated sovereigns, highlighting Sri Lanka’s greater vulnerability to shocks and its reduced space to maneuver to avoid debt-servicing difficulties," S&P said.

(For the full text S&P’s rating report see Island Financial Review of May 22, 2009).

Central Bank’s response to the external liquidity position is as follows:

"Over the past few days, the country has received higher than normal foreign exchange inflows pursuant to the victory against terrorists. At the same time, this year’s private remittances have comfortably exceeded the trade deficit.

"In fact, the country recorded the highest-ever inflow of remittances during the month of March 2009. Moreover, inflows into the stock market have been improving significantly during the last few days which have resulted in the rapid increase of all stock market indices.

"Business confidence levels have also been improving rapidly over the recent past, with the Sri Lankan Diaspora and other international investors beginning to invest in Sri Lankan Government Treasury bills and bonds, in significant amounts.

"As a result, the exchange rate which stood at approximately Rs. 120/- per US dollar a few days ago has appreciated towards Rs.115/- per US dollar. In that scenario, in order to support competitiveness, the Central Bank has been absorbing significant amounts of foreign currency from the foreign exchange market, which has resulted in the Central Bank building up its reserves rapidly.

"In addition, following the monetary policy relaxation measures taken by the Central Bank and the inflows of foreign currency, domestic interest rates have reduced, and the private sector credit is now beginning to increase. In this favourable scenario, international investors too have re-affirmed their confidence in the Sri Lankan economy, and as a result, the spread on the Sri Lankan Sovereign Bond has reduced sharply by well over 500 basis points over the past few days," the Central Bank said.

Sri Lanka is facing a balance of payments crisis and this is why an IMF standby facility for US$ 1.9 billion is being sought. The Central Bank is confident it will come through as would other bilateral inflows.

The Country’s foreign reserves as at the end of March 2009 stood at US$ 1.2 billion, enough to cover imports for about 1.2 months while exports declined by 7.8 percent along with imports which declined by 11.8 percent during the month.

Foreign currency reserves in February stood at US$ 1.3 billion.

Dealers say Central Bank reserves are now as low as US$ 830 million.

The Central Bank said the trade deficit contracted for the third consecutive month in March 2009 as imports continued to decelerate faster than exports.

The Trade deficit contracted by 17.6 per cent in March 2009, year-on-year, to US$ 383 million.

The cumulative trade deficit decreased by 54.0 per cent to US$ 645 million during the first quarter of 2009 from US$ 1,401 million for the same period in 2008.
Private remittances recorded the highest ever value of US$ 278 million in March 2009. Remittances reached US$ 774 million during the first quarter, (a decline of 1.7 percent) compared to US$ 787 million for the same period 2008).
The Central Bank says remittances during the first quarter amounted US$ 129 million (about 20 per cent) in excess of the trade deficit.
Export earnings declined by 12.9 percent during the first quarter of 2009 to US$ 1.6 billion from US$ 1.8 billion the previous year. Imports declined by 30.3 percent to US$ 2.3 billion from US$ 3.2 billion.
According to the Commissioner General of Labour, 32,000 people have lost their jobs as exporters closed-shop due to the ill-effects of the global financial crisis. But the Commissioner General concedes that the unofficial figure could be as much as 70,000.
The Central Bank is not ignorant of the government’s fiscal discipline either.
The Central Bank warns that the government’s domestic borrowings could increase sharply in 2009, as a result of the global economic slowdown and suggests it adopts measures aimed at contributing to economic activities that are well targeted and temporary given the government’s limited fiscal space.
“2009 will be a challenging one in terms of fiscal operations in the midst of the continuing global financial crisis and economic slowdown coupled with the need for accelerating the humanitarian and development activities in the newly liberated areas,” the recently published annual report of the Central Bank says.
It warns that government revenues could further decelerate if economic activities contract during the year.
The Central Bank points out that the government’s revenue collection for 2008 was Rs. 95 billion short of its budgeted target.
The overall budget deficit as a percentage of GDP expanded to 7.7 percent, as against 7 percent in 2008.
“The potential spillover effects of the global financial crisis may necessitate the government to adopt decisive and properly conceived responses through additional fiscal measures to mitigate such negative effects.
“Given the limited fiscal space, it is vital to ensure that measures so introduced are well targeted, temporary and contribute to stimulate economic activities without having a significant fiscal slippage,” the bank says.
Given the importance of developing the Northern and Eastern provinces, the Central Bank goes on to say that measures should be taken to minimize the revenue shortfall and control additional expenditure.
Its all sentiments…
Economics is called the dismal science. Economics can never agree because the heart of the matter is that economics is about human behavior.
What happened to the country’s exchange rate is a good example.
The rupee depreciated against the dollar to about 120 a few weeks ago but was brought back to the 117/118 range because Importers did not come forward forcing dealers to trade at lower margins. Earlier this week the rupee appreciated to 115 and could have gone to as low as 113.50 but then state agencies prevented this from happening by offering dollars at the 115 range.
According to dealers, the depreciation and appreciation of the rupee mentioned above was more to do with sentimentality and speculation and little to do with market forces. So, only time will tell where the exchange rate is heading once reality sets in.
Earlier the Central Bank depleted the reserves to prevent the rupee’s depreciation to protect the debt obligations of the government. Now, state agents are protecting exporters by not allowing the rupee to appreciate too much.
So S&P and the Central Bank will try to appeal to investors’ sentiments with regard to future prospects.
War on the economy…
According to President Mahinda Rajapaksa, now that the war on terror is, the war on the economic has just begun.
It is a war we would fight with our selves, because every individual, the entire private and public sector and all their organizations and institutions will have to do things differently. If war prevented our country from reaching its full potential, so did our laziness, sloth and corruption. Now the foundations will have to be shaken.
“The President said he would rid the land of terrorists, and he did. Now he promises to develop the economy, so we hope he will deliver,” is what many people say these days.