Some Challenges in fiscal consolidation
Posted on September 27th, 2016

By Paneetha Ameresekere Courtesy Ceylon Today

“…What our peers in South East and East Asia did were to contain the current account deficit and to make it a surplus, whilst at the same time moving towards fiscal consolidation, that helped them to become Asian tigers and all that,’….”-Central Bank of Sri Lanka (CBSL) Governor Dr. Indrajit Coomaraswamy speaking at his first press conference after his appointment. (Ceylon FT of 6 July) CBSL’s money printing machine over a period of five months has had decelerated by 44.12per cent (Rs 130,005.65 million) to Rs 164,652.02 million as at 15 September, data showed.
Money printing in the current dispensation peaked at a record

Rs 294,657.67 million on 12 April, statistics further showed. The current dispensation is defined as the period beginning from 2009 to date. The year 2009, is taken as the base year because it was in that year that Sri Lanka won its 26-year-old war against Tamil terrorism, on 17 May. It was also in that year Sri Lanka clinched its largest loan from the IMF, a US$ 2.6 billion standby arrangement to tide over a balance of payments crisis. The year 2009, was also the Mahinda Rajapaksa era of governance in Sri Lanka.

CBSL’s money printing is defined as its lending to the State, the figure is arrived at by deducting CBSL’s lending to banks, either through its standing lending facility window or by its overnight (as is also the current case) reverse repo window or both, from its total Treasury (T) Bill holdings.

A reduction in CBSL’s T Bill holding, vis-à-vis its lending to the Government of Sri Lanka (GoSL)-money printing-means a decline in a certain area of GoSL’s debt stock, that is, in this instance borrowing from the monetary authorities, in other words, from the CBSL. When such debt stock declines, ipso facto GoSL’s borrowing costs should also decline. When GoSL’s borrowing costs decline, GoSL’s expenditure also comes down, in consonant with Coomaraswamy’s thinking vis-à-vis fiscal consolidation.

Record lending

When analyzing CBSL’s money printing machine, just two days after Coomaraswamy’s inaugural press conference, CBSL recorded its third highest lending to the GoSL since 2009; that is a sum of Rs 280,208.79 million on 7 July. The second highest was on 15 April, that is a sum of Rs 289,859.94 million, when his predecessor Arjuna Mahendran was in office. The record lending of Rs 294,657.67 million to GoSL ‘achieved’ on 12 April, in the current dispensation was also when Mahendran was in office.

But, in the three-month period from 12 April to 7 July, 2016; CBSL’s lending to GoSL had marginally reduced by
Rs 14, 448.88 million (5.16 per cent) to Rs 280,208.79 million. However, in the two months that followed afterwards, that is up to 15 September, such holdings had had rapidly declined by Rs 115,556.77 million (41.24 per cent) to Rs 164,652.02 million; coinciding with Coomaraswamy’s desire to reduce the country’s fiscal deficit.

To make such T Bill retirements possible, there needs to be inflows, other than money printing. CBSL data for the period 12 April, to 7 July, showed that the money market on a net basis enjoyed inflows to the tune of Rs 6,280.40 million; leaving the balance retirement of Rs 8,168.48 million possible, in the review period from 12 April, 2016 to 7 July, 2016; by retiring a part of those T Bills originally printed for the purpose of providing liquidity to the GoSL.

The total number of inflows which the money market experienced in the period 12 April, to 7 July, was
Rs 395,310.7 million and outflows,
Rs 389,030.3 million.

Excess liquidity crunch

During the review two-month period, that is from 12 April, 27 July, due to the excess liquidity crunch witnessed by the money market, and as reflected by CBSL’s significant T Bill holdings, the weighted average yield (WAY) of the benchmark one year (364-day) T Bill, at the primary auction, increased by 22 basis points (bps), that is from 10.23 per cent as at 11 April, to 10.55 per cent by 5 July.

Meanwhile, the average weighted prime lending rate (AWPLR) of banks, increased sharply by 142 bps that is from 9.28 per cent as at 8 April, to 10.70 per cent as at 1 July. The weighted average rate (WAR) of overnight call money however, marginally increased by five bps to 8.20 per cent in the period 12 April, 7 July, 2016, though that of the WAR of overnight market repo transactions actually declined by 15 bps to 8.06 per cent. This ambiguity may be due to the fact that ‘Avurudu’ pressure caused abnormally high upward pressure on market repo transactions as at 12 April.

If, in the three-month period from 12 April, to 7 July 2016, the money market on a net basis enjoyed inflows to the tune of Rs 6,280.40 million; in the following two months however, that is from 8 July, 2016 to 15 September, 2016; it enjoyed net inflows totalling a massive Rs 110,628.33 million; that is 17.6 times more than the net inflows received by the money market; in the immediately preceding three months.

The breakdown of inflows vis-à-vis outflows in the two-month period 8 July to 15 September is as follows:
Inflows: Rs 344,998.26 million; that is 87.27 per cent of the value of inflows received during the immediately preceding three-month period from 12 April, 2016 to 7 July 2016. And, outflows: Rs 234,369.93 million; a mere 60.24 per cent, compared with the total outflow figure of Rs 389,030.3 million in the immediately preceding three- month period from 12 April to 7 July.

Acceleration

Therefore, one may see that there has been an acceleration of inflows into the money market in the two- month period 8 July, 2016 to 15 September, 2016; compared with the immediately preceding, but longer three-month period from 12 April to 7 July.
Further, there has been a rapid deceleration in outflows into the money market in the two-month period 8 July to 15 September, compared with the immediately preceding, but longer three-month period from 12 April to 7 July. These developments have resulted in the money market enjoying net inflows totalling Rs 177, 217.64 million to the market in the two-month period 8 July to 15 September, which is 28 times more than the net inflows received by the money market in the immediately preceding three months, a miserly figure of Rs 6,280.4 million.

Three reasons may be attributed to this State of affairs. Two are tangible and the third is not. Among those which are tangible are CBSL raising its policy rates by 50 basis points in July, that is its standing deposit facility rate to 7 per cent and standing lending facility rate to 8.5 per cent, which may have had accelerated the attraction of foreign investors to the Treasury (T) Bond and T Bill market and the higher interest rate regime engineered by CBSL increasing its policy rates in July, which may have had a disincentive impact on exporters to indulge in bank borrowings to meet its commitments, but rather, having had found that it’s more expedient to convert their US dollars to rupees to meet such expenses.

Debt stock

Nonetheless, an increase in foreign holdings of GoSL debt stock, ipso facto in the form of T Bonds and T Bill holdings, also increases GoSL’s total debt stock and the interest rate payments that have to be obligated with, in such an environment.
In the two-month period from 5 July to 15 September, foreign investments in the T Bill and T Bond market increased by Rs 51,274.10 million (19.99 per cent) to Rs 307,717.21 million. In contrast, in the relatively longer three- month period from 6 April to 5 July, foreign investments in the T Bill and T Bond market increased at a slower pace, that is by Rs 33,155.67 million (14.85 per cent) to Rs 256,443.11 million.

And the intangible factor that has seemingly brought in some stability to the money market: The confidence reposed on the new Governor by investors, possibly more than that which they had had reposed on his immediate predecessors. The ‘confidence’ factor in business revolves around ‘integrity’ and ‘certainty’, whereas the confidence factor of business vis-à-vis the political environment revolves around policies, foremost of which is economic stability; and integrity and certainty.
The commonality between CBSL Governor and Politics is ‘integrity’ and ‘certainty’. Meanwhile, as far as interest rates are concerned, the AWPLR of banks in the two month period from 8 July to 15 August had increased sharply by 193 bps to 12.57 per cent. Part of the reason for this steep increase is the 50 bp policy rate hike made by CBSL at its Monetary Board meeting of 28 July, the other, the illiquid state of the money market due to the paucity of inflows.

Short

For instance, on 15 September, the money market, on a net basis was short by an amount of Rs 31,452 million; despite enjoying net inflows to the tune of Rs 8,956.29 million on that day. However, the WAY of the benchmark one year T Bill in the two-month period from 5 July to 13 September had declined by 25 bps to 10.39 per cent. In this instance, the direction of the one year T Bill WAY cannot be taken as a guide, because that rate can be manipulated by CBSL/GoSL, either by offering too little T Bills to the market, thereby artificially creating demand, resulting in its WAY falling. T Bill borrowing is an accumulation of GoSL debt. Higher the T Bill WAY, higher the cost to the GoSL.

However, the WARs of overnight call money and market repos, in the two- month period from 8 July to 15 September, had increased by 20 and 59 bps each to 8.40 per cent and 8.64 per cent respectively.

Meanwhile, in the two review periods, the middle rate of the exchange rate (ER) for TT transfer, as per CBSL data has fluctuated sine type. For instance, in the three-month period from 11 April to 7 July, the ER had appreciated by 1.47 per cent to
Rs 146.78 to the US dollar, whereas in the period 7 July to 15 September, it had had depreciated by 0.93 per cent to Rs 145.41 to the dollar. In between, the foreign exchange (FX) market has alleged that there have been instances of CBSL applying a mix of moral suasion and selective selling of dollars from its foreign reserves in order to keep the rupee (ER) stable.

Consolidation

The challenge for CBSL, as enunciated by Coomaraswamy is to consolidate both the budget deficit and the current account deficit. According to CBSL, GDP last year was US$ 82.3 billion, current account deficit 2.4 per cent of GDP, budget deficit: 7.4 per cent of GDP and GoSL debt, 76 per cent of GDP.

According to available statistics, the trade deficit in the first six months of the year was $ 4,213.3 million. If that figure is extrapolated for the full year, a figure of $ 8,426.6 million is arrived at. Other outflows, such as payment of foreign loans (excluding maturing swaps which may be rolled over), are estimated at $ 4,998.46 million. This would take the envisaged total outflow for the year (excluding maturing swaps which may be rolled over) to
$ 13,425.13 million.

Maturing swaps for the year are estimated at $ 3, 232.49 million.
Meanwhile, according to available CBSL data, tourism receipts in the first eight months of the year are estimated at $ 2,253.9 million. If that sum is extrapolated for the full year, the figure arrived at is $ 3,380.85 million. Tourism, after remittances and garments, is Sri Lanka’s third largest FX earner.

Remittances in the first seven months of the year are estimated at
$ 4,185.9 million. If this number is extrapolated for the full year, a figure of $ 7,175.8 million is arrived at.

According to Sri Lanka Association for Software and Services Companies Operations Director Jeewan Gnanam, software and IT enabled services (ITES) exports for the current year are expected to top $ one billion. (Ceylon FT of 4 July). Software and ITES exports may be Sri Lanka’s fifth largest FX earner, the fourth being tea. The sum total of all of these envisaged inflows adds to $ 11,556.65 million (excluding maturing swaps which may be rolled over); yet leaving a deficit in the current account totalling $ 1,868.48 million. As per 2015 GDP estimates, a deficit of $ 1,868.48 million in the current account is equivalent to 2.3 per cent of GDP.

But in Sri Lanka’s case, its GDP is dynamic and growing, with only one instance in recorded GDP history, where it had retarded, which was in 2001. For instance, according to CBSL, GDP in the first half of the year grew by 3.9 per cent. Therefore, considering GDP growth, the actual current account deficit would be less than 2.3 per cent of GDP as per the aforesaid estimates, but it would be yet in deficit by a narrower margin, thereby moving to achieve Coomaraswamy’s objective of consolidation in the current account.

With reference to budgetary consolidation, it may be moot to quote an article which appeared in Ceylon FT on its issue of 20 July, under the heading, ‘Capex down 2.4 per cent.’ It said, ‘ Sri Lanka’s capital expenditure (capex) in the first four months of the year declined by Rs 3.6 billion (2.4 per cent) to Rs 145.4 billion from the estimated figure of Rs 150 billion, latest data released from the Fiscal Policy Department showed.

Capex is needed to grow
markets and jobs

Nonetheless, on a year-on-year (YoY) basis, capex increased, having recorded Rs 144,193 million figure in the corresponding period last year. Capex is needed to spur economic growth.
Government of Sri Lanka targets an economic growth of 6 per cent this year. Economic growth last year was 4.8 per cent.
Meanwhile, total receipts in the review period declined from the estimated figure of Rs 541.3 billion to Rs 472.7 billion, a decline of Rs 68.6 billion, or a 12.67 per cent. Meanwhile, on a YoY basis, revenue collection grew, having had reported a figure of Rs 395.1 billion in the corresponding period last year.

…on the positive side, current expenditure estimates which were
Rs 565 billion for the first four months, fell to Rs 559.7 billion in the review period, but, on the negative side, on a YoY basis, recurrent expenditure grew, having had recorded a Rs 522.5 billion figure in the first four months of last year, a YoY growth of 7.1 per cent or Rs 37.2 billion.

Meanwhile, the overall budget deficit in the first four months of the year declined from Rs 271.5 billion to Rs 233.4 billion, an overall decrease of Rs 38.1 billion (14 per cent).’

Sri Lanka last achieved a budget surplus nearly 40 years ago in 1977. But at what cost; with unemployment being at over 20 per cent! This is something which Coomaraswamy and the country’s policymakers should watch out for.

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