ECONOMYNEXT – Sri Lanka’s government and government-guaranteed domestic currency debt, heavily factored into the debt review, fell by US$19.6 billion as the economy swelled in worst crisis monetary history of the central bank of the island’s intermediate regime.

Sri Lanka’s central government rupee debt fell to the equivalent of $32.4 billion from $50.5 billion, a phenomenon termed high inflation and financial repression (IFR).

Sri Lanka had a debt in rupees of US$53.5 billion at the end of December 2021, made up of US$50.5 billion in central government debt and US$3.1 billion in corporate-guaranteed debt. Status, included in an update to creditors on data through December 2021.

Sri Lanka had $47.3 billion in central government foreign exchange debt, including $5.4 billion in guaranteed state enterprise debt and $3.0 billion in central bank debt.

Over the next six months, the rupee crashed from around 200 to 360 against the US dollar in a botched float with a buy-back rule (forced sales of dollars to the central bank), sterilized interventions and rates directors too low in a context of raging domestic credit.

At the end of June 2022, the debt in rupees had decreased to US$34.0 billion from US$53.6 billion at the end of December 2021 in high inflation and financial repression (IFR) or a real “cut of hair” according to the latest update from creditors.

Sri Lanka’s dollar debt included in the update had also declined slightly to $46.6 billion at the end of June 2022, from $47.3 billion in December 2021, consisting of $5.5 billion debt guaranteed by public enterprises and $3.2 billion in central bank debt.

The Monetary Authority, however, has more foreign exchange debt than is included in the update according to other data. The update took into account 1.1 billion US dollars owed to the International Monetary Fund (negative position in SDRs excluded) and 2.0 in external swaps only.

The treatment of deferred liabilities from the Asian Clearing Union and domestic swaps is not immediately clear.

The write-off of rupee debt to US$34.5 billion by June 2022, from US$53.6 billion six months earlier, reduced the total public sector debt considered in the compilation to US$80.5 billion, compared to US$100.9 billion over the six months.

However, there are classification differences between the two updates.

The new update indicates that foreign exchange debt represented 70% of public debt of 122% of public debt of GDP in June 2022, compared to 27% of public debt of 114% of GDP in 2020.

Sri Lanka’s economy is expected to swell to at least 23.8 trillion rupees in 2022, from 16.8 trillion rupees, in one of the biggest inflationary surges since the 1980s, when the rupee began to depreciate quickly in response to money printing triggering high inflation and social unrest.

A swelling rupee economy increases nominal tax revenue, automatically bringing “debt sustainability” as long as the public sector is not developed and wage moderation is maintained.

There are fears that rupee debt will be restructured, which will hurt banks, pension funds and other creditors who will pay more taxes anyway under the planned reforms.

Tax revenues increased by 25% in the six months to June 2022. In addition to the IFR, there are now concerns that a domestic debt restructuring DDR is being considered.


Sri Lanka does not yet have a final decision on the restructuring of its domestic debt

Sri Lanka rates rise amid failed float, DDR fears

The Sri Lankan rupee is collapsing due to its intermediate central bank regime which has no consistent monetary peg but practices generally known discretionary and confrontational policy and the impossible trinity.

Over the past 7 years, a highly discretionary policy has been practiced under “flexible inflation targeting”, where floating rate monetary tools (open market operations for stimulus) have been applied to an anchor gathering reserve in politics comparable to or worse than that of the 1980s according to critics.

However, over the past decade, Sri Lanka has become a market access country and the country defaulted in April 2022 after exhausting its reserves.

In all previous monetary crises resulting from flexible monetary policy, debt sustainability was achieved with high inflation and financial repression.

Currently, the yield on public debt is around 31% with historical inflation close to 70%.

A new monetary law that will subjugate discretion over the rule legalizing both a “flexible” exchange rate and “flexible” inflation targeting (a modernized version of the attempt to challenge the impossible trinity of policy goals currency) must be legalized as a prior action in a deal with the IMF.

Flexible or discretionary politics is a doctrinal foundation of classical mercantilism (John Law, James Stuart as well as the Anti-Bullionism and Banking School) which experienced a new lease of life under Keynesianism and constitutes the foundation of soft-pegs (intermediate regimes) .

Washington-based practitioners of neo-mercantilism, including Robert Triffin (spread of Argentinian-style Prebisch-Triffin-style central banks), John H Williams (key money), and later John Williamson (basketball band crawl/REER) peddled schemes trinity hoses impossible to unfortunate third world nations without a solid national classical doctrinal foundation.

Flexible monetary policy flatly rejects the rules-based principles of classical economists such as David Hume, David Ricardo, and Henry Thornton.

Flexible exchange rates, which are neither floating nor rigid, also reject modern classics such as FA Hayek, Milton Friedman, Ludwig von Mises, Bertil Ohlin, Wilhelm Ropke whose ideas led the Federal Republic and Japan from 1948 in the Bretton Woods era and the East. Firm pegs for Asia and the GCC and veritable currency boards.

Similar ideas also drove the United States and the United Kingdom into the period of the “Great Moderation” from the early 1980s until 2001, and continue to lead German-speaking countries, including Switzerland. . Germany itself is now under the ECB which printed money to stimulate employment and delay rate hikes.

The US also triggered a bubble with Jerome Powell delaying rate cuts, blaming supply chains and “transient” inflation taking refuge in non-monetary explanations.

In Sri Lanka too, it is strongly believed that some of the inflation is non-monetary and is used to trigger open market operations to suppress rates and trigger currency crises.

That inflation is non-monetary (supply chain, wages, interest rates, hoarding) stems from the ideas of classical mercantilists such as James Stuart.

That some inflation is non-monetary, however, is an ad hoc idea articulated by people such as Fed chief Arthur Burns who broke a three-century-old gold standard in 1971, for which it is difficult to find clear doctrinal authors, according to critics.

In a country with a loose peg of monetary policy reserves, nominal interest rates are high and long-term real growth is low due to loosely pegged central bank trade and foreign exchange controls that restrict economic freedoms, as well as production shocks.

In an IMF or other debt sustainability analysis, low growth and generally higher nominal interest rates should be assumed with no exit from the conflicting loose peg policy that prevailed from 1950 onwards. , compounded by the depreciation of BBC policy from the 1980s and market access over the last decade.

In a four to five year Federal Reserve cycle, a flexible country with loose policy will lose about two years of growth due to monetary instability. The combined effects of low growth (output shocks) have serious implications for long-term growth and prosperity.

In Sri Lanka’s current currency crisis that led to a sovereign default, growth is expected to turn positive in 2024 and remain around 3.0% through 2027 according to the creditors’ update. (Colombo/September 24, 2022)

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