Sri Lanka surtax on fuel imports to recover Rs700bn monetary instability loan

Published by Ann Thompson on


“The CPC had been given guarantees from the Treasury to get credit facilities,” Minister Semasinghe said.

“It is about 700 billion rupees in forex exchange facilities. From December the Treasury will begin to act under the guarantee. Then the CPC will be released from that responsibility.

“They (CPC) will then get the environment to service the public and open LCs. Then the burden on their balance sheet will reduce.

“There is a plan for the Treasury will take over the foreign exchagne loans and repay them over 10 years.

“The surcharge tax is imposed in this connection.”

CPC also has more Letters of credit owing to suppliers.

There is no plan as yet to bar the CPC from importing oil on credit and triggering external imbalances.

Dollar borrowings of all kinds lead to a widening of the external current account.

Monetary Instability Loan

The CPC was forced to borrow dollars from commercial banks each time the central bank printed money to mistarget interest rates and created foreign exchange shortages, going back several periods of currency crises.

A part of the loans were usually paid back after rates were hiked and monetary stability was restored such as in the year 2017.

However in the next currency crises triggered by liquidity injection tools CPC was forced to borrow from state banks again.

Bank of Ceylon and People’s Bank have loaned the CPC about 2.0 billion US dollar by the time the 2019 – 2022 currency ended.

In addition to the CPC loan the central government also borrowed dollars heavily as forex shortages came from liquidity tool employed to target an overnight rate in the middle of the policy corridor and longer term yields through term reverse repo injections and outright purchases and the country lost the ability to settle dollar loans from inflows.

The inability to squeeze the current account to repay financial outlflows, when liquidity is injected by a note issue bank, is generally called the ‘transfer problem’ by Keynesian macro-economists.

Sri Lanka eventually defaulted in April 2022 after printing money for two years and the central bank also borrowing heavily through swaps. The central bank is now about 4.5 billion Us dollars in debt.

Economists and analysts have called for a currency board to be set up so that the country’s macro-economists cannot mis-target interest rates in the future and the country will have the basic requirement to use its geographical position and become a regional economic hub.

Singapore Prime Minister Lee Kuan Yew labelled borrowings made after money printing as ‘cover up’ loans.

In Sri Lanka they have also called cover up loans in a Finance Ministry report, but are ususually called ‘bridging finance’.

“Now, we are going to run a Currency system which means that the moment we earn less, we spend less. This is a tough, vigorous regime. And I say we do it or we die because this is a society with an open market, exposed.”

In practice the currency board without a policy turned out to have low interest rates, low inflation allowing people to prosper and politicians to rule over multiple terms.

Cambridge Economics

It was in sharp contrast to Britain at the time – where Lee and his right hand man Goh Keng Swee – studied. Britain was consumed by ‘Cambridge economics’ or stimulus, now called output gap targeting.

As part of discretionary flexible inflation targeting the IMF taught Sri Lanka’s central bank to calculate and output gap targeting, putting the final nail in the island’s coffin, critics say.

“Before every election, over the last 15 years, every British Government – Conservative and Labour – has said, “Never mind what the National Income is; just spend,” he explained.

“If you spend, low interest rates, people can borrow from the bank. They will buy houses, buy television sets. So you create demands. So factories make television sets, shoes, clothes. So unemployment goes down.

“At the same time, because people buy, they begin importing from outside. And when you import, you have to pay the other person either your goods, your gold or your foreign exchange reserve.

“And you do that for about a year, never mind whether you are losing your foreign exchange reserve.”

Then the breaks are slammed.

“Right, stop; break; pull the money back,” PM Lee said.

“Bank rates go up; money cannot borrowed easily; shops cannot borrow money; private owners cannot borrow money to build houses, to buy cars; hire purchase is more difficult; expenditure contracts; demand goes down; imports go down; unemployment goes up.”

Sri Lanka is now in the ‘Right, stop; break; pull the money back’ mode.

Most Western countries which accommodated real economic shock (the Coronavirus crisis) with monetary policy is also now in full back peddling mode as inflation rocketed. Artfully, a commodity bubble has been blamed on Russian President Putin’s war in Ukraine though the Ruble is not a reserve currency.

Sri Lanka’s politicians gave macro-economists in a country without a doctrinal foundation in sound money, the power to print money by abolishing a currency board in 1950.

They have not been able to take it back since. Instead constraining the power to mis-target rates they enacted and gave the economists exchange and import control laws to take away the publics econonomic freedoms.

But along with the public they have have paid the price for monetary instability. Inst (Colombo/Nov16/2022)

Categories: MONEY