BoP crisis might lead to banking crisis – Dr Nandalal Weerasinghe

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By Ishara Gamage

The Sri Lankan Government must take prompt action to solve the prevailing Balance of Payments (BoP) Crisis as it can lead to a banking crisis, the recently retired senior deputy governor of the Central Bank of Sri Lanka (CBSL), Dr Nandalal Weerasinghe warned.

“If the Government becomes insolvent, two state banks will automatically become insolvent leading to a banking crisis on top of a BoP crisis,” he said in a recent webinar organised by the joint economic associations of Sri Lanka.

Therefore, Dr Nandalal Weerasinghe, urged the authorities to prepare a plan to strengthen the two state banks as their current exposure to the sovereign and foreign exchange risks are on the high side.

According to his observation, the current BoP crisis will be worsening further before turning around and it may be already too late to minimise more pain.

“Economic pain can only be minimised if essential policies and measures are implemented in the immediate future,” he asserted.

He suggested the monetary and fiscal authorities to tightenthe monetary policy by higher margins and fiscal policy by restoring tax rates to pre-2020 levels.

He also suggests introducing transparent pricing formulas for both petroleum and electricity prices while protecting tax revenues from excise duties.

He also requested the Government to make an announcement on its intention to restructure sovereign external debt and seek assistance from the IMF to commence negotiations for debt restructuring with creditors and financial assistance without any further delay.

On the basis of progress on IMF negotiations, he suggested the Government to seek short-term bridging facilities from official creditors until an agreement is reached with creditors on restructuring.

He also expected more flexibility in managing the exchange rate on gradual basis.

In the wake of the Sri Lankan exchange rate turmoil, the subject of financial crises have come to the forefront of academic and policy discussions. 

In his presentation, he analysed the links between banking and the currency crises. He pointed out that the problems in the banking sector typically precede a currency crisis with the currency crisis deepening the banking crisis, thus activating a vicious spiral. 

According to Dr Weerasinghe, the Ceylon Petroleum Corporation (CPC) and the Ceylon Electricity Board (CEB) are currently generating the biggest losses in their history. Such large losses have never occurred in their history. 

CPC, CEB and SriLankan Airlines have also become the largest rupee and foreign currency borrowers in recent Sri Lankan financial history. These institutions, which have obtained large sums of foreign currency denominated loans, are also facing severe difficulties due to the current currency devaluation.

Generally, state banks may have to fulfil their dollar obligations in the absence of sufficient foreign currency for them to honour their debt service on a timely basis and thus fulfil other repayment requirements.

Therefore, this situation is a major threat to the relevant institutions as well as the state banks. This situation poses a serious threat to the financial system stability of the country with the existing value of bank overdrafts maintained by the Government with the relevant banks exceeding a trillion rupees – the highest overdraft in history. The two state-owned banks have also released significant loans to other public corporations and institutions as well.

“There is a significant risk to the financial system stability resulting from the two-state banks’ exposure to the Government and state-owned enterprises,” he said.

Speaking about the countries worsening economic fundamentals he said, “The Nation is currently experiencing a historically low economic growth and falling trend of per capita GDP since 2017 with rising levels of poverty. It is also running the highest fiscal deficits since 1988 with the lowest ever government revenue as a per cent of GDP.

Interest payments absorb some 80 per cent of government revenue in 2020.

Sri Lanka also has the highest-ever government debt which is unsustainable at the moment. Debt dynamics might be worsening in the next few years unless the debt is restructured, he said.

Sri Lanka also recorded the highest rate of inflation in 12 years which is increasing sharply and is experiencing the highest-ever levels of money printing by the CBSL.

Referring to the current account of the country, he said, Sri Lanka has reported persistently high external current accounts deficits without sufficient capital inflows to finance such deficits, a major problem that needs attention.

He also pointed out the lowest ever levels of external reserves leading not only to a default of external debt obligations but also severe shortages in essential imports even for subdued economic activity.

These matters, he said weigh heavily against the country,as it has lost access to international capital markets due to the lowest ever sovereign ratings by all three rating agencies.