CBSL Road Map 2021 and Sri Lanka’s Economic Challenges
By Ishara Gamage
In a rambling 10,000-word, 2-hour speech, Governor W.D. Lakshman delivered the Central Bank of Sri Lanka (CBSL) 2021 Road Map on 4 January 2021. The 11th such presentation since 2009, ending with a quote commonly attributed to the US President Teddy Roosevelt, though not certified as such, it contained a mix of self-congratulations, historical perspective, policy and warnings with some hope for an equitable outcome. Devoid of colorful slides and fancy graphics the standard fare in earlier versions, perhaps more reflective of a more down to earth personality suitable for the times, we extract the important bits and provide a commentary on each of the selected items.
In the early part of the presentation, reference is made to the COVID -19 related expenditure carried by the Government. Admitting to funding the gap, not covered by state revenue, the Governor does not provide the amount of such funding. The Governor refers to “novel approach” to funding the 2021 Budget of the Government but fails to detail the novelties. Perhaps he is referring to the move to local, rather than foreign funding. If that is the reference, then such a move is rather a reflection of reality in that access to foreign funding is denied due to rating issues than choice. Offering a historical perspective, the Governor then refers to structural issues with the economy. Of significant benefit to those not familiar with the Sri Lankan economy, he puts the issues concisely as follows –
- relative neglect of domestic production,
- excessive product and market concentration of exports,
- heavily import-dependent consumption and production,
- prevalence of poverty pockets and economically vulnerable social groups,
- the so-called dual deficit (in the budget as well as on the external current account), and
- the over-reliance on foreign debt
Thereafter, the speech covers familiar territory of current events, except the admittance to CBSL entering into a currency swap with the Reserve Bank of India or RBI, a repurchase with the US-based Federal Reserve Bank and purchase of foreign exchange from the domestic Foreign Exchange Market of some $300 million during 2020.
Details of the swap or the repo are not revealed to understand cost, timing and amount of cash flows involved. Among other activities undertaken in 2020, much is made of the de-listing of Sri Lanka from the AML or anti-money laundering List compiled by the European Commission. Given the recent revelations in the press and by the Auditor General of BoC or Bank of Ceylon , activities in connection with funding the Batticaloa Campus, perhaps CBSL should take a more-proactive and strict stance in these matters to protect the country from re-entering the negative list. The Governor also gives himself a pat on the back for operationalising the Saubagya Loan Scheme although no reference, as expected, is made to the public caring by the President in this respect.
Ending 2020 history there, the speech then moves to 2021 policy prescriptions but first comes the observation that Sri Lankan economy will suffer a contraction of 3.9% in 2020, some 3 times the contraction forecast earlier in 2020 by CBSL. Then come the first of many policy announcements. Referring to 12-years of single-digit inflation, CBSL will establish and maintaining market interest rates at single digit levels going forward. Supporting this policy, the Governor points out that the business community will benefit from such low-cost borrowing, imperative to promote investment and entrepreneurship in the country, the foundation necessary for sustained high economic growth to encourage businesses, including start-ups, to venture into new industries and sectors that have high growth potential. We have to say that low interest rates alone are unlikely to generate what is described - essentially a significant leap of faith. Admittedly a low rate environment is conducive for business but ipso facto does not generate larger volumes whether out of existing or new businesses particularly from a banking system wedded closely to collateral than business plans who regard start-ups with disdain and too much hard-work. Thus, relying on rates to provide a leg up for business is a fallacy - the Governor needs to revisit basics and propose a more holistic policy for revival. Also to be taken into consideration is the possible escalation in commodity and oil prices as well as sudden expansion of pent-up domestic demand that can ignite currently subdued inflation. The other downside to low rates is the large rapidly ageing grey-haired segment that relies on interest as a major source of income. Though this risk is recognised by CBSL, pointing to mutual funds, pensions, etc. is somewhat academic as their contribution is only possible in the longer term although a start in that direction must be made now.
Next among 2021 policies is private sector credit growth forecast at around 14% in 2021 averaging 12-12.5% over the medium term. The policy, however, comes with a proviso that foreign exchange leakages for non-essential imports and outward investment are minimised, thereby permitting the domestic production to reap the intended benefits from easy monetary conditions. Almost in the same breath, the Governor says the performance of the open economy policies introduced from 1977 will be reviewed vigorously. As justification for harking back to the dark ages he provides the typical anti-market excuse – prevent being driven by short-term vicissitudes in the market and unbridled desire for short-term financial gains. In any market, the short-term is important for participants – hence we have quarterly reporting and daily market prices–as for unbridled desires, there should be active regulation – not what has been witnessed in recent times about non-banking financial institutions (NBFI) or pump and dump in the equity market. As for the policy of import restrictions to manage the exchange rate now extended for a further 6 months, smells of too little too late and the application of band-aid instead of robust policy. In fact, the import restriction is a response to indulging in big ticket vehicle imports for an extended period that generated easy money for government coffers by way of duty fed by foreign debt. Instead of advising the government to control expenditure and ensuring foreign debt was utilised to generate longer-term $ cash flows matching their repayment, rampant consumption was permitted. Referring to recent gyrations of the exchange rate, Governor issues a dire warning to market manipulators that negated his much-vaunted exchange rate policy. Given a thin market for USD, CBSL should have monitored settlement dates for the bunching or concentration of maturing letter of credit (LCs), the normal work of a Risk Management Unit. Perhaps less warning and more proactive policing would work. Also, to be noted is that a low rate environment will not only benefit the private sector but also the public sector in lowering its cost of borrowing, particularly if deficits continue to escalate. More important in this respect is the availability of savings to fund such borrowings and managing the rising trend of interest cost as a proportion of GDP.
The Governor then focuses on the Banking Sector, a regulated business in all jurisdictions, urging it to pass on the many current relaxations to benefit its customer base. More importantly, he asks the Sector to recognise the “new”normal, become more customer-oriented and develop a new business model. While congratulating the Governor on these words of wisdom, we remain unsure of any serious effort in that direction by the respective Boards and Senior Management of the Sector. The fact that the Governor has to point out the obvious does not offer much in the way of comfort. The Governor then returns to a favourite theme – consolidation of both the Banking as well as the NBFI Sector.
The policy with much benefit and foresight has been ignored for the most part by both Sectors and probably not considered necessary by their respective Boards and Management or looked upon as too much hard work for marginal gains. Relatively fat net interest margins (NIM) probably drive such thinking and retain a number of marginal players whose operating costs have to be borne by the struggling Micro, Small & Medium Enterprises (M/o MSME). Perhaps the two State commercial banks each boasting trillion-rupee balance sheets should take the initial steps by putting them to some useful purpose than simply flaunting them. Equally whether they have the management capacity to take on mergers and acquisitions (M&A) transactions remains a risk. With the expected dwindling of NIMs in 2021 as portrayed by the Governor, we hope action will result in some movement in this direction in the Banking Sector. As for the NBFIs, CBSL is indulging in an exercise much of their own making that should have been put to bed much earlier simply reeks of poor and indulgent management. Revising the Banking Act and shrinking the informal sector via the new Microfinance and Credit Regulatory Authority Act are pieces of progressive legislation that needs speedy implementation. Next, he takes aim at Sustainable Finance, the effort to green the economy of Sri Lanka. Although wholly absent in the 2021 Budget, we welcome the reference to it and the efforts underway to implement its practice. Recognising the increasing digitisation of the global financial architecture, efforts to promote and incorporate them in Sri Lanka is also to be commended.
The presentation also focuses greatly on managing the escalating public debt. It looks like CBSL has dusted the Medium-Term Debt Management (MTDM) Strategy inaugurated under a previous governor to get a grip on the mix of foreign/local debt, extending the Average Time to Maturity (ATM) of existing debt while restricting exposure to short-term debt with strong cost containment measures and reporting structures. The publication of an auction calendar 6 months ahead as well as issuance of fixed rate multi-currency Sri Lanka Development Bonds or SLDBs can also be considered advancements. The intention to re-balance the Rs.2.3 trillion EPF to obtain risk-adjusted returns augurs well for the fund while external assistance should be taken for a robust investment management process that will disable any return to previous methods of rogue trading. The Governors effort to build financial literacy, financial inclusion with a Consumer Protection Act in the offing should also be praised. Finally we point to the plethora of systems and reports that CBSL will indulge in to safeguard the financial system -
Modernisation of the existing Real-time Gross Settlement System (RTGS) and the Central Depository System (CDS) for Government securities; state-of-the-art Electronic Trading Platform (ETP) and a Central Counterparty Clearing House (CCP) for Government securities; issue of new International Securities Identification Numbers (ISINs) for 364-day Treasury bills; Shared Know-Your-Customer (KYC) Blockchain Proof of Concepts (POCs); draft of a Microfinance and Credit Regulatory Authority Act (MCRA); Group-wide Consolidated Supervision (GCS) framework; Forecasting and Policy Analysis System (FPAS); publish comprehensive Monetary Policy Report (MPR) and Prompt Corrective Action (PCA) Framework.
As we commented at the outset, the Road Map 2021 is a long journey similar to past efforts. Many promises within them remain undelivered. We trust the 2021 version will not suffer a similar outcome. While wishing the Governor much luck in its realisation, we believe a more limited effort on the important issues be undertaken. Given the Governors penchant for quotable quotes, we end with a quote from Teddy Roosevelt, the US President at age 43, and winner of the Nobel Peace Prize of 1907 taken from his speech in 1910 entitled ‘American Ideals in Education’ delivered to the Iowa State Teachers Association: “Nothing in this world is worth having or worth doing unless it means effort, pain, difficulty.”
(The writer is a senior staff journalist with nearly two decades of financial journalism experience. He can be reached at [email protected])