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FINANCIAL CHRONICLE™ » DAILY CHRONICLE™ » Sri Lanka external stability: retaining investor confidence is key: Moody's

Sri Lanka external stability: retaining investor confidence is key: Moody's

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CSE.SAS

CSE.SAS
Global Moderator
Retaining the confidence of external portfolio investors in key to maintaining stability in the exchange rate and balance of payments, Mood's Investors Services has said.

Sri Lanka has about 3.0 billion US dollars of investors in Treasury bills and stocks, Moody's said in a March report on Sri Lanka - The Post-IMF Backdrop: Downward Growth Pressures and Elevated External Pressures.

Sri Lanka dropped plans last month to go for a second International Monetary Fund follow up program after its 2.5 billion US dollar bailout program ended in 2012.

Moody's said its external vulnerability indicator (EVI) which measures whether foreign reserves are enough to cover debt maturing over the next year, was high at 124 percent in 2013, through slightly down from 132 percent in 2012.

Portfolio investors in Sri Lanka had about 3.0 billion US dollars in Treasury instruments and stocks.

"Retaining confidence of portfolio investors will be key for balance of payments and exchange rate stability, given the volatile nature of such short-term capital both within Sri Lanka and elsewhere, and Sri Lanka’s relatively thin official reserve coverage," Moody's said.

Analysts say in Sri Lanka's experience external stock investors have posed little threat to the exchange rate in the past as they get locked out of the island's illiquid markets when monetary conditions tighten

Stock prices also fall rapidly because there is no mechanism to provide liquidity to domestic buyers.

In 2010 for example foreign investors were able to exit because state-run Employees Provident fund was in the market. Foreign investors in the past had tended to mostly hold fundamentally strong stocks.

In Treasuries markets however, where commercial banks and primary dealers are involved, the central bank tends to print money through its several facilities and provide liquidity.

The Central Bank tends to print and inject money when conditions tighten and interest rates rise (the price of bonds falls) because there is a target policy interest rate.

When the central bank tries to maintain and the exchange rate by using up the foreign reserves to give dollar liquidity, while also injecting rupee liquidity, (sterilizing foreign exchange sales) to keep rates down, a so called 'balance of payments crisis' develops.

A vicious negative feeback loop of credit and imports, can then deplete any amount of foreign reserves rapidly, even in the absence of any fleeing capital.

In the 2011/2013 balance of payments episode, foreign investors stayed put, and credit growth picked up to unsustainable levels driven by central bank credit (printed rupee reserves inserted in to the banking sector by central bank purchases of Treasury bills).

From mid 2012 Sri Lanka allowed interest rates to rise, allowed the exchange rate to move in line with liquidity injections and also raised energy prices, to slow bank credit taken by loss-making state energy utilities.

The rupee after falling to 134 then started to appreciate.

Slower credit growth has also allowed the central bank to sterilize foreign exchange purchases (buying dollars and withdrawing liquidity) reversing the cycle of activity that takes place in 'BOP crisis', generating a positive feedback loop.

Sri Lanka's foreign reserves had since climbed.

In 2012 central bank also transferred its year-end profit to the Treasury not as rupee liquidity but as a book entry against maturing Treasuries, again locking up foreign reserves and preventing potential consumption and credit.

Meanhwhile Moody's said national debt was down from 105 percent of gross domestic product levels a decade ago though it estimates the ratio to have climbed to 85 percent of GDP, from 78.5 percent a year earlier.

But it expressed concerns about the volume of interest rate payments.

"External debt has been primarily concessional in nature, but this trend is reversing as Sri Lanka has attained ‘middle income emerging market status’ and increasingly depends on commercial financing," Moody's said.

"The fiscal burden of servicing this debt is high, and interest payments amounted to as much as 38 percent of revenues in 2011.

"Debt affordability, according to this measure, remains amongst the weakest of all rated sovereigns, barring that of Lebanon (B1/Stable)."

Sri Lanka is rated B1/Positive by Moody's.

http://www.lbo.lk/fullstory.php?nid=1221182289

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