Sri Lanka opposition warns on foreign borrowings, exchange rate

Aug 29, 2013 (LBO) – Sri Lanka’s main opposition United National Party has warned on continued foreign borrowings and the current developments in the island’s exchange rate market. Opposition legislator Harsha de Silva said in a statement that banks, including listed NDB and DFCC state banks are being pressured to borrow abroad to ultimately fund state expenses and loss making state owned enterprises.

De Silva said the currency was coming under pressure on account of loan repayments made by the state and the receding tide of money that came in during very loose policy by the Fed which fired a capital flow boom to Asia and other regions.

De Silva said “the stubborn fact” was that the Sri Lanka rupee instead of appreciating towards 125 as assured by authorities has depreciated to 135 to the US dollar and the currency was coming under pressure partly due to loan repayments.

Analysts say a currency comes under sustained pressure due to liquidity injections by a central bank – which increases the availability of domestic money beyond the inflows of dollars – including to offset debt payments made abroad.

If debt payments made abroad is allowed to reduce domestic credit (which may involve higher interest rates) currencies do not weaken and foreign reserves can also be kept stable.

De Silva said, a foreign fund Templeton had reported invested over 800 million US dollars at around 13 percent in 2009 and they would have made gains even if they exited this year.

Sri Lanka has been warned on excessive foreign borrowings even by rating agencies, he said.

“The UNP notes with serious concern the ‘force’ that is being applied on state banks to ‘somehow’ borrow overseas after the Government has for all practical purposes hit the maximum possible limit,” he said.

“Of particular concern is the borrowing that NSB is purportedly seeking of up to USD 1,000 million at rates perhaps close to USD 7.5 percent per annum that are clearly not going to be beneficial to NSB.

“Using the proceeds to fund ego boosting white elephants, as we now see all over this country, and to push others including Bank of Ceylon, DFCC Bank and NDB Bank for the same will certainly have disastrous outcomes.”

Sri Lanka has a soft-pegged exchange rate, which are inherently unstable because the monetary authorities target both the exchange rate and the interest rate (by printing money).

At least one analyst has noted that a key operational weakness in Sri Lanka’s exchange rate management where the Central Bank buys inflows to the government to generate liquidity even when the currency is under pressure, leads to rapid depreciation of the exchange rate.

Sri Lanka’s Central Bank was designed by US authorities who also advised Latin America and countries like the Philippines to build their central banks leading to disastrous consequences to all such countries.