Sri Lanka's Currency Crises….
…A Turn of The Screw
Last month Sri Lanka declared a state of emergency over food shortages, as essential food items have skyrocketed in price. There are groups of people hoarding basic food items such as sugar, rice, onions, and potatoes to sell at artificially high prices, adding to people’s misery. This is the story from government officials, they have increased penalties for food hoarding and arrested several people caught in the act. Food prices globally have been rising since the COVID19 pandemic began and supply chain disruptions have impacted farmers and food producers everywhere. Net food and fuel importers like Sri Lanka are hit particularly hard.
The root cause of this crises is a lack of USD availability for food importers, although government officials have not focused on that too much publicly. Most goods in the world are traded in USD, and a shortage of USD dampens the ability to make cross-border payments for the buyer. As a simple rule of thumb, the International Monetary Fund (IMF) recommends countries have enough USD to cover at least 3 months’ worth of imports at any given moment in time (import cover).
In July this year Sri Lanka paid back $1bn of debt using money from its foreign exchange reserves. Consequently, import cover fell to below 2 months, however this has improved now (up 26% to $3.55Bn) after the new IMF SDR’s allocations last month.
The Sri Lankan Rupee is one of the worst performing currencies vs USD in 2021, there is no spot market and the forward cover is banned. Authorities have already banned the imports of cars, and many other non-essential goods to restrict outflows of USD. Prices have stayed elevated for now, with annual inflation in August at 6% (at top end of the central bank’s target range of 4-6%). In attempt to counter inflation and alleviate some of the pressure on the currency, the central bank has raised the policy rate by 0.5% last month.
There is also a debt repayment of $1.5bn in January 2022 due, which the authorities say they will repay, but bond investors have a different view. A gauge by Bloomberg on how likely a country is to default on its debt puts Sri Lanka at around a probability of 28% (record high for an Asian nation). The total debt payments due in 2022 are around $5Bn. Ratings agency S&P have downgraded the debt of Sri Lanka to CCC- from CCC+ and issued a negative outlook.
Authorities have not made any announcements about seeking help from the IMF, although there are rumours that they are.
Tourism (5% of GDP) and remittances (8% of GDP) are a major source of USD for the country. Remittances have recovered from their 2020 low. China, India, and Bangladesh have also helped with the USD shortage by providing USD swap lines (effectively a cheap USD loan), it has not been enough.
The tourism industry has completely collapsed, and with it the inflow of USD. Below shows the number of tourists arriving in Sri Lanka. Between 2015 - 2019 there were on average 2 million people visiting Sri Lanka per year, with each person spending $150 on average. Direct and indirect employment in the tourism industry (3% of the total workforce), has fallen from above 400k in 2019 to roughly 350k in 2020.
Despite the efforts to stabilise the currency by the central bank, success has been limited. Until global travel activity returns back to somewhere near its historic norms, Sri Lanka will struggle with USD inflows. Unless of course they seek help and agree to go on an IMF program, which will come with restrictions on government expenditure. Bond investors will be keeping a close eye on the likelihood of this occurring. In the meantime, there is a new sherif in town, the central bank governor has been replaced with former State Minister of Money and Capital Markets Nivard Cabraal more here.
Have a gracious Sunday all and thanks for reading.
Insightful as always
Great article