Sri Lanka seeks $1.5bn in new loans from India amid loose peg break


ECONOMYNEXT – Sri Lanka has requested another US$1 billion credit from India for imports as well as a US$500 million loan for oil imports, Finance Minister Ali Sabry said while that the country is struggling with a broken floppy ankle that has triggered currency shortages.

“The talks with India are very fruitful,” Finance Minister Ali Sabry told reporters during an online briefing speaking from Washington.

“During talks at official level with the Honorable Minister of Finance of India (Nirmala Sitharaman), it was agreed to provide US$500 million oil facility. In addition, we have requested another billion US dollars for the imports they are considering.

India has already extended US$1 billion in loans to the State Bank of India for food and medicine imports. So far, only US$200 million has been used, Sabry said.

India has also deferred cross-border payments owed by Sri Lanka for imports under the Asian Clearing Union up to US$1.4 billion, he said.

India agreed to defer payments until January, he said.

Sri Lanka is unable to limit dollar outflows to inflows due to a loose peg broken by open market operations (money printing) which creates currency shortages.

Finance Minister Sabry and a team from the central bank and Treasury are negotiating with the International Monetary Fund for a program meeting with senior officials and also having discussions at the technical level.

However, the IMF does not disburse money until monetary stability is restored, usually as a prior action.

Otherwise, its disbursements will be wasted in central bank financing of imports like Indian credits.

This time, debt sustainability (restructuring debt to reduce gross financing needs) is also a prior action. The IMF said any disbursement under a rapid funding facility would also require debt restructuring as a prior action.

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An attempt to restore monetary stability by moving the peg to a float by completely suspending convertibility (not selling or buying dollars) failed due to a redemption requirement (strong sideways convertibility) that pushes the currency down.

Unable to re-establish a clean float or credible peg, Sri Lanka therefore scrambles for dollars as “bridging finance” obtaining inflows through the financial account, increasing external debt which in turn will stimulate imports (will increase the deficit current account).

Sri Lanka engaged in similar tactics after triggering currency shortages (breaking peg credibility) in 2015/2016 and 2018 when taxes were raised and fuel was at market price and that borrowings via international sovereign bonds have been made.

During the soft peg crisis of 2020, however, Sri Lanka was shut out of the debt markets. The state banks that loaded the ill-fated Ceylon Petroleum Corporation with debt when the money was printed also lost the ability to do so, and India is now extending oil credits.

For the CPC to “buy rupees” to “pay dollars” to suppliers, the central bank must restore monetary stability.

To repay external debt “to buy dollars” with rupees raised through taxes or borrowing (which will crowd out private sector imports until new notes are printed), the central bank must restore the monetary stability.

Instead of “buying dollars” with rupees from the national credit system linked to the rupee monetary base, Sri Lanka has introduced an Asset and Liability Management Act under which l he money was collected abroad via a credit system linked to the American monetary base (euro dollar market) external debt.

Sri Lanka is now trying to secure “bridge financing” with a broken peg despite the suspension of external debt repayments and the possibility of carry-forward savings to the level of gross budget financing.

Sri Lanka is also in talks with the World Bank, Asian Development Bank and China for new funds.

Sri Lanka has a habit of blaming policy errors inherent in the central bank of the intermediate regime (loose peg with peg conflicts) on budgets, taxes, imports, trade deficit and current account deficit in a extraordinary commercialism.

The Sri Lankan rupee fell from 203 to around 340 against the US dollar when the float failed, triggering a currency meltdown and potentially hurting the banking system as well. (Colombo/April 23/2022)

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