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Lanka's economy heads for disaster?

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Lanka's economy heads for disaster?
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  • Expert group says situation like "an accident waiting to happen"
  • Politics an extension of war, President and Ranil to meet Indian PM next week

Thursday's budget overshadowed other events to become the focal point of attention for Sri Lankans in all lifestyles. This is notwithstanding the remarkable victory of Barack Hussein Obama at US presidential elections on Tuesday. The Democratic Party president-elect has won the hearts of millions in not only the US but also the world over.

For the Government that is marketing its virtues, the budget proposals are encapsulated in a one-liner - substituting imports, saving foreign exchange and giving pride of place to local industry. The opposition's counter, interesting enough, is also a one-liner. One of them said the left hand has taken away what the right has given to the public.

In the past two days, the good and the bad of the budget have been disseminated in the media. More views on how it benefits or affects the Sri Lankan public appear elsewhere in The Sunday Times. Whatever the merits or the demerits are, it is abundantly clear that the Finance Minister, who is President Mahinda Rajapaksa, did not present an "election budget," one that offered all the goodies to help the ruling party win votes and return to power. There indeed was an anti-climax to it.

The reasons are significant. Most important is the global economic meltdown. The government has recognized the warning signs of what it means to Sri Lanka. It was only a week earlier that the rupee was de-linked from the dollar and allowed to float. Tea exports, one of the largest revenue earners, have been badly hit with half of the country's production lying in warehouses. The regular buyers were shying away.
Another important reason is the ongoing military campaign. It is no secret that the re-capture of Kilinochchi, once the political epicentre of Tiger guerrillas, would pave the way, if not for dissolution of Parliament and subsequent general elections, at least more provincial council elections. Such a move, it was argued, would see the return of the ruling party with an overwhelming majority, either at national level or at provincial level. Such an argument is not without justification.

Yet, for the past two months or more, going, going but not going to Kilinochchi has been a great damper on the government's timetable. Making it worse was the October 28 twin air raids by the guerrillas on the Army's Area Headquarters for Mannar and the Kelanitissa power station in Colombo. That it embarrassed government leaders is no secret. The matter figured at top-level security conferences. More so, since senior officials and security top brass had repeatedly asserted the invincibility of the skies, particularly over the City of Colombo and the immediate suburbs.

This is with the installation of modern air defence systems and the ability to intercept and shoot down guerrilla aircraft. That a ramshackle aerobatic trainer, described by Media Minister, Anura Priyadarshana Yapa as a "crop duster" (aeroplanes used for spraying farms to rid them of pests) could even force the closure of the Colombo airport for some hours did not augur well. Last year, it had forced the total closure of the airport at nights for four long months.

In the wake of the global economic meltdown, a market commentary by Citigroup Global Markets Asia describes Sri Lanka as "an accident waiting to happen." Here are some excerpts:

"Sri Lanka's FX (foreign exchange) reserves have fallen to an accelerated pace in the last month (October), with CBSL (Central Bank of Sri Lanka) Governor recently saying FX reserves are now down to US $ 2.6 billion in late October from $ 3.1 billion in September and $ 3.4 billion in August. We think Sri Lanka is vulnerable to sudden stop of capital flows and the Sri Lankan rupee (LKR) is unlikely to hold at current levels.

"Two major factors that are driving the decline in FX reserves -

  1. Foreigners exiting Sri Lanka T-bill and bond market - it is estimated that foreign holdings fell from $670 million in early October (we were told foreign holdings were $150 million in T-bills and $520 million in bonds in our early October trip) to now around $380 million in bonds and bills combined;
  2. CBSL has been intervening in the market to keep LKR stable with CBSL estimated to have sold about US $600mn to the market in the last two months.

"How externally vulnerable is Sri Lanka? We think they are very vulnerable though how close is a bit unclear. We have repeatedly argued that Sri Lanka is the most extremely vulnerable country in the region, as highlighted in our recent report….

"If we look at IMF's figures of short-term external debt by remaining maturity, the figure is about $3.5 billion for 2008, while Fitch's figures, which we are told is only "original maturity: is at $ 2.9 billion in 2008F and $3.1 billion in 2009F. Current FX reserves can't cover these drains and will need refinancing in an environment where capital markets are seriously impaired. Their recent announcement (October 7) seeking proposals for a $ 300m syndicated loan looks very difficult under the current environment.

"The CBSL argues that IMF's figures are overstated as they include dollar denominated Sri Lanka Development Bonds (SLDBs), outstanding amount is at $1.4 billion, which because of capital controls, does not represent capital flight if local banks do not rollover. However, it is not entirely clear how that would tally with Fitch's figures. According to CBSL, the projected debt payments over the next 12 months are only about $ 1.2bn - US$ 900 million for the government and $300 million for corporate, but we think these figures look too low when public external amortizations alone was $1 billion in 2008 and we expect that figure to be rising each year given the chronically high budget deficit.

"We also expect the FX reserves to continue to come under pressure - we think there is still more near-term pressure of foreigners liquidating their LKR bonds and bills, especially if LKR is at increased risk, thus, presenting possibly another $380m possible outflow (assuming foreign holdings could go to zero). We also think the $100 million NEXI-guaranteed loan due in December may not be rolled over.

"There is also a lot of ambiguity about the payment terms of the $700 million Iran oil facility, which we think could start in 2009F but is not yet being factored into the government's external debt repayment projections. Moreover, even the US $150mn 3-year loan to Sri Lanka in March (from Standard Chartered) has annual puts which could be exercised next year.

"Lastly, Sri Lanka's current account is now projected to hit a deficit of 7% of GDP ($2.1 billion) in 2008F and our economist expects it to remain very high in 2009F (at 3.1 billion deficit) on the back of an unexpected slump in export growth. With capital markets unlikely to revert to normality in 2009F and Sri Lanka remains highly reliant on debt-related capital inflows (plus over $ 1 billion in official flows), we think BOP (Balance of Payments) will likely remain under pressure in 2009F."


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