Reserve outflows ring alarm bells

From left: Sampath Bank PLC Director Deshal de Mel, Thomson Reuters Client Specialist Ritika Siddavaram, Frontier Research CEO Amal Sanderatne and Capital Alliance Chief Strategy Officer Purasisi Jinadasa Pic by Kushan Pathiraja

By Chandeepa Wettasinghe
Sri Lanka’s economy could possibly be at the early stages of spiralling into another crisis if the trend of reserve outflows experienced recently were to continue, the country’s leading economic analysts told a forum organised by a top commercial bank in Colombo, this week. 

Frontier Research (Pvt.) Ltd CEO Amal Sanderatne explained that in the past decade, a US $ 2 billion dip in reserves over a period less than two years has always led to an economic crisis. “The reserves in the economy are one indicator that gives us a pretty good idea. Every time the reserves fall more than US $ 2 billion, we’re in trouble. This has steadily happened, whether they (politicians) deny we’re in trouble, whether in 2008, 2011 or more recently,” Sanderatne told a forum tiled ‘Emerging Trends on International Trade’, hosted by Sampath Bank on Tuesday. 
Sanderatne noted that the reserves, which had begun making gains this July, had experienced a significant decline in October and November.

“Again, there seems to be a bit of a downturn. This is the number one thing to track. Does it keep going up or aren’t we getting out of the negative part of the cycle?” he pondered and went on to say, “We would like to have a positive cycle, hopefully, but we can bet on this continuing.”
The outflows seem to stem from the speculation of a Fed rate hike, as well as the strengthening of the dollar and US Treasury yields after the US elections. Also, the outflows were despite Sri Lanka receiving two tranches of the US $ 1.5 billion International Monetary Fund facility. 
Sri Lanka’s reserves improved to US $ 6.5 billion in July, up from US $ 5.2 billion in June, due to an international bond issuance and a syndicated loan facility. The reserves had remained relatively stable for the next couple of months, until recording a slip to US $ 6.1 billion in October.
Sanderatne said that if there is a US $ 2 billion deterioration in the reserves, there will be great pressure on the interest rates and currency.
Capital Alliance Chief Strategy Officer Purasisi Jinadasa added that there could also be pressure on the reserves arising from the maturing of massive corporate debt that had been drawn in the past. Sri Lankan financial institutions particularly had opted for foreign debt.
It should be noted that Finance Minister Ravi Karunanayake recently retracted his budget statement of utilizing the US $ 1 billion proceeds from the sale of state-owned enterprises next year for government debt repayment and said that such funds would instead be channelled to the reserves.
While the latest outflows may be due to influences beyond Sri Lanka’s control, Sanderatne echoed Central Bank Governor Dr. Indrajit Coomaraswamy’s take on past budget deficit-driven crises of Sri Lanka.
Sanderatne said that he had been hoping for a more positive cycle until the Trump ascendance, which has created confusion, but noted that the Sri Lankan government, while having set fiscal targets, which may be a bit too optimistic, would still come quite close to their targets in 2016 and 2017.
Dr. Coomaraswamy had also expressed his cautious optimism about fiscal operations in 2016 and 2017.

Sanderatne noted that as a base case, the rupee relative to the dollar might slip from the current Rs.150 to mid to high 150s over the course of next year, while the T-bill rates would fall from the current 10 percent rate to anywhere up to 7.5 percent. Jinadasa, while reflecting Sanderatne’s view on the rupee, said that the interest rates may increase and the consumption levels would fall by double digits. Both however noted that all would depend on how Trump’s presidency affects Sri Lanka.