Sri Lanka’s former finance minister Mangala Samaraweera warned of an economic collapse as a political crisis triggered by President Maithripala Sirisena’s controversial appointment of a Prime Minister left foreign investors shaken and the country was hit by the first credit downgrade.
“We managed the economy very carefully trying to put as little burden on the people as possible, because we inherited a lot of debt,” Samaraweera told reporters.
“But the political crisis has now put the country on the path of a crisis.
“As a result of these actions, Sri Lanka is on the brink of economic anarchy and chaos as never experienced before.
“The cavalier and irresponsible actions of the president starting on October 26th based on personal animosities and precipitating a series of illegal acts, places at risk Sri Lanka’s ability to meet its immediate debt obligations.”
Moody’s Investors Services downgraded Sri Lanka’s speculative B1 rating by a notch to B2 late Tuesday.
De Silva, said he had learned that Moody’s was planning to downgrade Sri Lanka’s and the central bank had appealed to the rating agency to not to do so until a political crisis was resolved.
“We also appeal to Moody’s not to downgrade, until the political crisis resolved,” de Silva told reporters in Colombo, minutes before the rating agency made its decision public.
Moody’s said foreign reserves were falling, external and domestic credit was tightening.
Conditions were “exacerbated most recently by a political crisis which seems likely to have a lasting impact on policy even if ostensibly resolved quickly, have heightened refinancing risks beyond levels anticipated when the rating agency affirmed the rating at B1 with a negative outlook in July.”
Sri Lanka’s Parliament has already passed two votes of no-confidence on newly appointed Prime Minister Mahinda Rajapaksa.
De Silva said President Sirisena had to take responsibility for the economic consequences of his decisions, which will hit ordinary people.
Samaraweera said without a budget in place and recognized Finance Minister Sri Lanka would not be able to repay debt or pay salaries in January.
De Silva said a billion US dollar bond was maturing in January which had to be repaid.
That bond was trading for as much as 9 percent since the crisis began, he said, showing the fall in investor confidence.
Central Bank Governor Indrajit Coomaraswamy said last week that there was enough money to repay the bond.
There are also other regular loans to be repaid especially in December to other lenders.
“We are being pushed towards a state of economic collapse as we stumble on to a road of a Greece like situation,” Samaraweera warned.
Greece however was part of a currency union and had the Euro to keep the lives of ordinary people stable.
When the currency in use is hard (such as US dollars or Euro), there could be sovereign default but people’s salaries will be intact and inflation will not sky rocket.
But when the money is a soft-peg to the like Sri Lanka where central bank prints billions of rupees while defending a peg to keep rates down the currency can slide rapidly, push up prices and destroy not just government debt but also private debt (bank deposits) and salaries (Sri Lanka and Ecuador; a cautionary tale of the Rupee and Sucre: Bellwether).
Sri Lanka’s rupee had already been de-stabilized by trying to operate an inflation-targeting framework with a reserve collecting soft-peg, aided and abetted by the International Monetary Fund.
Under IMF program Sri Lanka has to collect foreign reserves, requiring it to consistently operate a peg that mops up (sterilizes) inflows by shrinking domestic credit.
But the regime suddenly shifts to a floating rate with a domestic anchor made up of a wide near-double-digit inflation target with unsterilized excess liquidity collected during the pegging period intact, sending the rupee sliding down forcing currency defence.
While defending the peg to avoid what is called a ‘disorderly adjustment’ the central bank then prints tens of billions of rupees to keep rates down, which analysts point out is another soft-peg with a downward shifting convertibility undertaking.
When a central bank prints money to sterilize interventions, boosting domestic credit, no dollars can be collected to repay loans.