Sri Lanka’s risks already flagged by experts
Euromoney’s country risk survey has been pointing to its current predicament for some time.
The economic and political problems plaguing Sri Lanka were always expected to occur, according to the score changes in Euromoney’s risk survey, as economists and other experts monitoring the country downgraded the factors underlying its investor prospects.
Sri Lanka was marked down again in the first quarter of 2022, extending a longer-term trend of decline stretching back five years, highlighting the country’s increasingly risky nature from an investor perspective. This was worsened by the pandemic and the loss of tourism, ultimately causing a mounting fiscal crisis and lack of access to international markets.
Diving 74 places in the global risk rankings since 2017, to 148th out of 174 countries, Sri Lanka has crashed into the lowest category (tier five), representing the highest risk investments of all. That puts it on a par with Congo Republic, El Salvador, Algeria and Mozambique, among other extreme risk options:
An upsurge in anti-government protests over food, fuel and power shortages, prompting the cabinet to resign in early April, had been highlighted by a steady downgrading of the survey’s government stability indicator.
Along with similarly large downgrades to the information access/transparency and government non-payments/non-repatriation indicators, it was little surprise the government was forced into announcing a selective default on its foreign debts.
Its debt ratings and capital access scores had already taken a hit in 2021.
With the currency crisis worsened by low levels of tourism, shrinking foreign exchange reserves and import restrictions contributing to inflation, making it very difficult to maintain payments, the authorities have had no alternative but to seek a bailout from the IMF.
Outlook
Sri Lanka’s economic risk indicators have all been downgraded in unison. Not one of the five indicators measuring bank stability, economic growth, currency stability/monetary policy, employment/unemployment and government finances is now scoring more than four points out of a possible 10 in total.
The short-term outlook is concerning. According to the IMF’s latest forecasts, released in April, consumer price inflation is seen accelerating from 6% in 2021 to 17.6% this year, with the balance of payments current account deficit widening from 4.3% of GDP to 7.1% of GDP.
These forecasts are already worse than those published by the IMF in March in its regular Article IV Consultation report, while inflation has been consistently rising and skyrocketed the same month to 18.7% year-on-year.
The net effect [of the currency board] was economic stability – and while stability might not be everything, everything is nothing without stability- Steve Hanke
Achieving real GDP growth averaging 2.6% this year, down from 3.7% in 2021, may now be more hope than expectation. Growth slowed to 1.8% in the fourth quarter of 2021, and with the currency down, inflation up, and borrowing rates ratcheting, recession seems the more likely prospect.
The IMF’s report also indicated that foreign exchange reserves had fallen to one month’s worth of imports coverage, and that the fiscal deficit would be around 9.6% of GDP in 2022, coupled with a public debt burden of 120% of GDP, but these metrics may also be worse.
The authorities are being urged to tighten monetary policy, raise taxes and loosen the exchange rate. Street protests underline the scale of the humanitarian crisis and growing resentment towards the ruling Rajapaksa family, albeit providing a unified voice across the ethno-religious and sectional divide demanding change.
No confidence
The opposition is carefully moving to gather sufficient support against the government to bring a no-confidence motion with a draft bill to make political governance reforms, but clearly much more needs to be done.
Steve Hanke, a professor of applied economics at the Johns Hopkins University and a member of the Euromoney Country Risk experts panel, calculates his own inflation measure for Sri Lanka, which he says is running at 116% per year, with the Sri Lankan rupee's depreciation against the US dollar since Gotabaya Rajapaksa won the Presidency in 2019 at a cumulative 54.7%.
To combat this crisis, Hanke is calling for the introduction of a currency board, which it had (prior to its name change from Ceylon) from 1884 to 1950. Such an arrangement commits the country to converting domestic currency on demand at a fixed exchange rate with the currency board holding reserves at the fixed rate of exchange to at least 100% of the value of the domestic currency issued.
“Like all currency boards, the Ceylon board issued notes (of five to 1,000 rupees) convertible on demand into a foreign anchor currency (Indian silver rupees) at a fixed rate of exchange. It held anchor-currency reserves equal to 110% of its monetary liabilities,” says Hanke.
Most importantly, he adds, “the board could not loan money to the fiscal authorities, imposing a hard budget on Ceylon’s fiscal system.”
“The net effect was economic stability – and while stability might not be everything, everything is nothing without stability.”
Whether the authorities will heed Hanke’s advice is an open question. What is clear, though, is that the high-risk investor environment in Sri Lanka is likely to remain for some time. Euromoney’s metrics have been highlighting that.
