Sri Lanka Currency Line No Predicament Swap

After months of delay, the People’s Bank of China approved an RMB 10 billion swap line with Sri Lanka.  The announcement instantly buoyed the USD 1 billion sovereign bond due in July as the yield plunged 10%-points to 18%. The swap line will boost dwindling foreign reserves, which in February fell to USD 4.6 billion from USD 7.9 billion in the same month last year. The central bank has plowed through reserves to support the currency. In January alone it sold USD 75 million to defend its “soft peg” at around 185/USD.

The swap line is part of a broader strategy to boost reserves as the government insists it will not default and condemns predictions as “doom-mongering and plotting.”  The central bank last month mandated that exporters convert 25% of repatriated FX earnings within two weeks of arrival, and now is requiring that earnings are returned to the country and converted within 180 days from the date of shipment.  Last month it raised USD 8 million from export proceeds. In addition, as pandemic pressures mounted in the first half of 2020 the central bank introduced import restrictions to stem the use of hard currency as tourism receipts and exports collapsed.  In 2020 tourism revenue sank to USD 957 million from USD 4 billion a year earlier.

While import restrictions narrowed the trade and current account deficits as a percentage of GDP to 7.1% and 1.1%, respectively, pressure on the latter is expected to mount this year. Continued government resistance to an IMF program and recent sovereign downgrades will result in minimal foreign direct or portfolio investment while tourism is not expected to rebound until 2023.  In addition, the sharp rebound in commodity prices, especially oil, will further pressure the balance of payments even as mainstay agriculture earnings rebound. Low oil prices and reduced demand last year cut the import bill by 30% from a year earlier. This year’s budget planned for crude at USD 59/barrel and oil prices are already up more than 300% from 2020’s low.

The stock exchange has fallen 13% so far this year in dollar terms on the MSCI Frontier Index as worry about the economy mounts after output contracted 4% last year as total public debt approaches 100% of GDP. Fitch Ratings has cautioned that the banking sector’s access to foreign funding is at risk after the sovereign was downgraded to ‘CCC’ late in 2020.  While several banks have secured equity investment or loans from foreign counterparts, others have tapped the World Bank’s IFC or are holding talks with other development finance institutions for funding lines, according to Fitch.  The ratings agency noted that the sector has a high foreign currency loan/deposit ratio of over 100%, warning that “liquidity risk remains high.”  Moreover, local banks hold some USD 300 million of the sovereign’s 2021 bond, according to the government, which has since banned international sovereign bond buying.

The new swap line from the PBOC may allow Sri Lanka to muddle through this year. While local media reports that the government could tap the Crude Oil Price Stabilization Fund established last March when prices sank, government officials have publicly noted that the fund exists in name only. The Superintendent of Public debt has revealed that the country started 2021 with USD 6.8 billion of foreign currency denominated debt, USD 2.5 billion domestically owned and  the Treasury Secretary has indicated that it expects these commitments to be rolled over.  At the same time, evidence of local investor loss of confidence is growing as domestic investors shun local Treasury bond sales, resulting in money printing by the central bank so it can take on more government debt. Even if the government manages to meet all foreign currency debt payments this year, 2022 will be another year of reckoning with foreign currency obligations estimated at USD 6.8 billion as debt/GDP surpasses the critical triple-digit mark, and official and private sources alike tire and are tempted to close the curtain for the endless improvisation act.  

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