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Sri Lanka’s macroeconomic position and foreign reserves improve with fragility

By: Staff Writer

April 08, Colombo (LNW): Almost two years after defaulting on its external debt payments, Sri Lanka’s macroeconomic position and foreign reserves have improved, but remains very fragile although the World Bank’s projection of moderate growth of 2.2% in 2024, World Bank report revealed.

The continued external debt service suspension, inflows from development partners, large purchases of foreign exchange, and postponed repayments on existing credit lines have helped build usable official reserves to about 3 months of imports (US$4.9 billion by end-March  2024, compared to US$500 million in December 2022).

But this improvement is fragile. First, excluding currency swaps, “usable” reserves cover only 2.3 months of imports according to the IMF.

Sri Lanka’s gross official reserves grew 431 million dollars to 4,951 million US dollars in March 2024 from 4,520 million dollars in February, data from the central bank shows.

Gross official reserves include both monetary and fiscal reserves of the government that usually come from loans and grants.

Though gross official reserves are listed as 4.9 billion dollars by March, data shows that by February, the central bank’s net foreign exchange position was a negative 2.2 billion US dollars due to its borrowing.

The central bank bought over 400 million dollars in January and February and also allowed the exchange rate to appreciate amid deflationary policy.

The central bank had loans to India, the IMF and it had 3.2 billion dollars in swaps by February 2024, and they are being progressively being settled with reserves collected from deflationary policy or mopping up dollars bought outright from current transactions.

By engaging in swaps with domestic counterparties, the central bank can effectively print money, mis-target rates if the generated rupees are not mopped up, and leave the monetary accounts saddled with a debt in case the money is used for ‘reserves for imports’

Secondly, the recovery in external accounts results mainly from international financial aid, the suspension of payments of debt principal on the government’s external debts, the reduction in imports (a consequence of the economic crisis) and restrictions the central bank has imposed on imports, capital outflows and foreign exchange.

 These restrictions remain in force, even though they have been significantly relaxed since the summer. With the return to growth, the country would expect an increase in the current account deficit.

In addition, the restructuring of the government’s external debt has still not been finalised. The government must rapidly reach an agreement with private creditors to respond to the IMF’s requirements and cover its financing needs.

So far, however, although it reached an agreement in principle with public creditors in November 2023, discussions with private creditors (who hold 61% of the government’s external debt) are on-going. The IMF’s programme is extremely ambitious and the risks that the government will not meet the objectives set are thus very high.

 Any such failure would result in the release of the IMF loan being suspended and the government losing access to the foreign currency financing on which it is totally dependent, Finance Ministry sources said.

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