THE EBB AND FLOW OF EXTERNAL RESERVES
Shiran Fernando reviews trends in Sri Lanka’s external reserves
Quite often, growth, inflation, and currency and interest rates hog the headlines when the economy is being assessed and reviewed. While these are important variables for Sri Lanka, reserves deserve equal attention. In an economy such as Sri Lanka’s, reserves could be labelled as one of the most important leading indicators.
RESERVE MOVEMENTS In the last five years (i.e. January 2012 to December 2016), reserves have touched a high of US$ 9.1 billion (in August 2014) and a low of US$ 5.2 billon (in June 2016). The five-year average during this period has been 6.9 billion dollars.
Within this timeline, the Sri Lankan Rupee has slumped from 113 against the US Dollar to nearly 150. This movement in the currency could in part be explained by the volatility and lack of growth in reserves to cushion against external shocks.
CRITICAL BAROMETER Despite securing the International Monetary Fund (IMF) loan facility in June 2016, much against expectations, Sri Lanka’s reserves have not increased. They fell short by US$ 1.8 billion from the end target of 7.8 billion dollars forecasted by the IMF in 2016.
The IMF advised the Central Bank of Sri Lanka (CBSL) to build up reserves by purchasing dollars in the market, thereby allowing more flexibility for the local currency. The Central Bank is heeding this advice.
DEFEND AND RELEASE The above advice is contrary to the actions of CBSL in times of currency pressure, when it sold dollars from reserves to withstand depreciatory pressure. Central Bank Governor Dr. Indrajit Coomaraswamy explained this during a speech at the ‘Road Map – Monetary and Financial Sector Policies for 2017 and beyond’ presentation at the beginning of the year.
He stated that “wasting large amounts of the country’s external reserves – much of it borrowed – in a vain effort to defend the currency, which has to be ultimately depreciated anyway, is clearly unsustainable.”
This statement was strongly backed by evidence with Coomaraswamy highlighting the fact that during the 2011-2012 period, CBSL utilised about US$ 4 billion in external reserves to defend the rupee, which eventually depreciated by around 14 percent against the dollar.
TEMPORARY BOOST Over the last seven years, Sri Lanka has been very reliant on building up reserves through commercial debt. Since 2009 (barring 2013), Sri Lanka has issued sovereign dollar bonds in international capital markets. These borrowings have intensified over the last two years with US$ 2.15 billion and US$ 1.5 billion raised in 2015 and 2016 respectively.
The issuance of such dollar debt has largely provided a temporary improvement in reserves. An example of this was the bond issue of US$ 1.5 billion in November 2015: reserves increased to US$ 7.2 billion by end November in comparison with the previous month’s 6.5 billion dollars. However, by January 2016 (a mere two months later), reserves fell back to US$ 6.3 billion.
It is interesting to note that this has been a common trend as the dollars received through these bond issuances have been used to service debt.
BORROWED RESERVES The IMF review in December 2016 mentioned that CBSL and IMF staff had agreed to “reduce the reliance on borrowed reserves.”
CBSL has also been reliant on swaps both with domestic banks and with the Reserve Bank of India (RBI). The latter has been quite popular in recent times with the RBI, whereby CBSL receives dollars and RBI receives Sri Lankan Rupees.
However, this is not a very long-term arrangement because when these instruments expire, the Central Bank has to reimburse in dollars. In most times when CBSL has been short of dollars to repay a swap, there’s also been a subsequent decline in reserves.
PERCEPTIONS OF RISK Varied risk matrices consider reserves to be a key component. Sri Lanka performs poorly in the context of the absolute level of imports and reserves in terms of months of import cover (i.e. the expected number of months that reserves can cover a country’s import bill). The latter has hovered under comfortable levels in recent years as reserves have ebbed and flowed.
In the latest Bloomberg country risk score, Sri Lanka recorded a relatively low score. A key reason for this has been reserves adequacy, which was in high-risk territory.
EXPORTS AND FDI The Central Bank in most times has been left helpless, resorting to using reserves to defend against external pressures and debt repayments.
Reserves have been exposed due to a lack of growth in export earnings and lacklustre foreign direct investment (FDI) inflows, which now need to support the building up of reserves.