Sri Lanka’s Net Government Debt Soars in 2021 Due to Currency Shortage

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ECONOMYNEXT – Sri Lanka’s government external debt adjusted for foreign exchange reserves rose to 32.8 billion rupees in 2022 despite no external deficit financing during the year as money printing with a peg has created currency shortages and a decrease in foreign exchange reserves.

The government’s external debt, after adjusting for reserves, rose to 32.8 billion rupees in 2021 from 28.9 billion rupees in 2020 despite negative budget financing of US$69 million, according to central bank data. .

The debt was repaid in 2021 by depleting foreign exchange reserves and indebting the central bank, after depleting its net reserves. The central bank ended 2021 with negative net international reserves of US$423 million.

Debt after gross reserves also increased from 26.8 billion rupees in 2021 to 29.2 billion rupees in 2021.

When a central bank prints money, currency shortages arise and domestic economic agents lose the ability to buy dollars for rupees at the margin.

The government also loses the ability to repay foreign debt with rupee revenue and is forced to borrow dollars to repay foreign debt.

From 2015, monetary instability intensified as the country pursued discretionary policy involving flexible inflation targeting coupled with output gap targeting (printing money to stimulate growth), resulting in an accumulation of net external debt.

Monetary stability was only observed in 2017 and 2019 when debt was repaid on a net basis and foreign exchange reserves replenished by sterilizing inflows (deflationary policy).

When outflows are sterilized after interventions in a pegged central bank, credit and imports are boosted, above inflows in the lead.

In addition to flexible inflation targeting with output gap targeting which created monetary instability with currency crises in quick succession, Sri Lanka also began borrowing dollars to repay dollars as official policy. using ‘active liability management’.

Sri Lanka had a net public debt of US$17.2 billion (after deducting foreign exchange reserves) at the end of 2014. Inflationary policy started in the last quarter of 2014 in the form of liquidity releases as the he economy was recovering from the 2011/2012 crisis.

Net debt grew faster than the foreign financed deficit as dollars were borrowed at the gross financing level.

As a result, external debt began to skyrocket every year, liquidity injections created currency crises.

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Separately, the Ceylon Petroleum Corporation also borrowed from state banks and suppliers who also incurred debt during the years of inflationary policy.

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State banks are also struggling due to excessive lending to the CPC during years of currency instability.

In 2020, Sri Lanka was shut out of capital markets, which made it difficult for the government and state banks to borrow in international markets.

In 2021, with state banks and the government unable to borrow, the central bank borrowed and it now has negative reserves.

In 2022, Sri Lanka defaulted on its external debt after 5 of the last 7 years of monetary instability, despite the absence of war.

Sri Lanka is now jostling for US$3-4 billion of “bridge financing” in a similar strategy as foreign shortages persist, despite defaulting on most foreign debt in April.

The central bank has taken corrective action in the form of a rate hike, which is expected to reduce domestic credit.

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