“I’m confident that possibilities of debt default would fall into the realm of the highly unlikely”, Prof. W.D. Lakshman, Governor of CBSL

Born in the coastal village of Mihiripenna in the Galle District, Deshamanya Professor W.D. Lakshman, began his uphill climb in 1964 as a Lecturer at his alma mater, the University of Ceylon in Peradeniya. He concluded his doctoral studies at the University of Oxford in 1973. Today, he sits at the helm of the Central Bank of Sri Lanka as the Governor. He has held various positions of increasing responsibility including Vice Chancellor of University of Colombo. As the pioneer Vice Chancellor of Sanasa University Institute in Kegalle, Prof. Lakshman takes great pleasure in having played a lead role to build it up.

Narrating his illustrious career journey of over five decades, Prof. Lakshman stated, “I began my lecturing career in my alma mater, University of Ceylon in Peradeniya, immediately after completing my degree programme in 1964. I worked at the University of Peradeniya for 17 years until resignation in 1981, to join University of Colombo to take up the Departmental Chair of Economics there. I served the University of Colombo for over 25 years before retirement as Senior Professor in 2007. At the University of Colombo, I held the positions of Head – Department of Economics, and Dean – Faculty of Graduate Studies. The pinnacle of my academic career was the appointment as Vice Chancellor (CEO) of University of Colombo in 1995 – a position I served with distinction until 2000. I was awarded Deshamanya national honours in 2005 and, as Professor Emeritus, the University of Colombo awarded me the honorary Doctor of Letters (D.Litt.) in 2008.

“At different times in my academic career, I held visiting professorial positions in the Institute of Social Studies, the Hague in the Netherlands, Jawaharlal Nehru University in New Delhi, India, and Ryukoku University, Kyoto and Saga University in Saga, Japan. I was a member of the National Economic Council during the first half of 2000s and later, after retirement during 2007-9. I was Senior Advisor to the Ministry of Finance and Planning during 2008-9, Member of the Presidential Commission on Finance and Banking in 1990 and the Chairman, Presidential Commission on Taxation 2009-10. During 2010-15, I held the position of Chairman, Institute of Policy Studies and during 2015-19, as pioneer Vice Chancellor (CEO) of Sanasa University Institute, Kegalle. It was at the end of 2019 that I was invited to play, for me so far, the most challenging CEO role as the Governor of the Central Bank of Sri Lanka (CBSL).”

The COVID-19 pandemic has continued to affect many economies worldwide. The CBSL, in its efforts to fight against the pandemic, has introduced various programmes to strengthen the economy.

Working with the Government to Address the Pandemic Effect

Due to tax concessions offered to businesses and individuals following the Presidential election in November, 2019, to help revive economic activity from the subdued levels which then prevailed, the government revenues stagnated. Resources required for the government to implement its policies to address social difficulties associated with COVID-19 had to be supplied, therefore, by the CBSL. Easing the revenue pressures faced by the government, the CBSL continued to purchase government securities from the primary market. Much needed financial support was provided to the government to implement necessary social security measures, health and other public services.

Proactive Policies to Ease Monetary Conditions

Despite lockdowns imposed, the CBSL continued to provide its essential services to people and the financial system. The CBSL’s actions helped maintain people’s confidence in the financial system. Monetary easing measures of the bank, among others, lessened the burdens on the public.  Given the low inflation environment, the CBSL reduced its policy interest rates, namely the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR), by 250 basis points in 2020 on five occasions to 4.50% and 5.50%, respectively. These policy rates currently remain at their lowest levels in history.

Uninterrupted Functioning of Essential Services

The CBSL ensured uninterrupted functioning of all essential services related to the financial system during the pandemic. These included the smooth operation of the payments and settlements system and the uninterrupted supply of currency notes and coins to banks, thus fulfilling the cash requirements of the public. The CBSL, as the agent of the government for debt management, continued to service all public debt service obligations, thus maintaining Sri Lanka’s unblemished debt service record.

Further Easing of Policies

The Bank Rate, i.e., the rate at which the CBSL grants advances to banking institutions as the lender of last resort, was brought down by 650 basis points so far during the year. The intentions were to lower the entire structure of interest rates in the economy.  Low interest credit to needy sectors from the financial system helped to mitigate the adverse economic impacts of the pandemic.

The Statutory Reserve Ratio (SRR) was reduced by 3% points by two steps to 2%, thereby injecting additional liquidity to the domestic money market. Excess liquidity levels were maintained in the domestic money market to encourage bank lending to productive areas of private sector activity. Further, interest rate ceilings on selected loan products were imposed, thereby reducing the interest burden on marginal borrowers. The latest in this exercise is the 7% cap on housing loans to salaried personnel. Lending targets are expected to be introduced to boost bank credit flows to growth supportive ‘winning’ sectors.

Effective Management of the Exchange Rate

The CBSL managed the pressures on the exchange rate effectively, helped by the government’s restrictions on non-essential imports and also the contemporary low petroleum prices. Excessive volatility in the exchange rate was prevented while safeguarding the level of gross official reserves of the country.  This has been a time when borrowers in the private sector faced many difficulties in managing their debts. The CBSL took several measures to help them while ensuring stability of the financial system and enabling financial institutions to function smoothly. Regulated financial institutions were provided with some regulatory easing, thereby helping them provide more support for their customers. Distressed financial institutions were sometimes provided liquidity support as needed.

Saubagya COVID-19 Renaissance Facility and Government’s Recovery Programme

The CBSL, in consultation with the government, introduced the Saubagya COVID-19 Renaissance Loan Scheme Facility in three phases to provide working capital loans at an interest rate of 4% per annum, with a repayment period of 24-months, including a grace period of six months, to businesses, including self-employment activities, adversely affected by the COVID-19 outbreak. Maximum loan amount under the proposed refinance facility was Rs. 25 Million. The CBSL provided 100% refinance or interest subsidy for the licensed banks under this refinance facility. Altogether a sum of Rs. 179 Billion was approved for distribution in loans at the end of the facility, i.e., by 30th September, 2020, involving about 62,000 loans. Out of Rs. 179 Billion approved under the scheme, 52% has been provided to businesses in the Services sector, led by trading services, and 33% and 15%, respectively among businesses in the Industry and Agriculture. The bulk of these approved loans have now been disbursed by banks.

Speaking further, the Governor stated that those engaged in the Informal sector should be given priority in the government’s recovery programme, as 50% of total employment comprises the Informal sector, which means that a substantial proportion of the employed are highly vulnerable to job losses.

“In 2019, it was estimated that approximately 57.4% of those employed were engaged in the Informal sector, and of this, approximately 60.8% were engaged in non-agricultural activities, the remainder being agricultural workers. Detailed analysis across occupational categories shows that those in the most vulnerable occupations, (e.g., elementary occupations such as services and sales work, ‘skilled’ work in rural areas, crafts, plant and machine operators) comprise almost 87.3% of Informal sector employment and 50% of total employment. Being outside the ambit of formal employment, they face challenges due to their relatively low skill levels and poor occupational mobility. These are the segments of the population that ought to receive focus in the government’s recovery programme during a period like today. 

“It must be noted that since April, the government has undertaken several measures to protect vulnerable low-income households. The main item of policy in this regard was the distribution of a cash grant of Rs. 5,000 per person, distributed on several occasions during the times affected by COVID-19. Moratoria extended to micro and small size loans and various Samurdhi-based assistance programmes also helped. These, no doubt, didn’t at all suffice to help the people of this category who lost their jobs and other means of income due to the spread of the pandemic and the lockdowns imposed.  The provision of 100,000 employment opportunities to unskilled workers from extremely poor households when fully implemented effectively would be a significant part of the solution to this problem.

Budget 2021 and Its Impact

In addition, the Governor stated that the Government Budget 2021 places significance on Small and Medium Enterprises and recognizes their potential contribution to both the upliftment of livelihoods and well-being of affected households

“These would also promote their contribution to the growth process. The government has consistently invested in safety nets. What the government is now providing, if carefully utilised by these vulnerable segments of the population, there will be significant improvement in their life conditions.”

As stated by Prof. Lakshman, the Budget 2021 was presented at a crucial juncture of the economy and signifies the beginning of a search for an alternative development framework for the country, moving away from the neoliberal straight jacket of the immediate past. He added that it is a development-oriented budget which aims at economic revival, growth and poverty alleviation.

“Even before the pandemic hit, the economy was undergoing a period of below potential economic growth, and an increase in foreign debt. Against this backdrop, the Budget 2021 presents several macroeconomic targets for the medium term:  GDP growth of 6%, inflation around 5%, stable exchange rates and interest rates, and consistency in low tax policy. Debt-to-GDP ratio is expected to be brought down to 70% over the medium term, also minimising the exposure to foreign debt.

“The government offered a novel model of macroeconomic management.  The Budget 2021 included several proposals to boost investment and to provide opportunities to the business community, to shift away from the prevailing heavy import-reliance towards greater manufacturing and export bias, as well as diversification of exports.  The need to secure foreign exchange inflows to meet external debt service obligations is highlighted. Proposed reforms to the Banking and Financial sector and state owned business enterprises, Education sector and labour markets, and judicial and public services are intended to improve productivity and the business environment in the economy. 

“In respect of debt management, as already mentioned, the financing strategy will be tilted towards greater domestic financing, while capitalising on the benefits of increased domestic savings and the low interest rate regime already in place. Capital investments promoted will improve economic growth prospects in the period ahead. These processes will be helped by the low interest rate regime, improved investment environment and restored policy certainty. Improved economic growth will help consolidate public debt, along with the measures to curtail rolling over of maturing foreign debt. On the whole, I trust the country’s development path as anticipated in the Budget 2021, provides much hope and could promote positive expectations. The real test, no doubt, is how these good policy ideas are implemented on the ground.”

Sri Lanka’s foreign exchange earnings come mainly from remittances sent by expatriate workers, apparel exports, and exports of tea, rubber and fish. Apparel and rubber products categorised under industrial exports accounted for about 44.1% and 7.6%, respectively, of total exports from January to September, 2020. Agricultural exports such as tea accounted for 12.4% and seafood about 2.0%. Therefore, the government has taken steps to revive these sectors.

“Many measures were introduced to revive these traditional exports from the deleterious effects of the COVID-19 spread. In the meantime, the government is taking steps to develop other export activities, particularly technologically intensive and high value adding export products and services. The CBSL is supporting these export diversification efforts.

“In the medium term, the ongoing drive to enhance domestic production (agricultural, industrial as well as exportable services), the establishment of trade relations with new trading partners, efforts to diversify the export product basket, strong high level institutional support as evidenced by the establishment of the Export Development Council, enhancement of banking and insurance facilities for export industries, together with a more stable exchange rate are expected to drive the growth momentum in exports.”

The Budget 2021 of the government has proposed a large set of measures to develop all industries with export potential.  These sectors include the following:

  • Garment industry (focus on high quality garments) and leather products.  
  • Value added products in tea, rubber and coconut; Geographical Indication (GI) certification for tea and cinnamon; and fishery products.  
  • New export industries such as pharmaceuticals and technological services.  Budget provision for setting up investment zones and techno parks for these industries must be noted here.
  • Mineral resources. Measures to increase these exports in value added form. 
  • Further, the Budget 2021 proposed to formulate a balanced trade policy yielding long-term returns, through increasing export earnings while saving foreign exchange through domestic production of import substitutes.  These trade policy reforms will include new approaches to free trade agreements (FTAs).  
  • Further, insurance facilities for exporters through the Sri Lanka Export Insurance Corporation are to be enhanced.
  • Budget proposals and government action to enhance and diversify foreign employment opportunities for the people and to increase remittances have already been noted.

Sri Lanka’s possible credit default is a much debated topic, however, the Governor claims that there will not be any credit default as Sri Lanka has demonstrated its commitment to honour its foreign liabilities in the past and has maintained an unblemished debt service record so far.

“The government intends to continue this track record in future as well. Amidst the high debt service payments so far in 2020, Sri Lanka is maintaining a comfortable gross official reserve position of around US$ 5.9 Billion (end October 2020), after the successful repayment of an international sovereign bond (ISB) of US$ 1.0 Billion that matured earlier in that month.

“The long term solution to address the debt situation is improving the domestic production economy and boost exports, and other forex earnings, together with non-debt creating forex inflows. This is the approach that is being promoted by authorities now. In the short term, the government and the CBSL have already taken necessary steps to secure required foreign financing to meet debt service payments due in the rest of 2020. Blueprints are ready to do the same in 2021. Net inflows after debt repayments are likely to be adequate to maintain gross official reserves of the country at healthy levels.

“Import restrictions on non-essential goods are combined with those on agricultural imports for the purpose of boosting domestic production. Coupled with restrictions on capital outflows, these would help improve liquidity in the domestic foreign exchange market. The Colombo Port City Special Economic Zone, Colombo and Hambantota ports, and proposed new investment zones in various parts of the country are likely to help attract FDIs into the country. Incentives provided under the Strategic Development Act, would further facilitate these investments and associated foreign exchange inflows in the medium term.

“Furthermore, there are proposals in Budget 2021 to diversify and promote foreign exchange inflows through migration of workers for overseas employment. A contributory pension scheme is on the cards for migrant employees. Measures are being taken to facilitate migration of employees at higher skill levels and in specific high wage activity areas. These would diversify the foreign employment market, enabling the country to expand its remittance receipts. The proposal to pay Rs. 2 per dollar above the normal exchange rate for foreign exchange remittances sent through banks would enhance recorded workers’ remittances. Another important development is the likely selective opening up of the country for tourist arrivals in the near future. The COVID–19 has brought the country’s Tourism industry to a standstill and the above measure would begin to revive the industry in an environment of ‘living with COVID-19’. Tourist earnings have been a major forex inflow, and are likely to remain so in the future as well. 

“In conclusion, let me note that foreign commercial debt is only a relatively small share of the entire debt stock. Managing this portion is unlikely to be a critical issue, particularly in the context of the government’s policy commitment to gradually increase the domestic component of public debt, and not to allow debt creating investment projects involving forex inflows. Under all these conditions, I’m confident that possibilities of debt default, as speculated by critics, would fall into the realm of the highly unlikely.”

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