The Central Bank of Sri Lanka (CBSL) has devalued the currency, the Sri Lankan rupee, by 15% to shore up foreign reserves and to attract migrant worker remittances, but bankers say the move will not make a significant difference to the status quo. Instead, migrant workers are shunning the formal banking system due to the low exchange rate compared to the informal channels offering them at least 30% more.
As of March 7, the banking regulator raised the exchange rate to SLRs230 per US dollar, from SLRs203 held since last October. Analysts say this move is late in coming, as the new rate is not reflective of the economic realities. They also say that the exchange rate is still low compared to the grey market offered rate of SLRs270 per dollar, which can sometimes go up to SLRs300.
Workers’ remittances have contained around 80% of Sri Lanka’s annual trade deficit over the past two decades. CBSL’s Foreign Remittances Facilitation Department was set up in November to facilitate and streamline remittance inflows to the country, along with multiple special incentive schemes. However, many bankers say these initiatives have not yielded desirable results.
Additionally, CBSL launched the national remittance mobile app ‘Lanka Remit’ to assist Sri Lankans working overseas with direct access to the existing remittance channels, but again with limited results.
Migrant worker remittances have been persistently low during the past few months, and reached a 13-year-old low of $259m in January. Those employed overseas tend to use informal channels, such as Hawala and Undiyal, to send money back to Sri Lanka.
CBSL has been clamping down on these informal channels, attempting to prosecute those that offer the services under the Prevention of Money Laundering Act. A CBSL statement issued late last month says: “The permission to buy, sell and exchange foreign currency in Sri Lanka is granted only to authorised dealers (i.e. licensed banks) and money changers appointed by the CBSL. Therefore, foreign currency shall be purchased, sold or exchanged only through an authorised dealer or an authorised money changer.”
The bank expects a rebound in workers’ remittances in the coming months, saying that they are increasing notably due to the measures taken to combat illegal money transfers, while encouraging remittances through formal channels.
Sector strength
The expansion of domestic credit, particularly credit to the public sector, was robust during the past few months, according to CBSL, noting that some slowdown in the growth of broad money was observed due to the decline in net foreign assets of the banking system. “Following the monetary tightening measures, market interest rates are adjusting upwards,” said CBSL.
The banking sector has increased revenues during the past few quarters, due to the exchange rate volatility and interest rate fluctuations. Sivakrishnarajah Renganathan, managing director and CEO of Commercial Bank, says: “Most of the private sector banks have high liquid asset ratios and adequate capital adequacy ratios. Their profitability has increased substantially. But with the exchange rate increase and high inflationary pressures, the banks are expecting net interest margins to reduce, challenging liquidity levels and credit quality stress.”
Most of the private sector banks have high liquid asset ratios and adequate capital adequacy ratios
With the currency depreciation, some economists are predicting rampant inflation to set in.
Kenneth De Zilwa, a business cycle economist and managing director at Econsult Asia, says: “Depreciation as a tool to stem imports has not necessarily worked in the past. Neither has it improved our exports — i.e. foreign currency earnings. What depreciation does is increase input and intermediary costs across the board — input raw materials, refined crude oil, gas, wheat and coal, etc. This feeds into both consumer and export prices, making exports uncompetitive.”
He predicts that higher domestic five-year and seven-year interest rates as high as 17% could be on the cards within the next few months. “This would impede any new fixed-asset creation,” he adds. The Sri Lankan government’s new funding costs would increase significantly, too, and will need to be recovered by higher taxes, he adds. “This is an extremely dangerous prescription to an already fragile economy (which is mainly mooted by the International Monetary Fund [IMF]).”
In early March, CBSL increased the standing deposit facility rate and the standing lending facility rate by 100 basis points each, to 6.50% and 7.50%, respectively. In a statement, CBSL said: “Considering the severity of external problems and disruptions to domestic economic activity, a comprehensive policy package containing both traditional and non-traditional measures, along with other initiatives that have an impact on the overall economy, is essential to counter such economic headwinds.”
The Sri Lankan banks are bracing for low credit growth amid the rise in interest rates, rating downgrades, new taxes and the quality of the portfolio, all of which have impacted the banks’ capital growth.
A senior banker says that banks are forecasting single-digit credit growth this year, compared to last year’s 16%. Sri Lanka’s commercial banks provided a record amount of credit to the private sector in 2021, a reported SLRs810.5bn.
In 2022, the banking sector is wrestling with exposure to the country’s sovereign debt and economic vagaries. Apart from credit growth, analysts predict that these factors will weigh heavily on asset quality.
Tourism sector
The Sri Lankan banking sector has not seen bad loans increase in the past year as much as expected because the regulator extended the pandemic-related moratorium several times.
CBSL once again extended the debt moratorium for the tourism sector until June this year to revive an industry that had just started to recover from the Easter Sunday bombings in 2019 when it was then hit by the Covid-19 pandemic, wiping out $4bn in annual earnings.
However, industry officials say the banks could see a big uptick in non-performing loans once the debt moratorium ends later this year.
Plus, the sliver of hope the country had for tourism to rebound in 2022 has faded with break out of the war between Russia and Ukraine, which are two of Sri Lanka’s largest tourist markets. However, bankers hope that other tourism markets will help to bring in earnings in the sector.
Kapila Ariyaratne, CEO of Seylan Bank and chairman of Sri Lanka Banks’ Association, says: “While the war in these countries will impact the expected growth pace in tourism, it is likely that markets like India will grow and balance out the impact to an extent. Yet, it is also likely that hotels in this sector will continue to require financial support until the overall recovery in tourism is achieved.”
Support available for sustainable banking initiatives and green bonds, etc, continues to be strong and we are working hard at optimising these opportunities
Last year’s tourism industry loans stand at around SLRs350bn, with the interest component being SLRs100bn. At this juncture, the lack of tourist arrivals, coupled with exacerbating costs on the back of rising interest rates and inflation, will not allow hotel companies to meet debt commitments.
The industry has asked for either a write-off of the debt in full, or at least the interest. The government has been exploring the option to seek multilateral donor help in this regard, but no firm commitment has been agreed.
After lobbying from the industry, the government has also been exploring extending the moratorium until year-end or to grant further relief. However, the consensus among banks is that the support for the sector is best discussed with the individual client and tailored according to their specific needs, rather than extending a general moratorium.
Trade down
Many banks are saying that their trade finance business has been negatively impacted due to the acute scarcity of foreign exchange (FX), restricting importers’ ability to bring in goods. Banks have seen a reduction in both the amount and number of transactions.
Grappling with the acute foreign currency shortage, the banks are prioritising facilitating imports strictly in terms of the nature of the goods, with essential items such as pharmaceuticals, food and medical equipment being given priority. “While doing this, the banks try their best to serve the needs of all the clients to ensure the continuation of business. Otherwise, this will not only impact those businesses and their stakeholders, but also the portfolio quality of the banks. This, however, is becoming increasingly difficult,” Mr Renganathan says.
Several banks report issuing a third of the letters of credit (LCs) they used to. The foreign currency shortage in the banking sector means that the demand for outward payments, including LC settlements, far exceed the available stock of currency, which is why banks have resorted to rationing import LCs.
CBSL’s decision to encourage private banks to make import LCs available last month also increased the pressure on their FX reserves. In future, this will make it even more difficult for banks to support the trade and other outward remittance needs of their normal customers.
Early this year, CBSL imposed a 25% inward remittance surrender rule, leading to a large loss in FX in banks. To preserve their foreign currency, the banks were forced to curtail imports. However, in November the banking regulator further directed authorised dealers or the banks to convert money remitted into foreign currency accounts through export proceeds within one month and seven days into local Sri Lankan rupee accounts.
The regulator also extended export proceeds conversions to services to increase liabilities and boost FX liquidity in the banking system. However, none of these measures seem to have injected substantial liquidity into the market.
Credibility issues
The Sri Lankan banking sector is slowly losing credibility on the international stage, with correspondent banks reluctant to guarantee transactions with the low credit ratings of the country and its inability to raise funds in the international markets.
The country’s bankers say that overseas banks are requesting a third-party guarantee to honour local LCs. This is quite similar to the situation in the 1970s when all LCs issued by Sri Lankan banks needed to be guaranteed by a third-party bank based in Singapore.
Banks are working on raising long-term debt with a view to meet FX liquidity requirements to support local currency lending demand at concessionary rates for specific economic sectors, but they are increasingly facing difficulties.
Many bankers say development finance institutions’ (DFI) credit lines are slowly tapering off. Amid the exchange rate issues, as well as lack of reserves and liquidity in the banking industry, some commercial banks were in discussion with DFIs to secure credit lines and beef up their foreign reserves.
The country’s C-rating by multiple rating agencies has not helped their efforts, bankers say, noting that those DFIs that are extending credit lines with low interest rates are becoming exceedingly conservative in their lending, or being outright reluctant to do so.
Mr Ariyaratne says that the sector has witnessed a definite drop off in DFIs’ enthusiasm to lend, but the industry was able to successfully leverage its collective balance sheet strength and track record to raise some noteworthy volumes of credit during the past few months. “Support available for sustainable banking initiatives and green bonds, etc, continues to be strong and we are working hard at optimising these opportunities,” he adds.
The attractiveness of the banking sector will depend on whether Sri Lanka will seek IMF assistance and the sort of restructuring mechanism that will be offered to bondholders. All banks are trading on the Colombo Stock Exchange at a steep discount to their book value. Dimantha Mathew, head of research at investment bank First Capital, says: “The earnings for the banking sector will be mixed this year. On one hand, the banks will have to raise interest rates, which may lead to higher spreads benefiting them; but on the other hand, with the tourism moratoriums expiring and the current economic crisis in Sri Lanka, a higher impairment will be seen in the next few quarters.”
A recent Fitch Ratings report said that the Sri Lankan banks are likely to face continued asset-quality pressure in 2022, as the rising macroeconomic stresses stemming from the sovereign credit profile pose a threat to borrowers’ repayment capacity, alongside the conclusion of most relief measures in 2021.
