Tuesday, December 16, 2008

Absolute urgency for an immediate devaluation before its really too late

I was absolutely appalled to see a respected economist in the form or Dr Saman Kelegama who heads the Institute of Policy Studies, defending the Government’s stance on keeping the rupee at this unreasonably high level despite all evidence to the contrary.

I have stated time and again that the traditional reasons for not devaluing, namely of the inflationary impact does not apply now as we are in a situation of a substantial (50%) drop in commodity prices and so will be able to prevent any net inflationary impact. Furthermore, as the Indian rupee has depreciated against the US$, we can suffer an equivalent depreciation without affecting our food imports and for that matter other imports from India. The oil import bill which should (but for the disastrous hedging contracts) fall by over US$2B if the price of US$50 a barrel stays throughout 2009 will effectively leave the country in a Balance of Payments surplus situation on the current account even taking into account the reduction in value of Tea and Garment exports.

One possible area where he did make some sense was in the issue of repayment of international debt and credibility with international investors. I don’t believe there will be any grain left in that truth now the world is in recession and they have lost more money on their other investments than in their investment in SL treasuries which as we speak still yield in excess of 20% on a stable exchange rate. The other fallacies of not being able to carry out the government’s infrastructural development plans is totally predicated on inflation, which I have proved is not an issue.

A famed economist should realize if he has ever been in business, which sadly many of our intellectuals have not, that it is the businessmen who are importing who are amassing fortunes both in foreign bank accounts and on local profits, by not passing the substantial price reductions from commodity prices to their consumers. The fortunes amassed overseas from over invoicing exceed the total foreign reserves of the country.

So please I beg of you the reader to alert the state to the reliance on outdated economic theory that does not hold water at present in Sri Lanka, and the hardworking population overseas have kept the economy functioning through their remittances. They who have saved this country deserve more from the extra money pumped in from devaluation too. Just do it!

The leaders are engaged in an orgy, while the rest of us are struggling

Sri Lanka is in a pathetic situation. Nero is enjoying in Rome, oblivious to the cries at home. The finance minister who happens to be President does not understand Finance, the Governor who is the policy maker does not understand Banking and the Global Calamity. The country is being held to ransom, with no coherent stand by the opposition to address the issues and notify the people of the crisis at hand. This all because the country is being held to ransom on the pretext of being on hold to win the war at all costs.

This is the background today, and the purpose of my essay is to alert the reader to take a stand in some way to notify people in power and try to take action to minimize the effects of what is in store.

The captains of industry are busy shoring up their diminishing portfolios by taking full advantage of the substantial drop in commodity prices to maintain and enhance their profit margins, without upsetting the apple cart. No wonder the importers are not agitating for devaluation, as they are taking full advantage of the price falls to make large profits, despite a fall in demand for their products. There is therefore no agitation from them who are also helping the politicians to keep the status quo while the rest of the country which really does not have a say is suffering under this heavy burden.

This conspiracy of silence is being carried out because there is little competition in Sri Lanka, and the large businesses that are oligopolists are able to act in concert for their mutual benefit. In other words, the industrialists in Sri Lanka collectively seeing the demand for their products falling, due to lack of money with the consumer, is not passing the cost reductions arising from halving of commodity prices. Instead they are increasing their profit margins to maintain the cumulative profit. This process is being carried out both by the multinationals such as Unilever, the milk powder and flour producers as well as paint manufacturers and even the animal feed importers, just to quote a few industries. I have not noticed Arpico reduce the price of any rubber product, despite the drop in rubber sheet prices from Rs325 two months ago to Rs70 today.

The government is complicit in this scam, and instead of defending the rights of the people who have elected them are either in cahoots or ignorant of what is happening around them. Not even the Newspapers have competent staff to be even aware of this state of betrayal.

Economic consequences of the halt to most apartment construction

One just has to look at the halted construction projects on the Colombo skyline to wonder if a major crisis in the housing and hence in the banking sector is about to erupt. The Dawson Grand has ceased any further building work, and it looks like the Emperor has done the same. Ceylinco Celestial seems to be going that way, and Premier Pacific has declared insolvency. Just as there was a meteoric rise in the value of apartments, there is now a meteoric fall in the same.

In the past the builders took stage payments from the apartment buyers in order to finance the construction. That helped them construct with little bank borrowing by preselling the whole project. Premier being unable to sell all its apartments found itself unable to continue as they were unable to obtain bank borrowings at an acceptable rate of interest to make the project viable. So those who put in stage payments are faced with a dilemma and a part completed building. Of course an investor who can see a good profit may wish to buy the shell and promise existing purchases completion if they are willing to pay more than originally committed but that is another story.

What all this means is that the apartment and condo building boom in Colombo is over for the foreseeable future. Those buildings that have been completed all have issues that have dissatisfied the buyers. Therefore this is not a harbinger for the health of apartment living in Sri Lanka. Banks are either unwilling to lend or extend already stretched credit lines as this does not seem to be a good investment after all.

Many of those who bought apartments for speculative purposes have lost their money and are trying to cash in their investment at any cost as some have borrowed heavily to purchase them. The world economic crisis has resulted in rich Sri Lankan expats overseas not wanting to invest in an apartment in Colombo and some who have want to cash out as they need the funds. Many high net worth individuals who purchased apartments as part of their diversified portfolio have seen their wealth drop in many of their investment vehicles, that include stocks here and overseas, property and businesses, Only those who hold cash have weathered the storm but are unwilling to buy property now as it no longer seems a good investment as rental returns do not seem a possibility either with no demand. Banks who have lent on the valuation of property have seen their security drop in value by 50% but worse have realized that they are all illiquid at this time.

Interest rate and risk

Kalpanakaranna! Why is it so obvious to me and so oblivious to the Central Bank, that there is something extremely serious going on. There is month on month deflation in Sri Lanka today that is if one takes, October vs November and November vs December. The current interest rate on 5 year T Bill rates is 20%, which is an effective real interest rate of 20%. Is it no wonder that there is a huge credit squeeze on the lines of the international crisis and no one seems to be doing anything about it?

What is so obvious is that when the risk free rate one can earn is 20% on one’s cash, why would one want to lend at anything less than 35% in an environment where there is such a huge degree of uncertainty. For a business to borrow at that rate and make a profit is almost impossible. So we are about to see companies crash. It is so simple to understand but why is it that no one seems to do anything about it?

Added to this dynamic, there are many wealthy people, including the pettah traders who hold cumulatively, more US$ both in cash and in accounts overseas, than the Sri Lanka Central Bank. I am sure the Central Bank does not realize that. I can transfer US$100M tomorrow to any account overseas I specify, if I have the SL currency to give today at the black market wire transfer rate of Rs118=US$1. This is one reason that the SL rupee has to tanked nor has the pressure on the rupee yet been high to devalue. That does not mean the pressure will not come shortly if other circumstances like a banking crisis suddenly takes hold when all hell will brake loose.

In previous blog articles I have proposed urgent solutions, none of which have yet been implemented and therefore the impending gloom will be more severe when it actually transpires. I do not think it is too late but time is running out and the signs of a disaster are now obvious. Firstly the fall in commodity prices, has not been fully reflected in local prices, as importers are over invoicing and stashing their cash in US$ overseas. We have screwed up in oil hedging not passing the full benefit to the country, and if the deals are nullified by the Supreme Court will never be able to hedge or borrow from overseas banks again. With the collapse of Tea, Rubber and Coconut, there are many people out of work or are earning much less than a few months previously, which directly affects their pocket books which then directly affect consumption, and therefore impact on local industry. I see this first hand as I have a village shop in my farm and have noticed this.
When there is less money in the consumer pockets, in a simplistic form these are the ramifications. People who have leased vehicles or white goods cannot make payments. They are then reposed by the lessor. Just look at the lease returns available for sale with no takers as there appears to be no one with money to buy these cheap. Then with less money from income they are dipping into savings. People are now cashing in their CD’s so Finance Companies are finding it harder to keep deposits. They cannot offer ever increasing rates, as the real interest rate is already high and they cannot lend at higher rates. Additionally as these companies are lending long, by way of cash stream over the period of a lease of say 4 years and depositors usually hold a maximum of one year CDs that some are not renewing on maturity, finance companies are strapped for cash and will imminently face a liquidity crisis.

The Liquidity crisis is exacerbated because the banks invest surplus cash in Treasury Bills which are risk free, and are reluctant to lend to finance companies as they are now considered very high risk, because of what I have shown above. The imminence of a run on Finance Company deposits cannot be more convincing, the rollover effect to a run on the banks is just the next step, and there is no guarantee by the Central Bank of a bailout of the Banks or Finance Companies if this happens. The guarantee MUST be given now before a crisis happens, as it will be too late after as the cost will be much greater and the resulting loss of confidence in the banking sector more devastating.

I have earlier recommended a Central Bank guarantee of about Rs1M per name per Bank of Finance Company to forestall a run on these institutions. The various institutions are led by novices and the professionals in their midst are biting their nails and preparing their exit strategies in case the house of cards crumbles. Those affected will no doubt be all the innocent citizenry of this country who will see their life savings devastated and the resulting lack of funds for consumption will immediately reduce demand, output, layoffs, and a depression with stagflation with no one able to do anything about it.

Then the rupee will depreciate by 100% in a flash and the only people who will benefit are those holding US$ realizable assets who can pounce in and buy every asset in Sri Lanka at fire sale prices, due to the desperation of people for cash as there is no availability of ready of ready cash to conduct economic activity. This is the law of the jungle capitalism at its worst!