Transcription
A person is spending more than they're earning. The only thing to do is borrow. Governments have two options. They can borrow or they can print. We were doing both.
Suddenly, you have your fuel bill increasing by almost 900 million dollars in a span of two months. We saw the exchange rate moving up rapidly from say 310 to 320, 325. And then importers were like, "Holy crap, it's going to go to 500." So, we need to import double what we were when the currency was here.
[music] [music]
Hi guys. So, one of the questions [music] that we've gotten a lot after especially after the previous podcast that we've done. But it was on at Cali itself. And [music] and Cali's a place where there is a lot of conversation happening on a daily basis on the economy. Uh there's a lot of conversation happening on on investments. And so, through this segment, one thing that we really want to do is bring you all kind of under the hood as to what goes on in our offices. And and shine some light on the conversations that we have which we feel will be interesting to a general listener as well.
So, to kick off this series of podcasts, we have uh with me I have Kavinda from Cali Treasury's team. Kavinda is one of many uh resident economic experts that we have at Cali. Kavinda, thanks for joining us. We're going to keep it, you know, very informal and very brief. But one thing that we want to highlight from this chat is everything that has gone on in the country in the last 3 months, right? So, what 3 to 4 months ago uh the US invaded the Middle East. And things went pear-shaped in Sri Lanka to a great extent, right? The currency which was at 310 bucks is now at 300 but it went to 15, now it's at 30. Inflation which was steadily cruising along at 2% went up to 7%. Petrol went up in price by 50%. The economy slowed down and people are panicking about a crisis. You and I have chatted about this extensively over the last two to three weeks, but for everyone out there can you just explain this whole sequence of events and how it has impacted the economy?
Yeah, sure. Well, I think it has a lot to do with the external shock that we had.
Mhm.
You know United States in invading Iran, uh blocking off the straight which, you know, accounts for almost 20% of global oil.
And about 80% of our oil.
And about 80% of our oil. I mean, we've always been import dependent, right?
Yeah.
So, what really happened was you have an economy [snorts] that's moving smoothly, your average import bill staying as it used to be, you know, last year and the year before last. And then suddenly you have high oil prices out of nowhere, just overnight crude oil going all the way up to 105, petrol and diesel moving along with that. And then suddenly you have your fuel bill increasing by almost 900 million dollars.
Mhm. 900 million dollars over what timeframe?
In a span of two months. So, your Jan to February you were averaging around 300.
Mhm.
And then suddenly come March and April, you're averaging almost 700 to 800 million dollars.
And you're a country without many dollars to play around.
Exactly.
Yeah.
So, all of that actually drove a significant deficit on our current account. And then obviously [clears throat] with current account pressure comes exchange rate pressure.
Can you can you explain that a little bit more? I know I I understand it because we chatted about it, but just imagine that a layman is is watching this video. What does that mean? What does current account
Yeah, so current account is basically the account that brings in or takes out US dollars from your country.
Okay.
So, what happens when a current account is in a deficit is that your outflows of US dollars or the money that's going out of your country is much higher than the money coming into your country.
Right.
And so, there's a deficit.
Mhm.
And a deficit needs to be financed.
Yeah.
So, that's you to find the dollars to and on top of that you have people still importing because you know, you don't stop business just because you know, everything is going crazy. So, you still have demand for imports. But, you don't have the dollars to meet the demand for those imports.
Understood.
And so, when you need money to import something for your next month and your country doesn't have that then obviously the price that you're going to pay is going to be high.
And that pushes
That's what pushes your exchange rate up.
And I think that was also a factor of panic where people saw the exchange rate moving up rapidly from say 310 to 320, 325. And then importers were like, holy crap, it's going to go to 500. So, we need to import double what we were when the currency was here.
A lot of PTSD.
There was a lot of PTSD from what happened in 2021. And we'll talk about how this is different to 2021. But, yeah. So, it the the like you said pressure on the current account initially depreciates the rupee, everyone panics, piles on, and then the rupee just shot up.
Of course.
Yeah. And what impact did that have on everything else in terms of what you're tracking, currency, inflation, GDP growth, etc.?
But, we track mainly our calendar like, you know, your overall macro indicators. Um so, of course, uh negative current account would mean central bank's reserve accumulation slows down. So, we've seen that with our gross official reserves coming off a little bit um over the months of March, April, and May. Um
And can you give us some numbers on what the reserves are like?
Currently our reserves sitting at about 6.6 billion, whereas at the start of the year in January we were at seven.
Right.
Um right. That's been coming down on a consistent basis. And then on top of that higher prices, higher fuel prices means higher inflation because it you know, diesel, all of that that we import is part of our overall production, right? Manufacturing, every factory, every machine that's run
Yeah.
needs diesel.
Yeah.
And so, that feeding in to your production increase production costs.
Mhm.
Uh which then sent which trickled down into everything else.
Into everything we consume.
Literally everything. I mean, right now even in this room, right?
Yeah.
Everything we have every generator that's visiting. So, that sent inflation up.
Yeah.
And that's another key indicator that we saw moving significantly.
We were like, what? 2%?
And we were predicting inflation to be about 5% by the end of the year. We shot up to 7% in a month.
Exactly.
Yeah.
So, you have inflation going above your inflation target, and then central bank obviously has to take action on that. And so, that resulted in them hiking interest rates.
And to a layman, right? When a central bank hikes interest rates, we saw them hike interest rates by 1%, 100 100 basis points, right? And what does that mean to a normal person? How does that affect a normal person?
Well, that impacts a normal person in the sense that, you know, if you are borrowing money or if you're business owner, or if you have outstanding loans that you're still paying back to a bank, you are now paying that back effectively 1% higher than you were paying it before.
Mhm.
Um so, if you are like a 100 rupee loan, you were paying an interest on that, and you take 1% higher, that's like 1 rupee more you're paying to a bank.
Yeah.
So, that impacts everybody, right? Across the
And also, I guess it makes saving more rewarding than borrowing, so it slows down the overall economy, right? And then brings inflation under control, which is I think what they were trying to do. Um what do you Okay, so now over the last 3 months we've seen all of this playing out, and and there was mass panic, you know, rates went up, economy slowed down, stock market came down, all of this was happening and we were we were freaking out as well. And then suddenly, ceasefire, right? That happened 1 week ago. I think it was on Thursday that they announced it last week. What has changed since then?
Well, [sighs and gasps] what has changed is I mean, I think the main thing that has changed is oil coming down. We're at now what, $77 a barrel on crude?
As opposed to 105 at the peak.
Yes.
So, that I think has brought not just to Sri Lanka, but globally a lot of ease in terms of global inflation and import bills around the world. And for Sri Lanka, it's a huge relief. You know, we're we're coming off a fuel bill of 800 million, we're going back down to that 200, 300 million that we saw in Jan and Feb. How we started at the start, how I said higher fuel prices means higher inflation,
Yeah.
then the opposite applies, right? Lower fuel price is lower inflation.
You're expecting inflation to trend down sharply.
And also, the lower fuel bill means your current account,
Mhm.
you know, the account that sends your money
Dollars in, dollars out.
Yeah. That would that would improve, because you're having a saving of like, again, import bill that went up by almost 800 has come down by 800 again.
Yeah.
So, you're offsetting that impact and you're going back into surplus.
And you have this extra hundreds of dollars, millions of dollars that you can play with. And then don't forget on the other side, you have tourism, right?
Yes.
Um, we had a 40% drop in tourism, because most of the tourists coming into Sri Lanka come through the Middle East.
Exactly.
And the Middle East airports getting blown up by drones was not great for us.
Yeah.
And I think now, even on the channel checks that we are doing at the hotel guys we are talking to are already seeing bookings come back for later in the year. So, if that can contribute 100, 200 million dollars a month in in in extra cash, that's a huge amount for us. A lot of people have been concerned about this whole fuel price, right? That was the government was subsidizing fuel to some extent. Um even though we increased fuel prices, I think we increased fuel prices across the board by 48% and still the government was subsidizing. They were still losing money on it. What is your take on that with with global prices easing, will we also bring it down or what do you think the government will do on those?
Well, look, I mean, from a political standpoint, you would want to bring it down, right?
Yeah. But But is that possible given the economic reality?
Not really. I mean, we are under an IMF program. So, the IMF program says that you need to show cost-effective pricing in your fuel, right? But at the same time, CPC is treated as an independent private player according to the IMF program. It's not a state-owned enterprise. So, that means center the CPC needs to make their own profits. They need to recover their own losses. They can't be funded by the government. Which means even though our prices are lower globally, they will need to maintain these current levels. I mean, I think currently we are above the fuel price formula by about 20 rupees.
Right. We were below it. We were burning from what I recall about 60 billion rupees a month subsidizing fuel. So, now at today's current prices, what you're saying is that because all prices have come down so much, even if we leave petrol where and diesel where it is now, we will now be making money.
We will be making money.
Okay. The government has then has a choice. Do you want to do the popular thing and bring it down or do you want to keep to the IMF program and and have recouped the losses that we've made over the last 3 months, I guess, no?
Correct.
Now, a lot of people were saying or why a lot of people were panicking was that they felt that the 2020-21 crisis was happening again.
Yeah.
In in 2026. Now, for those of us who were talking about this, it was very evident that these were two very different scenarios. Um 2020-21 was a completely self-made crisis where we were running massive deficits, you know, dual deficits.
Yeah.
Uh whereas [clears throat] now, I think we are on a much better footing. Can we talk a little bit about that? What are the main differences you see between what we went through as a country in 2020-2021 when we didn't have petrol and electricity versus what you see now where there is a bit of unease in the economy.
I think the main difference that came into play, I think that changed everything for Sri Lanka was Central Bank's independence.
Absolutely.
Um that was a big big thing for Sri Lanka and that has clearly shown its reward. Everywhere, any any country you have an independent Central Bank. The government can't influence monetary policy, right? Um it's independent on its own. So that was a big structural change that happened. And on top of that Central Bank writing into law that money cannot be printed was also [clears throat] another big deal because before, you know, not just 2021, I mean 2010, 2015,
Pretty much from from post-independence, I think.
[laughter]
Ever since then, um we've been having multiple crises on our external front. Yeah, current account and we see it's driving exchange rates up.
Yeah.
Um and that was a lot to do with money printing. You know, you have money in your system, let's say 1,000 rupees, and that 1,000 rupees can be spread among so many different areas. You know, you'll lend to the private sector, you'll lend to the government. And then on top of that 1,000 rupees, you add another 1,000, which is out of nowhere. And now you've got 2,000, which is generating excessive demand that's not meant to be there.
Yeah. And I I also want to kind of just for everyone's understanding, kind of highlight what it means when you run 40 years of budget deficits, right? And and essentially what that means is that the government for from God knows where not on words, almost pretty much from independence onwards up to 2022 or 23, the government was collecting X amount of money in taxes and revenue, but they were spending 2X in terms of the subsidies they were giving out, the free education, free this, free that, free everything else, right? Uh, especially subsidizing commodities. We were all happily pumping, you know, fuel at subsidized prices. So, to do this when when forget the government, if a person is spending more than they're earning, the only thing to do is borrow, right? Governments have two options. They can borrow or they can print. We were doing both. And that is definitely not sustainable in the long run and that is one of the reasons why coming into crisis, the government that came into power in 2020, they took it to another level where they cut taxes by 60% and increased government spending by about 2x, right? And then that led us to crisis. So, what you were talking about about central bank independence, the stopping of money printing, so all of that has has saved that in that now we are running huge budget surpluses. I think we are You have about 1 and 1/2 trillion rupees in excess cash now the government is sitting on which they can do a lot with. That is on on our internal like within our but like that's our primary budget. On the external side, how did we go from running deficits to running dollar surpluses? What was the trigger for that?
Uh, I think the trigger for that was actually a lot to do with our debt restructuring. We had external payments that were almost, you know, close to 3 4 billion a year.
Yeah.
Which has now been cut down by almost half to like 2 billion a year.
Yeah.
So, that resulted in less money going out and also worker remittances.
Yeah.
That has been a huge thing. You know, tourism, yes, but it has it has followed its usual trend. You know, tourism rebounded after the crisis. But worker remittances have hit an all-time high. Yeah. So, that has been our main driver along with the restructuring.
And and to give people some context, how much does tourism bring in for a year in terms of dollars?
On a gross basis, brings about 3 to 3 and 1/2 billion.
Billion. And worker remittances?
Worker remittances brings in about 8 and this year almost we are tracking 9 billion.
Yeah. So, almost three times.
Exactly.
Okay, coming back to why those two crises are different, what is the recovery like then from that kind of crisis and what is the recovery like from the crisis we've been through in the last month? How would those two things change? Because we saw how painful it was to go through the first crisis. What would the recovery from this be like? Would it be anything similar?
Uh look, the recovery from this crisis I feel is much more easier than it was coming off that crisis, you know?
Yeah.
We have less things to worry about.
Yeah.
We have the reserves that
Yeah.
You know, this is just a matter of oil prices, right? It's not a matter of structural damage to Sri Lanka's economy. Once oil prices come down, which is what we've seen,
Yeah.
we automatically go back into surplus and then everything is
Hunky-dory again.
Exactly, as it used to be.
Yeah.
So, it's not a uh you know,
It it's normal for people to panic, right? I mean, you go through the worst and then
And also I think there's a lot of recency bias, right? I mean, everyone in Sri Lanka remembers what it was like to go through that crisis. We were lining up for fuel for, you know, 24 hours just to get 10 L of fuel. And I think people don't quite understand that there's a huge difference between having no money to buy fuel and now having money but having no fuel coming to us. I mean, that the second equation changes very quickly with the trade opening, right? So, again, I think overall takeaway and what we want to really get out of this uh what we want to show people is that you know, we have these chats all the time about what the economy is like, what we are seeing, what these crises are like. So, it's not as bad as it was essentially. And we still as a country are on very good footing at least domestically. Unless, you know, Trump goes crazy and decides to bomb Iran and this drags on for another 1 year, then we are in serious trouble because of of the dollar of the of the oil bill. But apart from that, things are looking okay. Finally, to kind of wrap up, since we are an investment bank and and a lot of people who watch this will want to know what to do with their money.
Yeah. Uh when you go through this kind of period of volatility, right? What are the investment options someone can look at? Hypothetically, if you had 10 million rupees 3 months ago, what would you have done and what would you do now in the next 3 months with the information that you have?
Well, if we talk about 3 months ago, since everything was totally fine, you know, I would be
Say from From the day Trump decided to invade or try to bomb Iran.
A lot of uncertainty, right? I would pull out from the markets. I would hold my money in cash. But, we know that along with uncertainty macro yeah, instability, you have, you know, higher rates in your economy.
Yeah. Interest rates go up.
Government securities and interest rates and all that. So, I would then, you know, move my money into government securities.
And we saw that, right? We saw the We saw the 4-year treasury bond go from giving 10% to giving 13% within the space of 3 weeks.
Correct.
So, that is an opportunity for sure.
That That is a definite opportunity. And then, now, so that's that's what would happen on the onset of uncertainty, right? But, now that things are going back to normal, obviously the opposite applies. Interest rates are going to come down, which means money should flow back into equities. Companies should have increased margins again because of lower production costs. You'll see better earnings, so then you move your money back into equities going forward from now. So, I think that would be
So, you play that cycle, basically. Cash, fixed income, now equities.
Yes.
Yeah. Makes sense. Awesome. Thank you. Good chat.
Yes. Good chat.
We are hoping to, you know, have more of these going forward because, I mean, obviously this is a trending topic, but we really want people to kind of understand what we talk about behind closed doors at Kel, and to kind of give people a look beneath the hood, let's put it off off the office that we work at. So, yeah, it was awesome having you, Terry. Thank you. Thanks a lot. And all the best.