Sri Lanka resorts to money printing as state revenues run dry

The Central Bank was again forced to pump massive amounts of liquidity into the government, as the state coffers were running dry, since the authorities reimposed the business and job-killing restrictions, which generate tax incomes to the government. 

According to the data, the Central Bank holdings of government securities or the printed money stock had surged by Rs.34.51 billion since the country went into a near total lockdown on May 21, through June 18, 2021, bringing the total outstanding printed money stock to Rs.896.24 billion.  

There has been serious concerns of growing holdings of government securities by the Central Bank, which is also referred to as printed money in the system by certain quarters as excessive liquidity has the effects of destabilising economies by stoking inflation, balance of payment crises and asset bubbles.  But the proponents argue that the economy, which is significantly battered by the virus, can and should be supported through easy money, until it reaches its equilibrium, as the economy still operates with a significant slack. And the Central Bank repeatedly said it was willing to take its foot off the gas if it saw significant excesses as a result of the current policies.

While last month’s Central Bank liquidity may not be specifically intended to provide for the welfare transfers, the government spends up to Rs.30 billion for a single such round to distribute Rs.5,000 stipend to support a family, who is unable to make a living due to the virus-related restrictions. 

As the government will continue to have to rely on the Central Bank liquidity amid slowing tax revenues, it could keep the domestic interest rates low to support the government financing as well as to support the broader economy significantly hurt by the virus-related lockdowns. 

Meanwhile, the government, which has limited options to raise foreign currency funding to bridge its budget gap, could also resort to the banking sector for borrowings, potentially leaving less money for the private sector - a scenario know as ‘crowding out effect’, albeit the possibility remains less of that happening. 

Sri Lanka is bracing for back-to-back years of blow out budget deficits in 2021, potentially reaching double-digit levels as a percentage of its gross domestic product (GDP) as it crimped its revenues through lockdowns while confronting with unexpectedly high expenditure on virus containment measures. 

The fiscal deficit can also look higher than it actually appears when the output gets compressed as authorities lost nearly a trillion rupees in GDP during the two months long restrictions since April 23, 2021.