Financial sector stable despite global crisis
Central Bank Governor Ajith Nivard Cabraal
Central Bank Governor
Ajith Nivard Cabraal
Q: You repeatedly said that the Banking system in Sri Lanka is stable
and will not be affected during this global financial crisis. However,
the situation has changed. Some financial institutions and commercial
banks are under threat. How do you explain this situation? Is this a
result of the global financial crisis or that of a local issue linked
with unregistered financial companies?
A: Since late 2007, the world faced several shocks. The sub-prime
issue that began in the latter part of 2007 turned into a global
financial crisis within a year. The shocks from the increasing food
prices and fuel prices too exacerbated the position. To address the
situation, major central banks reduced their policy interest rates and
stabilized financial markets by aggressively providing liquidity.
Further, several Governments undertook measures such as placing troubled
financial institutions under government control and injecting funds.
They also substantially expanded deposit insurance coverage, provided
guarantees for financial institutions’ debts and provided relief
packages to revive the banking industry and lessen the impact on the
The impact of the sub-prime turmoil on the Sri Lankan financial
system has been rather limited and the overall performance of financial
institutions remains satisfactory. On the whole, financial institutions
continued to be profitable and reasonably well capitalized with ongoing
improvements in risk management capabilities supported by an enhanced
regulatory and supervisory framework and oversight. Some of the recent
policy measures adopted by the Central Bank that included the
implementation of the Direction on Corporate Governance, requirement to
maintain capital on Basel II capital standards, requiring improved risk
management practices and a 1% general provisions on regular loans. As a
result, stronger financial positions had been built up in these
institutions in recent years, and that has enabled these institutions to
cope with the increased levels of risk.
Therefore, the overall Sri Lankan financial sector continues to
remain stable despite the global financial crisis.
Following the announcement by the Chairman of Ceylinco Group on 22
December 2008 of a major scam at one of their group companies, viz., the
Golden Key Credit Card Company, some of the licensed financial
institutions in the Ceylinco Group showed signs of stress. But now these
risks and stresses are receding, and it is likely that conditions will
return to normal soon.
Q: Can you explain the legal position that you used to rescue the Seylan Bank?
A: The Monetary Law Act provides wide powers for the Central Bank to
intervene in a distress situation in the case of financial institutions.
In view of the negative market development that severely affected the
confidence of the public in Seylan Bank in late December 2008, and the
potential danger that such a situation caused to the stability of the
financial system, the Monetary Board took the necessary action to ensure
stability, in terms of the Monetary Law Act.
Q: How does it work practically? Have you been able to restore the
confidence of the depositors?
A: In order to restore confidence, the Monetary Board discontinued
the services of the entire Board of Seylan Bank as at 29 December 2008,
and appointed the Bank of Ceylon to carry on the business of the Seylan
Steps were also taken to appoint experienced bankers, eminent
lawyers, and prominent administrative persons to the new board of Seylan
Bank. The services of the incumbent CEO and all current employees of
Seylan Bank, were retained without any interruption. Credit lines were
also restored to meet urgent liquidity needs of the bank and the bank’s
management ensured that sufficient funds were available to meet urgent
At the same time, the Monetary Board informed the public that normal
financial transactions should be continued with Seylan Bank and assured
the public of the safety of deposits and the stability of the regulated
financial sector. The public confidence on the bank has now been fully
restored. This is confirmed by the upward movement observed in the share
price of the Seylan Bank which reflects market confidence on the new
Q: Unregistered financial institutions have posed a threat to the
whole financial system. Do you still think that educating people on the
risk of such companies is enough?
A: It is absolutely essential that the public should be aware of the
consequences of the investment decisions they make. People need to
realise that the money they have earned should be invested carefully.
However, some people still risk their money in unregulated enterprises.
Although they have the freedom to do so, it is very unfortunate because
they may sometimes lose their money because of their greed. We will
therefore continue with our extensive programs to educate the public on
the risks regarding investing in unregistered financial institutions. We
are also taking steps to request Parliament to amend the relevant laws
to give the Central Bank greater authority and ability to deal with such
Q: The Global economic crisis has already hit our main export
industries. Under this situation, what would be our growth forecasts for
A: Our trade data up to November 2008 indicate that our exports have
grown by 9.7 per cent during the year. This growth has mainly been in
textile and garments, petroleum products, rubber products and diamond
and jewellery sectors. The growth rate of imports during the year, which
peaked at 35.4 per cent in July 2008, has declined to 27.9 per cent by
November, 2008, effectively containing the trade balance from expanding
However, the uncertain nature of the current global economic
situation, which has been dubbed the worst economic crisis since the
1930s, has made the extent of financial disruption on the domestic and
international economies, unclear. In that scenario, we could expect a
negative impact on our exports in 2009 mainly due to drop in demand due
to lower demand emanating from key export destinations such as the USA,
UK, Germany, Italy, France, etc. Our forecasts for 2009 also indicate a
clear decline in exports. Fortunately, however, imports are projected to
decline by an even higher rate. Therefore, the low growth of imports
that is expected to prevail during the greater part of 2009, will result
in a contraction of the trade deficit compared to the trade deficit in
2009, which would be beneficial for us.
Q: Many reports and experts have highlighted that Sri Lanka Rupee is
overvalued by over 20% against our competitors and propose to devalue
the rupee. Why is CBSL against the devaluation of the rupee?
A: The international value of the Sri Lanka Rupee is determined by
the market forces of supply and demand in the local foreign exchange
market; this should not be confused with imports and exports alone. In
this regard, the Central Bank closely monitors developments in the
foreign exchange market to avoid any sharp volatility in the market.
Naturally, the foreign external market is subject to sudden disturbances
in the external sector.
The stability of the exchange rate is more important in a commodity
price boom like what we experienced during 2008. Therefore, the Central
Bank had to intervene in the foreign exchange market to absorb and
supply foreign exchange when the Central Bank believed it was
appropriate, especially when sharp movements in exchange rates which are
not warranted under normal economic conditions, may have been inclined
to take place.
Arguments on the overvaluation of Sri Lankan Rupee is mainly based on
two factors. These factors are the relatively higher inflation in Sri
Lanka, and the sharp depreciation of some currencies of our trading
partners and competitors. We have already successfully addressed the
Our inflation is now decelerating at a faster rate than that of our
Therefore, the relative disadvantage arising from higher cost of
production is likely to erode in the near future. It is also important
to note here that in Sri Lanka, interest rates are rapidly declining,
fuel prices have been reduced substantially, and electricity prices have
also reduced significantly. In addition, the government has introduced a
support package to maintain the competitiveness of our exports. All
these will add to our competitiveness. People should not think that
competitiveness arises from the exchange rate only. They must remember
that productivity and efficiency must also be given a lot of attention.
Now, let us consider the second issue. That is the relatively sharper
depreciation of other currencies vis-a-vis the Sri Lankan Rupee. In this
matter, we expect this situation to be a somewhat short-term phenomena
arising from the recent global financial crisis. Once financial market
conditions improve, even slightly, it is likely that these other
currencies would revert back to their original positions. Therefore, Sri
Lanka’s rupee may not need to adjust sharply in response to such short
term sharp fluctuations in world currencies, which has actually
destabilized those economies and caused immense hardships to the people
of those countries. We should not follow such courses of action blindly,
without giving consideration to the many other factors that are impacted
by the exchange rate. The Central Bank of Sri Lanka’s policy has been to
maintain a reasonable stability in our exchange rate, while allowing
some limited depreciation to maintain competitiveness, and that we
think, will, someday soon, be acknowledged by many, as having been the
better course of action. Let’s wait and see.
Q: Do you think that the sharp decline in commodity prices have
passed to the consumers?
A: (Milk powder, essential food, fertilizer) Although commodity
prices started to decline from July 2008 onwards, prices tend to be
sticky with downward revisions, since it takes time for prices to adjust
downward to reflect those of the international markets. This does not
mean that there will not be an adjustment, but just that it will happen
with a lag.In fact, we observe a decreasing trend in retail prices of
essential food items such as wheat and dhal from July to November, 2008.
With respect to milk food, there has been a reduction in the retail
price of milk itself. However, the retail prices of other milk based
products such as butter and margarine have increased during this period,
possibly due to seasonal factors. At the same time, we also have to
understand that in order to support the domestic milk industry, the
price of imported milk powder needs to be maintained at a reasonable
price, and that is why the government has increased the import duty on
With respect to fertilizer prices, it is only the urea prices that
have reduced on par with those of other commodities. Other types of
fertilizer continue to be high in the world market. Since fertilizer is
subsidized by the Government, changes in fertilizer prices are not
expected to affect the consumers much.
Q: What is the level of our foreign reserves and fiscal deficit? Some
sectors accuse that the CB does not give correct figures?
A: Central Bank has been regularly publishing data on key economic
In this regard too, as we have already announced, the Gross Official
Reserve position of Sri Lanka including ACU balances as at end 2008 was
at US dollars 2,560.5 million. The Fiscal deficit as per the revised
budget of 2008 was 7.0 per cent of GDP, as has been published in our
“Recent Economic Developments” publication. In comparison, the fiscal
deficit of 2007 was 7.7 per cent of GDP. Some people, when they don’t
like the figures put out by us because it does not support their own
dooms-day theories, tend to criticize the Central Bank, or the
Department of Census and Statistics as we are the suppliers of
information. That is actually very pathetic and reflects badly on the
people making such accusations.
Q: How do you explain the decline in sovereign ratings of SL by
Standard and Poor’s from B+ to B?
A: The recent cut in Sri Lanka’s credit rating by one notch from B+
to B was based on factually incorrect, logically untenable and grossly
misleading information. The press release issued by the Central Bank of
Sri Lanka immediately upon knowing of the rate cut clarified our
position, and we would suggest that people look it up in our website.
Sri Lanka’s debt burden has been easing significantly over the years.
The public debt as a percentage of GDP declined to 85.8 per cent in 2007
from around 105.6 per cent in 2002, and is projected to decline to about
80% by the end of 2008.
On the political front, the government is stable with the
participation of several political parties in Sri Lanka. On the security
front, with the liberation of areas illegally controlled by the LTTE,
and by substantially reducing the terrorists’ destructive capacity, the
security situation has improved substantially. In that scenario, it is
not possible for anyone to logically sustain the reasons for the rate
cut. But, I guess rating agencies are now under tremendous threat
themselves because of their poor performances and in that context, they
may now be more inclined to downgrade developing countries, just to show
that they are doing a good job. However, it is very strange that some
institutions and countries that are having a lot of more serious
troubles than us, are still retaining their high ratings.
Q: How will this affect our foreign borrowings, especially commercial
A: In the light of ongoing financial turmoil, raising commercial
borrowings has become very difficult across the globe. The resultant
liquidity crunch and credit squeeze in the international market has
already made commercial borrowings challenging for all borrowers in the
Therefore, this will undoubtedly impact our foreign borrowings,
particularly in the year of 2009. However, in the absence of the
traditional commercial borrowings, the Central Bank has now initiated
many new innovative measures to build up the reserves to a higher level.
As already announced in our “Road Map: Monetary and Financial Sector
Policies for 2009 and beyond”, some of the on-going activities are
designed to fill this gap. First, we will enter into arrangements of
currency swaps with certain central banks in order to boost our gross
official reserves. Some central banks have already responded positively
and two such negotiations are at an advanced stage currently. Second, we
will start the active promotion of investments in Treasury bills and
bonds among the Sri Lankan diaspora. Six lead managers that have been
approved by the Central Bank have already taken many steps to promote
these investments worldwide.
Third, with effect from 1st February 2009, a payment of a 20% bonus
interest on NRFC and RFC deposits will be made as a special incentive to
encourage higher levels of inflows into NRFC and RFC accounts. Fourth,
we will encourage further inflows by Sri Lankans with perhaps only a
marginal once-and-for-all concessional final income tax for any new
foreign exchange inflows, if such inflows are liable to income tax. This
incentive too, is expected to attract a significant inflow of foreign
exchange into the country.
Q: How will the North and East contribute to the country’s economy in
this year and thereafter? What are the plans, sources of financing etc.
to rebuild the Northern and Eastern provinces?
A: The Eastern and Northern provinces presently contribute 5% and 3%
of the country’s Gross Domestic Product (GDP), respectively. With the
liberation of the Eastern province from the clutches of terrorism, a
massive development drive is now on, in order to rehabilitate and
reconstruct the social and economic infrastructure in the province while
also resettling Internally Displaced Persons (IDPs).
The main program implemented by the government in this context is the
Neganahira Navodaya, which has been given the highest priority by the
government. With the progress of these measures, economic activities in
the Eastern province are being revived and encouraged with a new
impetus, thereby gradually enhancing its contribution to the country’s
GDP. By now, most parts of the Northern Province have also been
liberated by our Valiant Security forces. As a result, the main two
access roads to Jaffna, i.e.The A9 and A32, have been cleared and their
rehabilitation activities are now underway. With the opening up of these
two roads, economic activities in Jaffna and the rest of the Northern
Province will be reactivated with a renewed momentum. The benefits of
this momentum will spill over to the rest of the country as well,
particularly with enhanced economic activities from the Northern tip of
the country, Point Pedro to the Southern tip, Dewundera.The program,
Uthuru Wasanthaya, is now in its early stages to rebuild and develop
Northern Province, which will cover the construction of the rail track
and highways connecting the North and the South, while schools,
hospitals and government offices will also be renovated and modernised.
The initial necessary financing to implement these projects have
already been allocated in Budget 2009. They will be financed through
concessional foreign loans, grants and domestic resources.