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What is Inflation Targeting?

“Given that Sri Lanka is a twin deficit country, in terms of budget deficit and current account deficit, the chances that Sri Lanka attracting new money at this juncture is very minimal indeed. By increasing interest rates, we will not be able to attract new money or keep the money already invested.”
Indrajit Coomaraswamy 02.10.2018
Inflation targeting as defined by Bernanke in one of his papers1
“The hallmark of inflation targeting is the announcement by the government, the central bank, or some combination of the two that in the future the central bank will strive to hold inflation at or near some numerically specified level.”
In the same paper he goes on to say
“We believe that it is most fruitful to think of inflation targeting not as a rule, but as a framework for monetary policy within which “constrained discretion” can be exercised. This framework has the potential to serve two important functions: improving communication between policymakers and the public and providing increased discipline and accountability for monetary policy.”
To put it in a local context, the movement to a flexible inflation targeting framework does not mean that we wholly ignore foreign reserves. It just means that we will consider other things as well. The governor signaled that he was looking to increase the growth rate in the second half of 2018 to close to 4% and to a lesser extent that he was hoping to close the output gap that exists.

Why rates will come down in the long term?

To put it simply the government is just better at borrowing now. It borrows less frequently and for less ambitious purposes. This is in a context of a complete legal overhaul of the way in which government financing occurs. We have a new bond issuance system, a new active liability management act, and most importantly significantly lower budgetary deficits proportional to GDP. The budget deficit for 2019 is close to 4.1% of GDP.
The relevant section of the active liability management act2 is as follows;
“The Parliament may, during a particular financial year from time to time, by resolution, approve to raise sums of money, the total of which shall not exceed ten per centum of the total outstanding debt as at the end of the preceding financial year, as a loan whether in or outside Sri Lanka.”
This gives the government the capacity to refinance and pre-finance any government obligations. This allows government financing to take place more smoothly. This and the capacity to tap international markets pre-emptively will help reduce the financing costs of the government. My sense is that the CBSL is now in a much better position to reject bids than it has been before. With inflation at current levels it is also forgivable for the CBSL to print money and end up at the upper band of the inflation target.

What About Foreign Reserves?

Here this article agrees with the consensus that reserves will slightly deteriorate. This however does not pose a significant risk to the economy as the magnitude of such deterioration will be small. We must remember that this is not a government that wastes foreign reserves on protecting the exchange rate and as such the level of reserves will not fall to a point wherein a crisis occurs. One must also account for the Samurai and Panda Bonds which are to be issued.
Further the halting of duty-free vehicle imports and the upcoming budget which many economists suspect will increase the cost of the yearly vehicle revenue license in a unit rate like fashion will ease pressures on the demand for foreign exchange. The revenue license hike would look to tackle the problem that high duties are realizable in the secondary market for cars and as they are FX denominated reward people who buy cars as a bet against the rupee.

Revisiting the exchange rate in this regard

Many analysts are concerned about the reserve position with the flow of funds back to the US and further the rising costs of oil. Our low rates of FDI should bring confidence about the magnitude of the fund flow back to the US. There is also much scope to increase FDI and foreign investment will invariably flow to build up the Port City project. With regards to the costs of oil there is little that interest rate policy can do.

Going long on government securities

Let us remind ourselves that the average AWPR in 2015 was 7.40%. The Central Expressway, the only heavy financing requirement so far, has been financed through an external party. Inflation is below 5%. An 11.32% yield on the secondary trading of a 9.91-year treasury bond as at 03.10.2018 seems a good deal.
We are a country with a primary surplus on our budget. A fiscally conservative government in the long run will bring down rates.
Footnotes

  • Inflation Targeting: A New Framework for Monetary Policy? Author(s): Ben S. Bernanke and Frederic S. Mishkin Source: The Journal of Economic Perspectives, Vol. 11, No. 2 (Spring, 1997), pp. 97-116 Published by: American Economic Association
  • ACTIVE LIABILITY MANAGEMENT, ACT, No. 8 OF  2018, Parliament of Sri Lanka

 

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Who We Pay for LankaPay

Full doc.x with images at bottom.
Arvind Subramaniam recently made statements in the Central Bank about rebuilding the social contract. He put forth a narrative of reform whereby he called for the building of trust in government institutions. The statements also coincided with the revelation to the general public that cheque payments had been made to the former president, members of COPE, and to political foundations. Here the general public should see an opportunity. We have a Central Bank eager to impress Mr Subramaniam and a political desire for some action. On your behalf this article looks to achieve two things;

  1. Reduced cheque usage via a reduction in the SLIP system cost to the consumer
  2. ITCA representation on the LankaPay Board

Cheques are notoriously bad instruments of payment. They are slow, subject to error, and expensive. According to LankaPay’s annual report “Out of the 51.45Mn cheques  presented for clearing, 2.15Mn cheques were  returned due to non-payment. This amounts to  4.18% of the cheques presented for clearing of  the total cheques returned, around 48% were  returned due to lack of funds.” Cheques also facilitate fraud and money laundering as they can be easily transferred and even encashed by 3rd parties notably members of a Minister’s Security Detail (MSD) with no questions asked. We have a perfectly good SLIP system which is underutilized due to extortionate pricing which was written about earlier (http://www.ft.lk/columns/Money-transfer-and-the-CBSL/4-658243). The previous article shows that to the consumer cheques are cheaper than electronic transfers even though the bank would find it cheaper to perform the latter via LankaPay.

Source- Central Bank Q3 Payments Bulletin
Looking at the charts from the payments bulletin we see that the majority of transactions in the SLIP system are also only for salary payments. These payments tend to happen only once a month. More widespread usage can be achieved with a lower price. The regulatory hatred towards digitization is also unfounded. Take the IRD, one of the few revenue institutions not to show a marked improvement since the taking over of the new government. One of their only long term achievements is the collection of PAYE tax. This is because the system does it for them. Mandating for instance that doctors and lawyers receive payment via the SLIP system or via card would be easy to implement given a more widely used digital payment system. This would then make it easy to collect revenue. To be fair to the IRD, it is the CBSL down the road in the much nicer office who are to blame. According to the Central Bank’s Payment Bulletin in excess of 90% of the total retail payments continue to be made via cash. The Central Bank is keener to see their friends at De La Rue succeed than for the IRD to meet revenue target.
All of this is facilitated by the undue power and lack of public accountability with the Central Bank and its many subsidiary operations. LankaPay, running contrary to the Capital Maharaja narrative, is a private company. It has some state and proxy state ownership but operates for profit and in the interests of its shareholders inclusive of the private banks. Also its monopoly status is not in the public interest. The board is also oddly comprised with the regulator taking board seats in the company. This ensures that the company is not particularly well regulated. The board also lacks any technical experts or any involvement of ICTA. This ensures that state institutions are unable to interface directly with the company bypassing the banking system. Sri Lanka customs was only recently given a solution through LankaPay. Institutions like the SEC who would greatly benefit from an operational digital payment platform have been noticeably silent. This may be due to the SEC commission comprising of one Ranel T Wijesinghe who is also on the board of the Bank of Ceylon, a major beneficiary of the poor payment system. The existence of these so called independent commissions might increase the number of interests represented but one must question if these interests are public or vested?

Name of Bank No. of Lanka Pay Shares Mn Value Rs. Mn % Held
Central Bank 2.95 29.5 19%
HNB 2.2 22 14%
Bank of Ceylon 2.1 21 14%
People’s Bank 2.1 21 14%
Sampath 2 20 13%
Others 1.85 24.75 12.17%
Commercial Bank 1 10 7%
Seylan 1 10 7%
Total 15.2 158.25 100%

Source- Lanka Pay Annual Report 17/18
LankaPay is best judged by the status of their planned expansion. The Central Bank has squashed both PayPal operations in Sri Lanka and also the planned operation of a competitor by ICTA. This is sad as PayPal would have helped Sri Lankan businesses better interact with companies overseas and ICTA’s competitor might have brought in innovation into an otherwise sluggish sector.
LankaPay acts as a rent seeking monopoly. The profits however are on respective banks profit and loss statements as they charge excessive mark ups on services provided by the company. It has failed to implement a national card system. It has failed to bring about wide usage of its certification technology. It reinvests in outdated technology. It prevents entry into the industry both through regulatory pressure and also through the excessive unutilized capacity of its own systems. The current switch has been tested and proven to process approximately 7 Mn commercial transactions a day. Sri Lanka is nowhere close to this figure. The marginal cost of processing an additional transaction must be negligible and as such the usage of cheques can be phased out in a few years.
The implementation of a national card system is something LankaPay will not do. It is in the national interests as it allows for lower costs, retention of payment information domestically, and wider financial inclusivity. The Banks however have very lucrative deals with VISA and Mastercard and will not allow for a domestic competitor to form. The technology is already available through a partnership with JCB and probably is already operational in a different form under the previous CPS system. Even though the CPS system is live there are no participant members. LankaPay’s 2018 investment in the common card and payment switch according to the cash flows is zero. The Central Bank is also pretending to work on a payment system for our transportation network. As a country we will continue to be declined widespread card usage by our Central Bank. What do we have to show for 436 million LKR in investment?
The maximum price for a SLIP transfer can be reduced and the cost of a cheque transaction can be increased. This is us, the general public, putting forth an offer for the beginning of a social contract.
Who We Pay for LankaPay