Sri Lanka’s EPF hit by US$6.5bn hair cut after soft-peg collapse

- economynext.com

ECONOMYNEXT – Sri Lanka’s Employees Provident Fund, a pension fund of private sector workers has suffered an estimated 6.5 billion US dollar hair cut after the collapse of a soft-peg after two years of money printing to mis-target interest rates.

Sri Lanka operates soft-pegged monetary rate regime made respectable by the label ‘flexible exchange rate’ which frequently runs into money and exchange policy conflicts and collapses steeply.

Monetary policy and open market operations (liquidity injections) employed against the peg became sharply more aggressive after 2015 with the adoption of ‘flexible’ inflation targeting leading to a series of currency crises and output shocks.

After the latest bout of open market operations to mis-target interest rates, the currency collapsed to 360 to the US dollar by March 2022 from 200 in January.

The Employee’s Provident Fund, the largest pension fund of private sector workers had total assets of 3,166 billion rupees, make up mostly of government securities denominated in rupees.

The fund also has some money in stocks.

Each year the fund earns interest on the government securities helping expand it.

Members an claim the balance in full at the retirement age but up to now new contributions have exceeded the withdrawal.

In 2021 the fund grew by 12.1 percent to 3,166 billion rupees with net contributions contributing 47.5 billion rupees.

The rupee fell from 186 to the US dollar at the end of 2020 to 200 to the US dollar by December, giving a dollar value to 15.8 billion rupees, up from 15.15 billion a year ago, despite the depreciation.

Sri Lanka has chronic monetary instability and depreciation keeping nominal interest rate generally higher than countries with consistent monetary policy.

In 2022 the currency collapsed steeply as an attempt was made to float the rupee with a surrender requirement and low policy rate.

If the fund grew at the rate of 12.21 percent, the highest seen in the last five years which is about 5.1 percent when prorate for five months, the fund could have grown to 3.3 trillion rupees.

However in US dollars terms the EPF would then be worth only 9.2 billion US dollars, with fund being hit by a hair-cut of 6.57 billion US dollars.

To get an equivalent haircut from sovereign bond holders who hold about 12 billion US dollars of government debt at least a 50 percent hair cut would have to be imposed.

All bank depositors would also have a similar hit their deposits.

The real hair cut on domestic debt is generally called inflating away the debt and imposes severe pain on the old and most helpless sections of society who has savings in pension funds or banks.

In Russia pensioners died when they could not pay for heating after a soft-peg collapse.

Sterilizing soft-pegs of the style found in Sri Lanka are among the most dangerous ever invented.

The sterilizing pegs were invented in Argentina during the Great Depression and popularized by several US academics during the depression and in the course of building the failed Bretton Woods system of soft-pegs.

The US shifted to a single-anchor clean float in 1971.

Many East Asian countries have more consistent pegs built by the British who operated the Sterling Area of consistent pegs and largely escaped US tinkering except for Korea, Philippines and Vietnam who lost their currencies or the central banks were re-built.

Sri Lanka also has a US-built central bank which is now deeply in debt. (Colombo/June22/2022)

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