SriLankan Airlines: Flying in circles with no flight plan

By Dhananath Fernando

Originally appeared on the Morning

SriLankan Airlines (SLA) is not a new name in the country’s long list of financial headaches. It is our National Carrier, a symbol of pride when it flies, and a source of embarrassment when it falls into losses and political meddling. Governments have changed, but the story has remained the same.

Today, the situation is worse than ever. The airline is practically impossible to rescue in its current form. The previous Government invited investors to take over or partner with the airline, but not a single credible party showed interest. The reason is simple: the balance sheet is deeply negative.

Last year, SriLankan Airlines made a profit of about Rs. 7.9 billion. This year, it has reported a loss of about Rs. 2.7 billion. Some argue that the airline should remain under State control. But even if the Government wanted to divest, the question is who would want to buy an airline buried in debt.

The truth is, the problem is more serious than it appears. The saddest part is that there is no restructuring plan at all. The Government seems to have accepted the airline’s own proposals and continues to operate without a clear direction.

According to the National Audit Office, continuous Government support is required just to keep the airline running. Last year alone, taxpayers injected Rs. 20 billion into it.

Let us look at how much public money has been spent over the years:

2010: Government buys back Emirates’ 43.6% stake for $ 53 million

2011/’12: Capital infusion of Rs. 14.3 billion through Treasury bonds

2014: Treasury settles Rs. 26.11 billion owed to the Ceylon Petroleum Corporation (CPC) for unpaid fuel bills

2016: Cabinet approves absorbing Rs. 461 billion of SLA liabilities

2023–2024: Government agrees to absorb $ 510–553 million of SLA debt

H1 2024: Equity top-up of Rs. 5 billion for cash flow support

Budget 2025: Rs. 20 billion allocation for legacy debt service

Since parting ways with Emirates, we have repeatedly returned to the Treasury for help.

Even though the airline shows an operating profit, it is not enough. The load factor is around 70%, while the break-even point is about 76%. The main losses come from finance costs, which are roughly Rs. 30 billion each year — a huge amount compared to revenue.

To stay competitive, the airline needs investment to modernise its fleet and improve efficiency. But the Government has no funds, and no investor or lender will come forward without a Treasury guarantee. The new Public Debt Management Act makes such guarantees more difficult and costly.

Revenue and passenger numbers have also declined compared to the previous year, even as tourism recovers. According to the Sri Lanka Tourism Development Authority, SriLankan Airlines carries only about 27-30% of tourists, while nearly 70% arrive through other airlines. This suggests that service issues, repair delays, and stronger competition are taking away loyal passengers.

At the group level, monopoly businesses such as ground handling and catering help to cover some losses, but they also make the entire aviation industry less competitive.

Even if the airline were liquidated today, it would still need Rs. 379 billion to settle its debts. Around Rs. 90 billion is owed to State banks such as Bank of Ceylon and People’s Bank. Writing off those loans would hurt the stability of the banking sector.

Despite its financial troubles, SriLankan Airlines still operates on important routes and has an excellent safety record. The brand has emotional value for many Sri Lankans, which is why restructuring will face resistance from employees, trade unions, and politicians.

So what can be done?

Option 1: Dress up the balance sheet once and for all. Inject the required taxpayer money, absorb the liabilities, and then look for a strategic investor.

We have tried partial fixes for years, taking over some debt and hoping the airline will perform better, but that approach has failed. If we want to attract a serious investor, we must clean it up completely and find a partner with deep experience in aviation.

However, this must be done with a clear legislative direction and timeline. Otherwise, once the debt is absorbed and the airline begins to show a profit, a new debate will arise questioning the need to privatise a profit-making National Carrier. The political economy will then move quickly to block reform, forgetting that the taxpayer had already paid for the cleanup.

Option 2: Package SriLankan Airlines with other State assets such as the Mattala or Ratmalana airports to make it more attractive to investors.

This might require relocating some Air Force operations and preparing a comprehensive restructuring plan. But such an approach takes time, and time is exactly what we do not have. The longer we wait, the deeper we fall, and the more political and geopolitical interests get involved.

There is no point blaming the airline or its employees. The problem is not in the sky but on the ground. We simply have no plan.

It is time to get our act together, because a national airline without a flight plan can only keep flying in circles.

Central Bank Defends Liquidity Injections Amid “Money Printing” Controversy

By Dhananath Fernando

Originally appeared on Ada Derana Business

A fresh controversy has erupted following reports that Sri Lanka’s Central Bank (CBSL) injected nearly 100 billion rupees into the banking system by October 25. Given that money printing was the major cause of the country’s financial crisis, this news has sparked considerable attention. CBSL has defended its actions, arguing that these liquidity injections do not equate to money printing.

What is the CBSL’s Argument?

CBSL asserts that these liquidity injections were necessary to address persistent imbalances among banks. Despite an overall surplus of funds in the banking system, this liquidity is unevenly distributed. Foreign banks operating in Sri Lanka hold significant liquidity surpluses but remain cautious about interbank lending due to strict risk management guidelines. As Sri Lanka’s sovereign rating is still ‘Default, this limits their exposure to local financial institutions. As a result, foreign banks deposit excess rupees with the Central Bank rather than in the interbank market.

While this was a serious problem in the midst of the crisis things have improved since: interbank call market (clean or unbacked) trading volumes, once as low as zero 1-2 billion rupees daily, has now returned to Rs10bn to Rs20bn (averaged 10 billion last month). Repo volumes (backed by T-bills) are back around 30 to 70 billion rupees, which is higher than pre-crisis levels.

Notably, auction data shows the central bank offering more than what banks bid for, with some banks bidding close to the deposit rate, indicating a willingness to lose bids—yet CBSL still provided new funds.

Given the much healthier interbank volumes, the CBSL should avoid undermining the working of the interbank market. The CBSL should be the last resort for a bank facing a liquidity crunch, not the first.

The Core Issue: Temporary vs. Longer-Term Impact

The debate centers on whether these injections are temporary or enduring. If CBSL swiftly withdraws the new money by selling Treasury bills or foreign exchange, the money supply remains stable. However, if these short-term purchases are repeatedly rolled over, the increase in money supply could become more long-term. Critics warn that this scenario is no different from lending money to the government, potentially triggering balance of payments problems and inflation, thus jeopardising the ongoing economic recovery.

A Matter of Terminology

CBSL’s reluctance to label this as “money printing” is essentially terminological. Regardless of whether the funds are lent to banks or the government, the impact on the money supply is fundamentally the same. Therefore, interventions must uphold the principle of currency stability, given the grave consequences of unchecked money creation.

Acknowledging CBSL’s Efforts

It is It is important to acknowledge that since September 2022, the CBSL has done an admirable job in restoring monetary stability. The critical task now is to maintain this hard-won stability. These points are presented to promote a healthy academic debate on an issue of great importance, not to cast blame on any specific entity or person.

Potential Alternative Strategies

What alternatives could CBSL have considered?

Purchase Foreign Exchange from Banks: Where balance of payments conditions permit, CBSL could continue the practice of buying foreign exchange, injecting rupees but reducing foreign currency in the If the injected rupees were later used for imports, CBSL could sell foreign exchange back, maintaining balance and avoiding exchange rate issues.

Use the Standing Lending Facility: Lending at the Standing Lending Facility Rate of 9.25% would ensure banks only borrow for urgent liquidity needs. As this penal rate is higher than the interbank rate, it discourages long-term dependency and helps avoid a lasting increase in the reserve money supply.

Reduce the Standing Deposit Facility Rate: If the CBSL wishes to lower rates, it could reduce the rate on deposits held at the Central Bank, which would encourage banks to lend more in the interbank market. However, this would also lower overall interest rates and must be carefully managed. To support reserve accumulation, interest rates need to remain at an appropriate level to curb credit and keep imports in check.

The Balancing Act

CBSL faces the difficult task of supporting the banking sector while safeguarding monetary stability. Any intervention must be carefully weighed to mitigate risks such as inflation and currency destabilisation.

Treasury and Central Bank should consider credit guarantees for COVID-19 distressed bank loans

Covered in the Daily Mirror, Daily FT

By Fellows of the Advocata Institute

Even though Sri Lanka’s economy has opened up, businesses are still recovering from the dual shock of the locally imposed curfew as well as the global fallback from the coronavirus. A vast majority of Sri Lankan businesses are in need of support if they are to survive the next few months. 

The need of the hour is for liquidity support and enhanced access to credit. However, banks find this situation to be challenging. They need to be able to finance the loans that are being demanded but they also need to have some guarantee that their loans will not go bad. 

Will Central Bank’s solution work?

In response to this problem, the Central Bank has announced a subsidised credit scheme for businesses. Through this, the Central Bank will be offering a facility of Rs.150 billion to licensed commercial banks (LCBs), at a concessionary rate of one per cent. LCBs, in turn, will be required to lend to businesses at a rate of 4 per cent. 

Put simply, the Central Bank is essentially offering commercial banks a credit line to solve their issue of a source of financing this new demand for loans.  

Assuming that the bank’s marginal cost would be around one per cent, it is left with a contribution of 2 per cent before provisioning. Lending to this segment of businesses will be risky as many of these borrowers are already leveraged and do not have spare collateral to pledge. 

Under distressed economic conditions, non-performing loans could increase significantly. While part of the non-performing loans could be partially recovered, the impairment cost or credit cost could be as high as 6 per cent.  

If the net contribution to the banks is 2 per cent after their direct cost, a potential 6 per cent credit cost per year would mean a pre-tax loss of 4 per cent per year, creating the need for a credit enhancement or guarantee. 

This credit line means that the Central Bank is printing money to meet this requirement, leading to a monetary expansion. The risk of increasing money supply in the current economic context is that the subsequent pressure on the exchange rate will result in a depreciation of the currency. 

Looking at Sri Lanka’s import bill, 19.8 per cent of our imports are consumption goods and 57 per cent of imports are intermediate goods for production. The share of investment imports is also higher than consumption goods at 23.1 per cent. The impact of a depreciating currency will be significant on the economy’s ability to recover and grow. 

There are additional risks associated with this solution. A key problem is that while banks are receiving newly minted money from the Central Bank to finance the loans, the bank and the depositors have to take the credit risk on the lending. The collapse of finance companies in recent years shows what happens when deposit taking institutions take on risks that they cannot bear. 

Bad loans of Sri Lanka’s banks have been rising since the currency crisis in 2018 and the Easter Sunday bombings. The banks are already burdened with the credit moratorium that was also given in early 2020. In the first quarter of 2020, bad loans had risen to 5.1 per cent, which is the highest since the third quarter of 2014.

If banks collapse, the government may end up having to bail them out with capital injections. At the moment, Sri Lanka’s banking system is fairly sound and given the indications that bad loans will rise, all efforts must be made to keep banks stable.

Further complications

As highlighted by former Central Bank Deputy Governor and senior economist W.A. Wijewardene, the issue with excess liquidity already in the system, the problem is not about liquidity but the fear of default. According to Wijewardene, this fear of default could be tackled by a comprehensive credit guarantee scheme and smoothing out banks’ internal credit approval systems. 

Instead of using the CRIB reports for rejecting loans, a rating system could be used to eliminate the worst ones. If treasury guarantees are available, it may not be necessary to create new money and endanger the balance payments. Banks may be willing to make loans from their own deposits if there is a guarantee. 

There is also a moral hazard associated with this decision. This crisis hit at a time where there was significant pre-existing distress in the economy, there is the possibility that this financing will be utilised to keep ‘zombie entries’ alive. Additionally, this would prevent resources from being allocated to productive and efficient firms. What is needed is quick support for viable companies to get their business going. Steeply subsidised credit may induce businesses to go after loans that are not needed and refinance other loans, which are at higher rates. Or whenever they have the cash, the incentive will be to settle the higher cost loan than the low-cost one, inviting default or delays. The artificially low rate of interest of 4 per cent for working capital also may create other distortions. 

A working solution 

Given a challenging environment, if the authorities want to direct banks to give loans, the government will have to share the risk. Ideally, the credit risk should be split three ways between the government, multi-laterals and banks, to ensure that they have skin in the game. The worst-case scenario would see the banks with a potential zero profit from this scheme and not the alternative of sustaining heavy losses, incentivising the banks to lend.

Guarantees could also be structured to give high credit cover to smaller firms and lower amounts to large firms, as it may not be necessary to give all borrowers the same amount of credit cover. 

For instance, loans up to a million rupees for very small firms could be covered by a 100 per cent guarantee, loans from 1 to 10 million by a 90 per cent guarantee, from 10 to 20 million, 75 per cent and loans above 20 million to 50 per cent or a similar suitable share of risk. Of course, this solution is not devoid of risk. This would allow the LCBs to meet the demand for the loans, with the guarantee offered by the government.