Spotlight: Econ Op-eds in Summary (Week ended 24th March '21)
1. What does a challenging economic environment facilitated by low-interest rates mean for corporates?
By: Charith Gamage
Sri Lanka is currently in a low rates environment amidst the COVID-19 pandemic. In such an environment, corporations can enhance their funding by either issuing new stock or borrowing funds from lenders. The total level of corporate borrowings can be ascertained from the Debt-to-Asset and Debt-to-Equity Ratios. These ratios measure a firm’s borrowings relative to their equity or asset base respectively, with a higher value indicating that a firm has a higher reliance on debt compared to its equity or asset base.
In general, a firm’s total financing will be procyclical and is consistent with the idea that firms reduce investments during economic downturns and vice versa, optimising their debt-equity choice accordingly. Studies show that firm size is a key consideration for firm financing over the business cycle, with funding needs and capacity differing across firms. Regardless of the business cycle stage, large firms find debt financing attractive, as economic downturns will have less of a detrimental effect on large firms’ credit quality than smaller firms.
Bank credit plays a crucial role in firm financing in recessions, particularly in Sri Lanka as the corporate bond market is illiquid. This means that firms must heavily rely banking channels for debt financing. An article from Global Finance demonstrates that low rates don’t mean that funds are accessible to all firms, given tighter lending standards for banks amidst COVID-19. Rather, a wave of mergers acquisitions which favour larger corporations have emerged. However, to mitigate adverse effects arising from excessive lending of regulatory measures must be in place.
2. Sri Lanka import controls and their impact
By: Asanka Wijesinghe
Sri Lanka had recently imposed a wave of import restrictions with the aim of boosting domestic production and avoiding re-exporting substandard products and foreign exchange leakage. However, protectionism has costs. One of the main concerns is the possibility of trade retaliation where import controls could lead to long lasting and damaging tariff battles with key trade partners, which could in turn hurt the country’s exports.
Another concern with regards to import controls lies in the manufacturing sector’s heavy dependence on imported raw materials. In such a situation import controls disrupt the input supply and may harm the export performance of industries that use foreign raw materials.
Historically, governments had resorted to import controls when there was a balance of payment crisis. However, the trade deficit’s temporary shrinkage may not be sustainable if there is no increase in exports. Instead, Sri Lanka needs to remove hurdles on input supply, exploit market opportunities under the rule-based free trade system, and in the long run, improve the country’s global value chain participation.
(Compiled by: Promodhya Abeysekara & Malitha Goonerathne)
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