IMF Programme #17: takes two to tango

Originally appeared on the Daily FT, Ada derana, Groundviews

By Daniel Alphonsus

On Sri Lanka’s reform-regress-run to the IMF crisis cycle

Countries never learn from others’ mistakes, they only learn from their own. Sri Lanka is an exception: we don’t even learn from our folly. Apparently neither does the IMF. Sri Lanka’s 17th IMF programme is set to be approved on March 20th. Is it welcome? Yes. Will it break Sri Lanka’s reform-regress-run to the IMF crisis cycle? Probably not. 

All reforms undertaken over the past half-year to win IMF board approval are reversible. None of them constitute entrenched changes in economic policy or governance. We are building our recovery on the shakiest of foundations. The fuel and electricity price ‘formulae’, tax plus interest rate increases and greater exchange rate flexibility can all be altered, more or less, at the stroke of a pen.  

This is not surprising. Sri Lanka has a chequered history of cosmetic compliance: ticking the boxes of virtue and sensibility via international undertakings during desperate times, and then reverting to business-as-usual once crisis abates. We have good reason to think that, this time too, the future will rhyme with this past. Undoubtedly, post IMF board approval, some reforms less easy to rewind will come to pass - the new Central Bank Act being the most notable. 

But the IMF’s bargaining power peaks prior to board approval. That is the decisive point in this process. It is the pivotal moment for any attempt to use this crisis to build the foundations required for breaking the crisis cycle and going from third-world to first. If the most contentious and critical reforms are not pushed through prior to board approval, there is good reason to think they will not come to pass. Remember that of its 16 programmes thus far, Sri Lanka’s has only completed two extended / structural programmes. The remainder are either relatively insignificant standby-facilities or derailed extended programmes

Considering the unprecedented nature of the current crisis, this is a colossal missed opportunity. As argued in a prequel article, Programme 17 could have and should have broken this cycle. Public opinion was desperate, the government commanded a super-majority in Parliament and the IMF held all the aces. The distinction between what is desirable and what is feasible had, almost overnight, dissolved. The cry for fuel and electricity was so piercing and loud that a comprehensive and deep programme permitting profound economic restructuring was possible for the first time since 1977. 

Moreover, even if some of the required reforms come to fruition over Programme 17’s next few reviews - it will still be a missed opportunity. Reform takes time, effort and energy. These are scarce resources. As major structural reforms - such as the central bank act, fiscal rules, privatisations and labour market reforms - were not completed as prior actions, it means the first few reviews will be focussed on them. This will leave little room for some of the more complex long-term reforms; especially in land, the public service and regulatory policy (e.g. competition policy). 

Of course, we are a sovereign state, so primary responsibility for this failure lies in our own polity. But we find little hope in ourselves. As weary and jaded citizens we tend to assume inertia, or worse, on our side as a given. Which is why this article is about the IMF’s failure. 

What could the IMF had done differently? Especially considering its familiarity with Buenos Aires, it should know that it takes two to tango. As Keynes famously said of the IMF and World Bank; the Bank’s a fund, and the Fund’s a bank. Considering the creditor-borrower relationship between the IMF and Sri Lanka; as a creditor the IMF should bear some responsibility for the failure of so many programmes over such a long period of time. The IMF’s own kapuralas have conceived of programme conditionality as a form of collateral. The IMF ought demand more conditionality as collateral prior to lending. This, of course, requires review of past country programmes and, as we all know, economic history and country expertise are not exactly first-rank priorities at the Fund. 

Anyone involved in economic policy-making in Sri Lanka, the IMF included of course, knows that much of the technical work was already done. When the staff-level agreement was signed in September last year, there was a great deal of reform that just required political will and nothing else. Cabinet had approved an earlier version of the new central bank bill during the last days of the Samaraweera ministry. Placing energy price formulas on a statutory footing shouldn’t take more than a day’s drafting. Fiscal rules legislation was already in a relatively advanced stage. Non-legislative measures could also have been mandated - the state could readily have divested its stakes in Sri Lanka Telecom and Lanka Hospitals. These firms are already listed with established valuations. Considering the 200 days between the staff-level agreement in September and board approval now, we had more than enough time to list the major state banks and Sri Lanka Insurance; maybe even privatize the East, Jaya and Unity container terminals. After all, for better or worse, remember the plantations were effectively privatized within fourty-eight hours. These delays are all the more astonishing due to the hypocrisy of asking for favours from our creditors while refusing to sell underperforming assets. 

Primary balance vs growth 

Considering the political cost of market pricing energy and increasing taxes, from a political point of view, there is tremendous incentive for the political leadership to undertake structural reform in return for less pain. Sri Lanka’s future debt sustainability (or lack thereof) is a function of current and future (a) government revenue, (b) government expenditure and (c) GDP growth. By raising Sri Lanka’s growth potential, both the IMF and long-term creditors could and should have been willing to trade-off revenue and expenditure targets for entrenched, high quality structural reform. The one percent rate hike - which the central bank opposed - just before placing Sri Lanka on the board agenda illustrates this well. Clearly, this temporary, one-off one percent increase in interest rates was considered decisive for obtaining board approval. Why then was not actually passing the central bank bill in Parliament - which is likely to shape inflation rates for decades? Note that in my view, the IMF’s bargaining power at this juncture could be so strong that a trade-off between primary balance linked targets and structural reforms may not exist. The IMF may have been able to demand both. That is the IMF could have had the cake, eaten the cake and called it a letter of intent. 

Primary balance today vs primary balance tomorrow

Even if one does not buy the argument of reducing the primary balance target today in exchange for growth tomorrow, two strategies superior to the status quo could have been pursued. 

First, instead of trading off the primary balance versus growth, we could have exchanged a primary balance improvement today for a larger primary balance improvement tomorrow. The IMF could have permitted reducing the primary balance target today in exchange for entrenched reforms that result in a paradigm shift in Sri Lanka’s primary balance trajectory for the future. For example, coming back to the central bank bill, through greater depoliticization and limitations on central bank funding of government deficits, this landmark reform is likely to change Sri Lanka’s medium to long term primary balance trajectory. The ‘net present value’ of this change in primary balance terms - even when discounted for the probability of it being unenforced - is likely to be greater than a few percentage point changes in the primary balance today. 

Optimizing this trade-off would also have the added benefit of placing less pain on the public and reducing the extent of contractionary policy amidst Sri Lanka’s worst economic crisis in decades. 

Second, there are some measures that can improve the primary balance today, and tomorrow. A good example is the sale of shares in state banks. The sale of minority stakes in BOC and People’s Bank will raise money for the exchequer, boosting the primary surplus. However, especially if the banks are listed, it will also make it more difficult for the state banks to permit the government to create enormous contingent liabilities via loans to the CEB and CPC, resulting in a healthier future primary balance. 

Overdiscounting the future

The argument often made in response is that the IMF cannot tradeoff the certainty of hitting quantitative targets today, in return for structural reforms whose fruits may not materialize tomorrow. This view is misguided. First, deep understanding of context enables a reasonably good assessment of the probabilities of a structural reform producing a desired outcome - enabling the computation of rough expected values. For example, we know that once a privatization takes place it is unlikely to be easily undone. Second, even after first discounting on the basis of probabilities, a second round of discounting can take place to compensate - to some degree - for the uncertainty inherent in structural reform.

Bailamos
There are two dancers in this toxic tango. They both need to take stock of the past, break with it and dance a new dance. Introspection is a good start. The IMF and our government should get together and commission a review of all past programmes to inform the design and implementation of the current programme. In the meantime, the priority should be to ensure as many structural reforms as possible are pushed through prior to the first review. If we are able to use entrenched, high-quality structural reform to credibly improve Sri Lanka’s medium term growth and primary balance trajectory, we should be able to avoid some of the short-term pain and contraction that we would otherwise experience. Then, maybe instead of toxic tango, we can look forward to a solid baila session. With the President, as he did with Iranganie Serasinghe, accompanying the IMF’s managing director for a round of kaffirhina. After all, compared to austerity, structural reform is a sumhiri pane.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

SL slides down to 115 on Global Soft Power Index

Originally appeared on The Morning

By Dhananath Fernando

Global research outfit Brand Finance ranks countries by considering each country as a brand through the Global Soft Power Index. Sri Lanka’s brand results as a nation were released in partnership with the Sri Lanka Institute of Marketing (SLIM) last week and the country was ranked 115th out of 121 countries – a steep drop of 42 positions from ranking at 73 on the index in 2022.

Below us are Iraq, Laos, Trinidad, Uganda, Guatemala, and Zimbabwe. This survey was conducted globally with more than 11,000 samples. SLIM has to be appreciated for taking such an initiative at a very difficult time for Sri Lanka. A country’s perception and brand image are very important, especially when it comes to ‘Country of Origin’ status in global trade. The same matters in tourism and many other income-generating activities.

Brand strength of a country is determined under eight key themes and sub categories for each key pillar:

Business and trade

Governance

International relations

Culture and heritage

Media and communication

Education and science

People and values

Sustainable future

It is said that “perception is reality”. In simple terms, though we may feel that we do not deserve to be ranked 115th, outsiders do not perceive us positively. The reasons for our steep drop are quite obvious. It is more important to understand the drivers of positive perception according to the Brand Finance survey than to dwell on our ranking.

Out of the key drivers of reputation, a strong and stable economy is considered the most important driver for people. In a survey conducted within the index, it ranked very highly, with 8.9 points out of 10. The next driver, with 6.2 points, is having internationally admired leaders. Being politically stable and well-governed is ranked as the third most important attribute, while ease of doing business and sustainable cities for transport are ranked at fourth and fifth place respectively, based on importance.

Developing a nation’s brand

The expectations of people indicate that a dynamic economy and the ability to do business easily are the main drivers of pretty much everything else. If we, as Sri Lankans, are serious about building our brand, attracting FDIs, and bringing in tourists, there is no other choice than to undergo economic reforms.

The expectations indicate that most of the attributes that help develop a nation’s branding are influenced by the market and freedom. When a paternal government steps in, there is no ease of doing business for enterprises. When a government imposes high tariffs on imports, there is no efficient trade. When a government restricts movement of people and adds visa regulations, tourism cannot prosper. Countries which experience a higher degree of economic freedom also have credible country brands and soft power.

In Sri Lanka’s assessment, our worst ranking is for ‘international relations’. We have ranked 120 out of 121 countries. This comes as no surprise after our poor management of foreign relationships with all our key friends including India, China, Japan, the Middle East, and the US.

Our immaturity in managing the Indian Free Trade Agreement (FTA) and the East Container Terminal (India), managing the Port City and the fertiliser shipment (China), cancelling the Light Rail Transit Project (Japan), forced cremations of Muslims (the Middle East), and dealing with the Millennium Challenge Corporation (MCC) (the US) undeniably isolated us, pushing our reputation to a historic low.

Our diplomatic service is basically a meal ticket for unemployable relatives of politicians. It is imperative that a merit-based exam for diplomatic service be required in order to ensure our economic prosperity. Diplomacy is economic; a friendship built on doing business is much better than a business built on a friendship.

We have ranked relatively better on ‘culture and heritage,’ standing at 92 from among 121 nations. On ‘governance,’ we are ranked at 118 and on ‘business and trade’ we come in at 115.

Solutions

There are quick fixes, but building a brand is like raising a child. Values, ethics, and dynamism take time to instil. If we are to improve Sri Lanka’s brand, a comprehensive economic reform package is needed. Countries that recently picked up their ranking did it through reforms and allowing markets to work smoothly.

New Zealand had a reform plan in the 1980s while South Korea transformed through market-based reforms. Dubai was converted into a business hub, Vietnam was converted into an export-oriented economy, and so on. The common denominator is a concrete economic reform plan.

In the short run, what we can consider is implementing a free, six-month business and vacation visa plan for countries with twice the per capita GDP of Sri Lanka. This will allow us to earn much more through their spending in Sri Lanka. At present, we have nothing to lose, as they are not visiting Sri Lanka anyway.

The next step is to allow foreign spouses to work in Sri Lanka. As many people leave the country, at least some may consider staying back in these cases, especially those married to foreigners. They will bring their skill set, which enables better knowledge transfer. In some areas such as Galle, this synergy can already be observed in the tourism industry, despite bad regulations.

Thirdly, all tariffs should be brought under either a four-tier structure (0%, 5%, 10%, and 15%) or a higher tariff structure that is simple and unified so that it can incentivise trade. We need to keep our Central Bank independent and not intervene in the forex market in order to get the maximum benefits out of this. All these can be done with just a stroke of a pen at zero cost to the Government.

The brand ‘Sri Lanka’ can only be built by instilling the right values within the brand. A communications campaign may only dilute the brand when people realise we oversell ourselves by overpromising and under-delivering.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Which reforms should take the spotlight after the IMF?

Originally appeared on The Morning

By Dhananath Fernando

According to news reports and a tweet by International Monetary Fund (IMF) Managing Director Kristalina Georgieva, Sri Lanka is likely to enter its 17th IMF programme since its membership began. We are yet to know the details of the programme, but we have an overview of key areas as per the press conference in September 2022, when we entered the Staff-Level Agreement. Out of the previous 16, we have only completed nine programmes and have given up in the midst of seven programmes without completion.

This time, things are slightly different, because on the previous 16 occasions our debt was sustainable, but this time it is not. Dropping out in the middle of the programme while we are under a debt restructuring plan will erode even the remaining confidence of investors and many other stakeholders.

There seems to be an overestimation that the IMF can fix all our problems. We have been trying to debunk this myth for a long time; the IMF cannot fix our economy. It is merely a lifeboat to make sure we don’t drown in our debt. Only we can fix our economy through economic reforms.

What the IMF can bring us is credibility. Credibility will provide us breathing space on a few fronts. It will provide room to negotiate debt with external creditors and enable us to obtain some relief before we start our debt repayments. This credibility will allow Sri Lanka to tap into more bilateral and multilateral funds to reactivate some of its economic activity.

It is imperative that we reform the economy and move forward with all this funding. Other countries that have gone through debt distress have fallen into a cycle of defaulting. We have to avoid this, which can only be done by creating a competitive economy.

A competitive economy can only be achieved through economic reforms and not in any other way. Most of these reforms are simple to understand but complicated to execute, as many of the beneficiaries of the current inefficiencies will be on the losing end. They will all have to work hard and compete in a market environment.

While there are many reforms to be undertaken, which will also be included in the IMF agreement in different forms, I would like to prioritise three key reforms.

Social safety nets to protect the poor

During an economic crisis, people are angry as well as hungry. Protecting the most vulnerable section of society has to be a priority. Ultimately, the objective of all economic principles we practise is to eradicate poverty.

Poverty eradication cannot be undertaken simply by distributing money to the poor. We can only eradicate poverty by opening up opportunities for the impoverished to engage in economic activity and expand their capacity to add productive value to society. During difficult times, they should have some support so they can worry less about basics and worry more about joining economic activities.

The current expenditure on our main social safety net programme – Samurdhi – is about Rs. 55.4 billion. This is peanuts compared to the losses of the Ceylon Petroleum Corporation (CPC) over eight months in 2022, which amounted to Rs. 632 billion. Most of the losses in petroleum caused by the Government’s fuel subsidy have benefitted 60% of the wealthiest families in the country.

Rather than entertaining the inefficiencies of the CPC and transferring fuel subsidies to those who can obviously afford it, the money should be channelled to the poor. This needs to be done by proper targeting and via cash transfers to their accounts, rather than in a material form.

It was reported that about 3.7 million families have applied for the social safety net system, but unfortunately, the Government authorities have been on strike without having verified the families that have applied. Cash transfer systems should ideally be connected to inflation with a targeted time frame, so that those below the poverty line are incentivised for upskilling and to contribute to economic activity.

State-Owned Enterprises reforms

It is no secret that our State-Owned Enterprises (SOEs) are massive burdens to taxpayers with limited value being added to our economy. Therefore, selected SOEs should be privatised, which will improve the income levels of employees.

It cannot be emphasised enough that the privatisation process has to be transparent and should take place on a competitive basis. Politicians cannot be the facilitators of these transactions. There are some SOEs which can be opened up for Public-Private Partnerships (PPPs). Certain SOEs can be consolidated and others can be brought under a holding company.

Some of these SOEs are managed extremely poorly. Therefore, with the current liabilities, finding a buyer too seems next to impossible. As such, unfortunately, some of the debt may have to be absorbed by the Government, considering the stoppage of longer-term money leakage. We have to realise that the Government has no role in doing business. This has been proven many times globally and in Sri Lanka. Without SOE reforms, Sri Lanka simply has no future.

Trade reforms

In many forums where we converse about solutions for Sri Lanka’s economic crisis, a common refrain is that “Sri Lanka has to come out of this crisis”. A country of 22 million, which is almost the same population as the city of Mumbai, cannot grow by selling goods and services to its own citizens.

Sri Lanka’s market size is very small, so we have to sell to a global market. However, we cannot sell to a global market without being competitive. As such, imports are a big component in being competitive. What we need is a simple unified tariff structure; when things are simple, we can limit the room for corruption.

The complicated para-tariffs such as cess, PAL, and many other tariffs added one on top of the other have to ideally be within three main tiers. For instance, 5%, 10%, and 15% customs duty so that importers are clear on what to pay and can estimate in advance.

Monetary policy has to be fixed with trade reforms so that we will not face a currency crisis. It is true that the US Dollar is required for imports, but import demand is created by the Sri Lankan Rupee when the exchange rate is artificially low and money is added to the monetary system in the form of filling the deficit in Government expenditure and income.

When we fix this monetary policy, the currency will remain solid and exports will automatically start picking up with the stability in the market. The scarce US Dollar resources will be shared only for the prioritised needs through the pricing system.

In conclusion

If we can implement these three reforms within the next 12 months and maintain them for three years, we most likely will not require an IMF bailout for the 18th time.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Feasibility of estimating economic recovery via LKR appreciation, CSE performance

Originally appeared on The Morning

By Dhananath Fernando

Sri Lankans base their assessment of the economy’s performance on two crucial factors. One is on the operations of the Colombo Stock Exchange (CSE) and the other is on the exchange rate – the appreciation or depreciation of the LKR to the USD.

However, neither are the right indicators to measure the performance of the economy. The companies listed on the CSE are insignificant compared to the number of business establishments in Sri Lanka.

Around 99% of the business establishments in Sri Lanka are Micro, Small, and Medium Enterprises (MSMEs) but they are not listed on the CSE. However, the MSME sector accounts for 75% of all employment. Large firms are responsible only for 25% of all employment, but not all large corporations are listed on the CSE.

For instance, MAS Holdings, which is one of Sri Lanka’s leading apparel manufacturers and employers in the sector, is not on the CSE. Moreover, just before the economic downturn in Sri Lanka, there was a bull run at the CSE. A performing economy is measured through the reduction of poverty and when the populace contributes to solving an economic problem.

The second popular measure to assess economic performance is the exchange rate. Recently, with the appreciation of the LKR, there is a sentiment that the economy is recovering. Previously, when the LKR was depreciating, the perception was that the economy was not doing so well.

Appreciation or depreciation of a currency has its own consequences, but connecting the exchange rate to performance of the entire economy is definitely not the right way to look at things.

There were few reasons behind the recent appreciation of the LKR. Nevertheless, the exchange rate is simply the price we pay to buy USD. Like for many other commodities and services, the price of USD is determined through demand and supply. Suppliers of USD are mainly exporters, service exporters, remittances, foreign grants, and tourism. Main buyers are importers, the Central Bank, service importers, etc.

If you are wondering how the Central Bank becomes a buyer of USD, that is one way reserves are built. Until the last week of February, the Central Bank had a direction for all commercial banks to surrender 25% of their USD flows from exporters. That limit has now been reduced to 15%, which means that banks will have an additional 10% of USD than they did before, so the availability of USD in the market is slightly higher. Further, over the last few months, the Central Bank has been the main buyer of USD/forex and as a result our reserve levels have improved slightly.

The International Finance Corporation (IFC) also approved a $ 400 million facility to support Sri Lanka to purchase essential items, so the inflows to the market are likely to increase. As a result of high supply and constant demand, the exchange rate has come down slightly.

Another reason is that the Central Bank increased the middle spot rate for banks to Rs. 5 from Rs. 2.50 last week. In simpler terms, previously, the Central Bank had provided a direction on the price of the USD. It is similar to a price control but slightly more flexible. As a result, banks can now provide better rates so that forex sellers are willing to supply.

As the economy contracted by 7.1% in the first nine months of 2022 and the World Bank projects a further 4.2% contraction for 2023, demand for imports has been low. On top of this, most imports are restricted. Additionally, tourism is slowly picking up and with many Sri Lankans migrating for work, it helps to recover remittances to an extent.

We need to realise that none of the above changes are reforms. They are just dynamics in the market. These little fluctuations are not an indication to measure whether we are moving in the right direction.

Reforms mean establishing a dynamic market and creating a suitable environment as soon as possible given the gravity of our crisis. When reforms are implemented, the exchange rate will become predictable rather than subject to speculation.

Reforms involve systems design and thinking, so that the system works even when a new person takes over. It is important not to mix up market changes and reforms. Markets will always fluctuate based on the availability and scarcity of resources, but reforms are about creating an environment for markets to work. Even the forex market optimises the use of resources.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Why it takes so long to recover from an economic crisis

Originally appeared on The Morning

By Dhananath Fernando

I have been reflecting on the last few years of public policy and discussion, which I can broadly divide into three main chapters:

Chapter 1 – Denial

Chapter 2 – Realisation

Chapter 3 - Recovery

Chapter 1 – Denial

There was a time when even respected businessmen thought an economic crisis was a distant scenario. Many politicians, across all party lines, failed to consider a situation of 12-hour power cuts and long fuel lines, and viewed debt restructuring and accessing the International Monetary Fund (IMF) as taboo conversations.

We relied on a $ 3.6 billion bailout from an unknown Omani fund and thought China and the Port City would bail us out as a last resort. Some even thought the discovery of a sapphire cluster might be the breakthrough Sri Lanka needed. Sri Lankans believed we were a special nation with a magical power that would rescue us in some other way.

Despite our strategic location, beautiful weather, and natural beauty being undeniable assets, they do not guarantee a rescue from our own bad policies. Our denial was so strong that an international institution titled their report on the Sri Lankan economy as ‘Denial is Not a Strategy’.

Chapter 2 – Realisation

The moment of truth came, but we were too late to respond. None of our bailout expectations materialised and the international financial architecture found it difficult to save us. Our debt is unsustainable and the IMF requires a commitment from our creditors before providing us financial assistance.

We are struggling due to global geopolitics and our poor diplomatic service and lack of professionalism doesn’t allow us to be taken seriously. We hurt all our friendly nations as well as India, China, Japan, and the US. Islamic countries too were concerned and unhappy with us over different issues.

People only realised the depth of the crisis when medicine was in short supply and their loved ones considered leaving the country. Inflation skyrocketed, prices increased, and poverty affected about 30% of the population.

Chapter 3 – Recovery

The moment people realised the severity of the crisis, they started asking about when we would recover. The simple answer is that it takes a long time and now many of us understand why. Overcoming a crisis of this scale, which in itself is a combination of multiple crises, cannot be done easily.

Simultaneously, we face a balance of payment crisis, a debt crisis, a financial crisis, a humanitarian crisis, and a political crisis. The cost of delaying a response to the crisis and mismanagement has to be shared by us all, with mounting tax increases and high inflation pressure from the grassroots.

As a result, we can see constant protests and interruptions to public life, further worsening the situation. At the same time, this opens a new political space where any political party can make unrealistic promises and auction for votes. This vicious cycle is why recovery from the economic crisis takes a long time.

The specifics of debt restructuring are still a mystery to us. We don’t know how the restructuring will be carried out or the impact it will have on the banking industry. It is also unclear how the markets will respond.

Without domestic debt restructuring, even if we apply a 50% haircut on International Sovereign Bonds (ISBs) and Sri Lanka Development Bonds (SLDBs), our debt to GDP ratio after 10 years will be 136%, according to a Verité Research study published in October 2022. Cost of servicing new debt and the cost of rolling over previous debt at a high yield curve will not bring down our debt to GDP ratio.

Nevertheless, it is still possible for domestic debt to be restructured and banking recapitalisation is necessary. According to the same document, investments in Government securities, primarily Treasury bills and Treasury bonds, account for more than 30% of the interest revenue for the total banking industry.

Hence, changing the interest rates on these securities will affect the stability of banks. On the other hand, 82% of the money in the EPF and ETF has been put into Government securities.

As the required changes take place, no one will be happy, so people and opinion leaders will react in different ways. The changes will go back and forth and recovery will be prolonged. Elections will come and decision-making authorities will change and policy decisions will also go back and forth.

All this is why it takes so long to recover from an economic crisis.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Our only saviour is reforms

Originally appeared on The Morning

By Dhananath Fernando

Whether we will be able to receive International Monetary Fund (IMF) Executive Board approval is now a topic of discussion even amongst the most economically-illiterate person. Let us first set the context.

The Sri Lankan Government and the IMF came to a Staff-Level Agreement in early September 2022. One of the key milestones we have to pass through is to get to some level of negotiation with our creditors. Our credit portfolio is diverse. We have multilateral senior creditors followed by bilateral creditors, including members of the Paris Club, mainly Japan.

On the other hand, there are two main creditors who are non-Paris Club members; India and China.

Paris Club members agree on equal treatment in debt restructuring. In simple words, all member countries of the Paris Club will be treated equally when it comes to restructuring. India has also agreed to assist Sri Lanka in the debt restructuring plan and has provided a letter to the IMF. However, according to the IMF, letters provided by China are not adequate. It has indicated a two-year moratorium, but given the financial needs expected by the IMF, Sri Lanka will not be on a sustainable debt path after a two-year moratorium alone.

Generally, credit assistance provided by multilateral donor agencies such as the World Bank and the Asian Development Bank is not restructured, provided it has been given with very long maturity periods and very low interest rates. Therefore, restructuring those loans has not been the practice. That is how the global financial architecture is designed, given their assistance in eradicating poverty and the IMF being the lender of last resort. 

However, over the last few years, there has been a request by private creditors, bondholders, and some stakeholders that the credit of multilateral donor agencies should also be restructured and China is one party that has made this request. Unfortunately, Sri Lanka is too negligible an economy to make that request or challenge the global financial architecture. .

Given the delays, there is now an emerging conversation on whether we have any other alternative options if the IMF agreement is further delayed. In fact, I asked this question at the meeting convened by the National Council Sub-Committee on identifying short- and medium-term programmes related to economic stabilisation, on whether alternative options were being considered in the likelihood of a delay. According to its Chair MP Patali Champika Ranawaka, the committee has not considered it, but he has an aim of being prepared for the worst-case scenario.  

As we have been saying over the years, we have come to this situation through our own policy errors and with our bad reputation, we do not have many choices in hand. Therefore, finding a solution without the IMF is a major challenge, but we, as a country, cannot avoid the consequences should this agreement get further delayed; social discussion is needed on what we can do to get it soon and on the available alternatives. 

Managing with what we have

One option is to drastically cut down our consumption, including essentials such as food and medicine, and face the situation with what we have. That option can trigger some level of social unrest because ‘a hungry man is an angry man’. 

Even at this level of consumption contraction, our poverty rate has increased above 30% according to a Parliament committee. Out of about five million households, about 1.7 million receive Samurdhi and another 1.1 million are on the waiting list. Of course, Samurdhi is not a good indication, as some people who should receive Samurdhi benefits are not recipients, while others who should not be in the programme are included. However, managing with what we have is one available option that comes with its own consequences. 

Moving ahead with debt restructuring without China?

The next option is to move ahead with debt restructuring without China. This option has a significant limitation because IMF confirmation is required even to restructure the debt of bilateral creditors. Without the IMF, it will be difficult to get Paris Club members and other stakeholders to a debt negotiation table. The more we delay and if China takes a very hard stance, which is likely, we have to request the IMF to move ahead with those who have agreed and hold China’s debt payments until we come to some level of agreement.

We have to understand China’s point of view and geopolitics as well. Our crisis has also become a tug of war between two economic powerhouses. On one hand, China does not want to align or agree with a US-led programme. On the other hand, the relief measures given to Sri Lanka have to be provided to all other countries making similar requests in future.

Pakistan and many African countries and emerging economies are expected to face debt distress in the coming years. China’s growth predictions are low, impacting global economic growth. Hence, the more we delay opening up Sri Lanka to geopolitical sensitivities, the more we will be pushed to align with certain superpowers. If we were to depend on China or India for continuous relief measures, it would be extremely difficult to avoid becoming a geopolitical pawn.

Possible reforms and opportunities 

In this context, it is clear that all available options (with the IMF or without the IMF), will result in extremely difficult times. However, in a crisis, there will be winners as well. Regardless of any of the aforementioned options, there are basic levels of reforms we have to undertake in any scenario. 

State-Owned Enterprise (SOE) reforms must be at the forefront. Without this, we have no future. One good opportunity is to capture the drive within the Indian market. Even if Sri Lanka does nothing, there will be spillover effects from India. The Indian economy, especially the North Indian economy, is growing very fast and we have to connect to their market. If we had played our cards right, we could have become a good connection point for trade between India and China. Instead, we made enemies all over. However, there is still potential. 

The more we delay reforms, it will further exacerbate the problem. As such, reforms are the only saviour in any scenario. It is sad to see how we are distancing ourselves from reforms, with political developments triggering another round of economic and political uncertainty which will lead to social uncertainty. Let us hope reforms move forward fast. 

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

One-size-fits-all reform strategy will not work

Originally appeared on The Morning.

By Dhananath Fernando

It is said that there are three kinds of people: those who watch things happen, those who make things happen, and those who wonder what happened. Sri Lanka’s economic crisis and its story of reforms is undeniably a case of the latter.

Unfortunately, our key institutions and the Government authorities who are currently in the driving seat fall into a new category called ‘those who wonder what happened, but frankly just don’t care’. 

A good example is the recent discussion on the validity of the debt servicing suspension announcement. Since Parliament has the power to approve all public finance decisions, questions have been raised as to how such an important decision, which was made for the first time in the history of Sri Lanka, was not tabled before Parliament for approval.  

Of course, if we had enough money and if our State coffers held a reasonable amount of foreign reserves, we wouldn’t have needed to skip debt servicing or suspend debt repayments, and this would not have been an issue. However, it is no secret that the country did not even have enough funds to clear a shipment of LP Gas worth $ 20-30 million. The phrase ‘scraping the bottom of the barrel’ is not appropriate in this instance, because there is simply nothing at the bottom. 

Warnings fell on deaf ears

There were multiple alerts on Sri Lanka’s debt sustainability issued by local intellectuals as well as by common men and women. Global banks such as Citibank even issued a report titled ‘Denial is not a strategy’. But their warnings fell on deaf ears as our Parliament and Central Bank did next to nothing to remedy the situation. 

Months after suspending debt payments, Parliament is now questioning whether the debt suspension decision had been approved by them. Instead, they should be asking themselves what they were doing for so long when it was obvious that we did not have money to pay our debt. 

When the country was heading straight towards bankruptcy, many policymakers did not bother to question what was happening. This does not justify the failure to follow parliamentary protocol, of course, but two wrongs will not make a right. 

In desperate need of reforms

The current system is a clear indication that our institutions are in desperate need of a complete reform programme, one that includes political reforms. However, expecting reforms to be implemented by a set of policymakers who, up until very recently, did not even bother to question what was happening may be too high an expectation. 

The execution of a solid reform programme requires building upon an understanding of what these reforms should be as well as understanding the importance of laying the foundations for strong, independent institutions. Along with specialist skills, a commitment to seeing these reforms through is required. Political reforms should support economic reforms and vice versa.

SOEs as a starting point

A good starting point is reforming State-Owned Enterprises (SOE). It is quite surprising to me that the International Monetary Fund (IMF) press release on the Staff-Level Agreement (SLA) gives little significance to SOE reforms. 

One of the seven main points highlighted by the IMF and the Government is the need for cost reflective pricing for energy and petroleum products. This is a welcome move, but it will lead to the same problems we have been facing so far. 

Given the state of our institutions, our politicians will adopt the cost reflective pricing strategy for as long as is needed and then simply revert back to their old habits – changing the pricing formula, bringing  prices down, and ignoring the cost factor. For this reason, our reforms have to be of a much more permanent nature this time around and that is why we need a strong combination of specialist skills and a commitment to implementing these reforms. 

The role of the Government

The Government’s role is not to conduct business, and a private sector business leader recently said as much: “The Government’s only business is to not to do business.” Simply looking at which enterprises make profits or incur losses is definitely the wrong way to look at it.  

Government businesses that make profits at present can incur losses in future. The Government has the ability to destroy any notion of a level playing field and can support Government businesses through loans, subsidies, and special permits. The vast majority of profit-making SOEs are not profitable solely due to their own efforts, and in reality, they aren’t competitive businesses.

For instance, it is widely known that the Development Lotteries Board is a profit-making Government institution. What may be a lesser known fact is that there is only one other competitor – the National Lotteries Board, and the directors of both these companies are appointed by the Minister of Finance. Under these circumstances, it can hardly be a surprise that the Development Lotteries Board is profitable. 

Therefore, looking solely at profitability won’t address prevailing issues. We have to first look at what the role of the Government should be. 

It is true that all SOE reforms cannot adopt a one-size-fits-all strategy. Different SOEs have to be treated differently. This treatment has to be based on the principle of the government having no role in business.  

In cricket and football, it is a commonly held view that the umpire or referee has no role in playing the game. It is the umpire’s responsibility to overlook the game and ensure that it is being played fairly. The umpire’s decision is final and if the umpire acts more favourably towards one side, there is another set of regulation mechanisms to manage this. The umpire facilitates the competitive nature of the game. The same holds true for the role of the government. 

Many options have been discussed for reforming SOEs, including privatisation and SOE consolidation that follows models like the Temasek in Singapore and Khazanah in Malaysia. Regardless of which option is chosen and which model is followed, we expect the Government to implement SOE reforms on a case-by-case basis, with special attention being paid to the role of the State.  

If we fail to understand the role of the State and implement solutions for SOEs based on this, Sri Lanka’s reform programme will probably fall into the category of things that make people ‘wonder what happened’. People will certainly question the reform programme and its credibility, while our next generation will wonder how they inherited such a poorly-managed nation that was once so full of potential.  

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Reform or perish

Originally appeared on The Morning.

By Dhananath Fernando

A Staff-Level Agreement (SLA) with the International Monetary Fund (IMF) is a positive indicator of things to come. However, we still have a long journey to go and getting an SLA is just the beginning. 

We have negotiated with our creditors and have begun to implement reforms to stabilise the ship. We have to continue this trend and perform hard reforms to ensure our economy grows to a level where we can sustain it without resorting to borrowing.

In the status quo, I foresee a few scenarios that could happen with present political dynamics.

Scenario 1: Forming reform committees but not performing reforms

Sri Lankan policymakers’ solution for all problems is to set up a committee. There is a risk that we will do the same for reforms. Already, committees are being formed to take reforms forward, but reforms generally get sidelined or stuck in limbo. 

I recall many years ago there was a Cabinet Committee on Economic Management (CCEM), which was later replaced by the National Economic Council (NEC). Afterwards, the NEC was also dissolved and no economic reforms were taken forward. 

In the interim Budget, a new committee on SOE reforms and a few other pre-reform steps have been suggested. But the willingness to reform and the ability to execute is the most important aspect. If we leave a committee for reforms to its own devices, it will kill time while this crisis kills many of us.

Scenario 2: Some reforms are as good as no reforms 

There is a probability that a few reforms will be enacted. This is also a dangerous scenario. While in 1977 some reforms were implemented, labour market reforms and many other required reforms were not carried out. As a result, we failed to get the maximum benefit out of opening up the markets. 

Reforms in the 1990s were also not carried out in a holistic manner. Half-baked and half-hearted reforms will not rescue us from this crisis 

Scenario 3: Capitalising on low expectations but no real reforms

Another possible scenario is that policymakers and politicians will try to build their political capital based on a low-expectation environment. 

People’s expectations have fallen so low that a two-hour power cut has become accepted given the circumstances. A few hours staying in a fuel line has also become acceptable and even an achievement, despite us taking the ability to freely pump fuel for granted only a few months ago. The availability of LP gas has also become an achievement. 

Given this environment, politicians may try to just keep the basics supplied and settle for a new normal with very low expectations and build political capital until the election without enacting hard reforms. That will not only take Sri Lanka backwards, but we will move towards stagflation. Our youth will be less aspirational and the dream of a higher income country will fade away 

Scenario 4: Making reforms the entry gate for corruption 

While economic reforms are essential, since we haven’t seen any reforms on the political front, the same corrupt politicians may misuse this opportunity. 

Important reforms such as privatisation and Public-Private Partnerships will be passed with less transparency and no accountability to benefit the inner circle of corrupt politicians and with minimum benefit for poor taxpayers. This will dilute the public’s trust of reforms and create resistance against much-needed change. 

Scenario 5: Reforms that snowball 

This would be the best-case scenario, where we move proactively on a series of reforms to completely transform our economy. These reforms will not just halt after one wave.

Given dynamic economic and global conditions, reforms have to keep moving while keeping up with global changes, since otherwise the reforms that we do today will pose the same barriers for us a few years later. Sri Lanka needs to move towards reform and resetting itself in a holistic manner. 

Our aim has to be to create an economy where the 17th time becomes the last time in which we go to the IMF.  We need in-depth thinking to move fast. Simply making statements or addressing the audience based on current sentiments is not a solution; we need genuine willpower to get reforms done.

We have to capitalise on the IMF SLA and move forward with the rest of the reforms without delaying the process. The research has already been done and what needs to happen is very well known. It is just that we need to get our act together and move forward.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Compounded crises: IMF the only way out

Originally appeared on The Morning.

By Dhananath Fernando

Economic crises are difficult to solve. In the case of a natural disaster, we know that it will come to an end at some point. We just have to manage for a short period until everything settles. By contrast, economic crises are different. They generally come in a package of five separate but intertwined crises if not managed well. It is clearly best to avoid crises, but when the crisis hits, and if we fail to manage it, the situation becomes significantly worse. Sri Lanka, unfortunately, seems to be managing the situation badly. 

What we are currently experiencing is the balance of payments crisis. Simply put, we don’t have sufficient US Dollars to import essentials, including fuel and medicine. As a result, the lifestyle that we used to live cannot be sustained as long as these conditions prevail. 

The second crisis just around the corner is the debt crisis. We have a $ 1 billion payment to be paid on 25 July and our usable reserves amount to only about $ 150 million. It has clearly come to the point where restructuring debt is unavoidable. Debt restructuring will be a painful process for creditors and debtors equally. This will have an unavoidable impact on the local economy. Additionally, the debt restructuring can be done with an IMF programme. The IMF is the only organisation that can bring credibility to a country that has proved that “it is not good for money”.

The critical question is, how is Sri Lanka going to finance its trade until we negotiate with the IMF and have an agreed-upon programme of restructuring debt? If we had sufficient reserves, we would at least have had a backup option, but we all know reserves are not built for day-to-day imports but for an emergency situation like Covid-19. The other option is to get support from bilateral partners until we finalise the negotiations. Even for that to take place, generally an IMF programme is essential as they need to have some assurance that the money will be utilised to import essentials but not to bail-out any bond holders. Hence it is essential to enter into an IMF programme as early as possible, rather than beating around the bush. 

In an ideal scenario, as a country we should have moved forward with reforms before going to the IMF seeking funds and advice. Indeed, if we had carried out these reforms at the right time, then we would not have needed to go to the IMF. But if we are not doing things correctly, it’s sensible to go to the IMF, not only because of the money, but for credibility and discipline. The current situation is that we are already late – and the clock is ticking. There are massive shortages nationwide, which have the potential to get worse. The Government is yet to be clear about whether we intend to have an IMF programme and even as this article is being written, the country did not even have a finance minister to initiate any such discussions.

The third crisis of the package is the financial crisis. Particularly in the process of debt restructuring, some of these bonds are held by domestic banks. So restructuring will affect the local financial system. Furthermore, most of the local banks have extended credit guarantees for State-Owned Enterprises (SOEs) and it is likely that their debt will also be required to be restructured. So the impact on the financial sector can trigger a third crisis.

As these triple crises bear down, the political capital enjoyed by the Government will undoubtedly wear away. As a result, political instability will start kicking in. Especially in a country like Sri Lanka, where most essential services like fuel, electricity, and water are provided by the Government, the moment interruptions start, public resistance increases at a higher rate. In the Sri Lankan case, the political crisis has overtaken the debt crisis and the financial crisis. We are in the middle of a political and balance of payment crises and the other two crises are just a matter of time. 

The final crisis in the package is the humanitarian crisis. Especially if we fail to secure some funding lines without also delaying IMF negotiations, there is a risk of extended power cuts and further deterioration of living conditions. This can trigger a humanitarian crisis. If we drift to a disorderly default, as the Financial Times reports, “Disorderly default is the same as civil war.”

Already there are stories in the news about shortages of medicine and medical equipment and postponement of surgeries, all of which impact the humanitarian needs of the people. So urgent action is needed! However, Sri Lanka is in a complete state of dysfunction; there is no solid Government or cabinet ministers to make decisions, while public resistance keeps mounting. 

The nature of an economic crisis is that one crisis will keep instigating another and it’s not going to just go away. It takes a lot of time to overcome after things go out of control. 

We are very far behind and we need someone who really understands the depth of reforms needed and the work plan we have to adhere to. The general optimistic sentiment of ‘this shall too pass’ really won’t work here. We have expected the same to happen for a long time but it really hasn’t happened. 

Before we move to reforms, we need to keep in mind, for future reference, the cost of bad economic policy. Self-sufficiency, protectionism, intervening in markets, and ad hoc policy decisions are a recipe for a disaster and sadly we are facing one now.

We have to immediately increase interest rates and remove all surrender requirements by the Central Bank. In an economic crisis, dimensions are different. We have to immediately go to the IMF with a short- and medium-term plan with political consensus on implementation for the next five to eight years.

The problem and the solutions are already known. We need credibility, commitment to undertake reforms, and competence for execution of reforms to overcome. 

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

A framework for economic recovery

Originally appeared on Daily FT

By Dr. Roshan Perera

A twin deficit problem

For much of its post-independence period Sri Lanka has been characterised by twin deficits: fiscal deficits and deficits in the external current account. What this implies is the country spends more than it earns and consumes more than it produces. The two deficits are linked because the deficit in the external current account reflects the sum of the deficit in private savings (where private investment is greater than private savings) and government dissaving (where government expenditure is greater than government revenue). If a government continues to consume more than it earns and/or domestic private savings are not sufficient to finance investment in the economy this is reflected in a widening of the deficit in the external current account. 

If a country is running a deficit in the external current account deficit it is important to understand what is driving this deficit. If it is due to a deficit in private savings and investment that may not be such a bad thing because the shortfall is probably being financed through foreign direct investments (FDI) and in any case it is leading to an increase in the productive capacity of the economy. Thereby increasing future growth potential of the country. On the other hand, if the current account deficit is due to the government spending more than it earns, this would need to be financed through increased borrowings. And a country just like a household cannot continue to borrow indefinitely. There will come a day of reckoning. You will come to a point where you are not able to service your debt or you may be able to service your debt, but you won’t have the income to buy what you need to live (food, clothing, education, health etc).  It may come to a point where your creditors will stop lending to you. Or even if they do lend, they will charge you a very high interest rate which will only worsen your debt situation. So, what is true for a household is true for a country.  

Consequences of living beyond our means

Large deficits in the fiscal and external account have been financed through borrowings both from the domestic market (which has crowded out resources for the private sector) and external sources (which has led to an unsustainable level of foreign debt). Although in the short-term high government spending may stimulate economic growth in the medium to long term it acts as a drag on growth due to its impact on interest rates and the exchange rate. 

When a government borrows continuously from the domestic market it crowds out resources from the private sector and drives up interest rates. Thus, making it unviable for a firm to borrow because the cost of borrowing is higher than the return it could earn from investing. In addition, when a country has a large external debt, it attempts to fix the currency to stabilize the debt stock. But this could result in an overvalued exchange rate which leads to an anti-export bias and an import bias which further worsens the trade deficit and external finances. This is contrary to what an economy like Sri Lanka with a small market (both in terms of size and per capita income) needs. As expanding trade is the only sustainable path to faster growth and employment generation. 

The availability of concessional financing from multilateral and bilateral donors enabled the country to run fiscal and external deficits over many decades. Although access to low-cost financing ended when the country graduated to middle-income status, we didn’t change our spending patterns to suit our income. Instead, we sought alternative sources of financing, borrowing from financial markets and commercial sources at high interest rates and with shorter repayment periods. Consequently, by 2016, the share of foreign debt from non-concessional sources rose to over 50%. This has enormously increased debt service payments. Today, Sri Lanka has one of the highest levels of government debt in its history and its debt service payments are one of the highest in the world (absorbing 72% of government revenue in 2020). This has led to both domestic and external resources being diverted to servicing past debt to the detriment of future growth. 

Policy Priorities

Advocata Institutes’ recent report “A Framework for Economic Recovery” propose several policies to address macroeconomic imbalances and structural reforms for sustainable and inclusive growth. 

Firstly we need to address the macroeconomic imbalances in the economy. Primarily, correcting the twin deficits because they have spillover effects into the rest of the economy through interest rates and exchange rates. Priority should be given to fixing the tax system. Tax revenue which was over 20% of GDP in the 1990s has plummeted to 8% in 2020 and is likely to fall further in 2021. Expanding the tax base and improving tax administration are key to reversing the long-term downward trend in government revenue. Currently the personal income tax threshold in Sri Lanka is more than four times its per capita GDP and even higher than the tax threshold in countries with per capita incomes that are several times that of Sri Lanka, such as Singapore and Australia. A high tax threshold removes a significant portion of the working population that can contribute to tax revenue. Tax exemptions for businesses should be rationalised and the granting of exemptions centralised under one authority.  Evidence suggests that sweeping tax exemptions are not the most important factor in attracting investments and foregoing this tax revenue is not sustainable in the long term. 

With declining tax revenue collection, the government faces severe resource constraints. Expenditure on contractual obligations interest payments, salaries and wages and pension payments) has come at the cost of spending on building human capital (health and education). This needs to be reversed. Serious attention needs to be paid in the budget to rationalising the public sector and strengthening budgetary oversight mechanisms so that the government is held accountable for how they use the resources entrusted to them.

Secondly, we need to stimulate economic growth and improve the country’s competitiveness. Sri Lanka has experienced very volatile growth rates and in recent times spurts of debt fuelled economic growth. But this growth has neither been inclusive nor sustainable. We need to generate growth that is both inclusive (benefits all our citizens) and sustainable (growth that does not jeopardise future generations). The budget needs to address the structural weaknesses in the economy hindering productivity driven growth. Some policies that we discuss in our report are: (1) improving the business environment by reducing regulatory barriers which are needed to attract foreign direct investment. Sri Lanka lags its peers in the areas of doing business and competitiveness; (2) unlocking access to land which has been identified as a major bottleneck for investment; (3) creating a flexible labour market and raising labour force participation. There are a plethora of legislation governing labour in SL which act as a serious impediment for job creation. Further, Sri Lanka has a rapidly aging population and is no longer benefitting from a demographic dividend. However, it has access to a large untapped source of female labour. Encouraging greater female participation in the labour force requires removal of legislation restricting employment of female workers and improved provision of services such as childcare and safe transport; (4) addressing infrastructure gaps to enhance productivity and efficiency of the factors of production. We need to invest in infrastructure that has high social and economic returns. This requires better processes for project appraisal and selection, better management of risks which otherwise could lead to cost overruns and project delays and greater accountability to reduce waste and corruption.

Finally, the budget needs to build buffers to strengthen the resilience of the economy to shocks. 

Households have been disproportionately affected by the ongoing pandemic because they lack the buffers to cushion them from economic shocks. Workers, particularly in the informal sector, have lost jobs due to the impact of lockdowns and the closure of borders. Although the government provided some relief to households affected by the pandemic by way of income transfers, the lack of fiscal space constrained the government’s ability to adequately respond to the crisis. In addition, Sri Lanka’s existing social protection scheme has significant coverage gaps. Establishing a universal social safety net and reducing targeting errors will ensure that those who need support receive it when they need it most. 

Micro, small, and medium enterprises (MSMEs) play a vital role in the Sri Lankan economy. This sector was severely affected by measures taken to contain the spread of the virus, such as travel bans, lockdowns and social distancing. To mitigate the impact of the pandemic, the government and the Central Bank introduced various emergency liquidity support programs, debt moratoriums and extension of credit at concessionary interest rates. These schemes may have prevented some firms from bankruptcy. However, the inability of the government to continue providing such relief given the prolonged nature of the pandemic and fiscal constraints requires other measures to be put in place to deal with such situations. Given the size of this sector and its importance to the economy, ensuring the solvency of these firms as well as increasing their productivity is paramount to Sri Lanka’s long term economic growth prospects. Many firms will emerge from this pandemic with seriously impaired balance sheets. Firms that are not resilient, uncompetitive, or heavily indebted will probably fold due the crisis. To reduce the adverse economic impact of ad hoc closures, the government must ensure access to an effective bankruptcy regime. Such a mechanism will strengthen economic resilience, while incentivising firms to prioritise strategies to repair balance sheets in the medium term before they reach bankruptcy.  

(The writer is a Senior Research Fellow at the Advocata Institute and a former Director of the Central Bank of Sri Lanka)

Budget 2022: Macroeconomic stabilisation and structural reforms for inclusive and sustainable growth

Originally appeared on The Morning.

By Dr. Roshan Perera

Years of profligate living finally caught up with us. Sri Lanka, for much of its post-Independence period, has been living beyond its means: We have been spending more than we earn and consuming more than we produce. Our extravagant lifestyle was made possible by the availability of concessional financing from multilateral and bilateral donors. This ended once we graduated to a middle-income country. But we didn’t change our spending patterns to match our income. Instead, we sought alternative sources of financing. We borrowed from financial markets and commercial sources at high interest rates and with shorter repayment periods.

Consequently, by 2016, the share of foreign debt from non-concessional sources rose to over 50%. This had an enormous impact on our debt service payments. Today, Sri Lanka has one of the highest levels of government debt in its history and its debt service payments are one of the highest in the world (absorbing 72% of government revenue in 2020). This led to both domestic and external resources being diverted to servicing past debt to the detriment of future growth.

According to current estimates, Sri Lanka has around $ 26 billion in foreign debt obligations due between now and 2026. Sovereign rating downgrades made rolling over this debt challenging. But these are contractual obligations and there could be serious repercussions if a country defaults on its debt. Due to the decline in foreign inflows owing to the pandemic, the Government resorted to short-term measures such as bilateral swaps to shore up foreign reserves. However, there was a steady drawdown of the country’s foreign reserves to meet these debt obligations. Foreign reserves, as at end-September 2021, declined to $ 2.5 billion (which was equivalent to 1.5 months of import cover). Foreign currency obligations falling due within the next 12 months amount to around $ 7 billion. The current level of foreign reserves is grossly inadequate to service the Government’s debt.

Furthermore, using a country’s foreign reserves to pay debt obligations is not a good strategy in the long term. Foreign reserves play an important role in an economy – by providing a buffer against possible external shocks, smoothing temporary fluctuations in the exchange rate, and providing confidence to foreign investors.

With limited access to foreign financing, the Government is relying more on domestic sources to bridge the fiscal deficit. To keep interest costs low, domestic interest rates have been suppressed, which has effectively dried up the market for government securities. This has led to debt monetisation, with the Central Bank of Sri Lanka (CBSL) purchasing a major share of government securities issued in the primary auction. However, there are costs involved with this strategy, as high monetary growth leads to high inflation. It also undermines the independence of the CBSL and hinders its use of its key monetary policy instrument, the interest rate, to manage inflation.

So, what needs to be done? Advocata Institutes’ recent report titled “A Framework for Economic Recovery” proposes several policies to address macroeconomic imbalances and structural reforms for sustainable and inclusive growth. These policies are not new. If you examine macro stabilisation programmes that have been implemented in this country (or in other countries that have faced similar economic issues), you would broadly find similar recommendations. This does not mean the recommendations made in the past were wrong – but rather that successive governments did not follow through on the reforms needed to ensure long-term macroeconomic stability and sustained economic growth.

This time is different in one aspect. Sri Lanka has lost access to financial markets due to its rating downgrade. Hence, it is not able to easily refinance its foreign debt. In previous stabilisation programmes, although debt sustainability was a major concern, it was addressed through a fiscal consolidation programme. This alone may not be sufficient in the current context. The country may need to engage in a pre-emptive debt restructuring exercise to prevent default. A wilful default could disrupt access to future financing, reduce investor confidence, affect credit ratings, and have a negative impact on the reputation of the country. However, debt restructuring is a complex process and securing a deal that is acceptable to a majority of creditors is fraught with difficulty, as there are many stakeholders involved, and conflicts of interest are inevitable, hence the need to engage with an institution such as the International Monetary Fund (IMF) in the negotiation process.

The focus of Budget 2022 should be to address the macroeconomic imbalances in the economy. Primarily, correcting the twin deficits, i.e. the fiscal deficit and the external current account deficit, because these have spillover effects into the rest of the economy through interest rates and exchange rates. Priority should be given to fixing the tax system. Tax revenue, which was over 20% of gross domestic product (GDP) in the 1990s, has plummeted to 8% in 2020 and is likely to fall further in 2021. Expanding the tax base and improving tax administration are key to reversing the long-term downward trend in government revenue.

Currently, the income tax threshold in Sri Lanka is more than four times its per capita GDP and even higher than the tax threshold in countries with per capita incomes that are several times that of Sri Lanka, such as Singapore and Australia. A high tax threshold removes a significant portion of the working population that can contribute to tax revenue. Tax exemptions should be rationalised and the granting of exemptions centralised under one authority. Evidence suggests that sweeping tax exemptions is not the most important factor in attracting investments, and foregoing this tax revenue is not sustainable in the long term. With declining tax revenue collection, the Government faces severe resource constraints.  Expenditure on contractual obligations (interest payments, salaries and wages, and pension payments) has come at the cost of spending on building human capital (health and education). This needs to be reversed. Serious attention needs to be paid in the budget to rationalising the public sector and strengthening budgetary oversight mechanisms so that the Government is held accountable for how they use the resources entrusted to them.

Secondly, we need to stimulate economic growth and improve the country’s competitiveness. Sri Lanka has experienced very volatile growth rates and in recent times, sudden spurts of debt-fuelled economic growth. But this growth has neither been inclusive nor sustainable. We need to generate growth that is both inclusive (benefits all our citizens) and sustainable (growth that does not jeopardise future generations). The budget needs to address the structural weaknesses in the economy hindering productivity-driven growth. Some policies that we discuss in our report are:

1. Improving the business environment by reducing regulatory barriers, which is needed to attract foreign direct investment (FDI). Sri Lanka lags behind its peers in the areas of doing business and competitiveness

2. Unlocking access to land that has been identified as a major bottleneck for investment

3. Creating a flexible labour market and raising labour force participation. There are a plethora of legislation governing labour in Sri Lanka which act as a serious impediment for job creation. Furthermore, Sri Lanka has a rapidly ageing population and is no longer benefitting from a demographic dividend. However, it has access to a large untapped source of female labour. Encouraging greater female participation in the labour force requires removal of legislation restricting employment of female workers and improved infrastructure such as childcare and safe transport services

4. Addressing infrastructure gaps to enhance productivity and efficiency of the factors of production. We need to invest in infrastructure that has high social and economic returns. This requires better processes for project appraisal and selection, better management of risks which otherwise could lead to cost overruns and project delays, and greater accountability to reduce waste and corruption.

Finally, the budget needs to build buffers to strengthen the resilience of the economy to shocks. Households have been disproportionately affected by the ongoing pandemic because they lack the buffers to cushion them from economic shocks. Workers, particularly in the informal sector, have lost jobs due to the impact of lockdowns and the closure of borders. Although the Government provided some relief to households affected by the pandemic by way of income transfers, the lack of fiscal space constrained the Government’s ability to adequately respond to the crisis.

In addition, Sri Lanka’s existing social protection scheme has significant coverage gaps and needs to be extended to include informal sector employees, daily wage earners, and self-employed workers. Ad hoc payments are not sufficient to keep people from falling into poverty. Urgent action is needed to establish a universal social safety net and reduce targeting errors to ensure those who need support receive it when they need it most.

Micro, small, and medium-scale enterprises (MSMEs) play a vital role in the Sri Lankan economy, accounting for over half of Sri Lanka’s GDP and over 90% of total enterprises and 45% of employment in the non-agriculture sector. This sector was severely affected by measures taken to contain the spread of the virus, such as travel bans, lockdowns, and social distancing. To mitigate the impact of the pandemic, the Government and CBSL introduced various emergency liquidity support programmes, debt moratoriums, and extension of facilities at concessionary interest rates. While these schemes may have prevented some firms from bankruptcy, the Government is unable to continue providing such relief, given the prolonged nature of the pandemic and the fiscal constraints it faces.

However, given the size of this sector and its importance to the economy, ensuring the solvency of these firms as well as increasing their productivity is paramount to Sri Lanka’s long-term economic growth prospects. As the pandemic continues to affect economic activity, many firms will emerge with serious impact on their balance sheets. Therefore, as economies transition to normalcy, it is important to repair balance sheets by reducing unsustainable debt and rebuilding cash reserves. Firms that are not resilient, are uncompetitive, or are heavily indebted will collapse during such crises. To reduce the adverse economic impact of ad hoc closures in the most productive manner, the Government must ensure access to an effective bankruptcy regime. Such a mechanism will strengthen economic resilience, while incentivising firms to prioritise strategies to repair balance sheets in the medium term before they reach bankruptcy.

In conclusion, the key focus of policymakers should be on addressing macroeconomic imbalances. Priority should be given to correcting the twin deficits, i.e. the fiscal deficit and the external current account deficit, stimulating economic growth, and improving competitiveness while building buffers to strengthen the resilience of the economy to shocks.

(The writer is a Senior Research Fellow at the Advocata Institute and a former Director of the Central Bank of Sri Lanka)

Prof Athukorala: Sri Lanka and the IMF: Myth and reality – Part 3

Originally appeared on The Daily FT.

By Prof. Prema-Chandra Athukorala

IMF programmes and economic performance

There are two ways to evaluate the impact of IMF stabilisation programmes: (a) counterfactual evaluation: comparing outcome with what would have happened without the programmes; and (b) comparing results to objectives: evaluate performance against the benchmarks imposed by the policy-makers. 

It is not possible to apply the first approach to assess the impact of IMF programmes using data for a single country simply because there is no suitable counterfactual (situation in the absence of the programme) for assessing how the country would have fared without the programmes. This approach can be applied with ‘proxy’ counterfactuals only in multi-country comparative analyses (Goldstein and Montiel 1986, Barro and Lee 2005, Easterly 2005, Vreeland 2003). We apply here the second methodology, using economic growth (measured by annual growth rate of real GDP) as the key performance criterion.

In Table 2, the average growth rate of the Sri Lankan economy during the years under IMF programmes (‘programme years’) is compared with that of the entire period (1965-2019) and years without IMF programs (excluding the ‘pandemic’ year of 2020). The growth rate in all programme years (4.91) is 0.42 higher compared to that of the non-programme years (4.49). When the programmes years are separated into years under fully-implemented programmes (proposes under with the entire committed fund was disbursed by the IMF) and partially implemented programmes, the growth impact of the fully implemented programmes is found to notably higher, as one would expect (5.16%). 

Note that doing the period under study (1965-2009), all non-programme years are preceded by programme years: the period stars with the first IMF programme in1965. Therefore, lower growth rates in the non-programme years reported in Table 2 shows that, on average, the positive growth impact of the programs has not percolated beyond the programme years. The average growth rate during the non-programme years is 4.49 compared to 5.16 during the average growth rate during the fully-implemented programmes. 

This simple comparison of growth rates ignores the possibility that the growth impact of reforms could have shaped by exogenous shocks such as the two JVP uprisings (in 1971 and during 1988-89), escalation of the separatist war, and changes in the terms of trade. Also, the economy has the natural tendency to grow over time at a certain rate regardless of reforms. Moreover, the degree of openness of the economy to foreign trade could impact on the nature of the adjustment process in the economy (Arpac and Bird 2009). The real issue is whether the IMF programmes have produced better growth performance after allowing for these other factors.

We undertook an econometric analysis to delineate the impact of IMF programmes after controlling for these influences. The results indicate that average growth rate is 1.26 percentage points higher using the 33 years under all programmes compared to the non-programme years. This estimated growth impact is however statistically significant only at 20% (that is, there is a 20% probability that this estimate is likely due to chance). By contrast, for the 25 years of completely fully-disbursed programmes, the growth rate is 1.45 percentage points higher compared to the non-programme years and incomplete programme years are taken together. This estimate is statistically significant at the one-percent level (that is, there is only one percent probability that this growth impact is likely due to chance).

In sum, the results of the econometric analysis is consistent with what we observed in the simple data tabulation (Table 2). This estimated growth impact is all the more impressive when we take into account what the econometricians call the possible ‘negative selection bias’. A country normally approaches the IMF at a time of macroeconomic distress. It would not, therefore, be surprising if we had found no statistically significant association or even a negative association between programme participation and economic growth (Easterly 2005). 

It is clear from this evidence that the growth outcome during the IMF programme years has been respectable. But, have the programmes been successful in rectifying macroeconomic imbalances of the economy to set the stage for sustainable growth? This is an important issue because the very purpose of IMF stabilisation programmes is to achieve ‘adjustment with growth’. 

Addressing this issue requires an in-depth analysis of individual programmes, paying attention to the programme objectives, problems cropped up in the implementation process, and the impact of the programmes on the overall incentive structure of the economy. However some tentative inferences can be made by comparing the relevant macroeconomic variable across years of the fully-disbursed programmes and non-programme years. The relevant data are summarised in Table 3. 

The data clearly indicate the catalytic effect of the programmes on net capital inflows to the country. During the programme years, net capital inflows relative to GDP was 1.4 percentage points higher compared to the non-programme years (or the level of net capital inflows was about 32% higher than during the non-program years). Increase in capital flows seems to have helped maintaining imports and government expenditure at relatively higher levels. However, there is no evidence of net capital inflows augmenting domestic investment: investment as a percentage of GDP is strikingly similar between programme years and non-programme years.

There is some evidence of improvement in the country’s international competitiveness (measured by the real exchange rate change), but this has not persisted beyond the programme years.

Government revenue was notably higher during the programme years, with an increase in tax revenue making a significant contribution to the increase. However, this was overwhelmed by the Government’s failure to contain Government expenditure. The difference of the magnitudes of excess domestic demand (which is equal to the sign reversed value of net capital inflows), current account deficit and the budget deficit during programme years and non-programme years are striking similar. 

This pattern suggests that domestic excess demand, which is driven by the failure to contain the budget deficit, is the prime driver of the failure of the reform programmes to contain the external imbalance (widening current account deficit). The current account deficit during the programme years is 50% larger compared to that in the non-programme years (4.8% compared to 3.2% of GDP).

The date relating to the domestic imbalance (domestic expenditure over income) of the economy and the overall Government budget balance are depicted in Figure 1. Note that the domestic imbalance is by definition equal to the current account balance (the external imbalance), after allowing for changes in foreign reserves and valuation effect on foreign assets resulting from exchange rate changes. The figure therefore vividly demonstrates that the explanation of the persistent external imbalance of the economy is deeply rooted in the failure of fiscal management. The widening budget deficit that propels domestic excess demand has been an endemic structural feature of the economy, notwithstanding repetitive recourse to IMF adjustment programmes during the period under study.

Concluding remarks: Seeking or rejecting IMF support

There is no evidence to suggest that the IMF has been a determining hand in shaping economic stabilisation reforms in Sri Lanka. In all 16 stabilisation programmes supported by the IMF during 1965-2020, the decision to go to the IMF has been dictated by the country’s own failure to keep the macroeconomic house in order. There is no evidence to suggest that the IMF insisted on implementing a stereotyped policy package in all ‘crisis’ cases. Moreover, governments in both ideological camps have gone to the IMF in times of need.

The Sri Lanka-IMF relationship during the UF movement during 1970-77 indicates that there is room to enter into an IMF programme even for a national government with an incompatible ideological position provided it agrees with the IMF on the importance of achieving macroeconomic stabilisation. During the right-of-the centre UNP regimes of 1977-’94, the IMF supported trade liberalisation, but subject to its standard conditionality relating to macroeconomic stability. In hindsight, one could surmise that the outcome of the liberalisation reforms would have been much more impressive had the Government followed IMF-World Bank advice (and Shenoy’s advocacy) for combining trade and investment liberalisation with macroeconomic stabilisation. 

There is convincing evidence that the growth rate of the economy was significantly higher during the years of fully-implemented IMF stabilisation programmes. However, the long-standing fundamental macroeconomic disequilibria of the country has persisted despite the repetitive reliance on IMF programmes. This simply reflect policy failures of the country to use the breathing space provided by the programmes to undertake the required structural adjustment reforms: the ‘repetitive client status’ of the country does not, therefore, make a case for rejecting IMF support. 

Borrowing from the IMF is much cheaper than raising funds through sovereign bond issues and borrowing from other commercial sources. Unlike other donors, the IMF always lend funds to the Central Bank of the country strictly for meeting external payments. Therefore, IMF programmes do not have a direct impact on the domestic money supply and hence domestic inflation. More importantly, entering into an IMF programme acts as a catalyst to generate additional financial assistance. 

Other international financial institutions such as the World Bank and the Asian Development Bank, and individual donor nations find comfort to lend to Sri Lanka as the lending risks are reduced given the financial discipline that an IMF programme instils. Financial credibility achieved by entering into an IMF programme also helps raising funds at competitive interest rates from private capital markets.

Delaying the inevitability of approaching the IMF can be costly in the form of more stringent conditionality. The IMF team visited Sri Lanka in February 2020 to meet with the new administration and discuss its policy agenda has pre-warned about Sri Lanka’s formidable macroeconomic adjustment challenges: ‘Ambitious structural and institutional reforms are needed to anchor policy priorities, buttress competition and foster inclusive growth. Fiscal prudence remain critical to support macro-economic stability and market confidence, amid high level of debt refinancing needed. Given risks to debt sustainability over the medium term, renewed effort to advance fiscal consolidation is essential for macroeconomic stability.’ [https://www.imf.org/en/News/Articles/2020/02/07/pr2042-sri-lanka-imf-staff-concludes-visit-to-sri-lanka]

(Prof. Prema-Chandra Athukorala is a Fellow of the Academy of the Social Sciences of Australia, an Emeritus Professor of Economics at Australian National University and an Advisor for Advocata Institute and can be reached via Prema-chandra.athukorala@anu.edu.au)

Prof Athukorala: Sri Lanka and the IMF: Myth and reality – Part 2

Originally appeared on The Daily FT.

By Prof. Prema-Chandra Athukorala

Since 1965 Sri Lanka has been a ‘repetitive client’ of the IMF. The country has entered into 16 economic stabilisation programmes during 1965-2000. Macroeconomic management of the country has been under IMF programmes for approximately 33 years of the 55-year period.

1970-’75: Trotskyite Finance Minister seeking IMF support again

The United Front coalition (UF) came into power in 1970 promising to ‘to lay the foundation for an irrevocable transition to the economy to a socialist one’ (Perera 1970a, p. 4-5). The development strategy of the new Government envisaged combining ‘outward looking development with the right mixture of internal policies and approaches to domestic resource mobilisation which prove to be socially acceptable’ (Perera 1970b, p. 176).

By 1970, Sri Lanka’s repayment obligations to the IMF had become an important factor that contributed to high level of capital amortisation because of repetitive recourse to borrowing in the second half of the 1960s (Central Bank Annual Report 1971, p. 194). NM, the Finance Minister, started negotiation for a fifth SBA with IMF within months of the new Government coming into power. In his 1970 Budget Speech he argued that “we cannot brush aside and completely ignore these international institutions; we can repudiate their terms only if we are prepared to face the far-reaching distortions” (Perera 1970).

The initial discussions were held in June 1970 in Colombo with D.S. Savkar, Assistant Director, West Asia Division of the IMF. NM attended and addressed the IMF-World Bank annual conference in Copenhagen in September 1970 and persuaded the IMF Managing Directors Paul Schweitzer to visit Colombo on 20 October 1970. Final discussion were held in Washington DC in December 1970. In the negotiations, NM was assisted by a strong team of technocrats including W. Tennekoon (Central Bank Governor), M. Rajendra (Secretary to the Treasury) and H.A. de S. Gunasekera (Permanent Secretary, Ministry of Planning and Employment).

The IMF was firmly of the view that the imbalance of payments can only be set right by a further devaluation of the Rupee. The Finance Minister opposed to the idea because of the perceived inflationary impact it would have and managed to convince the IMF team that the Government had the capacity to reduce the budget deficit by taking firm actions to reduce the budget deficit, promoting domestic saving, relaxing credit controls, encouraging exports and pursuing a vigorous programme of import substitution. The IMF approved a SBA of $ 25.6 million on 17 May 1971. To facilitate the implementation of the SBA, the IMF enlisted assistance of the World Bank and some downer countries for an aid programme.

After signing the SBA, NM emphatically defended his decision to go to the IMF in the Parliament: ‘effort to put its own house in order was not the result of IMF advice but was the obvious thing to do in the national interest’ (Hansard, Vol 91, November 10, 1971, cc 2621-2633).

The worsening balance of payment situation in the wake of the oil price increase in 1973 compelled the Government to negotiate another SBA. In preparation for negotiations the Government came up with some ‘sweeteners’ for the IMF: the rupee was re-linked to the pound sterling from the US$ when the pound was floated on 23 June 1972 resulting in an indirect devaluation of the rupee by about 7%.; in November 1972 the FEECs rate was increased from 45% to 65% with an expansion of the import coverage of FEEC scheme to nearly 75%, and the food subsidy bill was cut substantially on its own initiative. The negotiations took two years and a personal visit by the Finance Minister to the IMF before signing the agreement to the tune of $ 29.6 m on 30 April 1974.

Sri Lanka obtained only the first instalment ($ 8.5 m) under this SBA. The IMF withheld the balance because the Government failed to adhere to the ceiling imposed on domestic credit. Perhaps the Government was not under pressure to stick to IMF conditionality in that year because of the availability of ‘easy’ IMF finance under the newly-introduced Oil Facility (SDR 34 million) and the Compensatory Finance Facility (SDR 7.0).

The Government approached the IMF for another SBA in 1975. However, the discussions floundered allegedly on account of the Government’s reluctance to cut further subsidies as required by the IMF (Kappagoda and Paine 1981, p74).

The UF Government made considerable progress towards macroeconomic adjustment with the help of the IMF programmes. Both the annual debt servicing burden and the term structure of external debt significantly improved. However, as Kappagoda and Paine (1981) have convincingly argued, ‘the payment adjustment [cut in domestic absorption] proceeded faster than was warranted’ (p. 100).

The adjustment burden primarily felt on imports with serious adverse effects on the economy’s medium term prospects and consumer wellbeing. The groundswell of unhappiness of the electorate paved the way for the UNP to return to power with a landslide majority in June 1977.

1977-’88: The first wave of liberalisation reforms 

The widely-held view in the Sri Lankan policy circles is that the regime shift opened up the opportunity for the IMF to dictate ‘neo-liberal’ reform in Sri Lanka (Gunasinghe 1986, Lakshman 1985, Davis 2015). Lakshman (1985, p. 22), in particular, claims that ‘the determining hand of the IMF-WB group in shaping and implementing of the ‘open economy’ is abundantly clear’. This claim could not be further from reality.

Major reforms such as trade liberalisation and exchange rate depreciation and the opening up of the economy to foreign direct investment were, in fact, undertaken by the new Government in the ‘honeymoon’ period following the massive election victory, based on the recommendations of the Shenoy report. When the Government adopted pro-market policies for its own reasons, the IMF became an important partner of development policy, but, of course, subject to its standard conditionality.

As already noted, the balance of payments position was in relatively better shape at the time compared to the first half of the decade. There was also promising sign of massive concessionary capital inflows from the major donor nations in support of the economic opening by the new Government. Immediately after the new Government was formed, the Finance Minister, Ronnie de Mel made a one-month visit to a number of Western countries to seek aid and returned with promising pledges. In 1978, aid disbursements alone were sufficient to cover the current account deficit (Central Bank Annual Report 1978). There was no urgent need for approaching the IMF for balance of payments support alone. It seems that the Government choose to go to the IMF to gain credibility to the reform process. 

The Government presented a proposal for a $ 427 m under a SBA. However, in the absence of a well-prepared medium-term stabilisation programme, and because the Government’s disagreement with the IMF to phase out subsidies, the IMF approved a SBA of only $ 122 plus $ 50.3 million as a supplement from the IMF Trust Fund in 1978. Immediately after approving the SBA, the IMF opened a representative office in Colombo to work closely with the Government in monitoring the reforms. In January 1979, the IMF approved $ 317.2 m EFF programme to support structural adjustment reforms during the three-year period of 1979-’81.

The relationship between the Government and the IMF, however, began to come under strain from 1981 because of a significant disagreement relating to the policy priorities of the Government (Rajapatirana 2017). The Government swiftly implemented the Shenoy recommendations for economic opening, but it overlooked Shenoy’s recommendations for macroeconomic stabilisation, which was an integral part of the proposed overall reform package. It decided to accelerate the implementation of the Mahaweli Development Project (collapsing the original implementation period of 30 years to eight years), side by side with the liberalisation reforms. 

The IMF (and the World Bank) became concerned about the inconsistency between the objective of structural adjustment in the economy under liberalisation reforms and the inevitable macroeconomic instability resulting from the massive investment programme (Levy 1998, Athukorala and Jayasuriya 1991). 

Apart from the macroeconomic instability, there were also genuine concerns regarding the viability of the $ 664 m project: A study of the project financed by the World Bank in 1981 recommended a slower rate of implementation than what the Government envisaged to avoid possible cost blow-up. The study also expressed concern that donors had made aid commitments for the project without properly evaluating the project’s costs. 

In September 1983, the IMF approved another SBA of $ 105 m (as opposed to the Government’s request for $ 221 m). However, the IMF terminated the agreement after only half of the agreed amount was disbursed, over concerns about macroeconomic instability caused by the massive Mahaweli investment programme. The World Bank also withheld disbursement of allocations under a Structural Adjustment Loan (SAL) ($ 70 m) because of the Government’s dispute with the IMF. According to a confidential letter to the Ministry of Finance and Planning (leaked to Lanka Guardian), David Hopper, the Vice President of the South Asia Programme, emphatically stated that ‘the precondition for all Bank structural adjustment activities is an agreement with the IMF’ (Jayalath 1990). 

Ronnie de Mel, the Finance Minister, described the nature of the Sri Lanka-IMF relationship during this period as follows: ‘We have had discussions, intricate discussions, debates, long negotiations and many quarrels. We have had suspensions. We have had estrangements. It has been, in short, love-hate type relationship. It has been something like the relationship between Elizabeth Taylor and Richard Burton’ (Hansard, Vol. 22, No. 12, March 18, 1983, C 1768).

1988-2005: The second-wave reforms

The economic boom following the 1977 reforms mainly concentrated in the first three years (1978-81) when the economy grew at an average annual rate of 6.6%. In the ensuing years of the decade, liberalisation reforms were overtaken by the commitment to major infrastructure projects. The process of structural adjustment in the economy was hampered by the failure to complete implementation of the reform agenda, in particular labour market reforms and State enterprise reforms, and the adverse impact of the investment boom on tradable goods production in the economy because of the appreciation of the real exchange rate (Moore 1990, Dunham and Kelegama 1997).

Added to this was the economic disruption caused by the escalation of the separatist war from 1983 and JVP uprising in the south during 1987-’89. By the end of the 1980s, the Sri Lankan economy had come close to a foreign exchange crisis, with low foreign exchange reserves, massive security related Government expenses, and a misaligned exchange rate that propelled significant capital flight and under repatriation of export proceeds (IMF 2001). 

In this volatile economic climate, the UNP Government under the new leadership of President Premadasa embarked on the ‘second wave’ liberalisation reforms (Dunham and Kelegama 1995). The IMF supported the reforms under a Structural Adjustment Facility (SAF) of $ 209 m) and an Extended Structural Adjustment Facility (ESAF) of $ 478.6 m. Reforms included devaluation of the rupee against the US$ by 34% between mid-1989 and the end of 1993, further liberalisation of financial and commodity markets, revamping of the operations of the Board of Investment (BOI) with a one-stop-shop for investment approval process, privatisation of some State-Owned Enterprises (under an innovative politically-friendly label, ‘peopalisation’) and a poverty alleviation programme. 

Dunham and Kelegama (1995, p. 187) have characterised the second-wave reforms as an illustration of how ‘strong leadership proved critical in ... reforms, in a country where the state is not strong, and is neither cohesive nor disciplined, in organisational rearms’. 

The vigour of second-wave reforms was lost because of the tragic death of the President, but there was no back sliding from reform because economic outcomes had been impressive enough to make economic liberalisation by-partition policy (Kumaranatunge 2004). 

The new SLFP-led Coalition Government continued with trade liberalisation and privatisation of State enterprises. During 2001-2002 the Government received financial support for reforms under a SBA of $ 256.8 m. In releasing funds under the SBA the IMF was sympathetic to the difficulties faced by the Government in meeting conditionality because of the exigencies of the accelerating civil war. 

For instance, the IMF showed flexibility to extend the agreement to 19 September 2002 on a lapse-of-time basis to allow the completion of the final review and granted a waiver for the non-compliance of performance criteria and released the agreed amount, because non-compliance was largely due to factors beyond the control of the Sri Lankan authorities (escalating ethnic conflict and oil price hike). 

1995-2009: The period of escalating civil war

During the period from collapse of peace talks between the LTTE and Government in 1995 until 2009, the reform process was hampered by the escalating civil war. In 2003, the IMF approved a three-year PRGF to the amount of $ 392.7 m and an additional EFF in tune of $ 210.8 m over the period 2003-’06. Both programmes lapsed after the withdrawal of the first instalments.

The post-civil war era

Following the ending of the civil war in July 2009, the IMF approved the largest ever programme loan (SBA of $ 2.6 b) for Sri Lanka. The quarterly performance criteria (QPCs) related to the standard macroeconomic stabilisation measures. 

The Government’s poor record of revenue mobilisation, in particular continued decline in the tax revenue-to-GDP ratio, and the budgetary burden of supporting loss-making public enterprises, and the backsliding on trade liberalisation came up in the negotiations but did not become part of the conditionality. This was presumably because the IMF wanted to provide the Government with policy autonomy in restoring the economy after the three-decade civil war.

In June 2016 the Government entered into a three-year EFF ($ 1.5 b) with the IMF. The EFF aimed to harness an additional $ 650 m in other multilateral and bilateral loans of about $ 2.2 b (over and above the existing financing arrangements). The stated objective of the programme was to help the new Government restore macroeconomic stability and resilience of the economy to facilitate sustainable and equitable economic growth (IMF 2016). 

The programme focussed on reforms to tax policy and tax administration with a focus on increasing direct tax collection, fiscal policy management, and State enterprise reforms to achieve fiscal consolidation while providing fiscal space for the Government’s key social and development spending programmes. Fiscal consideration reforms were to combine with flexible monetary targeting under a flexible exchange rate regime, reforms in the trade and investment regime, and rebuilding foreign exchange reserves. 

The reforms undertaken by the Government under the programme during 2016-’19 included a major revision to the value added and income tax systems and introducing a new building tax and rationalising the customs duty structure (Coomaraswami 2017). On 13 May 2019 the IMF Executive Board approved an extension of the EFF until June 2020 with rephrasing of remaining disbursements to complete the reform agenda. However, the implementation of the programme abruptly ended with the change of government in early 2020.

To sum up, since 1965 Sri Lanka has been a ‘repetitive client’ of the IMF. The country has entered into 16 economic stabilisation programmes during 1965-2000. Macroeconomic management of the country has been under IMF programmes for approximately 33 years of the 55-year period. The IMF fully disturbed agreed funds under 12 (approximately covering 25 years) of these 17 agreements. The conditionality attached to the agreements has notably varied over time depending on shifts in the development thinking of the IMF and macroeconomic conditions and the underlying political developments of the country.

(Prof. Prema-Chandra Athukorala is a Fellow of the Academy of the Social Sciences of Australia, an Emeritus Professor of Economics at Australian National University and an Advisor for Advocata Institute and can be reached via Prema-chandra.athukorala@anu.edu.au)

Prof Athukorala: Sri Lanka and the IMF: Myth and Reality – Part 1

Originally appeared on The Daily FT.

By Prof. Prema-Chandra Athukorala

Read Sri Lanka and the IMF: Myth and Reality – Part 2 and Part 3

Sri Lanka is now in the midst of its worst macroeconomic crisis since independence. Whether to seek financial support from the International Monetary Fund (IMF) in managing the crisis is a hotly-debated issue in Sri Lankan policy circles. The debate is largely ideologically-driven: strongly-held, opposing views are expressed without facts.

The purpose of this paper is to demystify the debate by documenting and analysing Sri Lanka’s experience under IMF-supported macroeconomic adjustment programs, the economic circumstances that propelled the country to seek IMF support, and implications of these programmes for economic stabilisation and growth.

The discussion focuses on two key issues emphasised by the current political leadership and the Central Bank to justify their attempt to avert going to the IMF: IMF dictates policy reforms at the expense of national policy autonomy, and the conditions attached to IMF programs are harmful to national development. The paper primarily adopts an economist’s perspective, but where relevant economics is combined with politics in order to understand the vicissitudes of Sri Lanka-IMF relations.

The paper begins with a short introduction to the role of the IMF in economic stabilisation reforms in developing countries to provide the context for the ensuing analysis. The next section provides as analytical narrative of the history of Sri Lanka-IMF relations. The following section examines the impact of IMF programs on the Sri Lankan economy. The final section provides concluding remarks with a focus on the current debate on entering into an IMF programme.

The IMF and economic stabilisation

The IMF was set up in 1945 to provide member countries with bridging loans to help them get over balance of payments difficulties. A member’s access to the IMF’s financing is expressed in terms of tranches, equal to 25% of its quota of the IMF. The first four trenches (‘reserve’ tranches, in total up to 100% of its quota) can be accessed free of charge at the member’s own discretion.

The IMF also has other concessional credit facilities introduced to help member countries in the event of unforeseeable economic shocks: Compensatory Finance Facility (CFF), the Buffer Stock Financing Facility (BSFF), the Trust Fund and Subsidy Account (TFSA) financing, Supplemental Reserve Facility (SRF), Contingent Credit Lines (CCLs) and Emergency Assistance (EA).

When a country borrows beyond the reserve trenches or eligible concessional credit facilities, it has to agree on a reform package to overcome its problems that led to seek financial support. These lending programs are called structural adjustment (or stabilisation) programmes. The policy measures prescribed by the IMF relating to these lending programmes are known as ‘IMF conditionality’.

The main structural adjustment loan programme is the Stand-By Agreement (SBA) facility, introduced in 1952. The key objectives of SBAs are to rebuild the external reserves, strengthen the fiscal position, maintain monetary stability, and fortify the domestic financial system. The length of the typical SBA programme is 12 to 18 months and loans are to be repaid within a maximum of five years.

The other IMF stabilisation facilities are the Extended Fund Facility (EFF) (established in 1974); Structural Adjustment Facility (SAF) (1982) and later remained Enhanced Structural Adjustment Facility (ESAF), and Poverty Reduction and Growth facility (PRGF) introduced in 1999 in place of the ESAF specifically to help low-income countries. These programmes have been established to provide support to comprehensive structural adjustment programmes that include policies of the scope and character required to correct structural imbalances over an extended period. Normally the duration of these programmes varies from three to five years, and repayment is over four to 10 years from the date of drawing. 

Under the structural adjustment programmes, the IMF releases funds by quarterly credit tranches. The country has to observe the quarterly programme criteria at each test data. The interest rate comprises two components: the service charge and a ‘fixed margin’ (an annual interest rate). The service charge is calculated weekly, based on a Special Drawing Rights (SDR) rate (applicable to all borrowings from the IMF) and the fixed margin is applicable to loans up to 300% of the member’s IMF quota and a surcharge is applicable to loans beyond that limit. The interest rate is normally about one third of the average rate applicable to sovereign bonds issued by the typical developing country.

Unlike the other multilateral and bilateral lenders who lend to the government of the borrowing country, the IMF always lends funds to the central banks of the country. The IMF loans to the central bank are strictly for the purpose of building international reserves to meet external payments. Therefore, borrowing under IMF programmes does not have any direct impact on domestic money supply and hence on domestic inflation. 

Entering into an IMF supported programme also acts as a catalyst to generate additional international financial assistance in three ways (Bird and Rowlands 2007). First, having a macroeconomic adjustment programme with the IMF is often a prerequisite for obtaining World Bank adjustment loans. Second, as part of entering into a stabilisation programme, the IMF arranges aid consortia of donor countries to assist the given country, Most of the donor funds harnessed under these consortia are outright grants or long-term loans that carry low interest rates. Third, credibility of the reform program gained by entering into an IMF programme helps raising funds at competitive interest rates from private capital markets.

The core of an IMF stabilisation programme is a ‘letter of intent’ that contains ‘performance criteria’ (conditionality) agreed with the IMF. The performance criteria vary from case to case, but typically centre on four key variables: budget deficit, the rate at which domestic credit is created, interest rates for both depositors and borrowers, and the exchange rate. In recent decades, the IMF has begun to focus on domestic pricing policy for petroleum products, when the domestic prices are badly out of line with world prices. 

In the typical developing economy where the local capital market is weak and access to foreign credit is limited, domestic credit expansion is largely driven by the budget deficit. In IMF reform programs the major emphasis is, therefore, placed on fiscal reforms, cutting the budget deficit through both government revenue reform and rationalising government expenditure. (There is a saying that the acronym ‘IMF’ stands for ‘It’s Mostly Fiscal’!) 

A straightforward reduction of absorption (expenditure) is likely to entail a decline in total output and employment unless wages are exceptionally flexible and labour and capital is highly mobile among economic sectors. Therefore, exchange rate depreciation is recommended to make tradable goods (exports and imports competing goods) relatively more profitable compared to ‘non-tradables’ (mostly services and construction). The expansion of domestic tradable goods production relatively to non-tradable production is expected to help maintaining growth dynamism of the economy in face of policy-induced contraction in aggregate domestic absorption (Cooper 1992).

The decision to go to the IMF for assistance rests entirely with the IMF members. However, the relationship between the IMF and its developing-country members under stabilisation programmes has not always been smooth. Much of the disagreements hinge on judgements relating to conditionality attached to the lending programmes. While the principle of conditionality is not generally contested, often there are strong reservations on the part of members about the design and application of conditionality. The national officials are typically more optimistic than the IMF staff and the favourable developments they anticipate could imply less difficult action. 

On the other hand, in some cases, the national government’s discontent could also arise because, in setting conditions, the IMF staff has the tendency go beyond the basic framework. For instance, they could get into details of exactly what expenditures should be cut or what taxes should be raised to reduce the budget deficit, instead of leaving the responsibility for meeting the targets with the officials of the country concerned by taking into account country-specific political as well as economic considerations. 

Negotiating a stabilisation programme in a crisis context has the tendency to give the unwarranted impression that a country is rushing into action with a weak negotiating position vis-a-vis the IMF. The governments may resent IMF conditionality because of the loss of sovereignty implied and also because of a belief that the IMF’s objectives do not necessarily coincide with those of the national government. 

In such a context, naturally there is a tendency on the prat of the governments to make the IMF a scapegoat for (to hold the IMF responsibility for) politically unpopular decisions taken by them or for their own poor economic management. Indeed, such scapegoating often lead many to believe that the IMF forces countries to take politically disagreeable, and sometimes economically costly, action (Cooper 1992, Bird 2007).  

Sri Lanka and the IMF 

Sri Lanka (then ‘Ceylon’) became a member of the IMF (and the World Bank) on 29 August 1950. It accepted the obligation for liberalisation of the current account transaction under the IMF Article VIII in March 1994. 

Sri Lanka did not recourse to IMF financing throughout the 1950s, given the healthy external reserve position built up during the Second Word War, which was subsequently buttressed by the Korean War commodity boom (1950-51) and the tea boom (1954-55). The country obtained IMF finance for the first time in 1961, and then in 1962, within the reserve trenches. 

1964: Trotskyite Finance Minister seeking IMF support

Sri Lanka’s first attempt to borrow from the IMF under an SBA was by the Sri Lanka Freedom Party (SLFP) and Lanka Sama Samaja Party (LSSP) Coalition Government in 1964. By that time import restriction and capital controls had been carried out to the maximum and it was becoming increasingly difficult to introduce further restrictions without damaging the economy (Corea 1971). Because of the nationalisation of the foreign-owned gas and petroleum outlets in 1961, Sri Lanka became the first country against which the US Government invoked the Hickenlooper Amendment requiring the suspension of US aid to countries expropriating US property without compensation (Olson 1977). Following this, the international aid community virtually isolated Sri Lanka.

The pragmatic Trotskyite Finance Minister, Dr. N.M. Perera (NM) decided to approach the IMF. In September 1964, at the Annual Meetings of the IMF and the World Bank held in Tokyo, the Sri Lankan team led by NM consulted the IMF on the possibility of obtaining financial support under an SBA. The Government was defeated in the Parliament before the negotiations ended. However, according to a statement made by Dudley Senanayake (the Opposition Leader) at a parliamentary debate, the negotiation with the IMF failed well before because NM was not prepared to touch the politically-sensitive subsidy on rice (Hansard Vol 73, No. 13, 1767 c. 2898).

1965-70: Four back-to-back SBAs

During 1965-1970, the right-of-the-centre United National Party (UNP) Government obtained IMF financial support under four SBAs. The IMF conditionality of the Letters of Intent of these SBAs reflected the very nature of the mainstream development thinking at the time, which favoured import-substitution industrialisation with the Government directly playing a major role. 

Redressing the fiscal imbalance by rationalising expenditure, in particular reducing subsidies was the key focus. Reforming State-Owned Enterprises was not part of conditionality even though converting their losses had already become a big drain on the Government budget. Under the third SBA signed in May 1968, a Foreign Exchange Entitlement Certificate Scheme (FFECS), a dual exchange rate systems, designed to provide incentives to sleeted ‘non-traditional’ exports and to lift quantitative restrictions on selected imports at a premium above the official exchange rate (initially set at 44%). Other than this, there was no emphasis by the IMF on unshackling the economy from import restrictions and other direct Government intervention in the economy.

An important development in the policy scene during this period, which has not received only scant attention in the post-independence development history of Sri Lanka, is a failed attempt by J.R. Jayewardene (JR), the then Minister of State and Deputy Prime Minister, to seek IMF support for a major liberalisation reform. At the time the economy was in the doldrums because of the closed-economy polices pursued by the country from the late 1950s. JR ‘regarded the crisis as an opportunity to embark on a radical change in economic policies that would amount to a departure from the dirigiste policies’ (de Silva and Wriggins 1998, p168). 

He approached B. R. Shenoy, the Indian liberal economist (who had taught at the Ceylon University College in the late 1940s) for advice. Shenoy responded with a comprehensive policy blueprint for unshackling the economy (Shenoy 1966). JR presented the Shenoy report to the Cabinet but there was little chance of being adopted the radical reform package given the political adjustments and realignments within the multi-party Cabinet. He had to wait until the UNP’s election victory under his leadership in 1977 to implement the proposed reforms. 

(Prof. Prema-Chandra Athukorala is a Fellow of the Academy of the Social Sciences of Australia, an Emeritus Professor of Economics at Australian National University and an Advisor for Advocata Institute and can be reached via Prema-chandra.athukorala@anu.edu.au)

The Government’s dangerous honey

Originally appeared on The Morning

By Dhananath Fernando

Minister of Finance Basil Rajapaksa, moving two important bills in Parliament, recited a poem in Sinhala literature, which is also a proverb, to explain the sorry state of our economy. He compared Sri Lanka’s economy to a man in the jungle trying to rescue himself from three life-threatening challenges.

Firstly, a furious wild elephant, similar to our mounting debt obligations. Secondly, to avoid the elephant, the man attempts to hide in a pit, but before he jumps into the pit, he realises that there is a cobra in it. So instead of jumping, the man then decides to hang onto the roots of a tree that lies above the pit as an alternative. The cobra in the bottom of the pit is similar to our Balance of Payment (BOP) crisis. Our importers and exporters are in big trouble, having difficulties opening Letters of Credit (LCs) due to forex shortages, and currency is depreciating rapidly with attempts to keep interest rates artificially low by policymakers.

Then the man realises that one root he is holding onto is the tail of a venomous reptile. He now cannot release his grip on the tail as the reptile will bite back. So, the adventure of running away from the elephant waiting at the edge of the pit now has two more severe life-threatening risks. The Finance Minister’s analogy reflects that trying to avoid one problem without a proper estimation and analysis has now opened us to more vulnerabilities while the previous challenges remain as they are.

As the story goes, one tree root the man is holding in his other hand is attached to a bee honey nest. So when he tightens his grip, bee honey keeps dripping, and so he decides to indulge in some bee honey. While the man has three life threats from the elephant, the cobra, and the other reptile, he decides to enjoy the dripping bee honey for a moment.

The Sri Lankan economic crisis is exactly the same. At a moment in history where urgent, hard, and serious economic reforms are required to overcome the crisis in the midst of the global pandemic, some alternative policies such as self-sufficiency, Modern Monetary Theory (MMT), and import substitution have become sweet bee honey for some policymakers who really do not understand the gravity of the crisis.

Unfortunately, just as the man who attempted to jump to a pitfall without properly analysing the situation, some economic measures with little analysis are cornering us for a brewing crisis.

Fixing USD at Rs. 203

Attempting to fix our exchange rate at Rs. 203 against the USD to avoid currency depreciation is one such activity. Simply, it is a price control on US dollars. Every good or service with an economic value is naturally obliged to a demand and supply matrix. In other terms, there is no alternative to fix the price of a currency without someone intervening in the excess or shortage.

In the forex market, the Central Bank does not have adequate forex to intervene in markets any longer, with the mounting debt obligations. So it is natural that $ 1 for Rs. 203 is a complete misguidance where there is no USD in the market at that price. The downside of trying to fix the USD at an artificially lower price is the encouragement it would provide on more importers to open LCs, adding more pressure on banks as well as the USD.

“Imports” are incentivised at a lower rate than the market rate for the USD. Exporters, on the other hand, are discouraged to bring forex as they get a far less market rate if they bring USD to the market. As a result, exporters hold the USD as long as possible and many exporters maximise their offshore accounts, as it is very cost-effective and hassle-free. As such, banks’ forex market has now further dried up, with both importers and exporters falling into trouble. It is the same predicament faced by the man who tried to avoid an elephant and came across two more additional troubles.

Additionally, another restriction has been imposed on more than 600 HS codes where the full amount has to be paid upfront to open the LC. This move will directly impact micro, small, and medium-sized businesses that depend on imports in those categories. Consumers will have to experience higher prices and black markets in most of these product categories, and the quality of life will be affected drastically.

Concerns expressed by investors on property rights over seizing rice stocks

Recent raids carried out on rice mills in Polonnaruwa will worsen Sri Lanka’s image as a destination for investors. As previously written in this column, it is the lack of competition, along with political support, that leads to the creation of cartels in the rice milling industry. However, seizing private property of an individual undermines investor confidence – no investor will consider Sri Lanka if there is a fear that the government will take over their property rights.

This was the same point made by the President when he was questioned by Indian media in his very first international media interview about the Hambantota Port. Though his supporters claimed that the Hambantota Port will be taken back by China, the President mentioned that if we were to do it, it would completely provide a wrong message for the investor community. According to media reports, the Government is initiating a very important Selendiva project for investors (Hilton Colombo, Grand Hyatt, etc). However, property rights concerns will seriously erode attracting quality investors for the Selendiva project.

At the same time, exactly like the proverb in the speech by the Finance Minister, while we are in serious trouble on multiple fronts, ideological groups seem to be defending their ideology rather than finding solutions with pragmatism. Ideological groups are the same as the man who is focusing on bee honey dripping, by forgetting that we are already in a very serious situation. The narration created on self-sufficiency and import substitution are just an example.

The Finance Minister has to be objective and pragmatic instead of falling into ideological traps. Otherwise, he will be a victim of his own analogy and the proverb of the man who multiplied the problem by irrational decision-making.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Closing the gate once the horse has bolted

Originally appeared on The Morning

By Dhananath Fernando

Can price controls rein in uncontrolled depreciation?

People are infuriated over the recent drastic price hikes on essential food items, and analysts and policymakers are attempting to make sense of what triggered this.

Some argue that the increasing global commodity prices are indeed the root cause of these local price hikes. In my opinion, however, global price hikes cannot be the sole reason. This conclusion is misleading as the domestic prices of these food items are higher than the percentage increase of global commodity prices adjusted for the depreciation of the Sri Lankan rupee (SLR).

Steep depreciation of the currency

It is no secret that the Government sought refuge in Modern Monetary Theory (MMT) in recent times. This has had a considerable impact on commodity prices due to the depreciation of the rupee. A depreciating rupee coupled with increasing commodity prices is certainly an ill-fated combination. Even though many economists alerted the Government of the risks MMT could pose, they fell on deaf ears.

When global market prices rise, it is inevitable that domestic markets adjust accordingly due to price signals. This means that people shift their consumption behaviours and patterns with price volatility. However, Sri Lanka’s essential commodity price hikes came suddenly and have given people no time to adjust their purchasing patterns.

As per Central Bank data, Sri Lanka’s food inflation is increasing. Advocata Institute’s Bath Curry Indicator, which tracks the weekly expenditure of a four-member household on rice and curry, found that prices increased by 45% on a YoY (Year-on-Year) basis in July and by 30% in August.

I’d like to conclude my argument by quoting Nobel Laureate Prof. Milton Friedman: “Inflation is always and everywhere a monetary phenomenon.”

Acute foreign exchange crisis exacerbated by MMT

The acute foreign exchange crisis we are in, too, is a major contributor to recent price hikes. Oversupply of money has drained our reserves and added additional pressure on the currency. For example, when the government provides Rs. 20,000 (which is beyond the government’s capacity) for low-income families, money will flow out of the system due to the purchase of imported goods. People will be inclined towards buying imported LP gas, lentils, sprats, and tin fish.

Further, maintaining a negative real interest rate, which is to keep interest rates artificially low by increasing money supply below the inflation rate, will motivate people to spend more money than to save. More spending equals more expenditure on imports, which will then exacerbate the country’s Balance of Payment (BOP) crisis.

Currently, banks have different exchange rates for different customers. The kerb market’s exchange rate for the US dollar is between Rs. 250 and Rs. 260.

If this trend continues, the country’s fuel prices, LP gas, milk powder, and many other commodity prices will continue to rise.

Price controls

The Government has announced strict price controls and has appointed a designated officer to curb hoarding by traders with the objective of decreasing essential commodity prices. Recent news reports claim that hoarded essential food items such as sugar have been confiscated from stores by the authorities.

However, price controls are proven to be ineffective and will lead to goods disappearing from markets, as a result creating black markets. Further, it is likely that price controls will result in importers stopping the importation of goods. The first lockdown saw an initial price control of Rs. 65 on lentils and a controlled price of Rs. 100 on tin fish. Later, the Government had to withdraw the price controls as it resulted in severe shortages, with traders halting imports and the sellers hesitating to trade at a loss. Price controls simply don’t work because the price structure is unique for each trader.

Competition is the only factor that drives prices down. For example, the cost structure of a trader who sells lentils in an air-conditioned shop and a trader who sells at the Sunday market is different. The price they mark is based on the cost, and consumers buy it based on the value they get. Price controls hamper the signalling mechanism, resulting in severe repercussions.

Why do traders hoard?

Even with increased raids by the Consumer Affairs Authority (CAA), traders continue to hoard. This behaviour is intricately linked with the foreign exchange crisis the country is in. The Central Bank introduced regulations stating that traders cannot buy US dollars for a future day (forward market) at the current exchange rate. Further, importers were requested to open Letters of Credit (LCs) for a 180-day credit period. As a result, importers brought essential commodities in agreement to pay the exchange rate to be in effect after 180 days. They brought the goods they already sold at a calculated exchange rate.

However, now the exchange rates are depreciating further. For example, when traders imported the consignments, our exchange rate was about Rs. 190. But with the currency depreciation, now they have to pay the current exchange rate as there is no forward market or interbank market in operation. This is pushing importers to hoard to secure stocks for the future. Importers will also be inclined to increase prices to cover their losses incurred due to exchange rate volatility.

All of these trickle down to the average consumer as higher prices on essential commodities. Higher prices, long queues for essential goods, and empty shelves are symptoms of wrong macroeconomic policies.

This column and many economists alerted the Government that it would come to this, and I am disappointed that the Government did not heed our advice.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Reforms required, IMF or no IMF

Originally appeared on The Morning

By Dhananath Fernando

At Advocata’s first deep-dive session on Sri Lanka’s debt sustainability, Harvard Prof. Ricardo Hausmann emphasised on the importance of avoiding an economic crisis at all costs. As he is of Venezuelan origin, it is safe to assume Prof. Hausmann has first-hand experience of having to live through the realities of such a crisis. He warned that “an economic crisis comes slowly and then suddenly”.

Every week, the Central Bank attempts with various tools to subjugate the situation, but unfortunately the intensity of the wind seems difficult to change. The Energy Minister initiating discussions with the UAE to purchase fuel on a long-term credit period while restricting the country’s USD payments with a 5% ceiling on USD deposits indicates how hazardous things can be in future.

The Central Bank’s recent inflation numbers have indicated high food inflation. Now the last resort in sight is to approach the International Monetary Fund (IMF). Opinions on this are many.

In my view, emphasis should not be on the IMF. A credible plan to drive economic growth must take precedence. However, I don’t see such a plan in place as of now.

So let’s discuss solutions we can incorporate into a credible plan as the problem is clear.

Immediate policies

Cash transfer system for safety nets

Given the nature of the pandemic, it looks like we have to expect more lockdowns or limited travel in the immediate future. This will affect Sri Lanka’s MSME (micro, small, and medium-sized enterprise) sector and informal employment. At the moment, 99% of our establishments are MSMEs and more than 60% of our labour force is in the informal sector. MSMEs contribute more than 50% of our GDP. So any policy to stop spreading the virus through travel restrictions will undoubtedly affect our informal sector. We do not have a mechanism to protect them.

Samurdhi targeting and distribution through grama niladharis is extremely poor. Therefore, what governments often do is bring down prices of all food items, fuel, and other essentials across the board. This is direct intervention in the market in the form of subsidies. These subsidies end up in rich households due to their high consumption of commodities.

The solution is to introduce a cash transfer system to the vulnerable households. This will give them the freedom to choose what they want to spend on. The cash transfers can have multiple tiers based on the poverty levels. For example, when the global fuel prices are increasing, the cash transfer on fuel can be increased, but when prices decrease, the cash transfer can decrease proportionately. Simply, we have to introduce an agile digital safety net system in the future because market reforms are painful, especially for the poor.

Cutting down govt. expenditure and voluntary retirement scheme for govt. servants

A reason the Central Bank has to continue to follow Modern Monetary Theory (MMT) is the ballooning government expenditure. It is true our expenditure is somewhat on par with our regional peers, but our labour market is completely distorted by about 1.5 million people, and most of them are unproductive and dissatisfied with their work conditions. Undoubtedly, this is beyond our government’s afforbality, especially with pension payments and other expenses incurred utilising prime property across the island wasting most of our resources. Our state-owned enterprises (SOE) absorb a greater portion of our government revenue, their debt in state banks adding a serious risk to the stability of the banking system. So a freeze in the government sector is a must and we do not have any alternatives left.

Debt restructuring and debt conversion

We have to leave our current strategy of trying to manage debt with short-term swap agreements. The more we wait, the more the pain we have to go through. Debt conversion is a strategy that can be explored. We can consider a few debts to equity swaps similar to what we did with the Hambantota Port on identified unproductive assets. Debt restructuring or reprofiling is another option, which, however, requires serious effort. It will be an extremely costly process, where we will have to work with foreign legal firms and our creditors. This will have both positive and negative consequences.

Unlocking our land supply

Land is one of the main factors of production. It is unimaginable that 80% of land is owned by the government and only 3% of the land have clear titles, as per a World Bank study. Without having land ownership for its people, there is no opportunity for capital flow that can expand the entire business ecosystem. The Government has to prioritise creating a digital land registry instead of other unproductive alternatives.

Above are just a few recommendations for a credible recovery plan, whether we go to the IMF or not. The real problem is not whether we are going to the IMF or not. It is looking at what reforms we have to make on our own and how we are going to make these changes, which are required to drive economic growth.

Prof. Hausmann said that the big bad wolf comes slowly and suddenly. I hope we move much faster and get the reforms done before “the big bad wolf that comes slowly and suddenly” comes for us.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Avoiding IMF won’t help us avoid austerity

Originally appeared on The Daily FT, Daily Mirror, Lanka Business Online, The Island, ColomboTelegraph

By Naqiya Shiraz and Rehana Thowfeek

Sri Lanka’s debt problems are  a topic of national conversation. Foreign reserves, already low at USD 4bn in May 2021 fell to USD 2.8bn after the most recent bond repayment of USD 1bn in July 2021 . The Government claims that the timely repayment of the bond is proof that doomsayers were wrong and that it indicates a robust economy. Is this correct?

While it is true that a default has been avoided thus far it does not necessarily mean that the economy is sound. The recent bond repayment comes at a cost: a foreign exchange squeeze. Bond holders are being repaid, but this means that foreign exchange that could otherwise have been used for imports are now being used to pay bond holders instead.

The government seems to be adamant in avoiding the bogeyman, the IMF, perhaps to avoid the tough medication an IMF program will bring. Yet avoiding the IMF does not mean we can escape the inevitable austerity that will follow. Austerity is in fact already upon us, in the form of restricted imports. The restrictions are denying essential inputs to the local economy and medicines and food to citizens. These restrictions work   in two ways:

1. The outright restrictions on imports

2. The shortages of foreign exchange in the market

The government has banned or restricted imports of what is termed “non-essential” items although the list includes goods like some clothing items, refrigerators and food items ( live fish, tomatoes for example). 

In addition, Central Bank’s attempts to control the rate of exchange have resulted in shortages of foreign exchange. The Central Bank has decreed an official rate of around 200/- but only limited amounts are being converted at these rates resulting in a shortage of hard currency.

 Banks are now rationing foreign exchange with the result that even items that are not banned are becoming unavailable.

“We cannot accommodate the requests for LCs so we have to ration them,” a banker said. “There is no regulation to say to ration them, but we are forced to do it.”

https://economynext.com/sri-lanka-rupee-forex-markets-in-pickle-as-lc-rationing-froths-83224/

The import restrictions were supposed to be restricted to luxury items but the currency shortage means that even medicine and some food items seem to be running short

While foreign bondholders will undoubtedly be pleased to have been repaid, local consumers and businesses must now suffer, making do without everyday products. The shortages in supply mean that prices rise: of whatever available imported products as well as local products. 

This affects not only consumers but also businesses. With banks being unable to open a Letter of Credit (LC’s), imports of intermediate goods, even exports by SME’s which have no access to BOI facilities are at risk. 

Unable to trade or operate due to lack of stocks or input material, import-dependent businesses are losing out. The net result is an overall decline in economic activity and welfare of all Sri Lankans. 

A person interviewed for this report explained the difficulty in obtaining asthma medication for his mother. He had to try 4 different pharmacies to get the required drugs.  He said that he believes larger stores have fewer stocks available as the volume of people going to them is much higher. 

Another respondent said chemotherapy drugs brought in from Europe were no longer available with only cheaper products from India, Bangladesh or Argentina being available. As he had no other choice he used the substitutes for part of his wife’s chemotherapy treatment but was worried about the quality and safety. 

The knock on effects of these are palpable. Prices of basic goods are increasing. Inflation in January 2019 according to the NCPI was 127 index points which increased to 146 in June 2021. That means prices have increased by 15% in little over two years as a whole. But prices of essential food prices have increased by a lot more. Food inflation particularly has dramatically increased by 25% (NCPI). According to the Advocata Institute’s Buth Curry Indicator, prices of food that would be consumed in a buth curry meal have increased by 45% from July 2020 to July 2021.

The effects don’t end there. Importers of seeds were complaining that their sales have dropped by 50% because of uncertainty over fertiliser imports. These importers bring in seeds that are not produced in Sri Lanka, for vegetables like beetroot and carrots. Sales have fallen as they are not being purchased by domestic farmers. Farmers are holding back from cultivating due to the uncertainty caused by the shortages of fertilizers needed for production. A consequence of this would be shortages and rising prices of fruits, vegetables and other produce in the coming months. This will not only affect farmers' incomes but also result in higher consumer prices. The government may have to resort to importing more food, thereby negating the impact of the fertilizer ban to begin with. Only recently, the cabinet approved the importation of 6000 metric tonnes of rice from Pakistan to manage the shortage in the market.

This fertiliser fiasco has affected the poor disproportionately. Larger businesses are able to stock up on fertilizer, but not everyone can afford to do that. It’s the small farmers that lose out on income. The incomes of these small farmers are in jeopardy. Coupled with the milk powder and gas shortage, prices of these essential commodities are forced to increase at an already difficult time. 

Economic policy affects the ordinary person in a society. These may be individual stories but they are certainly not one off situations. 

The fact of the matter is that the country is undergoing a self-imposed austerity program in the form of import restrictions and more recently a foreign currency shortage that has resulted in the rationing of even items that are not subject to control.  

The basic principles of economics cannot be ignored in policymaking. By avoiding the IMF for fear of austerity measures, has resulted in more damaging self-imposed austerity. We need to ask ourselves how sustainable this really is in the long term. The longer we wait, more stringent austerity measures will be needed. 

Rehana Thowfeek is an economics researcher by profession. She has a MSc in Economics from the University of Warwick and a BSc in Mathematics and Economics from the University of London. She has worked previously for Sri Lanka-based think tanks; Verité Research and the Institute for Health Policy. At present she works for a US-based food technology company as a researcher. Naqiya Shiraz is the Research Analyst at the Advocata Institute and can be contacted at naqiya@advocata.org.

Poverty reduction needs to be prioritised with cohesive export-led growth policy framework

Originally appeared on The Daily FT

By Prof. Sirimevan Colombage

In Sri Lanka, around 40% of the population lives below the poverty line, according to expert opinion based on the survey data for 2016, in contrast to the official poverty ratio of only 4%. In the backdrop of the COVID-19 pandemic, the poverty ratio is likely to have reached nearly 50% of the population by now.

Adequate attention has not been given to poverty reduction in policy formulation agendas in recent times. 

An outward-looking trade policy aiming at export-led economic growth is imperative for poverty reduction, as evident from the fast-grown East Asian countries and emerging Asian economies such as Vietnam and Bangladesh. 

SL’s actual poverty 10 times bigger than official estimate

According to the Department of Census and Statistics (DCS), Sri Lanka’s headcount poverty index dramatically declined from 22.7% in 2002 to 4.1% in 2016, as per consumption approach. In computing this poverty index, DCS has used the National Poverty Line (NPL). 

The limitations of using the NPL for poverty estimation have been articulated in his incisive article by Wimal Nanayakkara, Senior Visiting Fellow at the Institute of Policy Studies (IPS) and former Director General of the Department of Census and Statistics. 

He suggests that the World Bank’s Global Poverty Line (GPL) is more appropriate for estimating the headcount index in keeping with international standards. The current NPL is based on the market values of an outdated basket of goods and services drawn from the Household Income and Expenditure Survey conducted by DCS way back in 2002. 

The World Bank’s poverty thresholds vary with the member country’s per capita Gross National Income (GNI). With her per capita GNI of $ 4,060, Sri Lanka reached the Upper-Middle Income Country (UMIC) status ($ 3,996 – $ 12,375) in July 2019, and hence, people who live below $ 5.5 daily income per person are poor based on GPL relevant to UMIC, according to Nanayakkara. 

Sri Lanka’s per capita GNI declined to $ 4,010 in 2019. As it was lower than the revised July 2020 UMIC classification ($ 4,046 - $ 12,535), Sri Lanka quickly slipped back to the Lower Middle-Income Country (LMIC) status ($ 1,036 - $ 4,045) along with Algeria and Sudan, as rightly predicted by Nanayakkara.  The applicable GPL for LMIC is $ 3.20. 

In terms of the GPL of $ 5.5, which is applicable for UMIC, Sri Lanka’s headcount poverty index for 2019 is as much as 40.4%, according to Nanayakkara. This can still be considered as the current poverty position of Sri Lanka, as her per capita GNI is still very close to the lower end of per capita GNI of UMIC, though she is now in LMIC category. 

Thus, the actual number of people living below the poverty line in Sri Lanka is about 10 times bigger than the mere 4.1% of population, as reflected in official statistics. 

Export-led growth for poverty reduction

It is essential to accelerate the rate of growth of Gross Domestic Product (GDP) to overcome poverty. The main ingredient for growth acceleration is foreign trade expansion which enables developing countries to gain market access, economies of scale, capital inflows, technology infusion, productivity improvements and efficiency. 

Open trade has been increasingly recognised as the key driver of employment creation and poverty reduction across the world in recent decades. Exports are critically important for economic growth, particularly for developing countries where domestic markets are small. Exports allow domestic producers to access international markets, and thereby to benefit from economies of scale. 

The world-wide evidence proves that those countries that achieved high export growth are the ones that enjoy high GDP growth and extensive poverty reduction. 

Sri Lanka’s backward technology and innovation

The formidable challenge currently faced by Sri Lanka is to raise her export growth at a rapid pace to achieve high GDP growth so as to reduce poverty. 

The country’s export sector, which is limited to a few low-tech products particularly apparels, has failed to graduate to high-tech and high value-added exports such as electronics and bio-technology products, unlike East Asian countries. This was due to the country’s backwardness in technology and innovation. 

In this regard, Foreign Direct Investment (FDI) can play a major role in fostering export growth by way of facilitating foreign capital inflows, technology infusion and foreign market access.

Trade opening and FDI inflows are found to be the major driving force behind the success stories of East Asian economies. More recent examples are India, China, Vietnam and Bangladesh. Outward-oriented economic strategies adopted in these countries, much later than Sri Lanka, led to foster export-led growth enabling millions of people to come out of poverty. 

Bangladesh: from a “basket case” to an economic powerhouse

Bangladesh is a good example to illustrate how prudent economic policies can turn a poor country, which was once branded as a “basket case”, into fastest growing economy in the Asian-Pacific region. It has become the new economic leader in South Asia with annual GDP growth rate over 6% in recent years, which was driven by the three star-performers – agriculture, garment exports and worker remittances. 

The key factor that fosters export-led growth in Bangladesh has been the liberal foreign investment regime by means of legal protection for foreign investment, generous fiscal incentives, concessions on machinery imports, unrestricted exit policy and full repatriation of dividends. 

Prudent fiscal management too was achieved in Bangladesh containing budget deficit to 3.5 - 4.0% of GDP. It helped to lessen inflationary pressures and to maintain exchange rate stability so as to facilitate the export drive. 

Export-led growth has enabled Bangladesh to reduce poverty from 40% of the population to 14%. In parallel, there have been substantial improvements in social indicators – infant mortality, maternal mortality, undernourishment, school education and adult literacy

Phases of foreign trade regimes

Sri Lanka has oscillated between inward-looking and outward-looking trade policies from time to time since Independence, and therefore, failed to sustain steady export-led growth path so as to bring down poverty levels. 

Perhaps, such policy changes can be conceptualised by using the theoretical framework developed by the US National Bureau of Economic Research (NBER) in its series of studies on trade liberalisation under the direction of Anne Krueger and Jagdish Bhagwati in 1978. They divided a country’s liberalisation process into five phases from trade controls to liberalisation, as shown in the Table.

The NBER studies, drawn from the experiences from different trade regimes in a number of countries including India, Ghana, the Philippines, South Korea and Chile provided ample evidence on the benefits of trade liberalisation.

Sri Lanka’s trade liberalisation under stress

In 1977, Sri Lanka moved from Phase II (NBER classification) of stringent trade and exchange control controls to Phase III marking the initial stages of trade and exchange liberalisation. The liberalisation process had been intensified since then.

In 1994, the Sri Lankan Government accepted the obligations under Article VIII of the Articles of Agreement of the International Monetary Fund (IMF). Accordingly, all restrictions on current account transactions of the balance of payments (BOP) were removed and the Sri Lankan Rupee was allowed to be freely convertible for such transactions. This shift to Phase V (NBER classification) was a major step towards trade liberalisation. 

However, the momentum of liberalisation was short-lived as various types of controls had to be imposed frequently due to the ethnic conflict, balance of payments difficulties, macroeconomic instability and external trade shocks. Thus, the country reverts back to Phases I and II from time to time.

Recent import controls

The country’s BOP situation has worsened since last year due to the COVID-19 pandemic which has adversely affected the export and tourism sectors. The external payments problems have been compounded by foreign debt commitments which amount to $ 6 billion this year. The rise in global market prices of crude oil and other commodities has further pressurised the BOP situation. The likely decline in worker remittances will further enhance the BOP deficit. 

In the backdrop of BOP difficulties, the Government has imposed import controls on a number of “non-essential” goods since last year. These include motor vehicles and various other consumer durables.

These import controls have adverse implications for economic activity, GDP growth and poverty reduction. 

Debt sustainability risks ignored through swaps  

The Government was able to secure $ 1.5 billion swap from the People’s Bank of China last week to meet immediate BOP needs. It is reported that the Government is negotiating with India to obtain another $1.1 billion under swap facility, debt freezing arrangement and development aid.

These swap facilities are temporary solutions to overcome BOP difficulties, and hence, deeper policy adjustments are essential to address the disarrays in macroeconomic fundamentals, particularly debt sustainability risks.   

Keeping IMF at distance

Overwhelmed by the Chinese swap, State Minister Ajith Nivard Cabraal claims that the Government can manage without IMF assistance. In fact, the challenge is to resolve the macroeconomic imbalances, rather than stubbornly refusing to go to IMF. 

Malaysia, which had strong macroeconomic fundamentals during the Asian financial crisis, could afford to refuse bailout from IMF. 

Sri Lanka’s case is totally different with her high budget deficit, unsustainable debt commitments, balance of payments difficulties, slow economic growth and more than anything else, acute poverty. 

It is ideal that if these deep-rooted problems can be resolved by ourselves without seeking anybody’s assistance, leaving aside the IMF.

IMF’s conditionality requires correction of macroeconomic fundamentals with stipulated deadlines. We ourselves can make these corrections without obliging to IMF. It is not happening that way, and therefore, swaps which do not impose any corrective measures, are the easy way out for the authorities to evade the much-needed policy reforms. 

So, the macroeconomic disarrays will remain unresolved forever exerting disastrous effects on the country’s economic growth. As a result, the poor who represent about one half of the population will continue to suffer without having basic human needs met. 

Outward-looking strategy imperative for poverty reduction

The current restrictive trade policy measures, which are based on the inward-looking approach, have been imposed to tackle the BOP difficulties. However, they are detrimental to export-led growth and poverty reduction.  

Hence, a cohesive export-led growth policy framework is essential to address the socioeconomic problems faced by nearly 50% of the population living below the poverty line. Poverty reduction, which is almost ignored in the current economic policy formulation, should be an explicit target of any future growth strategy. 

(Prof. Sirimevan Colombage is Emeritus Professor in Economics at the Open University of Sri Lanka and Senior Visiting Fellow of the Advocata Institute. He is a former Director of Statistics of the Central Bank of Sri Lanka, and reachable through sscol@ou.ac.lk)

Sri Lanka needs IMF even if it doesn’t want it

Originally appeared on The Morning

By Dhananath Fernando

With the visit of US Secretary of State Mike Pompeo, Sri Lanka’s national discourse shifted from the 20th Amendment to foreign relations. State Secretary Pompeo’s visit grabbed national attention for many reasons; one main reason being economic and diplomatic tensions between the world’s two largest economies, the US and China.  

Sri Lanka has transitioned through different phases of foreign policy, from the post-independence era to recent times. When the late Lakshman Kadirgamar was the Minister of Foreign Affairs, his main challenge was to stop the financing of the Liberation Tigers of Tamil Eelam (LTTE), while communicating to the international community the ground reality. With the tragic tsunami in 2004, the helping hand we received from our international friends cannot be forgotten. During the last stage of the civil war, we had to again seek assistance in terms of intelligence, supplies, diplomatic support, and military hardware from our neighbours and other economic powers. 

After the war, the next challenge was facing allegations of human rights violations at the United Nations Human Rights Council (UNHRC) and at the same time managing the development of our economy, in a post-war context. Therefore, we had to work tirelessly to regain the Generalised Scheme of Preferences Plus (GSP+) concession and to remove the fish export ban in order to strengthen our economy. 

Unfortunately, after gaining independence and secondly after the end of the war, Sri Lankan rulers have failed to carry out the necessary economic reforms to make our economy competitive. We have made gigantic investments in non-tradable goods by borrowing huge sums of money at high-interest rates on shorter-maturity in foreign currency and lived beyond our means. The investments we have made were not properly evaluated and have hardly generated adequate revenue to settle the loans we have taken. About 42% of the foreign debt portfolio is International Sovereign Bonds (ISBs) and our public finance management has been extremely poor. As a result, we are in a position today where 47% of our revenue has to be paid just to cover the interest of the loans we have taken.

In contrast to this, our overall average post-independence economic growth is about 4.2%, and it was just 2.3% in 2019. This year, it will be an economic contraction, not growth, which means we will be deep in negative territory. This crisis, coupled with the global Covid-19 pandemic, has resulted in our foreign exchange earnings being badly hit. The secondary bond market signals on yields and the rating downgrade by Moody’s has indicated that Sri Lanka’s finances are in a bad state.  

The foreign policy of a country is often connected to the country’s economy and trade. Most of the time, a policy stance has to be arrived at by considering the context of challenges of a country. Today, the importance of a good foreign policy has come to play again, especially in the context of servicing our debt. All the swap agreements and bilateral support are based on our relationship with our neighbours. However, the main questions remain: How do we get the assistance and from whom are we going to get it? 

On the one hand, during the visit by a high-level Chinese delegation led by Chinese Communist Party Political Bureau Member Yang Jiechi, it was reported in the media that we signed a credit facility agreement of $ 500 million and in July, the Reserve Bank of India (RBI) signed a currency swap facility of $ 400 million with the Central Bank of Sri Lanka. 

On the other hand, there is a $ 480 million Millennium Challenge Corporation (MCC) grant with zero interest – free money which is still hanging around the corner, and yet, the Government hasn’t communicated their stance to the donor agencies on whether we are going to take it or not. There were very sensitive political debates during the last presidential election, mainly on the land component of the MCC agreement on the basis of sovereignty and territorial integrity. Things have changed, now that the members of the then ruling party who believed that the MCC was a worthy agreement to sign with no impact on our sovereignty, are now opposing it. Similarly, members who vociferously opposed the agreement when in the opposition, are now turning a blind eye to it, while the Government provides general statements rather than a specific policy stance, such as “we will not sign any agreement that affects territorial integrity”. 

On our debt servicing obligations, we have to pay about $ 4 billion every year for the next three to four years just to roll over our debt. In this context, it is not only about getting money to roll over debt that matters. It has to be about financing through sources whom we could assure are fiscally disciplined and attempt to build investor confidence – this is what matters. Only then will markets take Sri Lanka seriously and we will be able to invest in foreign currency at somewhat lower interest rates. Otherwise, we will be caught up in the vicious cycle of taking more loans to pay the interest at even higher interest rates with a low growth trajectory. 

The question is, what could be the country or agency which ensures financial discipline and could build the confidence of investors worldwide? The only player in town that could do that is the International Monetary Fund (IMF). When a country is on an IMF programme, that respective country has to jointly agree to a programme on bringing the necessary structural reforms to secure the funding. So the respective government has a strings-attached relationship and pressure to perform well.

However, we have to understand that securing an IMF programme is not a thing to be proud of and it’s a signal that we have managed our finances very badly. It’s just a bailout programme. Our policy-makers have to conduct economic reforms in such a way that our economy can perform well, without seeking any help from the IMF. Sri Lanka often boasts that we have honoured all our debt commitments throughout our history. Unfortunately, this clean record is not due to our amazing financial management. We have run to the IMF 16 times so far for bailout programmes whenever we have had a balance of payment crisis and faced the risk of default. In fact, for almost half of Sri Lanka’s post-independence history, Sri Lanka has been under an IMF bailout programme.

The Government has lately maintained that they do not expect to seek IMF assistance and they are confident of managing the situation with the current financing strategies. However, I must highlight that we have to seek IMF assistance fast, without waiting any further, as we have a good story to sell on Covid-19 containment, despite the latest outbreak. The other reason for urgency is that there is a long line of countries waiting to get IMF assistance. The more we delay, the higher the intensity of the pain.

Interestingly, it was reported on The Sunday Morning under the headline “IMF still considering RFI request” that Sri Lanka had applied for the IMF’s Covid-centric Rapid Financing Instrument (RFI) earlier this year but that the application is still under review. The article goes on to say that the IMF had received just over 100 requests from countries seeking RFI support and as of mid-September, about 76 requests had been approved, meaning that Sri Lanka is among approximately 20 or 30 countries that have not been granted RFI support. If this is the case, it is likely that the Government is yet to agree to certain terms of the IMF and therefore, the application is still pending.

Ultimately, whether Sri Lanka has gone to the IMF and not been approved yet or Sri Lanka is not interested in an IMF programme, Sri Lanka needs an IMF programme now to ensure fiscal discipline and regain investor confidence. Going to the IMF often is not the solution, but it is probably the best option left for us to overcome the situation. Only time will tell how good or bad the strategies implemented are. My only hope is that whatever strategy that gets implemented persists for several years, at least. 

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.