Borrowing from Peter to pay Paul

Originally appeared on The Morning

By Dhananath Fernando

There’s a childhood memory engraved in my mind, of an incident with a fellow schoolmate concerning an act of borrowing. Back then, we borrowed money from each other constantly to eat sweets and junk food and buy video game gadgets. A particular friend of mine had the habit of borrowing a little money every week and settling the same again after a week’s time right on schedule. After a few weeks, I realised he borrowed the same amount of money from another friend as well. 

Like a well-planned roster, he proceeds to settle his debt with the other friend in a week’s time. One day my frequently borrowing friend did not settle my money as he promised. When I confronted him on the matter, he plainly stated that he settled the amount owed to me with the money he borrowed from my other friend and vice versa. At this one instance, the other friend had refused to lend money to my frequently borrowing friend so he was unable to settle with me. 

But what was particularly amusing was what he said after. “What I have been borrowing and settling for the past few weeks is money from the two of you to each other. So to resolve the matter, the two of you must settle with each other because it’s your money. Not mine.” 

Sri Lanka’s debt servicing is a much more complex version of what my classmate did; we settle our creditors by borrowing from someone else. Most sovereign countries do the same. However, this can only be done when someone agrees to give us money. Similar to the incident with my friend, the moment people refuse to lend us money, the cycle starts collapsing. That is exactly what happened to Sri Lanka. As a result, the country has lost its credit rating by international rating agencies and has thereby lost market access. 

The current strategy we follow is requesting lifelines from our bi-lateral partners as a form of assistance. As a result, in just five days, India threw in about $ 1.4 billion worth of credit lines and swaps to secure our fuel, medicine, essential supplies, and debt repayments. 

Initially, China provided us with a swap of 10 billion Yuan as a back-up, which the Central Bank absorbed as reserves according to their data. 

At the same time with some of the bi-lateral partners, our relationship has not been professional. We cancelled the LRT project with Japan, which is our main bilateral creditor as well as the main funder for one of our main multilateral partners, the Asian Development Bank (ADB). To make matters worse, we keep the trade channels such as vehicles and spare parts closed, which is precisely where the bilateral relationships can be strengthened. 

Our mismanagement of bilateral relations is reflected, even with China. Recent events, such as our shortsighted handling of diplomatic relations over the fertiliser issue, with China blacklisting a state bank for not honouring payments, illustrates this issue. 

Economically and geopolitically, we have lost market access for borrowing on one hand, and on the other, we have somewhat tarnished the relationship with our friends at a time when we need their assistance the most. So far, we have been very lucky to still have their continuous support regardless of the setbacks even though the fault is on our end entirely. As a recommendation, the Government should not take the silence of some bilateral partners lightly, but work double-time to restore trust and understanding in business and trade. 

The current strategy of paying our International Sovereign Bonds through bilateral swaps and depending on credit lines for essentials will eventually come at a geopolitical expense. We become more vulnerable with our past track record of working with our bilateral partners. 

In this context, the Central Bank increased policy rates by 50 basis points, a policy move in the right direction. However, this comes – unfortunately – too late to stop the inflationary pressure constantly building, probably due to the faulty use of Modern Monetary Theory, which we have been following for some time now. The policy rate revisions will encourage people to save more money instead of spending more. This will somewhat ease the pressure, but at the same time slow the economy down. But we can’t afford to accelerate the economy with a historic balance of payment crisis which was already exacerbated by a price control on US Dollars (USD) in an attempt to encourage imports and discourage exports. 

Surprisingly, policymakers have not taken any reforms to overcome the situation, believing that debt servicing through borrowed money will solve the problem. Very high hopes have been kept on tourism but the same thing that happened to remittances will happen to tourism when we try to keep the exchange rate very low. We encourage people to keep the USD in grey markets so people will become further reluctant to sell their hard-earned USD to the Central Bank. 

At the same time, we need to understand tourism also increases the consumption of the economy where, with USD inflows, there will be a fair share of USD outflows concurrently. Thus, keeping all our eggs in the basket of tourism would not be advisable at all. If policymakers recall, at the beginning of the pandemic, remittances were at a record high. With mounting debt, our policymakers replied that our solutions remained in our remittances, which today are in decline due to our own policy failures. In this context, there are certain areas for restructuring that policymakers have to consider if they were to come out of the crisis: 

1. Restructuring of our social security net. A market pricing-based digital cash transfer system with better targeting than Samurdhi is recommended to provide poor people the opportunity to keep their noses above the water to navigate through the economic reform period

2. Restructuring and Reforms on the State sector and State-owned enterprises are a must. Listing the debt of State-owned enterprises, privatisations, consolidations and outright sale of some of the assets owned by State-owned enterprises is required for the private sector, including land. Government care has to be limited through a reasonable voluntary retirement scheme

3. Restructuring and Reforming in our Central Bank .The current tools of excessive interventions by the Central Bank on interest rates, exchange rates and every part of monetary policy has to be refined

4. Restructuring and reforming our tax system and tariff system is a must. Currently, our income and corporate tax systems are too complicated and it has to be simplified if policy makers are interested in increasing revenue. The complicated tariff structure has to be simplified with three tariff bands. Bringing down tariffs will also help the Government increase the revenue and boost trade

5. Restructuring and reforming our production structures for it to be aligned with global production and supply chains is vital to increase export revenue. At the same time, a deregulation drive has to be initiated to ensure conducive business environment for locals and foreigners

6. If our debt is unsustainable, we have to consider a restructuring of debt, but with the above-mentioned reforms. Attempting to do a debt restructuring without a solid commitment to reform will worsen the problem and debt restructuring could become a frequent event causing us to lose our credibility and market access if we fail to do the necessary reforms

All these ideas are not new and not a first mention in this column. These have been repeatedly spoken of by countless economic experts. It is simply that the call to action rate is very low. Policymakers whose job is to change policies and get things done. Not to behave like my classmate – paying debts with borrowed money, wiping their hands clean, and shifting the responsibility elsewhere at the last minute.

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.