Economic experts have called for the immediate activation of the proposed economic assistance package from India, insisting that an International Monetary Fund (IMF) bailout is the only viable next step, despite the Government continuing to remain divided on its policy on seeking IMF assistance.
Portraying the economy as a drowning individual, Senior Economist and Former Central Bank of Sri Lanka (CBSL) Deputy Governor Dr. W.A. Wijewardena said that India’s economic support, which comes at the potential cost of sharing the Trincomalee Oil Tank Farms, was vital for the country’s survival.
He explained the present economic situation through an analogy: “The water is up to our nose and we are about to drown, so somebody has to save us from drowning. It is too late to go to the IMF, because we will have drowned by the time their assistance arrives in about six months. That is why an immediate rescue package from India is necessary, since we know how we can survive the upcoming three weeks.
“According to reports, India has come to an agreement with Finance Minister Basil Rajapaksa to give us a line of credit to cover the import of medicines, food, and fuel, but that is combined with the modernisation of the unused oil tank farms in Trincomalee. It comes as a package. So this credit line must be used immediately, but it means that these products must be imported from India and not any other country,” Wijewardena noted.
Dispelling IMF myths
He asserted that seeking the help of the IMF was the only available avenue for Sri Lanka as time had run out, stressing that: “The next step is for someone to pull us out of the water. For this, the only option is the IMF.”
He then dispelled allegations and misconceptions arising from certain quarters of the Government, which claimed that obtaining financial assistance from the IMF would result in Sri Lanka submitting to “conditions” of the fund. He pointed out that it would be the Sri Lankan Government itself which would propose the steps that would be taken to revamp and stabilise the economy.
He explained that: “The Sri Lankan people, including Parliamentarians, must first be educated on the current economic conditions and how IMF loans operate, before introducing any reform programme in Sri Lanka. Otherwise, it will be a failure. We see some MPs making bold statements saying that they don’t want to go to the IMF and accede to IMF conditions; I think they have to be educated. It is not the IMF which imposes conditions: it is we who suggest to the IMF the conditions that we will implement ourselves.
“For instance, when you go to the bank to borrow money, the bank doesn’t impose conditions. You go to the bank with the project report saying that you are doing this kind of reform and improvement, and if it’s acceptable to the bank, then they will finance it. Similarly, with the IMF, the Ministry of Finance and the CBSL Governor have to submit a joint letter of intent to the IMF suggesting that we would be introducing the following reform programmes in the country, if we were to receive the IMF loan,” he said.
The former Deputy Governor then noted that there was international experience and precedence to show that a country trying to fix the exchange rate artificially without sufficient foreign reserves would experience failure.
He said: “Regarding the exchange rate, we will have to see how long the Central Bank will be able to hold on to the fixed rate. International experience has shown whenever a Central Bank has tried to keep it fixed at that level, the Central Bank has failed. It happened with Myanmar and Thailand, and it is happening now with Lebanon and Turkey. Without sufficient foreign exchange reserves in hand, you cannot fix the dollar rate at the rate you want to fix it.”
Potential IMF conditions and their impact
Economist and University of Colombo Lecturer Umesh Moramudali elaborated on possible “conditions” that Sri Lanka may have to implement as a means of procuring the IMF loan.
Moramudali pointed out that floating the rupee was likely a requirement.
He noted: “One condition is that they would ask the recipient country to devalue the currency, which is to have a floating exchange rate system where the market determines the exchange rate. Currently the Government is holding the exchange rate at an artificial rate; this has also contributed to the dollar shortage. This is one condition the IMF is very likely to ask for – to let it float without defending it – which means the exchange rate is going to go up. The idea behind this is that they want the economy to stabilise on its own.
“How this helps, in their view, is when you allow the exchange rate to float, it drives up the exchange costs, resulting in increased import costs. When prices of imported items go up, people are compelled to adjust and bring down their demand. On the other hand, when the exchange rate increases, that also encourages people to engage in more export-oriented activities, because if you earn in dollars, a higher exchange rate means higher earnings. Essentially, through this condition more people will get into exports and bring in foreign currency while imports are reduced, curbing foreign exchange outflows,” Moramudali explained.
Fiscal policy changes would also be needed to demonstrate that Sri Lanka could increase revenue through the introduction of taxes, and possibly even revert back to the tax system introduced by the former Yahapalanaya Government.
“That will certainly be one condition, and this must happen regardless, because we have a very low tax revenue which would mean we would have to borrow continuously. One concern in this regard is that we don’t know what will happen with the VAT. This is because we decreased the rate from 15% to 8% and we increased the threshold, which means fewer businesses are liable to pay VAT. This contributed significantly to a shortfall of Government revenue, without bringing about a price reduction, meaning the objective of the VAT reduction wasn’t achieved,” Moramudali opined.
Reduction of expenditure would also be needed in tandem with an increase in revenue, which could further see subsidised services such as water, electricity, and fuel undergoing a price hike in order to reduce costs for those state-owned institutions.
“There is an IMF policy that state-owned enterprises shouldn’t be making losses, so they don’t advocate for subsidised water or electricity, which our Government provides. The consumer pays lower for a unit of electricity than its actual cost, and the remainder is borne by the Ceylon Electricity Board (CEB) at a loss. This is something the IMF would say to abolish because such subsidies are enjoyed by both the rich and the poor consumer. Instead, there should be targeted subsidies, since these losses are borne by the state and then subsequently passed down to the consumer one way or the other. Water and fuel subsidising also falls in this category,” Moramudali explained.
A key factor in Sri Lanka’s current economic disaster is the bunching up of massive foreign debt over the coming years. According to Moramudali, addressing this issue would significantly help Sri Lanka out of the current financial quagmire.
He said: “There’s a possibility that we may have to go for debt restructuring. Sri Lanka has not done debt restructuring before, so we don’t know what type of restructuring that might happen. For now it appears to be the best way out of this current crisis. The IMF will give us a short-term loan to stabilise the balance of payment issues, but since this won’t be enough to sort out the crisis, we’ll have to restructure the debt.”
While explaining the possible methods of debt restructuring, Moramudali noted that Sri Lanka and its citizens would inevitably face a tough economic period before things could recover.
He noted that debt restructuring could happen in different ways. One option is for the Government to restructure the sovereign bonds and inform the creditors that they would be paying the accumulated interest at the end of the two years. The other option would be for the Government to decide to pay the interest instead of the capital initially, and then pay the capital in four or five years.
He explained: “The idea is to postpone repaying the loans through an agreement with the creditors. Creditors in this instance will mostly be the sovereign bonds, because I don’t think it’s possible to restructure the World Bank or Asian Development Bank debts.”
IMF: Solutions for present economic crisis
University of Colombo Department of Economics Professor Chandana Aluthge spoke of the advantages of going to the IMF.
“Going to the IMF will boost the country’s credibility since we will receive IMF backing, and this will increase the confidence level of potential investors and those who have given loans to Sri Lanka. The second advantage is that IMF Loans are soft loans where the interest rates are nearly 0% with grace periods to commence the repayment, while the loan itself is long-term. However, all this depends on how the Government behaves during the loan agreement,” he said.
Aluthge also agreed that going to the IMF was the best option for Sri Lanka, since it would not be possible to obtain credit from the open market given the situation in the country. He further noted that around $ 5 billion would be needed as a loan considering the upcoming debt repayments.
“Since Sri Lanka had a weak foreign policy in the last few years, we do not have friendly countries that would bail us out. Therefore, the IMF is the best option. Deciding how much to borrow from the IMF depends on the immediate loan repayment. We have to repay about $ 2 billion next year, so I think it would be best to increase reserves up to $ 5 billion if possible as a good starting point,” he shared.
Speaking of how Sri Lanka needed to move forward in terms of bringing foreign exchange, Professor Aluthge said the economy should be revamped and the export sector expanded as the current traditional exports were either not sufficient or were being outmatched through market competition.
“In the near future and in the mid-term, Sri Lanka needs to overhaul the economy to attract more foreign exchange to the country. Our priority should be exports. We are still relying on tea, rubber, garments, and labour exports despite many issues; we’re sending labour to other countries but it is not easy to send money back to Sri Lanka. Therefore, user-friendly systems need to be implemented. In the garment industry, there are other countries supplying large portions of the world trade. Sri Lanka is still only supplying about 2% of the global demand for garments, but it is still one of the largest foreign exchange earners in the country. We will have to implement new strategies,” he warned.
He charged that the notion that Sri Lanka could be self-sufficient was a mistake and that history proved this, pointing out that even the largest of countries depend on exports to thrive.
“We also need to drop the idea of self-sufficiency, since it is not realistic. Sri Lanka is a very tiny country with a very small market, so self-sufficiency will not work. We saw this happen in the past in the 1970s. Even if you take China, which is a very large country, their economy depends very much on exports. If you look at smaller countries like Bangladesh, Singapore, and Korea, their world trade contribution to their gross domestic product (GDP) is very high. That is how they have developed their countries. They have a steady flow of foreign exchange that strengthens their economies,” he ventured.
Prof. Aluthge recommended that Sri Lanka move into high-tech industries for exports.
“We need to move into areas where export income is steady. Therefore, we have to identify those types of goods and services. New markets that have great potential are high-tech industries. We have no future otherwise. We’ll have to attract investors and the Government should support local investors who would like to take the risk. The Export Development Board should look for new markets and help investors,” he elaborated.
Government rejects possible IMF assistance
Despite various expert recommendations positing that the IMF was the lifeline the Sri Lankan economy needed to grab onto, the Finance Ministry remained adamant that it had no expectation of seeking IMF assistance.
“We have not spoken about procuring any loans from the IMF. Some are saying that $ 6 billion is needed by January. The IMF has never given $ 6 billion throughout its history. We haven’t spoken to the IMF, and nor do we have any intentions of going to the IMF for any loan,” Treasury Secretary S.R. Attygalle said, adding that the recent IMF visit was routine and no loan discussions had taken place.
“The IMF did not arrive on this occasion to discuss a loan. They will now give their report following their visit and issue a communique. That is all. We are not proposing anything,” he asserted.
He then said that the Indian credit line to import food, medicines, fuel and other essential items would be available by January.
“The Indian loan will come through. There are things that need to be arranged both here and in India for the credit line to be implemented. But it will most likely come through by January,” Attygalle said.
