Sri Lankan Recovery Strategy after the Power Struggle: IMF Bailout or Local Bail-in?
There is no controversy over the current political mess as a direct byproduct of the current economic crisis. Therefore, as soon as the political mess is sorted out and resolved, the economic mess should be sorted out and resolved on priority basis in order to prevent the recurrence of the political mess again in the near-term.
Despite high-ranking policymakers such as the Treasury and
Central Bank with all public powers well-enacted, people of Sri Lanka are now
aware that they have to rise again from the scratch and are now prepared as
they have no option but to live. As usual, the market mechanism that prevails
across the globe will facilitate the people to face the recovery at fairer
prices than the prices intervened by the policymakers.
Therefore, people or markets will find natural and
competitive solutions to the present economic collapse caused by the policymakers equipped with international know-how in macroeconomic planning and
management. There is no controversy over how the economy collapsed on unreasonably
heavy import dependence funded by the Central Bank’s foreign currency reserve and
exchange rates artificially maintained through the govt. foreign borrowing managed
by the Central Bank without strategic policies to secure a strong and
competitive export sector and domestic sector.
The present Central Bank Governor who managed the failed
economic model at the top for more than a decade has secured his new public
post with a promise to rebuild the economy through tinkering the same model.
Accordingly, as in 16 occasions in the past, the IMF loan program is sold as
the entry point for securing his public post for re-fixing the economy and serving his full term of 6 years. Given
its high hopes, the IMF loan program is known as Sri Lankan bailout package at this stage.
Key Ingredients of the IMF Bailout
Although there is no time frame and the amount of funding involved, the conditions that are to be involved in the bailout are not secret when the IMF’s macroeconomic conceptual background and experiences in IMF programmes implemented so far in Sri Lanka and other countries are considered. As such, following minimum IMF conditions could be expected.
- External debt restructuring programme agreed with creditors. This is essential for the IMF to assess the external debt sustainability of Sri Lanka as part of the programme approval to ensure that the IMF loan is serviced in the future.
The IMF considers unsustainable fiscal operations as the primary
cause for BOP/foreign currency problems and rising inflation through the excessive
demand side of the economy. This is based on their conceptual framework of
macroeconomic balance/imbalance of any country. Therefore, they are not
bothered about the productive resource base and supply side bottlenecks of the
economy.
As such, their next conditions will be to tighten the fiscal policy and monetary policy to cut the demand side of the economy to match the existing supply side. Key conditions in that regard could be as follows.
- Cut the fiscal spending to suit the revenue level. In this regard, a target of budget deficit of 3%-4% of GDP will be imposed. Therefore, while cutting the govt. spending, tax revenue targets through increased tax rates will be imposed. Accordingly, govt. income and expenditure have to be restructured sector-wise to remove subsidies and unproductive spending while tax administration has to be restructured in line with income generation of the economy.
- Commercialize state enterprises to operate competitively for profit in order to not be a burden to the fiscal policy. In this regard, restructuring of large loss-making enterprises such as CPC, CEB, CWE and Sri Lankan Airline will be crucial, given the possible protests by some social groups.
- Tighten the monetary policy further to reduce the demand side pressure that has caused protracted BOP deficits through increased govt. spending and imports. This may require further interest rates hikes and stoppage of money printing for funding the govt. through the direct purchase of Treasury bills.
- Free the exchange rates to be determined in the market while administrative restrictions imposed on international trade such as import controls and payments controls should be removed.
- Make the Central bank independent as in the case of western market-based economies. Most probably, the IMF may require the govt. to pass legislation for this and informal agreement to ensure that that the present Governor be in the office for the full term of 6 years as he constantly takes up it aggressively in the western media.
- Quarterly targets on the purchase of foreign currency by the Central Bank from the market. The purchase of foreign currency from currency swaps, mandatory sale of export proceeds and foreign aid will be excluded in such targets.
- Release of the loan in installments over a period of at least one year upon the follow up of the progress on the time-bound conditions.
Why IMF bailout alone will not recover the economy?
Sri Lanka has got 16 IMF programmes so far with similar
monetary and fiscal conditions to prevent acute BOP problems under same IMF
conceptual framework. The two largest programmes of SDR 2,724 mn secured in
2009 and 2016 have been managed under the direct supervision of the present Central Bank Governor being the then Deputy Governor on the subject.
However, the current crisis is a piece of real evidence that such IMF programmes are nto practical solutions to the macroeconomic restructuring and management required for the Sri Lankan economy at this stage. Further, there is no evidence from many emerging market economies which have sustained an economic governance system without acute BOP problems. Many economies which were under extensive IMF programmes in the recent past now confront currency/BOP crises, for example, Argentina, Pakistan and Ghana.
- Argentina has gone 22 times to the IMF for a total loan amount of SDR 81,917 mn. However, it has a long history of default and twice since 2001 where new IMF programmes are offered to prevent defaults. The latest programme has been for SDR 40,714 mn for June 2019-June 2021. However, the IMF had to approve another programme of SDR 31,914 mn in March 2022 and immediately released SDR 7,000 mn. to prevent a default, despite exceptionally high risks (with credit rating of default) to the programme. further, Argentina has rescheduled over US$ 100 bn of repayments to avoid the default in this year so far and finds it difficult to repay US$ 17.8 bn due this year under the IMF 2018 programme.
- Pakistan has gone 22 times to the IMF with a total loan amount of SDR 23,656 mn and got into the present currency crisis while being under SDR 4,268 mn programme agreed in July 2019. Ghana has gone to the IMF for 16 occasions for a total amount of SDR 3,024.8 mn. with the latest being SDR 664 mn in April 2015.
- Ghana govt. (like Sri Lanka) has made a late U turn decision on July 01 on the orders of the President to approach the IMF whereas civil organizations call for debt cancelation in the IMF bailout rather than debt restructuring for the benefit of private creditors paid from the IMF programme as in the recent past.
- In addition, both Pakistan and Ghana received SDR 1,015.5 mn and 738 mn, respectively, under the IMF Pandemic connected Rapid Financing Instrument and Rapid Credit Facility in April 2020. However, the currency crisis has hit both countries causing political and economic instability.
Sri Lanka is now not economically and socially in a position to implement above mentioned IMF conditions. For example, cutting down the fiscal spending and raising taxes based on the IMF concept will not be practical as the household and business sectors require the fiscal stimuli to recover at this stage as the market system has been paralyzed by the crisis and bureaucratic controls such as import controls and monetary tightening.
The monetary policy tightening since mid-August 2021 to
control inflation has already failed as it has raised govt. borrowing cost by
about 26% so far to around 30% while inflation has been galloping. An interest
rate structure of above 30% will no way help a country to recover from such an
acute economic crisis. The central bank independence and stoppage of money
printing for govt. funding will no doubt destabilize the country governance
system and the economy as the credit and financial flow across the economy will
be crippled.
Further, the present rate of inflation calculated on a fixed consumer basket is not reflective of the actual cost of living as households have now cut the basket and moved to various cheaper substitutes to manage the cost of living within the income streams. Meanwhile, present galloping inflation is not a demand pulled inflation, but a cost pushed and supply driven arising from the acute shortage of foreign currency and excessive depreciation of the exchange rate due to the failure of the Central Bank’s monetary policy.
Therefore,
the monetary policy to control inflation would be misguided as the Central Bank
is not aware of routes and extent of its transmission while the resulting
increase in the cost of funds will push the inflation further up.
Further, the independence given to few unelected individuals
of the Central Bank to control the country’s monetary system in a manner of
advanced market economies such as the US and Europe will be a huge threat to the
political governance system of Sri Lanka. Even at present, the prime source of
present crisis is broadly the monetary policy carried out by the Central Bank
in violation of the macroeconomic principles and rules prescribed in the
Monetary Law.
Some think that the IMF package will be the
international license to raise foreign finance from private and official
sources. This was the position in the global financial system prior to the Pandemic in 2020. However, in view of the subsequent developments, i.e., current bankruptcy of Sri Lankan economy, many
countries threatened with bankruptcy and global recession expected from the
current fast and coordinated tightening of monetary policies in the developed
world, the IMF package will not help such foreign finance inflows to Sri Lanka at this
stage, except the help provided to keep the high ranking public positions of certain
individuals in the Treasury and Central Bank.
Even if Sri Lanka is to get US$ 2-3 bn from the IMF, it will take
at least another 3-6 months due to debt restructuring trap where Sri Lanka has no luxury of waiting so long and
managing the crisis with this US$ 2-3 bn. alone. In this context, the promise given by the Central Bank Governor to recover the economy from the crisis within 5 months of the political stability with the expectation of the IMF bailout package is a willful act of misleading the public.
Given the current trend of the global economy with 4-decade
high inflationary pressures and disruptions in global supply chains caused by
the Pandemic and the war in Ukraine, this IMF model is not suitable even for
developed market economies.
In general, the IMF reform agenda attached to the programme is intended to reduce the size of the government in the economy so that private sector markets take the lead role. However, as economies of developing countries heavily depend on the national budget whereas the private sector and markets are not strong enough to drive the economies, the envisaged reduction in the government as in the case of advanced market economies has not been feasible, despite the long existence of the IMF agenda.
Therefore, it is necessary that relevant Sri Lankan authorities tell the truth to the public that the IMF is not the savior of Sri Lanka from the current catastrophic crisis.
Local Bail-in Package - The Alternative to the IMF Bailout
Therefore, political leaders who are responsible to the public must ensure that the new government implement a domestic economic model to generate a foreign currency surplus on the strength of the real sector resources and businesses in the economy in next 6-12 months without letting the economy to a further collapse by just waiting and giving hopes for an IMF bailout package with US$ 2-3 bn.
It is now clear that Sri Lanka would not have escaped the crisis and default even if it had received an IMF programme in 2020 or 2021, given the huge risks involved in the economy's funding model and global supply chain disruptions caused by the Pandemic.
The proposed domestic model is a bail-in package which means a re-fix of the economy through domestic resources assisted by a targeted fiscal
and monetary policy stimulus package. The policy package is
necessary to facilitate economic activities such as production, trade,
consumption, investment and savings as the markets are largely controlled by numerous
bureaucratic red tapes.
Accordingly, the policy package should target household basic
consumption, domestic agriculture production and productivity, export and
import substitution industries, foreign employment and inward remittances and foreign
income sources within the country such as tourism and foreign investment inflow.
For this purpose, it is necessary that debt management and govt.
foreign currency operations including transactions with the IMF and World Bank are
separated from the Central Bank and entrusted with the government as the
Central Bank has miserably failed on the duties leading to this historic economic
crisis. This will facilitate the Central Bank with more professional time and resources to conduct the monetary policy with a wider credit distribution strategy to suit the
real economy in line with the government's socio-economic targets.
The IMF bailout is a different form of bail-in programme to improve the BOP position by restricting the demand side of the economy through tightening the fiscal and monetary operations. However, the local bail-in is a supply side restructuring programme focusing on the BOP surplus while restoring the demand and living standards of the targeted households. Therefore, the IMF bailout is quite short-term to target cashflows to avoid BOP/foreign currency problems whereas the proposed bail-in is a long-term real sector programme to generate a sustainable BOP surplus.
Therefore, the IMF should be willing to provide a loan to be a partner in the local bail-in programme of more people friendly as the country authorities have a long-term plan. In contrast, in the case of IMF programmes, the authorities just make a request and wait for meeting after meeting with the IMF to provide them with information for the IMF to prepare a plan in their macroeconomic model.
Therefore, if the IMF is not supportive for the local bail-in programme, the
support of friendly governments could be arranged easily as the authorities have a plan. However, as IMF agents in the country are
trying to align such external support also to the IMF bailout, the government must be
able to separate it as it is the government that is responsible for the
underlying debt obligations.
Recommendation
However, the challenge here is to find a set of public officials to draft the programme speedily to get the Parliamentary approval for the underlying national budget. This can be done only by a new set of officials who are not the agents of the IMF and international financial institutions but respect markets.
Therefore, it is necessary that those public officials who
were behind the failed-IMF-based internationally financed economic model are
removed immediately. Otherwise, those officials will ensure that the new government
also will fail at its infancy in the current political environment.
The present political stage is a historic lesson to the next President of the country as he becomes singularly responsible for all public duties of the government, irrespective of whether the process involved in policymaking through public institutions and officials is democratic or autocratic.
Therefore, the new President runs an extraordinary risk of either running away from the country or going behind the bars in the event of the failure of the new govt. to recover the economy from the current crisis as all lapses and failures will be passed on to the President as just happened to the former President. This requires the new President to stop playing politics on the economy and lay a new foundation for the long term development of the real sector and living standards.
Therefore, what urgently needed is to get the public institutional system expeditiously to drive the public out of the economic mess rather than wasting the time for going after the Constitutional amendments and IMF as none of them is responsible for the current crisis.
The macroeconomic management
system or the recovery from the current crisis is not a rocket science or any
economic theory, but it is a system how the relevant public officials
understand blockages of markets with real time data and implement policy
solutions to clean up the blockages so that supply chain bottlenecks get eased gradually.
(This article is released in the interest of participating in the professional dialogue to find out solutions to enormous economic difficulties presently confronted by the general public consequent to the global Corona pandemic and subsequent disruptions and shocks.)
P Samarasiri
Former Deputy Governor, Central Bank of Sri Lanka
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