Columns

The New Year that has just dawned should have been a time of hope and expectations for the country. Unfortunately there are little expectations of economic prosperity. The economy is in crisis and hard times are inevitable as corrective measures are needed to stabilise the economy and place it on an even keel. In the words of Prime Minister Ranil Wickremesinghe, realistic assessment of the economic situation, we need to take the “bitter pill”.

In contrast, 2015 was heralded with much hope owing to the propitious political change that ushered in a democratic polity and society. The rule of law, law and order, freedom of expression and other democratic values were regained with the regime change in 2015. However, the lack of proper management of the economy during 2015 aggravated the fundamental weaknesses of the economic legacy the country inherited weakening the economy further to fragile proportions.

Economic weaknesses
The large fiscal deficit, widening trade deficit, a large balance of payments deficit and the high foreign debt servicing burden are not conducive to economic stability and growth. These serious fundamental macroeconomic weaknesses do not augur well for the country’s economic prospects in 2016.

Fiscal and monetary policies must reduce aggregate demand to contain the trade deficit, improve the balance of payments and strengthen the country’s external reserves. The foremost task of the government is fiscal consolidation that is essential to stabilise the economy and correct the other imbalances.

Challenging tasks
These are challenging tasks in a political milieu that is not conducive to rational economic policy formulation and effective implementation. However inability to address these problems could have very serious repercussions on the economy. Any further deterioration in the fiscal and external balance would impact on the livelihoods of the people and have adverse political consequences eventually. The current economic crisis requires bold decision making to prevent the economy from deteriorating further. Rational economic policies that are politically unpopular are imperative to achieve economic stability.

Multiple crises
The country is in an economic crisis. All the fundamental macroeconomic indicators have reached crisis proportions. The fiscal deficit is increasing; the current account in the balance of payments is widening owing to the poor performance of exports, on the one hand, and increased expenditure on imports on the other. Consequently the balance of payments is likely to be in deficit by over US$ 2 billion. Foreign reserves are at a low level inadequate to service the country’s foreign debt obligations. This is indeed a crisis situation requiring immediate remedial measures.

Fiscal deficit
The fiscal deficit that was expected to be brought down is likely to increase. Even the proposed budget for 2016 did not attempt to achieve a semblance of fiscal consolidation. The subsequent amendments to the budget have all been in the direction of increasing the deficit. The amended revenue proposals would reduce government revenue, while several other amendments would increase government expenditure.

The revised budget is likely to result in a fiscal deficit of 7 per cent of GDP or higher. This is a situation that would also weaken the external finances, as well as be inflationary. Therefore fresh revenue measures to reduce the deficit are essential as expenditure reductions are difficult to achieve. If expenditure cuts are effected they would fall on the capital expenditures for development. Much needed investment on education and health is likely to be the victims of this lack of fiscal space.

Balance of payments
The trade deficit that reached US$ 7 billion in the first ten months of last year is likely to reach around US$ 8.5 billion in 2015. This high current account deficit is likely to result in a balance of payments deficit of around US$ 2 billion, despite workers remittances, tourist earnings and services incomes being substantial. Meanwhile the gross foreign reserves of US$ 7.3 billion at the end of last November are considered inadequate to meet the external financing needs and foreign debt servicing costs that are estimated at about US$ 4.5 billion in the coming months.

Way out
This balance of payments crisis situation requires immediate remedial measures. The most sensible recourse is to seek a facility from the IMF to resolve the balance of payments crisis. There are several reasons why this is the best course for the country.

First, the interest cost of such borrowing would be less than from international commercial borrowing and the repayment schedule would be less burdensome than much shorter and costlier borrowing options from the international capital market. Second, the conditions laid down to ensure fiscal consolidation and strengthen other macroeconomic indicators would be good for the country’s economic management that has been undisciplined and imprudent for several years.

The government would have the excuse of following good financial practices as mandatory conditions imposed by the IMF. Another important advantage is that the IMF facility would improve the country’s risk assessment and induce higher inflows of foreign investment so essential to drive the economy to higher exports, transfer of technology and higher growth.

Criticism
There would of course be fierce criticisms of the government for resorting to the IMF facility and agreeing to its conditions, although they are the best monetary and fiscal options. These criticisms would be by an opposition that does not understand much economics and is primarily concerned with rousing emotions against the government. Their moribund ideas are best ignored in the interests of the economy.

Longer view
A bailing out by the IMF and other multilateral international agencies would provide a breathing space to undertake essential reforms to revitalise the economy. A hard look at the fiscal situation and government finances are essential. The government must find ways and means of enhancing revenue and reducing losses of state enterprises.

Challenging tasks
In 2016 the government is charged with the challenging task of resolving an economic crisis of serious proportions. How it manages it will determine whether the country could go forward or fall into further crises. The weak macro economic fundamentals have to be strengthened by corrective economic policy measures and actions that are politically difficult. Nonetheless, the manifold economic problems require immediate policy actions, however politically unpalatable the solutions are. Inability to take the “bitter pill” may result in a need for deep surgery sooner than later. That would be much more painful and politically catastrophic.