The granting of the IMF stand-by facility has once again brought out the lack of understanding on the reasons for the IMF loan and the rationale for conditions on which the loan is given.
 This lack of understanding is compounded by those who know the principles of economics construing these to paint a misleading picture. Their distortions are often clothed with excellent eloquence in language that makes their arguments very persuasive. Persons who mislead or misinform the populace are of diverse political shades and ideologies.
The debate becomes one of for and against the IMF or for and against the government. Whatever would have been the outcome of the loan negotiations and whatever the conditions on which the facility was obtained, those opposing the government will find reasons to condemn it. Economics is thrown out of the window for ideology, politics and party gains. Official statements in the last few months have hardly been enlightening.
In the first instance there is a lack of understanding on how the economic crisis developed. The crisis was created by three factors, not one or two. The three causes responsible for the crisis were the war expenditure, wasteful public expenditure and external shocks. There is a tendency to blame the high international prices experienced in 2008 and the global recession rather than the internal causes. Of the external shocks, the booming prices of commodities in the world market were more detrimental than the recession. The sharp prices of import commodities resulted in the country sustaining a massive trade deficit of over US$ 3 billion that eroded the country’s foreign exchange reserves. For some time the government replenished these by foreign commercial borrowing. When the loans were repaid with interest costs the reserves depleted again. If not for the large inflow of private remittances, mainly worker remittances, the problem would have been massive and would have precipitated a crisis much earlier and more far-reaching.
For some time the economy has been beleaguered by war, weighed down by debt and crippled by waste. The war expenditure over three decades created a huge public debt and a massive servicing cost. Consequently the government revenue barely covered debt servicing costs. For instance last year 90 percent of revenue went for debt servicing. In one year the public debt exceeded the GDP of that year. In this situation the government has to borrow again for expenses. The fiscal deficit has averaged more than 7 percent of GDP in recent years. Consequently the debt increases and the burden builds up.
The problem was not created last year or the year before. This is the backdrop as to why the containment of the fiscal deficit is important and why the IMF requires it to be pruned. Irrespective of the IMF conditions, if we continue to increase the fiscal deficit we cannot get out of the mess. The reduction of the debt entails cutting expenditure. The government has to find the means of reducing expenditure in order to meet the targets set by the IMF of a fiscal deficit of 7 percent this year going down to 5 percent in 2011.
Now that the war is over defence expenditure can be brought down. As the President has rightly said we must cut waste. That is precisely what is needed: cut unproductive expenditure. We must also tighten our belts; the people as well as the government. The detailed manner of how government expenditure should be reduced has not been specified. These have been discussed many times earlier. They include a leaner and more efficient public service, reduction in defence expenditure, a reduction in losses of some of the giant public enterprises and waste in government expenditure.
The IMF conditions do not envisage a cut in health, education and welfare expenditure. The IMF has quite rightly said that expenditure on health, education and relief for the poor and vulnerable sections of the population must continue. This is a change from IMF policies of the1970s and 1980s that were brought about by severe criticisms that the IMF policies were responsible for increasing world poverty. “Structural Adjustment with a Human Face” espoused by UNICEF has been gradually accepted.
Sri Lanka has had a tradition of welfare policies. These have been both praised and condemned. Some have praised these policies owing to the country’s achievement of higher human development indicators than countries of the same level of per capita income. These economists have praised Sri Lanka for achieving the goals of economic growth before achieving high incomes. Others have been critical arguing that there was a trade off between welfare and economic growth and argued that the country could have achieved a higher rate of growth had it spent less than it did on welfare. In the current context both health and education are underfunded. Hospitals are overcrowded, drugs are in short supply and many poor patients cannot get the needed treatment for serious illnesses. Therefore these are areas where far from curtailment of expenditure, it has to be increased.
The IMF facility is a relief that gives the country a period of time when it could get its house in order. The facility is one that would give the country less anxiety over its external financial position and enable it to continue the development of the country. The loan is given in tranches over 20 months at a nominal interest rate of 0.5 percent and a small service charge. The repayment period is four to five years. The first instalment of US$ 322 million has already been given and the country’s reserve position strengthened this week to around US$ 2.2 billion. There are conditions attached to the loan and these have to be fulfilled in order to obtain the remaining tranches.
There would be quarterly assessments of performance on the basis of which the other instalments of the loan would be given. At first the IMF would look to evidence of the government’s resolve to follow sound financial principles to achieve economic stabilization. Then the stated and agreed objectives have to be achieved. Therein lies the crunch.
One of the important conditions is to reduce the fiscal deficit, the root of most of the country’s economic ills. Last year’s fiscal deficit was nearly 8 percent of GDP. The government has agreed to reduce the deficit to 7 percent of GDP this year. This is a difficult undertaking in the context of the current situation in public finances. The first half of the year’s fiscal performance was heading to a fiscal deficit of around 10 percent. There have been significant drops in revenue collection this year, while public expenditure has increased. Analysts expected the deficit to rise to nearly 10 percent this year with several supplementary estimates and a drop in revenues.
Whether the trend in the collection of revenues could be stemmed and revenue collection increased is debatable. The IMF has laid down some conditions in this respect that includes the doing away with tax exemptions, improving tax collection and reducing tax avoidance. These are standard prescriptions. Whether these could achieve the needed increased tax revenue is arguable. There would have to be reductions in expenditure on the lines suggested earlier.
The conditions imposed by IMF are difficult to achieve. Yet they are conditions that must be achieved to ensure economic stability that is in turn the precondition for rapid economic growth. If we do not bring down the fiscal deficit the economy would hit a crisis not only in the balance of payments and foreign reserves but also manifest itself in higher unemployment and poverty. If we do not bite the bitter pill now, deep surgery is inevitable. |
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