Veteran economist and respected university don, T.L Gunaruwan (TLG), has raised a very pertinent question: Should we continue the SBA? (Business Times on Sunday, April 25, 2010).
He has taken the reader through the latest developments in the Sri Lanka’s economy and argued that the scary state that prompted the country to seek an IMF facility against its convictions in early 2009 does no longer prevail.
He further argues that IMF money given to a country to simply avert a balance of payments crisis is not available for development purposes and it does not help Sri Lanka to mobilise the massive quantum of resources needed for investment in the North and the East, the country’s most urgent requirement of the day. His position is that ‘the confidence factor’ that the country was able to earn with IMF support could anyway be gained by pursuing appropriate macroeconomic policies on its own volition. He comes up with the aphorism that ‘wise people do not wear winter clothes through hot summer as well and suffer’ insinuating that IMF was invited when there was a need and now, that need no longer pressing, IMF is a burden.
Hence, he advises the Sri Lankan authorities to correctly assess the economic climate and reconsider the continuation with SBA. Though TLG has not said it in clear terms, the message is obvious: abrogate SBA.
We should thank TLG for coming out with his ideas boldly, because it has enabled the country to debate this vital issue openly and reach a sound decision.
IMF, the Necessary Evil
It is not unusual for borrowers from the IMF to consider it a ‘necessary evil’. The opposition to IMF is levelled on two main grounds. First, IMF conditionality for supporting a member country is considered a fetter that prevents a country from taking independent decisions. The IMF advice that calls for a readjustment of the macroeconomy through curtailment of inflation, reduction of budget deficits and adjustment of exchange rates to reflect the country’s competitiveness is considered an interference by an outside agency in the affairs of a sovereign state. Hence, freedom loving individuals (and countries as well) are naturally inclined to opposing the IMF.
IMF’s knowledge base under challenge
Second, doubts have been expressed about the superiority of IMF’s knowledge base too. It was not long time ago that Nobel Laureate Joseph Stiglitz, then World Bank’s Chief Economist, publicly embarrassed IMF by questioning the competence of its economists and branding it as an institution run by ‘free market fundamentalists’ implying that IMF was not willing to listen to the other side of the argument too.
The writer has been privy to many top policy makers of governments, both in the developed and the developing countries, complaining of the immaturity and the narrowness of the policy advice being given by IMF advisors. In one instance, a Governor of a central bank of an East Asian country remarked at a public forum that ‘those so called IMF advisors were just raw graduates out of universities and they lacked experience or maturity to offer advice to its member countries’. There were many instances where the writer’s own colleagues maintained that their knowledge was much superior to that of IMF advisors.
Go to IMF when there is no other option
Hence, no one welcomes IMF willingly. Its assistance is sought by them because they do not have any other option. Their own follies have driven them to economic crises from which they cannot get out on their own. Hence, they turn to the ‘necessary evil’ grudgingly and seek to get away on the very first instance they get after obtaining initial assistance from IMF. This is shown by the dismal track record of borrowers from IMF, including Sri Lanka, with regard to the completion of a medium term IMF Policy Adjustment Programme. The majority of borrowers have dropped out of the programme midway and only a handful of them have completed the entire programme.
IMF, knowing well that borrowers are inclined to dropping out midway, makes available its facilities in instalments to be released on the condition that the borrower continues to maintain agreed standards on a continuous basis.
In the case of Sri Lanka, in its current IMF SBA programme, the first instalment was given, but the second is on hold since the country has not been able to fulfil its agreed performance criteria relating to the government budget.
IMF thinking based on sound economics
Though the staff attached to IMF may be raw graduates without substantial experience as alleged by some, it does not mean that IMF is without a sound knowledge base. Its policy prescriptions to member countries are based on another celebrated ecoomic model suggested by Robert Mundell (another Nobel Laureate) and IMF’s own Deputy Director of Research, Marcus Fleming, known as Mundell – Fleming Model. This model is an extension of the Keynesian Model, familiar to many, to an economy with relations with the rest of the world. Since all countries today are interrelated with relations and transactions with each other, working with a restrictive Keynesian Model that does not assume such external relations may not be appropriate. Hence, the rejection of IMF prescription requires one to necessarily refute the Mundell – Fleming Model and come up with a more plausible model applicable to a country with relations with foreign countries.
Mundell – Fleming Model
The Mundell – Fleming Model is simple enough to understand. If a country with external relations prints more money than what its people need (an undue increase in money supply), the excess money will be used on goods and services, a part being supplied out of domestic goods and the balance out of imported goods. When people are inclined to use more imported goods, it widens the gap between imports and exports leading to a trade deficit and if the trade deficit is not matched by its ability to sell services, to a current account deficit as well. This current account deficit has to be financed by using the existing foreign reserves or borrowing from abroad (a chronic balance of payments crisis). If the exchange rate is not allowed to depreciate appropriately, it will worsen the balance of payments crisis because, it encourages more imports and the use of foreign services and discourages exports and the sale of local services to foreigners. It causes the foreign reserves to fall further (an acute balance of payments crisis). Hence, the prescription is to cut down the money supply.
Government is the culprit
But the money supply is increased due to the heavy expenditure of the government which cannot finance its budget deficits out of traditional sources of income. The budget deficits are high because the government sector is too large and government’s economic enterprises are making losses year after year. The government’s budgetary problem is compounded because it now has to pay interest on bigger volumes on past borrowings, having to maintain an ever rising public sector and the need for financing the losses of the government’s economic enterprises. When these enterprises borrow from state banks to meet liquidity shortages and finance losses on government guarantees, any subsequent default of loans by them too falls on the government. The government further complicates the issue by using the lion’s share of resources of the economy leaving only peanuts to the private sector for its use. Since wealth is basically created by the private sector, it therefore leads to compromise economic growth, further aggravating balance of payments and inflationary pressures in the economy. Hence, the main cause of the economic crisis is the profligacy of the spending by the government and, without correcting it, the crisis cannot be solved on a permanent basis.
Policy Prescriptions from Mundell –
Fleming Model - Hence, the policy prescriptions needed to get out of a crisis arising from the Mundell – Fleming Model are clear.
- First, reform government’s economic enterprises so that they are not a burden to the tax payers.
- Second, reduce the size of the government so that its budget deficits are pruned to manageable levels.
- Third, avoid increasing money supply by financing the deficits by the central banks.
- Fourth, make available the permissible increases in money supply for use by the private sector so that the growth momentum can be continued unabated.
- Fifth, adjust the exchange rate appropriately so that exports are not discouraged, imports are not encouraged and those immigrants remitting money will get a better income.
- Sixth, avoid short term borrowing from international market sources at high interest rates so that future interest payments and loan repayments will not be a burden to the government.
- Seventh, maintain overall economic efficiency in the government sector so that money spent on public services will generate equally matching economic benefits to the people.
Sri Lanka’s situation is scary
Sri Lanka’s current situation in this respect is scary though there has been a temporary solace following the SBA deal. According to the Central Bank Annual Report 2009, the budget deficit defined to include grants too as revenue of the government is as high as 9.8 percent and, excluding grants, it stands at 10.3 percent. Six major public enterprises has had operating losses amounting to Rs 49 billion and with loan losses and depreciation properly charged, the net losses may be mounting. Gross foreign reserves stand at $ 5.3 billion, but two-thirds of that constitutes short term flows which are reversible at any time. Exports have become sluggish and imports buoyant creating pressures for the exchange rate to fall, despite the bold intention of authorities to raise its value. The slow domestic growth and rising aggregate demand have allowed inflation to raise its ugly head which may be a major problem for macroeconomic management in the future.
Abrogate SBA but inculcate self - discipline
Hence, the abrogation of SBA requires the country to make bold decisions with respect to budget, balance of payments and monetary policy. It is a kind of a self – discipline that has to be instilled at every level. It is difficult, but not impossible as has been shown by Singapore which did not rely on IMF or World Bank funding during its transmission from a third world country to the first world status.
The Singapore Story
Commenting on the importance of sound macroeconomic policies, Lee Kuan Yew, in the second volume of his autobiography From Third World to First, says that ‘we (Singapore Government) established good labour relations and sound macroeconomic policies, the fundamentals that enable private enterprise to operate successfully’. About the prohibition of printing money for financing the government, Goh Keng Swee, economic wisdom behind Singapore’s miraculous success, says the following: ‘Our economy was both small and open. Financing budget deficits through Central Bank credit creation appeared to us as an invitation to disaster.
There was no effective way of exchange control in an open trading economy like ours to deal with inevitable balance of payments troubles. Another contributing factor was the world outlook of our colleagues – the old guard as they are now called. We all grew up under difficult conditions and did not believe anybody owed Singapore a living. The way to better life was through hard work, first in schools, then in universities or polytechnics, and then on the job in the work place. Diligence, education and skills will create wealth, not Central Bank credit’. This was the economic wisdom of Singaporean leaders in 1940s and 1950s, before Mundell and Fleming and IMF SBA conditions.
Hence, Sri Lanka could throw away the SBA and the IMF. But it will require Sri Lanka to follow the same policy package on it own volition to create wealth, prosperity and a better future for its citizens.
(The writer can be reached on waw1949@gmail.com)
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