Editorial

The advent of a new Finance Minister heralds what many believe is the dawn of a new era. While this may be an exaggeration, it implies a desperate attempt at mid-course correction by the Government before the country is shipwrecked in the stormy seas of economic and financial mismanagement.

The Government has been preparing for this change for some time. The Prime Minister opting to take a tactical step back from active public life and slow down his hectic schedule comes as no surprise. His replacement displayed the extent of his political power with two-thirds of Parliament raising their hands to enable him to become an MP and sit in Cabinet as a dual citizen of Sri Lanka and the United States.

As soon as the appointment was officially announced, and he took the hot seat at the Treasury, Colombo-based envoys of some of the big-power nations wasted no time in paying their respects to him. Perhaps, because the new Finance Minister’s mindset is perceived as being somewhat different, they clearly see a window of opportunity for negotiations with the Government which previously did not exist for some of them.

If the PM had hitched his political wagon to the socialist star of no privatisation of state assets and the like, with a more recent pro-China line to boot, the President appears to be the one who wants to leave his options open with the foreign powers. Today, the Government is even more beholden to China because of the West’s aggressive, strong-arm tactics to bring Sri Lanka in line with its geo-political agenda, as opposed to the former’s well-masked, seemingly benevolent approach to negotiations.

The new Finance Minister has no known or dogmatic political philosophy, which makes him ‘a friend of all and enemy of none’; in other words, he’s regarded by the diplomatic community as a pragmatic politician despite his belief that the Chinese Communist Party and the Indian BJP are ideal models for the Sri Lankan ruling party.

The popular consensus is that it was he who masterminded its victory at both the 2019 Presidential and 2020 General Elections. Now he has to assemble a good team to undertake the task of rebuilding an economy hovering on the brink, an even more onerous responsibility.

International rating agencies have switched the amber light to red warning on Sri Lanka, which is facing a mounting balance of payments (BOP) crisis. Official foreign reserves have steeply declined from $7,600 million in December 2019 to $4,000 million in June 2021. A large international bond payment of $1,000 million due in only a few days’ time will leave foreign reserves in a precarious situation.

The Minister of Finance faces stark external financing choices. He can continue with the so-called alternative economic policy, which is nothing but a souped-up version of the all-too-familiar import substitution strategy. A combination of (a) opening the capital accounts via a “No Questions Asked” approach, to receipt of funds from abroad by firms and individuals, and (b) restricting payments through licensing of imports for “essentials” and rationing of foreign exchange via the banks has been the order of the day since March 2020.

This dual policy has not produced tangible results in respect of mobilising substantial external funds or staving off a foreign liquidity crisis, or promoting growth. Many banks are turning down smaller exporters/importers by refusing to fund their operations, thereby compounding the fragile economic situation. A flourishing ‘black market’ rate is operating alongside the official exchange rate, which is indicative of an acute foreign liquidity position. Widespread supply shortages and rising import prices of petrol and food, including flour, sugar, milk products and dhal have led to public discontent reflected in frequent demonstrations and protests.

Due to the shortfall in foreign reserves, the Government secured a commercial loan of $1,000 million from China as well as SWAP arrangements with India and China over the past 18 months to meet commercial debt payments in 2020 and 2021. Focus on a year-by-year approach to raising external finance creates enormous uncertainty, thereby magnifying the current unstable situation concerning the recurring need to settle international bond payments of nearly $3,000 million in 2022 and 2023 and over $10,000 million (10 billion) over the period 2024-2030.

Bilateral donors are unlikely to come to Sri Lanka’s rescue, year after year. The Government is hoping that the year-wise approach may be the way to go as Foreign Direct Investment in the Port City and Hambantota Port, and the anticipated tourism rebound will materialise in time to prevent a foreign exchange catastrophe from occurring in the medium-term. Still, in the near-term (2022 to 2023), the likelihood of a steep decline in foreign exchange reserves remains high. The probability of default on debt repayment obligations will also be high.

The Minister of Finance could, on the other hand, engage in a meaningful dialogue with the IMF so as to identify changes in economic policy which the IMF can support. A programme drawn along these lines will reassure investors and donors that Sri Lanka is on a reform path. Sri Lanka will then be able to access international markets, when needed, partly to avert a foreign exchange crisis on debt refinancing, and partly to address any BOP shortfall.

Fiscal consolidation through increasing revenue (which was at an abysmally low level of 9.3% of GDP in 2020) and pruning domestic expenditures drastically will figure prominently in any reform discussion. Difficult choices on moving towards a market-driven exchange rate, adjustment of interest rates, elimination of import controls, and pricing of energy are some of the critical issues that may be taken up during the negotiations.

While a reform plan (in theory) may bring about economic stability, it could well produce social and political fallout. Adjustment of prices due to further currency depreciation or rising costs of imports will significantly impact poor and low-income households. Already, more than 500,000 additional households have fallen into poverty because of the pandemic. A viable livelihood support programme, a ‘safety-net’ for the poor will be needed in tandem with a reform programme.

A programme aimed at improving foreign resource availability faces a major economic and political risk stemming from the Government’s intransigent fertiliser trade policy. The current import ban has led to organic agitation in the food growing countryside.

Experts have warned that producer incomes as well as production will plummet and food imports will have to inevitably rise sharply if the Government persists with the current fertiliser import policy. No one will envy the new Finance Minister his job and the work cut out for him.