How should we stop going to the IMF?
View(s):Last week, we dealt with the popular claim, “Stop going to the IMF” because Sri Lanka has been a “repeating client” of the IMF since 1965, securing ‘relief on 17 occasions’. We focused on the experience of India that did not go to IMF after 1991 and Thailand after 1997.
As per a popular school of thought, “there is a difference between going to the IMF and making economic progress”. But the core of our discussion was exactly the opposite. I thought of revisiting this issue today as well to stress the point – how to stop going to the IMF?
Debt restructuring deals
Perhaps, the most exciting news of the week was about the agreement that Sri Lanka reached with its International Sovereign Bond (ISB) holders, after its unsuccessful attempt in April. The agreement covers restructuring of US$12.5 billion worth ISBs which account for 85 per cent of the government’s outstanding commercial borrowings from abroad.
File picture of the IMF building during the annual spring meetings.
As per the restructuring arrangement, the terms include 28 per cent ‘haircut’ on face value, 11 per cent reduction in past interest, and coupon payments starting in September 2024.
It was in the previous week that Sri Lanka has successfully concluded debt restructuring of $10 billion with its major bilateral creditors. The concessional terms of this arrangement include a five-year period of deferment of loan repayment (2022-2028) and an extended loan repayment period until 2043.
Debt, unsustainable
Given the country’s inability to meet external debt service obligations, the Sri Lankan government suspended the repayment of both bilateral and commercial loans in April 2022. The amount of external debt that covers multilateral, bilateral and commercial borrowings was reported to be $37 billion.
It does not seem to be a ‘big number’ by international standards and there are even many individuals all around the world with higher amounts of wealth than that. However, for a country with an extremely poor record of annual export earnings amounting to just $12 billion, it is indeed a big number.
At the time of suspending debt repayment, Sri Lanka’s foreign reserves had declined to near zero levels. Ironically, the country didn’t have foreign reserves of more than $7-8 billion. In 2020, Sri Lanka was already faced with a loss of its ‘credit worthiness’ along with credit rating downgrades and the resulting non-access to international capital markets. With these developments, it was clear that Sri Lanka’s debt was unsustainable!
Restoring debt sustainability
The objective of the Extended Fund Facility (EFF) arrangement of the Sri Lankan government with the IMF is to “restore macroeconomic stability and debt sustainability” while mitigating the crisis impact on the poor and vulnerable, safeguarding financial sector stability, and strengthening governance and growth potential.
Debt restructuring must be in line with the IMF’s debt sustainability analysis (DSA). Restoring debt sustainability means that the government should have the improved capacity to meet debt obligations without external assistance and going into a default. In order to meet debt repayment obligations, there should be adequate tax revenue and foreign exchange earnings. The following are Sri Lanka’s debt sustainability indicators:
Firstly, Sri Lanka’s public debt that has increased to 128 per cent of GDP by the end of 2022 is unsustainable. It must be reduced to 95 per cent of GDP by 2032 to make it sustainable.
Secondly, gross financing need (GFN) of the country should be reduced from its current level of 34.6 per cent of GDP in 2022 to less than 13 per cent of GDP on average during the period 2027-2032. Gross financing needs refer to annual debt repayment plus new borrowings to cover budget deficit.
Finally, external debt service which is in foreign currencies should be reduced from its current level of 9.2 per cent of GDP in 2022 to less than 4.5 per cent of GDP per annum during the period 2027-2032.
Stability and debt
restructuring
Economic stability and debt restructuring are the immediate steps to achieve debt sustainability. Sri Lanka has now reached agreements on a large part of its public debt restructuring, including the government’s domestic debt. On the other hand, it has also been supported by revenue-based fiscal consolidation efforts aimed at economic stability.
Increase in direct and indirect taxes, fuel and electricity price adjustments, and other fiscal policy measures have helped the government to improve its debt sustainability and to slowdown the annual borrowing requirements. Of course, the burden must be shared by people who were already battered by the adverse impact of the economic crisis.
Tax revenue has increased from Rs.1.6 billion in 2022 by over 55 per cent to Rs.2.7 billion in 2023. Along with this achievement, the primary balance has recorded a surplus. The budget deficit has also declined reducing the borrowing requirements. Perhaps, for the first time the government has covered the budget deficit without resorting to ‘money-printing’ by the Central Bank.
Given the fiscal deficit, there has been an increase in public debt by about Rs. 1,400 billion in the first quarter of the year 2024. Nevertheless, an overall assessment shows that the economy is on the path to stabilise with debt sustainability. It is not enough, however.
Beyond recovery
The achievement of short-term macroeconomic stability and debt sustainability is only the first step of a longer process. The process of reforms must continue to achieve medium-term and long-term economic progress beyond and above the recovery for a number of reasons:
In spite of the signs of an economic turnaround, the crisis-ridden Sri Lankan economy is not yet out of danger. It continues to remain vulnerable to any external shock and is prone to collapse even to greater depths.
Apart from that, economic stability must be sustained by unlocking the country’s growth potential. It is only with economic growth that the government can maintain its fiscal consolidation by raising tax revenue.
The room for the improvement in debt sustainability through a negotiated debt-restructuring process is limited. Debt sustainability should be improved meaningfully through economic growth.
In addition, “recovery” means the achievement of the pre-crisis state of the economy which is not at all the desired level of economic prosperity and living standards that the nation aspires to be. Economic progress needs to be sustained in the long-run which is the key to ensure the progress of
Sri Lanka to a ‘developed country’.
The crisis has resulted in mass-scale poverty and vulnerability in the Sri Lankan society. In such situations, the poverty reduction strategy is centred around economic growth, while social protection has only a limited role to play.
Growth with exports
Sustaining economic growth should be accompanied by export growth, while export growth requires investment from both local private investment and foreign direct investment (FDI).
It is amazing to see that after 46 years of policy reforms, Sri Lanka was able to generate only about $12 billion exports, whereas many of the neighbouring countries have been reporting $300-500 billion exports. It is equally amazing to see that Sri Lanka was unable to attract more than $1 billion worth annual FDI, whereas FDI has been the major source of export drive in many of the neighbouring countries. The differences are due to the lack of reforms in the past.
Self-sustaining growth requires production for export markets which are the ‘global markets’ with billions of customers and ‘competitive markets’ with many other suppliers. Therefore, export-led production eliminates obstacles for industry expansion, permits benefitting from economics of scale and provides incentives for innovations.
An export drive requires FDI because domestic investment is too small to make a big difference. Apart from that, FDI comes with the state-of-art technology, management practices, export market access and supply chain connectivity.
The challenge
Economic stability, economic recovery, and economic progress beyond recovery … all require a series of reforms – policy and regulatory reforms, labour and land market reforms, public sector and public enterprise reforms, and other similar reforms. It is only with reforms that Sri Lanka can unlock its growth potential.
Sri Lanka has become a ‘repeating client’ of the IMF because it never continued with the required reforms. Every time, Sri Lanka has abandoned its reform process because elections were approaching, or the government changed after elections, or for some other political reasons.
If the same cycle continues, the consequences in a crisis-ridden economy are far more critical than in the past. And the country would not stop going again to the IMF.
(The writer is Emeritus Professor of Economics at the University of Colombo and
can be reached at
sirimal@econ.cmb.ac.lk
and follow on
Twitter @SirimalAshoka).
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