Postscript on IMF Loan

By Atticus

(September 24, Colombo, Sri Lanka Guardian) Was the IMF loan really necessary? There is no doubt that when the IMF loan discussions were initiated in the fourth quarter of 2008, the economy, on the face of it, seemed to be in a terrible shape. The Government (and the country) had caught a strain of the American disease of living beyond the means available and piling up huge local and foreign debt. The distress was compounded by the onset of the global economic crisis.

Cassandras among economists, astrologers, soothsayers, tea leaf readers were united in the view that the economy was about to hit the buffers. Inflation was sky high, the fiscal deficit ballooning, unemployment burgeoning, the balance of payments gap rocketing, the reserves dwindling, the exchange rate crashing. An economic cataclysm was imminent proclaimed the harbingers of gloom and doom.

Things are never as bad as they seem to those who gaze at crystal balls as a profession. So it proved. By the time the IMF approved the loan in mid 2009 the economy was on the mend though by no means in rude health. Import values had fallen steeply, inflation had dropped to single digits, and foreign remittances against all expectations remained robust. Additionally tourist arrivals showed signs of recovery, and the stock market soared. Above all, economic confidence blossomed overnight when the Tiger leadership was decimated.

The country could certainly have managed without the IMF loan if the Government had adopted the IMF conditions unilaterally without the IMF. Self-discipline, however, is not a national trait. IMF conditions without the IMF was a non-starter. Evidence of the ability to go it alone by mid 2009, nonetheless, was the strengthening of the rupee by about 5% prior to the IMF loan from the lows it had reached. Why this was allowed (to the detriment of exports, employment, revenue, foreign remittances and investment) with inflation decelerating fast (and the loss of GSP plus looming) is a mystery that the layman cannot fathom.

Just to be clear, the advantages of the IMF loan itself must be made in unqualified terms.

It would have been madness to refuse a $2.6 billion, infinitesimal interest, loan on feather-weight conditions unlike past IMF loans. The confidence it provides to the economy has been widely noted. We have seen the benefits already.

It is the immediate follow up of the IMF loan by the Government that leaves the layman baffled. The Government could utilize indirectly the IMF loan, as the tranches are made available, to pay off Government foreign currency loans as they become due. Instead, the Government has, or intends, to precipitously borrow from foreigners huge sums at high interest rates, around 10% on Treasury Bills, and at least 7% or more for the $500 million bond to be issued shortly. No wonder the foreign reserves have soared and boosted our collective egos. Panglossian euphoria on the economy seems pervasive. The foreign lenders for their part are laughing all the way to their banks as they are obtaining high interest not available elsewhere.

The layman asks why the IMF funds are not used to pay off loans as they fall due rather than rolling over the loans with new debts. That would save interest payments, and mutatis mutandis, contribute to reduce the budget deficit as a percentage of GDP as stipulated in the conditions of the IMF loan. Loans from the market should surely be obtained only when reserves reach minimum levels? Why have high reserves at great interest cost? Once again the layman deserves to be enlightened about the benefits of foreign debts ("hot money") being enlarged at great cost.

Is it any wonder that politicians and others make egregiously asinine comments on the IMF loan and subjects such as gold sales when there is a bias against the layman`s understanding of what the Central Bank is up to?

Much has been made that the IMF conditions require austerity cutbacks in government expenditure and increasing revenue by means of higher taxes. Budget deficits are to be reduced as percentages of GDP, a conventional but not too meaningful economic ratio. There are as many ways to skin a cat as to reduce budget deficits as a ratio of GDP. Even without reducing expenditures and increasing taxes one could envisage the budgetary deficit ratios falling by natural factors. GDP in the North and the East could be expected to recover from a low base following substantial reconstruction and agricultural output expansion. Consequentially national GDP would increase. The higher the GDP in 2010 and 2011 the lower the cuts in expenditure (and/or increases in taxes) in 2010 and 2011 from the 2009 level in absolute figures required to meet the IMF conditionalities.

Budgetary expenditures on interest payments though hard to predict, however, would fall because of the steep falls in government borrowing costs. Subsidies to CPC and CEB and manifestly wasteful expenditure too could be expected to be trimmed as the Government intended to do so with or without the IMF loan. These, in turn, would reduce the budget deficit/GDP ratios. There are also the possibilities of creative accounting, that is obtaining goods and services "on tick" with expenditure in a post IMF loan period. The Iranian investment on a new refinery is an example where Government expenditure seems to be down loaded towards the end of the project. There may be similar possibilities in respect of other expenditure, especially petroleum imports and military hardware.

The idea that the IMF loan conditions are cast in stone, and that the IMF would hold the country to the loan conditions in Shylock like fashion does not completely hold water in the context of the uncertainty in the direction of the world economy and financial markets. What has been set is a framework for macroeconomic policy. Best endeavours for targets to be met seem to have some elasticity as evident in the interpretation of flexible exchange rates to permit a fixed rupee/dollar exchange rate.

Moreover should many of the following indicators be met: inflation falling, a significant uptick in economic growth, exports recovering, direct foreign investment robust, foreign remittances buoyant, tax revenues up, feather bedding subsidies cut, the Government could well argue persuasively with the IMF that it should not be penalized by withholding further tranches of IMF funds for a relatively minor infringement of missing fiscal deficit/GDP commitments.

What the IMF loan and conditions did not do for the economy is perhaps now more significant than what they are intended to do. Large areas of economic policy vital to the economic welfare of a wide section of the population are only tangentially related to the IMF conditionalities. The command and control in these areas, for better or worse, are exclusively the responsibility of the Government.

Perhaps most important to the man in the street is inflation. It is too facile to believe that inflation is fairly closely related to the ratio of budget deficits /GDP in Sri Lanka. This financial year, the United States and the United Kingdom have budget deficits/GDP ratios of 13% or more, and Japan over 10% (and a gross public debt/GDP ratio of over 200%!). All of them have minimal inflation. Sri Lanka in the recent past has had a lower fiscal deficit/GDP ratio and sky high inflation. The Central Bank should throw some light on this paradox.

The nub of the inflation problem seems to be that we consume too much and produce too little. Reducing the government fiscal deficit is perhaps only part of the solution. By itself it may not be adequate to enable a low inflationary environment. So if inflation is to be kept at bay consumption has to be reduced or supply increased or both.

Government expenditure no doubt would be cut from interest rate falls et al. There are structural (a euphemism for political) factors such as wages and salaries, pensions, welfare, however, impeding drastic reductions in expenditures. In addition, there is no will to raise the tax burden. In these circumstances, the least painful way to keep inflation at bay is for private savings to rise towards East Asian levels rather than focus exclusively on the fiscal deficit. But can workers be expected to accept austerity on wage claims today (even if wage hikes are given as tradeable inflation linked saving certificates) for jam tomorrow when economic inequality is so wide, conspicuous consumption of the wealthy so blatant and waste in government spending seemingly an acquired right of office from the top to bottom?

Beside a tight grip on inflation, higher exports and competitive import substitution, broad based improvements in standards of education and health facilities, housing, transport and tackling the pandemic of corruption, are all relevant to accelerate economic growth and to improve the quality of life of the population. Faster economic growth is on the cards. The pandemic may well be treated with aspirin. But social equity seems to have disappeared from the radar as the whole thrust of policy since 1977 has been to install a two-tier system of opportunities based on what money can buy.

-Sri Lanka Guardian