Urgent external aid may provide immediate relief, but more fundamental economic and political changes are needed.
by Ajay Dua
At the current juncture, Sri Lanka faces two distinct sets of economic problems. Broadly speaking, the first is a lack of liquidity needed to let the economy function normally. The second, equally significant, is building up the solvency of the economy. During the last three years, the knee-jerk actions of the ruling—Rajapaksa—dispensation have hurt both the daily lives of average citizens, as well as the broader growth prospects of the country. Ill thought-out measures such as slashing tax rates, experimenting with organic farming, while banning the import of chemical-based fertilisers, and undertaking substantive investments in commercially dubious infrastructure projects through overseas borrowings, have all gone awry.
Alongside this, the federal government has been unable to contain the fallout of the church-bombing of 2019 and the added impact of the Covid-19 pandemic. The significant earnings that came from international tourists, and the high remittances from the Sri Lankan diaspora working abroad (together, accounting for $15 bn or 25% of annual foreign exchange earnings) have consequently sharply declined. The central bank’s reckless decision to first augment the money supply and peg the exchange rate of the Sri Lankan rupee against the US dollar at an artificially high rate, combined with a recent decision to let it float, have brought about rapid inflation, and a significant deterioration in the real value of its currency. The carefully built-up exports in key areas such as textiles, apparel, rubber and tea have all collapsed and depleted foreign exchange reserves to a pitiable under $2bn i.e. barely adequate to pay for 1 month of normal imports.
While exports have suffered, the import bill has remained substantial and inelastic, primarily because of the entrenched dependence on foreign goods even for essentials and everyday items of use. When the going was good and traditional exports were on a steady growth-trajectory, perhaps such imports could be afforded. However, when exports became uncompetitive due to currency mismanagement and high domestic inflation, the situation rapidly changed. To an extent, this also applied to the financing of some viable infrastructure projects that could be feasibly pursued as long as they were being built with private investment with no onerous conditions attached. With export earnings falling and foreign exchange reserves declining drastically, it was inevitable the earlier level of imports and long gestation infrastructure projects would receive a rude awakening.
Given the highly elevated fiscal deficit at 14% of GDP, and the greatly depleted foreign exchange reserves, there is no head room in the foreseeable future to repay or service overseas loans, including $13 bn of sovereign bonds. This was starkly evident last week, when the new Finance Minister and the recently appointed central bank of Sri Lanka governor threw up their hands and decided to default on their significant total borrowings (currently placed at $51bn). This represents the first such recent intent to default by any middle-income country and has correspondingly led to Sri Lanka’s downgrading in the global capital markets and the virtual “junking” of its sovereign bonds. If an actual default on commercial foreign debt was to occur—the country faces $8.6 bn worth of debt payments due this year and that includes a combined principal and interest dollar denominated bonds and loans of $2.2 bn—the rating could be further lowered and placed in the Selective Default category. That would make it difficult, perhaps impossible, for its government and businesses to effect overseas borrowings.
CURRENT ENDEAVOURS TO TIDE OVER THE CRISIS
The recently reconstituted Sri Lankan cabinet has explicitly prioritized addressing short term problems viz. devising ways and means to find the requisite resources in foreign exchange to pay for the import of essentials of food, fuel, fertilisers and medicines. This is understandable; lives must be prioritized above all else. In fact, the country had been headed towards this from last January itself when it had approached both India and China, its close “friend” in recent years. Since then, India has put $1.9 bn on the table in loans, credit lines and currency swaps to enable it to buy from India as well as elsewhere and has rolled over a loan due for repayment. Sri Lankan authorities have now put in a request for another financial package of $2bn, including the further rolling over of loans due in rest of the year. Though termed as “bridge financing” by Sri Lanka, in all likelihood, such a bailout by India could be more permanent in nature.
Surprisingly, it is the Chinese who have not responded adequately to the three-month-old request from their “ally”. With around 10% of the total borrowings being from it and representing the single biggest nation debt (followed by Japan), the Chinese role is consequential. In addition, there are substantive investments by its so-called private entities; the largest being in the upcoming Colombo port city project modelled along the lines of the Dubai International Financial Centre, the Hambantota international port, the Southern port terminal at Colombo, and the four-lane expressway connecting Colombo to Rajapaksas’ citadel Hambantota. Reportedly, the Chinese are circumspect about giving out further loans and making investments in countries that have not demonstrated the requisite financial prudence. Their preference seems to have shifted to smaller projects rather than the marquee ones that require larger outlays and have numerous other uncertainties. The Sri Lankan government is however confident that the Chinese will come around and offer some support, including in repaying the $1.3 bn existing loans due in July ’22, and perhaps as much in humanitarian relief.
Seeing the dire situation on the ground evolve, the in-power Rajapaksa clan has changed tact. After refusing for months to approach the IMF for another bailout (IMF had in the past extended 16 loan packages to Sri Lanka), it has now gone back to it and sought $4bn including in rapid aid. Clearly, it has dawned upon the government that most of the financial assistance needed to get out of their current predicament would have to come from multilateral agencies like the World Bank, IMF and ADB. Their assistance usually comes on softer terms, without repossession and similar stinging conditions. For its part, India too is happy that Sri Lanka is not leaning more on China—a situation which had become worrisome in recent years given the geographical proximity of the island to Indian borders. Unsurprisingly, India’s Finance Minister, Nirmala Sitharaman, has already supported the Sri Lankan request for aid in her interactions last week with senior IMF officials in Washington D.C.
In all likelihood, IMF would extend an emergency aid-package of about $1 bn to address the issue of liquidity. The remaining $3 bn for a longer structural adjustment programme would, however, take time and be precedent upon debt restructuring and the acceptance of major changes in approach. These would potentially include reducing the long-term dependence on the import of essentials, ending the aggressive push towards 100% organic farming, getting rid of price controls on food, other essentials and removal of controls on exchange rates in order to re-attract US dollars, remittances and international tourists. It may also discourage undertaking costly infrastructure projects and in fact, suggest the sale of the massive loss-making state enterprises. That should help it reduce the size of the bloated public service.
The World Bank and Asian Development Bank are also likely to chip in with immediate relief and then consider the measures to address the medium-term solvency related difficulties. Through these credible institutions and bilateral help from India, China, Bangladesh, UAE, Gulf Council members, the US and UK, a decent $12-$15 bn could be anticipated over the next couple of years. Of course, this would need to be in addition to the $5 bn or so coming in as urgent aid to provide immediate succour.
MORE CONSEQUENTIAL DOMESTIC ACTIONS IN THE LONG-TERM
Realising the gravity of the adverse political reactions from several sections of the 22mn strong country, recent statements from the two older Rajapaksas (President Gotabaya and Premier Mahinda) reflect a more responsible conduct than previously demonstrated. To start with, they have admitted to having made mistakes in their handling of the economy. Besides making them look more in touch with the ground reality, accommodative stances could open the doors for a constructive way forward, including holding negotiations with protesters and the strident opposition leaders. That said, the demands for their throwing in the towel are unlikely to materialise.
Their party, the Sri Lanka People’s Front (known by its Sinhalese name Sri Lanka Podujana Peramuna), continues to be the largest political outfit, though it is no longer in majority. The opposition remains unsure about its ability to vote out the government as is reflected in its dilly-dallying in moving a motion of no confidence against the government and the impeachment motion against President Gotabaya. The latter exercise requires a two-thirds majority in Parliament to succeed. The two experienced brothers in power, as well as their other kin, who till recently were calling the shots, are unlikely to accede to relinquishing power and face the prospects of prosecution from law enforcement agencies.
Another indication of course-correction from the Rajapaksas has been their “confession” that the decision to ban chemical fertilisers and opt for compulsory countrywide organic farming—which has caused much of the prevailing economic and political turmoil—was badly conceived. Such an admission of guilt may soothe many a Buddhist monk, as well as the Christian clergy; both of which wield considerable influence over the masses. The immediate independent inquiry into a police shooting a few days ago also puts President Gotabaya in somewhat better light. Premier Mahinda has also put out assurances that the earlier subsidy on the purchase of agro chemicals and fertilisers would stand restored. Though belated, this could appease the farmers and help the recovery of farm output across all crops.
With a $5 bn early bailout from international organisations and other countries, the large-scale import of fuel, cooking gas, food and medicines should again become a possibility. As a result, transportation and workplaces would reopen and a degree of normalcy could return. The GDP, which had fallen last year, could start recovering towards its set goal of 5%. Its Human Development Index value, which till 2019 was in the “high development category” and above India, Bangladesh and Pakistan, could again start creeping up. It has always been better off than its neighbours in gender equality. To facilitate this, the Rajapaksas would do well to, suo motu nullify, through moving an omnibus amendment, the several constitutional changes brought about by them and which had vested extraordinary and arbitrary powers in the President. Becoming more democratic and a ceremonial head of nation, is imperative to assuage the widespread impression of Gotabaya being arbitrary and authoritarian.
The Sri Lankan official set up must also recognise that in the interim till the economic relief comes, the structural adjustment measures prescribed by multi-lateral institutions will cause considerable pain to citizens living at the margin. Such sections and geographical pockets will need to be quickly identified with custom made ameliorative measures initiated. These would necessarily include subsidized food, fuel and cooking gas. Alongside, there should be no endeavour on the part of the government to tinker with core services the Sri Lankan citizens have always been provided by the State viz. universal education and basic healthcare. In fact, most citizens now consider them a right, and that belief needs to be fully protected.
This is particularly called for since, unlike the other countries of the subcontinent, Sri Lanka has a demographic disadvantage. It does not have a young population “which creates a rising consumption base and an expanding labour force. It has to depend on making its older labour force more productive. That process besides requiring investments in skill-building and technology, needs strong public finance” (Dushni Weerakon, executive director, Institute of Policy Studies, Sri Lanka). When the historical context of extending such fiscal support of several decades, and their usefulness going forward, is explained, the aid-givers should have no difficulty with the government continuing to fund these programmes.
One of the more difficult exercises to undertake will be the restructuring of the $51 bn in existing loans. To avail of the sought after bigger aid package, IMF has already called it a prerequisite to start these negotiations. For such a process to be completed with a degree of success, the Sri Lankan authorities would need to convince each institution and creditor country about their earnestness and sincerity in implementing the suggested reforms. Understandably, several of them will seek cogent explanations for the path treaded and the roadmap for the future. There might also be uncomfortable questions about ensuring political stability in the island. Such external pressure could even catalyse a change of guard in the country.
Dr Ajay Dua, a progressive economist by training, is a former Union Secretary, Ministry of Commerce and Industry.
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