A brick head regime and IMF

Two years of systemic economic mismanagement by a government elected to power with great expectations and grand promises has led the people into a miserable existence of hopelessness, despair and depression. The regime is scapegoating COVID-19 for the disaster, which no doubt aggravated it, but policy faults by the Government were several, and worse was its brick headedness not to listen to experts in the field simply because they were not part of its power cartel. 

Beginning from its approach to control the pandemic virus to President GR’s ad hoc tax concessions, his erratic import substitution measures and to costly debt management techniques, the Government blindly went on translating into practice what GR babbled and his former handpicked Central Bank Chief, Professor Lakshman interpreted as an “alternate way to development”. That this so-called alternate way is full of potholes and leading to disaster is clearly demonstrated by the economic misery gripping the nation. 

Given the widespread wretchedness and the forlorn hopes of a hyped V-shape or U-shape recovery, it is sheer madness and even criminal to cling on to the failed strategy of managing the economy hoping to pull the country out of its morass by relying on friendly countries for economic and financial assistance. Borrowing anew to service and settle past debt is a costly exercise. It is foolish for CB chief Cabraal to brag about not defaulting on debt payment without explaining to the suffering public the actual cost of that exercise. India and China, the two regional giants locked in a bitter cold war, loom large in the list of countries that are willing to help. These two powers are rivalling in their readiness to assist Sri Lanka as demonstrated by their currency swap arrangements, direct loans and food aid. This is neighbourly generosity at a price. The heaviest price to be paid for their largesse is not the economic pain to be incurred when settling the debts, but the long-term loss of Sri Lanka’s real assets and compromising its sovereignty. 

Sri Lanka’s foreign policy, because of its strategic location in the Indian Ocean and in the midst of growing geo-political tensions between India and China, and their respective allies, is tied to its economic policy. Balancing the two requires Chanakya expertise on both fronts, which regrettably seems to be lacking, especially in foreign affairs. Moreover, there is one heavenly truth that Sri Lankan policymakers must realise and that is, there is no free lunch for anyone anywhere. All friendly help and benevolence are tied with self-interest of the helper and benefactor.

With this backdrop it is important to discuss the IMF option, which seems to have gained momentum over the last few months. There seems to be an increasing consensus among experts in the field and observers on the ground that IMF assistance is unavoidable. In discussing IMF option, it is better not to get bogged down with the hackneyed ideological debate about IMF’s Western bias, a subject on which undergraduates had been lectured for decades by their university pedagogues. One has to be pragmatic in light of the present economic difficulties crippling the country. 

Even leftists who are aspiring to capture government in the near future must accept the reality that given the openness of Sri Lankan economy and the prevailing global economic and financial landscape, partnership with international institutions like IMF is essential especially when an economy is chronically facing financial difficulties.   

To start with, IMF and World Bank (WB) are the two Keynesian twins created after World War II to deal with economic difficulties faced by poor countries. While WB takes care of funding long-term projects, IMF specialises in assisting to rectify short-term balance of payments difficulties. However, when a country requests IMF for assistance, it is like a patient visiting his/her physician for prescription to cure an illness. The doctor after diagnosing the sickness would not only recommend the appropriate medicine but also advise the patient on other requirements that should be fulfilled for the medicine to be effective. More than the medicine itself it is those other requirements that guarantee long-term health of the patient.

Sri Lanka’s economic sickness is the result of a long-term neglect by successive governments to (a) maintain budgetary discipline, (b) initiate and implement economic reforms to enhance productivity, and (c) improve administrative efficiency. Apart from these there are a few other, yet equally important areas where this neglect is prominent such as in managing the country’s ethnic and cultural pluralism, and failure in nation building. These are however not directly relevant to IMF prescription and assistance.

To overcome financial difficulties, the main advantage of IMF help is the cheapness of its credit and flexibility in terms of settlement. Currently, the interest rate on loans is only 3.5%, which is the lowest available in the market. (That may go up, may be in a couple of years, when US and other large economies start increasing their interest rates to counter the threat of inflation). The settlement of debt is over medium to long term and could take as long as 10 years and that also in six-month instalments. Compared to the currency swap arrangements with India, China and Bangladesh these are unbelievably attractive terms. (Incidentally, there seems to be utter secrecy surrounding the terms and conditions attached to the latest 1.5 billion yuan-rupee swap with the Bank of China. It may cost more than what has been publicly told). 

The conditionality attached to IMF loan depends on the state of the economy in question. The more serious is a patient’s illness more severe will the restrictions imposed by the doctor. Likewise, had the ruling regime approached IMF quite early in time its conditions and their impact on public would have been milder. 

In general, IMF conditions are tied to two areas namely, improving internal fiscal strength by way of increasing taxes and reducing wasteful public expenditure, and carrying out economic reforms.

The gaping Sri Lankan budget deficits are totally intolerable if economic recovery to take place. But the Government’s decision to cut expenditure without raising tax revenue is not going to help reduce the deficit even in the short-term. On the revenue side, there are two shortcomings. The 12% tax revenue component of GDP in 2019, is among the lowest in middle income economies and it must increase. Although the top income tax rate is only 16% how efficiently that is collected is another issue. Sri Lanka’s tax administration is notoriously lax and corrupt. In reality, the poor pay more through indirect taxes than the rich via direct taxes. This inequity needs redressing. 

Economic reforms demanded by IMF would mean restructuring if not privatising all loss-making parastatals. The main reason why several state-run corporations fail is because of corruption. This again is a perennial problem in Sri Lanka. When managers of state-run corporations are appointed more on the basis of political affiliation than merit, corruption sets in. When the top is corrupt how does one expect the ones in the middle and bottom levels to remain honest. 

Sri Lankans know very well that a fish starts rotting from its head. From ministers to managers and to their subordinates, corruption is widespread. In 2020, the country ranked 94th in public sector corruption. What happened to GR’s promise of clean government? Didn’t the names of certain members of Rajapaksa family appear in the Pandora Papers? GR promised to investigate the matter. What happened to that investigation? All hushed up. 

In short, corruption is endemic and part of the country’s political life. 

This explains why the Government is dillydallying in seeking IMF assistance. When cabinet ministers indulge in private business deals and issuing government contracts in return for percentage kickbacks, how does one expect an economy to prosper? Getting away from corruption is to lose opportunities to loot. Will they hang themselves by going to IMF? 

IMF would also insist on further depreciation of the rupee to make it reflect market demand. At the moment the gap between CB-manipulated exchange rate for the dollar and that quoted in the black market is quite wide. CB’s higher rate would discourage tourism on which the country heavily depends. It is also a reason why expatriate labour is not willing to send their hard-earned dollars through official channels. 

Accepting IMF’s conditionality would certainly cause more pain to consumers. But whether that pain would be worse than that caused by GR’s alternate way is doubtful. However, short-term pain is tolerable if that conditionality promises long-term gain. What is the long-term gain? 

With IMF involvement, investors’ confidence would receive a boost and inflow of foreign investment would increase. Credit rating agencies like Fitch and S&P would start reassessing the economy’s prospects for future growth and at least keep the level of risk at current level for some time before upgrading it. There is also another indirect benefit. That is to reduce or remove the threat of EU withdrawing its GSP+ concessions to Sri Lankan exports. GR’s alternate way and his poor record on human rights violations are potentially dangerous to the survival of small and medium level industries, which depend crucially on EU market. (World Report 2022 released by Human Rights Watch once again points out the failure of Rajapaksa regime to improve that record). 

Finally, as the economy begins to show signs of revival with IMF assistance and as foreign investment flows in and economic activities take off the current brain drain would witness a slowdown. After all, not everyone is leaving their kith and kin to go and live abroad purely for the sake of earning dollars. Currently, even local investors are not willing to expand their operations because of shortage of skilled labour.  

Thus, there are distinct advantages in going to IMF. It is time the Rajapaksa regime either comes to some sense, approaches IMF for help and gets rid of GR’s ruinous alternate path, or prolongs the agony, faces people’s wrath, mortgages the country to foreigners and ends up causing a bloody upheaval.