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Sri Lanka at the edge of an economic abyss on its 74 th. Independence Day

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February 4, 2022
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Sri Lanka at the edge of an economic abyss on its 74 th. Independence Day

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By P.K.Balachandran

Colombo, February 4 (Counterpoint): It is widely acknowledged that Sri Lanka has not been in such dire straits economically as it is now in its 74 th. year as an independent nation. Seven decades of erratic economic policies adopted in the midst of a 30-year war, two insurgencies, self-defeating nationalism and ethnic and religious strife, have created a situation where the country is now going around with a begging bowl seeking loans from India, China, Pakistan and Bangladesh.

In a throw-back to 1952, when Sri Lanka had to barter its rubber for rice from China to stave off starvation, the government is now negotiating with China to secure a million tons of rice to make up for a severe rice shortage. The sudden ban on chemical fertilizers and pesticides to promote organic agriculture, and that in the midst of lockdowns, had hit farmers below the belt. A subsequent relaxation of the fertilizer policy left rice cultivation out and favored export crops like tea. Food price shot up. Government took to printed money. Inflation has now touched 14%.

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A survey done by MTI Business Review found that in 2020, 74% of the businesses were down. It came down to 54% in 2021 due to the lifting of lockdowns. Thanks to the opening of the economy in 2021, there was an all-round recovery with GDP growing by 4% and industry growing by 6.8%. Some sectors in agriculture like tea and vegetables, improved with a partial relaxation of the ban on chemical fertilizer. Tea production rose by 17%. Apparel exports went up by 21.9%. Overall, exports went up by 23%  to rake in US$ 15 billion.

Grim Downside

However, the downside remains grim. In 2022, debt service payments of US$ 6.6 billion are due. The current usable official reserves are less than US$ 1 billion (2-3 weeks of imports). Tourism was down with less than 200,000 arriving in 2021. It is yet to pick up. 

READ: Sri Lanka’s inflation accelerates to Asia’s fastest

Sri Lanka is confronted with both a cash flow problem and a debt problem, says the Colombo-based think tank, Pathfinder Foundation (PF) in its latest report.

“The liquidity problem is compounded by the fact that the only known additional external financing, at this point, are lines of credit from India (USD 1.5 billion)  and Pakistan (USD 200 million). These will certainly contain the depletion of reserves. They will not have a very material impact on the existing external financing gap, which is likely to be at least US$ 7 billion this year, even with very optimistic assumptions about receipts from tourism, asset sales, remittances and FDI.”

“With each passing day, the dollar illiquidity will worsen unless there are large inflows. There will be some temporary reduction in the hardships being experienced by the people due to the Indian SWAP, the deferral of the Asian Clearing Union settlement and the lines of credit obtained in recent weeks. The intention of the Indian government to provide humanitarian support in this time of great need is very laudable. However, these generous initiatives will not serve to buy more than two or three months’ time. We need to do much more to help ourselves rather than relying on the goodwill of friendly neighbors, such as Bangladesh, India and Pakistan, whose per capita incomes are below ours,” Pathfinder Foundation said.

Solvency Problem

“Thanks to the high level of external debt, the country also has a solvency problem. This formidable challenge will not be resolved by a few bilateral sources temporary financing. They do not alter the debt burden.”

“The Pathfinder Foundation advocates: (1) an immediate announcement of a preemptive restructuring of external debt, (2) a very early and urgent approach to the IMF; and (3) bridging finance from friendly bilateral partners pending completion of the negotiations with creditors and the IMF which can take at least six months.”

“Debt restructuring, excluding multilateral debt, can save over USD 3 bn, during the first year. These dollars can be used to finance imports that meet the essential needs of the people and urgent requirements of businesses. An IMF program can trigger a combination of balance of payments financing and direct budgetary support from the World Bank and Asian Development Bank to the tune of USD 1.5- 2.0 bn in the first year. The combined increases in USD availability during the first twelve months will have a huge positive impact in resolving the problems currently being caused by dollar illiquidity.”

Need for Austerity

However, there can be no gain without pain, Pathfinder Foundation said.

“The painful consequences of many years of indiscipline, resulting in the country living well beyond its means, cannot be wished away. An austerity program is inevitable. Its depth and duration can be mitigated by robust structural reforms that increase productivity/competitiveness and thereby strengthen the growth framework of the economy. This would increase output, employment and incomes. The policies adopted should also prioritize inclusiveness and sustainability.” 

“A home-grown program needs to be developed to meet these objectives. It should also be credible enough to negotiate with the IMF and creditors. Such a program may include, inter alia, the following:-

(1) A realistic exchange rate that contributes to building reserves; and ends the current multiple exchange rates that incentivize the expansion of the black economy. (2) Continuation of the Central Bank’s shift to a more market-oriented monetary policy. (3) A medium-term fiscal consolidation program which sets out a clear path to debt sustainability, including by improving the primary balance through a widening of the tax base, improving tax administration, rationalizing public expenditure in accordance with a clear set of national priorities, and adopting transparent fiscal rules by strengthening the Fiscal Management Responsibility Act. (4) Reform of the present highly inefficient subsidies, which disproportionately benefit the non-poor, with a well-designed and targeted system of cash transfers supported by a digital Identity Card. (5) Full-cost pricing of fuel and energy based on transparent and predictable formulas. (6) Further progress in commercializing State Owned Enterprises.  

Need to Seek IMF Help

“The above could, inter alia, be key elements of a home-grown reform program that can be the basis of negotiations with the IMF. It can also be credible enough to generate confidence among creditors. However, it is also important to accelerate the long over-due structural reforms to ensure that the above program, which is primarily focused on stabilization, does not lead to a growth deficit. This has been a repeated problem with reform efforts in the past decades.”

“The structural reforms to generate growth are very well known and relate to: factor markets (land, labor and capital); the investment climate; investment promotion; trade policy, including trade agreements; trade facilitation; education, training and skills development; and digitalization.”

In conclusion the Foundation issued a grim warning: “There is much to be done, and done quickly, to avoid falling into the abyss.”

END

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