A citizen’s understanding of the current economic crisis and the IMF programme

by Dhammike Amarasinghe

Synopsis

The current economic crisis is not something brought about solely by corruption in high places or some recent policy mistakes of the Gotabaya administration. While those matters certainly did exacerbate the situation, the crisis itself has been long coming.

Two features of our economic situation that needs to be noted are: 1. Government expenditure has been persistently in excess of its revenue, 2. Imports have also been persistently above exports. Both together indicate that persistently we have been living beyond our means. It is time to make corrections.

The immediate problem was the drying up of foreign exchange reserves resulting in our having to default our foreign debts and not being able to import essentials. The IMF programme is only a helping hand to get out of that crisis. We need to put our house in order by implementing the various action points we have agreed with the IMF to execute, while using the IMF money (and other donor assistance it might trigger)to meet part of our external fund needs as well as some part of domestic fund requirements, until we can again stand on our feet.

However, this ‘firefighting exercise’ will have to be followed up with a longer term reform agenda, if we are to set ourselves on the path to prosperity. Two items of the IMF programme that are not often highlighted are 1. the Social Safety Net for the impoverished and the anti-corruption agenda.

It is essential for all citizens to have a correct understanding of the current economic crisis and the programme of action agreed to with the IMF, because in the unprecedented crisis that we are steeped in, the solution of the problem or problems depends very much on citizen support – support, NOT for any individual or party, but for a course of action that is likely to lead to a solution. It is no time for political games. Emotional rhetoric has to be ignored. What is at stake is – without exaggeration – the future of our people including generations to come. And not whether some individual (that one may happen to dislike) will get credit or whether some party wins the next election. That would be an extremely foolish attitude. This is a make or break situation.

Educating the public on such issues is actually the responsibility of the expert. However I have not seen yet a comprehensive all-embracing survey of the current situation – from its beginnings, intended for the layman, written by any expert, What we have seen are expert analyses of particular aspects of the situation, not always fully understandable by the ordinary person. I am no expert. However, I shall try to set down my understanding of these matters, acquired from reading the relevant documents and the analyses of experts. (I intend to do this in Sinhala later) Some knowledge of the basics of economics acquired many years ago at the university did help. Assisting ones compatriots as best as one can, to understand the crisis and what needs doing to overcome it, is I think a civic duty. Experts are welcome to make any corrections necessary.

At the outset itself, I must say that the first point in my understanding of the current situation is that it has been long in coming, only accelerated by some incorrect policy decisions made by the Gotabaya administration. My understanding is also that although corruption in high places has exacerbated matters, it is not the root cause of the present malaise. I shall also try to show that corruption may not be limited to the stealing, misappropriation or misuse of public funds in various ways by the high-ups and others but also includes, according to some people, a certain feature of day to day normal commercial practice. I shall elaborate on this in due course.

The Immediate Problem

To take the immediate problem first, before going on to the root cause: that problem is our inability to repay our public debt (i.e the debt of the government and government entities) to various creditors, owing to the fact that we do not have the foreign exchange to make those payments. Apart from our inability to settle our foreign debt, the inadequacy of foreign exchange also resulted in our inability to import many essentials like medicine, some food items, fuel, and cooking gas – although the situation has now eased somewhat. We have survived so far only because of the helping hand given by our friendly neighbours. Why we came to such a pass is the root cause of the crisis that we need to explore at the end

The foreign debts are owed by us to (a) various muti-lateral agencies like the IMF, World Bank and ADB (b) various foreign governments such as those of India, China, Japan, Iran, Hungary and (c) to holders of bonds ( meaning acknowledgments of our borrowings) issued by the government and referred to as International Sovereign Bonds or ISBs). These are borrowings made in the international bond market. While the vast majority of these bond holders are foreign investors, there are some locals like local banks and funds like the EPF and ETF who also hold them. In addition, these locals have also lent to the government in local currency by way of Treasury Bills and Treasury Bonds. The Central Bank itself is a large holder of these Treasury Bills and Treasury Bonds. This matter of local creditors has complicated matters, as will be clarified later. Our total debts are in excess of US $ 50 billion (different figures are given from time to time based on differing definitions and categorizations but it is safe to say that it is over $ 50 billion, just to indicate its huge proportions).

By April last year (2022) the authorities belatedly recognized officially that we do not have sufficient foreign exchange to repay the loan installments and interest payments that were falling due. Realization of this dire situation should have dawned on those concerned much earlier, but for some unknown reason the authorities at the time fought shy of recognizing it. Anyway, in April last year, we officially declared to the world that we are unable to repay our external debt as it falls due and that we need to re-structure it. However, our repayments due to the multilateral organizations like the World Bank were exempted since the international practice is that such repayments are normally exempted from default declarations. Our debt repayments to foreign governments and ISB holders stand suspended at present.

IMF loan and IMF programme

We then applied to the IMF for a loan to enable us to get out of this situation, that is, to re-instate ourselves to a position that will enable us to again start repaying our debts ( referred to technically as ‘ regaining debt sustainability’) It is essential to understand this point well. The IMF facility was NOT meant to be a loan to develop the country. It was solely for the purpose of getting out of the hole that we had stupidly dug for ourselves, So people who are now shouting from public platforms ” We can’t develop the country through IMF loans” are simply talking through their non-existent hats! It was never meant to be so.

The strategy to be adapted is to request our creditors to agree to ‘re-structure’ our loans (to be explained) and for the IMF to lend us funds, partly to make essential external payments and partly to support the local budget, to tide over the period that it takes us to put our house in order. In order to lend funds to us, IMF insists on our following a mutually agreed course of action (usually referred to as ‘conditionalities’), to ensure that we will not again go and dig ourselves a pit and fall therein. Isn’t that reasonable?

To explain the ‘re-structuring of loans’: It can take one of three forms or some combination of them. 1. To allow the loan to be repaid over a longer period after an initial postponement 2. To reduce the rate of interest 3. To reduce the amount owed (referred to generally as a ‘hair cut’)

The IMF will give us this loan (roughly equivalent to US $ three billion) over a period of four years, in installments, depending on our implementing the agreed course of action. One of the key elements of this course of action is our undertaking to pursue negotiations with our creditors to re-structure our debt. We have to do that and not the IMF. Assurances have already been given by our creditors that they will co-operate with us in that process (India, China, Japan and some other countries and an ad-hoc organization of some of our International Sovereign Bond holders have been good enough to give those assurance to the IMF and to us. It must also be noted that our involvement with the IMF also gives these creditors an assurance about our conduct and our future capacity to re-pay them. In other words, our agreement with the IMF has given us some degree of respectability in the international financial scene.

IMF Conditionalities

It is necessary now to consider what the other IMF conditionalities are (We should remind ourselves that these conditionalities are what we have agreed to, in a lengthy process of negotiations that our authorities had with an IMF team. There would have been give and take during that process. For instance it transpired recently that at one point the IMF suggested that the tax free level of personal income be fixed at Rs. 43,000 per month, before the present Rs, 100,000 was finally agreed to. Admittedly of course our bargaining position was weak because of the mess we had created for ourselves.

As a background to the consideration of the conditionalities, it is necessary to first take note of a certain feature of our government’s budget. In the 2023 Budget (before the new tax proposals came into effect) the total government revenue was estimated at Rs. 3,456 billion while the total expenditure was to be Rs. 7,879 billion. So, there was a deficit of Rs. 4,422 billion (more than even the revenue itself). Even if we take out the capital expenditure in the budget estimates and take the recurrent expenditure only (salaries, pensions, other office expenditure, social welfare expenditure and debt servicing – i.e. without providing for building new hospitals, schools, roads etc.) it amounted to Rs.4,634 billion, still Rs,1,178 billion in excess of revenue. The payment of salaries, other administrative expenditure, pensions, and servicing of past debt alone accounted for 142% of the revenue. We must wonder how a country can run like that. Is it any wonder that we are in this mess and in debt?

At this point we need also to realize that there is not much scope for reduction of recurrent expenditure because the bulk of it consists of salaries, pensions, social welfare expenditure, repayment of debt to the banking system etc. (The World Bank in its latest ‘Sri Lanka Development Update 2023’ says: “At less than 20% of GDP, Sri Lanka’s expenditures are not high by international standards” thus underlining further the point that the solution to the budgetary problem lies more in the direction of revenue enhancement rather than in expenditure reduction, contrary to popular perceptions. However it is true that in a correct ordering of priorities we must refrain from completely ludicrous expenditures such as those on grandiose Independence celebrations, with tanks and all (!), in a country steeped in debt.

There was therefore a need for increasing government revenue. That is the rationale for increasing taxes. In addition to the income tax already imposed there will be a property tax and a gift and inheritance tax to be introduced by 2025, a tax that will fall on the top bracket of the really wealthy and not likely on wage earners and the majority of professionals. True enough, the new taxes are quite burdensome in the context of the general increase in the cost of living. It is hoped that the authorities will consider adjustments. However any such adjustments will be feasible only within the framework of various financial targets that the IMF programme has set, in order to achieve financial solvency within a reasonable time period.

For instance, it is required that the government Budget upgrades itself from its eternal deficit position (i.e expenditure exceeding revenue year after year resulting in the government getting more and more into debt) and attains a surplus of 0.8 % of GDP in 2024. increasing it to 2.3% in 2025 and beyond (this is what is called a primary surplus which does not take debt repayments into account) Any deviation from these carefully set down targets will only prolong the agony and condemn us to continue suffering in the long term.

Although as pointed out earlier there is not much scope for reducing government expenditure, the government is obliged under the IMF programme, at least to keep to the present level of expenditure. Thus it has some space only to make less than full compensation for inflation in respect of salaries and pensions. Anyway, in respect of other aspects of government administration most citizen are well aware that there is much scope for reducing inefficiencies, wastage and acts of corruption, leading not only to reductions in expenditure but to increased efficiency in delivery of services. In this connection one hopes that the government will embark on a full scale modernization and rationalization of its institutions and systems and procedures. In this endeavour it needs to allow for the introduction of digitization in a big way.

(To be continued)

(After a long public service career the writer retired in 1998 as Additional Secretary to President Chandrika Kumaratunga. He has served post-retirement as Chairman of the Sri Lanka Insurance Corporation and was an Advisor to President Mahinda Rajapaksa from 2005 to 2015)