A survival strategy amidst geopolitical rivalry

by Neville Ladduwahetty

During the course of his address, as Chair of the 55th Annual meeting of the Asian Development Bank, Sri Lanka’s President, Ranil Wickremesinghe, said, “As they say, in many of our countries, when the elephants fight, it is the grass that is crushed”. As far as Sri Lanka is concerned, its strategically significant location in the Indian Ocean makes it the turf for the rivalry between the QUAD made up of the United States, India, Japan and Australia on the one hand, and China on the other, to manifest itself. How Sri Lanka strategises its survival in such an environment is key not only to its immediate economic revival but also for all time.

The single most critical issue affecting Sri Lanka’s economic revival is debt, and therefore the need to restructure it. In this regard, the expectation is that the role played by the International Monetary Fund (IMF) backed up by the Extended Fund Facility of US$ 2.9 billion is expected to encourage the creditors to be more accommodative towards Sri Lanka, when addressing its debt crisis. This however is not an assured outcome. The President during his address announced the progress made with the IMF when he stated: “Towards this end we have already undertaken major macroeconomic policy reform measures. I am pleased to inform you that we have now reached a Staff Level agreement with the International Monetary Fund on a four-year program supported by the Extended Fund Facility. The program is aligned with the commitment of the Government to implement an ambitious and comprehensive package of reforms that will help restore the sustainability of our public finances, addressing external imbalances, and restarting our growth engine through structural reforms and improvements in governance”.

The question addressed below is the need for Sri Lanka to explore alternative strategies in the event Sri Lanka fails to reach a common agreement with the creditors despite the Staff-Level Agreement reached with the IMF, and Sri Lanka is left to its own devices to get back on a sustainable track. For these reasons, it is imperative that Sri Lanka engage earnestly in an alternative exercise to be prepared to meet unexpected exigencies that could arise from geopolitical rivalries.

IMF CONDITIONALITIES

Presented below is a press release issued following the Staff-Level Agreement reached with the IMF team. Parts of the “Key elements of the program” are highlighted to emphasise what it takes for Sri Lanka to comply with the 48-month arrangement under the Extended Fund Facility of about US $ 2.9 billion”

End-of-Mission press releases include statements of IMF staff teams that convey preliminary findings after a visit to a country. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF’s Executive Board for discussion and decision.

IMF staff and the Sri Lankan authorities have reached a staff-level agreement to support Sri Lanka’s economic policies with a 48-month arrangement under the Extended Fund Facility (EFF) of about US$2.9 billion.

The objectives of Sri Lanka’s new Fund-supported program are to restore macroeconomic stability and debt sustainability, while safeguarding financial stability, protecting the vulnerable, and stepping up structural reforms to address corruption vulnerabilities and unlock Sri Lanka’s growth potential.

Debt relief from Sri Lanka’s creditors and additional financing from multilateral partners will be required to help ensure debt sustainability and close financing gaps. Financing assurances to restore debt sustainability from Sri Lanka’s official creditors and making a good faith effort to reach a collaborative agreement with private creditors are crucial before the IMF can provide financial support to Sri Lanka.

Key elements of the program (emphasis mine) are:

RAISING FISCAL REVENUE TO SUPPORT FISCAL CONSOLIDATION.

Starting from one of the lowest revenue levels in the world, the program will implement major tax reforms. THESE REFORMS INCLUDE MAKING PERSONAL INCOME TAX MORE PROGRESSIVE AND BROADENING THE TAX BASE FOR CORPORATE INCOME TAX AND VAT. The program aims to reach a primary surplus of 2.3 percent of GDP by 2025.

INTRODUCING COST-RECOVERY BASED PRICING FOR FUEL AND ELECTRICITY

to minimize fiscal risks arising from state-owned enterprises. The team welcomed the authorities’ already announced substantial revenue measures and energy pricing reforms;

MITIGATING THE IMPACT OF THE CURRENT CRISIS ON THE POOR AND VULNERABLE BY RAISING SOCIAL SPENDING,

and improving the coverage and targeting of social safety net programs;

RESTORING PRICE STABILITY

through data-driven monetary policy action, fiscal consolidation, phasing out monetary financing, and stronger central bank autonomy that allow pursuing a flexible inflation targeting regime. A NEW CENTRAL BANK ACT IS A CORNERSTONE OF THIS STRATEGY;

REBUILDING FOREIGN RESERVES THROUGH RESTORING A MARKET-DETERMINED AND FLEXIBLE EXCHANGE RATE,

supported by the comprehensive policy package under the program;

Safeguarding financial stability by ensuring a healthy and adequately capitalized banking system, and by upgrading financial sector safety nets and regulatory standards with a revised Banking Act; and

REDUCING CORRUPTION VULNERABILITIES THROUGH IMPROVING FISCAL TRANSPARENCY AND PUBLIC FINANCIAL MANAGEMENT, INTRODUCING A STRONGER ANTI-CORRUPTION LEGAL FRAMEWORK, AND CONDUCTING AN IN-DEPTH GOVERNANCE DIAGNOSTIC, SUPPORTED BY IMF TECHNICAL ASSISTANCE.

These Key Elements of the program were known to the government at the time the Staff-Level Agreements was reached. It must then mean that the Sri Lankan government has agreed to commit itself to fulfilling the undertakings specified above to receive “about US$ 2.9 over 48 months to support its economic policies” notwithstanding the nature and range of its scope that amount to intrusion into the domestic affairs of a sovereign State. The other even more daunting challenge is reaching a common agreement on debt restructuring with countries such as Japan, India, China and private creditors. However, the fact that Sri Lanka is prepared to resolutely face such extreme challenges reflects the desperation Sri Lanka finds itself in at this juncture.

The question that arises and it is imperative that it is answered is: WHAT IF, after banking so heavily on support from the IMF for Sri Lanka’s economic revival, Sri Lank fails to meet the benchmarks and parameters set by the “key elements” in the IMF program or fails to reach a common agreement for debt restructuring with the creditors? Since such a prospect cannot be ruled out in a background of geopolitical rivalries, it is imperative that Sri Lanka prepare itself by seriously exploring alternative options independent of support from the sources currently being pursued. If Sri Lanka does not explore alternative options. its economic revival program would be severely impacted, and Sri Lanka would then be left to its own devices to meet all challenges.

THE FOCUS of the SURVIVAL STRATEGY

One key area that would impact on Sri Lanka’s economic revival program is the cost of fuel oil. A Special Press Release dated June 13, 2021by the Cost of Living Committee chaired by the President states: “Sri Lanka has become a country that not only spends a large amount of foreign exchange for fuel imports, but also a country where its transport services, power generation and the function of some of the factories are based on these imports. In 2019 alone, the foreign exchange spent on oil imports was US$ 3, 677 million”. However, with the reduction in international oil prices coupled with the ban on vehicle imports the cost of fuel imports was reduced to US$ 2,325″. DESPITE, SUCH FLUCTUATIONS, THE PRESS RELEASE STATES: “THE EXPENDITURE FROM THE FOREIGN EXCHANGE EARNINGS FOR PETROLEUM IMPORTS WOULD BE AROUND US$ 4,000 MILLION. THIS AMOUNT IS CLOSE to 1/3 of the TOTAL FOREIGN EXCHANGE EARNED FROM THE EXPORTS… THE PRIVATE AND PUBLIC TRANSPORTATION ACCOUNTS FOR NEARLY 60%OF THE FUEL CONSUMPTION”.

With the introduction of the QR system for transport and the continued ban on vehicle imports together with the fact that the cost of importing fuel oil is highly dependent on global developments, a more realistic import bill for fuel oil could be assumed to be US$ 2,500 to 3,000 million annually. This means that Sri Lanka would need US$ 10, 000 to 12,000 million over a period of 4 years. Since the Extended Fund Facility of about 2.9 Billion proposed by the IMF pales in significance to meet the fuel oil needs of Sri Lanka, and because fuel oil is fundamental to the economic revival program, it is imperative that Sri Lanka explores fresh strategies to meet fuel oil needs without which there would not be an economic recovery.

The following are the hard realities:

The economy cannot revive without sustained supplies of fuel oil.

Sri Lanka does not have the foreign exchange to sustain importing its fuel oil needs.

The economy cannot revive if Sri Lanka has to live from ship load to ship load, or on negotiated credit lines.

The Strategy:

Therefore, Sri Lanka has to negotiate a government to government arrangement or one that is underwritten by governments where the payment for immediate fuel oil needs is deferred to a later date, until a Refinery is set up and functioning on the basis of a Joint Venture. Furthermore, such a Joint Venture would enable Sri Lanka to repay deferred commitments from Sri Lanka’s share of the proceeds from the Joint Venture.

Savings arising by deferring payment while the refinery is being set up could be used to repay outstanding debts.

The Refinery should be located in Trincomalee.

The Capacity of the Refinery should be to meet Sri Lanka’s needs with the excess being exported to Indian Ocean Rim (IOR) countries.

Sri Lanka’s equity to the Joint Venture could be part of the Tank Farm in Trincomalee, its Harbour and its strategic location for distribution of finished petroleum products.

Equity of the Partner is the Refinery and the steady supply of fuel oil.

THE URGENCY of the SITUATION REQUIRES THAT SRI LANKA EXPLORES THIS OPTION at the HIGHEST LEVEL — an OPTION that is REFLECTIVE of the CORE VALUE of SELF-RELIANCE.

CONCLUSION

The Staff-Level agreement that Sri Lanka has reached with the IMF backed up by an Extended Fund Facility of about US$ 2.9 billion is expected to boost the confidence of the creditors and encourage them to be accommodative towards Sri Lanka in their efforts to reach a common restructuring arrangement to address its debts. If such a positive outcome materializes, the prospects of an economic revival would be real. On the other hand, if outcomes of the negotiations do NOT turn out to be as encouraging as hoped for, it is imperative that Sri Lanka prepares itself beforehand with alternative strategies, one of which would be to earnestly explore arrangements at the highest level to secure its fuel oil needs on the basis proposed above, if it hopes to revive its economy. If by a stroke of unusual good fortune, the outcomes relating to restructuring and a Joint venture to secure Sri Lanka’s fuel oil needs are both positive, the economic revival would be that much faster.