Sri Lanka has no room to manoeuvre: A Pathfinder Perspective

The Government has spoken of both Rupee and Dollar shortages. The severity of these problems is reflected in the following startling data points:

On the lack of Rupees (or fiscal space) for the government, interest payments alone account for over 70% of revenue. This is possibly the highest in the world. In addition, salaries and pensions account for over 90% of revenue. So, interest and salaries/pensions together amount to over 160% of revenue. It is hardly surprising, therefore that the Central Bank’s net credit to government (money printing) amounts to Rs. 1.1 trillion as at November 2021. This vast amount of money printing inevitably fuels inflation; exerts pressure on the balance of payments by boosting imports; and undermines exchange rate stability.

As for the Dollar illiquidity, net foreign assets of the Central Bank recorded a deficit of $1.6 billion as at the end of November 2021. The net foreign assets of the total banking system amounted to a deficit of US$ 4.1 billion. This explains vividly the cause of the large-scale scarring of the economy that is arising from the massive shortage of dollars. Turning this around will require radical action, including a debt restructuring and decisive measures to attract foreign inflows.

The consequences of these twin problems have already been severe. Inflation, particularly food inflation, has been rising sharply. There have been shortages in food items, including milk food; fuel; gas; and medicines. There is also a rampant black market in foreign exchange. Businesses have collapsed and livelihoods have been lost.

The Pathfinder Foundation in its previous articles has urged that immediate priority be given to: (1) restructuring external debt; (2) negotiating an arrangement with the IMF; and (3) mobilising bridging finance to meet the external financing gap in the next six months.

A debt re-structuring will provide breathing space to stabilise the economy. An IMF arrangement can catalyze much needed foreign exchange both directly from multilateral institutions and some bilateral donors; and indirectly by increasing confidence among investors and creditors. The bridging finance is necessary to fund essential imports and meet immediate obligations until the negotiations on the debt re-structuring and the IMF programme are completed.

The package of relief from India that is now expected is an encouraging beginning in terms of a bridging arrangement. However, it will only buy a couple of months’ time. This positive initiative needs to be supplemented by negotiating support from other friendly countries, including Japan, to obtain bridging finance that would be required during the time it takes to negotiate a debt restructuring and an IMF programme (about six months).

Action on all three fronts identified above needs to be initiated immediately to stem the ever-deepening crisis and support sustainable recovery.

This is A Pathfinder Perspective issued by the Pathfinder Foundation and can be viewed on https://pathfinderfoundation.org/ Readers’ comments via email to pm@pathfinderfoundation.org are welcome.