The road to economic recovery ahead is long, hard, and unavoidable

by Ravi Abeysuriya

 Talk to anyone waiting in a long queue to get fuel for daily living, the same set of emotions are apparent: lamenting about lost livelihoods, confusion about the mess we are in, fear and trepidation about an uncertain present and future, and anger at those responsible for the mismanagement of the economy.

 Along with those feelings come three questions. How did we get into this mess in the first place? What is debt restructuring and when will all this be over? and How do we get out of this crisis and who has to do what? The sense of uncertainty is almost physical. The answers will remain foggy for some time but let me attempt to briefly answer for all to understand.

 Looking back, but not in anger

 Start with Sri Lanka’s debt, especially its external debt. In 2000, exports of goods and services were 39 per cent of GDP; in 2020, they had declined to 20 per cent. Sri Lanka has faced a ‘twin deficit’ problem for decades: imports have consistently been higher than exports, and public expenditure has consistently been higher than revenues.

 The last 20 years is the story of a series of policy blunders reducing taxes and inefficiencies in tax collection, a bloated public sector, and unaffordable subsidies. Together, they drained the exchequer.

 On the external front, investing in ‘vanity’ and unproductive infrastructure projects, funded through foreign commercial borrowings at high interest rates to pay for them was the beginning of the external debt crisis, which only exacerbated thereafter due to infrastructure projects becoming a breeding ground for corruption.

 The 2016 IMF programme for a three-year $1.5 billion Extended Finance Facility (EFF) proposed a series of structural reforms to rebuild tax revenues and make Sri Lanka less reliant on foreign borrowing and an export-oriented economy and reduce the budget deficit. These included, tightening monetary policy, letting the currency float, and slashing food subsidies was suspended in November 2019 for a home-grown solution. As a result, those reforms were not implemented, plunging Sri Lanka into its latest crisis.

 Bad Politics, faulty policy exacerbated the situation

 Four more policy mistakes accelerated Sri Lanka’s descent into bankruptcy. What does bankruptcy mean; No financial institution is willing to extend any credit to Sri Lanka to import even the most essential medicine and fuel, leading to Sri Lanka degrading itself to a hand-to-mouth existence, having exhausted all foreign exchange reserves of the country.

 First, reducing taxes in November 2019, cost the Sri Lankan economy profoundly as concerns were raised about Sri Lanka’s debt sustainability, leading to the Credit Rating downgrades and resultant thwarting of the ability to tap global sovereign debt market for further foreign borrowings.

 Second, attempting to maintain a fixed exchange rate leading to a 52% reduction of worker remittances from a year ago (the only country to face a reduction of remittances). Approximately, USD 5 billion of the reserves was wasted to defend the Rupee, and another USD 500 million to repay foreign debt in January 2022 leading to a further depletion of meagre foreign reserves of the country.

 Third, the decision not to pre-emptively renegotiate debt restructuring with the IMF when the Covid-19 pandemic hit in 2020 while Sri Lanka’s debt was still sustainable. Lenders would have been willing for a more generous restructuring of debt, just as multilateral and bilateral lenders did in the wake of the tsunami in December 2004.

 Fourth, in 2021, a misguided and inappropriate policy to implement an outright ban on import of chemical fertilisers was imposed in the name of ‘import substitution’ to conserve foreign exchange reserves. This hit the tea industry and paddy crops, impacting Sri Lanka’s export crops, and forcing Sri Lanka to import food to fight hunger.

 Debt restructuring process will be tough and long drawn out

 So, what happens now? Sri Lanka had no choice but to approach the IMF again, for the 17th time. Since Sri Lanka has now defaulted on its debt, it does not meet debt sustainability criteria, obtaining a facility from IMF this time will be difficult, more long drawn out and accessing the IMF’s Rapid Financing Instrument is out.

 Negotiating a macroeconomic programme supported with IMF financing will be contingent on Sri Lanka undertaking accelerated structural reforms to achieve economic growth and debt sustainability. The process will require arriving at a debt restructuring agreement with bondholders, and then with Multilateral Financial Institutions (MFIs) and other bilateral borrowers. Given past failures for Sri Lanka to keep its word, they will be tougher this time.

 The first stage is to reach a Staff Level Agreement (SLA) with IMF and thereafter, seek the IMF executive board approval for an Extended Fund Facility (EFF). EFF will be further supported by World Bank and ADB and friendly countries such as Japan, USA and the European Union. The earliest we could expect some funding is in 2023 and country to get back to some normalcy by 2026.

 A System Change is required, all citizens will have to play their part

 The people of Sri Lanka have completely lost confidence and trust in the Government’s ability to resolve the crisis. The People’s struggle “Aragalaya” will only intensify. Their demands are well justified. A “System Change” is required and those responsible must leave and an all-party interim Government needs to be established. Further, it is imperative to have a general election as soon as possible for a more competent and honest set of professionals to be appointed to properly govern the country. The costs associated with having a General Election pale into insignificance compared to the massive costs of running an incompetent government. Perhaps, donor countries should give a grant of USD 20 million to hold a general election.

 What do we have to do? Sri Lanka needs a credible national policy and a plan agreed by all those who have the best interest of the Country at heart to get the country out of the crisis. The plan or reform agenda should comprise eight core focus areas. Win the credibility for the plan with IMF, that Sri Lanka is on the path to economic recovery and get the EFF facility. This is the only hope, there is no other alternative.First, Sri Lanka must stem the widespread bribery and corruption with harsh penalties, similar to penalties in countries such as Singapore. No donor or Sri Lankan expat wants to see their help to the people being scammed by the unscrupulous politicians and Government officials.

 Second, government expenditure must be curtailed, the burden imposed on the people of loss-making State-Owned-Enterprises (SOE) must be removed. One option would be to restructure and list all SOEs in the Colombo Stock Exchange for better governance and accountability of SOEs. It is time, the public change their misguided mindset and realise the futility of SOEs that are sustained for the ultimate benefit of politicians such as Sri Lankan Airlines where the public had to bear Rs. 372 billion of losses since 2008. The Ceylon Petroleum Corporation (CPC) operating loss, despite price increases is Rs. 64.9 billion in the first four months of 2022.

Third, Sri Lanka will have to live within its means; The government cannot simply print money, to provide relentless relief “Sahana” to the people and continue to be a welfare state. People should pay at least the cost for Government services and utilities. All spending must be carefully thought through and planned and public spending on infrastructure should only be on projects that would generate income to pay back debt. Financial discipline of the state is imperative manage the fiscal deficit.Fourth, the government revenue at 8% of GDP remains one of the lowest in the world. The tax system will have to be overhauled to widen the tax net to increase government revenue.

 Fifth, Sri Lanka should refocus on a major tourism drive to attract more tourists. In 2018, Sri Lanka Tourism generated receipts worth USD 4.5 billion, which can be swiftly achieved and surpassed. Further, a massive export drive to make Sri Lanka an export-oriented economy like Vietnam is essential (Sri Lanka’s exports grew by only 1.2 times whereas Vietnam’s exports grew over three times and Bangladesh 2 times during the period 2011 to 2021). We have an untapped opportunity in value-creating exports such as Graphite, crystal and Mineral Sand that can easily reach over USD 500 million per month. Attracting FDIs and adding even greater value should be encouraged with the appropriate policies to prioritize foreign-exchange-earning manufacturing industries, agriculture, and service exports.

 Sixth, a well-designed, and properly targeted social safety net will be crucial to protect the most vulnerable and provide for them adequately, but only for as long as necessary.Seventh, despite the hardship and the pain that comes from austerity, Sri Lanka, its people, and its government – the executive and all parties in parliament must stay committed to the agreed upon reform agenda for the next ten years. Repeating the mistakes of the past is unaffordable and will inflict pain upon the generations to come.

 Eight, the public is expecting restitution and those who brought economic ruin and robbed the country to be held accountable for their actions and prosecuted in a court of law also funds misappropriated to be brought back.

 As the famous words of President John F. Kennedy’s “Ask not what your country can do for you, ask what you can do for your country”. It’s vital that all Sri Lankan’s be smart at the next general election and send the right people irrespective of their party affiliation to the parliament to Govern the Country and not repeat the mistakes of the past 74 years.

(The writer is a Member of the Disciplinary Review Council of the CFA Institute, USA and Advocacy Chair and Board Director of CFA Society Sri Lanka and functioned as a member of the Code of Conduct Review Committee (CoCRC) of the Central Bank of Sri Lanka 2020-2021 and can be reached at abeysuriya@hotmail.com)