Economic crisis: Lankan-born former World Bank expert advises President what to do
Warns that without a proper roadmap and restructuring, Lanka might end up like Lebanon
The advice of Sri Lanka born Dr Shantayanan ( Shantha) Devarajan, former Chief Economist of the World Bank for Asia, Africa, the Middle East and North Africa, was sought by President Gotabaya Rajapaksa on matters relating to the ongoing debt crisis in the country. He spent hours talking to him in Colombo.
Following suit was Opposition Leader Sajith Premadasa, who kept directing questions periodically besides having a meeting. Then came a meeting with members of the Tamil National Alliance.
Dr Devarajan is now Professor of the Practice of International Development at the Georgetown University in the United States. He answered questions posed by the Sunday Times on the present debt crisis in Sri Lanka.
Q - In your view, what is the status of the Sri Lankan economy?
The economy is extremely dire for two reasons. The country’s usable foreign exchange reserves are at an historic low ( estimated at about $ 800 million in end-January 2022) while debt service payments over the next few months amount to $ 2 billion, and $ 6.9 billion for the remainder of the year. Secondly, Sri Lanka’s debt is unsustainable. That is, with realistic projections of economic growth in the future, the government will not take in enough money to repay its debt. In short, the country is both illiquid and insolvent.
Q - Without course correction what would be the repercussions (including inflation, unemployment, shortages, public services etc.) you foresee with examples of other countries which were/are in similar circumstances?
Without course corrections, the country will suffer a hard default. It will be unable to meet its debt service obligations, at which point the country loses access to foreign exchange. This is what happened in Lebanon in 2020. The country had to compress imports by so much that GDP fell 20 percent in one year, inflation reached 150 percent, and the currency depreciated by 130 percent. Even more troubling, the harsh economic conditions have led to violence in the streets, with clashes among sectarian militias reminiscent of Lebanon’s civil war.
Q - In your view, apart from Covid19 pandemic causing shortages of foreign currency earnings through tourism and remittances from overseas employees, what are the other factors, perhaps poor decisions of this and past governments that have caused this situation?
The cut in value added taxes in 2019, several months before the pandemic struck, led to a drop in government revenues that, in turn, caused the rating agencies to downgrade Sri Lanka’s credit rating to near default levels. Sri Lanka could not rollover its sovereign bonds and had to pay for them out of reserves, contributing to the foreign exchange shortage today.
Other factors include the large number of loss-making state-owned enterprises, such as Sri Lankan Airlines, Ceylon Electricity Board, and Ceylon Petroleum
Corporation, which not only drain the Treasury but also led to an inefficient economy. Finally, the country’s low tax-toGDP ratio (9 percent—one of the world’s lowest) and large civil-service wage bill make it very difficult to use fiscal policy to stimulate growth.
Q - How will the war in Ukraine impact Sri Lanka?
The main impact of the war in Ukraine is the spike in world oil prices (over $100 per barrel as of February 28). This creates a dilemma for the Government. It cannot subsidise fuel any more, given the high fiscal deficit and serious debt situation. But it also cannot pass the higher price on to the consumers, who have already been suffering from the pandemic, recession, and recent food, fuel, and pharmaceutical shortages.
Q - If you were the Governor of the Central Bank of Sri Lanka now what will be your counsel to the Government and particularly to the Minister of Finance?
The Government should embark on a debt restructuring programme and request assistance from the International Monetary Fund (IMF). A debt restructuring is different from a default. Working with a financial advisor, the Government, with the collaboration of the IMF, brings the creditors together to work out a plan by which the country’s debt can be re-profiled, rescheduled and in some cases reduced to a level where Sri Lanka can pay it back. Many countries have done this. In many cases, the debt restructuring takes about six months, and the country regains access to capital markets soon thereafter.
The IMF can play two roles. First, it can undertake the analysis to determine the level of debt that Sri Lanka can repay. Having an institution with the reputation of the IMF do the analysis strengthens Sri Lanka’s bargaining position with the creditors. Secondly, once the debt restructuring is under way, Sri Lanka can negotiate a programme with the IMF. In other debt restructuring cases, having an IMF programme increased the investor confidence that the country’s fiscal stance was credible, and contributed to the country’s return to the capital markets. In addition, an IMF programme can generate added resources to the country—from the IMF, the World Bank, the Asian Development Bank, and bilateral partners.
Because Sri Lanka has let its reserves decline to such low levels before initiating a debt restructuring, it will need some bridge financing to cover the import bill during the restructuring process. Some of Sri Lanka’s traditional development partners could provide this financing. The chances of their doing so will be greater if Sri Lanka has embarked on a restructuring programme in collaboration with the IMF, providing confidence that the country will emerge with a sustainable debt.
Q - Some argue that Sri Lanka should consider even defaulting on sovereign debt rather than placing the people of Sri Lanka through such unbearable burden, whilst restructuring and renegotiating debt repayments. In your considered opinion, should we? What may be the consequences? Please elaborate.
Sri Lanka should avoid a hard default. But it should undertake a debt restructuring, as outlined above, to reduce the size of its debt service payments and hence relieve some of the severe burden on the people caused by paying the full debt service.
In 2010, Jamaica had a debt-to-GDP ratio of 124 percent and debt service costs were 112 percent of government revenues. It initiated a debt restructuring (called a “pre-default debt exchange”), which led to a 20 percent reduction in the present value of the debt. The fiscal savings amounted to 3.5 percent of GDP. While Jamaica’s credit rating initially fell to “Selected Default”, it rose after restructuring. Ten months later, Jamaica issued a sovereign bond, which was oversubscribed.
Q - The Pathfinder Foundation says “The Road Map, presented by the Central Bank of Sri Lanka (CBSL), identified several potential sources of debt -- and non-debt-creating inflows to fill the external financing gap. The securitisation of remittance flows has been added to the menu of options recently. However, to date there has been an alarming depletion of external reserves and an inexorable increase in the external financing gap.” It further said, “If the anticipated inflows are not forthcoming in sufficient quantities to fill the external financing gap, there will be no option but to turn to the IMF to avoid further scarring of the economy and creating greater shortages of essential goods and services.” Do you agree? If so why?
I would rephrase it as “there will be no option but to undertake a debt restructuring and turn to the IMF.” The reason is that, if the country’s debt is unsustainable, the IMF cannot negotiate a programme. So, the country must initiate a programme of debt restructuring, with the appointment of a financial advisor, and then seek the IMF’s collaboration.
Q - “An IMF programme would impose significant burdens on the people.” Is this statement true? Will you please explain?
The statement is not true. The current situation, with the scarce foreign exchange causing cooking gas, powdered milk, and fuel shortages and power cuts, is imposing significant burdens on the people. A debt restructuring, combined with an IMF programme, can relieve that burden. The combination of lower debt service payments and new money from the IMF, World Bank, ADB, and bilaterals could leave the country with an additional $6 billion in foreign exchange, which could go a long way to purchasing much-needed imports.
The reason some people think the IMF “imposes significant burdens on them” is that most IMF programmes involve increases in taxes and cuts in public expenditures to reduce the fiscal deficit and make the debt sustainable. But Sri Lanka will need to undertake these tax increases and expenditure cuts anyway, to be able to negotiate a debt restructuring and avoid a hard default. The benefit of having an IMF programme is that the tax increases and expenditure cuts are accompanied by new money.
A recent independent evaluation of IMF programmes since 2009 found that countries that had IMF programmes grew faster and resumed their pre- crisis income levels earlier than similar countries without IMF programmes.
Q - India seems to be helping a lot during this crisis. How long can a neighbouring country help without Sri Lanka taking some fundamental decisions such as the possibility of IMF help on debt restructuring etc.? Also isn’t Sri Lanka further adding to its debt burden by keep borrowing more from India and others.
I don’t know enough to answer this question.
Q - In 1991, Indian foreign exchange was a fixed rate, it had import controls and had high Current Account Deficit (CAD) like Sri Lanka. In 1991 India had a major balance of payment crisis and only held foreign currency reserves sufficient for 15 days of imports. By 2004, it was USD 100bn and now it’s just shy of USD 650bn. The then Prime Minister P. V. Narasimha Rao appointed an economist (Dr Manmohan Singh) to run the Ministry of Finance without much political interference. They also had economists run their Central Bank (Reserve Bank of India). Don’t we need to take similar steps, if we were to recover faster and build a sustainable economy for the future?
The steps Sri Lanka needs to take to recover faster and build a sustainable economy are well known. The problem seems to be building a political consensus around these decisions. The statement by the opposition leaders in Parliament and some of the statements by cabinet ministers on debt restructuring and the IMF suggest that such a consensus is growing. Given the critical nature of the country’s finances, the time to act is now.