Since 1965 Sri Lanka has approached the IMF 16 times in its history, roughly about once in five years. We have approached the IMF on various issues such as tax structures, balance of payments, and so on. For the last 70 years Sri Lanka has been approaching the IMF and even post liberalisation since 1977, this has intensified.
We have been continuously talking about the twin deficit, the current account deficit and the fiscal deficit which have been discussed over the last 40 years. No one has addressed it. We have achieved some relevance in growth though it’s not great, on average a 4.7% growth during this period, nothing to feel proud of compared to other East Asian successful economies, who focused on manufacturing and production. Our capital formation is nothing great, about 22% on average. There have been blips where we have seen the capital formation jump up to 26% of GDP on two to three occasions. During the handful of occasions we can spot GDP growth of about 7% in 1969, 1973. Out of the six times the last four times Sri Lanka saw a GDP growth after the war.
With that growth story we have migrated to a middle income country. And do not have access to concessionary aid finance.
Therefore, accessibility to funding becomes a perennial problem given the continued widening of the trade deficit. To finance this gap you have to go into the financial markets. Trade deficit is the crux of the problem as it creates cash flow problems. The trade deficit needs to be looked at seriously if we are serious about 8% GDP growth, as we use all our current account cash flows/ resources to fund the $ 10 billion trade gap.
Looking at the debt portfolio, we have around $ 50 billion total debt. Roughly about $ 12.5 billion is our commercial debt, more so capital market debt, the others are all long-term multilateral and bilateral debt. This is not causing us anything, as they are technically long term, more than 10-20 years in tenure. And average interest rates are all manageable. It is the commercial debt that is causing us the problems, because it’s short-term and subject to credit ratings. It is refinanced every two to three years depending on how we float the bond to finance your trade and budget deficit. Like the trade deficit, the budget deficit is also a chronic problem for us. Our expenditures are relatively high, it’s not managed well. All governments have not managed it, nor does the private sector manage expenditure. Ultimately it’s passed on to the people.
Sri Lanka has missed out on global business cycles on two to three occasions where we could have reversed the budget deficit. In 2009 and 2016 and once again in 2020 we saw the global crude oil prices collapse. As we know the trade deficit is dependent on three to four big items. One of them is the crude oil bill, which is almost 20-25% of the import bill. When you have such a big ticket item on your balance sheet, as a risk manager you have to be proactive in managing that market risk, but we haven’t done that. We conveniently let oil prices rise and watch it pass us by, we cannot afford to let such costs be passed on or not be managed when the tools are there.
With the passing of such cost comes inflation which leads to a high upward sloping interest rate to compensate for the loss of purchasing power. Sri Lanka’s interest rates have mostly been in double digits and have cost the real economy dearly. Where are the foreign savings that we were supposed to get if the theory works well? If the real interest rates are high it has to attract foreign savings, which hasn’t happened. Sri Lanka’s FDI is a maximum of 1.5% of GDP on average, nothing much. Therefore, we must encourage our local businesses to increase profits which can be retained as they contribute to approx. 20% of capital formation, government 4-6% at best. Balance is FDI.
Also what happens when the interest rates remain high, is that domestic capital formation is negatively affected, capital formation is negatively affected, as the NPV (net present value of investments) new investments in production assets will not be viable now.
If Sri Lanka continues to go into this high interest rate binge there will be no technology brought in, no investment put in place, and our global production and products will never be competitive, this is as a result of high commodity price inflation being passed through to our cost of production. As the cost of inflation rises you have to depreciate the currency.
This is a vicious cycle again that the IMF brings. When the currency depreciates, inflation picks up once again. Not only that, the cost of USD balance sheet debt too increases, as your revenue is in rupees and the balance sheet debt is in dollars. Our balance sheet debt is approximately $ 50 billion, so each 1.0 rupee depreciation is Rs. 50 billion in additional funding that must be found to meet this expenditure, as the interest and capital has to be sourced from rupee financing. This tool of currency depreciation has been a typical IMF prescription used in all developing countries. Therefore, as a result the fiscal policy too remains relatively uncompetitive. How can we give incentives for domestic investment or investors, with this chronic fiscal condition?
In 2015, when we went into a programme with the IMF, they advocated a similar scenario. The IMF said “hands off the exchange rate and let it free float”. When you have a balance sheet debt in dollars and you free float the currency you are asking for trouble. It will come back to bite you because you have to finance it via more external borrowings. So, if you depreciate the currency your entire input raw material cost structure, transport, energy, packaging costs rises across the board, causing incremental inflation. Do you think we will remain competitive in exports? It has not happened over the many years despite a 8% average depreciation.
Sri Lanka has to revisit its “profit story” only through making the country’s exports, in the manufacturing and production sector (i.e. industrialisation), competitive so that this can be achieved, not services, as we have seen now. It’s not by going to the IMF. As we have seen across all countries that go to the IMF who tell you to depreciate the currency, increase the interest rates in the financial market, hands off reserves, this sounds good, these are all extremely dangerous prescriptions.
Globally too the IMF has done the same thing. All developing countries that have sought IMF assistance have not prospered. These are destructive policies the IMF brings into countries read (Nobel winner’s) Jeffry Sachs and Joseph Stiglitz who have openly criticised the IMF policies adopted in developing countries (even Cambridge economist Prof. Ha Joon Chang). IMF policies are known to make sure that competitiveness of countries erodes and are pushed into deeper debts. Is that something we are looking for as advice? Don’t we have the brains in Sri Lanka to get our own balance sheet restructured?
To me, the trigger point is your trade deficit. It will always remain a deficit, if you don’t adjust your structural problems via scrutinising your national cost structures. Ask the question, how do we make Sri Lanka profitable and compete? It’s not labour cost alone, but import raw material cost, transport cost, energy cost, packaging cost.
All this adds to the final product. Increasing labour productivity alone is of no use. If the manufactured output is not priced properly, you can’t sell it. It will eventually become bad debt on your balance sheet. As it will remain as inventory and it will not be sold, ultimately you have to write off that inventory. Finally you will have to take a capital loss on your balance sheet.
The core point is how do we look at making Sri Lanka profitable? How do we restructure this economy to ensure that our fiscal policy is right? Our borrowing costs are at the right price, and how do we ensure macroeconomic stability in the long run is achieved, and not in the short run. In the short run, there can be a few blips, concerns, and cash flow issues. The cash flow issues can be addressed as there are enough financial tools out there. There is enough multilateral and bilateral funding that we can access from our largest trading partners.
That is what Sri Lanka has to do, and what is being done now. Revisiting the IMF now is going to be at the cost of businesses. The country has seen this cycle repeat itself for the last so many years from 1965 i.e. 16 times. If we did all what the IMF said through multiple governments, and multiple programmes given to us, couldn’t we have gotten our act right by now? It’s a shame for us to go back for the seventeenth time.
The writer is a member of the Monetary Board of the Central Bank of Sri Lanka and Chairman of LankaClear
………………………………
The views and opinions expressed in this article are those of the author, and do not necessarily reflect those of this publication.The dangers of going to the IMF
07 Mar 2022
The dangers of going to the IMF
07 Mar 2022
Since 1965 Sri Lanka has approached the IMF 16 times in its history, roughly about once in five years. We have approached the IMF on various issues such as tax structures, balance of payments, and so on. For the last 70 years Sri Lanka has been approaching the IMF and even post liberalisation since 1977, this has intensified.
We have been continuously talking about the twin deficit, the current account deficit and the fiscal deficit which have been discussed over the last 40 years. No one has addressed it. We have achieved some relevance in growth though it’s not great, on average a 4.7% growth during this period, nothing to feel proud of compared to other East Asian successful economies, who focused on manufacturing and production. Our capital formation is nothing great, about 22% on average. There have been blips where we have seen the capital formation jump up to 26% of GDP on two to three occasions. During the handful of occasions we can spot GDP growth of about 7% in 1969, 1973. Out of the six times the last four times Sri Lanka saw a GDP growth after the war.
With that growth story we have migrated to a middle income country. And do not have access to concessionary aid finance.
Therefore, accessibility to funding becomes a perennial problem given the continued widening of the trade deficit. To finance this gap you have to go into the financial markets. Trade deficit is the crux of the problem as it creates cash flow problems. The trade deficit needs to be looked at seriously if we are serious about 8% GDP growth, as we use all our current account cash flows/ resources to fund the $ 10 billion trade gap.
Looking at the debt portfolio, we have around $ 50 billion total debt. Roughly about $ 12.5 billion is our commercial debt, more so capital market debt, the others are all long-term multilateral and bilateral debt. This is not causing us anything, as they are technically long term, more than 10-20 years in tenure. And average interest rates are all manageable. It is the commercial debt that is causing us the problems, because it’s short-term and subject to credit ratings. It is refinanced every two to three years depending on how we float the bond to finance your trade and budget deficit. Like the trade deficit, the budget deficit is also a chronic problem for us. Our expenditures are relatively high, it’s not managed well. All governments have not managed it, nor does the private sector manage expenditure. Ultimately it’s passed on to the people.
Sri Lanka has missed out on global business cycles on two to three occasions where we could have reversed the budget deficit. In 2009 and 2016 and once again in 2020 we saw the global crude oil prices collapse. As we know the trade deficit is dependent on three to four big items. One of them is the crude oil bill, which is almost 20-25% of the import bill. When you have such a big ticket item on your balance sheet, as a risk manager you have to be proactive in managing that market risk, but we haven’t done that. We conveniently let oil prices rise and watch it pass us by, we cannot afford to let such costs be passed on or not be managed when the tools are there.
With the passing of such cost comes inflation which leads to a high upward sloping interest rate to compensate for the loss of purchasing power. Sri Lanka’s interest rates have mostly been in double digits and have cost the real economy dearly. Where are the foreign savings that we were supposed to get if the theory works well? If the real interest rates are high it has to attract foreign savings, which hasn’t happened. Sri Lanka’s FDI is a maximum of 1.5% of GDP on average, nothing much. Therefore, we must encourage our local businesses to increase profits which can be retained as they contribute to approx. 20% of capital formation, government 4-6% at best. Balance is FDI.
Also what happens when the interest rates remain high, is that domestic capital formation is negatively affected, capital formation is negatively affected, as the NPV (net present value of investments) new investments in production assets will not be viable now.
If Sri Lanka continues to go into this high interest rate binge there will be no technology brought in, no investment put in place, and our global production and products will never be competitive, this is as a result of high commodity price inflation being passed through to our cost of production. As the cost of inflation rises you have to depreciate the currency.
This is a vicious cycle again that the IMF brings. When the currency depreciates, inflation picks up once again. Not only that, the cost of USD balance sheet debt too increases, as your revenue is in rupees and the balance sheet debt is in dollars. Our balance sheet debt is approximately $ 50 billion, so each 1.0 rupee depreciation is Rs. 50 billion in additional funding that must be found to meet this expenditure, as the interest and capital has to be sourced from rupee financing. This tool of currency depreciation has been a typical IMF prescription used in all developing countries. Therefore, as a result the fiscal policy too remains relatively uncompetitive. How can we give incentives for domestic investment or investors, with this chronic fiscal condition?
In 2015, when we went into a programme with the IMF, they advocated a similar scenario. The IMF said “hands off the exchange rate and let it free float”. When you have a balance sheet debt in dollars and you free float the currency you are asking for trouble. It will come back to bite you because you have to finance it via more external borrowings. So, if you depreciate the currency your entire input raw material cost structure, transport, energy, packaging costs rises across the board, causing incremental inflation. Do you think we will remain competitive in exports? It has not happened over the many years despite a 8% average depreciation.
Sri Lanka has to revisit its “profit story” only through making the country’s exports, in the manufacturing and production sector (i.e. industrialisation), competitive so that this can be achieved, not services, as we have seen now. It’s not by going to the IMF. As we have seen across all countries that go to the IMF who tell you to depreciate the currency, increase the interest rates in the financial market, hands off reserves, this sounds good, these are all extremely dangerous prescriptions.
Globally too the IMF has done the same thing. All developing countries that have sought IMF assistance have not prospered. These are destructive policies the IMF brings into countries read (Nobel winner’s) Jeffry Sachs and Joseph Stiglitz who have openly criticised the IMF policies adopted in developing countries (even Cambridge economist Prof. Ha Joon Chang). IMF policies are known to make sure that competitiveness of countries erodes and are pushed into deeper debts. Is that something we are looking for as advice? Don’t we have the brains in Sri Lanka to get our own balance sheet restructured?
To me, the trigger point is your trade deficit. It will always remain a deficit, if you don’t adjust your structural problems via scrutinising your national cost structures. Ask the question, how do we make Sri Lanka profitable and compete? It’s not labour cost alone, but import raw material cost, transport cost, energy cost, packaging cost.
All this adds to the final product. Increasing labour productivity alone is of no use. If the manufactured output is not priced properly, you can’t sell it. It will eventually become bad debt on your balance sheet. As it will remain as inventory and it will not be sold, ultimately you have to write off that inventory. Finally you will have to take a capital loss on your balance sheet.
The core point is how do we look at making Sri Lanka profitable? How do we restructure this economy to ensure that our fiscal policy is right? Our borrowing costs are at the right price, and how do we ensure macroeconomic stability in the long run is achieved, and not in the short run. In the short run, there can be a few blips, concerns, and cash flow issues. The cash flow issues can be addressed as there are enough financial tools out there. There is enough multilateral and bilateral funding that we can access from our largest trading partners.
That is what Sri Lanka has to do, and what is being done now. Revisiting the IMF now is going to be at the cost of businesses. The country has seen this cycle repeat itself for the last so many years from 1965 i.e. 16 times. If we did all what the IMF said through multiple governments, and multiple programmes given to us, couldn’t we have gotten our act right by now? It’s a shame for us to go back for the seventeenth time.
The writer is a member of the Monetary Board of the Central Bank of Sri Lanka and Chairman of LankaClear
………………………………
The views and opinions expressed in this article are those of the author, and do not necessarily reflect those of this publication.Kapruka
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Discover Kapruka, the leading online shopping platform in Sri Lanka, where you can conveniently send Gifts and Flowers to your loved ones for any event. Explore a wide range of popular Shopping Categories on Kapruka, including Toys, Groceries, Electronics, Birthday Cakes, Fruits, Chocolates, Automobile, Mother and Baby Products, Clothing, and Fashion. Additionally, Kapruka offers unique online services like Money Remittance, Astrology, Medicine Delivery, and access to over 700 Top Brands. Also If you’re interested in selling with Kapruka, Partner Central by Kapruka is the best solution to start with. Moreover, through Kapruka Global Shop, you can also enjoy the convenience of purchasing products from renowned platforms like Amazon and eBay and have them delivered to Sri Lanka.Send love straight to their heart this Valentine's with our thoughtful gifts!