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A national government for economic recovery

10 Apr 2022

BY Dr. Ramani Gunatilaka and Prof. Sunil Chandrasiri “Stand not upon the order of your going, but go at once.” – William Shakespeare, Macbeth, Act II, Scene IV Our current economic meltdown could have been predicted by a second-year undergraduate in economics. But most laypeople, even the best educated, cannot understand how we got into this mess. As for those who ran our economy over most of the last two decades, they seem to have understood it the least. It is really very simple. If you borrow money, you must make sure that you spend it on doing something that will earn enough for you to pay it back when it becomes due. If your creditors see that you have not done that, then they will not give you any more loans. By end of 2018, Sri Lanka’s creditors knew that our exports were not growing enough to pay back our loans. Then the Easter bombings of 2019 gutted our US dollar-generating tourism sector and economic growth plummeted. The Government elected in 2019 reduced taxes, thinking to grow an economy that was not held back by taxes but by structural constraints such as a poor investment climate, high budget deficits, skills shortages, technological backwardness, and the highest electricity tariffs in the region. Growth did not materialise, and Government revenue shrank by 25%. The credit rating agencies then knew for sure that we would not be meeting our debt repayments and immediately downgraded Sri Lanka’s credit rating. That made it impossible for us to get any more commercial loans to pay back what we had already borrowed. Until then, we had merrily rolled the loans over when the payments became due.  Then Covid-19 hit. Our foreign exchange earnings (exports, tourism, and remittances) plunged further. But instead of doing what was needed to generate the funds to repay and grow out of the crisis, the Government pretended that you only needed the same number of Sri Lankan rupees as was needed before, to buy a US dollar. It burned up our US dollar reserves to maintain this pretence and there was even less foreign exchange to pay our creditors and finance essential imports.  A bad situation became much worse when the Government banned the importation of agrochemicals to go organic in mid-2021, against the advice of all those who knew anything about it. Earlier, when Covid-19 had decimated businesses and caused job losses in the manufacturing and services sectors and reduced incomes, many people had moved back to agriculture for sustenance. But the Government’s fertiliser policy destroyed even that safety net and made food more expensive for those whose incomes had already been hit. When the Maha harvest failed and prices soared by the end of that year, the Government scrambled around for lines of credit from friendly countries to buy essentials. In January 2022, Sri Lanka ran down its foreign reserves further to pay up a large chunk of debt repayments that were due, against the advice of many economists who recommended that debt be restructured in order to ensure uninterrupted supplies of essentials to a population badly hit by Covid-19 and other man-made shocks. Paying the debt that was due left little foreign exchange with which to buy milk powder, gas, diesel, medicines, and equipment. Banks would not open letters of credit (LCs) for imports when they knew that we would not have the US dollars to pay for them. Without diesel, we cannot run our thermal power generators. Without power, our factories and businesses cannot operate. Our export industries are operating below capacity and we are earning even fewer US dollars. Our exports are losing the market share to competitors. Gas and diesel shortages have stymied the recovery of the tourism sector, so there is little hope of US dollars coming from that sector either. As for the impact on households and families – food prices have soared, there is no diesel to generate income, no gas to cook with, and no lights to eat by. People are forced to spend the time they would have otherwise spent on productive work, standing in queues for essentials. Children who were out of school during Covid-19 and the lockdowns can now go to school only when petrol or diesel has been queued for and obtained. When children cannot learn, it affects not only their future but all of ours as well. Our population is ageing, and we need skilled and productive young people to enter the workforce so that they can earn more to help look after us in our old age, and them in theirs. Instead, this man-made disaster is forcing young people to migrate, leaving more and more old people at home, and the country, without the skilled and unskilled workers needed to resuscitate the economy. So, what needs to be done in this catastrophe? First, we need to restructure our debt so that we can postpone the payment of $ 1 billion in debt repayments due in July of this year. Our creditors will agree to do that only if they can trust us to implement the policies needed to ensure that we will eventually pay them back. They will not restructure our debt if the architects of the disastrous economic situation we find ourselves in, are still in the saddle and are tasked with getting us out of it. Would you do so, in their shoes? Besides, since our poor record of economic mismanagement is there for all to see, creditors will not believe us even if we say that we will change our ways.  We need to restore our creditors’ confidence in our ability to grow our economy and generate the foreign exchange to pay them back. Creditors will agree to restructure debt only if we can get the International Monetary Fund (IMF) as a kind of guarantor and sign an agreement promising to undertake the necessary economic policy reforms. The IMF, in turn, will ask us to make a “down payment” in confidence-building measures by undertaking key stabilisation measures first, like devaluing the Sri Lankan rupee, increasing government revenue, and reducing expenditure. We need to show them that we are convinced and firmly committed to reform and that we will do the necessary adjustment. After that, they will offer us balance of payments (BoP)-related support, but in tranches, in return for further adjustment measures. When the exchange rate reflects the true value of the Sri Lankan rupee with devaluation, then exports will become cheaper and more will be demanded; and imports will become more expensive and less will be demanded. This will help balance our external payments. In this way, we divert expenditure towards the production of exports and away from the consumption of imports. This is how Germany grew after World War II to become the economic powerhouse it is now. China has also long maintained an undervalued exchange rate for the same reason. We will also be required to eliminate wasteful government expenditure on inefficient US dollar-guzzling government-owned businesses like the Central Electricity Board (CEB), the Ceylon Petroleum Corporation (CPC), and the SriLankan Airlines. We will need to raise government revenue by reversing the disastrous tax breaks granted in 2019 for the benefit of the rich. We also need to come up with a social safety net programme to help the poor. Friendly countries and international organisations may help cushion the people’s hardship with food, medicines, and other aid and their assistance need to be sought. This part of the adjustment is called stabilisation, and it is extremely painful. But this is the only way to crawl out of this self-created economic sinkhole. If we do not stabilise, the situation will only get worse.  After the initial stabilisation, there will be a period of structural adjustment in order to make sure that the external balance achieved through stabilisation measures is maintained. Structural adjustment involves economic policy reforms needed to ease the structural constraints on economic growth, the removal of which will enable the economy to grow and create decent jobs. These are measures that will help grow and diversify exports such as increasing skills, facilitating digitalisation, and the adoption of advanced technologies and attracting foreign direct investment (FDI). The reforms will be targeted at accelerating growth in productive sectors where we have the potential to compete with other producers. In a population that is rapidly ageing and in a country from which young people are migrating in droves, the reforms will have to enable women and young people to enter the labour market even to undertake part-time work with flexible working hours, through appropriate legal reforms. If well managed, we may eventually be able to attract back the young people who fled the ongoing crisis, but this will take time and effort. Structural adjustment needs to be managed by a team of technocrats in key government institutions such as the Finance Ministry and the Central Bank of Sri Lanka (CBSL). They need to have the confidence of the international financial markets, as the team which implemented Sri Lanka’s last stabilisation programme in 2016-2017 did. They need to be chosen for their competence and unquestionable integrity and not because of their political affiliation and connections. The technocratic team needs to make decisions that are in the interests of all Sri Lankans, not just for the benefit of a ruling party that only wants to win the next election and uses the machinery of the government to provide patronage at the expense of the people, to relatives, friends, and selected businesses.  The team of technocrats can be supported by a team of advisers who know what they are about. They must be trained economists. We have many eminent Sri Lankan economists who have served in international organisations and internationally acclaimed universities who can help support the policymaking process.  Most importantly, we need a national government that will bring together talents across the political party spectrum to lead us out of the economic abyss. The national government needs to manage adjustment and recovery until the elections, due in two or three years, deliver a government with a democratic mandate to lead the country thereafter. An orderly transition is essential. The President needs to step back and use his powers to appoint such a government in order to safeguard our future. In the 1950s, Prof. Joan Robinson of Cambridge University is supposed to have said that Sri Lankans ate the fruit before they grew the tree. What we really did was live on other countries’ resources through concessionary finance when we were a poor country, and then borrow funds from our children when we became a middle-income country. Meanwhile, our toxic political system and politicised public institutions ensured that the politically connected grabbed most of the fruits and distributed bits and pieces to the rest of us for votes and commissions and as unproductive transfers.  This needs to stop. We must demand that policymakers grow the tree, and the entire nation must help to nurture it. We need to wait patiently until it bears fruit and only then eat the fruit without wrecking the tree. This is our last chance to make sure that when we grow old, we will have fruit to eat and share with our children and grandchildren. Dr. Gunatilaka is a consultant, analysing labour markets and well-being in Sri Lanka and the region. Prof. Chandrasiri was the Head of the Colombo University’s Economics Department and the Dean of the same university’s Graduate Studies Faculty. ………………………………………………………………………….. The views and opinions expressed in this article are those of the authors, and do not necessarily reflect those of this publication.


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