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Avoiding a tsunami of debt

11 Apr 2022

  • Economists propose emergency measures to salvage SL's finances
BY Sumudu Chamara Sri Lanka’s present economic situation is such that the contribution of every party is crucial, and the Government, the authorities, and economists have a special role in addressing the situation. During the past few months, independent economists, as well as economists representing the Opposition parties, have been demanding immediate and concrete action from the Government to address the prevailing situation.  The key points they raised were improving exports, placing restrictions on non-essential imports, encouraging foreign currency inflows, discouraging non-official foreign currency transfer systems, curtailing the undisciplined printing of money, controlling inflation, and debt restructuring. Economic situation In such a context, last week, a group of independent economists put forward an emergency plan consisting of a series of proposals to address the prevailing economic crisis. Pointing out that Sri Lanka’s usable reserves have dropped to levels of about $ 150 million, and that acute shortages of essentials ranging from fuel to medicines have become prevalent, they said: “Increasing public discontent amidst increasing prices and shortages has led to large protests all across the country. The country has reached a position where it is unable to import essential fuel without the help of credit lines from bilateral partners. As the crisis reaches such depths, the Government and the administration have failed to come up with a credible economic plan capable of taking Sri Lanka out of a full blown economic collapse.” In this context, they urged the Government to take necessary steps to achieve the said outcome immediately, while key signatories of the emergency plan argued that a staff-level agreement with the International Monetary Fund (IMF) can establish market confidence and help unlock bridge financing. Macroeconomic risks  Macroeconomic risks were among key points discussed in the set of proposals, regarding which economists said that macroeconomic risks will continue to worsen if immediate action is not taken. They explained: “Sri Lanka has run dangerously low on foreign reserves, and faces the spectre of a ‘disorderly default’ on its debt obligations. Although a default may cause legal complications in debt restructuring negotiations and reputational damage for the future, much of the economic consequences of a sovereign default are already here.  “The country is already locked out of international debt markets and is unable to refinance its maturing debt or its current account deficit. The result is an acute shortage of foreign exchange that has led to power outages, shortages of cooking gas, fuel, medicines, and other basic necessities.  “With headline inflation based on the Colombo Consumer Price Index at 18.7% and food inflation at 30.2% as of March 2022, Sri Lankans are seeing the cost of goods spiralling upwards, and the value of their savings diminishing rapidly. Spiralling costs and wage demands are making it difficult to do business in particular for small and medium sized firms, who are struggling to survive.  “Long-term policy errors have become concentrated to a point that makes daily life very difficult. Most Sri Lankans are now facing more than 10 hours of power cuts per day, with no end in sight. This discontent is fuelling protests, as the authorities have thus far failed to put forward a credible plan to tackle the economic crisis. The economy is collapsing and people's livelihoods are being destroyed; therefore, the immediate objective should be to stem further collapse.” Emergency action plan The emergency action plan proposed by the economists – which they said requires the attention of Parliamentarians, activists, and civil society in order to take urgent steps to stem the economic decline – read that the immediate priority is to stop things from getting worse, and implementing policy changes that provide stability in the medium term. While emphasising this, they further pointed out that Sri Lanka has run out of foreign reserves and that its debt is no longer sustainable, and further that in this context, all independent analysis point to an inability to meet debt repayments, even leading up to the international sovereign bond of $ 1 billion maturing in July 2022. According to them, ill-conceived decisions to use scarce foreign reserves and over-reliance on short-term credit lines such as swaps have caused extreme damage to the domestic economy, and this, in turn, has aggravated the current shortages and pain felt by all Sri Lankans. The short-term objective, they said, is to stop the worsening situation by entering into negotiations with Sri Lanka’s creditors and building confidence in the overall currency and the economy. Urgent actions The group of economists presented 12 steps, which they said will help mitigate the prevailing economic situation, and should therefore be executed immediately. The first step was immediately appointing professional financial and legal advisors for debt restructuring. They said that these advisors will commence the external debt restructuring process. Ensuring that these advisors seek the creditors’ consent for the immediate standstill of external debt repayments was the second step, for which the rationale was: “To arrest the outflows from reserves and to preserve foreign exchange to pay for critical requirements of the economy such as fuel, food, and pharmaceuticals. Creditors will likely expect some visibility on progress in the negotiations with the IMF in order to agree to a standstill.” The rationale for the third step, i.e. expediting negotiations with the IMF, was explained thus: “A staff-level agreement with the IMF can establish market confidence and help unlock bridge financing. For the IMF to provide financial assistance to a country with unsustainable debt, IMF financing may proceed before a debt restructuring is completed if the member has taken credible steps towards completing the debt restructuring process in a way that will achieve debt sustainability.” The fourth step proposed by the economists was negotiating bridge financing with bilateral and multilateral partners. In this regard, they said: “Bridge financing will provide some inflows to the reserves and help build up foreign exchange to stabilise the economy. Early harvest in IMF negotiations may provide an opportunity to negotiate additional credit lines with bilateral partners to secure energy in the near term. Reaching out to the World Bank, the Asian Development Bank, and the governments of Japan, China, and India immediately, can establish the groundwork to draw down such financing as soon as an IMF staff-level agreement is in place. This can be utilised both for meeting essential imports as well as building the budgetary support necessary for such.” Appealing for emergency humanitarian aid from donor countries and organisations was listed as the fifth step, regarding which the economists said that this will help the most vulnerable population groups until bridge financing and other medium-term avenues can be opened up. Regarding the sixth step, i.e. increasing policy interest rates to establish positive benchmark real interest rates, the economists said that it would help control credit and import demand, control inflation-related expectations, and establish macroeconomic stability. As per the seventh step, i.e. rationalising non-essential Government expenditure and freeing up substantial fiscal space to provide support to vulnerable population groups, they said that it can help reprioritise capital expenditure on long-term projects such as roads and highways, as well as non-essential programme expenditures across all ministries. This is expected to create fiscal space for immediate priorities of social protection to vulnerable populations, freezing public sector recruitment altogether, freezing salary increases for a minimum of three years, and imposing hard budget constraints on state-owned enterprises (SOEs) by ceasing all non-essential capital and current transfers to SOEs. Providing cash transfers to vulnerable sections of the population was the eighth step. According to the economists, this can enhance the targeting of hitherto-excluded populations, and ensure the graduation of long-term beneficiaries.  “Transfers should be in the form of cash transfers directly to bank accounts or using mobile money. Lessons from the poor targeting and delivery of Covid-19-era welfare payments should not be repeated when designing this programme. Work already done to improve targeting and the efficacy of social safety nets can be utilized for this purpose,” they further explained. Enhancing Government revenue was the ninth key step the group of economists proposed. Under this step, they recommended mobilising revenue by restoring Value Added Tax rates and exemptions, as well as Inland Revenue Act provisions from pre-2019, and reintroducing the Pay As You Earn (PAYE) Tax and Withholding Taxes to improve cash flows to the Treasury. Gradually unwinding the Central Bank of Sri Lanka’s (CBSL) domestic balance sheet in a sequenced manner was the tenth step listed. The economists explained this step: “The CBSL holds Rs. 1,730 billion Government securities in its balance sheet and provides around Rs. 700 billion in market liquidity through the overnight-window Standing Lending Facility. The CBSL must take steps to gradually unwind its Government securities’ holdings in a carefully sequenced manner alongside market interest rate increases and foreign inflows. This would help anchor longer-term price stability in the market.” Proposing the introduction of a market-based pricing mechanism for the energy sector as the 11th step, the economists recommended implementing transparent, automatic, market-based energy pricing, and providing a legislative framework to create sustainability. They noted that the poorer sections of the society that will be affected by the price volatility need to be compensated using social protection mechanisms. The 12th step was protecting banking sector stability by avoiding domestic debt restructuring, regarding which it was noted: “The IMF indicates that Sri Lanka’s banks have preserved capital, liquidity, and earnings amidst the pandemic. Whilst banks have the capital buffers to withstand an external debt restructuring, a substantive domestic debt restructuring should be avoided by Sri Lanka’s negotiators.  “If domestic restructuring must take place, there are tried and tested tools to ensure systemic stability. For instance, domestic debt treatment could be limited to re-profiling, along with some regulatory forbearance, in order to minimise negative impacts on financial sector stability.” The plan also included several priority legislative reforms to build medium-term economic stability, and restore credibility and confidence in the governance of public finance and the country’s monetary policy. It added however that in order for such to be effective, these changes require broader changes in the governance structure, such as strengthening the independence of the Judiciary, the rule of law, and the necessary checks and balances for each branch of governance.   “This would inevitably mean constitutional reform that addresses these issues in order for these legal changes to serve their intended purpose,” it was stated. The proposals the economists put forward included reforms to the Monetary Law Act, the Fiscal Management (Responsibility) Act, and the Customs Act. Consensus on key economic reforms The economists identified current political instability as the main risk posed to macroeconomic stabilisation, and noted that political and policy stability is a necessary condition in order for economic stabilisation measures to succeed.  They explained: “During the fiscal adjustment, budget cuts need to be prioritised in a way that does not further burden vulnerable households already crippled by the current conditions. Any attempt to push through the reform programme without a clear and compelling articulation of the rationale, urgency, and expected outcomes, will be unwise.  “Ensuring that an agreement with the IMF can be eked out with political consensus, and as wide public acceptance as possible, is crucial. Political parties must come together to agree on a common programme to steer the economy out of the current crisis and towards macroeconomic stability.”  This consensus, they said, can then be extended to, and reinforced by, business chambers and think-tanks. Despite recommendations by many parties, the Government has not taken adequate and concrete steps in that regard, which, according to economists, can make the situation worse.  In fact, one of the priorities of those responsible for managing the economy should be preventing the worsening of the economic crisis. That is why urgent actions are necessary, while preparing for medium and long term steps.  

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