• Probably not enough faith for current Govt. to win an election
• Too early to comment on state of debt restructuring process
• IMF performance targets met and over-performed so far
• Tranche 2 delay likely if debt restructuring stalls completely
• Buy-in, trust important when implementing tough policies
• Sri Lanka’s debt-fuelled consumption cannot continue

“There’s probably more faith in the current administration than in the GR administration, although a lot of the faces are the same, but probably not enough faith that the current administration could win an election,” said Economist and Frontier Research Product Head Chayu Damsinghe, asserting that buy-in and trust were always important when putting tough policies in place – especially since it was otherwise easy to reverse such policies.

However, the fact that the earliest election that could change national policy would only be in late 2024 – though it could be called earlier – gives the administration some space to take some unpopular measures early on without seeing any electoral consequence and hope that by the time of the election, the benefits would have sufficiently accrued to prevent a reversal, he pointed out, in an interview with The Sunday Morning.

What matters most, according to Damsinghe, is the Government’s intention throughout this process, given that Sri Lanka’s economy over the years before the crisis has been driven by a debt-fuelled consumption boom as opposed to one caused by direct theft.

In the course of the interview, Damsinghe also spoke on Sri Lanka’s ongoing debt restructuring process, Sri Lanka’s position in relation to receiving the next tranche of the International Monetary Fund (IMF) Extended Fund Facility (EFF), and inflation and concluded with a Strengths, Weaknesses, Opportunities, and Threats (SWOT) analysis of Sri Lanka’s economy.

Following are excerpts of the interview:

How do you view Sri Lanka’s ongoing debt restructuring process? Is the Government showing strong progress? Where do things stand right now?

With regard to the external debt restructuring, it’s too early to really say. The Government could either speak to and arrive at some agreement with the bilaterals first or with the private creditors, but in practice this is a process that would take some time anyway. 

So far, it will be discussing different approaches, different priorities, and making some offers that could work for both sides. There’s no particularly strong deadline set up by the IMF yet, though it would likely need to see some progress by the next tranche and then some further progress closer to completion by the end of the year.

At this stage, I wouldn’t be expecting a lot anyway, just a positive approach from both sides – but over the next few months, if the approach looks antagonistic, I’d be worried.

What would you list as the implications of local debt restructuring and what kind of an impact will the debt restructuring process have on the local banking/financial sector?

On both of the above questions, due to covering the same work for clients in my work, I’m unable to talk publicly about it.

If International Sovereign Bond (ISB) holders do not agree to the debt restructuring programme, how should we proceed?

I think ‘ISB holders not agreeing’ is not how it will happen. In reality, there is no ‘this is what we’re doing, take it or leave it’ approach. What happens is a negotiation, where we’d talk to them and give an offer, they’d consider it and ask for changes, then we might consider those and give another offer, etc. Usually, as long as there’s no particular sticking point, this process ends positively with some sort of agreement, though it can get delayed. I think the possibility of a delay as these things get worked out definitely exists. 

What can be more of a sticking point is if there’s a particular point that either side is unwilling to budge on – for example, there’s some talk that the ISB holders might be looking at a GDP-linked bond and if that is something they are very strong on and we are very strongly against, that could be an issue that drags the negotiations.

In any case, however, neither side has an incentive to drag it on for long – Sri Lanka needs a resolution anyway to move forward and for the ISB holders, the longer the delay, the longer they have to hold bonds that have no return and could end up taking a larger cut subsequently due to the delay as well. Therefore, I think a delay into early next year is very possible, but years of delays seem quite unlikely.

What are the conditions we have to meet to get the next tranche of the IMF EFF and are we on track to realising them?

Some of the targets to be met are on particular policy measures that need to be put in place – for example, properly establishing the welfare scheme, implementing the Central Bank Bill, and a few more of this nature.

Beyond these, there are some performance targets to be reached – for example, on the primary deficit and the foreign reserves. So far, the legislative processes have been largely on track with maybe a few weeks of delay – but all happening in the end (so far at least).

The performance targets have definitely been met so far, and in fact been over-performed – so it seems quite likely that we’ll be able to meet those as well.

As I see it, the main thing that can delay the second tranche is whether the debt restructuring process, particularly with the bilaterals, stalls completely and we can’t show the IMF “here, we have a lot of progress on this side”.

We will have to show that progress; even without completing it, it will be essential for the programme to go ahead, in my view.

Do you see people’s buy-in for the required policy reforms? Do the people have faith in this Government? If not, what should be done to ensure this programme stays on track?

Well, I have no way to say if different people have faith in the Government for certain, but my assessment is that there’s probably more faith in the current administration than in the GR administration, although a lot of the faces are the same, but probably not enough faith that the current administration could win an election, for example.

Buy-in and trust are always important when putting tough policies in place, not only for democratic reasons, but particularly for the reason that it’s easy to reverse such policies otherwise.

The fact that the earliest election that can change national policy is only in late 2024 (though they can call it earlier, I think) gives the administration some space to take some unpopular measures early on without seeing any electoral consequence and hope that by the time of the election, the benefits of those have accrued enough to prevent a reversal. So from the point of view of the continuance of the policy reforms, there may still be space for them to continue.

For me, what matters most is the Government’s intention throughout this. Sri Lanka’s economy over the years before the crisis was very much one driven by a debt-fuelled consumption boom as opposed to one caused by direct theft, in my view, and if Sri Lanka is to change that into a different pathway, then whatever said and done, the same debt-fuelled consumption can’t happen.

However, since the economy for 10-15 years was driven by that pathway, there are so many people, firms, and industries which saw their own growth and livelihood benefit heavily from that debt-fuelled consumption pattern.

If I were to give one small example, the Sri Lankan urban ‘middle class’ who benefitted by having highly-subsidised fuel that made buying a car a reasonable financial decision benefitted from the debt-fuelled consumption story, even if they weren’t the ones who ‘created’ the model. 

The issue now is that by staying away and trying to prevent that debt-driven consumption story, everyone who previously benefited from that – even perfectly honest people who just happened to benefit – is affected and there’s plenty of them to oppose the reform.

I don’t personally think it’s realistically possible to have a reform agenda that is going to also make everyone happy, because by definition moving away from debt-fuelled consumption will mean those who benefitted from that will be hurt and there’s no way to both reform that model of the economy and keep the benefits of that model as well. 

In that context, I believe that what matters is whether the Government really intends to reform the model and whether it can stand up to the opposition against that model going away. 

It’s all politics in the end, but the driver of the politics, to me, is the underlying economics of the situation. For me, if the economics of the situation can’t be changed, then the Government has to communicate this necessity better – and that can always be done so much better.

The communication can’t be “I know this hurts, but I’ll give you your old life back too,” but something closer to “I know this hurts, but this is why we must do it despite the pain; this is why your pain will be worth it”. And it’s not just about saying it, but actually properly communicating and showing this to the people.

While inflation is dropping, this is not reflected on the ground and the public has seen no real relief in terms of the cost of living. Why is this and when can the people get some relief?

If we’re thinking of prices returning to pre-crisis levels, that will not happen and that is not something to ever expect. Once the economy has run on an unsustainable footing and has had to correct itself to a more realistic balance, we can’t return to the unsustainable level again, except, very simply, through a lot of new debt.

However, what will happen is that there will be some reductions in prices as some of the issues clear out and particularly the rapid increase in prices will slow down and then stop. Both of these are happening now – for example, we can see fuel prices having come down from their peaks and I would say that has been quite significant for people.

Inflation coming down has meant that the rate of change compared to last year is slower now, and this last month, prices overall fell as well. That particular change might not necessarily continue at the same rate, but the overall trajectory across this year should be that big further increases in prices are unlikely to happen and some prices should fall some more.

The relief is from both of these and the fact that, over time, the economy will grow to a level that people’s incomes will also rise, so that even though prices are higher, incomes are also higher than before.

Could you do a SWOT analysis of Sri Lanka’s economy as things stand right now?

Interesting question. I’ll say the main strengths that Sri Lanka has compared to other countries is that we have an easy export industry to grow quickly – tourism – and that (this may come as a surprise to many) we have relatively functional institutions and systems. I think these two factors will mean that the country is relatively resilient to shocks and can bounce back. 

In terms of weaknesses, the main thing would be the overall obsession with quick growth the country has – and that’s the number one weakness I see in Sri Lanka. Across the years, the people and the leaders have all looked for quick solutions that give quick growth to Sri Lanka and that inevitably leads to people voting for and taking decisions towards short-term unsustainable solutions. Right now, Sri Lanka doesn’t have the ability to take a short-term solution, but I do worry that once the situation stabilises enough, we’ll try to do the same.

In terms of opportunities, I think Sri Lanka’s proximity to India and sociocultural similarities is a great opportunity for the country to really boost our economic performance – trade with India, particularly for smaller businesses, could be a game changer that could really alter the trajectory of the country.

In terms of threats, I think the global economic environment is a main threat that could turn the wrong way and that could affect the country’s recovery prospects all around.

Fact box

Sri Lanka SWOT analysis

• Strengths: Tourism an easy export industry to grow quickly; relatively functional institutions and systems; country relatively resilient to shocks, can bounce back
• Weaknesses: Overall obsession with quick growth; people and leaders look for quick solutions, which leads to short-term unsustainable solutions
• Opportunities: Sri Lanka’s proximity to India and sociocultural similarities; could be a game changer and alter country’s trajectory
• Threats: Global economic environment a main threat that could turn the wrong way and affect country’s recovery prospects

Profile: Chayu Damsinghe

Economist Chayu Damsinghe is currently a Product Head at Frontier Research and works primarily with the Economics team. He plays a leading role in helping Frontier understand debt crises across the world and tying those into the Sri Lankan situation. 

He also heads work around understanding the Covid-19 pandemic and other black swan risks, and tying those into the macroeconomic stories of the country and takes a key role in the development of Frontier’s views on interest rates and the LKR and in the presentation of content to Frontier’s clients. Additionally, he handles work surrounding consumer demand and sales patterns in Sri Lanka along with the impact of global markets on the Sri Lankan economy.

Damsinghe also acts as an Executive Director for DaddysLanka Ltd., a family-run institute working in the field of special needs and mental healthcare.