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Economic and financial crisis: Sri Lankan economy in dire straits: Professor Devarajan

  • Urgent need for managed debt restructuring
  • Fiscal reforms needed to make debt sustainable
  • Calls for increased taxation to build Govt. revenue
  • Devaluing rupee without credible fiscal programme may lead to speculation

Intro

Sri Lanka urgently needs to seek managed debt restructuring and a credible fiscal reform to make national debt sustainable, World Bank former Acting Chief Economist Professor Shanta Devarajan told the US-based CNBC news channel during a recent interview regarding Sri Lanka’s state of the economy.

Devarajan is a Professor of the Practice of Development at Georgetown University’s Edmund A. Walsh School of Foreign Service. He was previously the Development Economics (DEC) Senior Director and World Bank Group former Acting Chief Economist.

Following are excerpts from the interview:

How dire are the economic conditions in Sri Lanka?

The outlook for Sri Lanka is very dire. Sri Lanka has about, at best, $ 800 million of usable reserves, and it has debt service payments of about $ 2 billion looking ahead to the first half of this calendar year. The economy is facing severe foreign exchange shortages. There is a shortage of fuel, foods, and pharmaceuticals and there are power cuts around the country.

The frightening thing is that the country could be on the brink of a hard default. It may not be in a position to pay back its creditors, and that could be devastating to the Sri Lankan economy.

What is the way forward, in your opinion?

The way forward requires at least two or three important steps that the Government must take. First, it needs to take a managed debt restructuring. So, instead of a hard default, the Government can hire a company or firm to help negotiate a managed reduction of its debt burden with the creditors, going forward.

The second is that the debt is unsustainable. The Government has to undertake its own fiscal reforms in order to make the debt more sustainable. In particular, in my view, the Government should increase taxes. It should increase tax revenues. You can do that with increased tax rates as well as changing the thresholds people have to pay taxes.  

The Sri Lankan Government has pushed back and said that an IMF programme would come with a lot of austerity and conditionality, and that it would place significant burdens on the people. Do they have a point?

No! That is completely wrong. An IMF programme will not bring any other burdens other than what the country needs to do right now. These are the things Sri Lanka needs to do in order to manage its debt – things like increasing taxes, cutting expenditures, and bringing the debt in line with something that they can pay back.

The difference is that the IMF programme will actually bring in more money for the country – not only from the IMF, but also from other donors such as the Asian Development Bank (ADB), World Bank, and other bilateral donors. Having an IMF Programme increases confidence in Sri Lanka within the international community that the country will maintain the reform programme, going forward.

The path that the current administration, the financial authorities, and the Central Bank have taken – are they on the right track? To be fair to them, policymakers across the world have been utterly blindsided by the crisis in Ukraine. No one expected this.

Absolutely, what it has done is make a bad situation worse for Sri Lanka. Even before the Ukraine crisis hit, Sri Lanka was on the brink of default and was in need of debt restructuring. As you said, the Government has resisted going in for debt restructuring or IMF help. Now, the burden for Sri Lanka from the $ 100-plus price for a barrel of fuel is going to be excruciating.

I’d like to think that this may be the way for the Government to say: “We didn’t realise how serious the problem was, we will now undertake debt restructuring.” I think this is now a way for the Government to shift its position, without maybe having to acknowledge that it was a mistake not to do so before. But rather, that the situation has got so bad, “I don’t think we can make it the way it was planned with such high oil prices.”

Recently, Central Bank Governor Ajith Nivard Cabraal, speaking to us, said that he could pass the higher cost of soaring commodities prices on to consumers. Is that even tenable, do you think?

Well, it is tenable if you consider the alternative. I think on this one I would agree with the Governor. If you don’t pass on the price increase to the consumer, that means you subsidise. That means you increase the deficit higher.

Given the way Sri Lanka has been financing its deficit, mainly by borrowing from the Central Bank, with more subsidies, inflation will grow higher. This means the consumer will have to pay anyway. Even though they have a subsidy, they are going to get hurt.

Let me add that the oil subsidies don’t necessarily benefit the poor. They benefit the rich, because it is those who are rich who drive gas-guzzling cars and use air-conditioning and things like that.

By providing a subsidy for fuel, you are actually providing a subsidy for the rich. If you pass on the oil price and introduce some form of cash transfer, which is targeted for the poor, you can still cushion the poor and ensure the non-poor are still paying a fair price for these higher oil prices.

Sri Lanka devalued the rupee recently. What do you think the policymakers in Colombo should do with their currency now?

Even before you adjust your currency, you need to have a credible programme for your fiscal reforms. One lesson many countries have learned from Africa to Latin America, and even in Asia, is that if you devalue currency without a clear and credible fiscal programme, it can lead to speculation about that currency, because people think that without a fiscal programme you will have to devalue again.

(Interview transcribed by Asiri Fernando)