By W A Wijewardena –
Time is running out for Ranil Wickremesinghe administration
There is a new President – Ranil Wickremesinghe – elected by Parliamentarians and a new Cabinet appointed by the President. The economic crisis which the new administration faces is so acute and grave that it is necessary for the administration to identify the priorities correctly and implement an appropriate program of action. Time is running out for the administration and the program of action need be introduced forthwith. Any misstep or a delayed correct step will be fatal to both the country and its people. It is also necessary to diagnose the crisis and treat it with the correct medication. An economy made up of millions of sub-parts is like a human body made up of billions of individual cells joined together to serve a general purpose. Hence, it is essential that correct medication is selected and administered at the correct time.
Inappropriate policies of Gotabaya administration
We have written repeatedly what went wrong with the Gotabaya Rajapaksa administration leading to the current crisis. Since almost all the Ministers in the present Ranil Wickremesinghe administration were those who held portfolios in the previous administration, it will be a bitter medicine for them to realise that the cause of the present crisis was the inappropriateness of those policies. There was a tax cut that caused a significant loss of revenue which was a historic mistake according to one time Minister of Finance, Ali Sabry.
The attempt at converting Sri Lanka’s agriculture to organic overnight resulted in a sizeable loss in the output of both food and commercial crops. This led to increase in food prices and reduced earnings from exports, on one side, and a looming food crisis in the near future, on the other. Then the administration refused to go to IMF despite the growing balance of payments gap and the depletion of reserves. Having realised the folly, Gota later admitted that both were mistakes.
This was exacerbated by the policy that kept the exchange rate and interest rates artificially low with the objective of stimulating investment. But because of the high inflation expectations producing negative real interest rates, savings flows dried up and the Government lost the opportunity to borrow from the domestic market. Meanwhile, the international sovereign bond market to fill the coffers was also out for Sri Lanka because all the rating agencies downgraded the country from B levels to CCC levels. This probable default warning caused the existing bondholders to sell them in the market pushing their prices down and raising yields to unaffordable levels.
Excessive borrowing from the banking sector
This led the Government to tap the banking sector to fill its rising budget gaps. The resultant increase in the Government’s borrowing from the banking sector amounting to Rs. 4.4 trillion from December 2019 to May 2022 caused the money stock to rise by an equal amount. This caused inflation pressures to build up which are manifest now at around 59% per annum. At the same time, increased liquidity through money stock expansion caused exchanged rate to depreciate and since the administration kept the rupee-dollar rate artificially at Rs. 200 per dollar, there was a shortage of dollars in the market. The result was the development of a lucrative black market outside the formal banking system.
The lack of foreign exchange caused all imports to dry up creating shortage of essential goods for consumption and raw materials for industries. It is this public frustration that brought in spontaneous protests and agitation campaigns that led to the fall of the Gotabaya Rajapaksa administration and the establishment of the new Ranil Wickremesinghe administration.
Suppression of protestors is not the answer
Last week, President Ranil Wickremesinghe removed the agitators from the main site of the agitation by using emergency laws, court orders, and the empowered armed forces. However, since the causes of the agitation are still there unattended, it is like trying to treat a cancer patient by giving him painkillers. The pains will temporarily subside giving a false sense of relief but the cancer without proper treatment will grow further eventually killing the patient. The new administration should avoid, by all means, this inevitable outcome. For that, only a limited time is available to it. Unless it acts fast and correct, the delivery of the promised future for Sri Lanka cannot be guaranteed.
Need for an action plan
What is the action plan which the new administration should implement? There are immediate, short-term, medium-term, and long-term measures to be taken. Immediate will be the addressing of the acute foreign exchange shortage. Short to long-term will involve the implementation of a credible economic policy program that will push the country back to its normal growth path and then to a high growth trajectory so that Sri Lanka could elevate itself to a rich country within the next 25 to 30 years.
Debt restructuring may be a non-event
Sri Lanka is presently negotiating with IMF for a bailout facility. An agreement at the staff level by officials of the Ministry of Finance and the Central Bank from Sri Lanka’s side and those technical experts at IMF from the Fund’s side is to be reached. However, this is contingent on Sri Lanka’s ability to present a credible foreign debt restructuring plan acceptable to both commercial and bilateral lenders. But this is a truncated plan since the total foreign debt of the country involves, in addition to these two lenders, other multilateral, private, and borrowing by government entities with a Treasury guarantee. What is to be covered by the proposed debt restructuring plan is about $ 24 billion. But Sri Lanka does not have foreign exchange to service these other foreign loans that amounts approximately to $ 45 billion. It is necessary for Sri Lanka to default these loans as well if it is desirous to maintain an import program by using the limited quantum of foreign exchange available. Those are clearly bottlenecks which Sri Lanka must clear before it enters a staff level agreement. Hence, it behooves the new administration to ask for a waiver of this condition which IMF wants to introduce as a precondition.
Conditions imposed by US Senate Foreign Relation Committee
After the staff level agreement is reached, an application jointly signed by the Minister of Finance and the Governor of the Central Bank should be made by Sri Lanka to IMF. Then it should be approved by IMF’s executive board which normally approves the loan requests by consensus. In this context, an opinion expressed by US Senate Foreign Relations Committee may hamper Sri Lanka’s attempt at getting approval. That committee has imposed three additional conditions, namely, making the Central Bank independent, observing the Rule of Law, and establishing an effective anti-corruption mechanism.
Regarding the first condition, there is a draft act proposed by a committee headed by the present Central Bank Governor Nandalal Weerasinghe and gazetted by previous Yahapalana Government led by Ranil Wickremesinghe as a bill before being enacted by Parliament. Since President Wickremesinghe has already accepted it, it is not a difficult task to meet this condition before starting further negotiation with IMF. The second will depend on the ability and willingness of the present administration to observe the rule of law. This cannot be done by uttering palatable words but by action that should satisfy all. The third condition can be fast tracked by bringing back the 19th Amendment as promised by President Wickremesinghe before he was elected President. But these are three conditions that should be satisfied by Sri Lanka on a priority basis since USA and its allies have more than a half of the votes at the IMF’s Executive Board.
Need for a real sector development plan
Even if an IMF bailout is arranged, it will not solve Sri Lanka’s economic problems. If it is fast-tracked and approved before the end of the year, it will deliver about $ 1.2 billion to boost the foreign reserves of the Central Bank. It does not provide any support to the budget. Further, it does not meet all the foreign exchange requirements of the country which has been estimated to be around $ 800 million per month assuming that the country will be able to prepare a debt restructuring plan for all its loans. Hence, a quick bridging financing facility of about $ 5 billion need be arranged with Sri Lanka’s friendly countries. The accommodation of such a request is a geopolitical matter for any donor. Hence, it will be a test of the diplomatic competence of the new administration.
IMF bailout is necessary but not sufficient
The other problem is that a bailout facility from IMF is necessary and useful for Sri Lanka. But it is not a sufficient condition. That is because an IMF bailout will help Sri Lanka to regain balance of payments stability. Such a stability is a financial sector achievement which is helpful for achieving real sector growth. It is the real sector growth-the final goal of society-that will create wealth, generate employment, and deliver incomes to people. The development of the real sector is not a responsibility of the central bank or IMF. It is the responsibility of the government to introduce a suitable real sector development package.
One reason why previous IMF packages have not been successful in attaining a noticeable growth-Sri Lanka had got 16 of such packages in the past from time to time beginning from 1965-is that the governments of the day had failed to introduce a suitable real sector development plan along with the IMF support loans. This time also it will be a failure if the new administration ignores this vital requirement.
Strategies of the real sector development plan
What are the main components of such a real sector development plan?
First, Sri Lanka will have to introduce systems that enable it to earn foreign exchange promptly to resolve the current acute shortage. A multi-faceted program should be designed as a matter of urgency to attract foreign currency investments in government securities. For this purpose, the Central Bank can offer its portfolio which amounts to more than Rs 2.2 trillion (about $ 5.5 billion) with an average yield rate of a little more than 9%. This will provide an attractive investment for all those who are desirous of maximising return in view of the high rates in government securities.
There is no necessity for the Central Bank to offer the same high rates of 30-34% which it gives to local investors but relatively a lower yield rates enabling it to make some capital gain. Sri Lanka started this scheme in 2009 and by 2014 had mobilised more than $ 4 billion. Since then, these investments began to fall, especially during the previous Yahapalana government, and they stand today at around $ 11 million. Given the gravity of the foreign exchange crisis today, it is advisable that the government should remarket it.
Apparel industry has new limitations
Medium to long term, it is necessary to introduce a real sector development program with emphasis on the development of exportable goods and services. Textiles and apparel exports have been the main manufactured export commodity in Sri Lanka bringing about $ 5 billion or 40% of the export earnings annually. The further development of this sector is untenable due to two reasons. First, with rising wage rates, Sri Lanka is unable to compete with low wage newcomers to the market like Bangladesh, East Africa, or Myanmar. Second, the main consumers of garments, namely, EU, UK, and USA, now seek to cut the delivery time by either setting up of digitised garment factories either in the respective country (on-shoring as against off-shoring done previously) or in neighbouring countries (called near shoring).
Hence, while keeping the apparel industry as a basic industry, Sri Lanka should expand its manufacturing to other products that utilise high technology. Technology acquisition for this purpose should be done by attracting quality foreign direct investments or FDIs as has been done by Thailand and Vietnam. In the long run, Sri Lanka should encourage through appropriate incentives universities and research institutions to develop new technologies. An important factor to be kept in mind in this connection is that Sri Lanka is still in the second industrial revolution, while the world has moved to the fourth level industrialisation known as Industry 4.0 or 4IR.
Sri Lanka is required to join the fourth industrialisation by bypassing the third industrial revolution. This is difficult but not impossible if the Government comes up with a long-term road map with appropriate milestones and sticks to it no matter what government has been voted into power. Vietnam announced such a road map in 2019 planning to join 4IR by 2030. In that road map, in addition to promoting high tech merchandise exports, Vietnam has included the development of high-tech services like ICT and other services, namely, hospitality, healthcare, and education. This is an eye opener for Sri Lanka.
Now follow Bangladesh
Sri Lanka does not have a massive resource base to promote merchandise exports. But it is endowed with a talented human capital base. This should be used to the maximum in the next ten-year period. It should get into such advanced services like ICT, healthcare, education, and hospitality as has been identified by Vietnam in its 10-year road map. For this purpose, Sri Lanka should rebrand itself. Historically, it had been branded as a country with cheap labour. But now, Sri Lanka has been beaten by other countries in the region like Bangladesh and Myanmar. Hence, it should now be rebranded as the nation with a talented human capital base. That will enable investors in ICT services to team up with Sri Lankan firms.
Bangladesh, a country which had been behind Sri Lanka a decade ago has now been known as the country with top 5 animation studios. Their services are being outsourced by producers in the Western world. If Bangladesh can do it, there is no reason why Sri Lanka cannot do it. What is necessary is to invest in advanced animation studios by the private sector. This is where the future of Sri Lanka rests.
These are the top priorities of the new administration.
*The writer, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at firstname.lastname@example.org