By W.A Wijewardena –

Dr W.A. Wijewardena

To or not to have IMF

A press release issued by the Central Bank last week just before the conclusion of the negotiation with IMF announced that the Sri Lankan authorities had decided not to get any more financing facility for correcting the balance of payments or BOP imbalance in the country because, “there appears to be a very limited need to build up a further cushion in external reserves through traditional IMF Balance of Payment (sic) support programmes, such as Stand-By Arrangements and Extended Fund Facilities” (available at: www.cbsl.gov.lk ). The experienced Central Bank has viewed that IMF support is there only for building up reserves and not for implementing a corrective policy programme for the country to get out of a BOP crisis if the country is presently faced with such a crisis or avoid getting into similar crises in the future. The implication of this view is that Sri Lanka’s BOP is in good health and there is no need for getting treatment from physicians based at IMF. But the international commentators do not appear to have bought that story. As James Crabtree of London based Financial Times has reported that “the IMF may be leaving now – but don’t bet against them returning before too long” (available here ).

Central Bank: We are ok and no need for IMF

According to the Central Bank press release under reference, the country went for a Stand-by-Facility or SBA with IMF in early 2009 when the country’s foreign reserves were at a very low level at just over $ 1 billion. The SBA which provided $ 2.6 billion in several installments over a period of 3 years has now been successfully completed. Thus, it is logical for a member country to seek further financial assistance from IMF to strengthen its economy. Going by this logic, it was Central Bank’s Deputy Governor Nandalal Weerasinghe, who first announced in September 2012 that IMF has offered a further financing facility and it is up to Sri Lanka to decide the quantum and conditions, if interested, in consultation with the Fund (available here). Later in January, 2013, the Treasury Secretary P.B Jayasundera, took a different view at a press conference announcing that the country’s foreign reserves are at a comfortable level and therefore the government is planning to seek a loan of $ 1 billion from IMF to finance the government’s budget for 2013 (available here ). This was in line with the announcement in the Budget for 2013 that the government will not go for any more commercial borrowing from international markets in this year.

But the alternatives are more costly

There was a reason for the experienced Treasury Secretary to make this announcement. Commercial borrowings are too costly – at around six to six and a half percent per annum given Sri Lanka’s current not so good credit rating – though they do not involve conditions being imposed on Sri Lanka. On the other hand, loans from IMF are subject to the implementation of a corrective economic policy programme but at a very concessionary rate of around two to two and a half percent per annum.

Special IMF loans to budget means the economy is in trouble

However, there is a downside in an IMF loan for supporting the budget as well. That is because IMF gives loans only to central banks in member countries to overcome grave BOP crises. There is exception to this only when a country faces a severe economic crisis pushing it to the brink of economic collapse. When a government is not in a position to raise revenue through taxation because the economy has hit the bottom, to enable that country to make a turnaround with the least pain, IMF provides “an exceptional and unconventional loan to the government”. The latest such accommodation was in the case of Greece and Egypt. Hence, getting this exceptional and unconventional loan from IMF would have meant that Sri Lanka has admitted that it has a severe economic crisis. That is not according to what has been announced by Sri Lanka’s authorities repeatedly. Hence, seeking an IMF loan for the budget was a reputation risk for the country; yet the fact that it has been prepared to undergo that risk meant one thing: This four percentage point interest rate benefit is a big deal for the Treasury which is hard pressed for revenue today.

Visiting IMF Mission: Risks in soft-words

A few hours after the release of the Central Bank press communiqué, the visiting IMF Mission in carefully guarded words not to annoy its host has drawn attention to three areas of risk the country is presently faced with. One is the underperformance of the tax revenue, another is the need for fighting inflation vigorously and the third is the instability to the economy associated with mounting losses in state enterprises, manly, CPC and CEB.

The erosion of the tax base

The budget 2012 had envisaged to generate a tax revenue share of 12.7 per cent of GDP which was later downgraded to 12.2 per cent. But the actual realisation, according to the IMF mission, has been 11.25 per cent. Though this has been partly compensated by an increased profit transfer from the Central Bank, up from Rs 15 billion in 2010 to Rs 27 billion in 2011 and further to Rs 33 billion in 2012, the erosion of the tax base over the years is not a sign of good health since one would expect it to expand along with the reported high economic growth in the past few years. As it is, the high economic growth has not taken place in areas where people pay taxes or the government’s tax administration has not been successful in capturing growth for generating tax revenue or both. Further, relying on central bank profits is also not a prudential budgetary management because in most cases such profits are generated by central banks by increasing inflationary pressures in the economy: So, more central bank profits means that, though the governments have got more money to spend, the people have become poorer in real terms.

Single digit inflation close to 10% is not an achievement

As the Mission has correctly identified, the current inflation close to 10 per cent per annum, though it is claimed to be preferable because it is single digit, is not a very creditable achievement. The increase in bank credit to the government, public corporations and the private sector in 2012 as reported in the Central Bank Road Map for 2013 has portended an ominous sign: The potential acceleration in inflation in the coming years. Hence, the Mission has advised the Central Bank not to further relax the monetary policy meaning that it should maintain at least the current policy regime. What the Mission should actually have done is the opposite – advising Sri Lanka that it should tighten the monetary policy to prevent inflation from creeping in and the exchange rate from further slipping away. However, the public announcements of IMF are always soft – worded and it is left to the authorities concerned to read the message hidden in that soft language and act appropriately.

Tame the public sector monsters

The leading public enterprises have been huge loss makers and the number of corporations that join the league every year has also been on the increase. The existence of such a loss making public enterprise sector is a risk for the country’s stability because their losses have to be borne by the tax payers eventually when the Treasury takes over such losses. Such loss-financing not only involves a forced diversion of the scanty resources of the government from more productive to less or unproductive areas which economists call “an unhealthy opportunity cost”, but also gives a bad signal to the management that there is nothing wrong in incurring losses year after year. That is the reason for the Mission to come out strongly against the current practice of shielding loss makers by covering up their losses through periodical Treasury grants.

IMF helps countries to have long term growth

When a country goes into a financing arrangement with IMF, there is always a programme of action proposed by the borrowing country with approval from IMF to fix its economy. The programme involves restructuring the economy: Removing the obstacles for the private sector to create income, employment and output, helping the country to remove inflationary pressures from the economy so that private individuals will continue to enjoy real prosperity and creating necessary conditions for the country to sell its products to outsiders in greater volumes, while enjoying the products of other countries. In popular parlance, this programme is known as ‘conditions imposed by IMF’ but it is implemented in collaboration with each other in order to make the country more productive in the future. In other words, it helps a country to put its house in order.

In-house policies should conform to laws in economics

What are the critical areas where the country’s economic house has become disarrayed? Many and unless they are re-arrayed in proper order, the continued high growth as planned by the authorities to make Sri Lanka a ‘breakout nation’ becomes elusive. To do that, there is no need for IMF physicians to come and prescribe medicine. Like Singapore, which was not a member of IMF till very recently, the appropriate corrective action programme could be developed ‘in-house’ and implemented voluntarily. All that is needed is that the programme should conform to the time tested economic laws which do not respect the economic laws promulgated by people in power. Even Malaysia which did not agree to get IMF support after the country was badly hit by the East Asian Crisis of 1997-98 had its own programme with one proviso: It conformed to basic economic laws.

Don’t have gala weddings out of borrowed money

The top most on the agenda of Sri Lanka’s corrective programme is the restructuring of the government budget. As already argued by this writer in the previous week’s My View, the stubborn deficit in the revenue account, previously known as the current account, has been an ominous development. These deficits mean that the government’s consumption is more than its revenue and at the end, it lives a good life by borrowing akin to the Sinhalese folk saying that “one lives to his destruction by having gala weddings out of borrowed money”. What it means is that one may borrow from others but such borrowed money should be used for productive investments so that he gets capacity to repay the same when it is due. If not, he will have to borrow more to repay his borrowings and pretty soon he would get into trouble when his borrowing sources dry up or lenders start imposing conditions by way of asking for “the Sherlock’s pound of flesh”. There is no need for IMF to come and tell this simple economic law to a country.

Taming the stubborn revenue account deficit

Thus, the budgetary reforms require Sri Lanka to at least target for balancing the revenue account if it is not possible to go for a surplus immediately. In the past, every budget presented by the government had attempted to have this goal – balancing the revenue account or having a modest surplus in the revenue account. But the actual realisations have been the opposite with a sizeable deficit in the region of about 1 to 2 per cent of GDP. Why have the budgets gone astray like this? The uncontrolled expenditure which has been sanctioned after the budget has been passed by people’s representatives in Parliament. Hence, it is of utmost importance for Sri Lanka to have a budget review and approval committee at the highest level and review every new proposal for increasing government’s consumption by reference to its impact on the targets of the budget.

Government’s overconsumption not good for growth

When the government over-consumes beyond its means, it has several adverse implications on the long term growth of the country. First, it will have the constraint of implementing a good public expenditure programme to build the country’s capital stock, a must for facilitating long term growth. Second, since it borrows even for consumption, it uses the country’s scarce savings denying that opportunity to the private sector. As a result, the private sector is forced to borrow from the banking system which is not healthy for a country that aspires to have an inflation-free world and ensure stability in the exchange rate. Third, the country needs to allocate more resources for research and development which has to be undertaken principally by the government. But when it uses its scarce resources for wasteful consumption expenditure, it has no opportunity to promote innovations through research. Fourth, the government may get into a serious debt repayment problem since its borrowings are not used for productive investment altogether. Hence, new loans have to be raised in order to repay the previous loans and it will cause the country to accumulate unproductive public debt endangering the country’s future stability, again a must for its long term growth.

Don’t seek comfort in borrowed reserves

Sri Lanka’s BOP is also not in good health as presumed by authorities. The stubborn gap between the imports and exports, also known as the trade gap, the poor performance of services despite many attempts at promoting the same, the rising oil bill surpassing the potential remittances by Sri Lankans working abroad, low appetite by foreign direct investors to bring worthwhile investments to the country are all portending a severe BOP crisis in the future. Though foreign reserves are at a high level right now, they themselves create a high risk because they have been built principally out of borrowed funds. As the US Ambassador is reported to have announced recently, the bulk of them have come from a single country, namely USA (available here ). This factor places Sri Lanka in a high risk category level since the country is dependent on a single source for building its foreign reserves. Any diplomatic row with USA could instantly reverse it.

From simple products to complex products

Hence, what Sri Lanka should do today is not to be complacent about the comfort of its reserve levels, but implement an economic reform programme aiming at restructuring the economy, especially the export sector. As this writer has been arguing in previous My Views, it is necessary to convert the country from the current simple export product model to a complex export product model. But to do so, new technology is needed and to acquire that technology, it should promote foreign direct investments of high calibre by creating the required ground conditions in the country. Those ground conditions take the form of comprehensive economic reforms involving macroeconomic stability, promoting competitiveness, developing skilled and competent workforce, reducing the unwieldy government, using borrowed funds to develop the infrastructure that will bring the highest social benefits as assessed by competent project assessment teams and protecting property rights to facilitate people to work hard and enjoy the fruits of their work.

Have policies to put the house in order voluntarily

This whole programme would have been easier had the country accepted IMF financing facility. But now IMF is gone, the country has to implement it on its own like Singapore since mid 1960s and Malaysia in the recent past. Otherwise, as James Crabtree of the Financial Times has predicted, the return of IMF to Sri Lanka will be a harsh reality.

*W.A Wijewardena can be reached at waw1949@gmail.com