The understandable desire to stimulate the economy in the aftermath of the Easter Sunday attacks by loosening the Government’s purse strings, has led to some calls to rethink Sri Lanka’s lending arrangement with the International Monetary Fund (IMF).
However, the Government garners significant benefits from the credibility the IMF provides with private investors. With large foreign debt repayments on the horizon that need to be refinanced, it makes sense to stick with the current IMF lending arrangement until its completion in mid-2020 to avoid a more serious economic crisis.
The IMF program limits Government support to the economy…
While recent data show that economic growth rebounded in the first quarter of 2019,1 the terrible events of Easter Sunday have clearly dealt a significant blow to the economy. Aside from the disruption to everyday life in the weeks after the attacks, tourist arrivals fell by 7.5% y/y in April2 and are likely to have fallen much further in May.
Industry organisations estimate that the loss to tourism income could be in the region of $ 1.5 billion this year,3 and the Government has acknowledged that the $ 3 billion target for inward FDI this year is unlikely to be met.4 This will have repercussions throughout the economy, and following lacklustre GDP growth of 3.3% in 2018 (the weakest since 2001),5 forecasts for growth this year are being revised down to around 3%6 or even less.7
Calls for the Government to do more to support the economy, have been met with a number of measures to support the tourism sector directly,8 including a moratorium on loan repayments, tax concessions and a new tourism promotional campaign. The Central Bank has also lent a helping hand by cutting policy interest rates.9 But policymakers have stopped short of major spending increases or tax cuts.
In fact, the one-year extension of Sri Lanka’s lending arrangement with the IMF, which received approval in mid-May, included a commitment to ensure a primary budget surplus (excludes interest payments) of 1.5% of GDP in 2019,10 up from an estimated 0.6% of GDP in 2018. This leaves the Government with very little, if any, space to loosen fiscal policy to support the economy.
…but Sri Lanka needs to stick with it to maintain the confidence of private investors
This is an unfortunate position for Sri Lanka to be in, but continuing with the IMF program is crucial to maintaining the confidence of private investors, and thereby avoid an even more serious economic situation. The Government is facing large foreign currency debt repayments of around $ 4 billion annually over the next four years11 and, with the Central Bank’s foreign exchange reserves only standing at around $ 6.7 billion at the end of May,12 they cannot be relied upon to cover a significant gap in the financing of these repayments. Sri Lanka, therefore, needs to ensure that it can borrow foreign currency at a reasonable cost to rollover some of these debts, which with the support of the IMF, it has been doing successfully.
In fact, reassuring private investors by demonstrating that the Government is committed to economic reforms and repaying its debt is one of the key reasons the current IMF program was sought in mid-2016. The total size of the current loan from the IMF is only around $ 1.5 b,13 but since mid-2016 the Government has been able to issue almost $ 10 b worth of international sovereign bonds,14 as well as continue to obtain financing from other multilateral organisations, such as the Asian Development Bank. Indeed, the issuance of $ 2 billion of international sovereign bonds just this week was more than three times oversubscribed.15
Borrowing from the IMF is a last resort
Giving up partial sovereignty over your economic policies to the IMF is not a situation that any country wants to be in, but it should be understood that it is a last resort. The IMF does not force countries to borrow from them and accept the attached conditions, rather a Government approaches the IMF when they are facing a balance of payments crisis and the alternatives are worse. In Sri Lanka’s case, if it wasn’t able to obtain enough affordable financing it would be forced to either restrict imports or default on public debt repayments.
Both of these options have serious economic and social consequences. Sri Lanka relies on imports for the supply of many essential goods, including food and medicine, which would become more difficult to get a hold of. This would hit vulnerable members of society who are least capable of absorbing the price increases that would inevitably occur as essential goods become scarce.
Defaulting on the Government’s external debt, while more politically palatable, also has potentially serious consequences, including losing access to international financial markets entirely, which exacerbates the problem of access to foreign currency and may anyway force restrictions on imports. If these appear to be unlikely scenarios, the tumultuous experiences of Venezuela and Argentina over the past decade are a timely reminder.
Sri Lanka thankfully has little experience with either of these scenarios, which is to the credit of its policymakers and economic institutions. But that does not mean it is not vulnerable – bear in mind that the Central Bank’s foreign currency reserves are only equivalent to the cost of around four months of imports.16 In fact, the relative stability of the economy also reflects the willingness of Sri Lankan policymakers to seek the help of the IMF when needed. The country has been in no less than 16 IMF lending arrangements,17 which is largely due to macroeconomic imbalances that have persisted since independence.
Now is not the time to abandon the IMF
Abandoning the IMF program now would increase the risk of a serious economic crisis in the near future. Sri Lanka should instead stay the course until the completion of the program in mid-2020 to ensure macroeconomic stability and, thereby, make a sustained economic recovery from the Easter attacks.
None of this is to voice unconditional support for the IMF. It is an institution in need of significant reform, and the conditions attached to its loans have often been overzealous in the past. The Government should consider arguing for a reduced 2019 primary budget surplus target in the next IMF program review to allow more flexibility. But it cannot abandon fiscal consolidation altogether.
The additional credibility the IMF provides with private investors is Sri Lanka’s best hope of fending off an economic crisis. If the Government wishes to avoid being subject to the whims of the IMF in future, it must focus on the home-grown reforms needed to deal with the economy’s persistent imbalances, and thereby, avoid the need for IMF assistance in the first place.
[Adam Collins is a Research Fellow at the Lakshman Kadirgamar Institute of International Relations and Strategic Studies (LKI). The opinions expressed in this piece are the author’s own and not the institutional views of LKI, and do not necessarily reflect the position of any other institution or individual with which the author is affiliated.]
1Daily FT. (2019). Economy Clocks Promising 3.7% 1Q Growth. [online] Available at: http://www.ft.lk/top-story/Economy-clocks–promising-3-7–1Q-growth/26-680340
2Sri Lanka Tourism Development Authority. (2019). Monthly Tourist Arrivals Report. [online] Available at: http://www.sltda.lk/sites/default/files/sltda-tourist-arrivals-report-april-2019.pdf
3Daily FT. (2019). Tourist Hotels Feart $1.5 b Revenue Loss from Terror Attacks. [online] Available at: http://www.ft.lk/front-page/Tourist-hotels-fear—-1-5-b-revenue-loss-from-terror-attacks/44-676993
4Daily FT. (2019). SL Will Not Meet 2019 FDI Target: Malik. [online] Available at: http://www.ft.lk/business/SL-will-not-meet-2019-FDI-target–Malik/34-678614
5Central Bank of Sri Lanka. (2018). Special Statistical Appendix. [online] Available at: https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/publications/annual_report/2018/en/15_S_Appendix.pdf#page=4
6Lanka Business Online. (2019). Sri Lanka Growth May Come Down to About 2.9-pct in 2019: Central Bank Chief. [online] Available at: https://www.lankabusinessonline.com/sri-lanka-growth-may-come-down-to-about-2-9-pct-in-2019-central-bank-chief/
7Daily FT. (2019). Moody’s Revises SL’s Growth to 2.6%. [online] Available at: http://www.ft.lk/top-story/Moody-s-revises–SL-s-growth-to-2-6-/26-680426
8Daily News. (2019). Relief Package to Strengthen Tourism Sector. [online] Available at: http://www.dailynews.lk/2019/05/08/finance/184959/relief-package-strengthen-tourism-sector
9Reuters. (2019). Sri Lanka’s Economy Recovered in Q1 but Faces Slump after April Bombings. [online]. https://www.reuters.com/article/sri-lanka-economy/sri-lankas-economy-recovered-in-q1-but-faces-slump-after-april-bombings-idUSL4N23Q3DV
10International Monetary Fund. (2019). Sri Lanka: Fifth Review Under the Extended Arrangement Under the Extended Fund Facility, Request for Waivers of Nonobservance of Performance Criteria, Extension of the Arrangement and Rephasing of Purchases-Press Release; Staff Report and Statement by the Executive Director for Sri Lanka. [online] https://www.reuters.com/article/sri-lanka-economy/sri-lankas-economy-recovered-in-q1-but-faces-slump-after-april-bombings-idUSL4N23Q3DV
11Ministry of Finance. (2018). Annual Report 2018. [online] http://www.treasury.gov.lk/documents/10181/12870/Finance+Ministry+Annual+Report+2018+English+updated.pdf/fa11483d-1999-448c-a825-cd170e207b45#page=137
12 Lanka Business Online. (2019). Sri Lanka Official Reserves fall to USD 6.7 bn by end May from 7.2 bn in April. [online] https://www.lankabusinessonline.com/sri-lanka-official-reserves-fall-to-usd-6-7bn-by-end-may-from-7-2bn-in-april/
13International Monetary Fund. (2016). Press Release: IMF Executive Board Approves Three-Year US $1.5 Billion Extended Arrangement Under EFF for Sri Lanka. [online] https://www.imf.org/en/News/Articles/2015/09/14/01/49/pr16262
14Ministry of Financie. (2018). Annual Report 2018. [online] http://www.treasury.gov.lk/documents/10181/12870/Finance+Ministry+Annual+Report+2018+English+updated.pdf/fa11483d-1999-448c-a825-cd170e207b45#page=127
15Central Bank of Sri Lanka. (2019). The Democratic Socialist Republic of Sri Lanka – USD 2.0 billion International Sovereign Bond Offering. [online] https://www.cbsl.gov.lk/en/news/usd-2-billion-international-sovereign-bond-offering
16Central Bank of Sri Lanka. (2019). Monthly Economic Indicators. [online] https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/statistics/mei/MEI_201905_e.pdf#page=20
17Collins, A. and Kannagara, P. (2019). The International Monetary Fund and Sri Lanka. [online] The Lakshman Kadirgamar Institute. Available at: https://www.lki.lk/publication/the-international-monetary-fund-and-sri-lanka/.