Sri Lanka needs to embark on a rapid export-oriented industrialisation strategy to find a long-term solution for the economic crisis and not rely on short-term relief measures, Economist and Retired Associate Professor at the International Institute of Social Studies (ISS), Erasmus University Rotterdam Howard Nicholas said last week.

According to Nicholas, Sri Lanka needs to focus on creating the right business environment to attract foreign investors and expand its export basket following the $ 2.9 billion International Monetary Fund (IMF) package, which is expected to be secured by the end of the month, and not rely on new borrowings from global financial markets using sovereign bonds.

In an interview with The Sunday Morning, Prof. Nicholas questioned the independence of the Central Bank of Sri Lanka (CBSL) and why the IMF seemed to be dictating policies for Sri Lanka as conditions for approving the Extended Fund Facility (EFF).

Following are excerpts from the interview:

Sri Lanka has submitted all relevant documents to the IMF and anticipates board approval for the $ 2.9 billion EFF by the end of the month. In your opinion, what key measures should the Government of Sri Lanka take once the EFF from the IMF is secured?

I have always been a bit wary of IMF packages and what it does for the business environment.

In my view, Sri Lanka needs an export-oriented industrialisation strategy. We saw this during President Premadasa’s period with many investors coming into Sri Lanka. The successful countries and developing countries which are advancing have followed this strategy. I was initially sceptical but then I saw this wave of investors coming in (early ’90s). When under such a strategy a dynamism had been created that investors came, not only for garments, but for other industries too.

Looking at the IMF package, it is mostly short-term fiscal management. However, we are coming from a 40-year trade imbalance. How we survived this long is a miracle. When there is a shock in the global trade system, we, like many other developing countries, are affected. We have gone to the IMF many times and then everybody focuses on the short-term solution without focusing on how we should get the dollars.

In the end, we must grow. We have to solve this weakness (trade imbalance and forex earning). For a long time, and even now, people talk about tourism as a saviour, but that is a short-term relief and vulnerable to disruptions. We need to go for production. We need to diversify and grow our export-oriented production.

What has happened over time politically is that we have postponed what we as a country need to do and this current situation was an accident waiting to happen. My fear is that we are not learning the lesson. Reading between the lines, the President seems inclined to move towards export-oriented industrialisation.

Do you think the EFF being approved will trigger a review of Sri Lanka’s ratings downgrades and will it improve investor confidence in Sri Lanka?

It could, but I think we need to make a distinction. If we are to attract investors, it means FDI. You need to partner with foreign companies. In my view, we can sign agreements with the IMF, but that alone does not create the environment for profits, which industries need to get investments. 

What the IMF agreement gives is a signal to lenders to give more money to Sri Lanka. Now, that is not what Sri Lanka needs to build investor confidence. I am wary of Sri Lanka borrowing more by issuing more ISBs. I would ask, how are you going to pay for them [ISBs], where is the foreign exchange going to come from? If we don’t have an export-oriented industrialisation strategy, where will you get the foreign currency to pay for it? Borrowing to sustain is short-term thinking.

If the long term problem was the trade imbalance and the Government printing money, which has been the entire premise of the IMF package, how will borrowing more and getting more cash into the system be alright?

I think we need to have a discussion so that we understand some of the issues and consequences and don’t go in blindly. If we get the $ 2.9 billion, then I think it could buy space for us to negotiate some bilateral loans on more concessional terms. When seeking such bilateral loans on concessional terms, we will need to work on what is in Sri Lanka’s best interest and not so much what is geopolitically suitable.

In your opinion, what is next for Sri Lanka? What should Sri Lanka’s policy priorities be after the EFF comes into effect?

I think we should definitely go for some bilateral financing, because the $ 2.9 billion EFF will not be able to do much. It may help with arrears and interest payments and there may also be a penalty to pay for default.

Then we have the problem of the liberalisation of imports. While we are getting dollars now from tourism, the peak season will end soon. Sri Lanka should think about alternative financing and rescheduling.

The Chinese have offered a debt moratorium for two years, which is good. I think we should ask the World Bank, the Asian Development Bank, and possibly others, like Japan, to do something similar. We need to buy some time to get the export machine going. We have to be mindful that there is a global crisis brewing. If we can buy two years, then hopefully we will be in calmer waters.

Will the IMF EFF improve Sri Lanka’s foreign currency crisis?

Not as much as we think. The $ 2.9 billion will come in tranches. I think the first tranche will be about $ 1.2 billion and the second will be issued only once certain conditions are met. However, there is a lot of optimism about the impact and the rupee has appreciated.  

If the EFF is confirmed and the tranches come in, how will the monetary landscape change in Sri Lanka?

Usually a country goes to the IMF when it has a foreign currency shortfall, so the EFF is not going to finance our budget. It is rather to build up our reserves to meet liabilities. That is the immediate relief we get, so that we can reduce import controls. We can start repaying debts and interest. It gives us those possibilities.

However, my worry is about what we did last time with the IMF when Wickremesinghe was the Prime Minister – the then Governor of the CBSL went to the international capital markets and borrowed quite a bit by using ISBs because the IMF funds were delayed. My worry is that a similar thing can happen this time as well.

What is your view of the CBSL raising policy rates in line with a target agreed with the IMF?

I think this has to do with the independence of the CBSL and by that I don’t only mean stopping politicians syphoning money from the bank. We need the CBSL to be accountable for the policies it implements and the results of such policies. That I think is a legitimate request because either we are in a democracy or we are not.

When the policy rates were increased, the Governor said this was a result of the IMF urging him to raise those rates. I don’t understand why he even said this. I mean, who is running our policy? Is it the Governor of the Central Bank or is it the IMF? Are these our policies or the IMF’s? Who is the IMF to tell us how to do this?

Secondly, I don’t agree with the justifications being given for this [rising policy rates]. The argument is that our inflation problem and trade imbalance are due to excess demand. I don’t think so. In my view, the problem comes when raw material prices increase across the globe and then all countries in the world have these problems. Trade balances collapse in many countries other than the oil producing ones.

This means that even though we do belt tightening, it may not solve the problem. When in a crisis, we do need to tighten our belts. However, are we mitigating the damage it has on the products? They are the ones that earn foreign revenue. Don’t forget, we have already imposed high taxes on them and now we are increasing interest rates; why would you continue to produce?

I feel that we should have maintained a development bank which could have provided the concessional finance for strategic industries, especially the export oriented ones. With a bank like that, you know which sectors to target for support.

The IMF has been firm with the Sri Lankan Government about fiscal discipline and the need for increasing revenue. However, the State has introduced new taxes, while many are seeking to enter the social safety net. What does this mean for vulnerable communities?

I don’t see why the previous Government [led by Gotabaya Rajapaksa] cut taxes the way it did in 2019. We are not an advanced country.

I also don’t understand why this Government introduced tax policies across the board. This Rs. 100,000 threshold is still going to catch people who are struggling. Taxes should have been raised but not across the board because then you can’t mitigate the impact on the vulnerable and poor sections of society. Many have suggested moving to a Rs. 250,000 or Rs. 300,000 bracket and widening the base. Why such a low threshold? Why would the IMF advocate such a move?  

Many SMEs and startups are suffering from this. Isn’t this pushing a broader segment of the community to require assistance? How will this tax help the social safety net improve? The immediate relief for vulnerable communities could have been a tax relief and similarly tax relief for industry which is vital to earn foreign exchange.