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Optimistic a govt. change will not derail IMF programme: Prof. Shanta Devarajan

Optimistic a govt. change will not derail IMF programme: Prof. Shanta Devarajan

09 Jun 2024 | By Marianne David


  • Sri Lanka’s economic growth has been positive for the last few quarters
  • Priority going forward is to accelerate economic growth, make it inclusive
  • Debt restructuring is not a requirement for disbursement of third tranche
  • SL has been making satisfactory progress in implementing IMF reforms
  • Significant Opposition convergence on IMF programme principles
  • Crisis of 2020 showed the costs of populist policies, delayed reforms

Given the ongoing positive economic growth, the clear priority going forward is to accelerate economic growth and make it inclusive, asserted Prof. Shanta Devarajan, in an interview with The Sunday Morning.

Listing key steps towards this end, he called for relaxing barriers to trade, increasing tax revenues by taxing the rich, reforming the State-Owned Enterprises (SOEs) that are bleeding the Treasury and threatening the banking system, and ensuring that ‘Aswesuma’ targets the poor and not the politically connected.

Speaking on the ongoing International Monetary Fund (IMF) Extended Fund Facility (EFF) in Sri Lanka, Prof. Devarajan dismissed concerns that have arisen over the disbursement of the third tranche, in the backdrop of the IMF Executive Board’s upcoming review of Sri Lanka’s progress this week and the lack of progress on debt restructuring.

“Achieving a debt restructuring is not a requirement for disbursement of the third tranche of the IMF EFF. In the absence of a debt restructuring (but with signs of progress), the creditors will have to provide a ‘financing assurance’ for the disbursement, as they did a year ago for the first disbursement,” he asserted.

He also pointed out that Sri Lanka and the IMF reaching a Staff-Level Agreement (SLA) in March indicated that the country had been making satisfactory progress in implementing the reforms in the IMF-supported programme.

“Apart from the debt restructuring, the main areas of concern were in governance, which has always been a weakness and was the main cause of the economic crisis of 2020. The fact that the Government has started implementing some of the recommendations of the Governance Diagnostic Report bodes well for the successful completion of the programme,” he added.

Commenting on how a change in government would impact the IMF programme, Prof. Devarajan said that although the rhetoric of some of the Opposition parties suggested that they had different views on the reform programme, he had found significant convergence on the principles of the programme.

“For instance, we had a meeting with Opposition leaders in Parliament about the Governance Diagnostic. Not only was there agreement on the main points in that document, but the leaders each picked one reform that they would champion in Parliament on behalf of the group,” he revealed, adding that he was optimistic that a change in government would not derail the basic thrust of the reform programme.

Prof. Devarajan also welcomed the key financial bills that were tabled in Parliament recently, stating that he was broadly supportive of the bills because they would help to hold the Government accountable for implementing the policies that it had already agreed to.

Following are excerpts of the interview:

 

What is your overall assessment of the Sri Lankan economy as things stand at present and what are the key steps you recommend to ensure continued recovery?

The Sri Lankan economy has stabilised after the 70% inflation, overvalued exchange rate, and dangerously low foreign exchange reserves of 2020. Inflation is down to low single digits; reserves are exceeding the targets in the IMF-supported programme; and the exchange rate, after a maxi-devaluation in 2020, is stable or appreciating slightly. In addition, economic growth has been positive for the last few quarters.

The clear priority going forward is to accelerate economic growth and make it inclusive. The key steps to achieve this are: (i) relax barriers to trade, so that cheaper imports can make exports more competitive; (ii) increase tax revenues by taxing the rich with, for example, a wealth tax and a uniform (positive) tax on foreign investments; (iii) reform the SOEs that are bleeding the Treasury and threatening the banking system; and (iv) ensure that the cash transfer system (‘Aswesuma’) targets the poor and not the politically connected.

In the longer run, I would also recommend reforming agriculture, which is a lagging sector, by allowing farmers to grow more lucrative crops such as fruits and vegetables rather than requiring them (through the Paddy Lands Act) to grow paddy.

 

Sri Lanka’s external debt restructuring has been dragging on for months, with no concrete progress. What do you see as an ideal outcome in this regard and what’s the best we can hope for at this point?

An ideal outcome is a reduction in debt that Sri Lanka owes to both official and private creditors so that the country can pursue its development programme while meeting its debt-service obligations. A reduction of the debt-to-GDP ratio to 95% (from 125%) is achievable at this point.

 

The IMF Executive Board will be reviewing Sri Lanka’s progress a few days from now. Despite assurances by political leaders on timely debt restructuring, will a delay in achieving this impact the disbursement of the third tranche of the IMF EFF?

Achieving a debt restructuring is not a requirement for disbursement of the third tranche of the IMF EFF. In the absence of a debt restructuring (but with signs of progress), the creditors will have to provide a ‘financing assurance’ for the disbursement, as they did a year ago for the first disbursement.

 

Where does Sri Lanka stand at present in terms of meeting key IMF conditions and their deadlines? Do things look good for the country or is there cause for concern in areas apart from debt restructuring?

That Sri Lanka and the IMF reached an SLA in March of this year indicates that the country has been making satisfactory progress in implementing the reforms in the IMF-supported programme.

Apart from the debt restructuring, the main areas of concern were in governance, which has always been a weakness and was the main cause of the economic crisis of 2020. The fact that the Government has started implementing some of the recommendations of the Governance Diagnostic Report bodes well for the successful completion of the programme.

I would add that the proposal by the private creditors to introduce a Governance-Linked Bond (GLB), where the interest rate goes down if certain governance improvements are undertaken, is encouraging, since it gives the Government a financial incentive to implement governance reforms.

 

What impact will a potential change in government have on the IMF programme, given the varied stances of Opposition parties regarding the programme? Can Sri Lanka afford any diversions from the laid-out conditions?

Although the rhetoric of some of the Opposition parties suggests that they have different views on the reform programme, I find, in meetings with Opposition leaders and the youth wings of their parties, quite a lot of convergence on the principles of the programme.

For instance, we had a meeting with Opposition leaders in Parliament about the Governance Diagnostic. Not only was there agreement on the main points in that document, but the leaders each picked one reform that they would champion in Parliament on behalf of the group. Similarly, my fellow advisors and I have been meeting with NextGenSL, a group of young leaders from diverse parties, who are developing a ‘common minimum platform’ on which they all agree and which they can then send to their elders. I am impressed at the progress they have made in reaching a consensus.

Finally, if I were to simplify, the United National Party (UNP) is advocating economic policy reform, while the National People’s Power (NPP) is emphasising good governance. These are actually two sides of the same coin.

For instance, the Central Bank Act of 2023 is, on the one hand, an instrument to control inflation by restricting Central Bank financing of the fiscal deficit. It is also an instrument of good governance because, by tying the Central Bank’s hands, it prevents the Finance Ministry from pressuring the bank to finance the deficit. So, I am optimistic that a change in government will not derail the basic thrust of the reform programme.

 

How will the upcoming elections impact Sri Lanka’s ongoing recovery? Will vote-buying tactics reverse the gains we have made or is there no room for such manoeuvring, in light of Sri Lanka’s economic status and especially given the ongoing IMF programme?

Around the world, we observe that some economic reform programmes, even those with IMF support, go off-track during election years. In Ghana, for instance, they would double civil servants’ salaries every four years. So, there is a danger that in Sri Lanka, the upcoming election and the temptation to undertake populist policies (not to mention the need for campaign finance) could delay the reform programme.

However, here too, I am somewhat optimistic because the crisis of 2020 showed the costs of populist policies and delayed reforms. It’s significant that the ‘Aragalaya’ movement, instead of invoking Covid-19 or the Ukraine war, put the blame for the dire economic conditions squarely on the policies of the Government of Gotabaya Rajapaksa. If the people see these policies creeping back, they are likely to say “never again”.

 

The bulk of the population is carrying a heavy economic burden, yet public buy-in is necessary to ensure progress in terms of reforms, sustained recovery, and growth. Ongoing speculation over a referendum has resulted in a further loss of faith in the country’s leaders. How do you view this development?

I will not comment on the referendum because that is a political matter for Sri Lankan citizens to decide. I will say that the public, especially the poor, are bearing a huge burden from declining incomes and higher prices. When they see the economic reform policies, such as cuts in subsidies and increases in taxes, it is natural to think that these policies are responsible for their deprivation and hardship. But the truth is the opposite.

Sri Lanka’s economic collapse was due to its running out of reserves in early 2020, itself the result of reckless macroeconomic policies followed by the previous Government. The economic reform programme is designed to help Sri Lanka recover from that collapse and start growing again.

The programme includes cuts in subsidies because about 70% of fuel and electricity subsidies went to the richest 30% of the population (who drive gas-guzzling cars and run air conditioners in their homes). If you replace these subsidies with targeted cash transfers, as Egypt and Indonesia have done, you achieve a more efficient economy and protect the poor. Similarly, the 2019 tax cuts clearly benefited the rich, so the tax increases are aimed at getting them to pay their fair share.

Of course public buy-in is essential to ensure progress. But the public should be properly informed about the relationship between the economic reform programme and their well-being. This is why the media, including The Sunday Morning newspaper, plays such an important role in society (and why I welcome this opportunity for an interview).

 

What are your thoughts on the key financial bills that were tabled in Parliament recently – the Economic Transformation Bill, the Public Debt Management Bill, and the Public Financial Management Bill?

I am broadly supportive of the bills because they help to hold the Government accountable for implementing the policies that it has already agreed to.

For instance, Sri Lanka already has a Fiscal Management Responsibility Act that requires that the fiscal deficit not exceed 5% of GDP. Since it was introduced in 2008, there has not been a single year in which the actual budget deficit was less than 5% of GDP.

The proposed Public Financial Management Bill seeks to avoid this problem by identifying clearly who is accountable for meeting the fiscal deficit target, what information should be provided in a timely manner and, significantly, the public’s right to information about public finances so that they can be the watchdog. These are practices that have shown favourable results in other countries, such as Indonesia.

The Economic Transformation Bill reads like a set of aspirations for a successful economy. Sri Lanka has had similar aspirations before (remember ‘Mahinda Chinthana’?). The difference is that, with this bill, if it fails to achieve any of the targets, the Government must explain to the people why it failed. This is another attempt at enforcing some kind of accountability for the development of the economy, something that has been lacking in the past.

 


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