• IMF Board approval allows a certain amount of money to flow into the country soon
• Also allows SL to showcase internationally that it is sticking to reforms commitment
• Two main challenges: recover from the crisis, ensure the crisis does not happen again
• Budget 2024 is definitely interesting, since we all know it’s an election year budget
• Vital to address corruption and, more importantly, the perceptions of corruption

 The International Monetary Fund (IMF) Board’s approval of the first review of the Extended Fund Facility (EFF) helps Sri Lanka in two ways, asserted Frontier Research Head of Macroeconomic Risk Advisory Chayu Damsinghe, in an interview with The Sunday Morning.

“Firstly, it allows a certain amount of money to flow into the country within a few weeks. Secondly, and arguably more importantly, it allows for the country to showcase internationally that it is sticking to a commitment of moving ahead with reform,” he stated.

While these two are probably the biggest benefits of the IMF approval, it also underscores some of the challenges that will likely still remain, he noted. “The pathway of the economy still means pain for many despite an overall improvement from 2022. The challenge will be to take the positives from this moment and move ahead despite the negatives.”

In the course of the interview, Damsinghe also spoke on the ongoing debt restructuring process, the current economic situation, Budget 2024, and the IMF Governance Diagnostic Report.

Following are excerpts:

The IMF has approved the second tranche of the EFF to Sri Lanka. What does this mean for Sri Lanka immediately?

The approval of the IMF Board of the first review of the EFF helps in two ways. Firstly, it allows a certain amount of money, both from the IMF and also from multilateral partners, to flow into the country within a few weeks. Secondly, and arguably more importantly, it allows for the country to showcase internationally that it is sticking to a commitment of moving ahead with reform, that it is not backtracking (at least not yet!), and shows continued progress in the pathway the country has chosen.

These two are probably the biggest benefits of the IMF approval, but the approval also underscores some of the challenges that will likely still remain. For example, it shows where the country has been underperforming, chiefly on the tax revenue collection, and strengthens the targets related to tax collection. 

The report released alongside the approval of the review also shows that the medium term is likely to be tight, and thereby faces significant amounts of risks towards implementation and continuity. The pathway of the economy still means pain for many despite an overall improvement from 2022. The challenge will be to take the positives from this moment and move ahead despite the negatives.

What are your views on the ongoing debt restructuring process and how do you assess the current situation? What are the key areas that need addressing in order to ensure debt sustainability?

Sri Lanka’s debt sustainability is currently assessed under a Debt Sustainability Analysis (DSA) undertaken under the IMF’s Sovereign Risk and Debt Sustainability Framework (SRDSF). The SRDSF came into operation in mid-2022 replacing a previous tool and Sri Lanka is the first country to be assessed under this new model. That can mean that even we are figuring things out as we go along.

In any case, the DSA has three broad targets for Sri Lanka’s debt sustainability – debt to GDP, Gross Financing Needs (GFN) to GDP, and foreign currency debt servicing to GDP at varied time periods. Without going into details here, the achievement of a pathway towards these will be considered in getting Sri Lanka towards debt sustainability and the debt restructuring process along with fiscal consolidation, which are key parts of this.

The current progress is roughly in line with what I’d expect, with some finalisation of both bilateral and commercial debt restructuring happening sometime next year with bilateral happening before commercial. That would mean showing a decent pathway towards the targets. 

The issue for me is that these targets are still well in the future – 2027 for the GFN and foreign currency servicing targets and 2032 for the debt to GDP target. Even 2027 is at least two national elections away and 2032 will be at least four elections away. There are so many things that can happen even outside of these and some very critical ones such as the space in the global environment for money to flow is not in our control at all. 

So given this, will we actually achieve debt sustainability down the line? The question is not possible to answer, in my opinion. More important for me is how the pathway looks like for the immediate year or two, 2024 and 2025 in particular. 

According to State Minister of Finance Shehan Semasinghe, Sri Lanka’s ambitious reform agenda carried out with IMF support has resulted in stability in the country within a short period of time. How do you view the current economic situation and the state of the nation? There is a constant refrain on resilience, calling on the people to tighten their belts and help the country recover. Is the burden distributed fairly?

I won’t comment on the State Minister’s statement directly, but talk of the country’s state overall. I would simplify the two main challenges to the economy as first to recover from the crisis and second to ensure the crisis doesn’t happen again.

Given that Sri Lanka’s crisis involved many aspects of the economy, addressing all of those would have been the first priority to prevent catastrophic worsening. Here, the lack of foreign reserves, the difficulty in meeting rupee expenditures, and the sharp increases in interest rates, inflation, and the currency that went alongside the crisis are probably the main economic factors. On this front, I would feel that we have made significant progress. Our reserves have risen, the Treasury is able to run a slight surplus in its cash flows instead of deficits, and macroeconomic variables have significantly softened. 

However, the cost of this improvement is, effectively, that the local consumption economy had to tighten significantly and the pain of that had to be felt by the people. In such a situation, the ideal situation is not to protect those who need it the most and allow the pain to be borne by the others, but to create a situation where the population is okay with taking up this burden. 

The Sri Lankan economy would have needed restructuring anyway and that would have been the second part of what needed to happen to ensure a crisis doesn’t happen again. 

If a particular economic structure led to the crisis, we can’t solve the crisis by returning to that same economic structure. Doing so means that those who benefited from that economic structure, which is most Sri Lankans, will have to feel the pain. If the Government doesn’t create an environment where this reality is understood and accepted and people are willing to take up this burden, it creates the space for more fanciful explanations of the crisis that ignore reality and significantly increases the risk of these sorts of crises recurring.

What are your thoughts on Budget 2024 and the impact it will have on the overall economy in the year ahead? How will it impact growth and inflation? Is the Government doing enough to protect the poor and vulnerable?

Budget 2024 is definitely an interesting one, since we all know that it’s the budget of an election year. Despite that, the fiscal pathway is that of fiscal tightening and quite significant tightening too – from 0.7% of GDP in a primary deficit (deficit excluding interest payments) to 0.8% of a primary surplus. Regardless of the specifics of this, the fact that the Government is not attempting to spend its way through broad election goodies in the lead-up to an election is commendable, I feel.

However, the question that most would have is actually on the specifics. Does the Budget do enough? Does it do too much? Does it do what it does fairly? These are not easy questions to answer because the particular fiscal challenges are not just limited to the numbers, but to the practical realities of implementing changes too. For example, trying to root out corruption will obviously mean those who benefit from it will resist it. So while that has to be addressed separately, that also then requires stopgap measures to keep the system running in the meantime.

All in all, my personal opinion is that directionally, Sri Lanka is going where a country at this stage of a crisis can be reasonably expected to go. As the country recovers from two years of recession, the economy should expand but it probably won’t be a booming recovery. That of course means that many people will still feel tighter belts and tough times continuing. 

In the past, the only ways we’ve avoided this is by debt; the country borrowed to directly and indirectly make the lives of the people easier, especially by creating the space for cheaper and more consumption (suppressed exchange rates, subsidised prices, and ill-managed welfare through salaries are key ways I feel this happened). The absence of these measures means that there’s really no way to have that sort of better situation so soon.

Of course, protecting the poor and the vulnerable has to be a cornerstone of this regardless. While steps have been taken to improve the targeting of welfare, the myriad issues in the Aswesuma programme means so much still remains problematic. Addressing this as a priority is not just an economic but also an ethical and moral priority.

The other big factor is addressing corruption and, far more importantly in the short-term, perceptions of corruption. That is a key part of what allows governments to maintain legitimacy and support, listening to the people’s voices; if that doesn’t happen, then the risks of a policy direction failing rise.

What are your thoughts on the Governance Diagnostic Report overall? Has the Government done enough to address deep-rooted corruption and what steps should it take to address this ongoing issue?

It is undeniable that corruption is a big part of the Sri Lankan economic story. It is also undeniable that this is not a uniquely Sri Lankan, or even a uniquely developing country problem. I have a strong belief that it is inaccurate to argue that developed economies have no corruption or that they have fixed all or even most of the issues on that front. Instead, what happens is that corruption moves from being theft to being more subtle and insidious. 

The examples I like to use here are that of Iceland in the global financial crisis, Singapore in the Asian financial crisis, and Norway during the Covid-19 pandemic. I argue that the massive increase in private sector debt through government policies that allow this, the government and regulatory support of the massive deficiencies this caused, and the opaqueness of investment decisions including that of public money are all indicative of corruption; the consequences of these were quite substantial as well.

Does this mean we ignore corruption and let it happen? Of course not. It just means we have to be aware of the reality of what corruption is, what it means, and how to address it. These three examples themselves give good lessons on what to do (take steps to address accountability) and what would be harder to do (recoup losses of the decisions made). But critically, taking steps to address corruption is absolutely essential even if we assume that there is zero corruption. As long as the people have a perception of corruption and it’s a key part of how they see the State, addressing this becomes critical. Hiding behind the reality is not enough of an argument, since part of the reality is also very much that people care about action.

The Governance Diagnostic is a useful step here, and the IMF review in fact operationalises some of the key recommendations as IMF targets as well. The challenge is really moving towards actual implementation and showing some sort of result. Doing this will, of course, be hard since so many will resist this, but doing so, and importantly communicating so, will be a critical part of the pathway forward. I would be realistic on what sort of results are possible in the short-term, but I would also be insistent that strong measures towards the results are important nevertheless.

Is there a long-term roadmap for Sri Lanka’s recovery?

What can Sri Lanka’s future look like? I think if we boil it down to the basics, we either need to be okay with long-term constrained consumption so that our current level of ‘income’ can meet this (the original East Asian development model of constrained consumption to grow the production side), or we have to grow our ‘income’ faster than our consumption (something closer to a service-driven growth model that keeps consumption growing but production as well). 

This will mean we have to set incentives towards these sorts of goals. This is where growing consumption fast doesn’t make sense, since there is no real incentive to grow your income-generating activities if you find out that consumption alone works well. For me, this is the key reason Sri Lanka’s exports never really grew that well, since it was almost always a better business decision to get into imports and local consumption.

There are risks with both of these pathways. The East Asian model came with long-term suppression of consumption so powerful that it became difficult to raise consumption even when the governments wanted to – take the examples of Japan in the ’80s and ’90s and China right now as examples. They also came with pretty brutal repression at some points such as Korea in the ’60s and ’70s. The service model comes with being highly exposed to capital movements that can result in very sharp swings in economic variables and lead to sharp crises as well – again, the Asian financial crisis is a good example here. 

Even a ‘third way’ model of being a high-tax and high-spend economy such as the welfare states of Northern Europe would still be highly exposed to external events, since any external event that either drops taxes or increases expenditure will showcase the fragility in the system. There are no real ‘silver bullet’ answers, but answers that can work in some ways.