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IMF only a first step in longer journey: Anushka Wijesinha

16 Apr 2022

By Marianne David  Working with the International Monetary Fund (IMF) to get Sri Lanka back on track is only the first step in a longer journey, asserts Economist and Centre for a Smart Future Co-Founder Anushka Wijesinha, noting that having the IMF in our corner will also help strengthen the confidence in the overall debt restructuring process, since it would encourage creditors to see the IMF in the equation. In the short-term, the Government must urgently address the needs of the most vulnerable in society, he emphasises: “We have had successive shocks in recent years (Easter Sunday attacks, the pandemic, and now the food, fuel, and medicines crises). These cause ‘scarring’ on households and firms. So the first step is to get the economy through this without further scarring.” In the course of a wide-ranging interview with The Sunday Morning, Wijesinha also spoke on working with the IMF, key short-term measures to improve the current situation, restructuring debt, the tax regime, national budget, protecting the vulnerable, current political instability, and outlook for the future. Following are excerpts of the interview:  The Government has bitten the bullet and finally approached the IMF. What can we expect and what do we need to do to ensure we reap the maximum benefits of this approach? It’s the first step in a longer journey. We can expect discussions with the IMF on a support programme to focus primarily on macroeconomic stabilisation and fiscal adjustment, where the IMF would provide some balance of payments support, alongside technical assistance for the stabilisation measures. Although it will be the Government’s financial and legal advisors who will work on the negotiations with our international creditors, having the IMF in our corner will also help strengthen the confidence in the overall debt restructuring process. Creditors, especially bondholders of our International Sovereign Bonds (ISBs) would be encouraged by seeing the Government having this technical advisor and neutral party in the equation. Especially as the IMF would release various data and analysis on the country’s macroeconomic conditions, and their verdict on the Government’s planned consolidation path, bondholders would look to this data and information for independent assessment of the situation. On your question of ensuring we reap the maximum benefits, the key would be to not be political about the required adjustments. We have to follow a sensible and technical approach and sequence the adjustments and reforms in a way that brings in macro stability but minimises the pain on vulnerable population groups. Groups that typically oppose IMF-type intervention should, instead of treating the Fund as the bogeyman, hold our leaders and officials accountable since it is they who would be making the agreement on behalf of the Sri Lankan people and the economy. The IMF is only one aspect. What else does the Government need to do in the short-term? What do you see as sustainable solutions? In the short-term, the Government must address the needs of the most vulnerable in society, and address pressing needs like the fuel, cooking gas, food, and medicine shortages. Without these basics to help keep firms’ and households’ heads above water, we cannot begin to think about ‘getting the economy back on track’. We have had successive shocks in recent years (Easter Sunday attacks, the pandemic, and now the food, fuel, and medicines crises). These cause ‘scarring’ on households and firms. So the first step is to get the economy through this without further scarring. With a severely wounded economy, it is first about administering triage and stemming the blood loss (the emergency humanitarian needs), then quickly stabilising the patient and conducting the most immediate surgery (the macro stabilisation measures, fiscal adjustment, debt restructure) and then beginning the recovery and recuperation efforts (the medium-term policy reforms). Sri Lanka defaulted on its debt for the very first time, a unilateral debt suspension that you and other economists and experts welcomed. What steps should Sri Lanka now take in terms of debt restructuring? I wouldn’t say economists ‘welcomed’ this, because it was entirely avoidable had the right steps been taken at the right time. We would have welcomed a more orderly process. But we had come to the brink and it was a no-option environment. What we did welcome is the realisation that we cannot meet both the forthcoming coupon and bond repayments as well as import essentials. What we did welcome was the effort to take the first, albeit very late and damaging step, of putting a debt standstill. The CBSL Governor has assured that domestic debt will be off the table and this is the stance the negotiators should stick to. The next steps should be a very organised, credible, and coherent approach to engaging with our creditors, through the legal and financial advisors who would be appointed by the Government. We cannot afford to fall off the wagon and have creditors fully lose faith in the process. We are not the only country to go through this process, so we should take heed from international experience and do this in a professional manner, so that two to three years from now we could potentially return to the markets. What do you see as the key reasons for this economic downfall? Where did we go wrong? We’d need the full extent of today’s newspaper to dissect and discuss that! In summary, it was a series of policy errors on the back of an already-vulnerable economy. The tax cuts at the end of 2019 were irresponsible and defied all logic. Sri Lanka does not have strong empirical evidence (tax elasticities, etc.) on the extent of tax cuts that would generate more growth. Not a single respectable chamber of commerce was lobbying for tax cuts at the time. Moreover, not just change in rates but also the change in collection techniques – removing PAYE, removing WHT – these hurt the timing of cash flows to the Treasury. Once Covid-19 hit, the Government should have sought assistance for a holistic Covid-19 relief programme. I recall submitting a recommendation to senior Government officials at that time with practical steps to provide relief to firms and workers, and structuring a comprehensive funding package. Instead, the approach that was followed was piecemeal – a Rs. 5,000 handout here, a loan moratorium there, a utility bill pause here, a welfare measure there. The onus of providing ‘relief’ was essentially passed on to the financial sector – banks and finance companies – through debt moratoriums and refinanced loan schemes. This is fine for the early days, but not for carrying through two years of the pandemic! The lack of fiscal space due to the tax cuts meant that the State could not meaningfully fund Covid-19 relief. The other intervening factor was the disastrous overnight banning of agrochemicals. This decimated the agricultural sector, hurt farming households, and impacted crop production. Consequently, it contributed to the domestic food production shortages we see today, contributing to the 18% inflation. Sri Lanka had to rely on ‘relief imports’ of rice from Myanmar – itself a country that is in a political and economic difficulty – to feed our people. Overall, if I had to characterise the economic management and economic policymaking of the last couple of years it would be – poorly-designed interventions, myopic, lack of listening to evidence and external expertise, full of false bravado, and over-reliance on some recovery bets (for instance, ‘post-Covid tourism recovery would save the day’). Sri Lanka can presently afford only a few weeks of imports. How can we build our reserves and return to a position of strength and how long will it take? Again, we cannot consider returning to a position of strength without stopping the bleeding. On this front, some recent steps are encouraging and will help preserve scarce reserves – the floating of the rupee, the debt standstill, and obtaining some emergency credit lines from bilateral (e.g. the Indian credit line for fuel and other essentials) and multilateral funders (e.g. World Bank loan for medicines). From here on, building reserves sustainably will rely on an increase in export and tourism earnings, remittances, and Foreign Direct Investment (FDI) inflows. I cannot see a dramatic increase in these in the short-term, but these inflows would certainly help. On the FDI front, we cannot expect major export-oriented FDIs coming in this year, given the volatility on the political and economic front. Good investors want to see some stability, and the operational basics (fuel, electricity, workers’ welfare). At this point, if we are to even contemplate getting back to a position of strength, then political and Government leaders should be focusing all their efforts on one thing – not making things worse. Once you take an already-vulnerable economy to the brink, it causes major scarring effects that last a while. We should be under no illusions that this recovery will be quick and easy. While the current and incoming credit lines certainly help in the short run, will they hinder Sri Lanka in the long run? Are they being given on favourable terms or are we digging ourselves into a deeper hole? The exact terms of each credit line or loan coming through now are not public knowledge, so I cannot comment for certain. But the fact is that at this point we have to take what we can and help stem the blood loss. We are in little position to negotiate. However, I would advocate that as much as possible we seek multilateral assistance (IMF, World Bank, ADB, etc.) over bilateral assistance, since the former comes with some checks and balances, puts an onus on the receiving country to put in some governance and other safeguards, and wouldn’t get caught up in geostrategic interests and regional power plays – like bilateral aid would potentially do. Additionally, the Government must be cautious about bilateral credit lines being agreed on in exchange for the sale or lease of assets, as this would leave a sour taste in the mouths of the Sri Lankan public and lead to unnecessary opposition to future FDI and Public-Private Partnerships (PPPs). Such sales or leases – whether they be in connective infrastructure projects or renewable energy projects – should be done through transparent and established procurement processes. Our tax revenue is rather dismal and Sri Lanka is among the bottom 10 countries in the world in terms of tax to GDP ratio. What are your views on Sri Lanka’s tax regime and what needs to change? Immediately? We should bring back the tax regime under the previous Inland Revenue Act. Even tax and accounting professionals who opposed parts of those reforms are now acknowledging they were good ones. We must look at a medium-term fiscal consolidation path, beyond quick tax policy fixes. That is what the previous reforms aimed to do. Sri Lanka isn’t like the US where the transmission mechanism from tax cuts to economic activity is well-studied and known. To use tax policy and tax administration for good – to generate inclusive growth and entrepreneurial activity, while adequately financing an exchequer to support socio-economic development – there needs to be a stable and predictable tax regime. But alongside taxation, the Government must necessarily focus on expenditure management as well. One of the faults I saw with the previous fiscal reforms was that it was entirely a revenue-based fiscal consolidation – it did not touch expenditure. This time, we cannot afford that dichotomy. Public sector salary increases and new hiring should be frozen, all unproductive programmes should be paused, and institutions that have overlapping mandates, staff, and activities should be merged. This is the ideal time to rationalise public sector spending since what’s at stake is so great and the wider public would get behind it. It would be hard for public sector unions to demonstrate against hiring freezes, cuts in their budgets, and their overall reducing space in the economy, while regular citizens are struggling to make ends meet. Sri Lanka has run budget deficits of over 10% of GDP in the last two years. What are the immediate steps the Government can take to get the national budget back on track? What should Sri Lanka be spending on and where should spending be halted? Ad hoc budget cuts or budget allocations must be avoided – it must follow some framework of thinking. For this, the Budget Department and National Planning Department should consult openly and widely (civil society, development partners, local governments, think tanks, etc.), over the next 60 days to help inform themselves on ground conditions and formulate a new expenditure prioritisation. The Government should come up with a two-year recovery and reform growth framework to help set the basis for prioritising public spending where it matters the most (e.g. humanitarian assistance to struggling population groups like the urban poor). Alongside this input, internally the Treasury would have to identify opportunities for budget rationalisation. The new Treasury Secretary should appoint an internal taskforce to go line by line on the annual budget and uncover places to free up fiscal space. No doubt, some non-essential capital expenditure projects would have to be put on hold to make fiscal room for relief measures. Notably, infrastructure construction – a big focus of the current regime – would perhaps be the first to be de-prioritised, especially amidst cost inflation controversies in projects like the Central Expressway. Some other capex – say, upgrades to agri irrigation tanks and canals – may need to be fast-tracked to support a recovery in agricultural production. Overall, budget discipline will have to be front and centre more than ever before. For the next three years, Government budget speeches should stay away from coming up with any new mega programmes that require time to design and new competencies to execute. I have experienced this first-hand while working in Government. Well-meaning Finance Ministry officials come up with an idea for a new programme and the Budget speech announces it and allocates it to a ministry. Often it is the first time the ministry hears of it. It takes weeks and months to figure out what Finance expects of it, more months to get the internal house in order to implement it, and then constant back and forth on project submission documents and budget requests to actually get the money to implement. By then it is nearly October and unspent monies have to be returned to the Treasury. Having under-spending is then frowned upon by budget officials, who then promptly cut the allocation for that programme for the next year! Now is the ideal time to bring much-needed rationality, logic, design rigour, and implementation bias to the national budget. For the next two to three years, only programmes and initiatives that were working well should be funded and programmes that have shown promise should be quickly evaluated and further enhanced. On the trade side, I couldn’t recommend more highly that the Government fully funds the implementation of the National Export Strategy, which would help generate export earnings and boost competitiveness in key sectors. How can we ensure the most vulnerable of society, who have been dealt blow after blow in the last few years, are not subjected to further hardship? The fiscal adjustment would have to be swift but sensible in its sequencing and sensitive to vulnerable population groups. Budget cuts need to be prioritised in a way that doesn’t further burden poorer households already crippled by the current conditions. I mentioned earlier about the need to curb some public sector construction projects to free up fiscal space. Even in this we must be mindful that a cut back in construction projects would see localised impacts on jobs too. Many seasonal farm workers often take on casual labour in these projects, and this had grown following the collapse of the agriculture sector due to the Government’s ban on agrochemical use. This is just an example of one sector where the fiscal adjustment path would need to be calibrated, and social safety nets put in place. That is where the biggest amount of the freed up fiscal space may need to go to – a well-formulated social safety net that doesn’t replicate the problems with Samurdhi, but builds on it, and plugs the gaps to ensure those who should be getting relief (but are currently out of the system), get it. Amidst all of the economic and political turmoil, how can we ensure banking sector stability? One major immediate aspect is to ensure that domestic debt restructuring is kept off the table and also ensure that the recent declaration of debt standstill doesn’t affect banks’ counterparty financing relationships for international trade to be financed smoothly. Beyond that, I think the authorities must reduce the multitude of ‘micro-interventions’ made on the banking sector, constantly. In the last two to three years we have seen so many of these – a rate cap here, a forced conversion there, a special lending scheme here, a compulsion to hold the currency there. My analogy of the financial system is to a nuclear reactor – it broadly has some parameters set, based on fundamental science (in our case, market principles). The control room only needs to check some main gauges, monitor some key variables in real time, and make some adjustments to keep things ticking along. Then one day we went and decided ‘let’s start playing with all the buttons and try and do our own thing’ – flipping a switch, turning another knob to its extreme, turning a component off autopilot, etc. – and suddenly the reactor starts vibrating violently, there is smoke billowing from the machines, and the critical dials are going haywire. That’s what we saw happen to the banking sector. My message is that Sri Lankan banks should be allowed to operate without all these micro-interventions that create so much distortion, noise, and distraction, create perverse incentives among borrowers, and ultimately weaken the medium-term capabilities for financing entrepreneurship and economic growth. Banks have corporate governance standards, prudential safeguards and good accounting practices, and proactive management and boards, all of which will help ensure these entities are run responsibly, in a way that balances the interests of borrowers, depositors, shareholders, and the regulator. The ongoing protests signify deep disgust with Sri Lanka’s political leaders and the governance structure. What are the immediate changes needed? How will this turmoil impact ongoing negotiations with the IMF and international institutions? As I wrote in a recent op-ed for the East Asia Forum, the key risk facing Sri Lanka in the coming weeks and months ahead is the fallout of the current political instability on the efforts at macro stabilisation. Given the wildly divergent political views and economic ideologies among the parties, getting political consensus on an economic reform programme will be the most important, but challenging task. Anti-IMF public posturing, disagreements on the budget cuts and reform pathway, could undermine near-term restructure efforts. Of course, political consensus around most economic policies in Sri Lanka – not least structural reforms – has always been elusive. As a former chairman of a prominent chamber of commerce once put it, “politics have always trumped economics in Sri Lanka”. Domestic political consensus on the core reform areas (fiscal adjustment, market-based pricing of fuel for instance, rationalising State expenditure including SOE reform, and a halt on State sector recruitment) must accompany efforts to agree on a reform programme with the IMF that sets the stage for a sovereign debt restructure. The IMF, and indeed bondholders, would want assurances of political continuity, not policy whiplash like in the past. Any attempt to push through the reform programme without a clear and compelling articulation of the rationale, urgency, and expected outcomes will naturally be met with resistance by politicians and the public. How do you see the year ahead panning out for Sri Lanka? Do we dare be hopeful? It will no doubt be a difficult year. It will have a lot of political and economic turmoil. We need to be ready for it. The private sector – the organised chambers of commerce and industry – must play a much more proactive and pivotal role in guiding government reform programmes but look beyond business interests. They should consult with think tanks, civil society, and rights groups, and formulate a more holistic position on key issues of inclusive growth, economic justice, and good governance. What I am most hopeful about is that we seem to have reached a mental tipping point. Groups that didn’t care about constitutional checks and balances during the ‘constitutional coup of 2018’ are now vocal about it. Those who had little interest in asset declarations of MPs are now interested in it. Those who had little interest in fiscal policy and good governance on public financial management are now interested in it. Those who paid little attention to the SOE losses and reform agenda are now tuning in more – all this especially among young people and young professionals. This is what makes me most hopeful this year.  


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