By Migara Rodrigo Sri Lanka is in the throes of a major economic and humanitarian crisis. Although this began with the 70% fall in tourism following the Easter attacks, it was exacerbated by the Covid crisis which affected nearly all sectors. The crisis was further exacerbated by high Government spending and tax cuts (such as the cut in VAT from 15% to 8% in 2019), eroding State revenue, while large debt repayments have left foreign exchange reserves at their lowest levels in a decade. Inflation has meanwhile been spurred by the Government printing money. While the Government has attempted to implement price controls on various essential goods, food price inflation reached 36.76% in December 2021 (according to Advocata’s Bath Curry Indicator), which risks plunging many middle-class Sri Lankans into poverty. That assumes they can obtain these goods at all – the dollar shortage has reduced imports while the agricultural community is still struggling to adjust to the Government’s fertiliser policy (and subsequent reversal).  Fiscal and monetary policy instability Fiscal and monetary policy instability are to blame for much of the present conditions including the sovereign debt crisis. Rating agencies have downgraded Sri Lanka’s credit rating to CC or CCC, well into the territory of a junk rating indicating high risk. This deters international investors who are wary of socioeconomic instability and also ensures that the Government cannot rollover debt at favourable interest rates. Sri Lanka’s economic woes are related to solvency (the ability to repay debts and financial obligations) and not liquidity (access to ready cash, easily-convertible assets and foreign exchange), recent measures such as currency swaps are not a sustainable, long-term solution. There must, therefore, be immediate reforms as the longer the Government waits, the worse the crisis will become. Dealing with the misalignment in prices resulting from a controlled exchange and interest rate is the first step. By floating the exchange rate and freeing interest rates to market forces and by halting further CBSL money printing, the foreign exchange and money market will begin working as normal again. Following these short-term reforms, structural reforms will be the nation’s best bet, in conjunction with IMF assistance. The Government needs to come up with a realistic medium term plan to stabilise and reduce the level of public debt. While sound macroeconomic and fiscal policy are a part of this, there is an ongoing need to balance cash flows: for gross financing needs, debt amortisation payments, and public investment, and a medium term debt management strategy: a rolling, medium-term plan outlining how the Government will meet the debt management objectives must be put in place. The constraints on public finance and the rigidity of recurrent expenditure means that significant cuts or postponements in public investment spending will be necessary to create the fiscal space for debt amortisation payments. Therefore, the Government will need to rely heavily on either Public-Private Partnerships (PPPs) or the private sector to finance public investment. The section on infrastructure details the institutional arrangements necessary for PPPs. Essential reforms Medium- to long-term reforms including structural reforms, fiscal adjustment (a reduction in the budget deficit), reducing informality (the informal sector accounts for over 60% of all employment), and finally institutional reforms (such as combating corruption and increasing accountability) are all essential. Some will be included in an IMF programme, but because the problems are many, the reforms need to be deep. Reforms to increase Government productivity cannot be ignored – these can include privatisation of State-Owned Enterprises, reforming the legal foundations of the economy, and increasing the efficiency of Government functions (e.g. in collecting tax and processing customs) to improve public and private sector efficiency and the ease of doing business. Increasing the openness of trade (e.g. through stabilising tariff structures, reducing non-tariff barriers, and negotiating Preferential Trade Agreements) will increase competitiveness within the economy and assist in promoting investment and Foreign Direct Investment (FDI). These measures would begin a shift towards pro-market and globalisation policies that will create opportunities and drive growth in the future. IMF assistance During the process of these reforms, assistance should be obtained from the IMF. This is often conditioned as a part of a debt restructuring so the IMF can underwrite the data, create an economic plan and engage in macroeconomic and fiscal supervision. In Ecuador, the IMF provided the country with a loan of $ 4.2 billion on the basis of strict conditionality and binding fiscal targets, which later expanded to austerity measures and structural reforms. A similar set of conditions would be necessary for Sri Lanka, with Government expenditure reduced, taxation increased and Government workforce gradually reduced. Measures to address macroeconomic stability to ensure future fiscal discipline, including controlling the budget deficit, levels of debt, and CBSL money creation. The most important asset that the IMF brings to the table is its reputation – obtaining assistance would demonstrate to creditors and investors that the Government is serious about reforms and discipline. This would likely boost Sri Lanka’s ratings, and attract much-needed FDI inflows. Unfortunately, both the Government and the Central Bank of Sri Lanka have expressed unwillingness to seek IMF assistance, as they believe the damage to Sri Lanka’s reputation would be higher than the cost of not restructuring. It is necessary for the leaders of these institutions to understand that it is not possible to carry on with business as usual before reforms can begin to be implemented. It is clear that Sri Lanka will be in a difficult position if decisive action is not taken. Borrowing for short-term expenditure and hoping that export growth increases is not advisable. It should also be noted, however, that simply obtaining assistance and restructuring debt will not solve all of our problems; they must work in tandem with domestic reforms.  (Migara Rodrigo is a Researcher at the Advocata Institute. He can be contacted at migara.advocata@gmail.com. The Advocata Institute is an Independent Public Policy Think Tank. Learn more about Advocata’s work at www.advocata.org.  The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute.)