Without a major course correction in its economic trajectory and a significant “haircut” on its external debt, the country will likely be knocking on the door for another IMF pact. It could face another default in a few years.
Ahilan Kadirgamar, Devaka Gunawardena and Sinthuja Sritharan
The International Monetary Fund (IMF) executive board’s approval of loans is being celebrated in the elite quarters of Sri Lanka. The IMF’s recommendations have been implemented for close to a year, however, they have exacerbated the island nation’s economic depression.
The reality is that the IMF agreement and the limited funds that will be released in instalments will not alter the trajectory of a collapsing economy.
Given Sri Lanka’s default on its external debt in April 2022, the debt restructuring process, which is aimed at reducing its unsustainable debt levels, is likely to drag on for months, if not years.
Indeed, without a major course correction in Sri Lanka’s economic trajectory and a significant “haircut” – reduction of outstanding interest payments or a portion of a bond payable that will not be repaid – on its external debt, it will likely be knocking on the door for another IMF agreement. It could face another default in a few years.
The agreement is based on the same assumptions and projections rooted in the free market regime. But Sri Lanka’s challenge is not to return to the deep waters of a turbulent global economy. Instead, the country must identify avenues to increase domestic production of essential goods which its people need for survival. This includes strengthening the food system through local agricultural production.
Sri Lanka may find itself drowning in the dead weight of external debt if the process of achieving debt sustainability is predicated on integrating back into the global economy through more loans and hypothetical opportunities in the distant export markets.
Economic and political scenarios
At the heart of the problem is the conflation of the country’s two deficits: 1) the primary budget deficit, which consists of the government’s revenues versus expenditure, and 2) the current account deficit, which is the country’s foreign earnings versus expenditure.
The effects of the IMF-recommended austerity measures to meet a primary budget surplus target for 2024 can already be seen in the tremendous contraction of the economy in 2022.
Sri Lanka’s gross domestic product (GDP) contracted by 12.4% in the fourth quarter of 2022 alone. However, during the same quarter, the external balance had a surplus of $ 154 million. This happened mainly due to the prioritisation of imports, which for years the nation’s governments had avoided, because of the ideological “straitjacket“ of free trade.
Going forward, a focus on domestic investment and production, while managing the external sector, should be the strategy for reviving the country’s economy. But due to the IMF’s emphasis on a primary surplus and a free market regime, the opposite policies are being pursued. This strategy is inflicting tremendous suffering on the people.
The “straitjacket” approach of free trade attracts foreign capital, which includes a return to borrowings in the international capital markets. But wasn’t that one of the central causes of Sri Lanka’s economic crisis in the first place?
Sri Lanka’s high-interest loans and debt-financed capital inflows were repaid with the hard-earned foreign exchange of its working people. And that debt was invested in unproductive infrastructure and luxury real estate.
Therefore, there is little room for alternatives if Sri Lanka continues with the traditional crisis-fighting approach.
Furthermore, how will the state obtain taxes amid drastically declining real incomes? How can an already unpopular government politically afford to tax a shrinking pie?
The current approach to fiscal consolidation will inevitably hit a roadblock. In fact, the hidden agenda of the ruling elite seems to be a fire sale of public assets and tremendous wage repression. Significantly, the real incomes of people have drastically declined and millions have slipped into poverty. In addition, the privatisation of state assets to foreign entities will both fill the coffers of the treasury as well as bring in foreign capital that can be used to pay back external debt. However, this twinned strategy is bound to provoke a massive political backlash.
Sri Lanka has already witnessed the consequences of a destabilising economy last year. The country’s economic crisis, coupled with tremendous shortages of essential goods and price hikes, led to the overthrowing of President Gotabaya Rajapaksa. The current government led by Ranil Wickremesinghe has none of the advantages of its predecessor, in terms of a popular support base.
Wickremesinghe, and the elites he represents, however, appear content with repeating the process.
Worse, they refuse to even hold elections, in which they are bound to be hammered. They are instead pinning their hopes on more promises of external aid and investment, believing that such pronouncements would placate the citizenry.
Wealth taxes, haircuts, and redistribution
The path laid out above is no doubt a recipe for disaster, but identifying alternatives requires understanding Sri Lanka in its historical and global setting.
When Sri Lanka defaulted on debt for the first time in its history last year, many analysts had spoken about drawing lessons for debt restructuring from other countries.
For instance, the case of the Latin American debt crisis of the 1980s. It may appear that Sri Lanka could bear the same process of structural adjustment. But the Latin American countries experiencing debt distress were incorporated into the expansion of global trade with the decade of hyper-globalisation in the early 1990s, albeit at great social cost and with long-term ramifications for inequality in their own societies.
However, Sri Lanka’s economic crisis has happened at a time when global growth has been slowing.
While there was a temporary recovery of trade in the aftermath of the COVID-19 pandemic, the long-term trend of slowing trade growth continues, aggravated by geopolitical tensions. Therefore, factoring in export-oriented growth opportunities, along with solutions for debt sustainability, must be looked at as per the prevailing global situation.
The Wickremesinghe-Rajapaksa government argue that the tax cuts by the then government in 2019 led to the economic crisis in the country. They further argue that this must be rescinded.
Amid declining income flows, the government is hiking taxes.
The problem, however, is that it is hard to generate revenues from a contracting economy with declining wages. Therefore, only a wealth tax on the stock of existing property and assets is realistic.
Of course, a wealth tax would also encounter fierce resistance from the elites who benefited from Sri Lanka’s neoliberal economic model. Indeed, they have long enjoyed the conspicuous consumption that drained the country’s external finances. There needs to be a redistributive approach focused on stabilising public finances by taxing the property and assets that the elite accumulated over the many decades since economic liberalisation began in the late 1970s.
In addition, amid tremendous price hikes and price volatility, there needs to be a public distribution system that prioritises the essential needs of the people who are on the brink of starvation.
Meanwhile, the lion’s share of Sri Lanka’s external debt is commercial borrowings, particularly international sovereign bonds. These bonds have high interest rates.
Sri Lanka’s bond holders earned high returns over the last decade. Their returns almost equalled their capital, particularly for the 10-year term sovereign bond. On the other hand, its own people have been paying these loans off for years now, by earning the country’s foreign exchange in sectors with little to no social protection. Meanwhile, the state cut back on social welfare spending and productive investment.
Future of development financing
So what is the way forward? The debt restructuring process will likely take time.
The existing debt restructuring frameworks – such as the G20 Common Framework and the Debt Service Suspension Initiative (DSSI), which was agreed upon by Western countries as well as China and India to handle the debt distress of lower-income countries – have proven to be slow and limited.
Moreover, Sri Lanka’s profile is complicated by its categorisation as a “lower middle-income” country. It also has much higher level of foreign commercial borrowings than other countries that have obtained debt relief through similar initiatives.
A just mechanism must be developed for resolving sovereign debt crises, especially for the countries in the Global South.
A new and fairer global regime of trade and investment is necessary. There is a need to build on the work of the Sri Lankan economist Gamani Corea and many others, who, for example, came up with the proposal for the New International Economic Order in the 1970s, which the major powers led by the US refused to consider.
Countries, such as Sri Lanka, that have sunk into an economic crisis cannot wait for a new global financial architecture. Instead, this is the moment when alternative development financing arrangements must be considered, even as hegemonic powers are challenged to move away from demanding austerity measures for developing countries.
Moreover, for countries such as Sri Lanka, their long-term prospects lie in eventual engagement through new forms of South-South cooperation. However, the existing political alignments within regional powers and the nature of their elites, who continue to benefit from and are committed to free markets, block this path. Overcoming these obstacles and building solidarity within the Global South will take time.
Currently, there is a growing international focus on the ongoing wave of debt distress affecting over 50 countries and the absence of a credible mechanism to solve these issues. The discussions on these issues by progressive thinkers, trying to tackle the emerging debt crisis in their own countries, provide a glimmer of hope.
Can we do without the dogmatic economic ideologies that have been part of the capital’s strategy of economic repression and dispossession in the Global South?
This week, for example, a three-day consultation on debt restructuring in Colombo, mainly for economists from the Global South, will be organised by the International Development Economics Associates and the Law and Society Trust. This is one such initiative that is taking up the challenge of conceiving alternatives to the current austerity framework of debt restructuring, and the ongoing devastation it is causing.
If Sri Lanka cannot expect the same growth rates, and if it must make do with a much smaller economic pie, then the question of redistribution becomes even more urgent to ensure that its people can survive, and avoid any danger of starvation.
In addition, policies guiding investment into critical sectors such as agricultural production and the food system may not yield high returns, but they can help ensure survival.
There is an opportunity for a critical shift towards lower but sustainable growth, along with the resistance needed to push back against the dogmas of free trade and capital account convertibility.
By pursuing such a strategy, Sri Lanka can hopefully bring its current account deficit under control and avoid the market fluctuations and repeated crises that have been the hallmark of the neoliberal project around the world. In addition, Sri Lanka must sustain enough public expenditure to prevent its economy from going into a tailspin. That will require considerable redistribution, including measures like a wealth tax.
For Sri Lanka’s elites, along with its international partners, who continue to push the same failed neoliberal growth model, these ideas may seem too radical, or a step too far.
However, for those concerned with a just resolution of a widespread debt crisis and dispossession in the Global South, considering the paths taken and not taken in Sri Lanka may offer a preview of alternatives. That includes reconfiguring the basis on which debt restructuring occurs, along with the possibility of different arrangements for development financing. As the Global South faces another period of great turmoil, its progressive intellectuals should begin debating and promoting these alternatives.
Ahilan Kadirgamar is a political economist and a senior lecturer at the University of Jaffna. Devaka Gunawardena is a political economist and an independent researcher. Sinthuja Sritharan is an economist and an independent researcher.