Sri Lanka ‘s new Finance Minister Ali Sabri started blaming and shaming previous fiscal and monetary authority heads of his own government for blocking the seeking of IMF aid to tackle the man-made economic disaster in the country.

He made these remarks when the time was running out for Sri Lanka to start talks with the International Monetary Fund (IMF) at its spring meetings in Washington on April 18 -24 as the country is yet to restore political stability.

Sri Lanka was blocked from going to the International Monetary Fund for assistance by the then Presidential Secretary, Central Bank Governor and Treasury Secretary, Finance Minister Ali Sabray said.

“The former Secretary to the Treasury Attigala, former governor Ajith Nivard Carbral and former president’s secretary P.B. Jayasundara did not want to go to the IMF when almost all the cabinet ministers were in favor of going,” Sabry told Sri Lanka’s Hiru Television.

“They were talking about a home grown solution instead.”je added.Senior officials have publicly opposed going to the IMF citing budget cuts and currency depreciation.

Ex-Central Bank Governor W D Lakshman, a former economics professor printed unprecedented volumes of money to run down reserves over two years and trigger over 18 percent inflation over two years under so-called Modern Monetary Theory, an extreme form of Keynesian stimulus.

Sri Lanka’s rupee depreciates due to operating a soft-peg and instability has worsened recently under flexible inflation targeting with the rupee falling from 131 to 335 since 2015

However Socio ,Political and Economic stability of a country are essential factors to reduce the risk of default on loan repayments and minimise moral hazards as most IMF lending arrangements are conditional on the member country involved agreeing to implement a set of economic policies approved by the IMF, IMF sources revealed.

Street protests which began a month ago are continuing and it has intensified recently demanding the ouster of the President.

This crisis situation triggered due to economic hardships faced by the people will have to be normalised restoring the confidence of international donor agencies, several economists said.

A new Central Bank Governor and Finance Ministry Secretary with a wide knowledge of IMF affairs have been appointed to fill the void created due to resignations of former heads of these monetary and fiscal authorities.

After a request for financial support from a member country, an IMF staff team holds discussions with the government to assess the economic situation.

Typically, a country’s government and IMF staff must then agree on a programme of economic policies to be implemented in return for a loan.

This is a long procedure and it will take at least 3-6 months to materialise, one source said adding that the government will have to initiate soon the procedure of debt restructuring with IMF mediation. It has to repay an International Sovereign US$1 billion in June this year.

The $1 billion Indian credit line and the Chinese government pledge of $2.5 billion in loans were the only hopes for Sri Lanka as its foreign reserves dropped to $1.9 billion in March from $ 2.3 billion, he added.

This situation was not sustainable, and put the government at risk of being forced to restrict imports, as well as default on external government debt repayments due to a lack of foreign currency. The loan from the IMF directly contributes to raising the country’s foreign exchange reserves at an affordable cost.

R. Ramakumar

The island nation of Sri Lanka is in the midst of one of the worst economic crises it’s ever seen. It has just defaulted on its foreign debts for the first time since its independence, and the country’s 22 million people are facing crippling 12-hour power cuts, and an extreme scarcity of food, fuel and other essential items such as medicines.

Inflation is at an all-time high of 17.5%, with prices of food items such as a kilogram of rice soaring to 500 Sri Lankan rupees (A$2.10) when it would normally cost around 80 rupees (A$0.34). Amid shortages, one 400g packet of milk powder is reported to cost over 250 rupees (A$1.05), when it usually costs around 60 rupees (A$0.25).

On April 1, President Gotabaya Rajpaksha declared a state of emergency. In less than a week, he withdrew it following massive protests by angry citizens over the government’s handling of the crisis.

The country relies on the import of many essential items including petrol, food items and medicines. Most countries will keep foreign currencies on hand in order to trade for these items, but a shortage of foreign exchange in Sri Lanka is being blamed for the sky-high prices.

Why are some people blaming China?

Many believe Sri Lanka’s economic relations with China are a main driver behind the crisis. The United States has called this phenomenon “debt-trap diplomacy”. This is where a creditor country or institution extends debt to a borrowing nation to increase the lender’s political leverage – if the borrower extends itself and cannot pay the money back, they are at the creditor’s mercy.

However, loans from China accounted for only about 10% of Sri Lanka’s total foreign debt in 2020. The largest portion – about 30% – can be attributed to international sovereign bonds. Japan actually accounts for a higher proportion of their foreign debt, at 11%.

Defaults over China’s infrastructure-related loans to Sri Lanka, especially the financing of the Hambantota port, are being cited as factors contributing to the crisis.

But these facts don’t add up. The construction of the Hambantota port was financed by the Chinese Exim Bank. The port was running losses, so Sri Lanka leased out the port for 99 years to the Chinese Merchant’s Group, which paid Sri Lanka US$1.12 billion.

So the Hambantota port fiasco did not lead to a balance of payments crisis (where more money or exports are going out than coming in), it actually bolstered Sri Lanka’s foreign exchange reserves by US$1.12 billion.

So what are the real reasons for the crisis?

Post-independence from the British in 1948, Sri Lanka’s agriculture was dominated by export-oriented crops such as tea, coffee, rubber and spices. A large share of its gross domestic product came from the foreign exchange earned from exporting these crops. That money was used to import essential food items.

Over the years, the country also began exporting garments, and earning foreign exchange from tourism and remittances (money sent into Sri Lanka from abroad, perhaps by family members). Any decline in exports would come as an economic shock, and put foreign exchange reserves under strain.

For this reason, Sri Lanka frequently encountered balance of payments crises. From 1965 onwards, it obtained 16 loans from the International Monetary Fund (IMF). Each of these loans came with conditions including that once Sri Lanka received the loan they had to reduce their budget deficit, maintain a tight monetary policy, cut government subsidies for food for the people of Sri Lanka, and depreciate the currency (so exports would become more viable).

But usually in periods of economic downturns, good fiscal policy dictates governments should spend more to inject stimulus into the economy. This becomes impossible with the IMF conditions. Despite this situation, the IMF loans kept coming, and a beleaguered economy soaked up more and more debt.

The last IMF loan to Sri Lanka was in 2016. The country received US$1.5 billion for three years from 2016 to 2019. The conditions were familiar, and the economy’s health nosedived over this period. Growth, investments, savings and revenues fell, while the debt burden rose.

A bad situation turned worse with two economic shocks in 2019. First, there was a series of bomb blasts in churches and luxury hotels in Colombo in April 2019. The blasts led to a steep decline in tourist arrivals – with some reports stating up to an 80% drop – and drained foreign exchange reserves. Second, the new government under President Gotabaya Rajapaksa irrationally cut taxes.

Value-added tax rates (akin to some nations’ goods and services taxes) were cut from 15% to 8%. Other indirect taxes such as the nation building tax, the pay-as-you-earn tax and economic service charges were abolished. Corporate tax rates were reduced from 28% to 24%. About 2% of the gross domestic product was lost in revenues because of these tax cuts.

In March 2020, the COVID-19 pandemic struck. In April 2021, the Rajapaksa government made another fatal mistake. To prevent the drain of foreign exchange reserves, all fertiliser imports were completely banned. Sri Lanka was declared a 100% organic farming nation. This policy, which was withdrawn in November 2021, led to a drastic fall in agricultural production and more imports became necessary.

But foreign exchange reserves remained under strain. A fall in the productivity of tea and rubber due to the ban on fertiliser also led to lower export incomes. Due to lower export incomes, there was less money available to import food and food shortages arose.

Because there is less food and other items to buy, but no decrease in demand, the prices for these goods rise. In February 2022, inflation rose to 17.5%.

What will happen now?

In all probability, Sri Lanka will now obtain a 17th IMF loan to tide over the present crisis, which will come with fresh conditions.

A deflationary fiscal policy will be followed, which will further limit the prospects of economic revival and exacerbate the sufferings of the Sri Lankan people.

The Conversation

The anti-government public protest launched on April 09 demanding the stepping down of President Rajapaksa and the Government continues for the fifth consecutive day at Galleface.

These demonstrations grow despite adverse weather conditions or any other obstacles.

People are staging their peaceful demonstrations ahead of the Sinhala and Tamil New Year. On the night of the Old Year (Parana Awrudda), people have gathered around the Presidential Secretariat.