Sri Lanka's economic crisis has been brewing for a while. Years of policy missteps and a problematic growth model came to a head at the start of 2022, with a debilitating foreign reserves crisis. Shortages of essentials hurt families and firms. A precarious balance of payments position left little buffers to face the shocks emanating from global markets. All this culminated in the people's rejection of the regime that oversaw the economic collapse, an uprising that lasted many months, and the installation of President Ranil Wickremasinghe under extraordinary circumstances, in July. Since the government's announcement in April of a suspension of foreign debt payments, discussions with the International Monetary Fund (IMF) on a bailout — an Extended Fund Facility programme — have progressed, and a staff-level agreement (SLA) is being finalised. In recent weeks, there has been a tendency by those in power to blame the people's protest, terming it as "anarchy" and "unrest", for the delay in firming up an IMF deal. This is not only disingenuous but unhelpful in understanding the rocky road ahead.
The road ahead
Even once the SLA is done, the IMF Executive Board will approve a programme and release bailout funds only once it has 'adequate financing assurances'. This means that Sri Lanka would have to secure some agreements with major creditors (to the IMF's level of comfort) and the Fund's major shareholders such as the U.S. would have to be confident of Sri Lanka's fair treatment of all creditors. Until then, other multilaterals like the World Bank and Asian Development Bank will also refrain from lending new money. For Zambia, which defaulted in November 2020, this process took nearly eight months, from concluding an SLA in December 2021 to getting agreement from its bilateral creditor group (which China co-chaired) in July this year. Evidently, Sri Lanka must make reasonable progress on debt negotiations quickly — with private creditors (holders of international sovereign bonds and commercial loans) and bilateral creditors like Japan, China, and India, to convince the IMF's Executive Board.
In this, securing support from China will be key. Chinese authorities have sent hot and cold signals in the months since the debt standstill was announced in April. While China has expressed support for Sri Lanka's talks with the IMF, it is yet to commit fully and publicly to joining negotiations alongside other bilateral lenders. Perhaps China, a relationship-based lender, is waiting for the new government to make fresh overtures at a high level. Meanwhile, Sri Lanka's debt advisers — Lazard and Clifford Chance — will commence negotiations with private creditors who hold sovereign bonds. Some of these are likely to get caught up in legal disputes, due to the nature in which Sri Lanka unilaterally defaulted in April.
To be sure, spending a few additional weeks on finalising the SLA might not be a bad thing, if it helps in better grounding the programme in the current socio-political realities. Trying to force through an agreement, which doesn't adequately appreciate the dramatic shifts that have happened, could risk the programme's public acceptance and longevity. There are four key areas that the new administration needs to consider. Firstly, the programme with the IMF cannot focus narrowly on revenue-based fiscal consolidation (simply, higher taxes) alone; it must tackle the spending side too. There is a growing public demand for accountability of public finances, better debt management, and combating politicisation and corruption in government. These are no longer concerns limited to policy wonks; they are shared across society. Mis-prioritised public spending (for instance, the dominance of military spending in the budget) has compromised investments in health, education, and innovation. While higher taxes and a wider tax base are indeed necessary, people's willingness to accept a tighter tax regime will improve when they see greater accountability over how revenue is spent.
Second, domestic political consensus on core reform areas must accompany any IMF programme. It isn't just about 'signing on the dotted line' of an IMF agreement now, but also about ensuring smooth implementation in the years ahead. The economic costs of letting narrow political kowtowing get in the way are too high. The scale of the reforms needed necessitate consensus across political parties and key interest groups. It is encouraging that we saw in recent weeks a group of MPs agreeing to pursue a common minimum programme, which had input from a range of stakeholders. This must get greater traction now, to prevent policy backsliding later.
Third, policymaking must be more inclusive. One of the biggest governance errors of the ousted regime was its tendency towards insular policymaking. The President's COVID-19 task force was chaired by a military commander, not by a health professional or a seasoned civil servant. The design and roll-out of COVID-19-era welfare payments had no inputs from those outside of bureaucratic and military circles. Poverty think tanks and civil society organisations, which understand the impact on families, informal workers, and vulnerable groups, were not welcomed. A COVID-19 economic recovery task force had a handful of non-government members who were from a narrow section of the private sector and just one woman, a political appointee in a public agency. The ill-conceived fertilizer ban was informed by paediatricians and priests, rather than those holding PhDs in agriculture and agro-economists. The Central Bank's Monetary Board and Monetary Policy Consultative Committee were reconstituted to oust those with diverse views and include those who shared the same economic and policy ideology of the government. The new administration should do the opposite: listen to voices more representative of society and allow for dissenting and outsider views in a structured manner.
Fourth, an honest and forward-looking picture needs to be painted. The new government needs to explain what policy steps are being taken, why and when, what the outcomes would be, and how these will help ease economic distress. There needs to be an honest conversation with the electorate, where the government levels with the public, and the public in turn feels that the government has its back.
The way forward
To be sure, getting the IMF agreement from staff-level to a fully-approved one by the Fund's Executive Board has less to do with domestic politics and more to do with the progress of debt restructure talks. Prospective IMF financing is contingent on a fair and expeditious renegotiation process with Sri Lanka's creditors (private and bilateral), to place the country on a path towards debt sustainability. But the future success of an IMF programme, once approved, and overall reforms under its ambit could be greatly determined by domestic politics and smart policymaking. Any attempts to push through a reform programme without clear articulation of its rationale, expected outcomes, and measures to protect the vulnerable will be met with resistance by politicians and the public. Any attempts by Sri Lanka's leaders to tighten their grip over society, under the guise of accelerating an IMF programme, will most likely be met with resistance by a newly awakened and vigilant citizenry.
Anushka Wijesinha is a Colombo-based economist and co-founder of the public policy think tank, Centre for a Smart Future
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