Sri Lanka and the International Monetary Fund: a troubled past

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Just a week ago, officials from the International Monetary Fund (IMF) visited Sri Lanka after the country descended into economic chaos earlier this year. The IMF press release on the trip, which ended with thanking “the authorities for the frank approach and warm hospitality and we look forward to continuing our discussions on behalf of Sri Lanka and its people. What exactly was meant by frank is not clear from the context. Does this mean that officials were transparent or does that mean they were honest that the country would adopt a different strategy than that recommended by the IMF? Perhaps neither interpretation is true.

Since the visit, the political situation has changed dramatically, with protesters invade the presidential palace on Saturday, July 9.

Faced with increasing pressure from other members of the government, the current president, Gotabaya Rajapaksaagreed to resign and leave office on July 13, 2022.

While announcing that the president would step down, Prime Minister Ranil Wickremesinghe also said he would be ready to step down once a new government was formed. He took to Twitter to share this message and encourage other leaders to make the same decision.

Sri Lanka and the IMF

The protests that led to these changes in government came as inflation grew up seventeen percent since the beginning of the year. These historic price spikes have led to food and energy shortages across the country.

In addition to the President and the Prime Minister, the IMF met leaders of parliamentthe Central Bank of Sri Lanka and the Treasury Secretarycivil society organizations, private sector actors and development organizations.

After so many meetings, the recommendations made by the IMF are quite vague.

What policy measures has the IMF recommended for Sri Lanka

After the officials’ visit to Sri Lanka, a few economic recommendations surfaced:

  • Reducing the high fiscal deficit while ensuring adequate protection for the poor and vulnerable
  • Deep tax reforms are urgently needed to achieve these goals
  • Contain rising levels of inflation
  • Responding to strong pressures on the balance of payments
  • Reduce vulnerabilities to corruption
  • Engage in pro-growth reforms.

A tighter monetary policy should reduce public spending and encourage the Central Bank to raise interest rates to slow inflation. On July 6, the The Central Bank announced that interest rates would be increased by 100 basis points, i.e. from 14.50% to 15.50%.

Noting the higher than expected escalation in headline inflation recently and the increased persistence of high inflation in the period ahead, the Council considered that further tightening of monetary policy would be needed to contain any accumulation of unfavorable inflation expectations

Central Bank of Sri Lanka

In most documents written by the IMF, the the organization draws attention to the need for the government to protect vulnerable groups as they identify ways to regain control of the economy. These questions and onepapproach taken to support economic recoveryare of particular concern to some who see the current problems as a consequences of IMF and World Bank structural adjustment programs at the end of the 20th century.

What is structural adjustment?

Scholars like Swarna Jayaweeralinked the liberalization of the economy, which includes the abolition of protectionist trade policies to the collapse of many national industries in the late 1970s. Without protectionist policies, the country has been unable to make its products more competitive for domestic consumers, resulting in a sharp decline in demand for Sri Lankan products. The second policy covered by Jayaweera was the IMF’s suggestion to establish an economic growth plan that moved towards a concentration on exports that attracted foreign investment mainly used on cheap female labor. Cases of labor exploitation, including child labor, have also been reported in the country.

The shift to exports came after the country had applied heterodox economic strategies such as import-substitution industrialization, which helped protect their domestic industries through the use of tariffs and other protectionist policies. These policies contributed to the growth of their economies in the 1950s, 1960s and early 1970s. For example, life expectancy increased sixty-eight and seventy-two percent for women and men, respectively, in the late 1970s. Literacy and hunger rates also declined during this period. Policies like import substitution are illiberal and therefore had to be removed after the country started receiving conditional loans from the IMF and the World Bank. Now, with tighter monetary policy, the state can take a number of routes, but it is increasing its Value Added Tax (VAT) and other taxes while, reduce funding for social and welfare programs and reduce labor and environmental standards.

Some scholars have speculated that this kind of policy is on the horizon because of the kind of loan that started to be negotiated between the government (which is out of stock) and the IMF during the last visit: Extended Fund Facility. These loans often come with structural requirements. These reforms are necessary because such loans are only offered to “countries experiencing severe payment imbalances due to structural impediments or slow growth and an inherently weak balance of payments position.”

These loans are designed at “correct structural imbalances over a long period.” So far, this type of loan has been offered to Ecuador and the government has been forced to lower the minimum wage, reduce pensions and contributions “considered excessively generous” and allow governments at all levels , to procure “infrastructure from foreign companies”, weaken the local economy.

Even before the pandemic, Sri Lanka knew economic turmoil with GDP starting to fall in 2018.

In 2015, annual GDP growth peaked, growth of 12.8 percent. These rates have not been reviewed since. In 2020, GDP declined, but has since returned to its pre-pandemic position. In 2019, President Rajapaksa delivered on a campaign promise by reducing value added tax (VAT), which applies to luxury goods, from fifteen to eight percent. It was seen as a strategy to encourage growth, but when the pandemic hit the government was left with far less revenue.

Finance Minister Ali Sabry, who pioneered the approach, has come to view the elimination of more than seven taxes that have drastically reduced the country’s tax base as a “historic mistake”.

Before providing any other financial support, the World Bank would like to see the financial situation stabilized.

“Until an adequate macroeconomic policy framework is in place, the World Bank does not plan to offer new financing to Sri Lanka,” read a Press release aimed at clarifying the Bank’s position.

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