Child’s guide to Ranilnomics V: Need is going for IMF Plus

President Ranil Wickremesinghe chairs a meeting with the IMF Mission, CBSL and Treasury officials in August - File photo

Whiz kid of economics, Aseni, and her grandfather, Sarath Mahatthaya, are continuing their probe into the economics of President Ranil Wickremesinghe, tagged Ranilnomics.

Previously, they talked about the ideological battle which Ranil should win to get the parliamentary group that supports him on board (available at: https://www.ft.lk/columns/Child-s-guide-to-how-Ranilnomics-should-be-designed-and-implemented-Part-I/4-739461), the folly of short-sighted policies he has introduced in the form of temporary suspension of essential machinery and inputs (available at: https://www.ft.lk/columns/Child-s-guide-to-Ranilnomics-Part-II/4-739758), how he should use the governance code of the Vajjis during the Buddha’s time which he cherishes profoundly (available at: https://www.ft.lk/columns/Child-s-guide-to-Ranilnomics-III-Buddha-s-prescriptions-on-governance/4-740034), and challenges he faces when restructuring a small part of Sri Lanka’s public sector foreign debt as a precondition for a bailout from IMF (available at: https://www.ft.lk/columns/Child-s-guide-to-Ranilnomics-IV-Proposed-debt-restructuring-will-pose-more-issues-than-answers/4-740260).

Today, they look at the IMF bailout package and what else he should implement to deliver rich country status to Sri Lanka by 2048, the centenary of the independence of the country from the British.

When we break Sri Lanka’s economic issue into two, one involving the most urgent issues, and the other relating to the longer-term issues, we find that the IMF bailout is needed to resolve the most urgent issues. The most urgent issues are that Sri Lanka has exhausted all its foreign exchange resources, it is saddled with a foreign debt problem, it cannot import the essential consumer as well as investment goods, and it cannot borrow abroad except from a few friendly countries. Hence, by any standard, it is a bankrupt nation. In this situation, any financial assistance from IMF will give some breathing space to Sri Lanka. It is the first step toward ensuring a sufficient inflow of foreign exchange to Sri Lanka

Aseni: Grandpa, in the presentation which the Central Bank and the Ministry of Finance made to a select group of Sri Lanka Government’s foreign creditors to win their support for a debt restructuring exercise, the size of the economy in rupee terms in 2022, called the Gross Domestic Product at current market prices, had been fixed at Rs. 24 trillion. It is a jump from the size of the economy in 2021 at Rs. 17 trillion marking an increase of whopping 41%. Does this mean that Sri Lankans have become more prosperous now than before?

Sarath: Not at all. The Central Bank is working on an estimate that the economy will shrink in 2022 by 9%. What this means is that if Sri Lanka had produced, say 100 coconuts in 2021, it is producing only 91 coconuts in 2022. Though the production is less, the market prices of these coconuts have gone up by about 50% inflating the size of the economy by that rate. But Sri Lankans have become poorer now because they have only lesser number of coconuts to eat. This is the effect of inflation, and no one should be misled by these numbers.

Aseni: How does this affect Ranil when he plans to rescue the economy, specifically from the point of his ambition to make Sri Lanka a rich country by the time it celebrates the centenary of independence from the British in 2048?

Sarath: It has serious implications for him. This 50% inflation that has been used to calculate the size of the economy in rupee terms is called the increase in the GDP Deflator. That deflator covers all the prices in the economy, the consumer prices, investment goods prices, and export prices. It is a comprehensive price indicator and not equal to the inflation measured by consumer price indices. Since it has gone up by about 50% during 2022, the size of the economy in rupee terms also has gone up to Rs. 24 trillion. But at the same time, the rupee has depreciated against the US dollar by about 80% from Rs. 200 to Rs. 360. As a result, in US dollar terms, the GDP has shrunk to $ 66 billion in 2022 from $ 85 billion in 2021. Consequently, per capita income which you know is calculated by assuming that the income is distributed equally among all the people, has declined from about $ 3,800 in 2021 to $ 3,000 in 2022. This has taken Sri Lanka back to the economy it had, say, in about 2011.

So, Sri Lanka has, as a whole, become poorer. Any march toward a rich country should be started from this lower position. Therefore, it is a longer march than what he had anticipated earlier. Also, in the next few years, Sri Lanka’s economy will become smaller due to the expected negative economic growth till about 2025. This will make his ambitious target more challenging.

Aseni: Does this mean that the proposed IMF bailout is not of any help to him?

Sarath: No, it is still helpful. That is because when we break Sri Lanka’s economic issue into two, one involving the most urgent issues, and the other relating to the longer-term issues, we find that the IMF bailout is needed to resolve the most urgent issues. The most urgent issues are that Sri Lanka has exhausted all its foreign exchange resources, it is saddled with a foreign debt problem, it cannot import the essential consumer as well as investment goods, and it cannot borrow abroad except from a few friendly countries. Hence, by any standard, it is a bankrupt nation. In this situation, any financial assistance from IMF will give some breathing space to Sri Lanka. It is the first step toward ensuring a sufficient inflow of foreign exchange to Sri Lanka.

Money given by IMF is not that much. It is only $ 2.9 billion to be drawn by Sri Lanka in eight instalments over four years. Each instalment will be about $ 360 million. But the country’s foreign exchange requirements over the next 12 months are about $ 5-6 billion. Hence, it is a peanut. Therefore, Sri Lanka will have to work with multilateral lending institutions like the World Bank and the Asian Development Bank for an urgent bridge financing facility of some $ 2-3 billion. Without that, Sri Lanka cannot survive. Therefore, the proposed IMF bailout is a necessity.

Aseni: But our teacher told us that they are all financial facilities, and they cannot resolve real issues. Is there any truth in that claim?

Sarath: There is. IMF will give a loan to Sri Lanka which is only a financing facility. Similarly, any bridging loan from World Bank or ADB is also a financing facility. It will improve the financial position or more specifically financial status of Sri Lanka. Finance cannot deliver real prosperity to a nation unless such finance is converted to real goods and services. This is the fundamental difference between money and real goods. Real goods are those that can be used for people to increase their pleasure. Also, they can be used as inputs for further production. For instance, coconuts can be consumed by people. At the same time, they can be used to manufacture, say, biscuits. But money cannot be consumed or used as inputs unless that money is converted to real goods. In the same way, money to be received from IMF or World Bank or ADB cannot deliver prosperity to people. It is a separate path which Ranil should take.

Aseni: What is that path, Grandpa?

Sarath: Though I called it a separate path, that real growth path and the financing path are interrelated. Without the financing path, the growth path will not be successful. Without growth path, the financing path will simply be a waste.

If Sri Lanka wants to be a rich country by 2048, it must attain a real economic growth of about 7% over the next 26-year period. When you allow for an average annual population growth of 1%, the growth rate that contributes to increases in per capita income is simply 6%. This growth rate should be maintained year after year. To attain that growth rate, Sri Lanka should invest more than 30% of its GDP. That is because Sri Lanka’s use of capital is inefficient. If it wants to attain a real growth of 1%, it should use about 5 units of capital. This rate is known as Incremental Capital Output Ratio or ICOR. In the short run, Sri Lanka cannot reduce this ratio. But in the long run, with new innovations introduced through investment is research and development, it can be reduced to facilitate higher growth through investment of lesser ratio of GDP.

Aseni: What should Sri Lanka do to improve its ICOR?

Sarath: It should continue to invest in new plant and machinery, computers, new technologies, infrastructure to facilitate bigger production by using a lesser quantity of inputs. This should be built into the annual government budget. In 1980s and 1990s, the National Planning Department of the Ministry of Finance prepared an annual public investment plan incorporating all these requirements. This plan, while helping Sri Lanka to solicit foreign funding for needy projects, prevented the politicians from promoting their pet projects by soliciting personal foreign funding. The public investment plan documented the country’s development priorities. As a result, there was no room for ad hoc development projects that did not contribute to national growth.

Ranil should reintroduce this system or a similar system as his long-term growth strategy. Without improving ICOR, whatever the money he invests in the economy will go waste like watering a sinking well. This is exactly what happened to Sri Lanka in the last two decades. It continued to invest scarce money in politicians’ pet projects that eventually became white elephants who had to be maintained out of taxpayers’ money. It was a case of throwing good money after bad. This is the pitfall to which Ranil should not jump deliberately.

Without improving ICOR, whatever the money he invests in the economy will go waste like watering a sinking well. This is exactly what happened to Sri Lanka in the last two decades. It continued to invest scarce money in politicians’ pet projects that eventually became white elephants who had to be maintained out of taxpayers’ money. It was a case of throwing good money after bad. This is the pitfall to which Ranil should not jump deliberately

Aseni: I understand. Will that be sufficient for Sri Lanka to become a rich country by 2048?

Sarath: No. Sri Lanka should introduce a growth strategy that will help it integrate with the global economy. For millennia, the country had delivered wealth and prosperity to its people via international trade. Its location in an advantageous position along the East-West trade route had been its plus point. This should be exploited to its maximum now. What this means is that Sri Lanka should get integrated to the emerging global trade pattern in which countries create wealth by producing one or more components needed for assembling a whole product. This is called the supply chain by supply managers and joining the production sharing networks by economists. Sri Lanka should concentrate on this strategy while helping its traditional exports like tea, rubber, coconut, and apparels.

Aseni: But why should Sri Lanka continue to support the traditional exports like tea, rubber, coconut, and apparels if they are not of any service to the country?

Sarath: You cannot look at the sub-components of the economy from that view. Though they are fast losing significance as growing export sectors, they still bring in much needed foreign exchange to the country. They have also offered livelihood to many thousands of Sri Lankans. You cannot sacrifice all these gains immediately without developing alternative means that would compensate their loss. Instead, what should be done is to modernize them to enhance their capacity and improve productivity. Once again, it is new research that will help Sri Lanka. For instance, tea and coconut are still exported only as edible products. But new research can help Sri Lanka to use them as industrial raw materials and produce new value-added products. For instance, through new research, India has got patents for manufacturing perfumes out of tea and you can find details at https://perfumelounge.eu/blogs/ingredients/tea-in-perfumes.

Those perfumes are sold in up-markets at premium prices. Similarly, coconuts also can be used industrial inputs. Some have already started research on extracting valuable medicines and chemicals from coconut leaves which are not used for export purposes at all at present. These are new areas of research that can be undertaken by the technology faculties of universities in Sri Lanka. Regarding rubber, Sri Lanka does not produce enough rubber for its value-added industries. Consequently, it at present imports latex and rubber sheets for use by rubber-based industries from Thailand and Vietnam. Hence, its cultivation on modern lines should be promoted. As for apparel industry, it is necessary to improve its productivity and content to facilitate it to join the world’s production sharing networks. Hence, every dollar is useful to Sri Lanka today and it should promote new lines of exports without killing the existing exports.

Sri Lanka has, as a whole, become poorer. Any march toward a rich country should be started from this lower position. Therefore, it is a longer march than what he had anticipated earlier. Also, in the next few years, Sri Lanka’s economy will become smaller due to the expected negative economic growth till about 2025. This will make his ambitious target more challenging

Aseni: I understand that Ranil should transform the country’s production system into a new technology-based industries and join the global markets without losing the existing sources of foreign exchange. Isn’t it a big challenge for him, Grandpa?

Sarath: Yes, it is a big challenge and difficult task. But it is not impossible if he comes up with a new long-term strategy to deliver results to the economy. Vietnam had introduced a 10-year road map in 2019 to convert the country’s economy suitable for the 4th Industrial Revolution by 2030. Sri Lanka should also follow a similar strategy. Without that, his plan to make Sri Lanka a rich country by 2048 will simply be a wish without any foundation at the ground level.

Aseni: My learning takeaway from this discussion is very important. IMF bailout package will help Sri Lanka to resolve its immediate problem of acute foreign exchange shortage. Therefore, Ranil should follow it reverently. But at the same time, he should come up with a real sector strategy that should be introduced as a long-term plan to make Sri Lanka a rich country by 2048. When doing so, while modernising existing exports, Sri Lanka should go for technology-based exports that should be supplied to the global markets as a unit in a large production sharing network. Therefore, the solution involving the resolution of the present unprecedented economic crisis in Sri Lanka lies in a strategy lies that requires Ranil to go for more than what the IMF bailout will deliver to the country.

Part I, II, III and IV of this series are available online at:

https://www.ft.lk/columns/Child-s-guide-to-how-Ranilnomics-should-be-designed-and-implemented-Part-I/4-739461

https://www.ft.lk/columns/%20Child-s-guide-to-Ranilnomics-%20Part-II/4-739758

https://www.ft.lk/columns/Child-s-guide-to-Ranilnomics-III-Buddha-s-prescriptions-on-governance/4-740034

https://www.ft.lk/columns/Child-s-guide-to-Ranilnomics-IV-Proposed-debt-restructuring-will-pose-more-issues-than-answers/4-740260

(The writer, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at [email protected].)