Dr. Devarajan sheds insights to Sri Lanka’s upcoming talks with IMF, debt restructuring

Dr. Shanthayanan (Shanta) Devarajan, who will be part of Sri Lanka’s delegation to IMF-World Bank Spring Meetings this week and talks on Sri Lanka’s debt restructuring and IMF support program, answers questions posed to him by the Daily FT sister publication Sunday Times. He is Professor of the Practice of International Development at the Edmund A. Walsh School of Foreign Service, Georgetown University. He is also part of the three-member advisory committee to President Gotabaya Rajapaksa on the debt restructuring strategy. Here are excerpts. 

Q: Will political instability be an impediment to receiving IMF funds?

 Political instability is not necessarily an impediment to receiving funds from the IMF, the World Bank, or other international organisations. These organisations look at whether the Government has undertaken the prior actions (such as tax increases, expenditure cuts and targeted cash transfers for the poor) of the program. If it has, they can disburse the money. Whether it is a minority Government or marginally majority Government does not matter if the Government has undertaken the prior actions.

Q:  Now that the Central Bank has publicly and formally informed all creditors that Sri Lanka cannot fulfil its repayment obligations, does this affect getting IMF help?

 The announcement that Sri Lanka will temporarily suspend debt service payments and undertake a debt restructuring, already announced by the Central Bank, will increase the chances that Sri Lanka can get financial resources from the IMF, the World Bank, etc. The IMF cannot provide resources to a country whose debt is unsustainable. The debt restructuring negotiations will lead to a debt that is sustainable, paving the way for an IMF program with financial resources that, in turn, will enable budget support from the World Bank, the Asian Development Bank, and others.

Q:  What is your view on current economic conditions, including debt servicing, inflation, foreign currency crisis, interest rates, shortages, industry and manufacturing?

 The current economic conditions are dire. Official foreign exchange reserves were at $ 1.9 billion at the end of March, but usable reserves are likely much less. Meanwhile, the Government had debt service payments of over $ 1 billion through July. The shortage of foreign exchange (and the practice of meeting the debt service payments in January and February) has led to the shortages of food, fuel, and pharmaceuticals in the country, as well as the power cuts of 10 hours a day in some places. 

Real interest rates (the nominal interest rate minus inflation) were negative until the recent increase by the newly appointed Governor of the Central Bank. The prospects for growth this year are grim, as there has been very little investment and the manufacturing and services sectors are, no doubt, constrained by the power cuts. Agriculture is also lower this year because of the disruptions from the fertiliser policy.

Q: What are immediate remedial measures that can be implemented?

 The immediate measures should try to increase the foreign exchange available so that people can get some relief from all the shortages. The two short-term measures are: (i) appointing a legal and financial advisor who can then negotiate a postponement of the upcoming debt service payments, thereby saving some foreign exchange. (ii) Obtaining some bridge financing from friendly nations to buy essential imports over the next few months.

Q:  What can be expected in the immediate, near-and medium-term future by people of Sri Lanka?

 If the above measures are implemented soon, the people can expect some of the shortages to ease. But to achieve a debt restructuring and a program that could lead to additional financing from the IMF, the World Bank, and others, the Government will have to cut the fiscal deficit. The people could expect to see some increases in taxes (either the lowering of thresholds or an increase in rates or both); restructuring of state-owned enterprises such as SriLankan Airlines, the CPC and CEB; and an increase in fuel and electricity prices to reduce subsidies.  Although the lion’s share of these subsidies goes to the rich, an increase in fuel and electricity prices will also hurt the poor, so we can expect to see some targeted cash transfers to them to compensate for the increase in prices. There is likely to be further increases in interest rates to dampen inflationary expectations and to attract foreign currency. In the medium term, if there is a debt restructuring and an IMF program, and tourism recovers, the people can expect an easing of the shortages and a gradual resumption of economic growth.

Q:  How can future policies of the Government, Parliament and the Central Bank impact on the public?

 The policies described above – debt restructuring, tax increases, expenditure cuts, targeted cash transfers, SOE (state owned enterprises) restructuring and interest rate increases – will improve conditions facing the people although in the short run, some of them such as the expenditure cuts may seem painful. That is why it is important to accompany these cuts with targeted cash transfers to the poor. These policies are necessary because the alternative is that Sri Lanka undergoes a disorderly default, which could be devastating. Countries such as Lebanon that have had such a hard default have seen their GDP fall 20% in one year, currency depreciate by 100% and inflation reach over 120%. And the effects of a disorderly default last for years since countries don’t regain access to capital markets for that long.

Q:  How long would it be before IMF can begin granting its first tranche?

 Negotiating an IMF program, assuming there is a debt restructuring under way, can take six to nine months. The process works as follows: The Sri Lankan Government initiates a debt restructuring by appointing a legal and financial advisor. As mentioned above, these advisors can help Sri Lanka postpone debt service payments that are due in the next few months. Meanwhile, the IMF advises Sri Lanka on the debt restructuring by providing an analysis of the level of debt that the country can repay (called the “debt sustainability analysis”). This analysis serves as a credible benchmark against which Sri Lanka, with the legal and financial advisors, can negotiate a debt restructuring with the creditors, including bondholders and official bilateral lenders.

At the same time, the Government, led by the Central Bank Governor and the Treasury Secretary, begins discussions with the IMF staff on the adjustment program (tax reform, expenditure reform, targeted cash transfers, etc.) The greater is the fiscal adjustment that Sri Lanka is willing to make, the greater will be the “haircut” that the creditors will be willing to take, because the fiscal adjustment is a signal of the sustainability of the program. When there has been an agreement on the program between the Government and the IMF (and the debt restructuring is proceeding well), the IMF Board will vote on the program and, if it is approved, will likely allocate financing for the program. 

The financing from the IMF could be up to $ 1 billion a year for three years. In addition, having an IMF program in place enables the World Bank and the Asian Development Bank to lend Sri Lanka budget support. Finally, other bilateral lenders and some private investors may resume lending since the IMF program gives them confidence that the country is getting on a sustainable path.