After IMF?

Sri Lanka went into its 17th IMF program in 2022, not an easy decision for the Gotabaya Government. Many said then that we should be like India in the 1990s. India was compelled to the IMF by a massive Balance of Payments crisis, did structural reforms, got on a higher growth trajectory, and never went into intensive care again. As the three-year Extended Fund Facility comes to an end in 2027, the question of what next is salient. 

There are different views on whether Sri Lanka can repay its debts. Former President Wickremesinghe has expressed doubts. The Finance Deputy Minister says the opposite, supported by the Central Bank Governor. Chair of the Parliamentary Committee on Public Finance says both are partially right, because what is in doubt is not whether we can repay in ideal conditions, but whether we can repay when affected by external shocks.

External shocks we’ve had aplenty. And we should not fool ourselves that they are behind us. 

The effects of the fertiliser shortages experienced in April will be seen when the harvests come in. No ships carrying fertiliser have crossed the Strait of Hormuz yet. Thirty percent of our fertiliser came through that chokepoint. Luckily, we import more from China which banned fertiliser exports in March but has since relaxed the restrictions. 

The conflict over the Strait of Hormuz keeps flaring up. The US cannot defeat Iran and vice versa. Countries dependent on fossil fuel imports remain vulnerable to price volatility and availability challenges. The oil tankers loitering in the high seas near Galle are mute testimony.

El Nino is building in the Pacific. Its interaction with the Indian Ocean Dipole is a subject of discussion among experts. So, it appears the shock scenario is the more likely one.

Repayment possible?

How are debt repayments made? Foreign currency (“dollars”) comes to commercial banks from various sources. These funds belong to Sri Lankan firms or individuals who take out the equivalents as rupees. The Central Bank regularly purchases the “dollars” with rupees that the Government has raised as revenue (taxes and non-tax revenues) to repay the debt that comes due at various times. 

Repayments are not made using the International Reserves accumulated by the Central Bank normally. But why are reserves given such weight by the IMF and by rating agencies? According to the IMF’s Assessing Reserve Adequacy (ARA) metric’s description: “They reduce the likelihood of balance-of-payments crises, help preserve economic and financial stability against pressures on exchange rates and disorderly market conditions, and create space for policy autonomy.”

The IMF sets the ideal ARA at 100%. Sri Lanka’s current ARA is quite a bit lower, around 60%. This does not mean that the debt repayments cannot be made. It means that repayments may be difficult in some circumstances. 

Sri Lanka’s situation was not that robust before 2020. Then, the credit ratings from the various agencies were in the B range. It was possible to roll over the debt. Now, even after emerging from default, the ratings are in the CCC range. If the rating were to be raised to B territory, a gradual return to commercial borrowing may be possible to smoothen out debt repayments. 

Credit ratings are affected by many factors, of which usable international reserves are one. This is where the otherwise commendable performance on the IMF program targets falls short. Because of that (and a few other things) Sri Lanka is still in C territory, as against a similarly positioned post-default country like Ghana. 

So, Sri Lanka has little access to commercial credit to smoothen out repayments. It should be able to manage, unless external shocks occur, of which there are plenty in the wings. 

What can be done?

IMF was about stabilisation. That job is mostly done. Now the question is whether Sri Lanka can manage the restructured debt. The short-term solution is a better credit rating. That means changing how our economy is perceived by the rating agencies. Simplest way is to get the usable reserves up. But not so easy given the current levels significantly below the target. Rapid purchases of dollars may result in the rupees weakening. 

A good privatisation may also change perceptions. Money hemorrhaging SriLankan would send the right signal but will be difficult. My candidate is the accidentally nationalised Lanka Hospital. Offer its shares on the stock exchange as was done in the old days.

The long-term solution is to get growth rates up without relying on construction contracts alone, as the Government appears to be doing, following the example of the second Mahinda Rajapksa term. The growth rates achieved so far are nothing to write home about. We must make structural changes to attract investment into tradables, creating exports and good jobs.

Sri Lanka’s two most important destinations for merchandise exports are afflicted by risks. The volatility of the US tariff regime and the unreliability of the word of the US Government makes diversification imperative. Exports to the EU are threatened by the India-EU trade agreement that is about to come into force and the Government’s apparent difficulties in delivering on the human-rights commitments necessary for the continuation of GSP+ concessions. 

The Government’s trade policy promises a pivot to Asia. But statements in policy documents do not create market access. Government must go all in on the India and RCEP (Regional Comprehensive Economic Partnership) negotiations by creating a dedicated and empowered trade office now.

Over the past few decades, governments erected protectionist barriers in form of para tariffs and complex import duties that have effectively barred participation by Sri Lankan firms in global production networks. Imports are subject to multiple taxes. These additional costs must be borne by the firms that use these inputs for their exports, making them uncompetitive. Therefore, we are stuck with a non-diversified export basket. 

The 2026 Budget Speech promised to remove para tariffs and a gazette was issued. But the reductions are backloaded to 2029-2030. They must be brought forward so that exports can be increased and growth achieved now when we most need it.

As the economy grows, the debt to GDP ratio will improve. These actions can be taken whether or not Sri Lanka is in an IMF program. Growth is not a priority for the IMF and the Central Bank. Government must drive growth while maintaining fiscal discipline. If failure to build up adequate reserves compels the Government to go the IMF for the 18th time, it will be sad. If Sri Lanka seeks the IMF’s supervision solely to maintain fiscal discipline, it is a choice.