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Sri Lanka, in the face of the ongoing economic crisis, has already taken the irreversible policy decision to seek IMF assistance. As the point of no return has passed, discussing that decision is only of academic interest. More appropriate at this point is to deliberate on Sri Lanka’s future course with the IMF. Contrary to the complete sanguine picture portrayed by the so-called ‘independent economists’ of the land, this would neither be a pre-defined nor a smooth one. Whether we would repeatedly waste our precious time in future on fuel queues will not be decided by the bailout package, but how we handle the IMF and finances. The objective of this article, therefore, is to analyse how we would not end up the IMF hitchhike being the one bartered ginger for equally hot or hotter chilies, as the famous Sinhala saying goes.
This is not the first time the island has been a similar soup. Rewind four centuries. The ginger-and-chilies analogy (“Inguru deelaa miris gatta vage”) was first used in the aftermath of King Rajasinghe II signing the Kandyan Treaty of 1638 with Dutch Naval Commander Adam Westerwold of the Dutch East India Company. The original intentions of both parties looked innocuous. Rajasinghe II wanted the bigger evil (Portuguese) out of the country; Dutch wanted to expand their trade. The latter even initially offered more favourable terms for the Sinhalese in procuring cinnamon. The pundits of the Kandyan kingdom, as they do today, would have eloquently hailed the idea as if it were the best at the moment.
How things materialised were different. Sure, the Portuguese were driven away by the Dutch who captured their fortifications one by one. Still what they demanded as charges were exorbitant – so much so that the already nearly bankrupt Kandyan Kingdom opted not to pay back at the cost of a fierce battle. While Dutch did face enormous fatalities, they at least won their trade interests. This time it could be the same with IMF. The Rajasinghe great grandchildren might be the ones to end up with a far bigger debt burden.
IMF is neither the Devil nor the God
The views of IMF in different ideological camps in Sri Lanka are so diverse that one may wonder whether it were the same agency that we debate about. The left and the ultra-nationalist camps naturally see IMF as evil. They represent a section of population that typically are more prone to austerity imposed by IMF. On the other side of the fence we find so-called ‘independent economists’ worshipping IMF as devout Hindus would do half dipped in Ganga, in a yoga position with holy ash in their foreheads. They too have their own reasons. Sorry to say this, but sometimes these reasons are purely personal.
Prof. Luxman Siriwardena once identified a set of intellectuals whom he termed “maggots in the wound” trying to exploit the present grave economic conditions of the island for their own personal advantage. (FT May 11, 2022). Still, fortunately, they are the minority. The majority of IMF worshippers are otherwise sincere retired academics and professionals who honestly but naively believe that would certainly be good for the country irrespective of the policies to follow. Not necessarily. So much of evidence exist to the effect that it would result in the opposite if the wrong turns were to be taken.
“Officially, the IMF’s main task consists in stabilising the global financial system and helping out troubled countries in times of crisis’, writes Ernst Wolff in his book, ‘Pillaging the World – The History and Politics of IMF’. “In reality, its operations are more reminiscent of warring armies. Wherever it intervenes, it undermines the sovereignty of states by forcing them to implement measures that are rejected by the majority of the population, thus leaving behind a broad trail of economic and social devastation.”
“In pursuing its objectives,” continues Wolff, “… the IMF never resorts to the use of weapons or soldiers. It simply applies the mechanisms of capitalism, specifically those of credit. Its strategy is as simple as it is effective: When a country runs into financial difficulties, the IMF steps in and provides support in the form of loans. In return, it demands the enforcement of measures that serve to ensure the country’s solvency in order to enable it to repay these loans.” This is a fair arrangement. Beyond that IMF is not necessarily our friend; or for that matter neither our enemy.
Joseph E. Stiglitz on IMF and its discontents
“IMF is not particularly in hearing the thoughts of its “client countries” on such topics as development strategy or fiscal austerity,” writes, Nobel laureate Joseph E. Stiglitz in his book ‘Globalisation and its discontents’. “All too often, the Fund’s approach to developing countries has had the feel of a colonial ruler. A picture can be worth a thousand words, and a single picture snapped in 1998, shown throughout the world, has engraved itself in the minds of millions, particularly those in the former colonies. The IMF’s Head, Michel Camdessus, a short neatly dressed former French Treasury bureaucrat, who once claimed to be a socialist, is standing with a stern face and crossed arms over the seated and humiliated President of Indonesia. The hapless President was being forced, in effect, to turn over economic sovereignty of his country to the IMF in return for the aid his country needed. In the end, ironically, much of the money went not to help Indonesia but to bail out the “colonial power’s” private sector creditors.”
Stiglitz, of course, presents more evidence than a single photograph (By the way, that photograph can be easily found by Googling) from countries such as Ethiopia, Botswana for his conclusions. Still we may not necessarily buy his views too. IMF is a lending agency with its own interests. It is not unfair to presume it holds its own interests over those of its “client countries”. If it were interested in the economic wellbeing of its clients, that would be to the range of its ability for repayment. Fine. We can work within that framework.
‘IMF Crisis’ in Korea
What is known as the ‘East Asian Financial Crisis’ elsewhere, is even today called the ‘IMF Crisis’ in Korea – because of the supposed issues created as a result of the austerity. (This is a debatable issue, though) ‘Vicious Circuits – Korea’s IMF Cinema and the End of the American Century’ is a book by Joseph Jonghyun Jeon, a Professor of English at the University of California. It discusses the decade of cinema following that crisis, arguing that one of the most dominant traits of the cinema that emerged after the worst economic crisis in the history of Korea was its preoccupation with economic phenomena. That itself shows how critical the impact of the crisis has been in the day-to-day life in Korea. Multiple TV series have been done with the crisis background.
Of course, the crisis in Korea was precursored by the IMF meddling. For at least two decades Korean companies were facing intense competition from foreign ones in both domestic and international markets. Competition has largely come from the rapid opening of Korea’s domestic market, and the rapid catch-up growth of the newly industrialising countries such as China, Indonesia, Thailand and Malaysia.
In the middle of all this, at wake of the downturn, triggered by with the financial collapse of the Thai Baht after the Thai government was forced to float the Baht due to lack of foreign currency, rating agencies lowered the credit ratings of other Asian economies. Moody’s downgraded Korea from A1 to A3, in November 1997, followed by to B2 two weeks later. Standard & Poor’s downgraded Korea’s sovereign credit rating two days later. These contributed to a further decline in Korean shares. Stock markets were already bearish in November. The Seoul stock exchange continued to fall, initially at the rate of 4% gradually increased to 6%. The speculation of an IMF intervention worsened the matters. In late November, stocks fell further to 7.2% on fears that the IMF would demand tough reforms.
IMF ‘solution’ to Korea and the strings attached
Koreans were not particularly happy about the prospect of IMF bailout. For three decades prior to the incident Korea has averaged a growth rate of 8.2%. Per capita GDP of the country has increased from $ 80 in 1960s to over $ 10,000. Still, the country has been in a real bad shape. By the time the Asian Financial crisis hit, Korean Chaebols – the family conglomerates that ruled the businesses in the land – held over $ 52 billion in bad debts; that is 17% of the total debts. Korean Won was in the verge of falling. Eleven Chaebols collapsed in 1997 and 10 more out of the 50 largest, were at the risk of bankruptcy. Chaebol bankruptcies cost $ 100 billion for Korea – almost 20% of its then half a trillion Dollar economy. Troubled Chaebols pushed the banking system over the edge. A banking crisis was on the cards with fallen foreign reserves. Feared investors dumped their stocks and amassed Dollars further depreciating the KRW. It was so clear that without a miracle or an IMF bailout matters would not come back to normal.
First the bailout package was estimated to be $ 40 billion. But the IMF team that visited Seoul recommended a $ 60 billion package; $ 58.4 billion was the ultimately agreed figure to be disbursed in stages. It included several conditions that were to help restore the health of the country’s economy. (Korea, of course was talking to the World Bank and ADB as well.) These conditions forced Korea to go through restructuring policies and programs, such as new labour market policies that allowed more flexibility in terminating employees.
In short, the structural provisions included:
Other policies and programs included ones that forced Korea to slash government expenditure, raise interest rates, liberalise trade, restructure the government, and stop Korean conglomerates from expanding, in the hopes of stopping inflation and increasing foreign reserves. According to the Fund, the key objective was to stabilise the Korea’s foreign exchange market.
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Readymade ‘One-fits-All’ policies of IMF
One fact about IMF is that it rarely proposes country-specific economic policies. This is standing out in all past case studies. It appears as if every country is the same for the Fund; diverse socio economic conditions that lead to the crisis are always ignored. In other words, if the country in crisis were the patient, and IMF were the physician, the diagnosis always ends with the single issue: Inflation. People have too much of money in their hands. To be fair this is partially correct. In almost every crisis one finds inflation as a key symptom. The problem, of course, comes with the treatment.
According to neo-liberal thinking influenced largely by Milton Friedman, who famously claimed “Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output,” IMF attempts to fight the inflation by immediately decreasing money printing. Key term used here is “Central Bank independence”. Simultaneously, to maintain the government revenue at the same level, it insists on increasing tax.
Sounds familiar? Yes, the treatment IMF proposes for Sri Lanka now, is the largely same “one-fits-all-solution” they practiced in Korea in 1998, while the two crises are entirely different. No doubt, a good treatment should be based on a thorough examination of the symptoms and a precise prognosis. IMF hardly knew what kind of a crisis they attempted to tackle in Korea. As the IMF later implicitly admitted, by changing targets, the initial ones for Korea were proved wrong as the key economic variables such as real growth rate and unemployment rate turned out to be worse than initially predicted. The gravity of the slowdown was not foreseen in the initial program projections, and major macroeconomic projections had to be revised sharply and successively downward during the course of the program.
Local currency depreciation, higher taxes and ‘Central Bank Independence’
Most so called ‘neo-liberal’ policies in the Sri Lankan economic pundits’ preachings today, have actually been implemented in Korea. The Fund recommended to the Korean government to increase interest rates to “restore the plummeting confidence of overseas investors” during the early months of the crisis. Local currency too was floated on the advice of IMF. In early 1997 USD:KRW exchange rate was 1:800. One year later it fell to 1:1,400. Weak Korean currency created an extra burden of $ 8 billion for Chaebols in interest payment to foreign investors. The domino effect of collapsing few chaebols drove the interest rates up and international investors away. Chaebols have to offer interest rates up to 30% to maintain investors, while it was only 13% just three months prior to the crisis.
Interesting what so-called ‘Central Bank Independence’ had to do with all this. “In the case of Korea, the loans included a change in the charter of the Central Bank, to make it more independent of the political process…,” writes Joseph E. Stiglitz, “…though there was scant evidence that countries with more independent central banks grow faster. European Central Bank has a mandate to focus on inflation, a policy which IMF advocated around the world around the world but one that can strife growth or exacerbate an economic downturn. Korea had not had a problem with inflation, and there was no reason to believe that mismanaged monetary policy had anything to do with the crisis. The IMF simply used the opportunity that the crisis gave it to push its political agenda.”
The Goods and Bads of the IMF bailout in Korea
What saved Korea: IMF bailout or its own industry growth? This is a difficult question to answer. In development economics we learn sometimes it is difficult to segregate the individual contribution of the success factors. The bailout was inevitable, as Korea was on the brink of bankruptcy in November 1997. Still, were the policies agreed with the IMF and pursued during the crisis appropriate? ask David T. Coe and Se-Jik Kim, on a book they jointly edited – ‘Korean Crisis and Recovery’. For example, did the high interest rate policy induce a fast economic recovery by stabilising the foreign exchange market, or did it deepen the crisis and delay economic recovery? Was it really necessary to restructure the financial and corporate sectors, which, after all, had contributed importantly to 30 years of rapid growth?
Indeed, was not there the risk that potentially misguided changes to the fundamental structure of the economy in reaction to a transitory shock would damage Korea’s long-run growth potential? Or was it necessary to exorcise longstanding weaknesses masked by rapid economic growth? These are valid questions. While one can argue for both sides, it is clear that the very fact that Korea was an industrialised nation with a historically high growth rate itself has played a far bigger role that one may presume.
Also we cannot completely ignore the cost Korea had to pay for the IMF induced ‘recovery policies’, some of which, like Central Bank Independence, had little to do with crisis recovery. Initial job loss has been colossal. More than one million jobs were reported to be lost. Unemployment has jumped from 2.1% in October 1997 to 7% in June 1998. IMF policies also triggered a stagflation in which consumer price inflation continued in an environment of rising unemployment. At the enterprise level, the high rate policy exacerbated firms’ financial instability. Smaller firms have been even more severely impacted. Credit squeeze and excess capacity in industry hit small-scale establishments especially hard as most of them heavily depend on the Chaebols for business.
With the economy contracting, as their big business customers cut back on production and investment, small, subsidiary firms were left with plummeting sales and bankruptcies. The figures for small business bankruptcy have been alarming: during the first five months of 1998 all but 18 of the 5,239 corporations that went bankrupt were small firms that had fewer than 300 employees each.
Can Sri Lanka afford to overlook lessons from Korea?
One critical difference exists between the Korean and the Sri Lankan case studies. Korea has already been a developed and industrial nation when it faced the economic crisis. Some of the Korean firms were world-class and had no difficulty in attracting foreign reserves under normal circumstances. Sri Lanka’s case is not the same. We face the crisis as a developing nation. We have no means to earn the repayment components easily and quickly. Korea, even with difficulties paid its loan by 2001. (It actually took only $ 21 billion – part of the bailout facility – not the full $ 58.4 billion.) Sri Lanka, under the current conditions, has little hope of reaching a level that it can repay the $ 2.9 billion bailout quickly. This is why it should have a separate parallel plan of developing the economy through rapid industrialisation and digitalisation. Unless we take the necessarily policy actions for that Sri Lanka’s IMF experience will be surely more rigorous and excruciating than Korea has ever undergone. Korea recovered within three years; we may sometimes end economically suffering for three decades.
(The writer is a Korealogist and the co-author of the book “From Poverty Prosperity – a review of Korea’s Development Model’. The ideas expressed are personal.)
One critical difference exists between the Korean and the Sri Lankan case studies. Korea has already been a developed and industrial nation when it faced the economic crisis. Some of the Korean firms were world-class and had no difficulty in attracting foreign reserves under normal circumstances. Sri Lanka’s case is not the same. We face the crisis as a developing nation. We have no means to earn the repayment components easily and quickly