IMF assistance could be most plausible solution for SL’s current economic crisis

• Softlogic Equity Research says it gives “perfect excuse” to usher in much needed by unpopular economic and public finance reforms 

An International Monetary Fund (IMF) bailout package presents the government with “the perfect excuse” to usher in much needed, yet unpopular economic and public finance reforms to drive economic growth, while enabling the country to find a mid to long-term solution to the worsening external debt crisis and foreign exchange liquidity crunch exacerbated by the COVID-19 pandemic.

“Whilst stockpiling terms and conditions seemingly pose many hardships to the struggling nation, these key economic and policy changes can be vital for the country to fight its way out of the crisis. Whilst some of these may be grossly unpopular amongst the general public, the IMF is the perfect excuse for governments to usher in much needed reforms,” Softlogic Equity Research (SER)  highlighted in its latest research report titled, ‘The Sri Lankan Debt Debate: Down but not out, a policy maker’s conundrum’. 

A potential IMF bailout package is likely to include demand for reforms in State-owned enterprise (SOEs), measures in lowering the currently high budget deficit including higher government revenue targets, while reducing the government borrowings and allowing room for private sector credit expansions, monetary policy reforms with an inflation-targeting framework and flexible exchange rate regime, discipline in public financial management and reforms for a higher trade and investments, while moving away from the current protectionist regime.
Although, these demands, may be tough, SER views them as pragmatic. 

“This would bode well for the country in the medium to long run and help strengthen investor confidence, positioning it on an ideal platform to exploit the global post-Covid recovery cycle as the worldwide vaccine rollout gets into its second gear,” the research firm stated. 

By end April this year, the government’s   total outstanding external debt stood at US$ 35.1 billion with 47 percent of it being market borrowings. 

Among multilateral and bilateral borrowings, Asian Development Bank (ADB) remained as the largest multi-lateral funding agency for the country with an overall US$ 4.4 billion in lending while China held the top spot as the single largest lender to the government extending borrowings worth of US$ 3.4 billion. 

Sri Lanka’s upcoming debt service payment pipeline for the remainder of the year is estimated at US$ 2.3 billion including the maturity of US$ 1 billion international sovereign bond (ISB) tomorrow (27th).

Short-term policy measures and short- term currency swap arrangements announced by the Central Bank (CB), SER expects the government to honour these debt-servicing commitments for the remainder of the year.

However, the report outlined that the country could face an increasingly challenging situation in honouring external debt servicing commitments from next year onwards amid an “unforgiving payment pipeline” of US$ 4 billion per annum on average till 2026, which is equivalent to current foreign exchange reserves.  “While the country may manage with the available credit lines and short-term regulatory measures, if SL fails to secure the much-needed funding lines, the country may have to call for external support,” it noted.For 2022, Sri Lanka is estimated to have US$ 4.5 billion in external debt servicing commitments compared to US$ 3.9 billion for this year. 

The current policy measures in place to address worsening external debt crisis include restrictions on certain foreign capital outflows and import controls on motor vehicles and certain other products, while the Central Bank backs further import controls.

In terms of foreign funding lines, the Central Bank has entered into multiple short-term currency swap agreements with other central banks. However, the report stressed that short-term swaps may not resolve the underlying debt sustainability concerns.

Hence, the report emphasised that the current short-term policy measures only have provided the country with a limited breathing space till next year.

“These measures may resolve short-term debt repayment concerns but may not be sustainable in the longer run unless Sri Lanka secures more sustainable foreign funding lines such as FDIs, tourism earnings, export earnings etc.,” it pointed out.Based on the country’s past experiences as well as similar experiences of other developing economics, the report hinted that an IMF bailout package maybe the most plausible solution for the country to emerge out of current crisis. “The country’s ability to work with the IMF during multiple setbacks has been the defining point towards a recovery at every stage. As such, the country has always been able to work its way out of potentially challenging situations. 

This phenomenon has also been seen in multiple emerging markets and developing economies that face debt and forex reserve crises from time-to-time,” it elaborated. In particular, in 2008 when the country’s foreign reserves fell to US$ 2.6 billion, which was sufficient only to cover two months of imports, Sri Lanka sought IMF assistance and secured the country’s largest IMF bailout package of US$ 2.5 billion. 

Subsequently, it enabled the country to boost its foreign reserves to US$ 5.4 billion by end of 2009 and to US$ 7.2 billion in 2010 while narrowing the trade deficit.Further, SER noted that a potential IMF bailout package would mostly remove current restrictions on capital outflows and imports.  

“As such, if the country does move into negotiations of a bailout package, these restrictions would most likely be reversed to accommodate for policy changes and economic reforms that would be required in order to secure the external funds,” it said.Since 1960, Sri Lanka has been the recipient of 16 different IMF facilities, however, on seven occasions, IMF didn’t disburse the initially agreed amount of funding, as the country did not fully comply with its conditions.In 2020, the IMF prematurely ended an Extended Fund Facility to the country after disbursing US$ 1.3 billion of an agreed US$ 1.5 billion facility entered in 2016. The repayment of this facility was scheduled to begin in installments from 2020 onwards.