Structural Adjustment and Stability after IMF Is it Adequate?

Sri Lanka has been a repetitive client of the IMF and by now has sought the assistance of the agency, a total of 16 times. The 17th approach is much anticipated to be concluded by September

Sri Lanka’s economic turmoil is today visible to the world as a full-blown, full-fledged political crisis and humanitarian emergency. After years of economic mismanagement which enriched a small number of elites, the citizens of the country are now left to reel with acute shortages of fuel, food and medicine.

As Sri Lanka awaits with heavy hopes on the bailout offered by the International Monetary Fund (IMF), the latest update of the process comes from President Ranil Wickremesinghe who last week announced that an agreement with the agency had been pushed back to September due to the unrest over the past weeks.
At the ‘Reform Now’ conference organized by the Advocata Institute under the theme “Let’s Reset Sri Lanka”, held at BMICH, President Wickremesinghe emphatically mentioned that Sri Lanka has no way out of the present crisis other than the bailout offered by IMF.

Taking an improvised stance, Australian National University’s Emeritus and renowned economist Professor Prema-chandra Athukorala insisted at the conference that true recovery for Sri Lanka is possible only after the inclusion of strong domestic elements in reforming policies.
Taking Thailand as an example, Athukorala explained that even though the IMF played a major role in structural adjustment in the 1997-98 Asian Financial Crisis, recovery was possible only through significant domestic components included in the reform process.
Some of the domestic factors adopted by Thailand included

• Rewriting laws to give independence to the Central Bank
• Reforming Foreign Direct Investment ratings
• Appointing new ministers, predominantly from the business community to run 
• the country.

75% of the reforms to tackle the crisis in Thailand are documented to be taken from tradable sectors primarily from the export sector.
Thailand, South Korea, Malaysia, Indonesia and the Philippines were the 5 most affected East Asian countries from the 1997-98 Asian Financial Crisis. None of the above countries have sought the IMF since 1998, after the regional catastrophe. In contrast Sri Lanka has been a repetitive client of the IMF and by now has sought the assistance of the agency, a total of 16 times. The 17th approach is much anticipated to be concluded by September.

On his presentation on Debt Crisis, Structural Adjustment and Trade Policy, Athukorala opined that Sri Lanka, during the era of Independence had maintained an export-oriented economy with a strong welfare component.
Sri Lanka was already a welfare state when it became independent, providing food subsidies, free rice, free education, and free healthcare to all. The UN Development Programme (UNDP) report on Human Development published in 2000, denoted that the Human Development Index (HDI) of Sri Lanka was 0.733, higher than other countries in the region. The report credits the social welfare programmes launched by pre- and post-independence governments to help achieve some remarkable successes in human development.

With income disparities in rural and urban sectors becoming low and falling, Athukorala explains that economic policies of Sri Lanka gradually became more focused on keeping up with welfare. This strategy, he explains was and is still well utilized by members of the Parliament and political candidates to win elections.

A report by the Social Watch reads that Sri Lanka did try in 1977 to reverse the development pattern and become more export oriented. According to the report the United National Party Government, which came to office in 1977, introduced policies to stimulate the stagnant economy and remedy high unemployment rates. Called the “Open Economy”, the report reads that these measures had both positive and negative impacts on social development. Structural adjustment policies were also introduced in the early 1980s to decrease public expenditure and increase repayment of external loans. But Athukorala explained Sri Lanka could not fully benefit from these reforms due to much of them being made without the consultation of the World Bank and due to the 30-year long civil war.
A publication by the Central Bank of Sri Lanka titled ‘Recent Trends in the Emerging Economy’ mentions that Sri Lanka had a reasonably high level of economic growth since 2005 with growth rates of 6.2, 7.7, 6.8 and 6.0 per cent, respectively, for the four-year period up to 2008.

The IMF advises member countries on economic and financial policies to promote stability, reduce vulnerability to crises, and encourage sustained growth and high living standards

Athukorala in his presentation compared the above period to a Japanese Sumo wrestler, who lives on a special high protein diet (stronger visually) but has a 20 years shorter life span than the average Japanese man.
Dr. Asanka Wijesinghe, a Research Economist of the Institute of Policy Studies in a webinar hosted by the institute in 2021 mentioned that Sri Lanka’s openness towards rates of globalization has continuously declined especially after 2005 due to GDP growth in non-tradable sectors. At the time, the World Trade Organization had predicted a pickup in global trade volumes for 2022 while an IMF database that uses signals emitted by sea vessels also showed an uptick in world trade from the beginning of 2021.

Wijesinghe also insisted that Sri Lanka should ready itself to take advantage of trade diversion and investment opportunities.
Athukorala demonstrated that this massive non-tradable bias which was increasingly adopted in Sri Lankan policy regimes especially after 2005 had devastatingly underpinned the growth spurt of the economy.
The outcome, he simply explained through an equation is The outcome = Vulnerability to Covid-19 + A debt overhang + debt service burden + drying up of foreign exchange reserves.

Export earnings of Sri Lanka for the past two decades have been dominated by merchandise and service exports adversely resulting in high debt dependence. Even though reports denote that the debt burden of Sri Lanka was much higher in the early 90’s compared to the present, the current situation is way more destructive as the external debt relative to the Gross Domestic Production (GDP) of the country is weighed out by non-tradable goods, which Athukorala points out “does not help us pay any debts”.

In economics, the Dutch disease is the apparent causal relationship between the increase in the economic development of a specific sector (e.g. natural resources) and a decline in other sectors (e.g. manufacturing sector or agriculture). The term was coined in 1977 by The Economist magazine to describe the decline of the manufacturing sector in the Netherlands after the discovery of the large Groningen natural gas field in 1959. The theory tries to explain how excess focus on non-tradeable sectors naturally decreases tradable production.
In his address at the Advocata conference, Athukorala listed out 3 factors that helped exaggerate the non-tradable bias in policy regimes of Sri Lanka while assuring that focusing on these factors will help take the country into a solid recovery route 

1. Exchange Policy – As people focus on the inflation, the nominal exchange rate has been used as an ‘inflation anchor’. A key cause for the non-tradable bias has been the preventing of the appreciation of the real exchange rates. This strategy had been used to maintain competitiveness to globalized markets and to tame inflation. “Pumping money into non-tradable sectors while simultaneously trying to maintain a constant nominal exchange rates is a serious mistake” Athukorala said.

2. The Tariffs Regime –In Economics, the Lerner Symmetry Theorem establishes that import tariffs and export taxes are equally protectionists in international trade. However, when export trade becomes more tariff targetted, production gradually becomes anti-exports. Sri Lanka is capable of moving into a more uniform tariff structure.

3. Policy backsliding in the area of promoting direct foreign Investment - Recalling his experience as a research fellow for the World Bank, Athukorala narrated that once when he had examined investment records of the Board of Investment (BOI), it was revealed that more than 200 export-oriented businesses had closed down during the period between 2005-2013 due to distorted approval processes and delays.

The International Monetary Fund advises member countries on economic and financial policies to promote stability, reduce vulnerability to crises, and encourage sustained growth and high living standards. But as Sri Lanka is a ‘twin deficit country’ with our trade deficit being mirrored in our budget deficit, Athukorala predicts the IMF supported stabilization and structural adjustment reforms would specifically focus on fiscal consolidation through ‘expenditure reduction’. In simple words, Athukorala explains 
IMF= It’s Mostly Fiscal (for the Sri Lankan context)

“Therefore, in an economy where anti-tradable bias has underpinned vulnerability to the crisis by building up a massive debt overhang, it is (critically) necessary to combine ‘expenditure-reducing’ policies with policies aimed at ‘expenditure switching’ from non-tradable production in the economy.”