“Sri Lanka is a classic soft State that has been unable to take tough decisions.We cannot do our usual thing this time. it is not possible to avoid taking tough decisions.The country has to push through the structural reform agenda” – Former Central Bank Governor Dr.Indrajit Coomaraswamy

BY Sumudu Chamara

Certain reforms and policies that are currently being implemented and those that are due to be implemented in the context of the current economic crisis, such as tax hikes, the appropriate depreciation of the local currency and interest rate hikes, should not be viewed as International Monetary Fund (IMF) policies merely because the IMF is supporting them. In reality, these are much-needed reforms which Sri Lanka should implement regardless, in order to stabilise the economy. Therefore, they can be considered pro-Sri Lanka policies.

This is former Central Bank of Sri Lanka (CBSL) Governor Deshamanya Dr. Indrajit Coomaraswamy’s opinion about the ongoing economic reforms, regarding which he further said that he remains optimistic about economic stabilisation in a context where some of the much needed stabilisation policies are already being implemented. He spoke extensively about the past, present and future of Sri Lanka’s economy during the 17th Sujata Jayawardena Memorial Oration titled “Economic crisis: Where are we, and where do we go from here?”, which was organised by the Alumni Association of the University of Colombo.

Macroeconomic stability

Dr. Coomaraswamy stated that it is important to look at how Sri Lanka found itself in the present economic situation, and that it is a seven-decade old story.

“At the time of Independence, Sri Lanka was second only to Japan on many social and economic indicators. We have regressed since then. Several Asian countries have bypassed us. While there are complex social and political issues which were contributory factors to this regression, in my view, arguably the most significant factor has been macroeconomic stress.

“I think this is something that 99.9% of the population of this country does not bother about. Because of that, we have been able to mismanage our macroeconomic policies without there being any serious pushback. The reason as to why the macroeconomic policies have been misaligned much of the time is the Government’s fiscal operations.
“Over the past 70 years, that has been a persistent problem, and that is a problem which we are only now beginning to try to get over. The reason as to why Sri Lanka has had to deal with the prevailing fiscal challenges stem from a rather toxic combination of populist politics and an entrenched culture of entitlement among the people of Sri Lanka.”

Dr. Coomaraswamy stressed that it is very difficult to bring about structural transformation in Sri Lanka’s economy if the platform of a stable macroeconomic policy and macroeconomic fundamentals are not in place.

“That is the foundation upon which you can develop a competitive and growing economy. We have not done that very well. When considering the challenges to macroeconomic stability, what has happened in the monetary policy is that because the Government is constantly having an unsustainable fiscal deficit, it has time and time again put pressure on the CBSL to provide money for the Budget through deficit financing, which, in common parlance, is referred to as printing money. That pumps excess demand into the system, which then causes inflation, and essentially undermines the whole macroeconomic stability of the economy.”

In order to put macroeconomic policy making right, Dr. Coomaraswamy noted that Sri Lanka needs to have a very clear framework for making macroeconomic policies.

One of the key macroeconomic instruments is the exchange rate. According to Dr. Coomaraswamy however, for a long period of time, Sri Lanka tended to have uncompetitive and overvalued exchange rates.

“If you do not have a competitive exchange rate, you are effectively subsidising foreign producers at the expense of domestic producers because you are essentially bringing down the price of imports by having an overvalued exchange rate. A competitive exchange rate is a very powerful impetus to productive growth.

“We keep saying that we do not have a production economy. One of the reasons is that most of the time, our exchange rate has not been competitive. It is very difficult to have this so-called production economy if you do not have a competitive exchange rate. The export of goods and services is key. Unless we get that message, we will not be able to transform our economy,” Dr. Coomaraswamy observed.

Structural policy reforms

Dr. Coomaraswamy opined that there is a lack of structural transformations in Sri Lanka’s economy, and that in addition, special attention needs to be paid to the manner in which the country ensures the proper implementation of its fiscal and monetary policies.

With regard to the management of the Budget deficit, Dr. Coomaraswamy said that in successful countries of East and South Asia, growth is highly correlated to the surpluses in their balance of payments, and that essentially, it is due to their export performance.

However, in Sri Lanka’s case, growth is correlated to the size of the Budget deficit, one example being in the 2010-2011 period, when Sri Lanka had very high economic growth, there was also a very high Budget deficit, according to Dr. Coomaraswamy.

“We create these sugar highs by having unsustainable Budget deficits, and then support unsustainable Budget deficits through fiscal forbearance in monetary policy. It does not last,” Dr. Coomaraswamy emphasised.

With regard to the Gross Domestic Product (GDP), he said that at the moment, according to his knowledge, targets are based on debt to GDP and Budget deficit to GDP approaches. He said that a more effective target would be the primary balance of the Budget, which means that, in any given year, the country’s expenditure should be covered by its revenue so that it does not accumulate any new debt.

With regard to the Government’s behaviour when it comes to taking decisions on fiscal policy, Dr. Coomaraswamy said that it is necessary to make sure that there is a greater level of responsibility when it comes to changing the targets within fiscal management. One way of achieving it, is making sure that a special majority is required to change targets, regarding which Dr. Coomaraswamy further explained that certain countries have constitutional provisions in relation to their Budgets and fiscal management which basically tie the lawmakers’ hands to a certain extent.

Speaking on monetary policy, he added: “There needs to be a clear framework, and it should be embedded in the law, because then it gives everybody a clear signal that there is a consistent and predictable framework within which the monetary policy will be conducted.”

In addition, Dr. Coomaraswamy explained the importance of fiscal and monetary policies working hand in hand, saying that neither side must interfere in the other, but instead work together.

Overcoming the crisis

Dr. Coomaraswamy stressed that given the ongoing reforms and certain positive developments such as the decline of inflation, he has some level of optimism about economic stabilisation.

“The much needed stabilisation policies are being implemented. The increase in the interest rates, the depreciation of the currency, and the increase in taxes are all necessary measures to stabilise the economy. These are not IMF policies. These are pro-Sri Lanka policies that have to be implemented if we are to get out of this situation that we are in.

“The thing about doing it with the IMF by your side is that the IMF is able to not just give us some money in a context where the money that they give is not very significant, but it is able to capitalise a lot of other money from monetary institutions, bilateral donors, and even private sector money once you have the IMF programme. If we do it with an IMF programme, then, we get some money to make it a bit easier to absorb.

“However, there can be some differences in terms of speed and timing. That is where you can negotiate with the IMF. We are beginning to see results. Inflation is abating, essential imports are being financed, and interest rates should begin to ease and there is strong guidance from the CBSL Governor on this already. In addition, the very high premiums that are being demanded due to the uncertainty on consensus about our debt restructuring I think will reduce once the IMF programme is on track, because if the IMF programme is on track, it also indicates that the debt treatment is also moving forward.

Another positive development is that the revenue collected between January and September of this year has already exceeded the revenue that was collected in the whole of 2021.”

He further pointed out the importance of Sri Lanka’s economic decisions being consistent, unlike before.

“We have to do something which we have never been able to do. As part of these IMF programmes, at least for the time being, we have had success in the stabilisation of the economy. The stabilisation policies have worked for a period, usually until an election comes by, at which point everything goes out the window.

“But in terms of going forward this time, we have to do structural reforms simultaneously, because normally when we are going to the IMF programme, it is when the economy is overheating. When an economy is contracting by 8% that is when we are now imposing this stabilisation. In the context of a contracting economy, unless we give a very strong push to the growth agenda, we will end up with very serious issues. So, this time is different from any other time. We cannot do our usual thing.”

Opining that Sri Lanka is a classic soft State, which is a State that is unable to take tough decisions, Dr. Coomaraswamy said that this time, it is not possible to avoid taking tough decisions and that the country has to push through the structural reform agenda.
Moreover, Dr. Coomaraswamy emphasised that Sri Lanka needs to make sure that the CBSL is autonomous enough to have a monetary policy that is aligned with its key objectives of price and economic stability.

Courtesy:The Morning