Two and a half years after Sri Lanka announced a sovereign default on all its foreign debt of about $51 billion and sought a rescue package from the International Monetary Fund (IMF), two pertinent questions arise.
The first is whether IMF’s Extended Fund Facility (EFF) provided to Sri Lanka in March 2023, a four-year bailout package of about $3 billion, has been able to put the country onto a sustainable path of recovery from its worst ever post-independence economic crisis. After all, the IMF had extended the support to the crisis-stricken country to “restore macroeconomic stability and debt sustainability, safeguarding financial stability, and stepping up structural reforms”.
Secondly, has the IMF programme put Sri Lanka on a path of reducing debt distress?
The announcement of debt default meant the country, once an unqualified economic success story in South Asia, was facing an unprecedented economic crisis since the Covid-induced downturn. Sri Lankan economy had shrunk by about 8 percent in 2022, while the inflation rate was galloping at over 50 percent. Foreign exchange reserves had suffered a precipitous fall since the end of 2020 and was below $2 billion at the end of March 2022, enough for just 10 days of imports, as against a 3-month import cover the IMF considers adequate.
These downsides created shortages of essentials, including food and fuel. But more importantly, it increased the number of people below poverty line by about half a million in 2021. Based on the Household Income and Expenditure Survey of 2022, the Department of Census and Statistics estimated that about 60 percent of total households were below the poverty line.
In September 2022, the IMF reached a ‘staff-level agreement’ on an EFF with Sri Lanka, leading to imposing several conditions on the borrower. These included fiscal consolidation through major tax reforms aimed at ensuring a primary surplus of 2.3 percent of GDP by 2025, restoring price stability through monetary policy action and pursuing a flexible inflation targeting regime, rebuilding foreign reserves through restoring a market-determined and flexible exchange rate, and mitigating the impact of the current crisis by raising social spending.
Implementation of the IMF conditions were initiated in earnest, with the budget for 2023 lowering fiscal deficit to 8.5 percent from 10.2 percent in 2022. This was achieved by squeezing total expenditure and sharply increasing tax revenue. Total expenditure less interest payments suffered a 9 percent decline in real terms, while tax revenue increased over 43 percent in an attempt to improve the tax-GDP ratio.
Inflationary pressures were sought to be contained by a tight monetary policy. Policy interest rates were raised by 700 basis points in April 2022. However, in response to the “necessity of fulfilling all the prior actions” towards “finalisation of the EFF arrangement”, the Sri Lankan Central Bank and IMF staff reached a consensus and raised policy interest rates further by 100 basis points in early March 2023.
Inflationary pressures were fuelled further as the Sri Lankan Rupee depreciated by 45 percent against the dollar (against the Indian rupee, the depreciation was 39 percent). But this measure provided a degree of succour in improving the country’s trade balance, which was already affected due to the country’s foreign exchange crunch.
Though the IMF conditions stated that “strengthening the social safety net and protecting social spending” was “critical to safeguarding the poor and vulnerable”, budgetary spending on the social safety net remained almost unchanged. Thus, under the EFF programme, the emphasis was on fiscal consolidation, while the interests of the Sri Lankan households below the poverty line were completely ignored.
It may be too early to assess the effect of the EFF programme on Sri Lanka’s macroeconomy, since it was officially put in place just over a year and a half back. However, given the island nation has frequently sought IMF’s assistance, a case can be made for assessing the efficacy of IMF programmes.
Year 2022 was the third time since the turn of the millennium that the IMF brought Sri Lanka under the EFF programme, and the second instance in less than a decade. In 2016, the IMF had approved a 36-month extended arrangement for about $1.5 billion to support the country's economic reforms.
Among the objectives of this programme was reduction of public debt relative to the GDP and lowering of debt distress risk. None of these objectives, especially the latter, was realised. On the contrary, the country’s debt increased from $44.8 billion in early 2016 to $54.7 billion at the beginning of 2019.
At the beginning of the current programme, Sri Lanka’s external debt stood at below $50 billion. At the end of the second quarter of 2024, it had increased to nearly $56 billion. More significantly, while the IMF had disbursed $762 million over the past two years, Sri Lanka’s repayments totalled $307 million—so repayments were 40 percent of the disbursements.
Surely, this cannot be a recipe for reducing the distress of a debt-stricken economy.
(Views are personal)
(bisjit@gmail.com)
Biswajit Dhar | Former professor, Jawaharlal Nehru University and Vice President, Council for Social Development