Sri Lanka needs IMF even if it doesn’t want it

Originally appeared on The Morning

By Dhananath Fernando

With the visit of US Secretary of State Mike Pompeo, Sri Lanka’s national discourse shifted from the 20th Amendment to foreign relations. State Secretary Pompeo’s visit grabbed national attention for many reasons; one main reason being economic and diplomatic tensions between the world’s two largest economies, the US and China.  

Sri Lanka has transitioned through different phases of foreign policy, from the post-independence era to recent times. When the late Lakshman Kadirgamar was the Minister of Foreign Affairs, his main challenge was to stop the financing of the Liberation Tigers of Tamil Eelam (LTTE), while communicating to the international community the ground reality. With the tragic tsunami in 2004, the helping hand we received from our international friends cannot be forgotten. During the last stage of the civil war, we had to again seek assistance in terms of intelligence, supplies, diplomatic support, and military hardware from our neighbours and other economic powers. 

After the war, the next challenge was facing allegations of human rights violations at the United Nations Human Rights Council (UNHRC) and at the same time managing the development of our economy, in a post-war context. Therefore, we had to work tirelessly to regain the Generalised Scheme of Preferences Plus (GSP+) concession and to remove the fish export ban in order to strengthen our economy. 

Unfortunately, after gaining independence and secondly after the end of the war, Sri Lankan rulers have failed to carry out the necessary economic reforms to make our economy competitive. We have made gigantic investments in non-tradable goods by borrowing huge sums of money at high-interest rates on shorter-maturity in foreign currency and lived beyond our means. The investments we have made were not properly evaluated and have hardly generated adequate revenue to settle the loans we have taken. About 42% of the foreign debt portfolio is International Sovereign Bonds (ISBs) and our public finance management has been extremely poor. As a result, we are in a position today where 47% of our revenue has to be paid just to cover the interest of the loans we have taken.

In contrast to this, our overall average post-independence economic growth is about 4.2%, and it was just 2.3% in 2019. This year, it will be an economic contraction, not growth, which means we will be deep in negative territory. This crisis, coupled with the global Covid-19 pandemic, has resulted in our foreign exchange earnings being badly hit. The secondary bond market signals on yields and the rating downgrade by Moody’s has indicated that Sri Lanka’s finances are in a bad state.  

The foreign policy of a country is often connected to the country’s economy and trade. Most of the time, a policy stance has to be arrived at by considering the context of challenges of a country. Today, the importance of a good foreign policy has come to play again, especially in the context of servicing our debt. All the swap agreements and bilateral support are based on our relationship with our neighbours. However, the main questions remain: How do we get the assistance and from whom are we going to get it? 

On the one hand, during the visit by a high-level Chinese delegation led by Chinese Communist Party Political Bureau Member Yang Jiechi, it was reported in the media that we signed a credit facility agreement of $ 500 million and in July, the Reserve Bank of India (RBI) signed a currency swap facility of $ 400 million with the Central Bank of Sri Lanka. 

On the other hand, there is a $ 480 million Millennium Challenge Corporation (MCC) grant with zero interest – free money which is still hanging around the corner, and yet, the Government hasn’t communicated their stance to the donor agencies on whether we are going to take it or not. There were very sensitive political debates during the last presidential election, mainly on the land component of the MCC agreement on the basis of sovereignty and territorial integrity. Things have changed, now that the members of the then ruling party who believed that the MCC was a worthy agreement to sign with no impact on our sovereignty, are now opposing it. Similarly, members who vociferously opposed the agreement when in the opposition, are now turning a blind eye to it, while the Government provides general statements rather than a specific policy stance, such as “we will not sign any agreement that affects territorial integrity”. 

On our debt servicing obligations, we have to pay about $ 4 billion every year for the next three to four years just to roll over our debt. In this context, it is not only about getting money to roll over debt that matters. It has to be about financing through sources whom we could assure are fiscally disciplined and attempt to build investor confidence – this is what matters. Only then will markets take Sri Lanka seriously and we will be able to invest in foreign currency at somewhat lower interest rates. Otherwise, we will be caught up in the vicious cycle of taking more loans to pay the interest at even higher interest rates with a low growth trajectory. 

The question is, what could be the country or agency which ensures financial discipline and could build the confidence of investors worldwide? The only player in town that could do that is the International Monetary Fund (IMF). When a country is on an IMF programme, that respective country has to jointly agree to a programme on bringing the necessary structural reforms to secure the funding. So the respective government has a strings-attached relationship and pressure to perform well.

However, we have to understand that securing an IMF programme is not a thing to be proud of and it’s a signal that we have managed our finances very badly. It’s just a bailout programme. Our policy-makers have to conduct economic reforms in such a way that our economy can perform well, without seeking any help from the IMF. Sri Lanka often boasts that we have honoured all our debt commitments throughout our history. Unfortunately, this clean record is not due to our amazing financial management. We have run to the IMF 16 times so far for bailout programmes whenever we have had a balance of payment crisis and faced the risk of default. In fact, for almost half of Sri Lanka’s post-independence history, Sri Lanka has been under an IMF bailout programme.

The Government has lately maintained that they do not expect to seek IMF assistance and they are confident of managing the situation with the current financing strategies. However, I must highlight that we have to seek IMF assistance fast, without waiting any further, as we have a good story to sell on Covid-19 containment, despite the latest outbreak. The other reason for urgency is that there is a long line of countries waiting to get IMF assistance. The more we delay, the higher the intensity of the pain.

Interestingly, it was reported on The Sunday Morning under the headline “IMF still considering RFI request” that Sri Lanka had applied for the IMF’s Covid-centric Rapid Financing Instrument (RFI) earlier this year but that the application is still under review. The article goes on to say that the IMF had received just over 100 requests from countries seeking RFI support and as of mid-September, about 76 requests had been approved, meaning that Sri Lanka is among approximately 20 or 30 countries that have not been granted RFI support. If this is the case, it is likely that the Government is yet to agree to certain terms of the IMF and therefore, the application is still pending.

Ultimately, whether Sri Lanka has gone to the IMF and not been approved yet or Sri Lanka is not interested in an IMF programme, Sri Lanka needs an IMF programme now to ensure fiscal discipline and regain investor confidence. Going to the IMF often is not the solution, but it is probably the best option left for us to overcome the situation. Only time will tell how good or bad the strategies implemented are. My only hope is that whatever strategy that gets implemented persists for several years, at least. 

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Birth of the 20th Amendment and death of a basketball legend

Originally appeared on The Morning

By Dhananath Fernando

Why planes must have two pilots and warning systems

After much elaborate drama, vehement opposition, and toing and froing, the 20th Amendment to the Constitution has been passed with a resounding majority in Parliament. The contents of this amendment and the seismic shift it creates to our governance system reminds me of a story from early this year before global headlines had begun to be dominated by Covid-19 – namely, the tragic helicopter crash on 26 January in Los Angeles which caused the death of basketball legend Kobe Bryant and his daughter.

The National Transport Safety Board (NTSB) of the US has come up with a 1,700-page report on the crash. While it provides no final conclusion, many aviation experts believe the pilot got disoriented, confused the pitch altitude, and though he was ascending when he was descending. This is not a novel phenomenon in the field of aviation and is always a possibility as you are in the air without visual references. At least, that was the reasoning at surface level. But when we go a little in-depth, there are two main factors highlighted by experts and the report (1).

1. The helicopter Kobe Bryant flew (Sikorsky-S76B) is operationally a hi-tech machine with a sophisticated flight-deck for two pilots. However, on this unfortunate day, it was operated by only one pilot. According to NTSB guidelines, any helicopter that carries more than five passengers must be a dual pilot operation, but in this case, nine innocent passengers died in the crash. A guideline for dual pilot operations was imposed post the investigations of a similar crash in the Gulf of Mexico in 2004. The simple reason to have a dual pilot operation is simply a check and balance mechanism to minimise the probability of human error in decision-making in flight.

2. The second reason was that the helicopter that hit the ground did not have a Terrain Avoidance and Warning System (TAWS) installed.

A dual pilot operation and installing a TAWS are simply just guidelines. Operating a flight without following those guidelines were not illegal, but the cost of not following the guidelines was proven to be human life.

When I think about Sri Lanka’s Constitution and the proposed constitutional reforms which affect the economy and our structure of governance, I think of a helicopter operation and the tragic crash Kobe Bryant had to face.

Checks and balances and processes are in place for a reason, and till things go wrong, we may not see the importance of their presence. In Sri Lanka’s context, our pilot is the policymaking unit and the 21 million population are the passengers who have to be safe onboard and flown to the destination of prosperity in their own lives. So we have to have systems in place where the aeroplane can be landed safely, even if key decision-makers in the cockpit get disoriented.

The discussion on the 20th Amendment has been evaluated in that spirit, in particular from an economic perspective. That is why the checks and balances are vital and a mechanism has to be established to minimise the probability of human error, similar to the dual pilot model and the TAWS system. Otherwise, it is natural that in a cloud of “political power”, individuals may disconnect with the ground reality and make decisions to accelerate the momentum in the wrong direction.

Our economy is already at a critical stage where we can’t afford to make any miscalculations. For example, there has been a rise in bond yields in secondary market bonds of Sri Lanka following the announcement of the changes in the 20th Amendment. One possibility for this could be the uncertainties created by the 20th Amendment with regard to checks and balances for the broader economy.

The executive powers vested with the President have to be looked at in the spirit of “responsibility”. Political power provides the decision-making ability, and yet we should not underestimate the “responsibility” factor that is interconnected with power, which may impact millions of lives. What do we do with political power franchised by the people to develop their economies? This is the vital question. The three arms of the executive, legislature, and judiciary are the governance equivalents of a dual pilot and the TAWS safety net: The “executive” as the chief pilot and “legislature”, lead by the Prime Minister, as the core pilot have to work hand in hand in ensuring that there are measures to recheck whether we do the right thing. Then there has to be an independent judiciary to resolve any conflict. If Sri Lanka is to prosper, it is essential that we protect these checks and balances.

It has been proven multiple times in Sri Lanka and across the world that when citizens are empowered to make their own decisions and choices, the chances for success and prosperity are greater. A single government trying to understand the needs and aspirations, motivations, behaviours, lifestyles, etc. of 21 million people is simply impossible. That is why the structure has to be organised in a way where people are empowered to make their own economic decisions and competition has to be in place along with a level playing field in order to ensure that hard work is incentivised and rewarded.

All constitutional reforms have to be in the view of what is in it for people to make their own choices and how it affects the creation of a level playing field.

As highlighted in this column less than a month ago on 27 September, the importance of the Auditor General having the ability to audit state-owned enterprises (SOEs) has to be appreciated. However, just the powers for the Auditor General will not ensure SOE governance as the corruption in SOEs is systemic and incredibly pervasive. The Government has to consider greater reform and should consider steps such as listing strategic SOEs at the Colombo Stock Exchange (CSE) and establishing a “Temasek model” for the governance of all SOEs.

The general Sri Lankan sentiment is that merely appointing a political leader or moving a constitutional reform would provide solutions to all problems. When the amendments were brought to increase female representation at local government level, many were of the opinion that it would solve the problem of female underrepresentation. Unfortunately, what happened in reality was far different, with some women contesting elections simply to enable their husbands to effectively take over once elected. It is required that Sri Lankan political leadership initiates a comprehensive economic reform plan if we are to have any hope of development.

What we do with the “powers” we have in hand is more important than what “powers” we install in one single position. In exercising power, we need a system to make sure we exercise it in the right way.

Sri Lankans’ experience in the economic context over time is that the powers granted by people have not been utilised for the right objectives, and in many cases, the same power they have provided have limited people’s own right and freedom to enjoy a prosperous economic life.

After the 20th Amendment, with new powers installed, “economic freedom” is a concept that we can start building into our country. It has been shown that countries with higher economic freedom, where people are provided with the independence and opportunity to earn higher incomes, generally experience a higher quality of life. Poverty levels reduce and the most vulnerable sections of society are able to have economic security.

Per capita income and economic freedom quartile

Sri Lanka has been ranked 83rd on the Economic Freedom Index and we have a long way to go. Let’s hope that with checks and balances and executive powers, Sri Lanka will establish systems and guidelines such as dual pilot systems in aviation and TAWS in the form of institutions to incentivise people to work harder and become prosperous, so that we can prosper as a country.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Economic reforms before constitutional reforms, please

Originally appeared on The Morning

By Dhananath Fernando

Kumar Sangakkara in his famous Colin Cowdrey Lecture at London’s hallowed Marylebone Cricket Club (MCC) in 2011 said: “In cricket, timing is everything.” Not only in cricket but in economics and politics too, timing is everything.

Unfortunately, Sri Lanka’s track record on “economic reforms” has been very poor and completely devoid of timing. We have been completely ignorant of the need for economic reform and things are now at a dire stage. Across the board, even the Government has conceded that things are not easy!

Sri Lanka is experiencing a second wave of Covid-19 and the continued imposition of curfew in parts of an important district such Gampaha, which is a key economic centre, is a cause for concern. The recent lockdowns also cover a free trade zone, the country’s main international airport, and many export-oriented factories. Hence, one cannot simply ignore the economic impact of this health crisis.

Our economy contracted by 1.6% in the first quarter of 2019 and the second quarter data is yet to be released. On the positive side, our exports have exceeded the $ 1 billion mark in September and our remittances have increased by 28% YoY (year-on-year). While this increase in remittances is a good sign, this sudden increase may be due to workers sending home their final savings due to job losses. Another positive sign is that our stock market is performing well with about Rs. 5 billion turnover with more than 41,000 transactions, the highest since 2011. However, on the other hand, following Moody’s credit rating downgrade and even prior to that, the departure of foreign investors from the stock market can be observed, and our treasury bills have been undersubscribed as of late.

Unfortunately, with Covid-19 infections picking up again, it is unlikely that people will see further relief measures from the Government, as the Government’s finances are in a complicated situation; in fact, they are probably worse off than our household finances. Reopening the country for tourism will most likely be postponed, at least until the end of the first quarter of next year, and further moratoriums or government handouts may be unlikely, given that the budget deficit for 2021 is expected to be around 9% of GDP.

In this context, we have to admit that our economy cannot be fixed just by incremental reforms. Superficial changes or stopgap solutions will not help us reach where we aspire to be.

Unfortunately what we are seeing at the moment are attempts to micromanage what is essentially a macroeconomic problem, while serious core economic concerns are reaching a boiling point. Measures such as the reduction of tariff lines on a few consumable goods and allowing the importation of some ingredients for the production of incense sticks are just a couple of examples of ad hoc micromanagement of the macroeconomy. When a senior minister has to engage himself in a micro-task such as creating a tiny tariff reduction on just one HS (Harmonised System) code, it prevents them from prioritising the broader issues to navigate the economy at a time where the country is facing the unprecedented crisis of Covid-19.

A similar situation was reported to have occurred during the 1970s where the Minister of Finance had to go through a file every morning to evaluate the licence requests for the importation of motor vehicles. When a Finance Minister has to sit and supervise such a micro issue, it is obvious that many other policy priorities will be either ignored or mismanaged.

The World Bank predicted an economic contraction of about 6.7% for 2020 even before the emergence of the new wave of Covid infections, but mainstream conversation has been focused on constitutional reforms, particularly the 20th Amendment. It is true that people have provided a clear mandate for a new constitution, but our policymakers have to think of the timing of the new constitution and other constitutional reforms. The country and people’s needs and expectations have shifted, especially as the entire world is grappling with a pandemic. New needs and lifestyles have been created. Consumer and citizen behaviour and priorities have undergone a massive transformation. This doesn’t mean that the mandate for a new constitution is no longer valid, but the timing and focus being given to a new constitution has to be reconsidered. This matter could just as easily be taken up whenever the current crisis has been dealt with.

There is no doubt that our constitution is far from our expectations, but the brewing economic crisis (not just in Sri Lanka but across the world) requires 100 times greater focus for the economy to be put back on the right track.

The previous Government too was spending its energy on a new constitution without focusing on much-needed economic reforms. After spending significant time and resources during its tenure on a proposed constitution, it was ultimately not even presented to Parliament. Much-needed economic reforms were postponed and we ended up with 2.3% economic growth with stagnation in exports and foreign direct investments.

It is a political reality that there is a trade-off between constitutional reform and economic reform. Ultimately, for both constitutional reforms and economic reforms, one needs to sacrifice some political capital as, naturally, there is opposition to any type of reform. It all comes down to prioritising what reforms are urgent considering the internal and external environments.

Serious legal reforms can be carried out to positively affect businesses and the business climate before these planned constitutional reforms. As I have highlighted before in this column, Sri Lanka’s land regulations, regulations on micro and small enterprises, and employment regulations can be easily reformed to bring faster results. Age-old laws, regulations, and bureaucratic practices continue to hamper investment. Therefore, instead of a heavily energy-consuming constitutional reform process, we can focus on getting our economic fundamentals right. Creating competition and competitiveness is the way to go.

Over the years, while we have been discussing constitutional reforms, our regional peers have moved ahead of us, especially on the economic front. For example, Vietnam increased its exports from $ 50 billion to $ 250 billion from 2008 to 2018, while Sri Lanka’s performance improved only from $ 7.5 billion to $ 10 billion in the same period.

National Budget 2021

Now the Government has a golden opportunity to bring in a series of economic reforms through the upcoming national budget. A clear direction through serious reforms will bring back credibility to the Government and the economy, and send a positive signal to investors locally and globally. Sri Lanka’s economic problems have gone far beyond ad hoc fixing. Now it can only be fixed through macro reforms.

Then comes the question of what sort of reforms. In the world of business and economics, it is incentives that drive growth and innovation. It is by expanding markets and access to markets that growth can be achieved. It is through competition and by creating a level playing field that growing economies, including our regional peers, have achieved growth. So, for a market of 21 million people, our reforms have to be based on setting up proper incentives, connecting with other markets, and improving productivity for those who work hard and value-free exchange of goods and services.

Bringing in these macro changes before micromanagement has to be at the forefront of government policy. Unfortunately, we have no other alternative if we are serious about creating a prosperous country. Let’s hope that Sri Lanka will get its timing right at least this time and establish the right fundamentals for a competitive economy.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Is Sri Lanka unlucky or unprepared?

Originally appeared on The Morning

By Dhananath Fernando

Some time back, a friend of mine died in a motorcycle accident. I consoled myself thinking it was pure misfortune. However, upon visiting the location of the accident, I discovered my friend had ridden his bike without a safety helmet. Needless to say, if he hadn’t met with the accident, regardless of whether he was wearing a helmet or not, he would’ve still been amongst us. However, if he had worn a helmet, it is likely that he would’ve survived the accident.

Most incidents in life, or even in the economy, can be seen through two lenses – of misfortune and mismanagement (in its positive variation, these can be interpreted as good fortune or as the results of hard work and smart decisions). It is embedded in Sri Lankan culture to interpret most unfavourable events in life through the lens of misfortune. However, a deeper dive into the root causes of unfortunate incidents often emphasises lapses of management.

A sudden uptick in Covid-19 cases can also be viewed by society through these two lenses. As individuals, isn’t it the appropriate time to question if we followed the simple steps of wearing a face mask, washing our hands, maintaining social distance, and taking precautionary measures to avoid greater misfortune?

On the broader picture of public policy; have we increased our testing capacity, have we followed the right testing strategy, and have we been conducting random testing? These are questions we should ask ourselves before jumping to any conclusions.

However, a combination of mismanagement and misfortune is deadly, and these two often complement each other. Whether it’s misfortune or mismanagement, the consequences for citizens would be very serious both from a public health perspective and from an economic angle.

One main lesson COVID-19 has taught us is that only self-control and self-discipline can contain the virus, not state control. The state can only play a facilitatory role, and the impact on public health and our economy worsens with each blanket policy decision.

When we look at the events over the last five to six years, an unaccounted cost of mismanagement is throwing away resources and opportunities that could have been utilised during hard times of misfortune.

For example, think of a cricket team which is chasing a total, and loses half their wickets due to the frontline batsmen playing careless shots. However, the team ends up losing only by two runs due to a brave fightback by the lower order batsmen, which took the team to the brink of an unlikely victory. Should we say the team was unlucky because it got agonisingly close and lost by only two runs, or should we blame the carelessness of the batsmen at the top, without whom the team would have presumably ended up winning the match?

When we look back at our recent history, in 2015-2016, the Central Bank bond fiasco affected our financial markets to an extent; in 2016, the drought greatly affected Sri Lanka’s economic prospects; in 2018, we had a constitutional crisis; this was followed by the 2019 Easter Sunday attacks which further shattered hopes of any economic recovery; we had the Digana riots and social media blockages in between; in 2020, we are still in the middle of a global pandemic. Some of these negative shocks are due to mismanagement, and some events are due to misfortune. But it is undeniable that we are hindered by the mismanagement of our misfortunes.

However, all the misfortune and mismanagement over the last few decades now appear to be funnelling down to a serious economic shock. The uncertainty of COVID-19 and its impact at the global scale have made it the right ingredient to stir up a storm for Sri Lanka.

Mismanagement and misfortune of exports

Covid-19 hit our exports badly on all fronts. As our export markets were affected by falling consumption, our supply chains for exports were interrupted during the first wave of COVID. Since then, however, our exports have been on the rise to reach pre-COVID levels. However, our apparel sector is one major industry that was badly hit by COVID-19 just at the start of this year – a time we need exports the most.

There is talk in society that the recent COVID-19 cluster is viewed as a result of both misfortune and mismanagement. However, we as a country cannot be forgiven for the mismanagement of our export sector over the years. Our mismanagement of exports backed by a system of unnecessary and excessive regulations on exports continues to handicap our export potential. According to a study conducted by Verite Research in 2018, registering as an exporter is an extensive process. The example they provided is of the coconut industry, where the process adds three to four weeks in the time taken to register, in addition to the time taken penetrating regulatory barriers that stand in the way of easy registration, only to prolong the process even further, continuing all the way to the point of customs.

The added unnecessary import restrictions further hurt Sri Lanka’s export potential with higher tariffs on imported raw materials for export processing making matters worse and Sri Lanka’s exports uncompetitive on the global stage.

The intention of protecting local industries by imposing tariffs has made our own local industries uncompetitive and has forced consumers to bear the cost of inefficiencies. As a result, local industries are neither productive for export nor competitive, and we are back at square one.

Our mismanagement has caused us to restrict our exports only to a few sectors and we have placed too many export eggs in the apparel basket.

Mismanagement and misfortune of our debt sustainability

COVID-19 has had a direct impact on our debt sustainability. As we have highlighted multiple times, servicing debt of nearly $ 4 billion till 2025 is a mammoth task. Our debt servicing cost has exploded to a whopping 107% of our annual revenue, and our annual revenue is declining as a percentage of GDP over the years.

The Government’s generous tax cut offered at the end of last year is expected to significantly reduce tax revenue for 2020. The Government assured us that we are in a position to service all our debts. However, that can be only done by borrowing money from other lenders and servicing the existing debt. Even if it is possible, it won’t provide a permanent solution due to the unsustainability of our debt.

If Sri Lanka had built the right economic foundations with proper social security safety nets and policies to boost competition and productivity with a firm understanding of economic fundamentals, we would never have reached this dangerous juncture.

By and large, we could also have navigated or totally avoided most of the misfortunes we are facing at the moment. Our mismanagement is what has made us believe that we are unfortunate. Unfortunately, the degree of mismanagement through which we have survived so far is more than we can afford. Therefore, we have now reached such a precarious position that we simply cannot afford to face any further misfortune!

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

How bad parenting leads to bad credit

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

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By Dhananath Fernando

Parenting a child is a difficult task. It is no doubt that educating and teaching a child takes a significant amount of time and effort for all parents. The bigger the pile of homework, the more it becomes an affair of the household, requiring the attention and time from either parents or caregivers.

Some parents take an easy route; instead of encouraging their child to get the work done, they do it themselves and bestow the child with all the credit. This may be owed to the fact that the assigned task is above and beyond the grasp of a child, or simply because parents can’t afford to allocate the time and effort required to assist their child. Undoubtedly, both reasons are not in the best interest of the child and will certainly hamper his or her learning curve and growth.

Given the above phenomenon, I can’t help but notice similarities between common parenting mistakes and the Sri Lankan economy. Our economy has adopted a habit of conveniently ignoring hard reforms for political motives and instant gratification. This has resulted in long-term damage to the country’s economy.

Moody’s Analytics downgraded Sri Lanka’s credit rating from B2 to Caa1 last week with a “Stable” outlook. While the Government has made a statement expressing their disagreement with Moody’s credit rating downgrade. It is important to understand Moody’s rationale in depth. Long-term measures to correct these problems are vital, and hard reforms may be the only way out.

The effective containment of COVID-19 and the recent performance of the stock market has been reiterated by the Government as part of their success story. Additionally, the rebound of exports and foreign worker remittances are highlighted as positives. The Government has further provided a commitment to reduce the debt-to-GDP ratio, serve all external creditors without delays, and uphold a clean record of debt servicing.

However, Moody’s evaluation, which was in the works since April, highlighted concerns over-servicing debt of about $ 4 billion (between 2021 and 2025) with a reserve level of $ 7.4 billion, along with low growth predictions. Moody’s estimation of raising the debt-to-GDP ratio of 100% exceeding the median of 86% in the Caa1 category has been highlighted as a fundamental reason for the downgrade.

Moody’s downgrade forecasts the possibility of Sri Lanka’s credit rating being further downgraded by other rating agencies such as Fitch and S&P in the coming months. This will thrust Sri Lanka into the “Speculative Grade: Very High Risks” category, raising serious concerns over the possibility of acquiring money in international capital markets. The risk attached to this doubles as the coming years are burdened with heavy debt repayments.

How can this be managed?

Prevalent data highlights that consecutive governments have resorted to borrowing in international sovereign bonds at high-interest rates of about 6.6%, with an average repayment period of nine years. It is no doubt that our economic woes are deep-rooted in these poor policy solutions.

It is vital that we acknowledge the damage caused by these measures and formulate a strategy to overcome it.

The diagnosis is clear – our interest payments take 47% of our revenue and 30% of our expenditure.

The first step to manage this downgrade is to build credibility in financial markets. This is both painful and time-consuming. However, this is not an excuse to postpone much-needed reforms. Doing too little too late would lead to severe consequences, further hampering our debt sustainability.

To build credibility, the Government enjoys the benefit of two main strengths, a key strength being the successful management of the COVID-19 pandemic, which has also been praised by the World Health Organisation (WHO). At the international stage, this can be our ticket for a possible debt restructuring, giving the Government leverage to convince the International Monetary Fund (IMF) of a credible debt restructuring plan.

As per the below graphs, a greater portion of our foreign debt is in international sovereign bonds (ISBs). The IMF programme, of course, will come with conditions which are painful, but it will also bring credibility to Sri Lanka within international financial markets. This will require a commitment from the Government to maintain fiscal discipline. Sri Lanka has spent 42% of the last 70 years under an IMF facility. We have approached the IMF 16 times for bailout programmes. This isn’t a point of pride but indicates how irresponsibly our economy has been managed over the years.

An IMF restructuring programme will not uplift Sri Lanka’s credibility to the point where a credit rating downgrade can be reversed. However, it provides additional confidence for creditors and investors who are looking to invest in high-risk markets even at a premium rate.

The second strength is the Government’s opportunity to present a convincing budget with serious reforms in November. The budget needs to have a comprehensive strategy on improving government revenue and achieving a positive primary balance. (Primary balance is the difference between government revenue and government’s non-interest expenditure.)

Both measures are painful, but the Government has the political capital and political strength to pass through key essential reforms. Unfortunately, although we measure ourselves with what we intend to do, the markets and outsiders assess us with what we have done and continue to do.

Similar to parenting a child and encouraging the child to complete their assigned homework, the path to hard reforms is difficult and time-consuming. But we all need to support and help the Government to carry out these hard reforms, as it is ultimately being carried out for the betterment of our beloved motherland and ourselves.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.