Sri Lanka’s political unrest risks further derailing the economy – Opinion

Usable foreign exchange reserves are just weeks away from imports (estimated at less than US$200 million), and there are shortages of fuel, gas and electricity

Sri Lanka is facing unprecedented political turmoil and, with a plummeting economy, is in its weakest state in decades. The country is grappling with a barrel of sovereign debt default and exposed to external shocks.
Usable foreign exchange reserves are just weeks away from imports (estimated at less than US$200 million), and there are shortages of fuel, gas and electricity. Banks and companies are short of dollars for commercial transactions and households are struggling to obtain basic food items.

President Gotabaya Rajapaksa announced his request for support from the International Monetary Fund (IMF) in March 2022 as a precursor to pursuing sovereign debt restructuring. He appointed a panel of three eminent experts to advise him on multilateral engagement. Ensuring the government can come to an agreement with the emergency lender – with political consensus and public acceptance – is crucial.

Political consensus
Political consensus around economic policies in Sri Lanka has always been elusive. In recent political cycles, economic reform programs were quickly reversed by the next government, resulting in political whiplash and macroeconomic damage. This trend must be reversed. Political consensus in key reform areas, such as fiscal adjustment, market-based energy pricing, streamlining state spending – including reforming state-owned enterprises and halting recruitment in the public sector – is essential.

For international institutions and investors awaiting Sri Lanka’s next step, the political turmoil of recent days is troubling. In the face of public protests, the cabinet of ministers resigned, forty-two deputies left the government, and the new finance minister resigned a day after being appointed.

Last month, three MPs began shaping an anti-IMF narrative. One of them even suggested that the IMF, and Western institutions in general, are responsible for the current crisis in Ukraine.

As calls for the president’s resignation grew, efforts were made to form an “interim government” with “multiparty representation”. Given the divergent political views and economic ideologies of these parties, it will be difficult to achieve any form of political consensus on an economic reform agenda. Public anti-IMF posturing, party-led protests over budget cuts and disagreements over the path to reform risk derailing urgent macroeconomic stabilization measures and undermining near-term restructuring and reform efforts. .

The Sri Lankan economy has run on excessive money printing for the past couple of years. The balance sheet of the Central Bank of Sri Lanka and the role of the state in the economy have expanded.

Everything from construction companies to consumer goods retailers did well during this period. Inflation is now over 17%, four times what it was two years ago. It is inevitable that an austerity program will be implemented within the framework of an IMF bailout and sovereign debt restructuring.

Fiscal adjustment must be quick, sensible and sensitive to vulnerable groups. Budget cuts must be prioritized so as not to burden the poorest households. As the Leader of the Opposition recently stated, “we must protect the less fortunate in society, we cannot have social upheaval just in the name and for the sake of restructuring and reform”.

Non-emergency capital expenditure projects – notably infrastructure construction – would be the first to be deprioritized, especially amid controversies over cost inflation in projects like the construction of the Central Expressway. The construction sector has been a mainstay of economic activity since the end of the Sri Lankan civil war in 2009. A reduction would also have localized effects on jobs – many seasonal agricultural workers often hold jobs in these projects.

Taxes and interest rates must rise and spending must be reduced. This will affect aggregate demand in the economy which has an important role for the state. Those who have benefited from government stimulus payments will be hit hard.
National political consensus on key reform areas should accompany efforts to agree a reform program with the IMF that paves the way for sovereign debt restructuring. The IMF and bondholders need assurances of political continuity. Any attempt to push through the reform agenda without a clear articulation of its rationale, expected outcomes and measures to protect vulnerable people will be met with resistance from politicians and the public.

need explanation
The government needs to explain what the next year will look like, why the measures taken are necessary and how they will help alleviate people’s economic hardship. Ensuring that key economic decision-making roles are filled by credible and competent people is essential to building confidence in the government’s economic management and its ability to engage in productive dialogue with the IMF and international creditors.

The main risk facing Sri Lanka is the fallout from the current political instability on macroeconomic stabilization efforts. Faced with the prospect of a disorderly default, Sri Lankan officials have a decision to make: will they bow to political constraints or will they come together to agree a common agenda that will lift the economy out of the current crisis and will move towards macroeconomic stability? Perhaps the current unrest in parliament and growing public recognition of the cause of the crisis will be what will catalyze a political consensus for reform that has eluded Sri Lanka for so long.

– Courtesy of East Asia Forum
(Anushka Wijesinha is a Sri Lankan economist and co-founder of the Center for a Smart Future, an independent public policy think tank. Ceylon trade.)