The story so far: The International Monetary Fund (IMF) on September 1 announced a staff-level agreement with Sri Lanka, months after the island nation’s economic crisis intensified this year, following a serious Balance of Payments problem.
It is a formal arrangement by which IMF staff and Sri Lankan authorities agree on a $2.9-billion package that will support Sri Lanka’s economic policies with a 48-month arrangement under the Extended Fund Facility (EFF).
However, even though the IMF has agreed to support Sri Lanka, the EFF is conditional on many factors. Sri Lanka must take a series of immediate measures that the Fund has deemed necessary to fix fiscal lapses and structural weaknesses — such as raising fiscal revenue, safeguarding financial stability and reducing corruption vulnerabilities. Apart from making domestic policy changes to strengthen the economy, Sri Lanka must also restructure its debt with its multiple lenders. The IMF has said that it will provide financial support to Sri Lanka only after the country’s official creditors give financing assurances on debt sustainability, and when the government reaches a collaborative agreement with its private creditors. The process could take several months.
Sri Lanka has already taken some significant policy measures. Beginning this year, the Central Bank has floated the rupee, raised interest rates sharply, increased electricity tariffs and fuel prices and restored tax cuts introduced during President Gotabaya’s time in office. While the government embarks on a path of fiscal consolidation, it has the difficult task of negotiating with a diverse group of creditors, including International Sovereign Bond (ISB) holders, to whom the island owes nearly half of its foreign debt, multilateral-lateral agencies, and foreign governments, mainly China, Japan, and India. While talks with the ISB holders are likely to be legal and technical, discussion with bilateral creditors is a more complex exercise, with geopolitical dimensions.
China has signalled its willingness to lend more money to the country but has put the onus of restructuring past debt on Sri Lanka. “We hope Sri Lanka will work actively with China in a similar spirit and work out a feasible solution expeditiously,” the Chinese Embassy said after the government firmed up the staff-level agreement with the IMF.
Japan has pledged to work with Sri Lanka and other creditors, but underscored that it is important for Sri Lanka, in collaboration with the IMF and Paris Club, “to work for the betterment of its economic and fiscal situation while securing transparency.” India, too, backs the IMF process and will likely cooperate, although New Delhi has said it is still studying the “evolving, unfolding” story of the IMF agreement. Ministry of External Affairs spokesman Arindam Bagchi said: “India has been advocating for assistance to Sri Lanka but let us see how it progresses. Issues of creditor equitability and transparency are important.” This means that India expects Sri Lanka to treat all its creditors equally and fairly. The statement comes amid speculation on whether Colombo might accord preferential treatment to one partner.
The IMF has indicated that creditors also have a role to play in ensuring Sri Lanka’s crisis does not deepen.
The $2.9 billion agreed upon by both sides, is short of Sri Lanka’s expectations of support totalling $3 to $4 billion. In any case, even if the IMF package arrives swiftly, subject to Sri Lanka’s success with the “prior actions” spelt out by the Fund, it cannot “bailout” Sri Lanka.
After a pre-emptive sovereign default in April — the island’s foreign debt totals $51 billion — Sri Lanka is still grappling with its Balance of Payments crisis. The government has resorted to wide import restrictions, while exports remain limited to the country’s traditional basket of tea, garments, and spices.
From the ordinary citizen’s point of view, cost of living is soaring. Headline inflation went up to 64.3% in August 2022, and food inflation increased to 93.7%. The World Food Programme estimated that about 30% of Sri Lanka’s population, became food insecure, since the crisis worsened this year. Many families, especially those belonging to the working population, are starving.
If it comes through, the IMF package will effectively make Sri Lanka credit-worthy again, allowing the government to borrow once again from private creditors, multilateral lenders and bilateral partners. While many see the programme as necessary, few think it will be sufficient for substantive economic recovery. They believe it would push the government to make necessary policy shifts to ensure higher revenue and lesser state spending and address the problem of corruption.
The responsibility of building fiscal strength and resilience is, however, Sri Lanka’s. For that, the government must also introspect on its heavy reliance on imports, the status of domestic production, prospects for boosting exports with greater value addition, and ways to address income and wealth inequality.
Over the last month, there has been an improvement in supply of fuel and LPG after the government decided to repurpose available World Bank funding for essential fuel purchase, and ration supply through a QR-code system. However, once the repurposed funds dry up the strain on the government will grow again. Despite some temporary relief in essential supplies, Sri Lanka's crisis persists and shows no sign of letting up as yet. The Governor of the Central Bank of Sri Lanka has said the country's economic meltdown will result in a record contraction of at least 8% this year.
Many families are not only skipping meals, but also contending with rapid price hikes. Kerosene prices saw a dramatic increase last month from LKR 87 to LKR 340 a litre. Many essentials and medicines continue to be in short supply. Doctors are pointing to malnutrition among children and pregnant mothers are unable to afford nutrition. The IMF has emphasised the need to “mitigate the impact of the crisis on the poor and vulnerable by raising social spending and improving the coverage and targeting of social safety net programmes”.