Financial Times

Devaluation, IMF or crisis


Not many people in the country – the man-on-the-street for example - would realize the seriousness of Sri Lanka’s foreign exchange reserves which is at precariously low levels to sustain an economy that is import-dependant.

In fact, according to an economist who earlier worked for an international lending agency, the level of reserves which is at around 1.5 months of imports or thereabout is the lowest in many years and – interestingly – similar to the 1975-76 level during the controlled economy era under the Sirima Bandaranaike regime. At that time however there were no imports unlike today in an open economic environment.

There is no doubt the money is running out. Only a few government officials are aware of this crisis and worried about it while the Central Bank governor is insistent that the government can manage the crisis.
Economists argue that the CB policy of using the exchange rate to stabilise the rupee is not the best policy. “It will fall flat in your face,” one official noted. While there are mixed views as to the extent of the crisis – some saying the shortage of foreign cash is already here while others see it going to happen - there is one factor that clearly points to the direction of the crisis already being there.

The current level of foreign reserves is at a critical stage of around 1.5 months of imports when three months worth of imports is the comfortable level and anything between 2-3 months being of some concern. So there is little issue with the level of the crisis though the CB repeatedly says it can manage the reserves. By end November 2008, gross official reserves had dropped to little over $2 billion, the lowest in the last decade. The oil costs, one bill alone, is around $2 billion which however would be lower this year due to falling oil prices.

The CB is confident that new strategies to raise foreign cash from Sri Lankan expatriates through their investment in bonds and treasury bills will help sustain reserves to a comfortable level this year. Many others disagree.

With oil prices still at low levels, oil incomes are falling in West Asia and putting pressure on construction and other projects. Dubai, in particular, has seen a fall in construction work. The World Bank already says remittances from the region, the lifeblood for millions in South Asia and the developing world, could decline by 9 % in nominal dollar terms this year, compared with a rise of 38 % last year.

Oil is the biggest dilemna for the Sri Lankan economy. On the one hand, falling oil prices reduces the need for more foreign exchange, while on the other lower oil incomes in West Asia could impact on the earning capacity of a million Sri Lankans and also deter new job orders. This will reduce remittances, a vital component in the economy. With falling reserves, there are few choices left for Sri Lanka in this scenario; Either devalue, seek an IMF bailout package or reduce imports, economists say.

The government and the Central Bank are vehemently opposed to the first two proposals particularly in the context of 2009 being an election year, while the third proposal is also said to be an unviable option.
Economists argue that devaluation would be the only option since an IMF Balance of Payments facility will be based on conditionalities like removal of subsidies and reduction in unproductive government spending which are contrary to the Mahinda Rajapaksa doctrine (Mahinda Chinthana).

The last time an IMF package was sought was in 2001 when there was a shortage of foreign cash due to high military spending on new equipment essentially to re-capture Elephant Pass, after it fell to the Tigers, and rising oil prices. The IMF closed its office in January 2007 saying it was part of a restructuring exercise and also because there was no lending programme with Sri Lanka.

The IMF policies are anathema to the government and groups like the JVP and Wimal Weerawansa’s breakaway faction. Thus it’s unlikely that the government will seek a facility unless the reserves fall to drastic levels. This leaves the devaluation and reduced imports options, with the former being the most favourable of the two steps. Things are getting worse on the external sector and to tackle the situation the government needs to get a cross-section of views from economists and key officials on the crisis instead of relying on a handful who are using elections, among other matters, to delay inevitable reforms.

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