Having read the article of Dr. T. L. Gunaruwan from the University of Colombo in last week’s Business Times, I could not resist presenting my own alternative views on this important issue.
Quoting the recently released Annual Report of the Central Bank, the writer points out that the country’s foreign exchange reserves have improved significantly to reach the level of around $ 5 billion. And, therefore, he argues that the “short-term” need of a Stand-by Arrangement (SBA) facility from the International Monetary Fund (IMF) does not seem to exist anymore. He further argues that these funds cannot be used for development purposes, and drawing from this facility will merely increase the foreign indebtedness of the country.
|Response to Dr T.L. Gunaruwan's views on SBA
Two retired Central Bankers have responded to last week's article by economist Dr T.L. Gunaruwan where he argues the case for ending the Stand-by Arrangement with the IMF. Their responses are on this page.
Of course, if the country’s foreign exchange position is strong enough, as Dr. Gunaruwan pointed out, it is not necessary to rely on the IMF to get a short-term balance of payments loan such as the SBA. So, I do not have any quarrel with that premise. But the fundamental questions that I would like to raise here are – (a) How did the country manage to build up this amount of foreign reserves? (b) Can we sustain this reserve growth momentum in the medium or long run? In other words, can we blow our own trumpet, and boast about our achievements with regard to the reserve buildup, and ridicule a loan facility offered by the IMF or some other agency?
Reserve buildup: Result of low imports and high remittances
In an article published in Business Times of 28 February 2010, I clearly explained that the improvement in the country’s foreign exchange reserve stock in 2009 was not due to any positive development in the domestic economy, but it was solely a result of a downward trend in imports coupled with a surge of worker remittances, particularly from the Sri Lankan workers employed in the Middle East. A large inflow of worker remittances amounting to over $ 3 billion in 2009 has greatly helped the country to almost double the gross foreign assets to $ 7 billion by the end of 2009 from a mere $ 3.2 billion in the previous year. This is a welcome development, but we should note that it is purely an external outcome rather than an upshot of domestic economic performance. More importantly, as a nation, we are indebted to these workers, who undergo tremendous hardships abroad sacrificing their family life, for bringing in so much foreign exchange without much incentive from the government.
Dismal foreign trade situation
Ironically, the foreign reserves went up in the backdrop of a dismal performance of foreign trade activities (please see the chart). Export earnings declined by 15 % in 2009. The setback was felt in all export categories – industrial, agricultural and mineral. Imports fell down at a much faster rate of 32 % last year. As in the case of exports, the import downfall too was experienced in all categories – consumer goods, intermediate goods and investment goods. The declining imports of the last two categories, of course, are a reflection of the economic and business setback.
The decrease in imports helped to halve the trade deficit to -$3.1 billion in 2009 from - $6 billion in the previous year. The inward remittance inflow ($ 3 billion) was almost sufficient to finance the trade deficit (- $3.1 billion) thus, leaving a smal current account deficit of -$214 million in 2009, as against a bigger deficit of -$3.9 billion in 2008.
This meant that the country did not have to use its foreign borrowing last year to meet her foreign exchange deficit in the current account, as in the previous years. The entire proceeds of the foreign borrowings taken last year thus, added-on to the country’s foreign reserves. This is how the foreign reserves were built up last year. If not for worker remittances, the current account deficit would have been over -$3 billion, and, the foreign borrowings would have been entirely used to bridge this gap. As a result, the foreign reserves would have been much less. The above facts clearly show the fragile nature of Sri Lanka’s foreign exchange position.
In July 2009 the IMF agreed to provide an SBA facility amounting to $ 2.6 billion to Sri Lanka in several tranches. The major objectives of this program were to strengthen the country’s fiscal position while ensuring the availability of resources for the much needed post-conflict reconstruction and relief efforts. The program was also intended to rebuild international reserves and strengthen Sri Lanka’s domestic financial system, and to protect the most vulnerable groups of the population from the burden of economic adjustments. The program also aims to lay a strong macroeconomic foundation to facilitate broader participation of international community in post-conflict reconstruction.
The SBAs are designed to help the member countries of the IMF to deal with short-term balance of payments problems. The length of a SBA is typically 12–24 months, and repayment is due within 3¼ to 5 years of disbursement. As usual, the present SBA has been tied up with certain programme targets agreed upon by the Sri Lankan authorities with the IMF. The disbursements of the loan facility are made conditional on achieving these targets (‘conditionality’).
Accordingly, it was expected to gradually reduce the government budget deficit/GDP ratio from 7.7 % in 2008 to 7 % in 2009, to 6 % in 2010, and to 5 % in 2011. However, the current indications are that the actual budget deficit for 2009 has far exceeded the program targets, and the budget 2010 will be delayed till next October. Under the SBA programme, the government was to also take certain steps to ensure reducing the deficits of the Ceylon Petroleum Corporation and Ceylon Electricity Board, and to reach a balanced budget for these enterprises by 2011. Reconstruction spending for the conflict-affected areas is to be balanced against the need to preserve debt sustainability. The program also envisaged to improve export competitiveness and external viability. It also included conditions relating to monetary policy and financial sector reforms.
From a nationalistic point of view one may visualize these SBA conditions as some kind of a threat to the country’s sovereignty.
This is where the question of ownership of an adjustment program arises. Over the years the IMF usually assigns the ownership of such a program to the authorities of the country concerned. It is left to the authorities, who themselves own the program, to go ahead with the agreed program or to abandon it. The same principle can be applied to the current SBA as well. In fact, the SBA has the flexibility which allows the recipient country to decide not to draw upon approved amounts immediately, but retain the option to do so if conditions deteriorate at a later stage.
Pro-government flattering and the silent economic profession
We need to carefully look at the repercussions of abandoning the SBA, as suggested by Dr. Gunaruwan. First and foremost, as he pointed out “the only benefit that Sri Lanka could possibly derive through this facility at present seems to be the so-called international investor confidence”. Of course, I do not think that it is the “only benefit”, but I agree with him that the SBA contributes to build up investor confidence. SBA gives an indirect assurance to investors – both local and foreign – that the right policies are in place. Apart from this benefit, there are other advantages as well.
Particularly, the program helps us to do our own housekeeping which is much needed to achieve financial and economic stability so as to facilitate the growth process.
For example, it compels the government to adhere to fiscal discipline. As we know, fiscal deficits not only lead to inflationary financing, but also pre-empt resources from the private sector. In this regard, I agree with last week’s Business Times Editorial which emphasized the need to pursue fiscal discipline. Restructuring of public enterprises and financial institutions is also essential for macroeconomic stability. These reforms are imperative with or without the SBA to shift the economy to a higher growth trajectory. Continuation of the SBA may not be important at this juncture, given the superficial increase in foreign reserves. But what is important is to revive the economic reforms to pave the growth path.
These are the bitter realities based on well-tested economic principles, and we have to face them sooner or later. It is rather unfortunate that the economic pundits who advise the politicians and policy makers knowingly or unknowingly hide these underlying hard facts, and attempt to paint rosy pictures of the economy. By such actions, they not only try to mislead the general public but also their own political masters.
These pro-government flattery reigns supremely in the absence of logical and objective counter-arguments from the economic profession or from the opposition political parties. Eventually, the much needed economic policy reforms are delayed or not implemented at all. This is exactly what happened in the recent decades. The victim of all these ill-advice is the country’s economic growth which is the ultimate determinant of the living standards of the people.