Financial Times

Fallacy and the reality of IMF Standby Arrangement for Sri Lanka

By Manoj Akmeemana

The International Monetary Fund (IMF) has been in centre stage for decades for its policy stances and way of governance which has often aroused many debates and arguments amongst political economists, policy makers, member countries and intellectuals the world over. Even in Sri Lanka, the IMF has become a hot topic nowadays, especially among local politicians merely for the sake of political advantage and not on more objective aspects such as the IMF policy framework and importance of its financial assistance to governance.

Central Bank GovernorAjith Nivard Cabraal announcing the IMF loan facility.

Hence, it is imperative to understand the IMF’s policy framework and global economic outlook prior to expressing judgments or opinions and arriving at conclusions.

The funding base of the IMF is deposits from member countries. The governance of the IMF is through a Board of Directors which consists of 25 directors from member countries. Today, the membership of the IMF is represented by 186 countries. A member quota is dependent on the relative size of a member country’s economy to the world economy. A member quota in IMF determines the amount of its subscription, voting weight, access to IMF financing and allocation of Special Drawing Rights (SDR). However, the US has exclusive veto power, due to their contribution and initiative for funding.

IMF’s share of criticism

The IMF has had its share of criticism from its inception. Many argue that member quotas and voting powers are not democratic and do not represent global realities due to the dominance of the US and EU in the governing body. One could argue that if the value of contribution or investment is higher, then that person should have a comparatively higher ‘say’ or vote.. Even in business, the voting rights of a quoted company are dependent on the number of shares held by a person. However, despite these arguments the debate is on how to change the governing structure of the IMF to represent the new world realities.

Among the many political and economic criticisms on the IMF policy framework, the Marxist revolutionary icon Che Guevara once said that, “interest of the IMF represents the big international interest that seems to be established and concentrated in Wall Street”. A former Vice President and Chief Economist of the WB Joseph Eugene Stiglitz, argues in his book ‘Globalization and its Discontents’ that “by converting to a mere Monetarist approach, the fund (IMF) no longer had valid purpose, as it was designed to provide funds for countries to carry out Keynesian reflections, and the IMF was not participating in a conspiracy, but it was reflecting the interest and ideology of the Western Financial Community.”

The fire branded leftist leaders, President of Ecuador Rafael Correa and Venezuelan President Hugo Chavez announced that their countries would withdraw from the WB and IMF but to date, both countries remain as members of those institutions. The bitter reality is today no country can isolate itself from the world financial system and stand alone as idealistic independent financial systems.

New Global Imperatives and the IMF

The subprime crisis in the US financial markets spread across the US and the rest of the developed world as a major financial crisis during the third quarter of 2008, much like an epidemic, starting with the collapse of Lehman Brothers in September 2008 and spreading to several major financial institutions. The rest is history.

One by one, financial institutions to industrial, retail and consumer goods manufacturers in the US and other developed markets started to collapse while unemployment ratios shot to the highest levels in recent history. Developing nations and emerging markets that had built their economies through exports and imports with developed markets faced severe repercussions.

Being strong advocates of free markets and neo-liberal economics, these developed countries were compelled to hurriedly work out massive bailout packages to rescue the fallen banks and industries in their respective economies. It’s estimated that the bailout package for the US alone is a trillion dollars. With these bailouts, it is quite evident that radical changes in ownership structures of most of these companies happened overnight, having been converted from private to state ownership.

The governments of these large economies intervened by spending taxpayer money to rescue fallen companies as opposed to their popular neo-liberal idealism which they had for decades tried to force developing nations to adopt.

With these changes and repercussions, the optimistic forecasts that were given for several years on the future global economies were downgraded within a matter of months!

Under this scenario, the members of the G20 summit held in London in April 2009 agreed to boost global liquidity, an agreement that was welcomed by the International Financial and Monetary Committee. As such, the Board of Governors of the IMF had in August 2009 approved a general allocation of SDR equivalent to US$250 billion to provide liquidity to the global economic system by supplementary funding for member countries to strengthen foreign exchange reserves. It is this action that allows any member country to apply for a Stand-by Arrangement (STB) or Loan from the IMF.

Lankan Economy in the global context

The Sri Lankan economy during the last two decades developed at a comparatively far greater resilience power to withstand any internal or external shock. Sri Lankan economic fundamentals had been sound and showed improvements on several fronts despite the government’s determined efforts to annihilate terrorism with intensified military operations in the backdrop of many local and foreign challenges.
As Sri Lankans and as individuals who are not blinded with coloured politics, one should give due credit and recognition to the respective authorities for prudent monetary and fiscal policies that contributed, to an extent, to safeguarding the Sri Lankan financial system from the global financial crisis. Though many have often criticized the highly regulated financial regime of Sri Lanka, it is this very system that protected the nation from the global financial crisis.

However, during the fourth quarter of 2008, Sri Lanka’s external sector began to experience problems. Foreign investors who had to face the bitterness of the global crisis were forced to withdraw their investment in government securities. FDI’s and other forms of commercial funding for various projects started to drop.

Financing of commodities such as petroleum imports were difficult in the short term financial markets and contributed to eroding the reserves. Value erosion of assets due to sharp depreciation of international currencies against the US Dollar affected reserves. Fortunately, substantial reserve holdings up to the third quarter of 2008 had absorbed these negativities without infecting the economy at large.

To face the external negativities on Sri Lanka’s Balance of Payment (BOP), exchange rates and the economy, it is necessary to beef-up the reserve holdings of the country. As a member country of the IMF, it is an obvious and a prudent decision to obtain the STB under current conditions as it is cheaper and more sustainable. It is the undisputable right of any nation to obtain its funding entitlement from the IMF as Sri Lanka did in August 2009. Hence the IMF loan should improve the reserve holding and have a positive impact in enhancing the country’s economic stand whilst boosting investor confidence.
The IMF facility which Sri Lanka obtained and amounting to SDR1.65 billion (US$2.6 billion) in eight tranches are subject to quarterly reviews on economic performance up to the march 2011. The loan is repayable within a four year period starting from April 2012 onwards.

Considering the current rates of commercial loans available in the market, and/or any other bilateral loan agreement, the IMF loan interest rates offer a comparatively better deal for the country. Presently, commercial loans are available in the financial markets at LIBOR + some 100 to 500 basis points which would end up at about 5% to 5.5% p.a. In comparison, the IMF’s STB facility’s total pricing under two components is as follows:

1. The Rate Component

  • Service charge weekly based on the SDR rate (0.3% p.a.)
  • Margin of 1% p.a. on loan outstanding amount.

2. Surcharges

  • When the outstanding loan amount exceeds 300% of the quota, a surcharge of 2% p.a. will be added.
  • When the outstanding loan amount exceeds 300% of the quota for more than 3 years, 3% p.a. surcharge will be added.

IMF Conditions versus Principles of Good Economic Management

No prudent lender will give away its money to a borrower unless the borrower establishes the right practices and good governance to ensure repayment. Even for a small personal loan from a bank, a borrower would have to show income sources, level of expenses and a satisfactory past track record. Bankers would not fund speculative activities or give away facilities to persons with dubious characters. Similarly, the IMF too is concerned on good governance, responsible fiscal discipline and prudent monetary policies to ensure that the expected outcome of IMF loan could be obtained. The key objectives of Sri Lanka’s IMF standby facilities as stated in the Letter of Intent is to rebuild external reserves, strengthen the fiscal position, strengthen the domestic financial system and maintain monetary stability.
It is important to accumulate foreign reserves to a substantial level in order to face any BOP issues. All countries, especially the Central Banks focus on this area as a top priority. Managing the budget deficit is imperative for the proper economic development of a country. Unacceptable levels of higher budget deficits result in borrowing money from inflationary sources and increasing inflation whilst delivering negative implications for the standard of living of the people.

The Central Bank (CB) of Sri Lanka’s proactive stance to reduce the budget deficit to 5% of the GDP by 2010 is evident from the fiscal management report 2009, (published in November 2008). It should be noted that managing the budget deficit was made mandatory under the Fiscal Management Responsibility Act that had been in place since 2004. Hence managing the budget deficit cannot be considered as a “new condition” for Sri Lanka. One should therefore ask whether mere repetition of the government’s policy stance in this letter of intent is actually a ‘condition’ or simply an emphasis on the endorsement for good practice of governance already in place.

The present government’s central policy document is the “Mahinda Chinthana” which emphasizes that the government will not sell or privatize public enterprises as a deliberate policy. In line with the policy stance, the government has already abolished the Public Enterprises Reform Commission (PERC) which was established to facilitate the privatization process of public enterprises. However one should be aware that efficiency and the productivity level of government enterprises are yet to be enhanced. It is the government’s utmost duty to arrest resource drains in public institutions and protect the general public from paying for the inefficiencies of the state enterprises.

There are several ways to enhance the efficiency and resource drain of public enterprises without privatizing or selling-out. Public Private Partnerships (PPP) are a better approach to restructure loss making public enterprises to make them more efficient and reduce their dependency on the state treasury.

For analysts who closely monitor the Sri Lankan financial system, it is evident that the CB has always focused on reserve money or high power money to control the money supply. Reserve money acts as the raw material for monetary expansion, where the banking system uses it as a platform for increasing domestic credit which results in the increase of money supply. The CB has already announced, in its road map for 2009, the forecasted reserve money positions well before the IMF STB had been obtained. Therefore, can anyone interpret this prudent monetary management approach as a ‘condition’ or the re-emphasizing of the CB’s position in the very letter of intent of the IMF?

Reap what you sow…

The global financial meltdown and economic downturn have several implications on governments, donor agencies and individual businesses. Before the advent of this crisis, neo liberal economics was the mantra for success and development that many countries adopted and promoted through various world bodies. Everyone was hyped on privatization and reducing the government’s role as an economic partner through de-regulation and other processes and as a result, many international agencies such as the WB, IMF and the ADB advocated these ideologies. It was no surprise that many governments embraced these changes in their policy documents as well.

We in Sri Lanka had experienced the same situation previously and the policy document “Regaining Sri Lanka” was also a heatedly debated topic on the same subject. However today, such economic policies are being questioned by governments and analysts across the globe in the wake of the lessons learned from the financial crisis. Most developed nations are compelled to adopt a different course of policies contradictory to neo liberal policies. Talk of increased involvement of governments as economic partners and as regulators in the current macro conditions are to be expected in the forth coming years.
In this sense, one should give the due recognition to the Mahinda Chinthana for having identified these new policy frameworks well ahead of the global crisis whether by choice or by chance!

Unique opportunity to walk the talk

During the last few decades, the government and the private sector blamed terrorism as the major impediment for growth and development. The talk did not end there; many analysts even went to the extent of calculating the ‘lost opportunities’ for income due to the situation that prevailed in the country. Policy makers were worried about low economic contribution from the Northern and Eastern provinces which covered two thirds of the sea territory and how the uncertainty hampers the foreign and local business projects.

Now our valiant forces have totally annihilated terrorism and captured the few remaining terrorist leaders in faraway lands taking away the obstacles that people had been highlighting for over three decades. This is not the time to give priority for petty political squabbles or dig on each others past sins. This is not the time for debating on ideologies of various theories and philosophical utopias. As Sri Lankans we are savouring a unique moment in history. The world economic turmoil has given us breathing space to rethink and to creatively look through new perspectives at the world and our positioning in the global economy. We should remember that the economic problems faced by many nations are much greater than us in this global financial meltdown and economic downturn.

In such a context, Sri Lanka has the unique opportunity for greater development. Our earnest proposition is, for all to stand as true patriots of our country and embrace the opportunities in front of us as a nation, and take this country to the zenith of global economic development.

(The writer is a Senior Banker with 20 years of experience in Sri Lanka and overseas in retail banking. He also has specialized experience in corporate strategic planning and adopting the balanced scorecard as a performance management tool.)

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