Columns - The Sunday Times Economic Analysis

The IMF dilemma: To give or not to give

By the Economist

American President Harry Truman once called upon several eminent economists to advise him on the economic problems of the country. They all said that, on the one hand, if you did this it would have this effect but on the other hand, if you did the alternative it would have this effect. Each and every economist he asked for advice said that, on the one hand it would do this and on the other hand, it would do something else. Ultimately, the exasperated President remarked: “Why can’t I find an economist with one hand!!”

The statement of the IMF on February 25 was a classic example of this type of ambiguous stance. The objective of the mission was to judge whether Sri Lanka had complied with the IMF’s conditions for releasing the third tranche of the IMF stand-by facility. The conditions that applied were several but the most important and difficult one was the containment of the fiscal deficit to 7 percent of GDP.

There was considerable scepticism that the fiscal deficit could be contained to anything like the required 7 percent of GDP owing to the extravagant spending of the government as part of the pre-election strategy. Besides this, revenue was continuously falling below expectations. However official pronouncements gave the impression that the deficit would be contained. Economists outside officialdom maintained that the deficit would be as much as 9 to 10 percent. It turns out to be about 9.75 percent of GDP, much above the required level for conforming to the IMF condition.

The IMF found that the Sri Lankan economy was like the proverbial curate’s egg. Good in some parts and bad in others. The good they saw was that, “Overall economic conditions are improving as expected, and the economy is poised for a recovery this year. External balances are strong, remittance inflows continue at a high rate, tourism prospects are rapidly improving, and gross reserves remain at comfortable levels.” And “For end-December, the government has met the targets agreed under the programme for net international reserves and reserve money.”

On the other hand: “ Final data for the overall budget balance are not yet available, but the ceiling on domestic budget borrowing—consistent with the government’s overall deficit target of 7 percent of GDP—was exceeded by a substantial amount.” This key condition of containing the fiscal deficit has been exceeded. But then, on the one hand, “This mainly reflects faster-than-expected infrastructure project implementation, higher interest payments, and sluggish fourth-quarter revenue growth. We are currently assessing the implications of this outturn for bringing the underlying budget deficit to a sustainable level.”

And the IMF points out that on the other hand, “Despite this higher borrowing, as well as a recent up-tick in year-on-year headline inflation, we continue to assess the central bank’s monetary policy stance as appropriate. With bank lending only slowly beginning to rebound, and economic growth remaining below its potential, we see little sign of emerging demand-driven inflationary pressures.” So there is a bouquet for the Central Bank.

“The Central Bank has acted appropriately through its monetary operations by not allowing higher budget spending to be financed through the creation of additional liquidity. The upward trend in inflation in recent months—reflecting the temporary effects of increases in food and other international commodity prices from low levels in 2009—is in line with our expectations and should peak somewhere mid-year before reversing itself in the second half of 2010. This phenomenon is not unique to Sri Lanka and is currently taking place in many other countries as well. Overall, we expect average inflation for the year as a whole to stabilize in the high single digits.”

On the one hand, the government has failed to keep to the targets but on the other hand progress on the economy is quite good and there are extenuating circumstances why the conditions have not been met. Then why not grant the third tranche owing to the good performance that the IMF has noted and the prospects they see in economic growth in 2010 and beyond? The IMF is only too aware that the reserves have been built up by international borrowing and the debt servicing costs are way too high. They know only too well that there has been considerable waste in public spending and a lack of prioritization. They also know that the fiscal deficit this year too will exceed 7 percent of GDP despite the tongue in cheek praise. The costly infrastructure expense for rebuilding the North and East are purposely excluded in the agreement. Therefore that is not an excuse for not complying with the IMF condition.

Then why is the IMF not willing to pull out. Probably the most important reason is that it would like to remain and have some influence on Sri Lankan policy. Western powers that are the most influential on the IMF Board would see a pull-out as another setback to their influence on Sri Lanka. The IMF itself having returned to the country after many years would not find such a withdrawal a good commentary on its work. Therefore it would like to find whatever excuses to save its own image and remain in Sri Lanka.

The government, on the other hand, appears to be hardly concerned about the IMF’s conditions that the IMF likes to call “conditionalities”. The government prided itself in being no beggar even when the country was in a serious financial crisis early last year. Now the attitude is, ‘Give if you want, but we can manage without you as we have a high level of reserves of US$ 5 billion and we have friends who would support us’. If however the IMF withdraws its stand-by arrangement, it would indeed be a disaster as there would be an erosion of international confidence in the Sri Lankan economy. The consequent international repercussions could be serious to the economy.

The withdrawal of the IMF would mean there would be a lack of confidence in the economy. Such a reduction of confidence would reduce the country’s credit ratings; foreign investments would decrease and the reserve position would decline. Once again we will be in the same plight as we were around March last year. Conforming to the IMF conditions are in any case good for the country as they are sensible and rational economic stabilization measures that would be a good foundation for rapid economic growth. We can only hope that sanity would prevail and good economic practices would be put in place with the next budget and the suspended IMF facility would be restored.

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