Tag Archive for: debt

Sri Lanka’s hard road to recovery

In 2022, Sri Lanka faced its deepest ever economic and political crisis. The country’s descent into chaos accelerated from March, sweeping away high-level bureaucrats and political leaders held culpable for implementing the misguided economic policies at the heart of the country’s problems. The political casualties failed to allay public disaffection with prolonged power outages, queues and shortages of essential commodities.

The primary target of public unrest was Sri Lanka’s elected president, Gotabaya Rajapaksa. His ouster in July was achieved amid outbreaks of violence and the occupation of key government buildings by protesters. For a while, there were real concerns that Sri Lanka would descend into a state of anarchy. The fact that it was averted—with a transfer of power to a new president elected by a majority of votes in parliament—speaks not only to the country’s tradition of democracy but also of a desire to avoid repeating past experience of violent upheavals.

The parliament’s appointment of Ranil Wickremasinghe as Sri Lanka’s eighth president was not without controversy. Wickremasinghe, the nominated candidate of the departing Rajapaksas, and his party had also been roundly defeated at the parliamentary polls in August 2020. Yet he was still seen as the safest pair of hands to carry Sri Lanka through what promises to be its toughest economic setback since independence. Complex negotiations with creditors on debt restructuring following a sovereign foreign debt default in April, and an International Monetary Fund bailout program, demanded a sound grasp of global economic forces and geopolitical relations. As a seasoned politician who has held the post of prime minister on numerous occasions, the new president would be in familiar territory.

Wickremasinghe lacks an assured parliamentary majority to carry through painful reforms—as well as the legitimacy of having been elected by the people to do so. These could prove serious drawbacks as Sri Lanka struggles to regain its footing in 2023 and beyond.

A cost-of-living squeeze—that placed Sri Lanka in the top five countries with the highest food-price inflation for much of 2022—tipped many vulnerable Sri Lankans into poverty. Poverty is set to swell, even as job and income losses signal the country’s plunge into a prolonged recession. GDP for 2022 is expected to contract by close to 9% and the latest estimates suggest that the economy will contract by around 4% in 2023.

With few policy choices, Sri Lanka is banking on an IMF bailout to facilitate access to bilateral and multilateral financial support to get the economy back on track. The IMF’s four-year, US$2.9 billion program provides limited provision of liquidity. What matters is its ability to give other official lenders, private investors and creditors confidence in coming to the party. But the standard IMF policy prescription that demands stringent financial discipline means that adjustment costs will be front-loaded, preventing the government from spending its way out of recession. Accordingly, taxes are being hiked and expenditure is being cut.

Even at the best of times—with a strong and stable government at the start of an electoral cycle—this kind of reform agenda is politically fraught. An economic crisis can sometimes be the catalyst for a major economic overhaul, but in the absence of political stability the downside risks are significant. Governments have far fewer resources in hand to compensate those who are bound to lose out from reforms. The loss of faith in political leaders and institutions, with the Sri Lankan public having clearly demonstrated its readiness to punish those who have failed to deliver, amplifies the perils.

The best hope for Sri Lanka is a swift conclusion to the debt-restructuring negotiations. The evidence is sobering in today’s complex creditor landscape. For Sri Lanka, having China, India and Japan as its largest bilateral creditors alongside primarily US-based private bond holders adds a layer of complexity in working out a treatment that is comparable and acceptable to all. China has been unwilling so far to take a cut in principal repayments, preferring to refinance payments with fresh loans. Sri Lanka will have to call on all its diplomatic skills to persuade creditors to arrive at a mutually agreeable formula.

Even if everything goes according to plan, it will be another two or three years before the Sri Lankan public feels any real improvement in economic conditions. The erosion of real wages and the introduction of higher taxes are squeezing disposable incomes, prompting many to leave and seek better living standards overseas.

With Sri Lanka’s economic progress set back by years by the debt crisis, the government can only hope that people will have enough patience to wait until painful austerity-inducing reforms start to work. With all the uncertainties, this year will be crucial for Sri Lanka as it gears up for the all-important presidential elections in 2024. Meanwhile, containing public disaffection amid calls for early elections—while ensuring that political uncertainty does not delay economic decision-making—is set to test the skills of even the most hardened and experienced political leader.

Radical action needed to stop economic collapse in Sri Lanka

The war in Ukraine has generated an economic tidal wave which is crashing over countries near and far. Among the more far-flung is Sri Lanka, half a world away from the battlefield, where surging food and fuel prices have supercharged a downward spiral that was already underway. Now, the island is being rocked by street protests, and every member of the cabinet—except Prime Minister Mahinda Rajapaksa, the brother of President Gotabaya Rajapaksa—has resigned. To save Sri Lanka from economic collapse and sociopolitical disaster will require radical action.

No credible discussions on a viable strategy to meet the deepening crisis are taking place. So, while escalating protests may bring about a change of government, it’s far from certain that this would lead to improved social or political conditions. Whoever’s in charge, the imperative remains the same: Sri Lanka must address the grave economic crisis it faces, beginning by putting its public finances in order.

There is no time to lose. Finance Minister Ali Sabry, who has been on the job barely a month, says that the country’s foreign-exchange reserves now stand at less than US$50 million. With around US$7 billion of the country’s US$51 billion in external debts due this year, a debt moratorium has been put in place. And the US$600 million the World Bank has given to provide for essential food imports won’t be nearly enough to stop the financial bleeding.

With public coffers all but empty, balance-of-payments pressures mounting and a massive debt overhang looming, the first priority should be a plan to address Sri Lanka’s dire fiscal position, including an effective implementation mechanism. Such a plan must include all the standard consolidation measures, such as eliminating waste and tightening budget management. But, with confidence in public finances depleted and the rupee’s value plummeting, Sri Lanka must also take the more radical step of installing a currency board.

Under such a system, the exchange rate would be set by law, and the central bank would have to be able to cover the entire monetary base with foreign-exchange reserves. By stripping the government of its discretionary power to run big deficits, a currency board would restore credibility to Sri Lanka’s finances relatively quickly. Once established, the board would provide the necessary solutions to Sri Lanka’s economic problems, with a particular focus on stemming the rupee’s decline.

Yes, a currency board is a form of shock therapy. But that is what Sri Lanka’s current crisis demands. And, in fact, because it can be installed immediately, and requires no immediate reforms affecting public budgets, state assets or trade, a currency board amounts to faster-acting and more effective medicine than the long dose of austerity that is often proposed.

The record speaks for itself. The most widely acclaimed modern currency board was established in Hong Kong in 1983. But examples of successful currency boards abound. In fact, in the more than 50 countries where currency boards have been installed, they have always succeeded at restoring confidence in public finances and the national currency.

In 1992, Estonia established its currency board in record time—just 30 days—to support the transition from the Russian rouble to the new kroon after independence. Its success inspired Lithuania, another former Soviet state, to establish a currency board in 1994. Lithuania—a country that I represent in Sri Lanka as an honorary consul—has been praised by the International Monetary Fund for its economic transformation, in which the currency board played a central role.

In Bulgaria, a currency board stopped a bout of hyperinflation in its tracks in 1997. The country quickly turned its fiscal deficit into a surplus and tripled its foreign-exchange reserves. Today, it boasts among the lowest debt-to-GDP ratios in the European Union.

Critics argue that currency boards are suitable only for small countries, and that a weak banking system will reduce its impact. But none of this would preclude a currency board in Sri Lanka. We are an island of 23 million people, and there are no weak banks now in operation in our country.

Former prime minister Ranil Wickremesinghe, with whom I have discussed this proposal, believes that a version of a currency board should be incorporated within the central bank, rather than as an independent entity. But the Central Bank of Sri Lanka’s problematic past performance, including its history of politicisation, makes this suggestion a non-starter, despite the increased credibility and international goodwill brought by its new governor, P. Nandalal Weerasinghe. In any case, a currency board is a very different creature from a central bank, because of its strictly limited functions.

Upended by crisis, Sri Lanka must finally face its financial demons head-on. It will be a difficult fight. But a currency board—which strips the government and the central bank of the opportunity to mismanage the budget and the exchange rate, thereby restoring the credibility of our economic governance—vastly improves Sri Lanka’s chances of winning.

Developing countries face triple threat that could tip the world into recession

Through no fault of their own, developing countries face a perfect storm of famine, political upheaval and debt crises. Russia’s invasion of Ukraine and the Western-led sanctions it triggered are partly to blame, as are Covid-19 lockdowns in advanced economies, which deprived poor countries of vital tourism and export revenue.

Millions of lives are now at risk, but mitigation is possible. It should start at this month’s spring meetings of the International Monetary Fund and the World Bank.

Policymakers have much to address—starting with spiralling food prices. The Russia–Ukraine conflict, involving countries that between them supply 29% of the world’s wheat, has contributed to a 67% increase in wheat prices since the beginning of this year. Export bans imposed by other wheat producers are also fuelling price increases, as is a fertiliser shortage because of reduced supplies from Belarus and Russia.

Unsurprisingly, famine is spreading. The first countries to be hit are those that were in desperate straits prior to Russia’s invasion, including Afghanistan, the Democratic Republic of the Congo, Ethiopia, Nigeria, Pakistan, Sudan, South Sudan, Syria, Venezuela and Yemen. Rapidly joining them are countries that rely on imported grain and were already facing acute food insecurity, such as Burundi, Djibouti, El Salvador, Eswatini, Guatemala, Honduras, Lebanon, Lesotho, Madagascar, Mozambique and Namibia.

United Nations World Food Programme Executive Director David Beasley recently issued a stark warning: ‘If you think we’ve got hell on earth now, you just get ready. If we neglect northern Africa, northern Africa’s coming to Europe. If we neglect the Middle East, [the] Middle East is coming to Europe.’

Rising food prices and hunger will make riots and political upheaval more likely. Even before the Ukraine war began, people had been plunged into crisis in Afghanistan, Ethiopia, Myanmar, Somalia, Syrian refugee camps, Yemen and elsewhere. In March, large-scale protests erupted in countries including Cameroon, India, Pakistan, Spain and Sri Lanka.

Governments that can take preventive action are already doing so. Egypt, for example, which imports around 80% of its wheat from Russia and Ukraine, recently introduced a price cap to counter the soaring cost of unsubsidised bread (the government already subsidises bread for most of the population). The government also announced an economic aid package totalling 130 million Egyptian pounds (US$7 million). These measures were made possible by assistance from the IMF and Saudi Arabia. But many countries have yet to receive such help.

Failure to cooperate is driving famine and conflict. Astonishingly, global stocks of rice, wheat and maize, the world’s three major staples, are apparently at historic highs. Even stocks of wheat, the commodity most affected by the Ukraine war, are ‘well above levels during the 2007–2008 food price crisis’, while estimates suggest that about three-quarters of Russian and Ukrainian wheat exports had already been delivered before the invasion.

A serious debt crisis is also developing as many low-income countries, stretched to their limit by Covid-19, are hit by higher food and fuel prices, lower tourism revenues, reduced access to international capital markets, trade and supply-chain disruptions, depressed remittances and a historic surge in refugee flows. Developing-country debt has soared to a 50-year high, at about 250% of government revenues. Around 60% of countries that were eligible for the pandemic-related G20 debt service suspension initiative are experiencing or at high risk of debt distress.

Moreover, slower global growth and rising inflation, together with tighter financial conditions in richer countries, are spurring capital outflows from developing economies, forcing them to devalue their currencies and increase interest rates. As World Bank President David Malpass recently noted, ‘Never have so many countries experienced a recession at once.’ Malpass added that advanced economies’ stimulus policies have helped to make matters worse by fuelling price rises and increasing inequality around the world.

Finding a genuinely global solution to these problems is now vital. In past debt crises, rich countries used the IMF and World Bank to push the adjustment burden onto developing economies, arguing that they must undertake reforms before receiving assistance. But the most potent forces buffeting indebted low-income economies today are global and beyond their control—and IMF and World Bank member countries must pool resources and cooperate to address them.

The good news is that powerful shareholders in these institutions have proven capable of collective action. Last August, for example, they agreed to a new US$650 billion allocation of special drawing rights (the IMF’s reserve asset).

But, because special drawing rights are distributed according to countries’ IMF quotas, most of the allocation went to the largest economies. Worse still, major IMF and World Bank shareholders have failed to channel resources to where they are most needed. Instead, to limit their possible exposure to any losses, they keep insisting on conditions that prevent rapid deployment. This approach also threatens to hinder the IMF’s new Resilience and Sustainability Trust and the World Bank Group’s emergency financing.

A far bolder collective approach is now required. The United States, China, Japan, the European Union and the United Kingdom depend on global security and prosperity. They must work together to prevent famine, conflict and a developing-country debt crisis that will tip the world into recession. They can prevent famine by acting in concert to calm global wheat and other grain markets and to take measures to keep exports flowing. They can reduce the risk of conflict by not hobbling emergency IMF and World Bank assistance with conditionality. And they can build on the G20 debt initiative by creating a debt-restructuring mechanism in which they all participate.

Two core elements are crucial to managing today’s developing-country crisis. Powerful countries must refrain from beggar-thy-neighbour trade, fiscal and monetary policies that wreak havoc on developing economies. And they must use their combined resources in the IMF and the World Bank to act quickly and unconditionally to avert disaster.

The challenges facing poorer countries are unprecedented. And that means the cooperative response from richer economies must be, too.

China’s ‘wolf warriors’ spring from internal problems

In Australia, as in many other countries today, two self-isolating clusters of influencers have emerged that seek to steer dealings with the People’s Republic of China.

The two groups rarely intersect except to voice mutual suspicion. Neither deploys sufficient time or effort to understand what’s happening deep within the PRC itself—the principal driver of events and of the surrounding heightened rhetoric.

They focus instead on how the PRC’s impact washes up on our shores. They play in the shallows.

One group has belatedly become so anxious about the PRC’s ambitions for Australia that it believes we can and should decouple from China in all spheres. But today’s turmoil cannot simply be rebadged as a new Cold War. The PRC is globally enmeshed, utterly unlike the Soviet Union of old.

This is a comparatively tiny group.

The second is the bulging circle comprising the elites whose broad backing the PRC has successfully enlisted—chiefly in state and local governments, and among university administrations and corporate leaders.

The members of this second group commonly recapitulate the key talking points of the party-state, as if they’ve privately uncovered rare truths:

  • To criticise the PRC is to be racist, or to dog-whistle to racists.
  • The PRC and the communist party that’s run it for 70 years cannot and must not be separated out from China and the Chinese people whom it rules.
  • Even mild questioning of party-state strategies amounts to ‘vilification’.
  • The rise of the PRC to global dominance, especially economically, is inexorable.
  • To criticise the PRC is tantamount to fawning on the US and endorsing President Donald Trump unquestioningly.
  • Chinese people all align with the party’s tightly scripted version of the country’s history that dwells on its suffering, uniquely, a ‘century of humiliation’ visited on it by foreigners, thus requiring foreigners today scrupulously to avoid appearing to revisit that century.
  • Taiwan must be viewed as a province of China, whose ‘return’ is inevitable.
  • China can only be governed effectively by a firm central autocratic ruler; democracy would be disastrous.
  • Most importantly, do not discuss or question the conduct of the party or its leaders within China, despite the massive churning of the political and security structures and of key personnel driven by the restless, risk-taking Xi Jinping.

Chinese diplomats are succeeding in having these talking points amplified by those whom they have over the years courted, including by offering preferential access to and in the PRC.

The success of this strategy relies overwhelmingly on China’s continuing capacity to weaponise its economic growth.

It will remain an important economic force. But the settings are changing, as testified by Premier Li Keqiang’s abbreviated annual ‘work report’ to the National People’s Congress on 22 May. It set no growth target, instead stressing stability.

That’s understandable as China attempts to resurrect a coherent economic strategy following first Trump’s trade war, then Covid-19. As the bottom line, China will battle, as Li said, to staunch unemployment, whose impact is already leaking alarmingly into the countryside, now bereft of much of its income as migrant factory workers lose their jobs.

These challenges have come at a peculiarly bad time—just as China was attempting to retool its economic fulcrum towards domestic consumption and away from exports and infrastructure spending. As a result of the latter—intensified following the global financial crisis—total debt had built by the start of 2019 to US$40 trillion, 304% of GDP and 15% of global debt, and each yuan spent has resulted in dwindling productivity.

But Beijing has now committed ¥3.75 trillion to back new local government special-purpose bonds, the chief source of finance for infrastructure. That’s good news for Australian iron ore, coal and nickel producers; it buys a lot of steel, even though it also ensures that the debt burden keeps building.

Xi, like Trump, is also championing self-reliance, especially in technology. But it needs, for now, the support of global tech to achieve this, yet those firms have begun disinvesting from China for a range of reasons, including production costs.

Outward investment will continue, but at an even lower level. It simply can’t be a priority. Australia has naturally experienced this decline. It’s part of a broader trend that’s being felt all over, especially in developed economies.

After capital controls were toughened, China’s direct investment overseas fell in 2017 by 53%. The announced value of Chinese overseas mergers and acquisitions fell 31% last year, and Britain replaced China as one of the top three investors in Germany.

Further pressure is being placed on China’s financial system by Xi’s hallmark Belt and Road Initiative. The program is built on hundreds of billions of dollars of loans, chiefly coordinated through the Chinese Development Bank and China Exim Bank. Now, the borrowing countries are suffering grimly from the Covid-19 economic lockdown and urgently pressing for restructuring, repayment holidays or simply forgiveness.

Conceding would cause economic—and possibly popular—trouble at home, while refusing to do so would risk shedding the global influence Beijing has so assiduously built up.

Xi has just been forced to concede to an investigation by the World Health Organization into the origins of the pandemic, though he tried to spin that it’s what he always wanted by throwing forward its timing.

But this hasn’t been a good year so far for him or for the PRC—although Premier Li Keqiang naturally put a brave gloss on these dilemmas at the opening of the National People’s Congress last week, declaring ‘decisive victory’ against the pandemic in Hubei province and ‘pivotal progress’ in the ‘three critical battles’ against poverty, pollution and the risk of a financial collapse.

However, the PRC cannot now achieve Xi’s ambitious goal of doubling the economy in the decade to the end of this year. That would require about 6% growth in 2020. And how will he now seek to celebrate the party’s centenary next year?

Both of those Australian China cohorts predicate their positions on Beijing’s continued surge in strength, while flagellating themselves about our getting too close, or too far, from their versions of China.

But Australia’s problems with Beijing result from the latter’s travails—and from the new directive for Team China to parade its wolf-warrior credentials—more than from what might be called the Canberra consensus.

This loose understanding of how best to relate to a changed China has won the support of a large majority of Australians. It encompasses most frontbenchers of both major parties, and many leaders in the defence, security and economic establishments.

It champions Australia’s important economic connections—one-third of exports and one-quarter of imports—and diverse people-to-people links with China, insofar as that is commensurate with safeguarding our core interests and values. Both have been put in play by Xi’s Make China Great Again program, which is tangling riskily with countries everywhere.