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Deloitte in Sri Lanka and Maldives appoint new leadership team
ECONOMYNEXT – The International Monetary Fund could have moved faster on Sri Lanka using existing policies as the small island struggled to get financing assurances from China and India, following a default, a former Fund official said.
Sri Lanka had borrowed substantial amounts of money from China and India and especially after the war from private creditors as a series of currency crises hit the island from activist monetary policy and cheap global credit amid quantitative easing.
Sri Lanka defaulted in April 2022 after the most aggressive deployment of ‘macro-economic policy’ in the central bank’s history involving rate cuts which were backed up by tax cuts to close what official economists said was a ‘persistent output gap’.
Sri Lanka struck a staff level agreement on September 01, 2022 with taxes hiked to boost revenues and promised to do other reforms. After a rate hike monetary stability was slowly returning and BOP turned into surplus in September.
However, the IMF’s board did not approve the first disbursement until March the following year until after China gave an assurance that it will comply with the IMF debt targets.
Power Imbalance
The IMF put the burden of getting the creditors together on Sri Lanka which had no leverage against large countries, Sharmini Coorey, a former IMF director who had worked in policy development among other areas who advised Sri Lanka’s President.
“Basically it was very hard to coral the debtors together,” Coorey told a forum organized by Oxford Global Society, a UK-based think tank.
“They were not talking to each other. We had China, we had India and the Paris Club. They were not talking to each other. I think the IMF should have got them together. But they asked Sri Lanka to get them together.
“We were writing letters begging the presidents and prime ministers of respective countries to provide the financing assurance,”
“My response was where was the IMF? It wasn’t till November-December that we even had a meeting. Because we were a little country. We have no leverage. I was quite upset that they seemed to think that this was Sri Lanka’s fault.”
Running Official Arrears
The IMF had tools like its Lending into Official Arrears (LIOA) policy where the Fund could disburse when loans from a laggard creditor fell below a threshold, while a country was making good faith efforts to negotiate.
China’s loans fell below the threshold, Coorey said.
“So China was not formally a block to using the LIOA policy as it is called,” she said.
“But the Board, it is not so much the staff so much, but the Board did not want to go ahead until they had some extra safeguards beyond the LIOA policy, to give Sri Lanka the approval of the program.”
“How do you assure a creditor that you are not going to pay one creditor selectively?
“You can promise that during the program period, but they wanted assurances beyond the program period, that could well involve another government, some future government, no democracy can promise that credibly.
“I think the Board has a conflict of interest here. In Sri Lanka’s case they could have gone ahead by using the lending into arrears policy.”
China was a new creditor and they were not coordinating with the Paris Club, who were used to working with the IMF. But China was also a top IMF shareholder, third in line with voting power behind the US and Japan.
It was a difficult political situation.
There are concerns about the power of China and that it could extract preferential terms from Sri Lanka.
“Having China as a big creditor is important in a certain way that is new,” Coorey said. “It is the power of China that they were concerned about. That China would extract preferential terms from Sri Lanka.
“But it was also a fact that China is an important shareholder of the Fund. So you are talking about the Fund going ahead without one of the major shareholders on board.
“I understand why there are these concerns, but these have to be worked out.”
There was some discussion that the IMF could go ahead and lend with a written down agreement with other creditors called the Most Favoured Creditor Clause, sources said at the time.
Similar procedures had been used to lend to Russia.
“…Sri Lanka will refrain from resuming debt service payments to any external commercial or bilateral creditor unless it agrees to a comprehensive debt treatment in line with the IMF program parameters, debt sustainability targets, and the comparability of treatment principle,” Sri Lanka said in its IMF program.
“We are willing to use additional safeguard mechanisms, including appropriate forms of contractual commitments such as Most Favored Creditor Clause, acceptable to relevant creditors at the time.”
Meanwhile, Coorrey said the IMF had been more proactive in bringing creditors together in some Latin American countries, she said.
It had also moved fast in East Asia, she said.
While sterilizing central banks in defaulting Latin American countries and Sri Lanka act in the same way and into trouble repeatedly when economies recover, including within IMF programs now, analysts say East Asia was different.
With exception of the Philippines and Indonesia the countries had very good pegged central banks which did not re-finance the domestic banking system but instead had issued sterilization securities and built reserves leading to stable pegs, which had served as a check on fiscal metrics.
Domestic assets of the Bank of Thailand – which was among the first to be targeted by hedge funds with currency swaps and failed to allow rates to rise in time – was negative before and after the crisis, and fiscal numbers were generally above average, including surplus budgets, as is usual in countries with tight monetary standards.
Bank Negara fixed itself without a formal IMF program.
Hong Kong and Singapore Monetary Authorities were not fixed policy rate central banks and therefore could not trigger forex shortages or deplete reserves for private imports or other outflows as in Sri Lanka and did not need the IMF in the first place.
Sri Lanka however has an activist central bank which uses open market operations aggressively to mis-target rates and had missed reserve targets within the last two IMF programs themselves, running up external debt as forex shortages emerged.
Central Banks in the West started to run balance of payments deficits in peacetime after the 1920s as a bureaucratically decided fixed policy rate, devised by the Fed spread to other countries.
Aggressive macro-economic policy in the 1960s led to the collapse of the Bretton Woods in 1971 and mass defaults in Latin America and Eastern Europe started about a decade later with steep depreciation, giving a new job for the IMF. (Colombo/Oct29/2023)
