By Namini Wijedasa
A senior economist has warned that the Central Bank’s reactive, defensive and combative role in “talking up the economy” has eroded the credibility of the institution.
In a presentation at the World Bank headquarters in Washington DC last week, Muttukrishna Sarvananthan maintained that the “permissive culture of denial and falsehood by the Central Bank” was a “moral hazard”. For instance, whenever institutions like Standard & Poor’s or Fitch revised the country’s credit ratings downwardly, the regulator immediately issued a press release disputing their assessments.
“No IMF bailout” – Central Bank
Sarvananthan cited other examples of the Central Bank’s “culture of denial”. On 19 January 2009, the regulator issued a press release refuting reports that Sri Lanka will have to seek an IMF bailout package. In it, the regulator shot down claims by economists that the current reserves position was similar to that which prevailed during the controlled economy in 1976. The statement claims that current levels of gross official reserves were well above those that prevailed before 1977 and even above levels at the end of 2004.
Revealing four steps that had been taken to increase reserves, the statement adds significantly that: “The Central Bank is confident that above measures will help build up official reserves to a substantial level and therefore the claims made by certain persons that there would be a significant devaluation or that Sri Lanka will soon apply for an IMF bailout are erroneous and misleading”.
But on 4 March 2009 — six short weeks later — the Central Bank issued another press release confessing that Sri Lanka had started negotiations with IMF for a standby loan of US$ 1,900 million.
Even this communiqu‚ is misleading, Sarvananthan states. “The Central Bank attempts to justify seeking an unprecedented huge quantum of external assistance saying they need money for urgent ‘…resettlement, rehabilitation and reconstruction work in the Northern province, and the continued rapid development of the Eastern Province’,” he asserts. “The fact is, any financial assistance from the IMF does not enter the national budget and, therefore, cannot be used for the said purposes.”
“This is yet another attempt by the Central Bank of Sri Lanka to mislead the general public,” he continued. “Such falsehoods have been the norm of the Central Bank in recent years.” The regulator issued sovereign bonds worth US$ 500 million in October 2007, claiming the government would use this to finance infrastructure projects in the South. The government later publicly admitted that a bulk of that money was used to retire their short-term borrowings. Commenting on declining foreign reserves, Sarvananthan says there has been a galloping trade deficit of almost US$ 6 billion at the end of 2008. Foreign exchange reserves have been drained mainly due to oil and food price increases in the international markets during the first quarters of 2008. He also blames Central Bank interventions in the foreign exchange market to prop up the rupee, forestalling depreciation. The government has withdrawn foreign investments in government securities and other short-term portfolio investments since October 2008.
Meanwhile, garments exports have been declining since last quarter of 2008 as a consequence of recessions in two major export markets — the US and UK. There has been a dramatic drop in tea prices since the last quarter of 2008, from US$ 3 per kilogram to less than US$ 2 per kilogram.
Sarvananthan says that domestic sector fragility remains. Not only have economic reforms been stalled, there has been a rolling back of reforms undertaken by previous regimes — for example, a re-nationalisation of the Sri Lanka Transport Board (SLTB), SriLankan Airlines and the Thulhiriya Textiles Mills. There has been wasteful expenditure on projects like Mihin Lanka and the Weerawila international airport; on efforts like the resurrection of the bankrupt Pramuka Bank into a state-owned savings bank; and on things like the jumbo cabinet and the fertiliser subsidy. On the positive side, however, state subsidies on wheat and fuel were removed in 2007 and 2008 respectively.
The privatization or reform of the Sri Lanka Administrative Service, Ceylon Electricity Board (CEB), Department of Railways, Ceylon Petroleum Corporation and Sri Lanka Transport Board are long overdue, Sarvananthan emphasizes. (A bill to restructure the CEB was recently passed in parliament but the details are yet to be fully explained to the public). But Sarvananthan appreciates that work on the Norochcholai coal power plant — put off by successive governments since 1979 — is underway.
Separately, there has been a resurgence of economic nationalism after 30 years of liberalization and reform. For instance, on 17 March 2009, President Mahinda Rajapaksa said: “We will not pawn or sell our motherland to obtain monetary aid….Neither will we bow down to any conditions or transform our land to a colony….” He was referring to ongoing negotiations for standby credit with the IMF. In spite of economic fragilities, vulnerabilities and turbulence, however, “there has been hardly any public unrest due to unrelenting battlefield successes resulting in feel-goodness,” Sarvananthan says. This was demonstrated through resounding victories in five consecutive provincial council elections between May 2008 and February 2009, he notes, calling this the “political war dividend”.
“Thus, psychological feel-goodness has triumphed over economic rationalism and prudence among the politicians, policy makers and, above all, the masses, including businesses,” the economist observes. Consequently, he predicts, the current economic turbulence is unlikely to develop into the type of economic crisis experienced in 2001.
Sarvananthan emphasizes there are challenges as well as opportunities in the political war dividend. “After all,” he asserts, “Sri Lanka is not under a military dictatorship as in Sudan, or Pakistan (until recently) nor is it Zimbabwe”. He stresses that national policy makers should use growing popular support to the government to inculcate “economic rationalism or economic prudence”. He encourages the government to undertake long overdue economic restructuring and reform.
“This is a golden opportunity that should not be missed,” he concludes. “It is up to the politicians, their advisers and policy makers to make the strategic choice.
Policy advice is free, but policy choice is pricey
Sri Lanka has sought IMF funds only five times since 1983. Three of these loans were solicited in times of great economic distress: in 1991; in April 2001 when standby credit of US$ 253 million and an additional US$ 250 million Poverty Reduction and Growth Facility (PRGF) was approved; and in March 2009, when Sri Lanka has sought IMF assistance to the tune of US$ 1.9 billion.
According to the Central Bank’s own figures, the money sought by Mahinda Rajapaksa’s government is 300 per cent of Sri Lanka’s current IMF quota. It is largest loan ever to be solicited from the IMF by Sri Lanka. Negotiations are ongoing and expected to be concluded by the end of March.
The other times Sri Lanka requested IMF funds were in 1987 and 2003, when the economy was performing relatively better. The IMF was shown the door in 2006 after the installation of Ajith Nivard Cabraal as governor. [courtesy: LakbimaNews]
