By Yashovardhan Chaturvedi
In the wake of the COVID-19 pandemic, countries in the Global South have accrued debts to tackle the global economic downturn and humanitarian crises. With debts becoming unsustainable in regions like Africa and South Asia, the impending fears of defaults have led to such countries resorting to the help of the IMF for providing emergency assistance. However the conditionality of such assistance comes with the implementation of austerity measures which may only serve to exacerbate the cost of living crisis in such countries.
The pandemic brought about devastation of human lives not seen since the Spanish Flu of 1918. Alongside the severe loss of human lives, the subsequent economic glut experienced by economies across the world has made the crisis more aggravating. According to the estimates of IMF, the oncoming recession was expected to have a decline in real economic growth that was 30 times from the global financial crisis (GFC) of 2009. While it is argued that recovery was made in most countries to pre-pandemic levels in most countries by 2022, it required a strenuous effort on behalf of national governments to kickstart their domestic economies.
With businesses coming to a standstill, the creation of infrastructure to facilitate the economic recovery process required governments to take up huge expenditure. As the revenues also started to dry up during such a period, governments were required to raise funds through public debt. In fact, the global debt grew by a whopping $19 Trillion by 2021, with the International Monetary Fund (IMF) itself providing financial assistance of about $171 billion to 90 countries in the form of emergency loans. While certain developed nations were able to service their expenditures through counter-cyclical responses or by having access to bilateral credit swap lines with the Federal Reserve, the developing countries faced enormous difficulties in servicing their debt in presence of large interest payments and service fees. Disruption in the supply chain and subsequent energy crises as a result of the Russia-Ukraine War has also added to governments’ woes of tackling inflation and dwindling foreign exchange reserves. A report by the World Bank finds that about 58% of the world’s poorest countries are debt distressed, or run high risks of it. As such, in cases of default on payments of external debt, these countries would also be looking to IMF and other international financial institutions to provide the assistance for the same. This article will look into the experience of the Sri Lankan economy, and its history in navigating their debt structuring with the help of the IMF.
The Role Of IMF
While the IMF was established under the Bretton Woods Agreement in 1944 as an institution to promote international financial cooperation, its role has evolved over the decades. With the Bretton Woods system collapsing in 1971, IMF has resorted to promotion of openness of the capital accounts to support the new order of the free-floating US Dollar anchoring the international monetary system. The inequalities emerged between the Global North and South, with access to liquidity being a major issue for such a divergence. As such the IMF aims to bridge this gap by providing emergency loans or access to regional financial arrangements.
The Latin American debt crisis of the 1980s, followed by Eastern European, Mexican and East Asian crises in the subsequent decade forced the US to develop the Brady Plan that would be deployed in the bailout programs to prescribe structural adjustments. Bailouts from the IMF thus came with strict fiscal conditionalities that would complement the neoliberal policies as were pursued in the developed nations during this period. As the conditionality established in the negotiations were meant to be pro-cyclical, many developing countries have opted to prop up their accumulation of foreign reserves rather than be subject to the IMF programs. However, the GFC increased the dependence of seeking debt to manage primary deficits in these developing nations. The onset of pandemic led to a larger expenditure being taken up by governments, who looked towards financing such expenses by taking on more debt. This meant that in case a slowdown of the economy were to become an eventuality, like in the case of interest rate hike by the Federal Reserve back in 2022, demand for goods will also go down. This meant that countries are unable to meet their debt payment obligations, and run the risk of defaulting on their debt.
The Sri Lankan Conundrum
Shocking images emerged from the streets of Colombo July 2022, as massive protests and demonstrations swept the nation, forcing the President Gotabaya Rajapaksa to flee the country. What followed in the wake of such protests was a surge in commodity prices, power outages, with long queues being formed outside fuel stations, and shortages of food and medicine. While the issues of shortages have been subsided by the government, it comes at the cost of a threefold increase in the fuel prices, skyrocketing inflation and food insecurity. Businesses have been forced to close down and rising interest rates have led to dampened demand for credit. All this economic and social turmoil follows from just a few months ago, when the Sri Lankan government decided to default on its foreign debt obligations. Further, in September 2022, the IMF stepped in to negotiate a policy package that would infuse funds in the economy and developed the country’s plans to sustain its debt and achieve a primary surplus by 2025.
A brief glance in the past of the relationship between IMF and Sri Lanka showcases that it too has suffered at the behest of IMF’s policies of structural adjustments and economic liberalization. Initially, both the IMF and the World Bank gave the Sri Lankan government leeway to pursue its populist measures to build large scale infrastructure projects in 1978. That soon changed with a greater emphasis being put on adoption of austere measures in the 1980s. In the post-war regime of Mahinda Rajapaksa, the plans of infrastructural development were intertwined with a inviting foreign capital infusion in the economy, a plan that was supported by the international institutions. The expectations of economic boom were short lived, however, as the electoral defeat of Rajapaksa government in 2015 and droughts distressing the rural economy, led to another agreement being reached between IMF and the Sirisena-Wickremsinghe government in 2016.
With the country experiencing a significant dip in inflows from the tourism sector in the wake of the Easter bombings of 2019 and the global lockdowns due to the pandemic, the current account ran into a deficit. Coupled that with the global price hikes, supply chain disruptions and the diminishing foreign exchange reserves led to the government declaring a preemptive default on its debt obligations in April 2022. The terms as per the Article IV of the agreement, the recommendations included raising indirect (which, for years, contributed to about 80% of the total tax revenues) and direct taxes, fiscal consolidation, interest rate hikes, devaluation of the currency, and targeted social protection, the latter of which is yet to be implemented.
The remedial measures point to the concerted effort of the government and the IMF to debt sustainability through austerity. However, it appears to be misguided at best, with the brunt of the distress being levied upon the lower and middle income groups. The pro-cyclical policies appeared to have eroded incomes of the lower income groups and increased unemployment, while the rising inflation is leading to a cost of living crisis with food shortages exacerbating the conditions of the rationing and depletion of savings of the middle income groups.
As per the analysis of Oxfam, 13 out of the 15 IMF loan programs negotiated during 2021 required governments to cut down on its expenditure, thus putting its public services at risk. Coupled with this, governments were encouraged to take up raising taxes on commodities and fuel. These austere measures are pushed particularly on the lower-income countries, who don’t possess much of the negotiating power, while cautioning richer countries to steer away from such measures that hamper economic recovery. Countries like Kenya have secured loans under the conditions of a public sector pay freeze, while other West African nations are encouraged to increase their share of indirect taxes, which end up disproportionately hurting the lower income groups. The effects of such measures in tackling the post-COVID economic glut has been laid bare as in case of Sri Lanka, and the distribution of the impact in the countries fail to alleviate the pertinent issues of poverty and shortages. This process hampers the development of such regions and makes them susceptible to an ever-increasing dependence on the largesse of these international institutions, even at the cost of waning sovereignty.
About the Author
Yashovardhan Chaturvedi is a master’s student at Jindal School of Government and Public Policy, pursuing his degree in Economics. His interests lie in the field of political economy, technology and economic crises.
Image Credits: DINUKA LIYANAWATTE (Reuters)