Sri Lanka’s Great IMF Lie

Decades of looking to the IMF for salvation has yielded only crises. Sri Lanka’s economic crisis demands urgent relief measures for a desperate citizenry and a new, self-sufficient model of development

Sri Lanka has been subject to a great lie: the IMF solution! For close to a year now, the country has been implementing the International Monetary Fund’s recommendations with complete obedience. The sudden devaluation of the Sri Lankan rupee, a drastic increase in interest rates, the withdrawal of fuel subsidies and severe cuts to state expenditure all amount to harsh austerity measures. The consequence is economic devastation as the country sinks into a depression. Millions now suffer dwindling incomes, tremendous increases in the cost of living, food insecurity and even starvation.

Yet the much-touted IMF funds presented as a way to salvation, a meagre USD 2.9 billion over four years under the proposed agreement, have proved elusive. Compare this amount to Sri Lanka’s foreign earnings for last year, which added up to USD 18 billion. The IMF insists that Sri Lanka first convince a range of creditors to commit to restructuring its defaulted external debt before the organisation’s Executive Board will release the funds. But Sri Lanka’s economy is in free fall. Its GDP contracted by roughly a tenth last year and is on the path to continued contraction this year. Under these circumstances, the IMF agreement and its paltry funds may as well go into the dustbin.

Some of us have seen this crisis coming for a long time. A few months after the end of the civil war in May 2009, Sri Lanka obtained an IMF Stand-By Arrangement of USD 2.6 billion. This gave the green light to a considerable inflow of speculative foreign capital, in addition to commercial borrowings at extremely high interest rates in the form of International Sovereign Bonds (ISBs). At that point, the warning bells began ringing for critical analysts who could see the consequences. But back-slapping and self-congratulation among Sri Lanka’s elites continued amid a boom in economic growth built on a dubious basis, including speculative investment in urban beautification and needlessly large infrastructure projects. This debt-driven boom soon petered out.

Sri Lanka’s lop-sided economic structure, with a bloated import bill and unrestrained financial speculation, now faces a reckoning. The years of conspicuous consumption through imports from abroad are over.

Sri Lanka then faced balance-of-payments problems, which pushed it towards an IMF Extended Fund Facility of USD 1.5 billion in June 2016. Some of us sounded the alarm again as the government at the time, led by Ranil Wickremesinghe, pursued another IMF-led solution. But, again, our critique fell on deaf ears. Worryingly, the following month, with the IMF’s approval, Sri Lanka went ahead and floated another USD 1.5 billion in ISBs. Indeed, the  latest IMF agreement – the 16th deal between Sri Lanka and the organisation over the decades – offered nothing new. Rather, it promoted Sri Lanka’s continued liberalisation of trade and capital accounts, dating back to the opening of the economy in 1978. The crisis tendencies in the Sri Lankan economy were ramified through adherence to IMF packages.

Historical memory is short in Sri Lanka, particularly among the elite. The crisis accelerated with the onset of the Covid-19 pandemic three years ago. Again, we warned of the imminent dangers of an unsustainable balance of payments and the need to drastically reassess and reprioritise imports for the purpose of maintaining foreign reserves, given decreasing streams of foreign earnings. That would have meant restricting the import of luxury consumer goods while using the available foreign exchange for essential supplies and intermediate goods necessary to boost domestic production. The arrogant Rajapaksa regime then in power nevertheless persisted in the blind hope that fortunate times were just around the corner. It argued that tourism, for example, would soon pick up. Meanwhile, the opposition and neoliberal think-tanks proposed yet another IMF agreement as the magic bullet. Worse, they even started calling for an early default on Sri Lanka’s external debt. Their convoluted logic was that once the country defaulted, it would have to surrender to the IMF and all its conditionalities, such as austerity and fiscal consolidation. There could be no way forward other than with the IMF.

The reality is that tourism will not be enough to revive Sri Lanka’s growth during a period of painful austerity. The same goes for any number of hare-brained ideas that may now be touted by the country’s economic establishment

That is exactly what the government led by Gotabaya Rajapaksa did in April 2022. It prematurely defaulted on its external debt while the finance minister went on pilgrimage to Washington DC to the annual meetings of the IMF and the World Bank. The default was premature because only USD 78 million in debt-servicing was due that month, while the next large ISB repayment, of USD 1 billion, was due in July 2022. Only in Sri Lanka could the elite celebrate when the country defaulted on its sovereign debt for the first time in its history. They were confident that Sri Lanka would get bridge financing from donors, an IMF agreement with additional funds in three months, and a rapid process of debt restructuring. Ten months later, the outcome of these expectations remains a shameful zero. There is no more bridge financing. No IMF funds. And an agreement on debt restructuring appears uncertain at best.

Given all the above, Sri Lanka is a case in point of consistently insipid economic policymaking. It is also a study in how the myth of an IMF quick-fix can paralyse a country, putting on hold policies and relief measures urgently needed to help a citizenry drowning in economic depression. As the country awakes to the great lie of an IMF solution, it is forced to go back to the drawing board  – not just to deal with the social devastation and political backlash that the IMF agreement is bound to generate, but also because the global order that provided its reference points is unravelling.

From debt to a new development model

Sri Lanka’s long engagement with the IMF and the broader neoliberal policy consensus – austerity, privatisation, and the liberalisation of trade and capital markets – has been an utter and complete failure. Nevertheless, for the IMF and Sri Lanka’s establishment, resolution of the crisis appears to call for the introduction of austerity measures like the ones applied to many other countries that have experienced sovereign default, along with restructuring of defaulted debt. The idea is that Sri Lanka’s problems are rooted in a fundamental mismatch between its macroeconomic indicators and the debt it has accumulated.

The idea that Sri Lanka can achieve higher stages of development by pursuing the same growth path rooted in dependency on the external sector is a non-starter. The neoliberal development model has collapsed. The Sri Lankan establishment has practically admitted as much by seeking lower-income status for the country to obtain more concessional financing from international donors and aid agencies. At the same time, the government, led by Ranil Wickremesinghe, is eager to celebrate the return of tourists after a long absence caused by the Covid-19 pandemic and the Easter Sunday terror attacks in 2019. But the reality is that tourism will not be enough to revive Sri Lanka’s growth during a period of painful austerity. The same goes for any number of hare-brained ideas that may now be touted by the country’s economic establishment in the absence of serious thinking about an alternative development model.

Sri Lanka’s lop-sided economic structure, with a bloated import bill and unrestrained financial speculation, now faces a reckoning. The years of conspicuous consumption through imports from abroad are over. The question is, how can investment be channelled into those sectors necessary for the country to achieve self-sufficiency in the goods and services ordinary people need for survival? This perspective is a far cry from the IMF solution, which presupposes Sri Lanka’s continued subordination to a global economic structure that has clearly failed. Taking up the question of an alternative means returning to issues that had supposedly been bypassed with the triumph of neoliberal globalisation. It requires revisiting the many “reforms” – from the push for trade and capital-account liberalisation to the promotion of foreign direct investment and privatisation – that it has entailed.

Towards self-sufficiency

Under these circumstances, the idea of self-sufficiency offers a crucial response to the rapidly changing, uncertain global order. This churn may provide an opportunity for foresighted actors within Sri Lanka to demand a fundamental re-conceptualisation of how external engagement fits into the country’s development model. If it is imperative to revive the country’s domestic food production, for example, how would this flow into a broader rethinking of the composition of intermediate imports needed for production? What type of external financing would be necessary to develop the domestic food system?

Global growth, especially in trade, is likely to continue slowing in the face of a complex set of challenges. In this scenario, how can Sri Lanka’s debt be made sustainable by further exposing the country to these chilling headwinds?

Sri Lanka’s domestic debt is also a critical part of the equation for overcoming the current economic depression. That includes the need for counter-cyclical spending, as opposed to pro-cyclical policies of fiscal consolidation. But external development finance would also continue to play a role. The key question is whether such borrowings are integrated into a process of planning, so that an alternative development vision takes precedence over the mainstream understanding of market-steered investment that has long shaped countries such as Sri Lanka. The country must push back against global capital geared towards the sole end of financial extraction. Indeed, the lion’s share of foreign direct investment into Sri Lanka went into speculative investment in real estate rather than ventures that increased local industrial production. Development financing should be reconfigured as part of a bottom-to-top restructuring of the economy, along with changes in trade policy away from excessive imports. That is necessary both to repay the current debt – with deep haircuts for creditors, if not debt cancellations – and as a means to develop Sri Lanka in the long run.

This alternative goes back to similar points made by development economists such as Ha-Joon Chang and Abhijit Sen, who were early critics of the Washington Consensus. Such critical economists recognised the flaws in the previous model of import substitution, but they framed it as an ongoing concern of the balance of social and class forces required to ensure that capital, as it grows, is also disciplined to invest in critical sectors. In Sri Lanka’s case, that process of disciplining capital must now include prioritising imports of essential and intermediate goods necessary for production. It also requires revamping the defunct public-distribution system to ensure food security and prevent outright starvation. As the economy stabilises, further measures must also include redistribution and investment through a wealth tax on existing property and assets.

Sri Lanka has to have stronger debates about its development vision, including a rethink on relations between its rural and urban arenas. There must be greater room for rural industries rooted in the livelihoods and reproductive needs of ordinary people. This is a far cry from the elites’ vision of the economy, which has repeatedly driven Sri Lanka into financial difficulties. There is now tremendous anger in the country because of the devastating fall in living standards. This discontent, in addition to the unravelling global order, may finally trigger a break with liberalisation.

For the IMF, of course, a programme rooted in self-sufficiency with wealth taxes and reinvigorated public investment will be a step too far. It is entrenched in its own institutional processes, despite the organisation’s fuzzy rhetoric around its newfound supposed awareness of the social implications of austerity-driven bailout agreements. Nevertheless, Sri Lanka’s crisis may offer a turning point for those global and domestic coalitions that are aiming to push back against renewed subordination to global financial capital. That means rethinking a number of trends that have long coalesced under the banner of economic liberalisation. After decades of repeated mistakes and failures, with consequences for the people on an unprecedented scale, will the establishment at last be forced to reconsider Sri Lanka’s development model?

Ahilan Kadirgamar is a political economist and a Senior Lecturer at the University of Jaffna. Devaka Gunawardena is a political economist and independent researcher.

This article was originally published on Himal South Asian.
Views in this article are author’s own and do not necessarily reflect CGS policy.