March 20, when the IMF Board approved an Extended Fund Facility for Sri Lanka, now seems a long time ago. For many people this felt like a major step toward the resolution of the country’s economic problems. It certainly seemed to indicate that there was international agreement on how to deal with the government’s bankruptcy.
Some people will have been surprised to see that on April 17, in Washington DC, the government and its creditors launched formal negotiations on what actually to do about the debt, how much will be written off and how the cost of those write offs will be distributed among the many creditors. Previous agreements were just about principles. Now the details have to be decided and signed off before most of the IMF loan can be released.
Every report on these Washington negotiations emphasises that China, Sri Lanka’s largest single creditor, was not present on April 17. Some commentators suggest that the meeting has been called to put pressure on China to become seriously engaged. They also point out that time is short.
The agreement with the IMF might be aborted. In other words, the IMF has not actually come to Sri Lanka’s rescue and may not be able to do so. This is not because the IMF lacks willing but because the international institutions and arrangements to deal with the problem are in a mess.
When companies go bankrupt, they are wound up or restructured under national law. There is no international law to deal with bankrupt governments. Until recently, the world has muddled through to case by case solutions with an ad hoc combination of legal contracts and informal understandings. That combination worked in large part because it was run mainly by the more influential Western nations, through arrangements labelled Paris Club in the insiders’ jargon. The IMF was broadly the secretariat to the Paris club, enjoying considerable influence all the time it enjoyed the trust of the Western nations, but not ultimately calling the shots.
Why do Paris Club arrangements no longer deliver either for Sri Lanka or for the growing list of governments of low and middle income countries that are in debt distress? The main reason is that the owners of the debt have changed. When the 1980s debt crisis hit many low income countries, most of their debts were owned by the Paris Club, i.e. by a combination of Western governments, Western banks and multilateral organisations very much influenced by Western governments.
Sri Lanka’s debts, like those of many other contemporary distressed governments, principally take the form of either loans from Chinese banks or international sovereign bonds (ISBs). ISBs were originally sold on international financial markets by the Sri Lankan government. The government received a capital sum and in return agreed to pay a fixed rate of interest to the bondholder.
The government became bankrupt in early 2022 when it finally admitted that it did not have the money to pay all the interest due to the bondholders. In the meantime most these bonds have been sold on, often repeatedly.
The Paris Club no longer includes or has much direct leverage over the organisations to which the governments of many poorer countries, including Sri Lanka, owe the most money. The dispersion of the ownership of Sri Lanka’s ISBs could become a problem if the current court case in the US goes against the government of Sri Lanka.
American law in this area remains murky and subject to re-interpretation. Otherwise, all the signs are that the bondholders will be cooperative in agreeing to accept a write-down of the value of their bonds. Many of them purchased those bonds speculatively, at a heavy discount to face value, after it became clear in 2020 that the government of Sri Lanka could not redeem them in full because it was heading for bankruptcy.
China is a much bigger potential obstacle to a quick agreement about which creditors will accept how much of a haircut. This is not just because the government of China, understandably, is unwilling to accept the leadership of the Paris Club, and wants new international arrangements that give it the influence it believes it merits as a major creditor; it is also because China’s banks have become a major source of lending to poorer countries and, now that many of these loans have turned bad, collectively face bankruptcy threats of their own.
The Rhodium Group, a New York research organisation, has just estimated that, over the past three years, almost $80 billion of Chinese loans for roads, railways, ports and other infrastructure given under the Belt and Road Initiative have been renegotiated or written off. The government of China needs an effective international mechanism to deal with the debts of bankrupt governments. But it wants a mechanism which gives it, the biggest creditor, more influence. In the meantime, it does not intend to be generous in writing off the debts it is owed because it cannot afford to do so.
The negotiations about the debts of the government of Sri Lanka are enmeshed in complex international geo-politics. Understandably, the IMF has kept quiet about this and emphasised the potential domestic political problems: “Risks to program implementation are high, given adverse initial conditions, political risk, a complex debt restructuring with a potential for delay, ambitious fiscal consolidation, large downside risks to the baseline scenario, and Sri Lanka’s weak track record for reform and program implementation” (From p.30 of the formal request for support approved by the IMF Board).
Domestic and international politics will interact, possibly in surprising ways. Internationally, the government of Sri Lanka will need to be friends with everyone, especially with the West, with China and with India, which is taking a leading role in the current negotiations. The government would be in a stronger position in these negotiations if it enjoyed significant levels of support and trust from the public and opposition politicians. It does not, and seems likely to continue on its current path of demanding allegiance and quiescence on grounds of national necessity, and accusing critics of disloyalty to the country.
The immediate implications for Sri Lankan democracy are negative. The country will not be consulted about how the government is trying to deal with and influence these complex interactions between the IMF-Sri Lanka programme, debt restructuring for Sri Lanka and the fragile and somewhat dysfunctional international arrangements for dealing with sovereign bankruptcy.
This is partly because the current government in temperamentally disinclined to be transparent or to consult but also because it will be playing a relatively weak hand in a complex international game, and would genuinely find it difficult to consult with domestic political forces that do not trust it. To this extent, the pessimists who see a direct contradiction between the IMF agreement and internal democracy are correct. But only to this extent. There are other elements of the IMF agreement that could be embraced to provide a useful boost to both progressive public policies and democracy.
The IMF agreement does not mandate the savage public spending cuts that some have feared. That is principally because, aside from selling off loss-making public enterprises and cutting some big public infrastructure projects, there is currently little scope for cutting public spending without putting many (poorly-paid) public sector workers out of a job. That is politically too provocative.
The IMF documentation suggests that it places higher priority on what it terms social safety nets i.e. direct cash transfers from government to the poorest families. The issue appears in the sixth line of the press release that the IMF issued on March 20. It is treated in some detail in the 131 page technical document that forms the basis of the agreement. The messaging is clear. Whatever steps the current government has taken to protect the poor have been more than eroded by inflation (p.9). Spending needs to be increased in 2023 to meet an indicative target.
It is a structural benchmark for the whole programme that the Sri Lankan parliament approve a whole new social safety net scheme by May 2023 (p14). There are four pages of more technical material in Annex IV, including an incisive comparison with other middle income countries, pointing out how miserly are the transfers that the government makes to poor Sri Lankans.
The IMF has placed much more emphasis on the need to spend public money to protect the poor than have most Sri Lankan politicians and political activists. We have seen plenty of protests recently about the increase in personal income taxes by people who are certainly hard pressed but not in most cases forced to go hungry. Where are the protests about the failure of the current government to live up to the commitments it made last year to protect those who really face destitution?
It is probably a sign of how little the current government is really interested in this issue that in his address to Parliament on 22 March to celebrate the IMF agreement, President Wickremesinghe devoted just 20 of his 3,174 words to social safety nets, and those only near the end of his speech. That could be taken as an indicator of how important it is for progressive organisations to get behind this issue and pressure the government to live up to its commitments.
There is another element in the IMF agreement that relates more directly to the future of democracy. The key paragraph, from the main IMF document, reads “An IMF governance diagnostic mission has started to assess Sri Lanka’s governance and anti-corruption framework. The diagnostic report will be published by September 2023 (structural benchmark). The report’s findings will help identify specific priority and time-bound reforms to be implemented under the program” (p.23).
Many Sri Lankans will view this provision as outrageous and a vindication of their belief that the IMF agreement is an instrument through which international finance will seek to get control of the Sri Lankan economy. What right does an organisation with a purely fiscal and financial mandate have to investigate the governance of Sri Lanka and to suggest, urge or decree how governance should be reformed?
Surely this is the very antithesis of democracy and of national sovereignty? My answer is not necessarily; the potential gains from IMF engagement in these sensitive issues might much outweigh the costs but only if progressive political forces in Sri Lanka seize the opportunity to shape what actually takes place under the rubric of an IMF governance diagnostic. There are two main reasons why I suggest that progressive forces might like to sup with this particular devil.
First, a strong nudge from the IMF could be very helpful because the set of issues that their governance diagnostic is addressing – issues of corruption, lack of transparency in the uses of public money, widespread failure by recent governments to follow their own rules about the management of public money – have become increasingly central to the decline of democracy and constitutionality in Sri Lanka but have not received adequate attention from domestic democrats.
There is no consensus on the causes of the decline of democracy and constitutionality over recent decades. Some point fingers at particular leaders or at elite leadership in general. Others cite larger forces like (international) capitalism, the gradual militarisation of the state that can be dated back to the response to the 1971 JVP insurgency or the exploitation of ethnic and religious differences and competition for educational opportunities and public sector jobs. All played some role.
In my view, one of the more important recent causes lies in the discovery by those in power, especially since the defeat of the LTTE in 2009, that the very strong executive power that had been gradually been established could be used to by-pass all kinds of fiscal and expenditure rules and procedures, and to loot the state. Verite Research has documented some of the tricks used.
This looting goes along with a long term decline in the competence, capacity and professional autonomy of the public fiscal institutions that are supposed to uphold good management of public money, notably the Ministry of Finance and the Auditor General, but also the legislative committees (Committee on Public Accounts, Committee on Public Enterprises) and even the Central Bank. I don’t think we can restore effective democracy until we can find new, binding ways of preventing people who win elections from continuing to loot.
If they can loot, they have both a strong incentive to remain in power and the resources to buy off all the people and institutions that might stop them. These are far from the only issues that matter for democracy. There are many others that are equally important, including human rights, extra judicial killings, judicial independence, ethnic majoritarianism and the abuse of the police for political purposes. But these issues of fiscal and financial rules and procedures are not only important but are complex and technical and do not get much routine coverage in places such as Groundviews. It would be good to have the IMF drawing attention to the problem and suggesting remedies.
The second reason I would be willing to sup with the IMF devil is that I have no fears that the IMF is about to take control of the governance of Sri Lanka. Indeed, my concern is the very opposite: that the IMF will produce a governance diagnosis, that may or may not be made public, but the IMF itself will not be at all insistent that it be taken seriously and will be all too inclined to leave the report and retreat to Washington at the first sign of serious push back from the government.
Why is the IMF likely to be so timid? One reason is that it is actually a very small organisation that specialises in monetary, financial and fiscal issues. It is not set up exercise much influence in any of its 190 member countries. It currently has only about 2,700 employees, which is one seventh of the number of people who work for the World Bank. Its staff are cautious technocrats – economists, financial specialists, lawyers and accountants, much better suited to sitting at desks doing financial calculations than undertaking the kind of political networking needed to rule.
The other reason is closely related. The IMF is simply not used to undertaking the kind of governance diagnosis that it is now doing on Sri Lanka. This is a little outside the organisational comfort zone and probably at the margins of its competence. Its natural instinct will be to hand over a report to the government and back off, especially if vigorously challenged by the government. x
And that is why civil society and progressive politicians in Sri Lanka need to get their challenges in first. This governance diagnosis is already underway. Sri Lankans should demand of the IMF transparency and serious engagement with representatives of the nation other than the government. They should be ready with their own diagnoses. In the longer term, they should be mobilising to critique the IMF report and, above all, to keep the government’s and the IMF’s feet to the fire on the issue of re-establishing effective management of public money in the public domain.
The IMF agreement is not in reality a done deal. It is going to be argued over and likely renegotiated for several years to come. The less those negotiations are monopolised by the government and the IMF, the better are the outcomes likely to be for Sri Lanka and Sri Lankans.
This blog was originally published as a blog on Groundviews.