A tragedy is unfolding in Sri Lanka. Citizens must queue for food and pharmaceuticals, vehicle owners cannot fill their tanks, and there are power cuts. The economy is paralyzed, and because the country’s debts are unstable, it cannot borrow. The country is grappling with the world’s worst economic crisis since World War II.
The situation is so dire that lakhs of people have come out on the streets. The former president has fled the country and its parliament has chosen a new, but unpopular, replacement. If all goes smoothly (a big one given the events of recent weeks), the International Monetary Fund (IMF) may come to Sri Lanka’s aid with a rescue loan package – allowing for the purchase of essential imports. Gives – and a program to achieve sustainable financial. , monetary and exchange rate policies.
Sri Lanka’s plight serves as a lesson for other governments. When a country’s economic problems are apparently becoming insurmountable, postponing the calculation through various piecemeal measures will make matters worse in the end.
Over the years, Sri Lanka was a ‘donor darling’ due to its relatively high standard of living, good social services and strong economic growth. In the first half of the last decade, it claimed an average annual growth rate of 6.5% – one of the world’s highest and very low population growth rates. Although economic growth slowed after 2015, it averaged over 3% by 2019.
But later that year, a new government came to power and immediately announced a major tax cut. In both 2020 and 2021, the government ran a fiscal deficit of more than 10% of GDP. The annual inflation rate rose from an average of 5% in previous years to 39.1% in May and then to 54.6% in June.
Worse, even with inflation already accelerating, the government announced in the spring of 2021 that it was banning all chemical-fertilizer imports. An estimated 20% of rice production fell, tea exports fell to their lowest level in more than two decades, and more than a third of the country’s agricultural land remained fallow.
The COVID pandemic came on top of these self-inflicted wounds, causing a sharp drop in tourist revenue, which then deepened Sri Lanka’s foreign exchange deficit and further reduced its ability to buy imports. By the end of 2021, the situation was spiraling out of control; And in May, the government defaulted on its foreign debt.
Now, Sri Lanka cannot get the inputs it needs to restart its economy unless it has restructured its debt and installed a functioning government. Reworking the country’s debt would be unusually complex as a significant portion of the debt is owed to China, which does not participate in a multilateral Western-led restructuring exercise for highly indebted sovereign borrowers.
Again, the lesson for other indebted nations is clear. While a country’s economic authorities may delay some of the consequences of erroneous policies for some time through import rationing and prohibition, price controls, fiscal deficits, foreign borrowing and money printing, the music will eventually stop. When a government has the only option of implementing serious reforms or implementing desperate and economically irrational measures, doing so will only deepen the misery and human suffering caused by the policy mistakes of the latter.
If Sri Lanka had approached the IMF at the end of 2021 (or even earlier) and implemented the painstaking reforms needed to curb inflation and reduce its current account and fiscal deficits, it would take at least six months. The pain could have been avoided. The country’s foreign debt would not have been so high and the road to recovery would not have been so long. More to the point, the descent into complete political chaos of the country could have been avoided altogether.
Since the start of the COVID pandemic, the global community is justifiably paying more attention to the plight of heavily indebted developing countries, with the G-20 launching a debt service suspension initiative that will provide 48 countries with nearly $13 billion in relief in 2020. has given. -21, but that was just a drop in the bucket relative to actual needs.
Worse, there has been little difference between countries whose underlying economic policies were sustainable and those whose policies would have become unstable without reform, even in the absence of COVID. In the latter category, lending to a country without ensuring that it has or will implement sustainable economic policies is not doing it any favors. Conversely, such ‘support’ only postpones the day of calculation and leaves it with an even greater debt-servicing burden when the time comes.
Policy makers in other economically struggling countries should heed the Sri Lankan story. The lesson can be traced to the people of Brazil, which, after the debt crisis of 2002, quickly adopted the necessary policy reforms and enjoyed years of sustained growth thereafter. At the time, Brazil also had a choice between swift painful action to create the necessary conditions for recovery, and refusal and delay to foresee the inevitable. Its leaders proved to be wiser than those who have since driven it out of Sri Lanka.
(Anne O. Krueger is a senior research professor of international economics at the Johns Hopkins University School of Advanced International Studies and former Chief Economist of the World Bank)
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