Devjyot & Uditha Jayasinghe

COLOMBO (Reuters – After winning the Sri Lankan presidential election, and several months ahead of a parliamentary poll that would once again test his popularity in Sri Lanka, Gotabaya Rajapaksa assembled his cabinet to fulfill a campaign promise to reduce taxes.

    The move, which included a near-halving of value added tax, blindsided some top central bank executives.

P. Nandalal Weerasinghe was the Central Bank of Sri Lanka (CBSL), Senior Deputy governor until September 2020. He recalled that the tax cuts were made just after the elections.

    “There was not any kind of a consultative process,” added Weerasinghe, who spent 29 years at the CBSL before retiring.

    The economic argument for the cuts was simple – to free up spending and boost Sri Lanka’s ailing finances.

According to a Rajapaksas member, similar actions by the government led by Gotabaya’s elder brother Mahinda helped the country’s recovery from a decade-long civil war that ended in 2009.

Milinda Rajapaksha stated, “That is why the promised… And then came the pandemic.”

    The case against was that reducing potential revenues when obligations were high was risky and undermined a 2019 debt management plan that hinged on a narrowing fiscal deficit.

W.D. In his first interview after leaving office, Lakshman, who was the governor of CBSL between September 2019 and September 2020, spoke out about the cuts.

    Not long after the move, the pandemic struck, crippling an economy heavily reliant on tourism.

The hit on Sri Lanka’s finances was almost inevitable. However, former CBSL officers and analysts stated that the policies implemented before COVID-19 were a problem and have since exacerbated it, leaving Sri Lanka in an unstable financial position.

An inquiry by The Guardian asking for information about the state of the economy, and whether any policy errors have been made by the government was unanswered.

CBSL released a statement saying that the economy is better than reports suggest, and with key sectors like tourism showing signs of revival as well as the stock market doing “reasonably” well.

However, foreign currency reserves fell almost 70% to $2.36 Billion in just two years. This is short of the $4 billion in expected debt repayments in 2022.

The inflation rate has increased, imports to Colombo have been delayed due to cash shortages and energy costs are higher because of the conflict in Ukraine. The fuel supply is limited to a few days. National power outages have already begun.

‘NEVER DAUNTED’

In 2020, Sri Lanka was in dire need of access to capital markets in order to maintain its debt management program. A string of ratings agency downgrades effectively shut it off.

When times were difficult in the past, Sri Lanka turned to the International Monetary Fund for assistance.

However, any discussions with IMF regarding restructuring Sri Lanka’s foreign loans were stopped by the government and CBSL leaders as soon as April 2020. Lakshman also stated that he was the governor.

Weerasinghe stated that even with the IMF off the table, there was still a possibility for the government to move towards fiscal consolidation or provide a credible recovery program, but it did not.

He stated that “what was presented in the budget for 2021 was totally inconsistent with what would be accepted by international lenders or investors.”

The budget forecast a rebound of economic growth around 5.5% in 2021. This was partially due to the Delta variant which caused island-wide lockdowns.

Sri Lanka exceeded its fiscal deficit goal by more than 2 percentage points in 2021. The trade deficit increased to $8.1 Billion in December 2021 from $6 Billion a year earlier.

In 2021, the remittances of foreign workers dropped 22.7% and reached $5.5 billion.

Rajapaksa’s government and his siblings have raised credit and swaps worth $1.9billion from India.

Sri Lanka received $1.5 billion in swaps in December, and the final tranche of $1.3 billion syndicated loans from China arrived September 2021.

Basil Rajapaksa, the Finance Minister – brother to the President and Prime Minister Mahinda Rajapaksa — has taken a positive tone since taking over the position in July.

He stated last November that “The Rajapaksas are a family with a track record of never being discouraged by difficulties” in his budget speech. It proposes to create a deficit budget of 8.8% of GDP as well as raising taxes.

In its statement, the CBSL stated that it is committed to fulfilling all debt obligations. It also said that any suggestion that Sri Lanka was in danger of default was incorrect.

“The Sri Lankan authorities are working on a plan to ensure that Sri Lanka is able to sustain its debt and recover economically.”

FEARS OF DEFAULT

Opposition politicians and analysts fear Sri Lanka will default next year if the country does not reform its debts in the next months.

“This prevarication, and somehow imagining there is another solution, I think, is a delay that the country can ill afford,” said Nishan de Mel, Executive Director of the Verité Research think-tank, adding that the 2022 budget did not go far enough.

Failure is only possible by mucking along. The path to success is through restructuring.

The 10-year yield on Sri Lankan bonds was 13% Wednesday, as compared to 8.13% February 23rd last year.

Economists and politicians from opposition parties have called on the government for assistance from IMF lenders and other lenders. This would allow it to tap capital markets and reduce the burden of debt.

IMF loans may come with some conditions. These could include measures to reduce the debt and other austerity measures.

Basil Rajapaksa is keen to get the economy back on track before looking into loan programmes. However, Milinda Rajapaksha, an aide, told Reuters that this month. And the CBSL denied the need for any IMF program.

Masahiro Nozaki, IMF’s chief mission chief for Sri Lanka said that although the IMF has not yet received a request from Sri Lanka for financial support, it was ready to talk with them about options.

As a challenge further, the soaring oil prices in Ukraine could “really hurt” Sri Lanka, warned Ramesh Pathirana, Cabinet Spokesperson and Plantation Minister.

Russian invasion began and crude oil prices peaked on Thursday at $105 per barrel, the highest level since 2014.