The Politics Of Default

By Shawn Fernando –

Sri Lanka has defaulted on its debts. The default is at this point still orderly. Talks are proceeding between the current government and creditors. But make no mistake, this is default. And with that default comes consequences. No government, be it composed of devils or saints could spare Sri Lanka from the credit squeeze that will accompany this default.

However, one must also recognize that the human toll of this crisis is much more severe than it needed to be. Even if one ignores the graft, corruption, and poor decision making that brought Sri Lanka to the point of default, the fact remains that shortages of food, fuel, and medicine could have been avoided.

For many months, it was clear that Sri Lanka was headed for an inevitable default. Reserves were dwindling, and there was no reasonable path toward solvency. A responsible government could have dealt with the crisis proactively by beginning restructuring negotiations. An earlier recognition of default would have allowed Sri Lanka to maintain some currency reserves and thus maintain the supply of essential goods. The Rajapaksa government chose to deny reality instead.

This phenomenon is discussed in Borensztein and Panizza “The Costs of Sovereign Default” (2009).

“…politically costly defaults might lead to ‘gambles for redemption’ and possibly amplify the eventual economic costs of default…”

“…a politician concerned about his/her political survival faces a tradeoff that is somewhat different from the one affecting the country itself, say, the representative citizen.”

In other words, politicians will value their own short term survival over the inevitable long term harm being done to their citizens.

In practice we can see this in the piecemeal loans the government has been taking over the past year to shore up foreign reserves. They were fully aware that foreign reserves were dwindling unsustainably. Yet they chose to delay default temporarily to avoid facing political consequences. Like Nero, they fiddled while Rome burned.

The result of their denial is the pain and misery faced by the people right now. Every hour spent in fuel lines, every delayed surgery, every power cut faced by the citizens of Sri Lanka was avoidable. These human catastrophes are the price of the government living in blissful denial for the past year.

So what now? Now that the country has been brought to penury by corruption, incompetence and selfish delusion, what can be done to minimize the damage moving forward?

The answer, as protestors have been insisting, is complete system change. To do anything less is to invite further economic peril.

The current PM has benefitted mightily from the supposition that any delay to IMF negotiations would be fatal. Sri Lanka cannot, as the logic goes, risk too drastic a change in leadership. In such a dire economic catastrophe, the government cannot waste time reimagining domestic politics. A “stable” government is needed to negotiate with the IMF. But this logic does not hold up to scrutiny.

First, An IMF Bailout is not a short term solution. Lebanon took two years to reach a staff-level agreement with the IMF, and their bailout has yet to be implemented. Sri Lanka has begun negotiations with the IMF with an eye toward a speedy resolution, but this process will take time nonetheless. At this point we do not even know what conditional reforms such a bailout would include, let alone whether such reforms are able to pass through parliament.

Second, political change will have to be part of the bailout anyways. The package of reforms the IMF will recommend will no doubt include anti-corruption and transparency measures, dramatic cuts to government spending, and increased taxes. None of these measures will be popular with the current ruling party, hence the SLPP reluctance to agree to negotiations in the first place.

The current leadership has embezzled and mismanaged government funds, actively creating the conditions for this crisis. How can we expect the same leadership to actively dismantle their own system of graft and payouts?

Third, this government is not stable. 9 out of 10 citizens want the president to step down. Even if the SLPP committed to a package of IMF reforms, they do not have the backing of the people. It seems almost laughable to expect a government so roundly hated by its people to enact painful austerity measures.

The fact is, they can’t address this crisis while clinging to power by their fingernails. This is simply another “gamble for redemption.” When viewed from this angle, one can see the current PM and the President are actually operating exactly in their own interests and against the economic interests of the country. If they were truly concerned about reducing the suffering of the Sri Lankan people, they would step down with whatever dignity they have remaining.

What Sri Lanka needs is new leadership, leadership with new ideas and the political backing of the people. Only such a legitimate government can navigate the painful realities that will accompany this crisis.

Because this crisis is far from over. The literature shows that the immediate effects of a default, including the withdrawal of credit currently affecting the Sri Lankan government, will likely remain for one and-a-half to two and-a-half years. Reduced growth will likely hamper the economy for close to a decade.

What will determine the length of these effects is the boldness of the steps taken to mitigate the harm of the crisis. Trying to return to business as usual will undoubtedly extend the period of malaise. However, a new government based on a genuine anti-corruption and green growth platform could significantly shorten the credit squeeze.

In a period where private credit for businesses will be in short supply, implementing anti-corruption measures is one way to reassure potential foreign investors. Much of the damage of a default is reputational. Transparency and genuine reforms directly address that reputational damage. As for green growth, there is still the potential for Sri Lanka to access the green bond market in order to decarbonize its energy supply, even in the midst of a crisis.

Green Bonds are a new financial instrument, designed to overcome the difficulties of financing public and private green development projects, especially in countries without perfect financial stability. These bonds involve more stringent oversight and reporting standards than traditional bonds. Yet despite the higher transparency requirements this bond market is growing exponentially. Both Sri Lankan government agencies and private businesses would have to adapt in order to meet these standards, but given the current state of disastrous credit drought, it seems a small price to pay.

At a time when Sri Lanka will be struggling to access other lines of credit, these green bonds would serve a dual purpose. First, to stimulate the economy in the aggregate, and second to reduce the monthly expenditure on imported fuel. At this point the levelized cost of energy for solar and offshore wind power are significantly lower than diesel-burning plants. Given the fact that fuel imports are the largest category of dollar expenditures in the economy, such projects can only serve to help Sri Lanka’s balance of payments. Though foolish spending has wounded the nation’s balance sheet, smart investment could stanch the bleeding.

But these types of bold ideas are far from what is on offer from the current government. They had their chance to access the green bond market before the crisis but they chose not to. It seems that politicians in the ruling party have little interest in taking money that cannot be diverted towards personal enrichment. Once again, what is in the best economic interest of Sri Lanka is complete system change.

Unfortunately, even ambitious political and economic ideas will not address the immediate pain of this crisis. Which brings me to the bitter reality of the short term. The coming months will be brutal for the people of Sri Lanka. Imported fuel, medicine, and food, will be in supply only through the largesse of trading partners. Shortages of vital supplies will only compound existing problems with local food production. This will be a time when the priorities of a nation will be tested, and the threat of hunger looms large. But even through the darkness there is hope on the streets right now.

The spirit of these protests, the spontaneous social cohesion, the joy and common purpose, these are precisely what will deliver the people through calamity. While this government has shown time and again that it acts only for itself at the expense of the people, the protests show the possibility of a different kind of politics. It is the politics of genuine brotherhood, of solidarity, and of a humble yet unshakeable patriotism. It is, one can only hope, the politics of the future.

Over the coming months there is no king coming to save Sri Lanka, and there is no bailout to be had. All that can be done is to mitigate the inevitable harm. These times call normal citizens to feed the hungry, to comfort the afflicted, and to recognize the common humanity in struggle.

There are no stirring words, nor are there clever plans that will come to the aid of the people in the coming months. It will be only the common heroism of everyday citizens that will deliver the country, from one meal to the next.

In the short term the people of Sri Lanka have only each other. They have only the ties that bind them, and their willingness to work together towards a better future. May history prove it was all they needed for victory.

*The writer is an independent analyst, and lives in Austin, Texas, USA.

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