Sri Lanka and us

Sri Lanka has recently emerged as a lesson in how not to manage an economy. According to news reports, food, medicine, and fuel are in short supply, and power cuts have become a daily occurrence in the country.

Sri Lanka is facing the worst economic crisis in its history. After the country defaulted on its sovereign debt earlier this year, it has come to the International Monetary Fund for financial assistance.

The IMF staff has reported that an “IMF team held technical discussions on a comprehensive reform package to restore macro-economic stability and debt sustainability. The team made good progress in assessing the economic situation, and in identifying policy priorities to be taken going forward. The discussions focused on restoring fiscal sustainability while protecting the vulnerable and poor; ensuring credibility of the monetary policy and exchange rate regimes; preserving financial sector stability; and structural reforms to enhance growth and strengthen governance.”

The IMF staff went on to say that continuing “discussions will help the [Sri Lankan] authorities formulate their reform program. The team welcomed the appointment of financial and legal advisors to engage in a collaborative dialogue with their creditors as an important step towards restoring public debt sustainability. Since Sri Lanka’s public debt is assessed as unsustainable, approval by the Executive Board of an IMF-supported program for Sri Lanka would require adequate assurances that debt sustainability will be restored.”

Shorn of the politesse of communiqué-type statements, the IMF staff is signaling that Sri Lanka needs an IMF ‘bail out.’ Its economic crisis involves macroeconomic instability (GDP is weak or falling, inflation is high, and the local currency has depreciated sharply), and a severe external debt problem (the country is unable to repay its debts because it has been running high fiscal deficits, and has run out of official foreign reserves).

In effect, creditors are not willing to extend further credit to Sri Lanka without the IMF ‘blessing’ a “difficult” reform program.

What does this bit of news have to do with the Philippines? In a benign world, not much. In a somewhat cynical environment, the “not to ask” question is: Is the Philippines like Sri Lanka?

The official answer is No, because unlike Sri Lanka, the Philippines has ample foreign exchange reserves, and its debt ratios, while high, cannot be considered as ‘unsustainable.’

Obviously, while Sri Lanka needs a ‘bail-out’ from the IMF, the Philippines is in a substantially-better situation – a case of us thinking that “There for the grace of the Almighty go we.”

It is unthinkable for the Philippines to have to undergo an IMF-supported program. In the latest official IMF report on the Philippines (in 2021), the IMF staff said: “…If downside risks to the economic recovery materialize, the Philippines has some fiscal space to respond. The indicative public debt cap of 60 percent of GDP should serve as a medium-term anchor, and allow for flexibility in fiscal policy in the short term. The eventual rebuilding of fiscal space will enable adequate responses to large shocks in the future, and should be facilitated by the formulation of an explicit strategy, including fiscal targets.

…The monetary policy stance is appropriately accommodative, given the inflation outlook. Economic slack should help to contain inflation, as the temporary impact of domestic supply shocks has started to reverse. While monetary policy decisions about exit should await the recovery becoming more entrenched, phasing out direct budgetary financing should be the first step in policy normalization, to preserve the BSP’s operational capacity and independence.”

In short, the Philippine economy is nowhere near the crisis mode that has engulfed that of Sri Lanka. The Philippine government will, however, have to restore some order in its budgetary accounts (because it is at, or near, its self-imposed 60 percent debt-GDP ratio).

Moreover, per the IMF staff, monetary policy can remain accommodative (interest rates will not rise) so long as inflation is contained.

A large part of the difference between the two countries can be seen in their outstanding debt ratios, which form a key component behind their credit ratings. The Philippine debt/GDP ratio had fallen sharply from more than 70 percent in 2003-04 to around 40 percent in 2016-17.

Consequently, the rating agencies have rated Philippine debt as “investment grade” in recent years. Fitch has rated Philippine debt at BBB since 2017 (when it was raised from BBB-).

Similarly, Moody’s has maintained its rating of Philippine debt at Baa2 since 2014, while Standard and Poor’s has put the country at BBB+ since 2019.

For comparison, Sri Lanka’s government debt to GDP ratio was relatively high through most of the 21st century, and this ratio had ominously climbed to more than 100 percent by 2021.

Sri Lanka’s credit rating was well below that of the Philippines (in 2018, Sri Lanka was rated B+ by Fitch and B1 by Moody’s). When Sri Lanka defaulted on interest payments to foreign creditors in early 2022, its credit rating collapsed, and Sri Lanka is today considered to be in “selective default” in the international credit market.

Yet, another crucial difference is the maturity profile of these two countries’ external debts in relation to their official foreign exchange reserves.

The Philippines has managed to contain its short-term external debt to a small proportion of its foreign exchange reserves (generally below 20 percent since 2008).

Sri Lanka, on the other hand, has allowed its short-term external debt to rise from about 50 percent of its foreign reserves in the first decade of the 21st century, to about 150 percent by 2020; this ratio has since risen further to something like 300 percent by end-2021, when the country’s short-term external debt stood at $8.4 billion, and its reserves were $2.8 billion.

The Philippines at the end of 2021 had short-term external debt of $15 billion, and foreign reserves of $107 billion.

Nonetheless, in many ways, Sri Lanka is quite similar to the Philippines. Both countries are run by political leaders – the extended Rajapaksa family in Sri Lanka, and a combination of political dynasties in the Philippines – who get their support through populist measures that tend to ignore economic realities.

In Sri Lanka, the political leaders promised to cut taxes and delivered a large cut in the value-added tax, which weakened the government’s finances; while in the Philippines, the incoming administration made an election campaign promise of lowering the price of rice to P20/kg for the consumer (from the prevailing price of about P40/kg).

Amidst the economic difficulties brought on by the CoViD pandemic, both countries saw their fiscal balances go into large deficits in 2021: Sri Lanka’s to about -12 percent of GDP, while that of the Philippines to about -8.5 percent of GDP.

As noted earlier, the Philippines had the benefit of a substantially-lower debt-GDP ratio prior to the onset of the pandemic, and this appears to be a kind of buffer (in IMF-speak, ‘fiscal space’) that gives the Philippines an ability to avoid the kind of crisis that Sri Lanka now faces.

In several other respects, the two countries are also quite similar. Both depend heavily on inward worker remittances (both at 9-10 percent of GDP in 2020). Both depend significantly on tourism; Sri Lanka’s tourism receipts fell from 6.4 percent of GDP in 2018 to 1.3 percent in 2020; while in the Philippines, tourism receipts fell from 3.0 percent of GDP in 2019 to 0.8 percent of GDP in 2020.

Both have similar income inequality or relative poverty profiles: the latest official data show that 47 percent of Filipinos are poor (based on those who live on less than $5.50/day, using 2018 data); while the comparable figure for Sri Lanka is 42 percent in 2016 (although the poverty figure for Sri Lanka is likely much higher for 2022).

In terms of ‘absolute poverty’ profiles, the two countries are also broadly similar. GDP per capita in constant international dollars (at PPP exchange rates) was $12,500 in Sri Lanka in 2020, while that of the Philippines was lower at about $8,000.

In current US dollars at market exchange rates, Sri Lanka’s per capita income in 2020 was about $3,700, while that of the Philippines was $3,300.

More importantly, both countries score quite high in the Fragile State Index of the Fund for Peace. Both countries have almost identical scores in 2021 – 81 or 82, out of a maximum of 120 (the higher the score, the more fragile the state).

The index measures the vulnerability of a country in pre-conflict, active conflict, and post-conflict situations, using 12 conflict risk indicators on the security apparatus, factionalized elites, group grievance, economic decline, uneven economic development, human flight and brain drain, state legitimacy, public services, human rights and rule of law, demographic pressures, refugees and displaced persons, and external intervention.

These scores compare poorly with those of Singapore at 27, or Switzerland at 20, although Thailand is also relatively-high in fragility (at 70).

Is the Philippines on the same downward path as Sri Lanka? Probably not.

For sure, our economic managers are working hard so that we do not follow in the footsteps of Sri Lanka. They have also put on a brave face of optimism, with one official saying that “[o]ur country is on the way to further growth and development.”

Still, the outgoing administration has suggested that the government will have to broaden the tax base, and postpone tax reductions, while maintaining the safety nets for the poor.

On the side of monetary policy, I expect the Central Bank to err on the side of ‘tightening,’ not only to maintain its announced inflation target but also to attract capital inflows, and stabilize the peso exchange rate (even as the major central banks also tighten their monetary policies).

The combined effect of these suggested macro-economic policies will then tend to dampen aggregate demand, and slow down the economy. Well, after all, there is no free lunch!

The appropriate economic policy measures are doable, and may be seen against the backdrop of a newly-emerging external debt crisis faced by many poor or poorer countries that have been hit by the CoViD pandemic.

In many ways, the Philippines is indeed a blessed country.

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Author’s email: oroncesval4@gmail.com; Twitter: @ORoncesvalles