The Need for Governance-Linked State-Contingent IMF Programmes: A Third Way for Sri Lanka

Abstract

The recent sovereign default of Sri Lanka has once again brought attention to the effectiveness of the International Monetary Fund’s (IMF) Extended Fund Facility (EFF) approach. This programmes provides loans of short duration (generally up to four years) with a few disbursements, conditional on a programmes of medium-term macro-fiscal adjustments. However, there is little evidence that this approach yields long-term success. On average, countries experience 2.1 restructuring episodes when entering default, with a typical resolution time of 7 to 10 years. Currently, debt renegotiation is handled separately from the IMF programmes, based on the view that sovereign-default episodes are primarily a balance-of-payments crisis. However, in cases such as Sri Lanka and others, the crisis is a twin-deficits crisis, involving both a fiscal and balance-of-payments crisis. This crisis is often due to domestic macroeconomic, fiscal, and monetary policies, as well as governance failures, institutional difficulties in implementing evidence-based policies, corruption, and political capture of institutions. Weaknesses in domestic policies reflect institutional shortcomings, such as difficulty in implementing evidence-based policy, corruption, and political capture. The table summarizing the weaknesses of institutions in Ghana, Sri Lanka, and Zambia is significantly greater than that of Greece, which was also severely criticized for its weaknesses at the time. Developing countries’ institutions tasked with implementing policies for rapid and severe fiscal adjustments are often limited, and cultures of favouritism between governments and elites exacerbate this issue. While the IMF’s governance-related conditionality is now often part of its programmes, they may not be comprehensive, directly linked to disbursements, nor are economic targets always grounded in reality. This article proposes a third way for the IMF’s lending programmes in countries such as Sri Lanka, which includes: a longer horizon of 15 years with smaller and more frequent tranche disbursements linked to shorter-term macroeconomic, fiscal, and governance targets.