Can Sri Lanka solve its debt and monetary crisis sans the IMF: Bellwether

ECONOMYNEXT – The question is often asked whether Sri Lanka do without an International Monetary Fund program. It is certainly possible to do so if there is knowledge about monetary policy and pegging and there is an ideology based on classical economics and a return to sound money.

The world managed without the IMF before World War II. Some may say there was the gold (or Silver) standard at the time, which provided a simple basis for sound money, which is also true.

However there are enough ways to provide better fiat money than a money printing soft-peg with ‘flexible’ policy and modern monetary theory.

Though there are many examples, with the current fixation with Asia, Japan and Malaysia are good candidates.

There was no IMF before World War II

Any soft-peg crisis (read BOP crisis) can be fixed without the IMF, especially if it only involves current or capital transactions of private citizens and not state debt. All that needs to be done is to raise rates to slow credit.

Some fiscal fixes are needed since a currency collapse puts energy prices out of kilter and tariffs have to be raised. Usually in countries prone to currency crises, energy utilities that are state owned and money is printed to give energy subsidies and they have contributed to the crisis along with the central bank.

State banks, which give credit to loss making SOEs breaking prudential norms also contributes to the balance of payments crisis.

Energy subsidies financed by central bank credit is a key driver of the crisis in the first place and a reason for a monetary meltdown as a crisis gets underway.

Income tax also collapses as consumption falls. There may be bank failures or not, depending on how severe the currency crisis is and how long it progresses, but bad loans always rise.

State expenditure cuts are needed since taxes will fall after the currency crisis and the general public cannot bear the entire burden of a profligate state.

In Sri Lanka there is an excess of state workers, who are always molly coddled by the anti-austerity brigade. Austerity for the poor by currency depreciation is perfectly fine but cutting benefits to state workers are out of the question according to them.

To stop future crises the central bank has to be overhauled.

If that is not done, the country will go the IMF again and again and again … and yet again until default or a monetary meltdown drives the country to dollarization which is an extreme case of central bank bankruptcy.

There are many cases of countries fixing themselves without going to the IMF. Before the World War II all countries fixed themselves without going to the IMF.

Germany (Ordoliberals) and Japan (Ordoliberals inspired Joseph Dodge) did after World War II, simply with Austrian economics.

These people could teach a thing or two to the New Dealer inspired IMF.

The Meiji better-than-IMF- program

Japan had done it much earlier also in the 1880s after Meiji reforms failed amid SOE losses and an uprising in Seinan which triggered money printing. Japan had borrowed heavily in the London financial market.

Japan in fact probably invented privatization.

At the time Finance Minister Masayoshi Matsukata engaged in a mass-privatization. That saved the Meiji reform program and made Japan an industrial power by the turn of the century and it fought on the side of Britain in World War I against Germany.

The business houses that bought privatized assets became the big names that people now know, Sumitomo, Mitsui and the Zaibatsu system. Some of these firms dated back from the Tokugawa Shogunate trading houses.

International treaties limited protectionism and these firms become strong and competitive by the turn of the century. Taxes started to rise later after nationalists got control of the polity and import duties were raised to finance military spending and war.

But the recovery program was based on monetary reform involving…