The revenge of orthodoxy

Across the world, emerging economies that tried to defy orthodox policy making are in danger

Sri Lanka has been hit by something of a perfect storm. It had a feckless leadership interested in populism and not policy; cranks pushing anti-Western theories had great influence in the corridors of power; the country had built up a large store of debt during its long civil war and rebuilding effort; one of its main foreign exchange earners, tourism, had collapsed thanks to the pandemic; another, tea, had suffered because those aforementioned cranks imposed a ban on fertilisers; foreign capital is flowing back into the West as their central banks raise rates; the dollar is, consequently, strengthening; and, finally, prices of imported food and fuel shot up as a consequence of the invasion of Ukraine. It would be hard for any small open economy to survive this sort of combination — leave alone one run into the ground by the Rajapaksa family and their allies.

But Sri Lanka is the canary in the coalmine. Multiple analysts have used that phrase, alongside harsh warnings. And it is true that the tsunami that has swamped its economy will hit other shores soon; some of those will also be inundated.

A quick look at some of those other economies is illuminating. Sovereign bond yields are above 10 per cent in almost one-third of emerging markets, according to the International Monetary Fund (IMF). Sri Lanka’s 10-year dollar bond yields increased by the most in the world (other than Ukraine’s) this year so far. But close behind Sri Lanka is El Salvador, a country that also allowed anti-establishment cranks to take charge of policy. In Colombo, the president’s advisors refused to talk to the International Monetary Fund and the central bank chairman talked up money-printing thanks to fraudulent “modern monetary theory”. Meanwhile, in San Salvador, the president declared a few months ago that the United States dollar was “dead” and put his faith in bitcoin — which promptly lost 60 per cent of its value, taking valuable Salvadorean reserves alongside it.

Over in Laos, the cost of food and fuel imports is also devastating the economy of another small country that is $14.5 billion in debt. An even larger proportion of Laotian external debt is owed to the People’s Republic of China than in Sri Lanka. This complicates multilateral bailouts of both countries. It is also a problem, of course, in politically divided Pakistan, which has a public debt to GDP ratio of barely over 70 per cent (compared to say 90 per cent in Brazil) but also has such depressed export earnings that it struggles to finance its imports and pay the interest on its debt.

Interest payments are also a problem in large emerging economies like Egypt and Ghana. In fast-growing Ghana, the government took a strong anti-IMF stance as late as May, with its finance minister confident that another crank solution — an “e-levy”, or 1.5 per cent tax on all electronic transfers — would stabilise the country’s finances. Like Sri Lanka, Ghana’s exports are undiversified (cocoa and gold are its traditional strengths); the country is thus particularly exposed to price volatility. Its debt to GDP ratio is at 84.6 per cent, and interest payments are more than seven per cent of GDP.

Illustration: Ajay Mohanty

Ghana has grown at above six per cent for several of the past non-pandemic years. Egypt, too, was growing at between five and six per cent in the years prior to the pandemic and crossed six per cent in 2021-22. But the country — once the breadbasket of the Roman Empire — depends on imported wheat, which has shot up in price following Russia’s invasion of Ukraine, the breadbasket of the 21st century. It already has a debt to GDP ratio of close to 90 per cent, and interest payments consume over eight per cent of GDP.

Further along the Maghreb coast, Tunisia is also particularly vulnerable to default — with debt to GDP rates equivalent to Egypt’s, and bond yields northward of 30 per cent. Bread and fuel are subsidised in Tunisia, and soaring global prices for both have pushed government finances to the edge. A populist president, who has been described as thinking he can solve the crisis “single-handedly”, is in the process of seizing power and stamping down on the opposition — and, therefore, cannot negotiate structural reform credibly with the IMF.

If there is any lesson to be taken from these —and a dozen other examples around the world — it is that orthodox economics still remains the most sensible predictor of a country’s macro-economic fate. Don’t take on too much debt; don’t expand subsidies and entitlements excessively; diversify exports as far as possible; don’t depend upon portfolio investors to prop up your currency; listen to technocratic advice; and avoid nativist and populist leadership. One more lesson might be valuable: GDP growth alone can’t protect you, as Ghana and Egypt — and others, especially Turkey — have discovered.

India is not immune to this tsunami. The rupee has soared to a record high, crossing 80 to the dollar; and India’s foreign exchange reserves also hit a 15-month low. They now cover between 10 and 11 months of imports; danger hits when this number drops below eight or nine. But we may be safe from the worst consequences of this moment precisely to the extent that policy makers here have been prudent and orthodox. A Reserve Bank constrained to target consumer price inflation has meant prices have not spiralled out of control. The Union government has kept at least half an eye on the fiscal deficit, meaning that interest payments are at uncomfortable but not unmanageable levels — yet. The degree to which we will avoid any slide towards crisis in the coming years will depend upon how much sensible policy making — deficit reduction, interest rate hikes, export promotion, and productivity-enhancing reform — is carried out in the next months and years. In troubled times even more than otherwise it is wise to stick to orthodoxy.

The writer is head of the Economy and Growth Programme at the Observer Research Foundation, New Delhi