At the time of independence, Sri Lanka was second only to Japan in terms of various socio-economic indicators, but there has been regression since then due to complex socio-economic and political reasons. The most significant cause is the macroeconomic stress stemming primarily from the government’s unsustainable budgetary operations. Populist politics and entrenched entitlement culture too have contributed to this stress.
Sri Lanka is often compared to Kerala for its great social and human development indicators. He quoted Professor Joan Robinson’s words, “Ceylon has eaten the fruit before she has planted the tree”, indicating the high human development indices in Sri Lanka combined with poor macroeconomic fundamentals.
There has been a high budget deficit, excessive inflation, high nominal interest rate and an overvalued currency economy; diametrically opposite to the successful countries of East and Southeast Asia.
For years, Sri Lanka has been a persistent twin deficit country with a budget deficit and a current account deficit. These twin deficits have now been amplified, partly because of the pandemic and partly due to the domestic policy response. The underlying cause of the budget deficit is the drastic reduction in collection of government revenue while the expenditure remains high. On the current account deficit side, there is a structural deficit owing to the anti-export bias in the country’s policies. The way forward must be to increase exports, non-debt creating flows and foreign direct investments.
The primary challenge for Sri Lanka is to improve the quality of public expenditure and enhance revenue by adjusting the fiscal deficit in a financially sustainable way.
There has been severe illiquidity of US dollars and Sri Lankan rupees. One of the reasons for the illiquidity of US dollars was the collapse of tourism. The second reason is the loss of access to international capital markets as the government decided to not go ahead with the IMF program and Sri Lanka was downgraded to triple C rating. To overcome this, the Governor of the Central Bank set out a comprehensive roadmap listing potential sources of inflows, however, this is a work-in-progress.
The other option would be to have an IMF program that would unlock other multilateral financing sources, but the downside is, there could be conditionality like debt rescheduling attached.
As for the Sri Lankan rupee illiquidity, the government gave a wide range of tax reduction during the pandemic which led to extremely low revenues and the Central Bank’s deficit financing stimulated unwavering and consistent inflation. “The operation was reasonably successful but the patient died because the growth rate was only 2.3%.” There is a need for both stabilisation of the economy and structural reforms.
The neglect of the agricultural sector has trapped the Sri Lankan population in low productivity, net deficit, and low-income activity cycle. Industry dynamism to encourage higher productivity is required to break from this trap.
The import restrictions in Sri Lanka are temporary and are imposed only under emergency conditions.
The Indo- Sri Lanka Free Trade Agreement must be widened to improve trade opportunities.
Lessons for South Asian counterparts from Sri Lanka’s economic situation:
High economic reserves, resilient banking and fiscal space are essential for macroeconomic stability.
Fiscal forbearance and fiscal excess are the reasons for the present economic crisis.
Politics dominating economic policy is a dangerous precedent in Sri Lanka.
Economies must create a good business climate for domestic and foreign investors.
Discussant : Mr. Shivdas B Menon
It is necessary to build trust between India and Sri Lanka. A win-win situation is possible if both the countries worked together and capitalized on each other’s strengths.
The trade restrictions in Sri Lanka should be eased so that its businesses can enter international markets.
The fertilizer subsidies given to farmers without training them led to detrimental health and economic issues. To overcome this, the government decided to adopt organic farming overnight. However, the move has drastically reduced the production.
India has a big market that Srilanka could tap on. It has a definite role to play both in terms of strengthening the business relations and fostering trust between both the countries.
This event report was prepared by April Suzanna Varkey, Research Intern at CPPR.
In case you missed it, watch the event video recording here: https://www.cppr.in/videos/cppr-townhall-on-decoding-the-economic-emergency-in-sri-lanka