16 February, 2025

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Challenges Faced By The New Government

By Harsha Gunasena

Harsha Gunasena

A delegation of International Monetary Fund (IMF) headed by Krishna Srinivasan, Director for the Asia Pacific Department, visited Sri Lanka to hold discussions with the new government of Sri Lanka. The following was stated by Srinivasan according to the  statement issued by the IMF on October4, 2024.

“We held productive discussions with President Dissanayake and Sri Lanka’s economic team on the economic and financial challenges facing the Sri Lankan economy. We agreed on the importance of continuing to safeguard and build on the hard-won gains that have helped put Sri Lanka on a path to economic recovery since entering one of its worst economic crises in 2022. We are encouraged by the authorities’ commitment to continue the reform efforts.”

This statement negates the statement in the NPP election manifesto which they have repeated several times in the election campaign that they will renegotiate the Debt Sustainability Analysis with the IMF. Allegations are leveled against the NPP that they have misled the voters, but we knew that this would happen. However, we all should be happy with the current status along with the IMF and Fitch Ratings.

There is a Table in this article which was compiled with the information from the annual report of the Ministry of Finance for 2023 and IMF targets. In the year 2023, in relation to the estimates income was more and the expenditure was less so that the primary balance which is the expenditure minus interest and loan repayments was increased by Rs. 394 billion from negative balance of  Rs. 221 billion to a positive balance of Rs. 173 billion. This balance is to be used for repayment of loans and for the payment of interest. The primary balance in 2023 as a percentage of the Gross National Product (GDP) according to the IMF agreement was negative 0.7 and the actual figure was positive 0.6. Hence there was a positive performance according to the IMF target as well.

Economic growth was positive since the third quarter of 2023 and as a result the real economic growth, which means economic growth adjusted for inflation, in 2023 was negative 2.3%. This was better than the figure of negative 3% growth agreed with the IMF. In the year 2024 the growth in the first quarter was 5.3%, in the second quarter was 4.7%. Hence this will well exceed the target agreed with IMF which was 1.5% for 2023.

In the first four months of the year 2024 the primary balance was Rs. 365 billion. This is well ahead of the expected figures. Capital expenses were reduced in order to achieve this result.

According to IMF agreement the government revenue in 2024 should be 13.3% of GDP and in 2025 it should be 14.9% of GDP. If the tax cuts proposed by  NPP are implemented the smooth functioning of the fiscal consolidation will be jeopardized. However, a proposal such as the one suggested by the former president reportedly with the IMF agreement  could have been implemented.

Also in 2024 government expenditure should be 12.5% of GDP. Hence as indicated in the NPP election manifesto, spending 6% of GDP for education and 3% of GDP for health in near or distant future will be fallacy.  Therefore the government  will face a challenge of balancing election promises and fiscal consolidation.

The government announced that Sri Lankan Air Lines will not be privatized. Liberal thinking was introduced to Sri Lanka with the term neo liberal which is often used in a defamatory context. Many do not understand liberal thinking. Sri Lankan thinking which is based on outdated Marxist thinking promotes to keep the so-called national assets with the government even though those were running at losses. People, who exercise their sovereignty, like it. This airline cannot be uplifted without new investments or loans obtained with treasury guarantees. The issue is that the government is handicapped to implement either of these proposals. Also, if the Airline continues to make losses the government is unable to finance those losses. If these so-called national assets could be privatized at the market value the government would be able to get some relief for the sovereign debts.

In the accounts of Sri Lankan Airlines for the year 2024, there is a deficit of Rs. 400 billion of the total of Stated Capital, Reserves and accumulated losses. Assets were financed by short-term and long-term loans. The total loans obtained by giving treasury guarantees and concessionary letters from the government amounts to Rs. 146 billion. According to IMF agreement for the year 2024 treasury guarantees should not exceed Rs. 2,100 billion. However, according to the interim report released by the Ministry of Finance for the year 2024, by April 30, 2024, the total of treasury guarantees amounted to Rs. 2,228.

When JR Jayewardene wanted the help of Lee Kuan Yew to develop the Airline, Lee suggested instead to develop the airport. Suggestion  was made probably thinking of the strategic location of the country. However, JR opted for the first option. Our leaders are still thinking in the same lines.

Therefore, the slogans the government tries to implement are not a reality in the ground. Similarly, it is uncertain the reaction of the government to the IMF agreed condition of recapitalization of Bank of Ceylon and Peoples Bank. Former president proposed to issue 20% of the shares of those banks to the employees and depositors but I think that those two banks should be listed in the stock exchange   and 20% of ownership should be privatized. If so, it would be a revolution in the banking industry in Sri Lanka as happened at the point of incorporation of Sampath Bank.

Adopting a policy against privatization stating that some of the government entities are strategically important and not defining the dividing line is not beneficial to the economic development of the country. The business community should be given back the wealth taken over from them by the governments from 1956 in the guise of nationalization. Socialism in 21st century is not that the governments should engage in businesses or centrally handling the economy. It is that  the governments should work towards distributing the benefits of development of the country to the people and  lifting them from poverty. Also  reducing the income inequality of the country. This could be done through the system of taxation.

What is more important is the approach of the NPP to handle the economy. The source to find out is the election manifesto. The Extended Fund Facility program of IMF is aimed at fiscal consolidation and not economic growth. Even during this difficult period, the country has achieved considerable economic growth ahead of IMF agreed  targets. To uplift the economy, we should achieve higher economic growth at the earliest.

During the Mahinda Rajapaksa era the economy was centered on constructions done with borrowed money and the productivity of those projects was low.  Based on the problems faced by Sri Lanka, economic growth  should be centered on trade, based on exports. The swing moves to both sides, not only to one side. Similarly imports also should be improved along with exports. Out of the imports to Sri Lanka in 2020 consumer goods amounted to 21% and the rest were intermediate and capital goods.

NPP plans to have a production economy. Although they say that they promote exports as well this word connotes that ‘we produce for our country’ or ‘if we grow, we eat’ type of concept which had prevailed in Sirima Bandaranaike era. This system is an extension of the defensive system of import substitution that prevailed during Mahinda Rajapaksa era. This is proved by  imposing additional tariffs for imported potatoes and onion by the government.

The export promotion system which is the opposite to this system converts our market beyond that 22 million to indefinite level. This is an offensive system. Those who provide inspiration for this are the ones who have done away with the defensive mentality especially the governments, people, the trade negotiators in respect of free trade pacts with other governments and business community. It appears to be that none of the above are in this mentality. Unfortunately, except for a few the business community also are not in this mentality.  That is why out of the prominent businesses in Sri Lanka there is a lessor number of exporters and there are more banks. It appears to be that the NPP government does not have the capacity or intention to change this mentality. Fifty years back the Marxist Minister of Finance NM Perera said, export or perish.

NPP said that it will abolish the pensions of the former presidents and members of Parliament. This was a popular slogan. The government recently appointed a committee to investigate this.

As per the Article 36(1) of the constitution the president is entitled to a pension; when a person appointed the president that parliament should decide on it; any subsequent amendment, repeal or replacement of this Article and any subsequent law or any provision thereof inconsistent with this Article shall not have retrospective operation; and Parliament may by resolution increase, but shall not reduce,  pension entitlement of the holders of the office of President. In addition to that under the President’s Entitlement Act No. 4 of 1986 a retired president is entitled for a pension, a residence, transport and payments to a secretary. Parliamentary Pensions Law No 1 of 1977 was approved by the National State Assembly. In Sri Lanka laws cannot be passed with retrospective effect.

An essential condition for elimination of corruption of the politicians is to increase their direct benefits such as salaries and pensions, not to reduce those. Also, proportional representation system where a lot of money to be spent on elections, should be changed to a mixed system. There should be severe punishments for corruption and there are laws for that. Thereafter only corruption would be reduced and talented people will come to politics. In order to eliminate the corruption and inefficiency of the public servants the excess employees should be removed, and the salaries of the balance should be increased. Efficiency targets should be set. Thereafter the red tape culture also should be changed.

The main reason for the economic problem of our country is not corruption but the steps taken by populist governments to pacify the voters and invest in low yield projects. Borrowed money was spent on these instances.

It should be emphasized that an ideology which is against globalization, privatization, minimal intervention of the economy by the government .and free trade would not be able to find out the solutions for the economic issues the country faces even if they are against corruption although it is appreciated much. Hence the government should seriously consider these points.

Latest comments

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    Challenges Faced By The New Government

    By borrowing and investing you can see the light in end of the tunnel Currently, IMF funds are being directed toward fisheries, agriculture, and assisting flood-affected populations, highlighting the urgent need to stabilize these suffering sectors. If future IMF funds are invested with proper forecasting and free from corruption, they can significantly contribute to long-term economic recovery. Unlike projects such as the Watala Airport, which failed to generate income, strategic investments can drive sustainable growth. With disturbances in Bangladesh leading garment industries to shift to India and Sri Lanka, Sri Lanka could capitalize on this by planning effectively. The NPP’s forecast aligns with this approach, showing that with foresight and responsible investment, growth is achievable.

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      NPP has three major challenges : Economy, Tamil issue and Geopolitics. They have capitulated in two areas: In election platforms they said that they will cancel the agreement and negotiate for a fresh one. Now they have agreed to continue the process where it was left. In election platforms they said they will never allow the bridge between India and Srilanka built. Now they have signed the MOU to build the bridge, wholly financed by India. They are painfully realising that they can say anything in public, but when it comes to governance, it is different. In economy they may succeed in micro-economics but will fail in macro-economics. In Tamil issue they will miserably fail and exacerbate the problem. In geopolitics, if they try to play double game, they will come a cropper.

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        Dr Gnana
        No They did not say that they will cancell the agreement. It is news to me that they signed a MOU with India about the bridge. Yes in Tamil issue based on the past experience they may not handle it properly but too early to comnent. It is open. Foreign policy is also similar.

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        Dr.GS
        “Now they have signed the MOU to build the bridge, wholly financed by India. “
        When did they do that? Do you have a source?

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          oc
          That question amounts to sacrilege.
          He is the ultimate authority on all news.
          You are doomed to be called an idiot or some such thing.

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      RBH 59
      Thanks.
      You are not responding to my narrative. You have a different one.

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      I believe the author has conveniently overlooked the fact that the economic growth observed over the past few quarters mainly stems from increased worker remittances and tourism income. The economy is currently in a deflationary cycle, indicating that real economic expansion has not occurred in the service or manufacturing sectors. Even in tourism, the boost in income is primarily due to filling existing capacities that had not been utilized, with little to no real investment being made in this sector.
      These foreign exchange inflows will likely contribute to a higher growth rate, regardless of whether there will be real expansion in manufacturing and services. While this may trigger more consumer spending, the outcomes remain uncertain. Clearly, this growth is not a result of the government managing the macroeconomy efficiently. Instead, they have increased taxes on the advice of the IMF to generate more revenue, aiming to reduce government borrowings, which could positively impact interest rates and facilitate credit expansion.
      The core issue is that the tax increases have negatively affected the local economy, leading to a collapse in demand for goods and services. As a result, job market growth has stalled, and credit expansion is not occurring because people cannot borrow, and banks are reluctant to lend unless sustainable income can be guaranteed for workers. This situation has led to a significant appreciation of the currency.
      Sugath Amarasekera

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    “We are encouraged by the authorities’ commitment to continue the reform efforts.”
    Harsha Gunasena,When you say, “this statement negates the statement in the NPP election manifesto”, you may be taking it ad verbatim. That is the standard language of lenders.
    (I am not saying that NPP can act, independently.)

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      Nathan
      Yes it is the standard language but I believe that IMF would not endorse complete the opposite in the guise of diplomatic language

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        Local debt restructuring should have been implemented but did not occur. The primary reason for this seems to be that the government aimed to protect private fund holders—mainly primary dealers—whose funds were heavily invested in bonds, benefiting significantly from interest accruals at rates as high as 33-35%.

        If haircuts on the interest accruals of the private funds had been done similar to Employees’ Provident Fund (EPF) and Employees’ Trust Fund (ETF) , the government could have avoided imposing substantial tax increases on VAT and personal income. These tax hikes negatively impacted the local economy by causing a collapse in demand. Currently, interest payments on local debts amount to 2.7 trillion, which is equivalent to 78% of the government’s yearly revenue. Moreover, primary dealers refrained from investing in Treasury Bills (TBs) and bonds when bank interest rates were low during and post 2022 crises period. Their absence in the market led to a rise in interest on TBs and bonds, increasing to between 24% and 35% to attract these funds back into the market. Essentially, the government became dependent on these fund holders, who are now earning substantial profits, as reflected in their profit and loss statements.

        What should the National People’s Power (NPP), which claims to be people-centric, do under these circumstances? Should they continue servicing this high interest payment that negatively impacts the economy while following the course set by the previous administration?

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    Overall, the stability of the currency is not primarily due to RW’s actions but rather to the possible developments resulting from increased remittances and tourism income. The author also neglects to address why the government did not undertake substantial restructuring of local banks, a move that could have avoided the drastic VAT increase now used to service the enormous interest payments on treasury bills and bonds—issued at excessive rates of 20-35%, totaling around Rs 2.7 trillion. The IMF did not advise the government to raise VAT in this manner; instead, it expected RW’s administration to restructure local debts and impose significant haircuts on the interest rates that burden the economy. Had this been done, taxes could have been reduced, preventing the collapse we have witnessed, allowing RW to potentially win the presidential election.

    RW has prioritized the interests of large fund owners, imposing austerity measures on the general public. He further applied substantial haircuts to EPF and ETF funds invested in treasury bills but spared wealthy fund holders, who receive 24-35% interest on their treasury bills, while EPF and ETF funds, which invested 44% in these bonds, received only 9%, well below the prevailing inflation rate.

    RW continues to survive politically, but his days may be numbered due to the actions he has taken. If the IMF had collaborated with AKD, the latter could have managed the situation better and likely would have taxed these large funds heavily to avert the significant tax increases.

    Sugath Amarasekera

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    Privitation is not panacea for every economic woes that we have been experiencing, as state sectors in capitalist France and Socialist China and Vietnam have been very successful as what matters is the efficiency with which social resources are invested to generate output with max productivity, and that is what matters. Whereas private sector in underdeveloped countries like Bangaladesh, India, South Africa, Mexica, where social resources are invested by private sector and reaps huge profits but we can say productivity is very high but all that has been achieved at the cost of low wages, and the profit earned by the private sector is not getting reinvested in the real economy as we have seen in our country. Private sector should not be considered as a panacea for every economic woes in the country

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