27 May, 2022


Covid-19 Economic Recovery: Most Probably It Will Be A Flattened U-Shaped One

By W A Wijewardena

Dr. W.A Wijewardena

The new world order of living in isolation

One thing that we now know for sure is that COVID-19, further abbreviated to C-19 for economy and convenience, is to deliver a massive negative shock to the entire world economy without exception. Economic growth at least in the current year is to recede to a negative range. If mishandled, economic recovery to pre-C-19 levels would be prolonged for another three to four years.

The mobility of people, for work, health, education or pleasure, from country to country is to be curtailed if not totally disallowed. The established global economic order that ushered an era of interdependence among nations is to be abandoned. Instead, a new economic order that prevailed when Homo sapiens were living in caves many thousands of years ago is being advocated. In this order, men and women were living constantly in fear of and suspecting the other Homo sapiens cohabiting even in the neighbouring caves.

The global goods and services as well as financial flows are to fall to levels well below those that could sustain the global economy. In a nutshell, people are cherishing and their political and religious leaders are promoting, self-isolation from the rest of the world as the new way of living.

Sri Lanka’s economy was sick even before C-19

Sri Lanka has been successful in containing the spread of C-19 to a national epidemic level. But the same cannot be said about its economic fallout. Even before C-19 hit Sri Lanka, its economy had been limping forward having been infected for long by a number of ailments.

Economic growth had been slowing down from 2013 and in 2019, it fell to 2.3%, the lowest in a decade. Exports have been virtually stagnant at around $ 11 billion on average during this period. Since the import bill was almost double this amount, the trade gap stood at about $ 10 billion on average. Since the net earnings on account of services, incomes and remittances could not fill this gap, the current account of the balance of payments was in deficit at around 2.5% of GDP.

The government budget had been infected with a difficult-to-cure disease: the revenue base was falling, while expenditures were rising. As a result, the overall deficit in the budget amounted on average to 6% of GDP and was on the increase. The deficit had been financed in turn by borrowing leading to an unwarranted increase in the stock of public debt from 72% of GDP in 2013 to 87% in 2019. Debt servicing, that is, repayment of the principal and the payment of interest, became problematic forcing the government to borrow more year after year to avoid a possible debt default. This was specifically true for foreign debt. Without borrowing anew, the country could not honour its foreign debt obligations.

Since the inflow of foreign exchange was insufficient to meet the annual foreign exchange demand, the rupee was under continuous pressure for depreciation. The Central Bank kept on holding onto the exchange rate by supplying dollars out of its foreign reserves to the market intermittently. However, this could not keep the exchange rate stable and it saw a one-way journey to depreciation. Accordingly, the US dollar that was traded at Rs. 127 at end-2012 fell to Rs. 182 at end 2019. In the first half of 2020, the rupee came under severe pressure for further depreciation and at one point it even crossed the mark of Rs. 200 per US dollar. Though there was a slight reversal of this trend recently pushing down the rate below Rs. 200, the uncured sickness in the external sector forebodes a massive adjustment in the rate in the coming months.

Playing the blame game by politicians 

Thus, Sri Lanka was hit by C-19 when it was sick with severe macroeconomic complications on all fronts. For this malaise, politicians on both sides of the main political stream have begun to play the usual blame-game of pointing fingers at each other. It is customary for them to claim that when they handed the government to their rivals, the economic situation was better than what the rivals had inherited to their successors. It is like a man falling from the 20th floor of a building shouting at a man at the window of the 10th floor that he is well and not to worry ignoring that he is falling and there are 10 more floors below him.

Time to become a rich nation is to be further deferred

According to the Central Bank, the economic fallout of C-19 would be short-lived with a quick V-shaped recovery. The growth rate would fall from 2.3% in 2019 to 1.5% in 2020 but start to recover steadily though at a slow pace in the succeeding years. Accordingly, growth will bounce back to 4.5% in 2021, 6.0% in 2022, 6.2% in 2023 and finally, 6.5% in 2024. This 6.5% was the growth rate which President Gotabaya Rajapaksa had planned to attain from 2020 onwards in his drive of the country to a rich nation within roughly about 20 years after accommodating an annual average population growth of about 1%. It appears that C-19 has derailed this plan. However, this goal could still be attained in 25 years if the economy makes a quick recovery as predicted by the Central Bank, sets on an annual average growth of 6.5% and there are no other negative economic shocks hitting the economy in the intervening period.

Impediments created by the Government

Thus, the challenge before Sri Lanka’s economic policy makers has been to make this predicted quick economic recovery a reality. However, there are certain impeding factors that stand to foil the realisation of this goal. Some of these impediments have been created by the government itself. Some others have been delivered to them from outside and therefore are beyond their control.

Costly tax reforms 

Of the impediments created by the government, the most prominent one is the dearth of funds within the government – known as lack of fiscal space – to undertake expenditure programs needed to initiate a quick recovery. One reason for this is the erosion of the revenue base of the government by offering a series of generous tax concessions to income tax and VAT payers. Another is the absence of a budget for almost the entirety of 2020 and having to operate on a truncated expenditure programme known as a Vote on Account. As it is, a full budget could be offered only for 2021 after a new government is formed subsequent to the Parliamentary elections of early August.

Erosion of the revenue base

The tax cut offered by the government with effect from January 2020 was an unconventional stimulus package. When this was announced in December 2019, I warned the government in an article in this series that it could backfire and measures should be taken to control the damage forthwith (available at: http://www.ft.lk/columns/Tax-cuts-Control-the-damage-before-the-unconventional-stimulus-backfires/4-691207). The objective of the government by offering these tax concessions was to reduce tax rates and relieve the taxpayers, catch more potential individuals to the tax-net and rely on large taxpayers for generating revenue for the government in the long run.

Though it might help the government to establish a viable tax regime in the country in the long run, immediately, it would eat into the revenue base of the government. My prediction at that time, based on the revenue generation in 2019, was that the government would lose between Rs. 650 billion and Rs. 680 billion in 2020. This is a significant income loss amounting to about 4-4.5% of GDP. What it meant was that in 2020, tax revenue would fall to about 8% of GDP from around the historical average of 12% during the preceding four-year period.

Since it would take time for the new tax regime to get established and fully operational, it was predicted that the government would have to live in a low-revenue regime in the next few years too. This was to adversely affect the government programs, especially those targeting higher public sector investments in infrastructure, human capital advancement and research and development.

The option available to the government was to borrow more money, both from domestic and foreign sources, and increase the stock of public debt further to unaffordable levels. Surely, this was not a gamble which the government would have played at the present juncture of development of the country.

An alarming fiscal situation in the first four months of 2020

These fears have now been confirmed by the Minister of Finance in his mid-year Fiscal Position Report 2020 just released. In terms of this report, the fiscal position during January-April 2020 has been alarming. The tax revenue has fallen by Rs. 143 billion from what the government had raised during January-April 2019. Government’s consumption expenditure – known as the recurrent expenditure – has increased by Rs. 80 billion.

The reduction in revenue and the increase in the expenditure have caused the government to run a bigger deficit in its revenue account meaning that the government was consuming more than what it was earning or making dissaving in its financial operations. This deficit amounted to Rs. 344 billion in the first four months of 2020 compared to Rs. 152 billion in the corresponding period in 2019. It is an unaffordable 7% of GDP projected for 2020. Consequently, the budget deficit too has shot up to Rs. 452 billion amounting to about 9% of GDP.

This deficit has been financed by borrowing, on a net basis, Rs. 26 billion from foreign sources and Rs. 426 billion from domestic sources. These new borrowings have increased the debt stock of the government from Rs. 13,031 billion at end-2019 to Rs. 13,483 billion at end-April 2020. This is a further increase in the debt stock as a ratio of GDP from 87%  to 90%.

A flattened U-shaped recovery 

Thus, the budgetary outcome in 2020 and in the next few years will not help the government to undertake the needed expenditure programs to realise a quick economic recovery. Contrary to the prediction of the Central Bank that the economy would grow at a reduced rate of 1.5% in 2020, the available information point to a negative growth of about 6% in 2020 followed by a slow recovery in the next few years. Economic growth would become slightly positive only after 2024 due to the prolonged effect of C-19 pandemic. Accordingly, it would be a flattened U-shaped recovery and not a quick V-shaped recovery which Sri Lanka would realise in the post C-19 period.

Need for postponing tax reforms 

Noting these adverse developments, I argued in a previous article in this series in May 2020 that the government should suspend the implementation of the tax reform programme immediately (available at: http://www.ft.lk/columns/Constrained-fiscal-space-for-post-COVID-19-reconstruction-Consider-postponing-costly-tax-reforms/4-700327). Given the need for introducing measures to have a quick economic recovery, I argued that the present state of the economy does not support trying out costly economic reform programmes. They should be postponed for implementation until the economy returns to normalcy and it would be after 2024.

Difficulty to borrow from external sources 

As it is, the government itself has created a huge budgetary gap which has to be funded by resorting to borrowing. Its ability to borrow from foreign financial markets has been impeded by the eroding confidence which the investors have about the bonds to be issued by Sri Lanka. This is evident from the deep discount at which the bonds already issued by Sri Lanka is trading in the secondary markets for same. Before March, these bonds were traded at a premium. But today, they are traded at $ 94 per $ 100 bond in the case of those maturing in October 2020 and at $ 66 in the case of those maturing in 2030.

The other bonds maturing in between are traded at prices within this range. What this means is that if Sri Lanka goes to the market now to raise funds for undertaking C-19 recovery programmes, it has to offer those bonds at a relatively higher yield. Hence, the government has resorted to other tactics like getting a SWAP facility from India or entering into a REPO with the Federal Reserve Bank. Both these measures would help the Central Bank to boost its foreign reserves but not the government to finance the budget.

As a result, the increased expenditures have been funded by borrowing from domestic sources. There-again, these borrowings have been made principally from the Central Bank and commercial banks – two inflationary sources of financing.

In these circumstances, it is a flattened U-shaped recovery that Sri Lanka could bargain for at the present moment. If it desires to have a quick V-shaped recovery, its government has to put its house in order by attaining a sufficient fiscal space to undertake expenditure programs.

*The writer, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at waw1949@gmail.com

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Latest comments

  • 3

    what is a flattened U
    a flattened U is a straight line a dash? ie no recovery?

    • 3

      Flattened “u” means the it started from to decline from 2013 and would take many more years to increase and to show positve. Yes, it will take long to recover with the stupid leaders being the head of states. No hope at all. Not just for the economy but also regarding COVID’s bell curve flattening. I have added enough info that srilankens did it to some extent, but they could do lot more better if indecent and unethical brother duo would have been whole hearted.
      But self glorifications and congradulations as usual would work pleasing gaping gawky masses across the country, specially in rural corners.

      • 3

        leelagemalli – absolutely…that was a tounge in cheek comment by me.

        yes absolutely no economic recovery at all

  • 4

    I profusely thank the top-dogs of this webpage for keeping me busy in exposing the sordid doings of the much-despised Rajapuk’s.
    In my opinion and studies, I have been able to ascertain ever since the 1956 poll where the blue-shirted SLFP led by the doubtful SWRD Banda’s has to this second been on a downward spiral and in layman’s parlance KOTA UDA.
    With the advent of godfather China’s generous gift to the world the whole world’s economy has gone bankrupt – kaput. and to come back to a degree of normalcy it will take the once strong economies of the globe many a yonk to recover.
    The sad fact that to this moment no vaccine of any sort has been found to bring much-needed relief to the affected who are increasing by the second.
    As one who has been doing business in Australia ever since 1988, I have been able to come to the conclusion that the Australian economy was in recession but the governments of the day especially the Liberal/National who are the present rulers pat themselves on their sore backs stating that the economy is growing and is on top of the world even though all the indicators are and were going negative.

  • 15

    Sinhala ladies go to Middle East, work hard and bring foreign exchange.
    Tamil and Muslim businessmen eat that foreign exchange to import everything possible under the sun and get rich.
    Dong keys in Diyawannawa import luxury vehicles, sell them and get rich (Rs. 35-40 million) overnight.
    Gamarala and Dr. Bond imported bullet-proof cars.
    Politicians go for ‘Study Tours’ but they do not study/learn anything.

    • 6

      Srilanken economy was made highly dependent on export poor sinhala housemaids and drivers to middle east – was in the high days of MAFIA BOSS and his Mugabe style govt. Now his brother being the president, the manner the current adminsitration treats those poor people roaming and littering in ME cities prove well about the human nature of Rajapkashe genetics.

      Each time, waiting for my transit in a middle east country heading either to Srilanka or transatlantic destinations, I get to see, poor labouerer women/men roaming inthe airports. Be it was that in Doha orDubai, that was the case. Some sleep under the benches and most of the srilanken women are among them.
      Prior to cheap labour export from Srilanka, srialnka’s economy was based on sTEA, RUBBER and COCONUT as the main source to bring foreign exchange to the country apart from tourism industry. Those days, uni professors from Europe spoke to me about the beautiful landscapes of the island, becuase it was their dream paradise for thier annual holidays.

      • 6

        However, bastards dominated mafia culture was started with Beliatta Rascals becoming sun gods to stupid masses inthe country since they licked the bo trees from dawn to dusk fooling and tricking on the vulnerable for their selfish gains.

        Evem down syndrome patients would be regarded as intelligent and brave, so long they would not open their mouths. Likewise, so long press shying GOTABAYA would stay away from the press to enlarge the FAKE picture drawn in the hearts and minds of the masses until votes are grabed for their power abuse.

        Give us one single good thing Gotabaya to have acheived in his current adminstration to be treated with ” wow effect” ? That gramasewaka led former govt achieved lot more alread in their ” 100 day program”: Now indecent sons becoming leaders, enjoy SUVAWSARIYA or others that the former govt succeeded during that decent 4.5 years.

    • 2

      Dumb racist Eagle, so the inference one makes from your statement is that Sinhala men are so lazy they send their ladies to work in the ME and squander all the money they remit. So you now know whom to blame!

      • 1

        Sinhala men go as Professionals or skilled workers. They do not use self-inflicted wounds to get asylum and work as toi let cleaners like some other men.

    • 5

      Eagle Brain Dead Blind Eye

      “Sinhala ladies go to Middle East, work hard and bring foreign exchange.”

      while the Arab Ladies progress themselves in all kind of fields, including Inter Planetary Travels.

      Sarah bint Yousif Al-Amiri Minister of State for Advanced Sciences is firing rockets to Mars has plans to develop the state further in the field.

      UAE created 50 years ago.
      Ceylon/Sri Lanka was dead in 1948 and buried in 1956.

      Dumpasses elect dumpasses and send their women folks to Middle East Medieval countries as if it is the greatest scientific achievements.
      Shameless dumpasses make sure their women folks toil like donkeys, send every dollar back to them, so that dumbasses could have a jolly life back in this island.

      • 1

        Native (Fake) Vedda,
        At least Sinhala ladies go and bring money but what other ladies do. They stay at home and become breeding machines. When checked for Corona victims, they found a house where there were 14 children. That is the output of about five Sinhala families.
        Tell your ladies to do some productive work and earn money instead of increasing the number of mouths to feed.

    • 1

      Eagle Eye is having a drink of arrack today
      he got 12 thumps up and 6 thumps down
      he is happy

  • 4

    A well researched article by a good economist. Restoring the VAT to 15% and reducing the VAT limit may become a necessity after the election, while protecting the low income segment.

    The only option available to the government to create jobs is foreign direct investments and fully funded infrastructure projects like the light rail project and the maligned MCC road development projects. It is doubtful that there will be any investors who are prepared to consider joint ventures with CEB or CPC and hence they need to be replaced by export oriented large scale investments in Hambantota, with guaranteed purchases by CEB and CPC at international FOB prices.

  • 2

    The mobility of people, for work, health, education or pleasure, from country to country is to be curtailed if not totally disallowed
    It is clear that collective action at the moment is our only hope. We are all going to start developing a lot of new habits, Whether or not we want to,
    Will dress codes at offices get more casual? will we Habitually stay 6 feet away from people in publc Will we stop hugging each other

    The way we socialize and interact with people in public could change dramatically
    energy consumption is being shifted to things like excessive internet use through streaming, online learning, and work conferencing.

  • 0

    There is nothing to be pessimistic about. There is a silver line.the recovery may take time and it may be a flattened U -shaped rather than “V” shaped.

    Nevertheless,according to Export Development Board EDB, The bounce is back – Export Performance June 2020.

    It is certainly impressive to see a strong V shaped recovery in the export sector,
    Exports had bounced back.

    Total export earnings for January to June 2020 was US$ 4,362.34 Mn compared to US $ 5,929.74 Mn. – a decline of 26.43% as per custom statistics..

    It is only earnings from merchandise exports.

    It is an impressive outcome indeed !

  • 1

    A well researched article from a well known experienced professionals. None of the Mahinda Family and those Buddhist Monks who support anti racism do not understand the impact of Corona in the economy because they are well off in any situation. For majority Sinhala Buddhists Federalism and democracy are dangerous and they need Mahinda Rajapakse Family to save this country from USA and India. Their friends in China thought that they can become world number one after Corona but they are now loosing in all front in terms of economic power and military power. India’s economy is suffering from Corona, similarly world economy . Today Buddhist Monks warned that if Tamils asked Federal, North -East will floods with Blood shed. They also warned that Muslims will face the same if any one do not obey them. Srilanka’s hotels are empty and going to be empty for many years. Srilanka is not competitive enough to increse export sector and EU will not continue export subsidy for cloths. Aid is not going to come from any western nation. The money came from diaspora Tamils (including Sinhala) is not going to flow because of dictatorship and no one will trust Rajapakse Family. Gotabaya cannot give 1000 Rs. he promised to plantation workers but Mahinda family already bought Thondaman’s son.

  • 0

    When writing an article use terms that a common man can understand. The flat region U the writer refers may be that economy `will have downfall and remain in the same situation for a long time Their many economic terms that an economic professional try to use in an article COVID 19 has affected the economy of many countries even the US, UK and western world. Government p, policy plays a vital part to revive from the downfall of the economy. Many politicians have no knowledge e of basic factors that affect the economy of Sri Lanka. The labor force is a major factor. The Middle Eastern labor brought n foreign` exchange. That labor `sector is badly affected. one of the reasons is the attitude of the government towards the mulsim community. The tourist sector long with the hotel industry and investors are badly affected. This could be seen from the way the value of SLR is dipping in value and going far below the Bangladesh currency. About few decades go One I is of lower value than SLR Noe it is one IR is three times valuable than SLR What are the reasons for this decay? he foremost thing is the ethnic policy of the government and corruption.

  • 0

    There are about 10,000 Sri Lankan Government Pensioners, living in Foreign Countries earning about 250 million rupees monthly as pension. Many of them, though living abroad, use their pension money in Sri Lanka itself. But from late last year, the Director General of Pensions (D.G.P.) had forced the Colombo banks not to permit the pensioners to transfer their pension money to their accounts in other banks in Sri Lanka itself or to their relations and friends in Sri Lanka – but is encouraging the pensioners to get their pension money transferred to their bank accounts in the countries where they reside.

    Are the D.G.P., the 4 Colombo bank branches where these foreign pensioners’ pension money are deposited monthly by the D.G.P., the Central Bank and the Government not realizing that valuable foreign exchange will flow out of Sri Lanka?


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