By W.A. Wijewardena –
A country in deep crisis
By any indicator, Sri Lanka is going through the worst of the economic crises in its post-independent history. Noting that Sri Lanka Government has defaulted its foreign debt repayments since April 2022, some have branded that the country is financially bankrupt today. If an entity is unable to meet its liabilities to outsiders, that entity is classified as insolvent or bankrupt. By this criterion, Sri Lanka Government is financially bankrupt.
The manifestation of the crisis
The details of the manifestation of the crisis are well-known and documented. Hence, it suffices only to mention them briefly here.
Real economic growth is in the negative range and has been negative for three consecutive quarters, qualifying Sri Lanka to be officially in economic recession. The budget is fragile with a total gross expenditure level of Rs. 11.7 trillion in 2023 as against a gross revenue of Rs. 3.4 trillion. The consequential gross budget balance is about historically high at 28% of the estimated GDP. The external sector is still not out of woods needing short-term funding lines from friendly neighbours to meet day-to-day requirement. As a result, the rupee is still under pressure for depreciation.
A bailout from IMF in the form of an extended fund facility amounting to $ 2.9 billion over a period of four years is still hanging on balance due to the country’s failure to reach a consensus among creditors for debt-restructuring. Faced with the massive gross budget deficit, the Government has been borrowing heavily from the banking sector. From December 2019 to December 2022, the Government’s net borrowings from the banking sector had amounted to Rs. 4.7 trillion, marking an increase of 167% over this period.
The consequential increase in the broad money stock which the public loosely refers to as money printing has amounted to Rs. 4.6 trillion or 60%. Its effect has been to increase the inflation rate to above 60%. Though the Central Bank says that this will fall to a single digit level by the end of the 2023, it is just a statistical development and prices are still high and rising forcing the real welfare of people down. Hence, Sri Lanka has been hit by multiple whammies making it difficult for the country to arrive in a quick recovery.
Trigger point of the crisis
A question that arises is whether this is a recent development or whether it is an ailment that had infected the country since independence. The answer is yes and no. Yes, because the trigger point of moving into the deep crisis took place within the last three years after the Gotabaya Rajapaksa administration took office. His chief economic advisors had stubbornly maintained that Sri Lanka should adopt a domestic economy based economic growth strategy and it had a more advanced internally drawn economic recovery plan than those proposed by IMF and outside agencies.
When this did not work, Gotabaya should have changed the course, but he was also too adamant about modifying his economic policy. His tax policy, fertiliser policy, and anti-IMF policy were responsible for the economic malaise. But the economic malaise had been gradually brewing up within the system since independence.
It is just worth in mentioning that at the time of independence Sri Lanka had inherited from the British a foreign exchange reserve that was sufficient for 17 months of future imports, a vast resource base by any standard. The country’s foreign debt was just 4% of GDP and the domestic debt, 14%. The trade balance was a comfortable surplus, and it was continued to be so during the first four years of independence too. But things began to change since then and the gradual deterioration of the economy has now placed Sri Lanka in the present crisis.
King Parakramabahu policies
The main cause of the growing imbalances has been the anti-trade policy adopted by successive governments. It was basically like a mercantilist policy in which exports were promoted and imports were abhorred. But this was not the case during the times of ancient Sri Lankan kings. If we consider the golden era of the country’s economic history, the reign of Parakramabahu, the First, we find that all systems had been aligned to create vibrant trade flows, both imports and exports. According to Chulavansa, the second part of Mahavansa, when Parakramabahu became the Lord of the Dhakshina Desha, he had wanted to unite the whole country by waging a campaign against the other lords.
He had asked his Treasurer, the equivalent of the Minister of Finance today, whether he had resources to lead this campaign. The reply was that the Treasury was empty. Parakramabahu had set up a special export processing zone called Antharanga Dhura around Kalu River and exported from the zone various merchandise. That enabled him to wage his war without burdening the citizens. His civil servants’ training school had a curriculum consisting of such skills as fencing, archery, fine arts, and foreign languages. The foreign languages were added because the civil servants should have the capability of communicating with foreign traders freely. If the leaders in post-independence Sri Lanka had followed a similar policy, perhaps, the country would have avoided the current malaise.
Real burden is the unbridled total government expenditure
A criticism levelled against the present Ranil Wickremesinghe administration is that it has increased the tax rates and imposed an unbearable burden on people, especially, the professionals. While it is true that any tax is a burden, the actual burden is not only the tax payments but the total government expenditure. This was the thesis presented by the English economist David Ricardo in the early 19th century. He said that there is no difference between tax financing and debt financing as for the burden of the people. This thesis is now known as Ricardian Equivalence. When the taxes are paid, people bear a burden today by curtailing their consumption. But when the government issues bonds to finance the budget deficit, people should pay more taxes in the future to repay those bonds. Therefore, bonds are a future tax.
Ricardo’s time, there was no money printing for financing the deficit. But today, it is a very popular method of deficit financing among politicians. But if it is done excessively, it leads to an elevation of prices causing inflation in the economy. That inflation reduces the quantum of the real goods and services which people can buy from a given amount of money. That reduction of the real goods and services is like a tax paid by people to the government. Hence, it is known as the inflation tax.
Therefore, according to Ricardian Equivalence, which was further improved by Harvard economist Robert Barro, the true burden is the total gross expenditure of the government and not merely the tax payments made by people. In the budget for 2023, the total gross expenditure is about Rs. 11.7 trillion as against a gross revenue level of Rs. 3.4 trillion. The ensuing gross budget deficit amounts to 28% of GDP which has been estimated at Rs. 30 trillion for the year. The way-out is the shrinking of the Government progressively to an affordable level as dictated by the tax potential of the country. This is the most urgent policy measure which the Government should take today. It requires the Government to prepare a list of priorities for its planned expenditure programs and invest the scarce resources only in the most productive sectors.
What is the way forward for Sri Lanka? That can be analysed in terms of immediate, short-term, medium-term, and long-term actions.
Immediate action to be taken
As mentioned before, the short-term actions include the preparation of a list of priorities for the Government since it cannot continue with the high gross expenditures approved in the budget for 2023. These priorities should be carefully selected in consultation with the opposition in Parliament considering the essential public services which the Government should perform. This is a time where bi-partisan governance is needed. In this bi-partisan system, the executive cannot say that it has no money to ensure the exercise of democratic rights of the people.
The other immediate action is to secure the bailout package from IMF that would provide a certificate of good intention for the Government. Such a certificate is necessary to marshal resources from other bilateral such as friendly governments and multilateral such as ADB and WB sources. It hangs on Sri Lanka’s ability to get China on board with the rest of the creditors to restructure the country’s foreign debt in the form of a reduction in the principal and/or interest involving the debt. China has agreed to offer only a debt moratorium for two years. It will not reduce the debt levels but increase them further. This is a test for the government to prove its diplomatic competence.
After accomplishing these immediate tasks, Sri Lanka should set itself to the short-term tasks it should undertake. That includes the reforming of the state sector – both the central government and state sector corporations – to ensure cost-efficacy, productivity, and efficiency. This requires a comprehensive assessment of the present state, consulting all the stakeholders including customers and officials, preparing a time-bound action plan, and implementing it with periodical progress reviews that involves any modification of the plan if necessary.
For instance, take the digitalisation of the government services. About a decade back, immigration and motor vehicle registration departments were digitalised. But over the years, with no new technology introduced, those systems have now started decaying. This is a pitfall that should be avoided. Some of the local government institutions have computerised the payments to them. But when a citizen logs into their website, a warning immediately pops up that the security certificate attached to them has expired and as a result, they are exposed to hackers. What this means is that it is necessary to continue the updating of the systems as is being done by various computer apps.
Medium to long-term action
President Ranil Wickremesinghe has announced that his goal has been to make Sri Lanka a rich country by 2048 when the country will celebrate its centenary of independence from the British. Previously when he was the Prime Minister, in 2018 he made a similar announcement to make Sri Lanka a rich country by 2025. That was just a promise without any concrete action. The same fate should not befall on the current goal too. For that, Sri Lanka should come up with a comprehensive roadmap with milestones of goals to be achieved over this period. Vietnam in 2019 announced a similar roadmap to make the country compatible with the goals of the Fourth Industrial Revolution by 2030. Its goal has been to increase the share of high-tech exports above 40% of the manufactured exports. The necessary resources have been diverted for achieving this goal.
Integration with the global economy
Sri Lanka’s future prosperity depends on its integration with the global economy seamlessly. The global economy is now ruled by technological advancements taking place almost every day. Twenty years ago, those advancements were concentrated on a few new developments in nanotechnology, artificial intelligence, genetic research, and digitalisation of services such as entertainments. But that number has increased by tens and hundreds today as pronounced by the Davos based World Economic Forum every year. If Sri Lanka is to become a rich country by 2048, it is necessary to jump onto the bandwagon of technology and ride on it. This is difficult but not impossible.
Importance of technology
Sri Lanka cannot be technologically driven nation overnight. Its research facilities at present are not adequate to meet this challenge. But given the necessary inducements and facilities, Sri Lanka can over the years overcome this deficiency. A plan should be devised to help Sri Lankan universities and research institutions to align themselves with foreign universities and research institutions in the interim period. In this context, the abandoned tech city at Pitipana, Homagama, should be immediately restarted. It was expected to serve as an incubator of research and new inventions through collaboration of private businesses and state universities. It should now perform this role with a new vigour.
Sri Lanka cannot be a rich country by 2048 unless it implements a comprehensive plan to reach that goal. It is a long date and during that period there will be many governments in power. If any of these governments abandon this goal, it will be a failure. It is necessary to consult all the stakeholders to reach a consensus about this goal. It requires collaboration and not confrontation that we observe in the political arena in the country. If the President is successful in getting all the stakeholders on board, Sri Lanka can expect to become a rich country within the next generation.
*Excerpts Of A Presentation Before Economics Society Of Kelaniya University
*The writer, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at email@example.com