28 October, 2021

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Reform Or Perish; It’s Not Too Late

By Naqiya Shiraz and K.D.D.B Vimanga

K.D.D.B. Vimanga

Naqiya Shiraz

The Sri Lankan economy faces a historical crisis. The root causes are the twin deficits. First, the persistent fiscal deficit – the gap between government expenditure and income. Second, the external current account deficit – the gap between total exports and imports. The problems have been festering for too long. Without urgent reforms, the crisis could easily morph into a full-blown debt crisis.

Sovereign debt workouts are extremely painful for citizens. A mangled debt restructuring can perpetuate the sense of crisis for years or even decades. A return to normal economic activity may be delayed, credit market access frozen, trade finance unavailable.

With the global pandemic, these are unusual and difficult times. The next five years are going to be crucial for the country. The problems can no longer be avoided and should be faced squarely. The journey ahead is going to be painful but the longer these are delayed the worse the problem becomes and the magnitude of the damage compounds.

The State of the Economy

The new government inherited a fragile economy, battered by the Easter attacks of 2019, the constitutional crisis of October 2018 and the worst drought in 40 years in 2017. With the pandemic in 2020 Sri Lanka’s economy shrank by 3.6% with all sectors of the economy contracting.

Yet, the pandemic is not the sole cause – it only accelerated the decline of Sri Lanka’s economy that was weak to begin with. The country has long been plagued by structural weaknesses, with growth rates in the last few years even below the average growth rate during the war. Mismanaged government expenditure coupled with a long term decline in revenue have characterised Sri Lanka’s fiscal policy. As of 2020 total tax as a percentage of GDP fell to just 8%, while recurrent expenditure increased.

Borrowing to finance the persistent budget deficits is proving to be unsustainable. Total government debt rose to 101% of GDP in 2020 and has grown since. Sovereign downgrades have shut the country from international debt markets. The foreign reserves declined from US$ 7.6 bn in 2019 to US$ 5.7bn at the end of 2020 and to US$ 2.8 bn by July 2021. This level of reserves is equivalent to less than two months of imports. With future debt obligations also in need of financing, the situation is dire.

Source: Central Bank of Sri Lanka

The import restrictions placed to combat this foreign exchange crisis have failed to achieve their purpose and are doing more harm than good. imports rose 30% in the first half of  2021 compared to 2020 despite stringent restrictions.

The problem lies not in the trade policy but in loose fiscal and monetary policy that has increased demand pressures within the economy, drawing in imports and leading to the balance of payments crisis and consequently the depreciation of the currency.  

Measures by the Central Bank to address this by exchange rate controls and moral suasion have  caused a shortage of foreign currency leading to a logjam in imports.

Source: Central Bank of Sri Lanka

Fundamental and long-running macroeconomic problems were  intensified by the pandemic.Import restrictions, price and exchange controls do not address the real causes.

Treating symptoms instead of the underlying causes is a recipe for disaster.

The continuation of such policies will lead to the deterioration of the economy,  elevate scarcities, disadvantage the poor who are more vulnerable and in the long run lead to even higher prices and lower output due to lack of investment.

Source: Central Bank of Sri Lanka

Sri Lanka’s GDP growth over the last decade has been alternating between short periods of high growth and prolonged periods of low growth. This is a result of the state-led, inward looking policies of the last decade.

A comprehensive reform agenda must be built around  five fundamental pillars:

i) fiscal consolidation – The need to manage government spending within available resources and to reduce debt are paramount. Revenue mobilization must improve but the control of expenditure cannot be ignored. Budgetary institutions must be strengthened and there must be reviews not only of the scale of spending but also the scope of Government.

ii) Much of government expenditure is rigid – the bulk comprises salaries, pensions and interest so reducing these is a long term process. Reforming State Enterprises, especially in the energy sector and Sri Lankan Airlines is less difficult and could yield substantial savings. Continued operation of  inefficient and loss-making SOE’s is untenable under such tight fiscal conditions. Financing SOE’s from state bank borrowings and transfers from government reduces the funds available for vital and underfunded sectors such as healthcare and education. Excessive SOE debt also  weakens the financial sector and increases the contingent liabilities of the state. Therefore SOE reforms commencing with improving governance, transparency, establishing cost reflective pricing and privatisation are necessary. This can take a significant weight off the public finances and by fostering competition contribute to improvements in overall economic  productivity.

iii) Tighten monetary policy and maintain exchange rate flexibility. Immediate structural reforms include, Inflation targeting, ensuring the independence of the central bank by way of legislation and enabling the functioning of a flexible exchange rate regime. Further significant  attention has to be placed on the financial sector stability with a cohesive financial sector consolidation plan, with special emphasis on restructuring of SOE debt.

iv) Supporting trade and investment. Sri Lanka cannot achieve economic growth without international trade which means linking to  global production sharing networks. Special focus has to be given to reducing Sri Lanka’s high rates of protection which creates a domestic market bias in the economy along with measures to improve trade facilitation and attract new export oriented FDI.

Attempts to build local champions supported by high levels of protection have

(a) diverted resources away from competitive businesses,

(b) created a hostile environment for foreign investment,

(c) been detrimental to consumer welfare,

(d) dragged down growth

(e) Structural reforms to increase productivity and attract FDI – Productivity levels in Sri Lanka have not matched pace with the rest of the growing economies. The reforms mentioned above are extensively discussed in Advocata’s latest publication “Framework for Economic Recovery”.

Sri Lanka  stumbled into the coronavirus crisis in bad shape, with weak finances; high debt and widening fiscal deficits. It no longer has the luxury to delay painful reforms. Failure to do so will not only jeopardize the economy; it could even spawn social and humanitarian crises.

*Naqiya Shiraz is the Research Analyst at the Advocata Institute and can be contacted at naqiya@advocata.org. K.D.D.B. Vimanga is a Policy Analyst at the Advocata Institute. He can be contacted at kdvimanga@advocata.org. The Advocata Institute is an Independent Public Policy Think Tank. Learn more about Advocata’s work at www.advocata.org. The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute

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Latest comments

  • 14
    2

    Guys , now that greatest scammer Cbraaaaal is nominated as the gov of CB, your timely recommendations are of vain. Cabraaal seems to have his own recommendations which he believe are worthy of Nobel price nomination. Who else would have thought of Greek bonds, oil hedging – – -.

    • 5
      1

      We are on the verge of bidding to host the next World Cup cricket, Commonwealth Games and Olympics in SL.
      await the news of the people going to all parts of the world on chartered Sri lankan flights with on board parties and and dancing on board.
      Welcome to Cabraal world!

  • 14
    2

    First and foremost Rule of law must be strictly adhered to by the rulers. Over seventy years rule of law has suffered immensely. Rule of law has reached a rock bottom with present government. Even a minister recently committed a criminal act against Tamil prisoners in a state prison. I am sure he will go Scot free or be pardoned by the president!

    Corruption, racism, cronyism, lack of merit based recruitment have all contributed to the Fall of the Sri Lankan state, not to mention its economy.

    Fundamental change in thinking by the ruling class of politicians and the people can only bring about a sustainable positive change; be it, peace, prosperity or progress.

    • 1
      3

      Thiru,
      “Corruption, racism, cronyism, lack of merit based recruitment have all contributed to the Fall of the Sri Lankan state, not to mention its economy.”

      You forgot to mention Tamil and Muslim terrorism that had a devastating impact on the country and the economy.
      LTTE Tamil terrorists massacred 57 Sinhala villagers in Gonagala, Eastern Province of Sri Lanka on 18th September 1999. This is how Tamil terrorists ruined Sinhale.

  • 8
    1

    More articles like this please. Refreshingly educational.

  • 10
    3

    Dear authors,
    Thank you for highlighting the problems of the economy and suggesting for reforms. You have highlighted some of the management problems of the finance and policies that is fine. But you have mentioned that the root cause of the problem as twin deficits as the gap between government expenditure and income. Second, the external current account deficit. These are not root causes but these the outcomes of the root causes. Why there is an expenditure income gap deficit? Sri Lanka had a continuous uncertainty because of the ethnic conflict from early independence period. Have you analysed how the military expenditure increased over the time and how productive is the military investment. You should also consider what is the what is the cost of destroying the businesses and forgone income during the so called riots. You should also consider the impact of tourism during the period of war and forgone investment opportunities. Reforms cannot work until political and social stability. Just imagine if the country have to start a new armed struggle or even mass protect within few months what will happen to the reforms.

    Unless people encourage the governments to create an environment for permanent stability the reforms will at least start to work.

    • 1
      5

      Ajith,
      “Unless people encourage the governments to create an environment for permanent stability the reforms will at least start to work.”
      —-
      Sinhale/Sri Lanka could not have the stability that it required to develop the country after Europeans exploited the country for about 450 years because of racist separatist Tamil politicians who started riots attacking Native Sinhalayo every time they introduced changes to become a truly independent nation. You know very well how they destabilized this country. Even now they are playing the same game.

  • 11
    2

    Economic crisis?
    The cause?
    Champagne tastes with Toddy incomes………..
    Mattala Airport………
    Hambantota Port,,,,,,,,,,

    The Rajapakse Allday Party on loans and more loans……..

    Now the slogan would be Haal Nathuwa Bath Kamu………..

    • 1
      5

      Plato,
      “Economic crisis?
      The cause?”
      —-
      Mismanagement of the economy by ‘Yahapalana’ Government.
      Look at the GDP growth figures from 2015 to 2019.

  • 9
    2

    The $ crisis is even greater for Gota and Basil …… how do they convert their loot into $?

    You have made the assumption that Gota and Basil have come to fix the economy. That’s why serious articles are the best source of comedy.

    • 6
      1

      In fairness to Gota and Basil …….. there is greater talent for destruction elsewhere in the world.

      Lanka has only it’s labor force in the Middle East …….. but these people have the largest reserves of oil …….. although not the best quality crude ……….


      Oil Reserves by Country

      1 Venezuela 299,953,000,000
      2 Saudi Arabia 266,578,000,000
      3 Canada 170,863,000,000
      4 Iran 157,530,000,000


      Crisis in Venezuela

      https://en.wikipedia.org/wiki/Crisis_in_Venezuela#Maduro_presidency

      Now, who wants to blame America, IMF, WB, flying bats, Rambo ………………. for their problems?

  • 4
    20

    Before 2015 election Harhsa de Silva, the expert on economics in UNP told that they know how to fix the economy, how to make loss-making SOEs profitable by introducing a system from Singapore, attract FDIs. He said foreign investors are waiting in the queue to come to Sri Lanka after UNP come to power. People were given the impression that Ranil Wickramasinghe is an expert on managing the economy. Dong keys who got misled by these promises elected ‘Yahapalana’ Government. The chart on GDP growth from 2015 to 2019 show what happened to the economy. We all know Harsha’s Volkswagen fiasco.
    ‘Yahapalana’ Government opened the flood gates and allowed to import every damn thing draining foreign currency reserves. Nephew made the same blunder his uncle did. They borrowed left and right and increased the debt burden. No visible results from the money they borrowed. In 2019, ‘Jadapalana’ Government handed over almost an empty Treasury.
    I wonder whether Advocata advised ‘Yahapalana’ Government how to manage the economy.

    • 3
      0

      EE, you mean the Tamils and the Muslims had nothing to do with the economic crisis. It was entirely the work of the Mahavamsa Morons. Let us send them back to India where they came from.

      • 0
        4

        Cicero,
        “…you mean the Tamils and the Muslims had nothing to do with the economic crisis.”
        —-
        Why not? Tamils and Muslims played their roles by protecting Ranil’s Government. Muslims were in ‘Yahapalana’ Government. Sambanthan as the Leader of the Opposition (unofficial) provided the support from Tamils to Ranil to drag on. Although TNA was the Opposition, they never opposed the Government. Ranil’s Government survived because of the support from Tamils and Muslims.

    • 2
      1

      Part 1 – Chinese loan mess created by self-aggrandisement of past King 2005-2104
      2015 January 8th, the country was handed over to Yahapalanaya, not only with an Empty treasury, but a treasury riddled with all sorts of ills – No proper tax revenue (DIR failed) No proper customs revenue (Vexatious manoeuvering by politicians in power) depleting local revenue to almost nil..
      Add to this misery the indomitable debt burden repayment of the Hambantota expressway, Port , airport, Suriyawewa projects by name, funded by commercial Loans, exorbitant interest rates with no or 5 year grace for to commence repayment in 2nd 2014/15!
      Repayment per year 2.8 Billion US dollars!
      The Jadapaksha oligarchy with the conniver PBJ – ST, the Presidential election advanced end of 2014, repayment grace period for Chinese loans ended.
      Treasury PBJ’s advice “inability to meet repayment post 2014”! This was widely published in media in Sept. 2014.
      If not advanced to end 2014/early 2015, and continued residual term, and held elections 2016, the myth of the King who created myriad of development for the people would be, busted and declared non electable. The economic mess created, & consequent woes to Sri Lankans.
      Emperor unclothed!
      Who is fooling whom?

      • 0
        0

        Mahila, I agree with you. What ever economic recovery took place during MS/RW term should be credited to those few ,who were around and unlike Rajapaksas, RW took their advise and did not interfere much.

    • 2
      0

      Part 11 – Chinese loan mess created by self-aggrandisement of past King 2005-2104 (Karma)
      It is unfortunate that GR shold be saddled with this mess created to fund these projects by “Hook or by Crook or ham or by Bacon” – choose whatever by MR as President, head of cabinet and finance minister 2010-2014 and even before 2010.
      He must have sought sound advice or heeded such advice proffered by the then opposition.
      “HAMBANTOTA FUND” project issue should have been an eye opener for all sensible electors, even though we had a cloudy eyed and more clouded mentalist passing judgement on that occasion, who viewed it from the driveway of the circular road round the Diyawanna Lake (‘Gedera Yanagamang’) and envisioning MR as a Premier and President in waiting! Heart ruled mind!
      That was an irrelevant excuse by any individual and GR would not agree, because it is “One Law One country”, as deemed in his reign.
      He was helpless to intervene at that time as he was abroad and dutifully employed in the US in 2004/05
      Trying rewrite history; facts distorted to make “NEW TRUTH”, for the masses inveigled to elect again.
      Whither Sri Lanka?! Manipulative Thinking
      Facts are sacred!!

      • 0
        0

        Mahila, true that GR was handed a bankrupt treasury but then again it is his choice to be surrounded by the very same people PBJ, Cabraaaal and the rest. Unlike MR his nexus with corrupted businessmen who financed in getting him elected is not a public secret. Giving tax holiday to super rich was GR,s decision on which he won elections.

  • 6
    1

    Firstly, all politicians and diplomats must declare their assets publicly. Non declaration should be made a crime, with large fines. Assets which cannot be explained, must be seized/sold and deposited in banks. All ongoing projects funded from abroad should be cancelled. MPs should be given salaries and travelling allowances, or free travel by state vehicles. Non attendance in parliament should be subject to a fine for each day of absence. All MPs must spend at least 25% of days in their electorates.
    All embassies must cut staff by 50 %. Salaries should be equivalent to public service emoluments.
    All travel abroad must be only for essential national matters.
    No expenses should be incurred for religious matters.
    If all this is done, the national wealth will increase, waste will be minimal.

  • 7
    2

    Is it possible to reform the economy when it is being run by racketeers, swindlers and shysters like Basil, Cabraal and Jayasundera? Their priorities are different. Right now they’re preoccupied with laundering all the black money they have made over the years and getting rid of their criminal liabilities. There is no possibility of salvation for the people of Sri Lanka under the rule of these financial bandits. The urgent priority is political reform. Hopefully the people will realize this and kick them out once and for all at the next elections [if they are lucky enough to have one] and elect a government capable of reforming the political system.

    • 1
      4

      Ajay Sundara Devan,
      “Hopefully the people will realize this and kick them out once and for all at the next elections…”
      —-
      In 2015, dong keys who got carried away by the slogan ‘WENASA’ elected two guys who formed the ‘Yahapalana’ Government. Those two jokers who had no vision to develop the country ruined this country. Eventually, the ‘Yahapalana’ Government turned out to be a ‘Jadapalana’ Government. So, the voters kicked them out not giving even a single seat in the Parliament to the Unpatriotic National Party led by Ranil. Funny thing is, the dong key who ruined the economy is now talking about how to recover the economy from the present crisis. What a joke!

  • 6
    2

    Protectionism is the most wanted commodity consisting of the 6.9 million voters so they can comfortably earn substantial profits from their ventures/investments sans competitive pricing of the market economy. so please empower those 6.9 million to invest their funds so that the economic activity is accelerated, though the unfair pricing will not attract foreign markets and offset trade balance and/or dollars!
    This infantile approach must be thrown out forthwith, like buffoons’ in the loose!
    This Stone Age, international trade is the modality to achieve excellence/supremacy. Being competitive is ‘Sine Quo Non’,
    Cocooned, ‘Caveman’ restrictive/monopolistic practices is unhelpful.
    That is ‘Hog wash’.
    The champions of that cause, in 60’s have learnt bitter lessons.
    1980’s changed their motto and Hymns to suit the times. Open economy/societyto achieving prosperity/superiority, within 35 years!
    Multilane highways in Russia/china/India 50 years ago were hogged by crowded Buses and Bicycles, sprinkling of motor cars.
    Latter, was privileged use by high Russian or Chinese CP officialdom. Not the common man!
    Chines don’t barter Rice for rubber anymore, to fight the Korean War 1951!
    They give US$2.5 Billion Development Loans at Commercial Interest! Alternatively give $ 0.5 Billion currency Swap!!
    See the difference in outcome; will be overtaking US as the world Economic Power this decade!!!

  • 7
    3

    Typical homily.
    Sri Lanka faces three not “twin deficits”; the most important of the three is a deficit of trust and traction in political space. The author’s recommendation are not new, many have been saying this for maybe 5 years (mainly on the ‘right’ but that’s not my point). One element is belt-tightening (why not have the courage to say this explicitly?) This is impossible unless the government of the day enjoys the people’s trust and there is public confidence that a serious policy framework is being adhered to.

  • 7
    1

    Clear and concise article. Thank you.

  • 2
    4

    The best option now is to develop a business canvas for resurrecting the company. I recommend that the country procure the services of business canvas expert Mr Ruwan Fernando. In fact, he lives and breathes canvas. Some say he even shits canvas. Nevertheless, business canvas is the only thing that he talks about day and night.

    Three days ago, the Australian design platform Canva was valued at USD 40 billion. Melanie Perkins, the founder of this company, is now the richest woman in Australia. Melanie’s father is Sri Lankan. A few years ago, Melanie visited Sri Lanka searching for her roots. That’s when she met our Sri Lankan canvas expert who business canvassed her to start Canva.

    Our Sri Lankan business canvas expert Mr Ruwan Fernando is now attached to an NGO called Chrysalis. With his expertise, this NGO will be valued at over USD 40 billion in the coming weeks.

  • 8
    2

    The first act of Cabraaaal within 48 hours , as gov is to fire the person in charge of forensic auditing. She was in charge of forensic auditing Bond scam, recommended by presidential commission,when she detected the paper trail between scammers Mahendran and cabraaal. Now he is free to play stock market 9as he did before) and manipulate treasury as he wish with no person to monitor or blow whistle. Congrats to 6.9 million retards.

    • 1
      5

      Chiv,
      “Congrats to 6.9 million retards.”
      —-
      Sri Lanka got in to this mess because of 6,217,162 retards who voted for Maithripala Sirisena and retards who elected Unpatriotic National Party Government. ‘Yahapalana’ Government was a disaster to Sri Lanka, worse than Tsunami.

      • 3
        0

        Eagle, You mean majority of Lankans are retarded . OMG, Is there some thing in water or what they smoke ???? With great difficulty I have to agree with you on this. But Eagle the question is who is Profound, (in a scale of mild, moderate, severe and profound, in intellectual impairment) ???

    • 2
      1

      Chiv,
      Do you think the 6.9 M are retards? Beg to say no, but add that 6.9 M, helped to identify the retards in the SL community and forever banish them to Ignominy and extinction from the electoral map of SL.
      Otherwise they would have remained in the picture to comeback eveyr 5 years or so by blaming every one else than themselves for the state of Bad affairs in this country!
      Proof of bitter sweet of a Pudding is in the process and outcome will be recognised and committed to human memory, by the process of eating the Pudding

  • 2
    0

    Unfortunately, this is just another run-of-the-mill analysis and policy prescription. The authors do not display a deep understanding of the economy and what ails it. They can be excused: they are young. However, I applaud their courage and willingness to try to address a very complex set of problems.

  • 2
    1

    The most important thing for sri lanka to do is to become more competitive than our huge neighbour india.Currently sri lanka is 84th in rank and india is 68.How do you survive with a huge neighbour more competitive than you.Contrast that with taiwan which is 12th while china is 28th.

    Do we need another infusion of indian settlers to come to our land as they did for the last 2000 years?Hopefully the best in india and not the vijaya mob like characters.Enough of the Ratwattes etc.

    The best and brightest are leaving our shores and contributing vastly to other countries economy.So we must try to draw in the best and brightest from india to become permanent citizens here.

  • 1
    1

    Also we must bring in a system of meritocracy.Otherwise our people’s quality is being wasted.There must be a minimum educational qualifications to enter parliament too.People like arjuna who have contributed vastly to the country in sports and therfore had to forego their studies can be made an exception.many of our parliamentarians are without even ord level qualifications.Our young people mus be thinking what is the point of them getting ord level qualifications if the people representing them don’t have them.take Lohan Ratwatte for example.Duminda silva?They look like morons to me.

  • 2
    0

    why i mentioned duminda was the bullet lodged in his skull without affecting the peanut sized brain.God nows what he is doing now with those resposibilities handed to him by the president.

    as for lohan ratwatte everytime his brain refuses to function due to its lack of capacity he has to start firing in the air to start it again.

    these two look great for the sinhala cinema or something but to lead our country……….phew.

    there are plenty of other morons too in parliament.I think out of the 225 about 100 are w/o ord levels.

  • 2
    0

    what happened to that other joker mervyn silva?he is quiet now.The oly good thing he did in his parliamentary career was to squeeze that monk parliamentarian balls on his first day in parliament and hospitalize him.Other than that i can’t think of anything worthwile he hs done for the country.

  • 3
    0

    Hope the present government does the right thing and take steps to prevent a complete economic collapse.

    Already the Bangladeshi government is braging all over the place about how good the Bangladesh economy is doing. citing the fact that Bangladesh has done a currency swap with Sri Lanka.

    This is becoming a selling point to draw more foreign direct investment to Bangladesh.

    Bangladesh has now overtaken Sri Lanka in the garment industry about 5 years ago.

    What has gone wrong in Sri Lanka??????

  • 3
    0

    There are many untapped natural resources including mineral deposits, limestones, etc. in the north and east. Selling these to China is the only way out of the debt trap. No votes will be lost either. (The government doesn’t get votes from these areas anyway. Nothing to lose.)

    • 1
      0

      gatam

      what about the oil in the mannar basin.That is the way out,if indeed there is oil.

      also what about selling the whole country to the chinese for a trillion dollars?

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