Colombo Telegraph

Sri Lankan Economy Heading For A Depression 

By Milton Rajaratne

Professor Milton Rajaratne

Depression is defined as continuous fall in national output for a several years. Sri Lanka’s national output began to decline from its peak of 9.1% in 2012 and ended as 3.1% in 2017. In the first quarter of 2018, national output runs at a level as low as 2%. Performance of the economy and the success or failure of the government’s role in maneuvering the economy is presented in the annual reports of the Central Bank and it has confirmed that the output has been drastically declining and the economy as a whole performing poorly. This article compares and contrasts the state of the economy in 2017 with that of 2014 in order to assess the direction and performance of the economy in the new policy regime. Among 30 different criteria presented in the table below, only five have shown slight progress whereas 25 have failed in contrast to their values in 2014. As this is a mere continuation of failure since 2015, this article analyses economic implications of the five improved areas. 

Selected Macroeconomic Criteria – 2014 & 2017      

Criteria 2014 2017
1 Economic Growth Rate (%) 5.0 3.1
2 Private Consumption (%GDP) 67.4 62.2
3 Unemployment (%) 4.3 4.2
4 Gross Domestic Investment (% GDP) 32.3 36.5
5 Gross Domestic Savings (% GDP) 29.9 29.3
6 Change in Consumer Prices (%)  2.1 7.7
7 Change in nominal wage index (%) 3.7 0.0
8 Trade deficit (US$ bln) -8.3 -9.6
9 Export Earnings (US$ bln) 11.1 11.3
10 Import Expenditure (US$ bln) 19.4 20.9
11 Gross Official Reserves (for months of imports) 5.1 4.6
12 Debt Service Ratio (% Export income) 20.8 23.9
13 Public debt (% GDP) 71.3 77.6
14 Foreign debt (% GDP) 30.0 35.5
15 Exchange rate (Rupee/US$) 131.05 152.85
16 Government revenue (% GDP) 11.6 13.8
17 Government expenditure (% GDP) 17.3 19.4
18 Budget deficit (% GDP) -5.7 -5.5
19 External borrowing (% GDP) 2.1 3.3
20 Interest rate (FDs at Savings Bank) % 6.5 11.0
21 Lending rate % 6.2 11.5
22 All Share Price Index (units) 7299 6369
23 Value of shares traded (SLR bln) 340.9 220.5
24 Non-national net purchase (SLR bln) 21.2 17.6
25 Market capitalization (SLR trln) 3.1 2.8
26 Manufacturing (% of GDP) 15.7 15.7
27 Industrial strikes (Man days lost) 37,000 58,279
28 FDI inflow (US$ million) 1528 1375
29 Capacity utilization (factory industry) 81% 78%
30 Incremental Capital Output Ratio 6.5% 11.8

Annual Report – 2017, CBSL.

Government revenue has improved from 11.6% to 13.8% during the three year period. This is due to widened and deepened tax net. On the contrary this siphons moneys from individuals and industry. Thus increase in government revenue through tax income has adverse repercussion on consumption. This causes decrease in private consumption in the first round. This leads to inventory accumulation and production cut consequently which curtail factor income causing contraction in national income. As government’s expected income drops due to economic contraction, government tend to widen and deepen tax net in the second round to increase income or otherwise fills overall deficit through inflationary sources. As this cycle deepens a vicious circle of economic depression and inflation are experienced. The continuous decrease in GDP from 5% in 2014 to 3.1% in 2017 and 2% in the first quarter in 2018 can partly be appropriated to this phenomenon. However, if the government spent tax revenue to generate new revenues, then this process is cancelled out and GDP is recuperated. Government expenditure has increased by 2.1% while government revenue has increased in 2.2% during 2017 and as a result budget deficit has decreased slightly. The increase in expenditure is mainly due to uneconomical projects that do not generate new incomes. As there seems to be an expansion in the budget deficit of Rs. 733 billion this year which requires financing through loans or other means that eventually causes tax or price increase during the year. 

The improvement of unemployment rate from 4.3% in 2014 to 4.2% in 2017 indicates a progress of 0.1% during a three year period. This comprises a large portion of recruitment into government service. As the job market has shrunk due to growth contraction, new employment opportunities have not been generated in the private sector to a satisfactory level. The growth contraction is mainly due to decrease in private consumption and poor exports. Unsatisfactory job creation has withered the one million job creation program. The much expected employment opportunities from FDI and foreign employment also have dwindled due to falling FDI inflows and failure to harness foreign employment opportunities.           

The increase of gross domestic investment (GDI) from 32.3% to 36.5% during this period is remarkable. According to theory, there should be an ascending relationship between GDI and GDP growth rate. However, contradictorily, descending relationship between the two has been reported; GDP growth rate has decreased from 4% in 2016 to 3.2% in 2017 while GDI has increased significantly. The relationship between GDI and GDP is explained by the concept of Incremental Capital Output Ratio (ICOR). This measures the units of capital required for a unit of growth in GDP. In 2017, this ratio has been 11.7:1. That is 11.7 units of investment are required to generate one unit of economic growth. In Sri Lanka, throughout the past decades this ratio has been generally 5:1 i.e. five units of investments bring about one unit of GDP growth. The government utters 7% of economic growth in the coming years. According to ICOR calculation for 2017, there should be 82% of GDI to gain 7% of economic growth which is beyond imagination. 

Export earnings have marginally grown by 1.8% from Rs. 11.1 billion to Rs. 11.3 billion during three year period which in other words is US$ 70 million average increase per year. This growth should be seen in the context of rapidly depreciating rupee during the period. It is believed that depreciating local currency is helpful in boosting exports. Sri Lanka’s exchange rate against US$ has depreciated by almost 30 rupees or by 20% during the period. If exports were stimulated due to rupee depreciation at this rate, export earnings could have soared at least by US$ 2 billion. This suggests that the government has failed in its export promotion drive together with FDI led export promotion. Although FDI has picked up in 2017, it has not significantly contributed to boosting exports. This encourages us to conclude that new FDI has focused more on local market than export market which is less advantageous.                

Above discussion reveals that the four indicators, out of 30 as indicated in the above table, that have shown progress since 2014 also have encountered macroeconomic complications. The economy has become almost numb and thus irresponsive to policy measures introduced since 2015. This ailment of the economy can be observed from several symptoms. They include irresponsiveness of output to increasing domestic investment, irresponsiveness of exports to increasing FDI, irresponsiveness of exports and imports to depreciating rupee, irresponsiveness of the production system to increased government expenditures. Additionally, hyper sensitivity in sectors of the economy has caused several problems which include increase in cost of production due to increase in factor costs, decrease in real consumption due to taxes and increasing consumer prices, and the vicious cycle of tax. In general, the performance of the economy in 2017 is mostly a continuation of policy failure since its onset in 2012. 


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