1 December, 2021

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The Economy Of Sri Lanka: Is There A Way Out?

By Arusha Cooray

Prof. Arusha Cooray

Sri Lanka is currently facing an unprecedented set of economic challenges: a large and increasing public debt, rising fiscal and current account deficits, foreign exchange shortages and declining investor confidence. The collapse of tourist revenues and remittances due to the pandemic, have compounded the situation. Sri Lanka’s foreign exchange reserves are at an all-time low, currently sufficient to cover two months of imports. As a rule of thumb, a country’s foreign exchange reserves should be sufficient for at least three months of imports. The fall in foreign exchange reserves has led to a depreciation of the rupee against the US dollar, making it more difficult to service the debt denominated in foreign currency. Sri Lanka’s debt to GDP ratio currently stands at 101%. Businesses relying on imports are struggling to make foreign currency payables. Prices of essential food items have risen, leading to hoarding and black markets. The government’s ban on the use of chemical fertilizer for farming and the printing of money by the Central Bank, has intensified the situation.

Sri Lanka has responded to these challenges hereto, by imposing capital controls, restricting imports, and engaging in currency swaps. Import controls have led to a shortage of essential goods. Currency swaps and capital controls are short terms measures. There is no strong evidence to show that import and capital controls succeed during a foreign exchange crisis.

Is there a way out? It is imperative that the government undertakes a reform plan that addresses key priority areas to salvage the economy.

Fiscal consolidation: One, is fiscal consolidation. Sri Lanka’s government finances are dominated by expenditure on public wages and government transfers, subsidies, and interest payments on rising debt. Greater effort needs to be made in curtailing current expenditure and channelling these expenditures into more productive use. Cutting down on public sector spending will reduce the large and persistent budget deficits. Continuing budget deficits can undermine investor confidence and crowd out private sector investment.

A concerted effort also needs to be made to reduce the size of the public sector. Sri Lanka’s inflated public sector is in serious need of restructuring. Re-assessment and reform of the number of ministries and government agencies will reduce the wasteful and inefficient use of government funds and increase productivity.

On the tax front, Sri Lanka needs to address structural weaknesses in the tax system. Sri Lanka’s tax burden as % of GDP is 12.6%. The low tax revenue to GDP ratio has meant that Sri Lanka has faced difficulties in meeting its expenditures which have consistently exceeded tax revenues. A large proportion of government revenue has been generated through indirect taxes which are regressive. Tax evasion, moreover, is high. Rather than introduce new taxes which will further burden low-income groups and undermine economic growth, tax management and collection can be improved by focusing on reducing loopholes for tax avoidance and evasion.

Monetary policy: The success of monetary policy in achieving goals has been severely constrained by to the government’s policy of deficit financing. To the degree that the government is induced to run debt financed fiscal deficits, the main function of the money market would be to engage in the sale of government securities to finance the servicing requirements of the government debt. Fiscal consolidation would help raise public savings, contain price rises and enhance the effectiveness of monetary policy. There are concerns further about the Central Bank’s lack of independence. Increasing Central Bank autonomy will assist in insulating monetary policy from the pressures created by the government to finance budget deficits.

The banking sector: The continued dependence of the government on the state-owned commercial banks has not only inhibited their efficient functioning, but also constrained the competition and efficiency of the entire banking system. Political pressures to finance unviable projects and limited incentives for screening and monitoring projects has led to a rising volume of non-performing loans by these banks. Therefore, the government should reduce reliance on these two banks for funding.

The External Sector and GDP Growth: Higher GDP growth can be promoted by diversifying export markets and export sectors and encouraging foreign direct investment (FDI), all of which will help relieve Sri Lanka’s foreign exchange position and rising debt levels. Sri Lanka attracts disproportionately very little FDI compared to its South Asian counterparts. Increased FDI inflows and trade will generate new employment opportunities and increase the tax base. Economic policy, therefore, should focus on developing comparative advantage in a broader range of sectors, rather than relying on a few areas. Entering into trade agreements with countries will also help.

Skill Development: Policy aimed at promoting investment in infrastructure, research and development, learning, competencies and skill development through education and on-the job training will encourage FDI in high-skill industries. This would give local firms the capacity to absorb the technologies and skills that come with FDI. A large proportion of jobs created by FDI in Sri Lanka, are in low paid, low skilled areas. Sri Lanka possess a highly literate population. It has however, not succeeded in harnessing this stock of human capital to foster comparative advantages.

Policy Consistency and Domestic Savings: The sustainability of economic policies will reduce not only private sector concerns about policy reversals and the lack of policy consistency, but also that of foreign investors. Incentives can be introduced to stimulate domestic savings and promote greater participation in economic activity by the corporate sector.

Getting the economy out of this state will not be easy. Sri Lanka possesses several underlying strengths such as a well-developed stock of human capital and resources, which can be built upon, but have not been harnessed to their full potential to foster comparative advantage. Unless policymakers make a concerted effort to ensure macroeconomic stability through a sustainable and coherent reform plan that addresses structural shortcomings in the economy, Sri Lanka will be trapped in a vicious cycle out of which it will find difficult to get out.

*Arusha Cooray is a Professor of Finance at James Cook University, Australia. She served as Sri Lanka’s Ambassador to Norway, Finland and Iceland.

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Latest comments

  • 9
    1

    Professor Arusha Cooray,
    It looks like a very good academic presentation or advise to the Government. You may have to make a lot of assumptions in doing many of those macro economic policy changes in a corrupted political system that is not in favour of country or people. Unless you have a clean political system and stable environment for investment there is no chance for economic recovery. The country never had a political stability for over the period of seven decades for FDI. It is true the public sector expenditure is very high because of the size. Can you reduce the expenditure of defence ministry which eats much of the public money without any productive benefits? If you reduce the size of the military into half What will happen to them and what will happen to government? Corruption among politicians from top to bottom is very high and how to stop that?
    The country need fundamental change in politics, political system, economic systems and social systems. Without that everything is a failure.

    • 10
      2

      “There are concerns further about the Central Bank’s lack of independence. Increasing Central Bank autonomy will assist in insulating monetary policy from the pressures created by the government to finance budget deficits.”
      All our institutions have been stuffed with spineless incompetents afraid of the wrath of an equally incompetent Executive President.
      The simplest solution would be to abolish the LKR and declare some stable foreign currency as legal tender. The foreign monetary authority cannot be coerced by any political clown that happens to be in power here.

    • 1
      2

      Ajith,
      “The country never had a political stability for over the period of seven decades for FDI.”
      —-
      I agree with you. But who is responsible for that?
      It was JVP, racist separatist Tamil politicians who promoted violence and terrorism against indigenous Sinhalayo and Muslim terrorists. Out of these three factors, Tamil terrorism that dragged on for three decades had a devastating effect on FDIs.

    • 0
      3

      Ajith,
      “Can you reduce the expenditure of defence ministry which eats much of the public money without any productive benefits?”
      —-
      Ensuring security is a productive benefit. Sri Lanka has to incur huge amount of public money to ensure security because of Tamil and Muslim terrorists.

      • 4
        1

        EE,
        Your brain is full of venom which is covered by Buddhist Sinhala Fundamentalist Terrorism. If you get rid of that venom from your brain you will be a Lord Buddha.

  • 5
    5

    “Sri Lanka is currently facing an unprecedented set of economic challenges “
    This is a classic example of the Sinhala Intellectuals’ convolution of attention to the problems masses facing in Lankawe. Purposely, narrow focused start to introduction of the Lankawe problems of the masses, in an attempt to make it appear as honest financial mismanagement while it is colossal racist actions. Hiding the racial divide, used from Don Stephen time for personal gains of rulers, in the academic studies of budget, is very poor analysis of the budget and Lankawe’s economic problems. The current status of the country is because the existing problems were aggravated by covid-19 shut down. That part is accepted. Country is not ready to absorb an extra inch of rain, in the rainy seasons. But when in the 1960s, India faced famine, Ceylon diverted its shipload of wheat for India because the country was having good stock of anything and prepared to face much bigger disasters. Bangladesh was the poorest country in the hemisphere when it was oppressed by West Pakistan. Now it is going to be one of the 10 richest countries in two decades and already lending to its poor & pity neighbor Lankawe. The Time has passed for Sinhala Intellectuals (the Viyathmaha gang) to be honest and true in their talks. Time for Tamils to go alone.

    • 1
      2

      Mallaiyuran,
      “Time for Tamils to go alone.”
      —-
      No problem. Use the ‘Saloon Door’ that indigenous Sinhalayo have fixed to their country.

  • 3
    4

    The country’s only refinery is shut because there is no raw material to process. The government donkeys explained that there won’t be any shortages of oil products because we don’t depend on the Sabugaskantha refinery. Damn, if the donkeys have money to import processed oil products, why didn’t they import enough crude oil in time so the refinery can keep going and produce it locally? 100% of Kerosene used in the country is coming from this factory. People are substituting kerosene for LPG and gasoline; How many contracts Ganapathi Pillai has already signed to import the kerosene for additional uses? Why did they invest money in the refinery, first? if putting idling & importing oil products is better, then depreciation cost is eliminated for consumers? Why this poorly administered refinery is not closed and extradite Ganapathi Pillai to Australia, where Grand Larceny charges pending? The current cabinet wants to get IMF finance. The Joint Comedy Club chiefs, who tore off the Yahapalanaya that time, is now challenging the Slap Party if it can agree with IMF economic guidances and fetch financing from IMF. (Sorry we are noy crying for Yahapalanaya and Ranil’s party’s demise). Then who is really asking for an economic consultation. Communists are only calling for China loans for exchange of local land.

  • 3
    4

    China is playing all kinds of bullying on Lankawe to feed their Hunu into the hungry mouths of Lankaweyans. First, they refused to give time to NPQS to test the Hunu for germs. Then they argued that the NPQS test is not valid because they didn’t take enough time to test. Then the Ambassador released a threatening press notice that China will break up its relationship with Lankawe if Lankawe is not assimilating the Hunu but vomiting it. Then they filed a case in Lankawe court for collection of LC payment. Then the company said it had received the payment from its bank so People’s Bank must pay for their Bank. LET me ask a stupid question based on my level of intelligence. If the Chinese bank has paid to the Hunu Company, isn’t the remaining problem between the People Bank and the Chinese bank; then why the ballige putha, Hunu Company is still barking in this matter? Then, China pressured to have the Hunu tested at a lab that they could accept. Then they, one snidely tested in their client’s lab and threatened Lankawe for defamation. (The Client lab has said that they tested some substance which was given to them by the Chinese company. That is not anything near to a product certification for import-export purpose.)

  • 4
    4

    Remember, still it is not known why China didn’t contain Covid -19 in China. China never allowed UN doctors to satisfactorily detect the reason for the pandemic spread. The whole world threatened to sue China on that. That China is now want to sue Lankawe at UN for breaking the Hunu contract, under that China attempted to dump infected Hunu in Lankawe, as per Appe Aanduwa. Then Ambassador blacklisted People Bank.

    That China’s action badly affected the credit rating of Lankawe. Standard and Poor devalued once again. Appe Aanduwa don’t blame the Ambassador who blacklisted People Bank but blamed that the credit rating company was sabotaging their Budget presentation. China asked for Hunu ship idling cost and coming back cost while having the ship forcefully anchored in Lankawe waters, violating international regulations. (No talk about cancelling the wrong contract). Now, the Chinese Ambassador is saying that he was doing some trade negotiation, but the ill -willed Colombo media described it as a nuclear war between China & Lankawe! He says the nice baby, Lankawe, has conceded that Lankawe don’t even have a lab to test garbage, so it will accept the China’s client’s lab’s test results. (Then how are they testing for the latest virus, Covid 19?). It is for that extent Lankawe has surrendered to China.

  • 3
    4

    Now our Communist Pakkya, Ganapathi Pillai, Lemon Puff Veeraya are saying that they will fight to death if the IMF facilities are taken, which the other cabinet ministers want to go. These are pus dripping brain headed people, man! Then who wants to do economic consultation for these communist donkeys.
    By reading Colombo Media’s reports, can somebody explain to me the financial and economic implication involved in the China Hunu import Drama of Appe Aanduwa? If you don’t know, I tell you about it. When Siri Ma O faced exchange shortage, she wanted to load that trouble mainly on Tamils’ heads. Communist MN banned serving rice on Fridays, the Hindus’ Tamils fasting day of the week (Say it as their Poo Aiyya day). MA O Madame banned most of the spices and beauty, dress products Hindu Tamils use, and which come from Hindu India. Jaffna peninsula, which suffered most because of this ban, recovered by introducing home gardening and local weaving looms. North produced, consumed and transferred to South the extra produce. It was the North that first recovered from those problems. Then JR dismantled that set up by importing unlimitedly and expanding southern irrigation systems to overwhelm Northerners’ well water farming.

  • 4
    4

    It appears that when faced with the current exchange dollar shortage, Royals could not import fertilizer from China for land pledging, but it offered only unsolicited Hunu. Royals wanted to imitate Madame, Ma O. Royals changed the wording for Modayas as Eco Farming and band using fertilizer. These donkeys have no idea of what to do and when to do. The Royals just blindly shut off food imports and fertilizer imports, hoping those areas to magically grow, locally. Keynes said if the government infuses some resources into the stagnant economy, it will grow more than the infused money ($10 may uplift the economy by $20 level, so if you put $10 in $80 economy, it will grow as $100 economy, but not it will stop at $90). On the other hand, if the government withdraws resources, the economy will shrink more than what the government withdraws. That is what the downturn we are facing now. To manage the exchange shortage, the government shut a side (imports) of the economy; that has aggravated the severity of the economic problem. That is the truth. That has nothing to do with the Budget 2022. The Budget was made only to promote the Vista for the coming election, but not to bring relief for the people affected by various conditions.

  • 5
    1

    This is a rational 45-minute critique of the Budget by Sunil Handunetti, the JVP’s spokesperson on Economic Affairs.
    .

    https://www.youtube.com/watch?v=PuH08IfAJAI
    .
    It is in Sinhalese, but those Tamil speakers who understand a little Sinhalese will be able to follow because he speaks clearly and without jargon.

    • 2
      4

      Sinhala_Man,

      I don’t understand Sinhala. But I just saw two, three points of his talk about the looming power problem for the entire country. (But, I don’t know if the people are interested in kind of talk but their fears get invoked only after standing in the line for their purchases). I know that he is a good talker; bring out points from foundational- basic level. He said about the 2014 election budget which was full of bribes, rather than calling those as relief: “My wife came from school and ask me, their(government) budget looks good, and everybody thinks so too, then why are you opposing it?” . When when Chitanta government lost the power in two months after that mesmerizing budget presentation, Ranil, Ravi and Mahendran gambled at Central Bank because the treasury was flat empty.

      • 1
        5

        Mallaiyuran,
        “I don’t understand Sinhala.”
        —-
        You followed GG Ponnambalam’s instructions to the letter. This is the problem with Tamils.

      • 1
        0

        Thanks, Mallaiyuran,
        .
        At least you made the attempt. Language is a huge problem for most individuals. I don’t know Tamil. I think that some have an aptitude for languages, and those who don’t have the gift are lambasted. At least both of us have two languages.
        .
        Prof. Arusha Cooray has said that we have “a highly literate population”. True, almost all can write their names in a language, but our people are not “educated” – they don’t understand concepts that are vital for planning life today.
        .
        Ask them how old the world is. I can’t, myself, answer that off-hand, but that it is so old as to dwarf our individual lives to negligible proportions should be understood. Evolution must be understood. That the “Sun” (a medium-sized star) created and sustains life on Earth is not understood. Just ask and see what we are told! If understood, we will care for the environment.
        .
        Instead, too many quote religious “truths”. Hold on to the myths as allegorical, and work out system of ethics based on them, but not metaphysics!
        .
        English as a World Language gets ever more important. Teach it, but respect other languages as well. However, there now is a proliferation of University Courses, where neither Lecturer nor Student knows English, but we imagine that they do a lot of good.

  • 6
    2

    An excellent analysis, but who is listening? Is the government/finance minister listening? As rightly pointed out by Ajith above, the country has seen no peace due to communal politics since independence. The majority Sinhala – Buddhist voters have been brainwashed by scheming politicians to believe that their prosperity depends on subjugating the minority Tamils and Muslims.

    For economic development, political stability is a must. Political stability is the condition of the government of the country that precludes the possibility of open revolt because the government is governing justly, people are content, the leaders are free from corruption and citizens benefit from progressive policies.

    The public service, including the Central Bank, has been politicised by politicians both ruling and opposition and as a result, the economy is limping, crawling and collapsing.

    • 1
      2

      Thanga,
      “…the country has seen no peace due to communal politics since independence.”
      —-
      Communal politics of racist separatist V-Tamil politicians in Yapanaya.

  • 3
    2

    Arusha Cooray,

    Yours is the typical UNP financial plan, such that JR executived himself with the presumptuous belief that money would flow from thin air, with the capitalistic jump-start. It put the Motherland into greater misery.

    Public wages and subsidies are important for the sustenance of the average man. The fiscal consolidation that you mention will hurt the average man’s livelihood. The average man is the one that brings in the money after working at hard labour in the Middle-East. The private sector makes use of the loans from the country’s wealth (brought in by the ME workers), to make profits for themselves. Or from loans from other countries, that the average man will have to eventually pay back. It is then correct that some of the country budget goes back to them for public wages and subsidies.

    • 3
      0


      But I agree with some of your plans. In the midst of it all, it is unbelievable that current government is building all these unnecessary highways and racing-tracks that won’t pull in any revenue for the several decades, if ever, considering the b.o.p., and that will drive the country into greater debt. As a country in severe debt, we cannot speculate on a “Fiat” for development based on a country like America’s development that began 100 years ago (with vehicles), or on China’s that came out of tight communist budget consolidation for over 75 years before bursting out temporarily into capitalism.

      And on top of that are the Panama and Pandora accounts stashed away as personal profits instead of being reinvested into the country to assist the masses who made their money in the first place. These are huge, probably 75% of the country’s GNP. Instead, masses are taxed in all kinds of hidden and deliberate ways that creates even more misery for them.

      Then is the cryptocurrency situation, where much untaxed money of the country has been placed, so it can Never be taxed. These scenarios are what happened during the time of the French Revolution. Country should Revolt!

  • 0
    4

    The good symbolic action to strip or denude the worry of the economic failure of the nation from the mind of the masses would be the Chief Justice of the Supreme Court walk to the Tomb of Don Stephen, wake him up, pass verdict of capital punishment for murdering the country’s future prosperity by deporting the estate workers, then hang him in 1950, i.e. before he fall from horse. Then the CJ has to carry the efficacy in parade and re-bury. This is how the Vijeya No2, who too debut a new nation with in-washable sin, can be cleaned and the nation can be redeemed from the continued curses.
    Jeyawewa for Appe Rata! (Just leave alone Tamils)

    • 2
      1

      Mallaiyuran,
      “…murdering the country’s future prosperity by deporting the estate workers,..”

      If D.S. Senanayake deported not only the estate workers but those who were brought to Yapanaya by Portuguese and Dutch as well, probably Sinhale would have been better off. No separatism and no terrorism.

  • 3
    0

    Wrong plan.

    The biggest problem is the massive public sector. It must be reduced.

    Remove the provincial councils system. We do not need 10 ministries each for the same thing!! 10 times the same thing done.

    Remove local government bodies too.

    Why are there 8,000+ politicians, their ministries, support staff, etc., etc. for a small island like SL? Makes no sense.

    These 2 things can save billions of dollars every year. All economic problems will be over.

  • 0
    0

    If there is a will , there is a way .Our economic crisis is chiefly due to lack of will .
    Lack of will among the public and the same among the leaders . And then
    even knowledgeable leaders who are blinded by selfishness that serves only
    their group , individual and family interests and ego. Clearly the country is not
    first to any of these groups or individuals . How can such people attract business
    local and international ? The world wants not only quality products but also
    quality people to produce them . The trend is becoming the same even among
    the locals but where are the leaders off to ?

  • 0
    0

    This is a well written article but highly theoretical As long as corrupt leaders hell bent on earning commissions run countries like Sri Lanka. The ruling family has siphoned away money from all projects carried out with loans. Can you imagine 4000 million paid just before the 2015 election for the Nilwala scheme where not even sod of soil is cut. All this money end up in the ruling clan’s pockets.
    Even if SJP comes into power they will protect the corrupt family. UNP or SJP/PP are two sides of the same coin. The only alternative for people who want a better country is the JVP. Let them be given a chance and see how they do it. When they had some powers in a previous regime they showed the country that they are different from the rest of the ministers.

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