Navigating The Economic Reawakening & Sustainable Growth

Dr. W.A Wijewardena

Bankruptcy and remedial measures

By any standard, Sri Lanka is recovering from economic bankruptcy today, though chief economic policymakers seem to be disputing the claim of bankruptcy.i In the case of a private venture, bankruptcy means inability to honour financial obligations to outsiders due to its financial net worth becoming negative. By the same token, the bankruptcy of a country means that it is not able to honour its debt obligations to foreign creditors or a given segment of foreign creditors.

In April 2022, Sri Lanka announced that it will not honour the debt servicing obligations – that is, repayment of the principal and payment of interest on the debt when they become due – in the case of two selected foreign creditors, commercial and bilateral creditors. Since then, several policy measures have been taken by Sri Lankan authorities to get out of the economic crisis and place the country on a sustainable growth path.

Sri Lanka applied for an Extended Fund Facility (EFF) from the International Monetary Fund (IMF) to support the external sector stability, on one side, and establish credibility among the foreign donors, on the other. This facility amounting to $ 2.9 billion was granted to the country by IMF in March 2023 subject to an IMF supported reform program concerning the fiscal sector, monetary sector, external sector, and the real sector. Sri Lanka met all the quantitative and structural benchmarks agreed with IMF except the requirement to agree on a viable debt restructuring with commercial and bilateral creditors. The foreign debt restructuring plan is presently being pursued and the governmental authorities have expressed confidence that it could be completed by June 2024.ii This is a postponement of the target date which earlier had been fixed for September 2023.iii

In the meantime, inflation rate has been brought down from about 70% in September 2022 to a single digit number by end 2023. The exchange rate which fell to Rs. 370 per US dollar in mid 2022 has now been stabilised around Rs. 320 a dollar. Economic growth which was in the negative region for six consecutive quarters since January 2022 made a turnaround by the third quarter of 2023 promising that in 2024 and beyond, the country will have a growth albeit at a low rate.

Low-level equilibrium

The state of the economy attained by Sri Lanka has been termed a low-level equilibrium in which the output is below the potential by President’s economic advisor, Dr. Sharmini Cooray, who delivered the Central Bank Anniversary Oration in 2023.iv Emphasising that the country’s economic crisis is not yet over, she had noted that the way out has been to “grow at a rate of about 5-6% a year in a sustainable inclusive way”. She further noted that “Without such growth, we cannot escape our high debt burden even after a successful restructuring. And because the debt burden lies with the public sector, the public sector will need to contract not just this year, but also in the decade ahead. So growth will need to come from the private sector and be export-oriented given our foreign exchange needs. There is simply no other option”.

Cooray has presented her critical review of many other structural reforms that have been adopted by Sri Lanka since the agreement with IMF for the ongoing EFF. I will confine my analysis on the above diagnosis of Sri Lanka’s ailments and the prescription recommended for Sri Lanka to get out of the external debt issue looming over the country.

The two sides of sustainability 

Since my topic is also concerned with the issue of sustainable growth, it is necessary to make the following clarification about two sides of sustainable growth being debated by economists. One is the sustainable development from the quality of life and conservation of resources as presented by The World Commission on Environment and Development, known as the Bruntland Commission. The Commission has defined the sustainable development as ensuring “that it meets the needs of the present without compromising the ability of future generations to meet their own needs”.v This is a medium to long term goal requiring both the domestic and global community to cooperate with each other.

The other is sustaining growth continuously once it has been kicked off by the help of some outside force. In the case of Sri Lanka, this initial support maybe given by a country like India or by multilateral agency like the World Bank, IMF, or ADB. Since it is not proper to give this support continuously due to the apparent moral hazard issue, it should be withdrawn after a given timeframe. If the country is able to stand on its own feet and sustain the growth momentum, it is sustainable development from this point.vi This is a goal which a nation should endeavour to attain continuously. In the case of Sri Lanka today, both these approaches to sustainability are applicable and relevant.

Need for economic expansion  

No country can get out of poverty, or indebtedness without having sustained economic expansion. It is the economic surplus that is produced that will be used to reduce poverty through new investments and repay the creditors without being indebted further. However, growth is necessary but not sufficient to sustain the expansion of an economy. Growth will produce a higher volume of goods and services for consumption by people. But unless the people within the country have purchasing power to buy the same, producers will find that they are saddled with unsold stocks. Therefore, in the second year, they will cut back production leading to a reduction in the growth rate. The real purchasing power of a population is determined by the income after taxes, both direct and indirect, and the level of prices in the economy. On both counts, the real purchasing power of people is severely constrained.

Declined purchasing power 

The high income and commodity taxes that have been imposed on Sri Lankans to achieve fiscal stability through increased revenue without cutting the Government expenditure has taken about 12% out of the incomes earned by people. However, taxes are only visible payments made by people curtailing the purchase of goods and services produced through economic expansion. The actual burden falling on people, following the burden analysis of the English economist David Ricardo,vii is the total gross expenditure of the Government. In the recent years, this has amounted to about 40% of GDP in Sri Lanka. Of this 40%, the bulk goes out of the country through interest payments and foreign loan repayments made by the Government without creating demand for locally produced goods and services. The other bulk is used for paying salaries, pensions, and subsidies to people.

The real purchasing power of that income too falls due to high level of prices, though the rate of increase in prices is subdued in the recent months through severely restrictive monetary policies. Hence, to sustain economic expansion, the domestic market is not capable of buying the increased flow of goods and services produced through economic growth. This is evident from the drastic decline of micro, medium, and small enterprises in Sri Lanka by May 2023 compared to their best performing year, 2018, as revealed by the survey on the impact of the economic crisis on MSMEs in Sri Lanka conducted by the Department of Census and Statistics in 2023.viii

Seeking markets outside

This problem can be partly resolved if Sri Lanka is able to export a sizeable volume of its products, in the form of goods as well as services, to foreigners. In the recent past, this has amounted to about 15% of GDP. It is necessary to increase the share of the export of goods and services to compensate for the low purchasing power of people due to high taxes and increased high Government expenditure, exacerbated by increased cost of living. This requires Sri Lanka to change the structure of its exports to suit the requirements of foreign buyers. The present visible export structure is heavily skewed toward the apparels and the three tree exports, namely, tea, rubber, and coconuts. Sri Lanka became a beneficiary of the wave of offshoring that took place in 1970s and 1980s seeking after low wages. With rising inflation and the gradual increase in income levels, the low wage advantage is no longer available to Sri Lanka.

Amidst this market distortion, Sri Lanka has been hampered by two other adverse developments as well. One is the transfer of apparel industry to other low-wage countries like Bangladesh, East Africa, and East Asia. The other is the attempt made by major buyers of apparels to locate manufacturing plants close to markets, known as nearshoring, and in the buying countries themselves, known as onshoring, facilitated by automation and advancements in technology.ix Sri Lanka’s main tree export, tea, has been affected by the change in the global tastes, production technologies, and deficiencies in marketing strategies.x

Both apparels and tree exports are based on simple technologies. At present, the world is moving toward high-tech manufacturing and Sri Lanka has no choice but to follow the changing trends in global manufacturing technologies. This cannot be attained in the short to medium term. Hence, a proper action plan should be designed to facilitate the country to make a seamless transmission to high-tech manufacturing over the next decade.

In this context, it is necessary to change the scope of the free trade agreements to be signed by Sri Lanka with some of the fast moving neighbours like India, Thailand, Vietnam, and the Philippines to comprehensive technological and economic partnerships. It is also necessary for Sri Lanka to join the global production sharing networks to harness the best for the country.xi

Imports first

Sri Lanka cannot promote its export sector while having an unproductive tariff structure and restrictions on imports.xii Since Sri Lanka’s manufacturing exports are highly dependent on imported raw materials and components, without a free flow of imports, it cannot ensure an uninterrupted production of export goods. Import restrictions had a role to play when the country was burdened with a severe foreign exchange problem in 2022 and 2023. At present, the country does not have a severe foreign exchange problem as being revealed by the progressive accumulation foreign reserves by the Central Bank performing better than the quantitative benchmark of $ 1.4 billion agreed with IMF under EFF.

The foreign reserves as at end-2023, except the $ 1.5 billion agreed with people’s Bank of China under a promised SWAP facility which is not counted for reserves, stood at $ 2.9 billion. Hence, with the improved foreign exchange flows, it is now time to remove all the prohibitive restrictions on import of raw materials and other components needed for manufacturing.xiii The motto for Sri Lanka to expand its manufacturing exports should be ‘import freely and develop exports’.

Goal of 2048 

Sri Lanka’s growth facilitation requires careful short to medium term economic policy designing and management. At the University of Sri Jayewardenepura, there is a special course on development policy and management taught at both the undergraduate and postgraduate levels emphasising on the management side of economic policies. The management of economic policy at the national level requires goals to be presented in the form of a plan and then, the plan broken into projects, projects to programs, and programs to activities at the planning side. The activities with targets and key performance criteria should be monitored continuously for successful realisation. If there is underperformance, it should be immediately attended to by introducing the necessary corrective measures.

Sri Lanka plans to become a fully developed country by 2048 when it celebrates the centenary of independence from Britain as pronounced by President Ranil Wickremesinghe in his address to the Parliament in August 2022.xiv He said that to attain the development goal of the country, the economy will be transformed into a competitive export economy, an apparent recognition that the domestic economy is not strong enough to sustain high economic growth.  Addressing the nation in June 2023, Wickremesinghe outlined his policy management strategy to become a developed country by 2048.xv Accordingly, the Government will be using the Growth Lab approach – a technique developed by the Centre for International Development of Harvard University’s Kennedy School of Government – to design the policy strategy to reach the goal. In this approach, the private sector leaders, bureaucrats and Cabinet ministers will be assembled in a six week long policy retreat. The timeframe given was that the Lab will be convened in July, its report ready by September in the form of a national transformation plan, and it will be signed off by people by end 2023.

Showing that Sri Lanka is weak in policy management, none of the milestones in the timeline announced has been met. But addressing Parliament in February 2024, Wickremesinghe announced that his Government will introduce an economic transformation act to Parliament soon which is a narrowing of focus from national to economic matters.xvi The objective of the new legislation, as was announced by Wickremesinghe, is to transform Sri Lanka’s backward economy to a modern, robust economy. The details of this act have not been revealed but it is presumed that it is the same national transformation plan, in a narrowed focus, which the Government was hoping to design under the Lab approach announced in June 2023.

It seems that the plan has been prepared without the participation of the private sector leaders or the people of the country thereby ignoring the essential requirements of the democratic economic policy governance to which Wickremesinghe has subscribed to under his social market economy ideology. It is a serious weakness in the development policy management and, therefore, is inclined to meet with public protests.

Transitory stability 

The Central Bank, following the IMF’s EFF, has stabilised to a reasonable degree the prices, and the exchange rate. Since the foreign debt restructuring is still not completed, even that stability appears to be a temporary solation. The Government’s plan to address the fiscal sector issues through revenue based consolidation, as recommended by IMF, is defective. By continuously increasing taxes and adding new taxes to the book, the Government seems to be going after a moving target without a corresponding reduction in the gross expenditure of the Government.

Hence, it should be a hybrid of both revenue increasing and expenditure cutting fiscal consolidation. This requires the shrinkage of the public sector as recommended by Cooray in her Central Bank Anniversary Oration referred to above.

But as the data reveal, the shrinkage has come not by economising on consumption expenditure but through a drastic cut in capital expenditure. For instance, the much praised surplus in the primary balance of the Budget in 2023 has come from a cut in the planned capital expenditure of Rs. 1,000 billion to about Rs. 500 billion. With weakened private investments, the decline in public investments will hamper the country’s growth prospects substantially. What this means is that economic reawakening is still not fully established as a goal in the country’s development policy and management strategies.

Thanking you.

Endnotes:

i) See the evidence given by the Central Bank Governor Nandalal Weerasinghe before the Parliamentary Select Committee on Economic Bankruptcy: see: https://english.theleader.lk/news/7483-cbsl-governor-rejects-bankruptcy-claims (accessed on 18.2.2024).

ii) Sri Lanka targets debt restructuring framework by June – Nikkei Asia (accessed on 22.2.2024).

iii) President sets ambitious timeline for Sri Lanka’s debt restructuring and reconciliation efforts – Presidential Secretariat of Sri Lanka (presidentsoffice.gov.lk) (accessed on 22.2.2024).

iv) https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/about/speech_20231102_CBSL_73_anniversary_oration_e.pdf (accessed on 18.2.2024).

v) Brundtland Commission, 1987, Our Common Future, Oxford University Press, Oxford, p 8. 

vi) Purvis, Ben et al, 2018, Three pillars of sustainability: In search of conceptual origins, (available at: https://www.weforum.org/agenda/2022/07/sustainable-resilient-inclusive-economic-growth/) (accessed on 18.2.2024).

vii) Abel, Andrew B, 1991, Ricardian Equivalence Theorem, in Eatwell et.al (eds) The World of Economics  Palgrave McMillan, pp 613-22 (available at: https://link.springer.com/chapter/10.1007/978-1-349-21315-3_83) (accessed on 18.2.2024).

viii) MSMEs_Media Release_English (statistics.gov.lk) (accessed on 22.2.2024).

ix) https://fashinza.com/brands-and-retail/news/how-reshoring-and-onshoring-are-changing-the-apparel-industry/ (accessed on 18.2.2024).

x) Wijewardena, W.A., 2016, What is wrong with our ailing tea industry and where does its cure lie? (available at: https://www.colombotelegraph.com/index.php/what-is-wrong-with-our-ailing-tea-industry-where-does-its-cure-lie/) (accessed on 18.2.2024).

xi )See: https://www.ips.lk/wp-content/uploads/2017/03/IPS-Lecture-3-February-b-2016.pdf (accessed on 18.2.2024). 

xii) https://www.trade.gov/country-commercial-guides/sri-lanka-import-tariffs-and-taxes (accessed on 18.2.2024).

xiii) file:///Users/weerskoon/Downloads/1LKAEA2023001%20(3).pdf p 19 (accessed on 18.2.2024).

xiv) https://www.presidentsoffice.gov.lk/index.php/2022/08/03/full-text-of-the-statement-made-by-president-ranil-wickremesinghe-presenting-his-policy-statement-at-the-ceremonial-opening-of-the-third-session-of-the-ninth-parliament-3-august-2022-2/ (accessed on 22.2.2024).

xv) https://youtu.be/p8hND7-0_IA?si=Yh79YWT32rHmGmZn (accessed on 22.2.2024).

xvi) https://www.parliament.lk/news-en/view/3884 (accessed on 22.2.2024).

*These are some excerpts of a keynote address delivered at the University of Sri Jayewardenepura at its International Conference on Business Management 2024; the writer, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at waw1949@gmail.com