Crisis-ridden Sri Lanka economy: Time for

economics to prevail on politics

Three-and-a-half years have elapsed since the Government has taken control
of the management of the country’s economy. Except on the inflation front
where inflation has largely been subdued, there has not been any significant
improvement in any other area in the macroeconomy – Pic by Shehan
Gunasekara

Release of GDP data

Monday, 25 June 2018

Sri Lanka’s official statistics bureau, Department of Census and Statistics or

DCS, has released the country’s 2018 first quarter provisional economic
growth data in its website (available at:
http://www.statistics.gov.lk/national_accounts/dcsna_r2/reports/2018.06.18/Q
1_2018_(2018_06_18).pdf).

These numbers may change later when DCS refines its data set. For instance,
in the current release, DCS has firmed up its estimation of total output in the
first quarter of 2017 by reducing its value from the previously released
numbers. Had that previous high number been used, the growth rate in the
first quarter 2018 would have been much lower than what has been
announced in the current release.

A declining growth rate

But, whatever the number used, the results have been contrary to the
expectations of authorities. The expectations were that the economy would
bounce back to high growth in 2018 from the declining growth trend it has
experienced from 2013. Thus, if the total economy could be equated to a cake,
the size of the cake, measured as the real gross domestic product or real GDP
based on the prices that had prevailed in 2010, has been enlarged by 3.2% in
the first quarter 2018. The real GDP growth had amounted to 5% in 2015, to
4.5% in 2016 and to 3.1% in 2017.

The Central Bank had expected the growth to move up to 5% in 2018. But,
the first quarter results show that the country’s real GDP in 2018 will be more
in line with the prediction made by IMF in April 2018 than the Bank’s
expectation. IMF in its prediction had put the growth possibility for this year
at 3.8%. Even to reach this level, the real GDP growth has to accelerate on
average to 4% in the three remaining quarters of the year. To reach the
Central Bank’s expectations, the average growth rate in the next three
quarters should be as high as 5.6%, a challenging feat for Sri Lanka’s
economy, indeed.

Crisis started from around 2013

 The fact that Sri Lanka’s economy has been in a crisis is not a
new revelation. The crisis has been manifested from around 2013 when the
economy had begun to slow down its growth from the high growth it had
recorded temporarily in the immediate post-war years. By the time when the
present Government came to power in January 2015, all the available
macroeconomic indicators had shown signs of distress.

Rupee under pressure for depreciation

The exchange rate was under pressure for a massive depreciation because the
previous Government had kept the value of the rupee artificially at high levels
by supplying dollars to the market from the country’s scanty foreign exchange
reserves. When the reserve levels which had been built by borrowing and not
by earning had fallen to a critically low level, the country could no longer
continue to feed the market’s voracious demand for dollars. Exports, a means
of earning reserves, had been declining both in dollar terms and as a share of
the total GDP.

Shortage of foreign exchange in the market

Meanwhile, imports had been ballooning creating a high trade deficit in the
region of $ 9-10 billion annually. This was cushioned partially by the
remittances sent to the country by Sri Lankans working abroad; but that also
became saturated at around $ 7 billion in the recent past compelling Sri
Lanka to borrow abroad to fill the gap.

The country’s freely available foreign exchange reserves, the money

immediately available for meeting future foreign debt repayments and
making payments for imports and other services, had amounted to $ 6 billion,
a little higher than the identified future obligations. The Government budget
was in a precarious situation with its revenue falling relative to the country’s
GDP, generating stubbornly high overall budget deficits and making it
necessary to borrow more to repay maturing debt stocks.

Rising foreign debt stock

The last outcome had augmented the Government’s debt stock year after
year. The economic patient was, thus, in the intensive care unit and the new
Government was expected, as a matter of urgency, to administer it lifesaving
medications to get it out of hospital and back on the job. The mainstream
economists as well as economic think-tanks like the Institute of Policy Studies
or IPS and newly-established Advocata Institute had warned the Government
that it was deep in crisis and running out of time.

An unheeded warning

For instance, IPS releasing its State of the Economy Report for 2015 warned
the Government in October about this sad eventuality. A review of the report
highlighting this waring was made by this writer in a previous article in this
series (available at: http://www.ft.lk/columns/ipss-soe-2015-has-delivered-a-
strong-message-to-govt-which-it-cannot-ignore-reform-or-perish/4-487845).
This writer who reviewed the report at its launch drew the attention of the
Deputy Economic Enterprise Reform Minister Eran Wickramaratna to the
gravity of the crisis in the economy (available at;
https://youtu.be/igsAaLP2wBY).

When the Government postponed the needed economic reforms and the then
Finance Minister Ravi Karunanayake sought to resolve the burning foreign
exchange crisis by getting an imaginary Belgian investor to bring in $ 1
billion, its fallacy was pointed out in another article in this series (available at:
http://www.ft.lk/columns/the-illusive-rescue-of-the-rupee-by-an-elusive-
belgian-investor-is-the-yahapalana-government-on-the-/4-519497).
In January, 2016, the Government hosted the first ever Sri Lanka Economic
Forum in Colombo with support from economists from Harvard University’s
Center for International Development or CID. A video record of the
proceedings of the Forum could be accessed at https://youtu.be/kMF6nRc7E-
o. At this Summit too, the main focus was how to get out of the economic crisis
and place Sri Lanka on a long term economic growth path. But still no action
was taken and it appeared that the Government would have expected the
crisis to disappear on its own.

Then, in July 2016, the Ceylon Chamber of Commerce or CCC hosted the Sri
Lanka Economic Summit in Colombo. This Summit had advised the
Government to ‘focus, act, and deliver’ to place Sri Lanka back on a fast
development path. The strategy for achieving this goal has been, as the
Summit had thematised, to change from ‘issues to solutions, potential to
performance and rhetoric to action’. That was a fine piece of wisdom given to
the top leaders of the Government by the country’s leading business chamber.
The subsequent actions of the top Government leaders showed that that
wisdom had been transmitted to deaf ears.

Sitting on the crisis without taking needed action

Now, three-and-a-half years have elapsed since the Government has taken
control of the management of the country’s economy. Except on the inflation
front where inflation has largely been subdued, there has not been any
significant improvement in any other area in the macroeconomy. The
Government was expected to consolidate the budget by expanding the revenue
base, curtailing the expenditure programmes, narrowing the budget deficit
and slowing the growth of public debt.

However, the achievement has been only with respect to a marginal

improvement in the revenue base and the enactment of a new revenue
legislation. Since new loans had to be raised in order to pay interest and repay
the maturing loans, the debt stock too continued to increase unabated. As a
result, the debt to GDP ratio which had been declining marginally in the
recent few years took a reverse turn in 2017. Though the Central Bank had
purchased some $ 2 billion from the market to build the country’s foreign
exchange reserves in the last one-and-a-half-year period, a part of that had to
be sold in the market to prevent the rupee from further falling in recent times.
When the deficit is massive, using the country’s reserves to hold up the rupee
will be an abortive exercise. Hence, as Sri Lanka had already experienced it in
2000 and 2012, sooner or later, the Central Bank will have to give up its hold
on the exchange rate. If this happens, no amount of IMF support will be able
to prop up the rate.

Immediate action needed

Sri Lanka therefore needs to take immediate measures to arrest the current
declining trend and place the economy on a long term economic growth path.
It calls upon the Government to introduce an economy-wide economic reform
programme. All economic reforms are painful since they require at least some
section of the population to make sacrifices.

In the current political environment, these are difficult and challenging tasks.
But, they are not impossible to accomplish if the political leadership has the
will, dedication and commitment to take the country through the needed
reform programme.

Above all, what is needed is the capacity and ability to manage the reform
programme. An essential part of the management capacity is getting the
public support for reforms.

Flawed economic management

Since coming to power in January 2015, the management of the country’s

economy had been placed under a Cabinet sub-committee titled Cabinet
Committee on Economic Management or CCEM that functioned under the
chairmanship of the Prime Minister. Instead of coming up with an effective
macroeconomic development plan and a strategy, CCEM devoted its time and
energy to sort out day to day micro issues in the economy. Now, CCEM has
been dismantled and its powers have been assigned to another high-powered
body titled National Economic Council or NEC. While all the members of
CCEM are also members of NEC, it functions under the chairmanship of the
President supported by a special secretariat.

In April 2018, NEC announced that it had formulated an economic plan for
the country. However, it has not been released to the public domain and
therefore, members of public have not been able to assess its adequacy,
suitability or efficacy. Meanwhile, NEC has continued to address day to day
micro issues like its predecessor, CCEM.

Some of the issues it had handled, according to reports, have been whether
fertiliser should be issued to farmers in the form of a cash subsidy or a
quantity subsidy, whether the tea sector should be permitted to use the
banned pesticide ‘glyphosate’ or whether medical consultations should be
exempted from VAT or not. These are micro issues that should have been
resolved by the respective ministries. Surely, they are not the functions of a
national economic council.

NEC should address macro issues

Then, what should NEC do in order to take Sri Lanka out of the current
economic crisis? It can take cue from the Economic Planning Board or EPB
setup by President Park Chung-hee in South Korea in early 1960s. EPB,
staffed by technocrats rather than military personnel, took a macro view of
the Korean economy and formulated its policies accordingly.

It came up with a series of five-year plans that concentrated on promoting

exports, developing science and technology, reforming the university system to
support industrial growth, increasing national savings for investment in
industry and commerce and supporting the establishment of heavy industries
like steel, ship-building and chemical industries.

These strategies were converted to plans and plans to projects. They were
then implemented with close supervision by the President himself. The results
were impressive and South Korea began its journey from a very poor third
world country to a developed nation within a single generation. Poverty in
Korea was reduced from about a half of the population in early 1960s to less
than 5% by 1990s. The secret was nothing but the effective management of
economic policies.

Political leadership should set an example

Hence, NEC in Sri Lanka should change its focus from micro to macro now.
The economic plan which it says it has formulated should be released to public
domain immediately in order to win the support of the people. This is because
without public cooperation, no plan could be implemented successfully.

Winning public cooperation is another art and it is necessary that all the top
political leaders of the Government master that art. An important
requirement today is to prepare the people for the hard times they are to face
in the coming years. To get their support, it is necessary that top leaders in the
Government should set an example by going for a voluntary cut of their
perks.

Malaysia’s new Prime Minister Mahathir Mohammad set a fitting example by

cutting the salaries of ministers by 10%. This is not much but it has a
tremendous mass appeal by generating a highly productive communication
effect. The argument made out was that in order to gain capacity to repay the
mounting foreign loans of the Malaysian Government amounting to some $
170 billion, the country needs to make sacrifices and the political leadership is
in the forefront in making those sacrifices.

Politics should not prevail on economics

A general political wisdom, as the left-wing politician Colvin R. de Silva had

once remarked, has been that good politics does not go along with good
economics. What he meant by good politics was the political mastery to win
elections.

That may be true in normal times. But when a country has been engulfed in a
deep economic crisis, practicing bad economics to win elections would send
the economy further down the drain. Along with the economy, the political
party too will go down in the drain. Hence, given the intensity of the current
crisis, politics should not be allowed to prevail on economics.

(W.A. Wijewardena, a former Deputy Governor of the Central Bank of Sri

Lanka, can be reached at waw1949@gmail.com.)
Posted by Thavam