‘Sri Lanka cannot afford yet another replay of the old script’

 ‘People would know good governance when they see it’

by Sanath Nanayakkare

Dr. Sharmini Coorey last week expressed her understanding and sympathy with the Sri Lankan economic policymakers and the Central Bank of Sri Lanka (CBSL) for getting the blame from the general public as they were taking ‘corrective’ measures to rescue a faltering economy, without which it could ‘give way’ to another economic collapse in the years to come.

Dr. Coorey, Member of the Presidential Advisory Group on Multilateral Engagement and Debt Sustainability advising the government of Sri Lanka and a former Department Director of the International Monetary Fund (IMF) made this remark while delivering the 73rd Anniversary Oration of Central Bank of Sri Lanka (CBSL) on 01st November 2023 at the CBSL Head Office in Colombo.

Her oration was centred on the theme “The Way Forward: Price Stability and Prosperity Need Good Governance.

Addressing the policymaking and financial community in the audience she first recognised the talented and hardworking leaders and members of the CBSL staff and those on the policymaking front for taking on a ‘very challenging’ year and a half since April 2022 where they took ‘bold’ decisions in terms of technical work to stabilise the economy out of the deepest economic crisis that Sri Lanka has ever suffered.

Addressing the audience she said: “It is perhaps easy to take for granted the progress made so far. But let’s not forget that barely 20 months ago, Sri Lanka’s inflation was unanchored, the exchange rate was depreciating uncontrollably, foreign reserves were depleted and the economy was collapsing with shortages of food, fuel and essential medicine. However, you have been able to bring the inflation down from almost 74% in September 2022 to less than 2% a year later beating the projections. To accomplish this, financial stability was all the more important given the deep economic contraction together with the preceding pandemic which had dented financial sector balance sheets. The monetary policy was also responsive in lowering the policy rates as clear evidence was emerging that monthly inflation was stabilizing.”

“Let me say, based on my years of experience at the IMF working with countries around the world – often during economic stress – these are, by any standards, impressive accomplishments. Without skilled leadership and decision making the situation would have been a lot worse.”

“Deep monetary policy decisions were successful also because of the support from the government’s fiscal policy and the leeway given to the CBSL to conduct monetary policy according to its best judgment. Tax cuts from the previous government had reduced Sri Lanka’s tax ratio from 11% of GDP in 2019 to a mere 7.5% of GDP in 2020/21- one of the lowest in the world – lower even than very poor countries like Central African Republics. With interest rates taking up 73% of our revenue and the overall fiscal deficit of 12% of GDP in 2021, the fiscal position was not simply sustainable. The government took necessary steps to increase tax rates, tax collection and implement cost-recovery pricing in energy. Efforts were made to generate the needed improvements in the primary fiscal balance in line with the IMF-supported programme.”

“These were difficult decisions. They were politically unpopular, but were necessary. Unfortunately, the shift thus taken cannot turn around the economy quickly. So, people tend to blame the corrective approach to policymaking when the policymakers are doing the right thing rather than the reckless policies of the past that were fundamentally flawed. Such is the unenviable position of the policymakers who stepped into rescue their country from the crisis. So you have my sympathy.”

“So what now? Even though significant progress has been achieved, we are in a low level of equilibrium with our economic performance below potential. This crisis is not yet over. The only way out is to grow at a rate of about 5 or 6% a year in a sustainable and inclusive way. Without such work, we cannot escape our high debt burden even after a successful debt restructuring. And because the debt burden lies with the public sector, it 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 need. There is simply no other option.”

“Much remains to be done to get the economy on a dynamic growth trajectory. It shouldn’t be taken for granted that having achieved your inflation target, it will stay within CBSL’s target of 5% or that the progressive fiscal endeavor would continue. Our post-independence economic history is full of stopgap policies and brief victories of stability that were not sustained. We cannot afford yet another replay of that familiar script. Why not? Well, this time it is really different for three reasons.”

According to the IMF even if we successfully restructure our debt and adhere to the tight policies that would generate a primary fiscal surplus of 2.2% of GDP , from 2025 until at least 2032, our public debt would decline to only about 95% of GDP by 2032 from about 130% of GDP now. By 2032, government debt to GDP would average 65%. Looking at our neighbours, this number is 55% in India, 40% in Indonesia and 54% in Thailand. So, unless we bring debt to GDP ratio to about 60-80% of GDP, the baseline debt ratio will be much higher. Sri Lanka will be at a higher risk of debt distress even after a successful debt restructuring. If we become complacent and go back to our past ways, we could easily go back to a crisis where we are unable to pay our debts. In such a context, the adjustments next time would be far more painful because we would already have restructured our domestic and external debt.

More people are now in poverty according to World Bank estimates and have little cushion against it. The UNDP has estimated that over a half the population grapples with multidimensional vulnerability. The World Food Programme has estimated that 31% of children aged under 5 are malnourished. Many people grapple with basic needs such as healthcare. Progressive education has been severely hampered as a result of the pandemic and the economic crisis. So, the impact of another debt default would entail adjustments that would be disastrous and would lead to social unrest.

Sri Lanka has suffered from a damaging outflow of professionals who are the backbone of economic recovery and growth. These professionals are leaving not merely because of taxes as is often said. They have lost hope because of the corruption Sri Lanka has been mired in for decades. They don’t see a future in a country where they don’t see the culprits are punished. We have also been vulnerable to many exogenous shocks like wars, higher world interest rates, poor agricultural harvests and natural disasters. We are on a knife-edge and there is no room for policy reversals.

“But, with the focus on progressive efforts, we can shift to a path of sustained growth and inclusive prosperity. What is the way forward? How can we avoid stop gap policies? For this we need, fiscal discipline, an open trade regime that encourages exports, protective markets, modernized labour laws and adequate infrastructure. I believe our fundamental problem is our poor governance. Unless we address that issue head on, we can’t overcome our economic problems and prosper. So, when we discuss economic policies, we need to primarily focus on the governance around those policies. What do we mean by good governance? There is no standard definition. But people know good governance when they see it.”

“My point today is not just about economic policies, for instance, whether interest rates or taxes or a particular SOE should be privatized or not. It is about ensuring policymaking and implementation more accountable, transparent and getting them to adhere to the rule of law and so on, which will improve the results of the economic policies. Good policymaking needs to be backed by strong institutions. It requires sustained social pressure to take on the vested interests that are served by poor governance. We need to ensure that policies serve the interests of not just a small group but an inclusive society,” Dr. Sharmini Coorey said.