Is Sri Lanka heading for authoritarian statism? – The Island


by Seneka Abeyratne

The immediate future of Sri Lanka is extremely bleak as the economic and political crises are continuing to reinforce each other in a synergistic manner. Because the government is totally bankrupt and unable to meet its external debt-service obligations, it is having difficulty securing bridging loans to finance imports of essential goods. Hence, a viable alternative to bridging finance should be found as soon as possible.

Since foreign currency reserves are negligible, government should seriously consider debt to equity swaps with bilateral donors (such as China, India and Japan) as well as bona fide private creditors to boost external reserves and enable the private sector to restore the supply-chain for essential goods and services. Desperate times call for desperate solutions. Government should seek to obtain a minimum of $25 billion through quick debt to equity swaps. Top contenders in this regard are ports, airports, Sri Lankan Airlines, large state-owned plantations, and other state-owned facilities or lands which could be utilized by foreign investors for a variety of productive economic activities. As the old saying goes, “We can’t have our cake and eat it.”

Create large fiscal deficits

macroeconomic instability

The fiscal deficit in Sri Lanka increased from 11.1% in 2020 to 12.2% in 2021, largely due to a decrease in the revenue + grants to GDP ratio from 9.1% to 8.7% and an increase in the expenditure to GDP ratio from 20.2% to 20.1% over the same period. This is not a sustainable fiscal path, which is why government is resorting to excessive money printing, thereby adding fuel to the fire of galloping inflation. The last time Sri Lanka registered a fiscal deficit of under 5% was in 1977. Large fiscal deficits create macroeconomic instability and discourage foreign direct investment (FDI). No country in Asia has prospered without a stable macroeconomic climate and substantial FDI inflows on a sustained basis.

Key elements of a macroeconomic

stabilization program

Both a stable and consistent macroeconomic policy framework and a robust business climate are necessary for attracting significant inflows of export-oriented FDI on a sustained basis. In this regard, transaction costs should be eliminated wherever possible. A macroeconomic stabilization program should focus on fiscal consolidation in the medium term. This will include (a) a substantial increase in direct and indirect tax revenue; (b) rationalization of recurrent and capital expenditures; and (c) the exercise of fiscal discipline in all public institutions. The program should be accompanied by a comprehensive external debt-restructuring exercise with a view towards attaining debt sustainability in the medium term. The relevance of debt to equity swaps should be critically assessed in this context.

On the revenue side, key policy reforms would include restoration of VAT and income tax to their pre-2019 levels and measures for achieving a substantial increase in the income tax to GDP ratio, which was only 1.8% in 2021. On the recurrent expenditure side , downsizing of the public service (including the military), restructuring/privatization of loss-making state-owned business enterprises (in all sectors of the economy), and a significant reduction of government subsidies could be viewed as three critical policy reforms. In respect of capital expenditure, the need for focusing future expenditures on infrastructure for supporting significant improvements in education, health, and export performance is critical.

On the monetary side, maintaining a flexible, market-float policy for the exchange rate is vital for stimulating exports, enhancing FDI inflows and foreign remittances, and promoting tourism. These are the main avenues for boosting foreign currency reserves in the medium to long term. Maintaining a tight monetary policy vis-à-vis high interest rates is also vital for reducing inflation and enhancing foreign capital inflows.

Market distortions retard

economic growth

Removal of market distortions is critical for stimulating increased private-sector development and for achieving a rapid and sustainable economic recovery. At present, imports are heavily controlled and regulated by the state due to the severe dollar crisis. However, without a liberal trade and investment policy, the economy is likely to remain stagnant as a wide range of imported intermediate goods are required by entrepreneurs in the manufacturing, processing and service sectors. Imports of intermediate goods (including fuel, fertilizer and agrochemicals) as well as consumer goods linked to tourism should hence be liberalized.

Import bans are tantamount to protectionism, which tends to drastically inhibit GDP growth. Protectionism discourages FDI inflows as well as foreign remittances through the banking system. Protectionism does not stimulate economic growth. On the contrary, it creates economic stagnation and widespread poverty and underemployment.

The Daily Mirror of July 26th reported that government may restrict fuel imports for the next 12 months due to the foreign exchange crisis. This will do more harm than good as it will worsen macroeconomic imbalances. A far better option is to liberalize fuel imports so as to create space for the private sector to supply the markets.

Generally speaking, with a few exceptions, the market, not the state, should determine the prices of goods and services available to consumers. A significant number of public enterprises and services would become profitable if they were exempted from price controls and permitted to adopt a cost-reflective pricing mechanism.

Authoritarian statism

What we are currently witnessing in Sri Lanka is the rise of authoritarian statism – a protectionist, state-dominated economic growth model similar to the one introduced by the Sirimavo Bandaranaike regime of the 1970s. The experiment proved to be a colossal failure, which is why this inward-looking, statist regime got booted out of power in 1977.

The private sector is the engine of growth, not the state. The shackling of the private sector is not the solution to the current economic crisis. What is needed at this time are deep structural and market reforms aimed at promoting private sector development as well as improved productivity across all spheres of economic activity so that Sri Lanka could become globally competitive in a wide range of exports.

The author is a retired economist/international consultant to ADB MANILA. He can be contacted at snabeyratne@gmail.com

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