By Chathurrdhika Yogarajah
Sri Lanka’s macroeconomic outlook amid the COVID-19 pandemic was highlighted during a discussion webinar on October 11, to mark the release of IPS’s flagship report, “Sri Lanka: State of the World”. ‘economy 2021’. The event featured presentations by Dr Dushni Weerakoon and Dr Asanka Wijesinghe of IPS with expert guidance from Dr Missaka Warusawitharana, Financial Economist, Johns Hopkins University, USA. IPS’s Tharindu Udayanga moderated the discussion.
Prospects and possibilities Dr Dushni Weerakoon, Executive Director, IPS
A V-shaped recovery is likely to take shape, but Sri Lanka faces relatively weak output growth. A critical challenge is to bring the growth rate to at least 5-6% and maintain this momentum over the medium term. Investment performance will be a crucial determinant, as the decline in investment was one of the main drivers of the output contraction in 2020. With little fiscal space, Sri Lanka has relied mainly on Monetary Policy. Direct financing of budget spending has exploded and efforts have been made to ensure that borrowing costs remain low through yield control measures.
Sri Lanka is not as well positioned when considering the risks of large-scale debt monetization programs due to high debt levels, high exposure to external debt with repayments of large amounts in the medium term and low reserve stocks. With such weak fundamentals, the backbone of debt monetization programs is policy credibility. But over the past 18 months, there has been no notable effort to cut discretionary spending and anchor budget plans. Sri Lanka, for example, is reluctant to accept IMF conditionalities.
Policy measures should address fiscal imbalances by reducing national spending or increasing national income. As the latter takes time, governments tend to focus on a combination of policies to reduce domestic spending that includes tighter budgets allowing interest rates to move with market fundamentals and implementing rates. more flexible exchange rates. The downside is that growth suffers in the short term with worsening debt ratios. These are politically difficult choices when economic conditions are tough as they are now.
Sri Lanka needs to strengthen its access to foreign capital markets to balance the risks. If Sri Lanka achieves a fiscal adjustment and improves access to capital markets, this will free up space for a more orderly macroeconomic adjustment. Although the exchange rate may initially exceed, it can stabilize over time. This will allow the Central Bank to reverse the monetization of its debt and focus on price stability, as this will be of concern in the coming months. A policy framework in this direction will provide a more solid environment to support investment and support Sri Lanka’s recovery.
Opportunities and Costs Dr Asanka Wijesinghe, Research Economist, IPS
During the pre-pandemic period, the rate of globalization stabilized, but Sri Lanka’s openness has steadily declined, especially after 2005 due to GDP growth in non-tradable sectors. However, Bangladesh, India and South Asia in general show a growing trend towards openness. COVID-19 caused a sharp drop in industrial production and global trade in 2019. But even after this collapse, it recovered in early 2021. There is no evidence of the effects of de-globalization due to the pandemic.
When the outlook for world trade is taken into account, the WTO predicts a recovery in world trade volumes for the year 2022. An IMF database that uses signals emitted by seagoing vessels has also shown an increase in global trade volumes. global trade from early 2021. Sri Lanka is expected to be ready to take advantage of trade diversion and investment opportunities as tariffs imposed on Chinese textiles by the United States, for example. At present, its participation in the global value chain (GVC) is low and actually declined from 2009 to 2019. In contrast, countries like Bangladesh, Viet Nam, India and Pakistan posted an upward trend. He pointed out that the trade war between the United States and China presents opportunities for Sri Lanka to increase both upstream and downstream participation in GVCs.
A major challenge is the costly import substitution policy, leading to misallocation of resources, reduced competitiveness and possible retaliation from trading partners. Another challenge for Sri Lanka is the potential withdrawal of GSP + which will hit the seafood and textile industries hard. Sri Lanka should strive to secure GSP +, disengage from “anti-trade” bias, integrate into GVCs and restructure existing regional trade agreements.
Paths to recovery
Dr Missaka Warusawitharana, Financial Economist, Johns Hopkins University, USA
Sri Lanka’s growth trajectory has not been in line with its true potential, which has had a negative impact on the well-being of the population. This can be attributed to the low level of productivity growth. Although the manufacturing sector has contributed to growth, it has not demonstrated sufficient productivity that would allow the country to achieve better production.
In addition, the current fiscal difficulties may be linked to structural imbalances in the country’s budgets that span decades as well as different administrations that have been unwilling to make difficult choices. In the longer term, budgets must be structured to bring debt down to a manageable level.
The global economy is moving away from physical goods to a digital-based economy, requiring greater provision of services. Sri Lanka scores well on the Human Development Index with its skilled workforce. It is about increasing productivity by investing more in education and service-producing industries and improving the business environment by reducing institutional barriers.
Link to blog: https://www.ips.lk/talkingeconomics/2021/10/15/covid-19-and-the-sri-lankan-economy-policy-choices-and-trade-offs/
Chathurrdhika Yogarajah is a research assistant at IPS with research interests in macroeconomics and trade policy. She holds a BSc (Hons) in Agricultural Technology and Management, specializing in Applied Economics and Business Management from the University of Peradeniya with First Class Honors. She is currently studying for her Masters in Agricultural Economics at the Postgraduate Institute of Agriculture in Peradeniya. (Speak with Chathurrdhika: [email protected])