The fault of successive governments has been that this public expenditure including on welfare, which in fact extended to government provided jobs and pensions resulting in the public sector expanding to over 1.4 million employees, has not been backed up by domestic revenue mobilisation.
by Mahinda Siriwardana
Editorial Note: This series is based on the keynote speech by the author, titled “Shaping the Future: Policies for Dynamic Growth towards Improving Social Protection and Well-being of the People,” delivered at the launch of Sri Lanka’s National Social Protection Policy on 16th August 2024.
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| Ragala, Sri Lanka [ Photo: Shashank Hudkar/ Unsplash] |
Whilst this policy framework is a milestone in social protection and well-being of the people of Sri Lanka going forward, I thought it is important to share my views on “Shaping the Future: Policies for Dynamic Growth towards Improving Social Protection and Wellbeing of the People“, considering the fact that Sri Lanka is at crossroads at present towards responsible macro-fiscal management and governance.
Historical Context
A robust social welfare structure has been engrained in Sri Lanka’s socio-political fabric even prior to independence. A long history of universal free education and universal free healthcare has resulted in Sri Lanka’s human development surpassing that of regional and income peers over many decades. In fact a key goal of economic development, if not the most important goal of economic development, is to uplift the well-being of the population.
The long-standing commitment of successive governments to public welfare has enabled Sri Lanka’s life expectancy at birth to reach 72 years as early as 1990, well ahead of most income and regional peers. Sri Lanka’s infant mortality in 2019 was 6 per 1,000 live births, still one of the lowest among peers. Secondary school enrolment was 96% in 2019, well ahead of regional peers. Sri Lanka also leads among access to sanitation in the region and has one of the highest levels of access to electricity.
These indicators provide a stark contrast to the popular public sentiment that no progress has been made in 76 years since independence. The well-being of Sri Lankans, as reflected in human development indicators, far surpassed those of countries with similar levels of income over several years. This is not to say that things are perfect and that nothing further needs to be done. For instance, while access to education is excellent, the quality of education delivery has fallen short of requirements to compete in the modern economy. The same applies to healthcare, public transport, and other public services.
The fault of successive governments has been that this public expenditure including on welfare, which in fact extended to government provided jobs and pensions resulting in the public sector expanding to over 1.4 million employees, has not been backed up by domestic revenue mobilisation. Successive governments have been reluctant to build a sustainable tax base. Some have said that “Sri Lanka has a Scandinavian style welfare state with a Hong Kong style tax system” – it is difficult to disagree with this perception as the maintenance of these facilities has become a challenge given the ongoing economic crisis. In fact, the result has been an accumulation of public debt as government expenditure has persistently exceeded revenue. It must also be noted that politicians respond to signals by voters. As Prof. Sirimal Abeyratne outlined in a recent article, “every time Sri Lanka has had a primary surplus in the budget, the incumbent government was voted out in the subsequent election”1. Therefore, one cannot ignore a degree of collective responsibility for Sri Lanka’s fiscal malaise.
Economic Crisis
The culmination of Sri Lanka’s fiscal vulnerabilities was the deep and unprecedented economic crisis that reached a peak in 2022. The long-standing structural weaknesses were unravelled as ill-timed tax reductions in end 2019 led to a collapse of the country’s credit ratings. This was compounded by exogenous shocks, including the COVID-19 pandemic and commodity price hikes associated with geopolitical tensions. In the absence of global financial market access and continued service of external debt, reserves declined rapidly and the inevitable sovereign debt default took place in April 2022.
I have over four years of direct experience on Sri Lanka’s economic crisis. The first two years, I spent at the Central Bank as a Deputy Governor. I very clearly saw the crisis approaching. I made every effort to apprise the then Governors, the then Monetary Board, and the then Ministers of Finance, on the impending serious crisis. Unfortunately, my early warnings, like many others’ at the time, were not heeded. Eventually, we as a country ended up in a disastrous crisis. Sri Lanka experienced a “great crash”. The government machinery was struggling to find solutions. Some of the key decision makers, both at a political level and administrative level, vacated their positions hastily. At times, during the worst of the crisis, it felt like there was virtually no functioning government.
As a consequence of the crisis, the entire 22 million population of Sri Lanka had to “Pay the Price”, a huge price, particularly for the poor and the vulnerable, from North to South and East to West, with no exceptions. The impact was, as we all know, extremely serious. The significant increase in multi-dimensional poverty, food insecurity, malnutrition, the collapse of the MSME sector etc. provide ample evidence of the destructive implications of the crisis. In fact, Sri Lanka’s experience clearly reflects the human cost of economic mismanagement in a country.
In the following two years, I was entrusted with the task of assisting the government in managing the crisis as the Secretary to the Treasury. As you may imagine, it was not a “business as usual” situation. It was in the midst of a deep crisis that had unimaginable challenges and implications. The Treasury was metaphorically burning. Anxiety, hopelessness and frustration was everywhere. There was a need for a cautious, focused and determined approach to handle the issues despite enormous negativities prevailed at the time. As Dr. Harsha de Silva, Member of Parliament, has opined in one of his tweets just after a meeting held with the Opposition Leader in early May 2022, where I also participated, the “Situation (is) grave. Going to be unenviable gigantic challenge for anyone to save Sri Lanka”. This was a clear reflection of the real status of the Sri Lankan economy at the time, which was indeed a desperate situation.
Over the last two years, a comprehensive and coordinated set of macroeconomic and other policy reforms were implemented to bring the country to where it is today. Many remedial measures, which would only provide benefits in the medium to long term, were introduced at the expense of measures that provide a short term boost, which has been the practice of the past.
Today, Sri Lanka is gradually emerging from the economic crisis. The macroeconomic reform programme has thus far been able to re-establish a degree of stability in the economy from the height of the economic crisis. As economic stability is being restored, it is essential that the stability is converted into inclusive and sustainable economic growth, such that the prosperity and well-being of all Sri Lankans is enhanced.
I am making these remarks based on the knowledge that I gained and the pain that I went through during the crisis management process, a unique experience that could be described as a once in a lifetime experience. In fact, the reform measures put in place over the last two years are with the hope and expectation that future policy makers and economic administrators would never make the same policy mistakes made in the run up to the economic crisis and would never face a similar experience in the coming decades.
Policy Reforms
Today, Sri Lanka is in the process of pulling itself out of the deepest and most complex economic crisis it has experienced in post-independence history. It is said that one should never waste a good crisis. If there is one positive that I could note from this crisis, it is the fact that the “Bar has been raised” with respect to expectations of responsible macro-fiscal management and improvement of governance in the country during the last two years. Many legislative and institutional frameworks have been introduced to address the structural weaknesses in economic management and governance that have plagued the country in the past.
Sri Lanka has had a long history of incomplete economic stabilisation programmes. The country’s macroeconomic framework has historically been characterised by persistent budget deficits and deficits in the current account of the balance of payments. This twin deficit leads to frequent balance of payments crises, reserve depletion, and bouts of inflation. As the crisis sets in, Sri Lanka has often sought the support of the International Monetary Fund (IMF), following which macroeconomic stabilisation measures are introduced. However, as soon as a degree of stabilisation sets in, Sri Lanka has a tendency to revert to past habits of fiscal excess, accommodated by monetary policy. Following several such cycles, in the lead up to the economic crisis, Sri Lanka ran out of all of its fiscal and external reserve buffers as the public debt to GDP ratio increased to around 120% and usable forex reserves declined to near zero levels in 2022. It is important to understand that it was Sri Lanka that went to the IMF in mid-March 2022 to obtain assistance when the economy was in its weakest footing, a decision which was delayed unnecessarily until then by the then senior economic administrators.
It is in this context that the economic reforms are being implemented. Preventive measures are being implemented proactively in many areas in contrast to the reactive curative measures introduced in the past. Ensuring macroeconomic and financial sector stability, while protecting the poor and most vulnerable, are the key priorities in the reform process. The reform program continues to be structured around seven main pillars: (i) an ambitious and primarily revenue-based fiscal consolidation, accompanied by institutional reforms and cost-recovery based energy pricing, aimed at restoring fiscal sustainability and strengthening fiscal discipline; (ii) a stronger social safety net to protect the poor and most vulnerable (iii) a sovereign debt restructuring process aimed at restoring public debt sustainability (iv) a multi-pronged strategy to restore price stability and rebuild international reserves under greater exchange rate flexibility (v) policies to safeguard financial stability (vi) focused reforms to address governance and corruption issues and (vii) broader structural reforms, including on trade and investment, to unlock Sri Lanka’s growth potential. These reforms have encompassed all key sectors of the economy;
Fiscal Reforms – Tax policy, tax administration, compliance and base broadening, expenditure management, fiscal legislature, including the landmark Public Financial Management (PFM) Act, to improve disciplined fiscal management and digitalization of Treasury operations through the Integrated Treasury Management Information System (ITMIS). These measures enabled Sri Lanka to convert a 5.7% of GDP primary budget deficit in 2021 to a 0.6% of GDP primary budget surplus in 2023.
State-Owned Enterprise (SOE) Reforms – Cost reflective pricing, balance sheet restructuring, institutional reforms, governance and legislation were introduced to reduce fiscal risks. As a result, the losses of Rs. 775 billion recorded in 2022 in key 52 state owned enterprises (SOEs) have been turned in to a profit of Rs. 456 billion in 2023, making a strong turnaround in their financial performance.
Monetary Reforms – The Central Bank of Sri Lanka Act provides the legislative and institutional framework to enable inflation targeting. This contributed to inflation declining from 70% in September 2022 to 2.4% in July 2024.
Financial Sector Reforms – The amendments to the Banking Act and Banking Special Provisions Act were introduced while comprehensive reforms to the State Owned Banks (SOBs) are being implemented. Optimisation of capital deployment will be supported by new guidelines for business revival units in banks and the forthcoming Insolvency Bill. Strengthening SOBs and undertaking reforms will be done to reduce the sovereign- bank nexus through a Cabinet decision in April 2024, which overhauls the business models of Bank of Ceylon (BOC) and People’s Bank (PB) away from financing the budget and SOEs, and strengthen the governance framework for all SOBs; and (ii) a new
regulation on large exposures, which addresses gaps that previously allowed excessive exposure to financially distressed SOEs.
Debt Restructuring – Sri Lanka concluded the domestic debt optimization (DDO) process successfully in 2023, enabling the debt targets to be met whilst ensuring financial sector stability. External official sector debt restructuring was also completed in June 2024. The final stages of the external commercial debt restructuring are now taking place. To provide the legislative and institutional framework to enable durable debt sustainability, the Public Debt Management (PDM) Act was passed by Parliament in June 2024 and the Public Debt Management Office (PDMO) will be fully established by end 2024.
The debt restructuring agreements provide significant cashflow relief in the short term. However, the breathing space provided through the restructuring is not perpetual, and Sri Lanka needs to effectively use the time available to build up its fiscal and reserve buffers prior to the resumption of higher debt service obligations and to prevent a need for a second round of debt restructuring.
In addition to fiscal and reserve buffers, it is necessary to use the breathing space to build up capacity to increase non-debt creating inflows, such as exports of goods and services, and foreign direct investment (FDI). Such an increase in non-debt creating inflows would be crucial to facilitate foreign currency debt service payments in the period ahead.
Growth Enhancing Reforms – To reduce trade and investment policy distortions and uncertainty, and restore the economy’s competitiveness and growth, the government has made significant efforts to modernize the country’s investment and trade frameworks. In July 2024, the Economic Transformation Act (ETA) was enacted, with the ambition of overhauling the existing institutional framework for trade and investment, boosting investment promotion efforts and attracting FDI, and building a foundation to promote economic competitiveness. In addition to the institutional framework, the new ETA also simplifies the investment entry process (including provisions to speed up approvals and implement other facilitation measures), increases transparency on restrictions, strengthens investor protection and sets the foundation for further business environment reforms.
- The government is now in the process of establishing the Economic Commission (EC) and Invest Sri Lanka (Invest SL) in line with global best practices. The organizational structure and regulations under the ETA are expected to improve transparency, streamline administrative processes and more effectively facilitate investment.
- A comprehensive review of the costs and benefits of past tax incentives granted will be initiated to have a more rigorous approach to the granting of new incentives to investors. This approach will have specific and transparent criteria and processes, and include sunset clauses to limit the duration of incentives and include assessment of benefits and costs. Amendments to the Strategic Development Projects Act will be submitted to the Parliament by February 2025 to introduce transparent, rules-based eligibility criteria, to increase the effectiveness of granted tax incentives, and to limit the duration for which incentives can be granted.
- Trade is seen as an engine of growth that creates better jobs, reduces poverty, and increases economic opportunity. The government is continuing negotiations for additional comprehensive Free Trade Agreements (FTAs) with strategic partners. Regulations have also been adopted to rationalize and remove para-tariffs. The National Tariff Policy, expedited efforts to implement the Trade National Single Window, and recent Customs reforms, such as the Authorized Economic Operator initiative, all serve to provide a qualitative improvement to Sri Lanka’s growth, driven by non-debt creating inflows such as exports of goods and services and FDI.
- Crucial legislation such as the Electricity Act and the amendments to the Telecommunications Act will contribute to lower costs of key economic inputs, such as electricity and high quality broadband services. The amendments and regulations to the telecommunication sector will strengthen the digital infrastructure needed to develop Sri Lanka’s digital economy.
- The government is also taking steps to address key supply bottlenecks in the economy. Comprehensive reforms are being put in place to address factor markets in land, labour, and capital. For example; under-utilized state owned land is being earmarked for commercial use. A new labour law that is being drafted will address a number of existing rigidities in the labour market.
To be continued
K. M. Mahinda Siriwardana, Secretary to the Treasury and Ministry of Finance, Sri Lanka
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