Sri Lanka has gone to the IMF 16 times before this 17th programme, which began in 2022. In my view, this 17th programme should be the last one and we should use this as an opportunity to implement the critical reforms to put the country on a sustainable path.
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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| Photo taken on March 29, 2024 shows the city view of Colombo, capital of Sri Lanka. (Xinhua/Xu Qin) |
Production Economy or a Competitive Economy?
We often hear in the public debate of the need to invigorate the production economy in order to drive economic growth. Most often proponents of the production economy refer to a need for industrialisation, where economic growth is led by the manufacturing sector, which creates some product. Proponents argue that a production economy would lead to a higher degree of production than consumption, creating an exportable surplus. In this process, manufacturing and industrial sector jobs would be created along various value chains, leading to higher prosperity. Many proponents of the production economy either explicitly or implicitly suggest that industrial sector growth is somehow superior to economic growth led by the services sector. They assert that the government has a role to play in the propagation of a production economy by implementing a strong industrial policy, including investments in R&D, training, and various other interventions.
Whilst there are several merits to the concept of a production economy, a narrow focus on the industrial sector may not lead to the optimisation of economic and social returns for a country like Sri Lanka. There are several reasons for this;
Manufacturing typically has lower returns in the value chain, with areas like design, product development, and marketing, yielding higher returns than the pure manufacturing segment of the value chain.
Manufacturing (like other sectors) is increasingly focusing on automation, allowing near-shoring of manufacturing closer to end markets, and reducing job creation in the manufacturing sector.
The contribution of manufacturing to global GDP has been on the decline, with services accounting for more than 60% of global nominal GDP in 2023.
Manufacturing is often associated with higher resource consumption and in many cases, more pollutive manufacturing activities are shifting to developing economies from the advanced economies.
None of this is to say that there are inherent problems with the manufacturing and industrial sector, but the point here is that an exclusive or predominant focus on this sector is not an optimal approach.
A more constructive approach would be to focus on competitiveness, more broadly. That is to focus on expansion of highly productive sectors, irrespective of whether they are in manufacturing, services, or agriculture. For example, a highly protected, globally uncompetitive shoe manufacturer selling to the domestic market is likely to be less productive than a highly competitive logistics service provider that competes with the top global logistical companies. A more productive entity will have higher real wages, generating better livelihoods and greater prosperity and well-being to citizens.
One of the keys to productivity is whether a sector is tradable or not. In the past, technological limitations meant that only goods were tradable, making industrial sectors typically more competitive than protected services sectors. However, with the advent of the digital economy, almost all services are now tradable as well, from professional services like architecture and engineering, to design and management consultancy. Sectors exposed to trade and competition are forced to be more productive, and higher productivity is what drives growth in real wages. Accordingly, if the objective of a government is to enhance the livelihoods and prosperity of the population, it should focus on growth of sectors that are tradable and highly competitive. The objective of government policy must then be to create an environment that enables such sectors to thrive by maintaining macroeconomic stability, removing impediments and facilitating the skills and other inputs required for those sectors.
Amending the IMF Programme amidst Debt Restructuring
There have been numerous recent statements by various groups regarding re-negotiation of the IMF supported reform programme. However, Sri Lanka’s present IMF supported Extended Fund Facility (EFF) programme is very different to Sri Lanka’s past programmes with the IMF given the fact that the restructuring of public debt is an integral component of this 17th programme.
The debt restructuring process envisaged in the programme is required to provide debt relief such that the key debt related targets as set out in Sri Lanka’s Debt Sustainability Analysis (DSA) can be met by 2032. The DSA is based on the IMF’s Market Access Countries Sovereign Risk and Debt Sustainability Framework (MAC SRDSF). The MAC SRDSF is a model applied to emerging market countries in general and is based on a combination of historic trends, peer country comparisons, and interactions between different variables (for instance the GDP growth projection would interact with the degree of fiscal consolidation, real interest path, and other variables).
Therefore, the outputs of the MAC SRDSF model are to a great extent mechanical in nature, with very little room for judgment and negotiation. Judgment based adjustments are also subject to inter-departmental review at the IMF and finally the decisions of the IMF management and Executive Board.
One of the key inputs for the DSA is the primary budget balance target. Sri Lanka’s programme includes a primary budget surplus of 2.3% of GDP from 2025 till 2032. This forms a key input into the Gross Financing Needs (GFN) target in particular.
The primary budget balance in turn determines the fiscal path in terms of how revenue must increase and expenditure must be managed to enable the 2.3% target to be met. The fiscal path in turn influences the interest rate trajectory, which influences the growth path. The macroeconomic baseline also includes an international reserves path, which influences the currency trajectory, which interacts with inflation. All of these contribute to determine the GDP growth path in the baseline.
It is a failure to understand the dynamics of these macroeconomic interactions that has led many to believe that the IMF targets can be casually re-negotiated and adjusted to meet various political or ideological ends. The bottom line is that expectations for re- negotiation of Sri Lanka’s DSA targets are based on a fundamental misunderstanding of the nature of the IMF programme structures, particularly one including debt restructuring. The targets are non-negotiable, whilst there can be some flexibility in terms of how those targets are to be achieved.
For example, earlier this week, the Hon. President announced some proposed amendments to the Personal Income Tax (PIT) structure. The Treasury began negotiating such an amendment with the IMF as far back as September 2023. It was not possible to implement such a proposal previously given the fact that revenue was falling short of targets. However, with the improvement in revenue performance this year, it has become possible to negotiate an adjustment to the PIT structure which provides some relief to the tax payers in the middle bands, whilst ensuring there isn’t an excessive gain for the highest income earners. The proposed adjustment to the PIT is estimated to cost around 0.08% of GDP and compensating revenue measures have already been discussed with the IMF, such that revenue targets are not compromised. As has been stated previously by the government, whilst the ultimate programme targets are largely non-negotiable, the policy mix by which such targets are met has more flexibility. In this instance, the ultimate targets of tax revenue and the primary balance are not compromised since the government has quantified the revenue impact and already discussed compensating revenue measures with the IMF.
Sri Lanka has gone to the IMF 16 times before this 17th programme, which began in 2022. In my view, this 17th programme should be the last one and we should use this as an opportunity to implement the critical reforms to put the country on a sustainable path. Let us recall Mr. Nigel Clarke’s rationale for Jamaica’s fiscal reforms, “The 7 percent primary surplus target is merely an intermediate goal. It is a means to an end. The substantive goal is the achievement of real economic independence”. So, it is abundantly clear that it was our failure in the past to “put our house in order” that led to Sri Lanka’s economic plight. Now, at least after this serious economic crisis, our duty and aim should be to implement required reforms following a focussed and committed approach to strengthen our economic levers and buffers so that, “we Sri Lankans can achieve our real economic independence and even enhance our economic independence”, going forward.
Addressing the Impacts on the Poor and Vulnerable
The crisis had disproportionate impacts on the poor and vulnerable, exacerbating existing social inequalities. The remedial measures to address the crisis at times added to the shocks faced by these groups. In fact, some critics argue that even though the economy has stabilized, this has happened at an adverse equilibrium where costs are higher and incomes have not caught up.
Whilst accepting that it is true that costs are higher and incomes have not yet caught up, it is also important to consider the counter-factual. What would have been the outcome if the reforms had not been implemented two years ago?
Source: Department of Census and Statistics
The coordinated monetary and fiscal policy measures were able to control inflation from the latter part of 2022. If this had not been done, inflation could have continued to increase like it has done in other countries that have undergone sovereign debt crises.
Inflation Date
Ghana 23.1% May-24
Zambia 15.2% Jun-24
Argentina 276.4% May-24
Lebanon 51.6% May-24
Venezuela 59% May-24
Suriname 20.7% Apr-24
Ethiopia 23% May-24
Ecuador* 2.5% May-24
Sri Lanka 2.4% Jul-24
*Ecuador is a dollarized economy
Once inflation is brought under control, as it was done successfully in Sri Lanka, nominal wages will gradually rise to compensate for the loss in real earnings due to inflation. However, typically this period of wage catch up does not occur immediately, but happens gradually as the economy recovers and productivity driven economic growth returns. Between January 2022 and May 2024, private sector wages have increased by 32% in nominal terms according to CBSL’s wage rate indices. During the same period, public sector wages have increased by 21% in nominal terms. This trend will continue as long as economic stability is intact, allowing growth enhancing measures to take full effect.
The protection of marginal groups, who face the brunt of the crisis and could be potentially excluded from the broader economic process, is crucial. The empowerment of women and the elderly are the other key areas that are being addressed given the importance of empowering them. The reduction of multi-dimensional poverty is also a priority by improving social safety nets, education and health facilities, and creating economic opportunities towards promoting more inclusive and sustainable growth.
Social protection reform became one of the priority reform agendas of the government as it attempted to address the crisis. The Samurdhi framework was overhauled with new selection criteria being implemented. The new criteria were based on objective, verifiable factors which minimized room for subjective decisions or politicization. A clear framework for application, verification, and transparent selection was implemented. Another key mechanism was the grievance handling process and allowing for appeals and review. Naturally, like with any other major reform after three decades, there have been teething issues and resistance. However, with the grievance handling mechanism falling into place, these issues have eased. The new mechanism has been named Aswesuma.
The cash transfers now take place direct to the beneficiaries’ bank accounts, and the improved selection mechanism has enabled a larger allocation of funds to each vulnerable household. The total cash transfers to vulnerable households have increased by over three-fold compared to pre-crisis levels in 2019. In 2020, the budget expenditure for school nutrition food programme was Rs. 2.3 billion which increased to Rs. 12.5 billion by 2023, with the number of beneficiaries more than doubling during this period. Public expenditure to fund school text books increased from Rs. 4.8 billion in 2018 to Rs. 23 billion in 2023. Government expenditure on free medicines for the general public increased from Rs. 54 billion in 2019 to Rs. 144 billion in 2023.
The total cash transfer each year is also a quantitative target under the IMF supported EFF programme, with a floor under the minimum transfers each year. A graduation mechanism is also being put in place, whereby those who are no longer eligible for cash transfers will still receive other non-cash benefits, such as livelihood support, concessionary financing, among others.
However, cash transfers are just one element of the broader policy ambit of social protection. As mentioned at the beginning of this address, Sri Lanka has had a long history of social welfare policies, however there is a long way to go in terms of optimizing such measures for the full benefits to accrue to the population. One of the key shortcomings in Sri Lanka’s social protection architecture is the lack of a holistic Social Protection Policy. The shortcomings resulting from this are many, including issues ranging from coverage of beneficiaries to adequacy of benefits. Furthermore, fragmented programmes, schemes, institutions, and products which are integral to the current social protection system have been proven to be inadequate, resulting in sub-optimal developmental outcomes.
To address this gap, the government developed the National Social Protection Policy. The key pillars of the new social protection system include social assistance, social care, social insurance, and labour market and productive inclusion programmes. The policy is underpinned by the principles of equity, inclusivity, and sustainability, ensuring that resources are allocated efficiently and effectively, to reduce poverty and social exclusion, fostering a society where everyone has the opportunity to thrive. The principle of ensuring access to necessary social protection for all citizens throughout the lifecycle is embodied in this policy.
To be Continued
K. M. Mahinda Siriwardana, Secretary to the Treasury and Ministry of Finance, Sri Lanka
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