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Real challenge is getting GDP growth between 5-6%

17 Oct 2021

  • Dr. Dushni Weerakoon, Dr. Asanka Wijesinghe on Covid and SL’s economy
By Imesh Ranasinghe After going through probably the worst crisis the world experienced since the Second World War, the global economy is growing back to its pre-pandemic era. But many countries have changed plans for the post-pandemic world in order to capitalise on the economic growth that had boomed for a longer term. In Sri Lanka, even though the country experienced a V-shaped economic growth in 2021 after its worse economic performance in 2020, many fear the country would not be able to capitalise on its recovery and grow even better than the pre-pandemic period. A webinar held by the state think tank Institute of Policy Studies (IPS) discussed Sri Lanka’s economic state and how to continue to grow while grabbing the opportunities available in the global economic theatre. V-shaped economic recovery in 2021 Speaking at the webinar, IPS Executive Director Dr. Dushni Weerakoon said that Sri Lanka has experienced, as predicted earlier, a V-shaped recovery in its economy in 2021. She said that even if a 4% growth is expected this year, that will take the economy back to the pre-pandemic output level, thanks in part to the relatively weak output growth that was seen in the pre-pandemic years. But she said the critical challenge is to lift that growth to 5-6% and maintain it in the medium term. In order to do this, she added that a critical factor will be how investments perform, as the drag on investment was the major driver of the output contraction of 2020. “Similar economic rebound can be observed all around the world, which is largely due to the fiscal and monetary stimulus that were rolled out,” she said. Dr. Weerakoon said that Sri Lanka has little fiscal space and relied mostly on monetary policy, and added that there was a surge in direct financing of fiscal spending by the Central Bank since the start of pandemic in 2020. She said efforts were put in place to ensure that the borrowing costs were kept low through yield control measures to put a lid on interest rates. However, the economist said that few would argue that the stimulus measures by the Government were mistaken, given the scale of the crisis initially, “but concerns due arise when such temporary measures seem to take on a more permanent mode of policy engagement”. Further, she said that large-scale debt monetisation programmes have macroeconomic risks and these are more manageable for advanced economies as they have convertible currencies and historical low interest rates. Also, she said that risks are more manageable for those emerging market economies that have low levels of debt, limited exposure to foreign debt, and high reserve stockpiles. “But Sri Lanka, on the other hand, has high debt, elevated exposure to foreign debts, and low reserve stockpiles. Looking at Sri Lanka’s fiscal policy path in the last 18 months, it is difficult to detect any notable effort to curtail spending, particularly discretionary spending,” she said. According to her, this could be seen when looking at the public sector employment that jumped by 4.2% in 2020 and the public sector salaries and wage bill which expanded by 16% in 2020, while 72% of the country’s revenue in 2020 was swallowed up by debt interest payments. Dr. Weerakoon said that these are some pointers as to why Sri Lanka is reluctant to deal with the International Monetary Fund (IMF), as IMF programmes do not provide such flexibility. She added that when looking at the ongoing negotiations the IMF is having with countries that have approached them for assistance, freezing on wage bills, freezing on recruitment to the public sector, etc. are high on the agenda, alongside the efforts to raise revenue through revisions to tax regimes, etc. Moreover, the economist said when fiscal plans are not anchored, large-scale debt monetisation will generate expected macro consequences. For Sri Lanka, she said, the first consequence is on the currency side, with depreciation pressure on the rupee, along with the potential for the inflationary pressures to build up by huge liquidity injections. Addressing imbalances in state income and spending “To address these imbalances, policies should be brought in to increase national income and cut off national spending,” she said. In order to bring about a cut in national spending, she said the Government could do fiscal adjustments through a tighter budget, allowing interest rates to move with market fundamentals and implementing a more flexible exchange rate. However, she added that through these measures, the growth would suffer in the short term while debt ratios will worsen and lead to unfavourable political decisions. According to Dr. Weerakoon, the alternative policy mixes to raise income (growth) are also associated with spending cuts. She said that more investments (borrowings) will lead to risks of higher inflation plus currency pressures. Also, she said adjustment policies involve spending cuts or holding onto an overvalued currency, imposing import curbs, capital controls, etc., “but these have a distortionary impact on the economy over time”. The other option is to increase earnings by pushing exports from the country. Dr. Weerakoon said: “Of course, an export push should be a part and parcel of our growth strategy, but as a short-term measure to raise export earnings substantively, (it) requires a resource switch to the production of tradable goods and a real depreciation of the currency.” On the important question any government will ask itself, as to how it will be possible politically to tighten a budget, she stressed that first the Government needs to commit to strengthen revenue mobilisation. The argument for that, she said, is that the country should hold onto the current tax regime because any changes will generate uncertainty and lead to under investment. “This pretty much true when you have a high debt overhaul to begin with, because the private sector will factor that as a potential reason for tax increases in the future,” she added. Secondly, she said the Government should reduce leakages and improve efficiency of existing expenditure. Furthermore, she noted that access to capital markets can free up space for a more orderly macro adjustment, and although iInitially there would be volatility as exchange rates may overshoot, it will stabilise over time. “It will also allow the Central Bank to reverse its debt monetisation and focus on price stability,” she said. The emerging global order and globalisation Speaking at the webinar, IPS Research Economist Dr. Asanka Wijesinghe said that with the 2016 US presidential election, people started to talk about the rise of protectionism and deglobalisation. It did not help Trump to win his re-election in 2020. He pointed out that it showed protectionism failed economically and politically in the US. Yet, he added that with the pandemic, many economists and politicians are talking about reshoring and whether coupling from the global value chain will be beneficial for the countries. Dr. Wijesinghe said when looking at the trade aspect of globalisation, there was a higher trade-to-GDP ratio between 1986 and 2008 in the world, which is called the “Golden Era of Globalisation”. Although it halted to some extent with the global financial crisis in 2008, he said the ratio reverted back in 2010 to the long-term trend, which resulted in the form of stabilisation and the steady growth the world sees today. “This is something which can be expected after a period of hyperglobalisation,” he said. Moreover, he said globalisation experienced a deep plunge in 2020 due to the pandemic, but even after that collapse, industrial production and trade recovered at the beginning of 2021. “So the conclusion is actually we don’t see much evidence of deglobalisation, but there is a slow down of globalisation,” he noted. On the world trade outlook, Dr. Wijesinghe said that World Trade Organisation (WTO) predictions were pretty much gloomy in the pandemic; the initial prediction was that trade will collapse between -13% and -30%, but contraction was just -5.3% in 2020. Similarly in 2021, the WTO revised its predictions which were done in March, where the March forecast was revised optimistically to 10.8% in October from the 8% for 2021 and to 4.7% from   4% for 2022. Speaking on the Trump tariffs, he said the current Biden administration in the US has not yet revised them fearing political backlash. Their main strategy of the Trump tariffs, he said, was supply chain realignment where they will be less dependent on large capacity batteries, semiconductors, materials such as lithium, cobalt and graphite, and advanced packaging (HS chapter 85) from China. “Most of these were outsourced to its allies in the European Union (EU) and Quadrilateral Security Dialogue (QUAD) countries by the US,” he said. On the Chinese strategies, he said that China is trying to deepen its ties within Asia and beyond, are taking partnership in the Regional Comprehensive Economic Partnership (RCEP), have applied for Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), and completed the EU-China Comprehensive Agreement on Investments in 2020. Opportunities for Sri Lanka He said if Sri Lanka could analyse the ongoing China-US trade war and the tariffs imposed on China’s textiles by the Biden administration, using the partial equilibrium model, the country can expect investment and trade diversion. However, he said the gains are not yet materialised and added that it will take some time for the US retailers to realign supply sources. Also, he said since China is deepening trade integration, there is a chance for Sri Lanka to increase its value chain participation with China which has a huge production economy. “Another key opportunity for Sri Lanka is increasing semiconductor exports because the US is trying to realign supply chains to the EU. It is critical for us to safeguard the EU market and work on increasing our exports in electronics and equipment products to the EU,” he said. On the policy challenges in Sri Lanka, he said there has been increased quantitative restriction on imports, as initially in April 2020, the Government was somewhat selective on import goods as they were targeting consumption goods, but when the choice set contracted, the Government moved towards intermediate goods like fertiliser and agro chemicals. Right now, he said, 31.7% of the imports are under import control. Dr. Wijesinghe said the way forward is to move away from the anti-trade bias, secure the Generalised Scheme of Preferences-Plus (GSP+), integrate global value chains, and restructure existing regional trade agreements.

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