When were the seeds of the economic crisis sown?

18 Mar 2022

When were the seeds of the economic crisis sown?

18 Mar 2022

Finding the way out of the crisis

By Madhusha Thavapalakumar Last Wednesday (16), President Gotabaya Rajapaksa addressed the nation and stated that the current economic crisis the country was enduring was not created by him. Simultaneously, a video was making rounds on social media last week where a woman stated to reporters that the general public should not blame the Government for the current economic crisis, as it too was helpless. On the other hand, several politicians and netizens blame Covid-19 for the prevailing chaotic state of the economy. Needless to say, the Russia-Ukraine conflict has also become a factor to blame amongst the ruling party sphere. The past week also witnessed #GoHomeGota trending on Twitter and other social media platforms with an enraged general public publishing posts on price hikes, power cuts, and fuel shortages while several netizens counter-attacked the aforementioned hashtag with #WeAreWithGota. Two of the most mentioned words in news reports in the past few weeks were price hikes or price increases, with a slew of rate hikes of goods and services following the Central Bank of Sri Lanka’s (CBSL) decision to float the rupee after forcibly holding it below Rs. 203 for months. Increases in prices of certain goods have been pointed out in images around this article. The Market Mine of The Sunday Morning Business with the input of economic experts is determining this week whether the current crisis is indeed an economic fiasco created by this Government and its policy decisions, while also exploring ways out of this crisis. Where did Sri Lanka start going wrong?

‘Sri Lanka did some crazy things like tax cuts’

Public Policy Specialist, Economist, and Former CBSL Director Dr. Roshan Perera told The Sunday Morning Business that the Covid-19 pandemic definitely had an impact on the Sri Lankan economy, with the subsequent lockdowns and its impact on Sri Lanka’s tourism and other foreign exchange earning sources. However, Perera added that the Government did several “crazy” things, the biggest amongst them being the slashing of taxes in late 2019 by the newly elected Government at that point. “The biggest mistake was slashing down the taxes. As soon as it happened, Sri Lanka’s bonds started trading at discounted rates and subsequently the international rating agencies downgraded us. This was the starting point where this Government went wrong. Nobody asked for these tax reliefs,” Perera stated. She added that the Government could have announced those tax cuts after careful analysis and study rather than announcing it to the public in an ad hoc manner. According to Public Finance, a website powered by Verité Research, a Colombo-based independent think tank, there has been a decline in Sri Lanka’s tax base between 2019 and 2020 with a 33.5% decline in the number of registered taxpayers (corporate and individual). This decline is most likely associated with the major changes in tax policy introduced in December 2019, particularly the increase in thresholds for Value Added Tax (VAT) and the abolition of the Pay As You Earn (PAYE) tax.

Controlled exchange rates, interest rates, a recipe for disaster

According to Perera, the CBSL’s move to control the exchange rates and the interest rates too had an impact on the current crisis. “Keeping both the exchange rates and the interest rates instead of loosening the fiscal policy is a recipe for disaster. Other countries did not impose control in this manner and that is the reason why Sri Lanka is more affected than the other countries,” Perera asserted. Further, she noted that the decision to control the exchange rate severely hampered worker remittances and added that even with the two initial waves of Covid-19 and weeks-long lockdowns, Sri Lanka’s worker remittances in 2020 were still higher than that of 2019. However, it slumped in 2021 with the CBSL’s move to keep the rupee below Rs. 203. As per CBSL data, workers remittances dropped to a 10-year low at $ 5.49 billion in 2021. However, during 2020, workers remittances increased by 5.8% Year-on-Year (YoY) to $ 7.1 billion, despite the pandemic impacting most of Sri Lanka’s labour markets. The CBSL two weeks ago decided to float the rupee and the selling rate of the USD as of last week surpassed Rs. 270 at Licensed Commercial Banks (LCBs) while the kerb market rates of the USD edged Rs. 300.

‘16 times to IMF, still no financial discipline’

Speaking to The Sunday Morning Business, Advocata Institute Chief Operating Officer Dhananath Fernando stated that global issues such as the recent fuel price hikes definitely affected the Sri Lankan economy. “At any given point, there will be such issues in any part of the world. Something will keep happening somewhere. There could even be a natural disaster. Our economy is so fragile that when such things happen globally, it will have a massive impact. But our local crisis started a long time back,” Fernando added. According to him, the root cause of Sri Lanka’s issues was its lack of financial discipline. He added that Sri Lanka had sought financial assistance from the International Monetary Fund (IMF) 16 times, which itself demonstrated the country’s lack of financial discipline. “All our economic theories and policies are completely against what the IMF suggests us to do. Seeking their help again indicates how badly we manage our finances,” Fernando explained, as President Rajapaksa during his speech addressing the nation expressed his wishes to work with the IMF for debt restructuring.

Why is the Govt. involved in all kinds of businesses?’

Fernando stated that the current import ban would aggravate the condition further as import bans would hamper the country’s exports as well. He further noted that the Government was involved in all kinds of businesses including airlines, hotels, and petroleum, which according to Fernando was inappropriate as it created inefficiency in the State sector. Another concern raised by Fernando was that the 1.5 million people employed by the country’s State sector posed a huge burden for the Government, as these employees’ pensions and bonuses were an added burden to the country’s expenditure.

Lack of financial literacy

Former CBSL Deputy Governor Dr. W.A. Wijewardena told The Sunday Morning Business that people in Sri Lanka should possess high economic and financial literacy in order to make independent judgements on whether this crisis was created by the current Government or whether the sole factor that led to the current state of the economy was merely the pandemic that started in early 2020. “People can lie, but statistics will not lie. Anyone can say anything, but people should be able to make the judgement on their own,” he stated. Way out of the crisis

Go to IMF, not just for technical assistance

Wijewardena stated that it was time that Sri Lanka sought IMF assistance immediately and it should not be merely for technical assistance. “Restructure the debt for the next twelve months. Increase the interest rates and go back to the tax system that was in the country before 2019, so that the Government can get more revenue. Also, introduce a long-term economic restructuring plan,” the Former Deputy Governor stated.

It is a long, long, long road ahead, but taxes should be increased

According to Former CBSL Director Perera, Sri Lanka’s way out of the prevailing economic crisis was indeed a “long, long, long road ahead”. However, she expressed relief that the Government had already made some progress with regard to exchange and interest rates with its recent decision to float the rupee and increase the interest rates. “But they have not done anything much in the fiscal sector. Taxes need to be increased. The Committee appointed to advise the National Economic Council has some tax experts and I hope they will advise the Government to go back to the tax system that was there in 2019. Basically, we all have to go through pain in order to recover,” she added.

Serious reforms needed

Echoing Perera’s sentiments, Fernando noted that Sri Lanka’s economic crisis was not easy to overcome and the ways out of this crisis would certainly be painful. “We have to undertake economic reforms and these reforms will be difficult for the public. Political popularity will suffer due to these reforms but we have to do that. Restructure the State sector, bring down the number of staff, and close down some of the State entities. Connect with the global production network because we are trying to become self-sufficient at the moment while the world is moving on. The Government should also reconsider the tax system. Those are the list of things that we need to do,” Fernando noted. ===End Box===

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When were the seeds of the economic crisis sown?

When were the seeds of the economic crisis sown?

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