• Sri Lanka is not out of the woods yet; the economy is still contracting
• Inflation has fallen significantly from about 70% in late 2022 to 12%
• A resumption of growth is key for ordinary Sri Lankans to benefit
• We need political consensus on the IMF programme and reforms
• All major political parties should formulate a national economic agenda
• Economic policy experimentation could result in ‘lost development decade’
• India-SL ties should shift to deepening bilateral trade and investment flows
• Stringent IMF conditions reflect scale of mismanagement and inefficiencies

Sri Lanka needs to do three things to have a sporting chance of exiting the economic crisis in a few years, according to Dr. Ganeshan Wignaraja – stay the course on the International Monetary Fund (IMF) programme until 2026; increase non-debt raising sources of foreign exchange such as exports, Foreign Direct Investment (FDI), tourism, and worker remittances; and ensure political consensus on the IMF programme and reforms to boost non-debt foreign exchange and create the conditions for growth.

In an interview with The Sunday Morning, Dr. Wignaraja asserted that Sri Lanka was in a better place than the dark days of 2022, while pointing out, however, that the economy was still contracting. He also warned that experimentation with economic policy at this crucial juncture could result in a ‘lost development decade (2025-2035)’ in Sri Lanka with terrible consequences for the youth.

“All the major political parties should join to formulate a national economic agenda until 2030 which sets realistic targets for a small economy like Sri Lanka and adopts pragmatic market-friendly policies,” he emphasised.

Following are excerpts of the interview:

How would you assess Sri Lanka’s economy at present compared to last year?

Sri Lanka is in a better place than the dark days of 2022. 

In the dark days of the unprecedented economic crisis in Sri Lanka last year, mismanagement of the economy meant a foreign debt default of $ 50 billion, foreign reserves depleted to $ 20 million, people were in petrol queues for days, inflation was at about 70%, and the economy contracted by 8% in 2022. 

Now, remarkably, there has been rapid economic stabilisation within 14 months for a crisis-hit developing country like Sri Lanka. Useable foreign reserves are a healthy $ 2 billion, fuel is available under reasonable quotas, and inflation is just 12%. 

But the problem is that the economy is still contracting. The IMF conservatively projects -3.1% growth in 2023, with a return to growth expected in 2024. Others may be more pessimistic. Uncertainties around elections and the world economy cloud the economic horizon in 2024, which could affect the Sri Lankan economy.

While inflation is slowly easing, there hasn’t been any real relief for the people on the ground. Are the dark days behind only for the more affluent section of the population? When will the man on the street see some relief?

Inflation has fallen significantly from about 70% in late 2022 to 12% at present. This reflects decisive action by the Central Bank of Sri Lanka under Governor Dr. Nandalal Weerasinghe to raise interest rates to control inflation and subdued consumer demand in a contracting economy. Lower inflation means that the Central Bank has started reducing interest rates.

International experience suggests that lower inflation will likely translate into economic benefits for ordinary Sri Lankans. For instance, low interest rates mean more consumer spending and more borrowing, which stimulates demand for household goods. Likewise, companies can borrow more and invest in capital projects, which spurs employment. 

A resumption of growth is the key for ordinary Sri Lankans to benefit. In the interim, other important steps include: (1) more targeted cash transfers to support the poor and vulnerable throughout Sri Lanka, (2) raising productivity of domestic agriculture to increase food security, and (3) improved logistics to reduce post-harvest losses. One hopes that World Bank and Asian Development Bank (ADB) assistance will be effective in alleviating the hardship of ordinary people. 

What measures would you list as being essential to keep the economy going forward in this positive direction?

Sri Lanka needs to do three things to have a sporting chance of exiting the economic crisis in a few years.

First, stay the course on the IMF programme until 2026. The 17th IMF programme of $ 2.9 billion is toughest yet in our history to fix the troubled economy. It seeks to restore fiscal and debt sustainability by raising taxes and improving tax administration, improving public expenditure management and anti-corruption measures, better targeting poverty reduction programmes, creating an independent central bank, and recapitalising the banks. 

Second, increase non-debt raising sources of foreign exchange such as exports, FDI, tourism, and worker remittances. Sri Lanka needs reforms to become more open to international trade, cut red tape regulations, privatise loss-making State-Owned Enterprises (SOEs), and invest in skills and infrastructure to support business competitiveness and growth. Tourism and worker remittances may be an easier ask in the short term with the right policies. Exports and FDI are crucial to Sri Lanka, but may take more time to move upwards. 

Third, we need a political consensus on the IMF programme and reforms to boost non-debt foreign exchange and create the conditions for growth. All the major political parties should join to formulate a national economic agenda until 2030 which sets realistic targets for a small economy like Sri Lanka and adopts pragmatic market-friendly policies. 

Do you see the Government having a clear economic policy as opposed to engaging in experimentation?

To move from the dark days to the present, Sri Lanka adopted a range of stabilisation measures even prior to the present IMF programme. Examples of the new measures include: the hike in interest rates to control inflation, controlling public expenditure and hiring into the public sector, stress tests and capital adequacy requirements on banks, and opening the fuel market to competition from foreign petroleum sheds. Sri Lanka also engaged actively with its foreign creditors and important development partners. 

These stabilisation measures and partial reforms have helped to restore some policy credibility with the international community and investors after the episode of the so-called ‘home-grown policies,’ which contributed to the debt default. 

Even today, some suggest that there are alternative economic solutions to economic stabilisation and reform. In view of the upcoming election cycle, it is imperative that proponents of such solutions set out cost proposals for candid public debate on economic costs and benefits. Experimentation with economic policy at this crucial juncture could result in a ‘lost development decade (2025-2035)’ in Sri Lanka with terrible consequences for the youth.

How can the Government’s domestic debt restructuring programme help towards the growth of the economy? Is the path selected by the Government sufficient for the purpose?

Internationally, restructuring of domestic debt often plays a role in the resolution of debt crises. But it has bred controversy due to some issues, particularly different estimates of Employees’ Provident Fund (EPF) losses in Sri Lanka. 

My guess is that the Government of Sri Lanka felt that domestic debt restructuring would bring net economic benefits to the country by: 

(1) enticing foreign creditors to agree to serious haircuts on debt values and lengthening maturity terms. The principle of fairness applies to debt negotiations. That is, the pain of haircuts on debt values and maturity should be equally shared between foreign and domestic creditors. 

(2) restoring foreign investor confidence in Sri Lanka, 

(3) enabling Sri Lanka foreign borrowing again, and 

(4) reducing economic vulnerabilities and laying the foundation for growth. 

One notable positive in the path selected by the Government is that the domestic banking system was largely exempt from domestic debt restructuring to avert a possible banking crisis on top of the debt crisis, bringing more misery to ordinary Sri Lankans. 

What role should India play in Sri Lanka’s recovery and what would the ideal outcomes of the President’s Indian visit be? What should Sri Lanka hope for?

In April 2022, when Sri Lanka announced a preemptive default on its external debt of over $ 50 billion, the Central Bank of Sri Lanka held foreign exchange reserves of only $ 20 million and delays in political decision-making meant an IMF programme was months away.

Sri Lanka faced a terrible situation of not being able to import food or fuel for its people and issued calls for international aid. India played a critical first responder role by providing $ 4 billion in 2022, which enabled Sri Lanka to import food and fuel. This is the largest bilateral aid package that India has mounted in its history to any country.

India also actively pursued quiet diplomacy to make the case for an IMF programme for Sri Lanka. 

India is forecast to be one of the world’s fastest growing economies in 2023-2024 and a magnet for foreign investment. Now with the Sri Lankan economy showing signs of stabilising and an IMF programme in place, India-Sri Lanka ties should shift from foreign aid to deepening bilateral trade and investment flows. This would be an ideal outcome of the talks in New Delhi between President Ranil Wickremesinghe and Indian Prime Minister Narendra Modi on 21 July.

Private Indian investment is starting to make a mark through Adani’s investments in renewable energy and the West Container Terminal. The hope is that these infrastructure projects will be transformative for Sri Lanka, bringing not only capital but technology and skills transfer, but also deepen local linkages with the Sri Lankan economy.

Furthermore, the confidence built through such investments could encourage perhaps an additional $ 3-4 billion in Indian private investment in Sri Lanka in the next few years in sectors like agro-processing, light manufacturing, and information technology services. Likewise, large Sri Lankan companies should follow the example of Brandix and invest in India. 

The IMF programme is a tough one. Do you believe we will be able to meet its targets and receive the next tranche without any hiccoughs?

The IMF is not a grant giving aid agency but a lender of last resort to countries like Sri Lanka in a crippling balance of payments crisis. The very stringent conditions of the present IMF programme – including governance reforms and an independent Central Bank – reflect the scale of mismanagement and inefficiencies of the Sri Lankan economy and the requirement for the IMF to be paid back.

Sri Lanka has met some IMF targets since March 2023 while others are a work in progress. The IMF has shown understanding of the challenging political environment and one is hopeful that the IMF has a realistic view about the pace of programme implementation. 

What’s your outlook for Sri Lanka in the months ahead?

In the final analysis, the debt default has brought terrible pain for ordinary Sri Lankans. The good news is that the economy is in a better place in July 2023 compared to the dark days of 2022, but we are not out of the woods yet. The economy is still contracting. 

Continuing the IMF programme and implementing reforms to create a more market-oriented economy offers Sri Lanka a sporting chance of coming out of the crisis in the next few years. This will help to build a better Sri Lanka for future generations.