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Harsha’s prescription for economic recovery

  • New 10-point Common Minimum Programme highlights measures to pull Sri Lanka out of debt crisis and towards sustainable and inclusive development

 

BY Sumudu Chamara

 

Sri Lanka’s economic crisis is not an unexpected one and is a result of decades of short-sighted policies and half-hearted reforms which have weakened the country’s foundation. Even though global crises have pushed the country to the brink of economic collapse, the country can still recover by reforming the economy, among other priorities. However, the country has to take some urgent measures to achieve it, and these measures need to be well-planned and honest.

 

This reality was underscored in a proposal titled “Blueprint: Out of the Debt Trap and Towards Sustainable Inclusive Development: A 10-Point Common Minimum Programme for Sri Lanka’s Economic Recovery” and was presented by Samagi Jana Balawegaya (SJB) Opposition MP and economist, Dr. Harsha de Silva to revive the country’s collapsing economy. It highlights what short, medium and long-term measures the country needs to take.

 

Debt crisis management 

 

In regard to managing Sri Lanka’s debt situation – adding that Sri Lanka’s urgent needs are to manage its immediate sovereign debt crisis by obtaining bridging finance until the International Monetary Fund (IMF) disburses funds and to engage with the IMF while restructuring debt – the proposal noted that maintaining financial system stability is critical.

The proposal identified several key areas in this regard – namely, managing imports and obtaining bridging finance, engaging with the IMF and restructuring debts, and ensuring financial system stability.

Noting that sovereign credit rating agencies have downgraded Sri Lanka to “default”, signalling tough times until the country enters into an Extended Fund Facility (EFF) with the IMF, the proposal cautioned that Sri Lanka must manage import flows of essentials in line with current account receipts (made up of export earnings, remittances, and tourist receipts) unless the country secures bridging financing from friendly nations or from the IMF under its Rapid Finance Instrument (RFI) facility.

Explaining the present situation with regard to foreign exchange and the depreciation of the Sri Lankan rupee against the US dollar (USD), it added: “The bridging requirement for essential imports and the mandatory payment of multilateral debt is approximately $ 3-4 billion for the rest of 2022 (besides India’s $ 4 billion assistance via credit lines, currency swaps, etc.). Ongoing discussions with Japan, China, the Middle East, and Russia have not resulted in tangible results. The US and the European Union (EU) have thus far provided some emergency assistance (e.g. the US provided a $ 20 million grant for feeding school children). The IMF cannot release RFI funding until the Government reaches significant progress in debt restructuring, which could take up to several months after the IMF completes a debt sustainability analysis (DSA). This DSA, which was submitted to the Government end-June, will serve as a credible benchmark for negotiating debt restrictions with creditors.”

In this context, the proposal said, in order to solve Sri Lanka’s immediate liquidity crisis, it is essential that the country obtains short-term bridging finance from friendly nations, such as credit lines for imports, foreign currency swaps, or barter trade (e.g. the China-Sri Lanka Rubber-Rice Pact of 1952).

Adding that privatisation is also an option, it noted that desperately selling assets without transparency and competition will be disastrous.

In addition, with regard to the negotiations with the IMF, the proposal stated that extensive economy-wide changes are needed to come out of the prevailing economic crisis and that Sri Lanka must address its solvency issues through reforms that allow debt sustainability. Designing and implementing an IMF-assisted EFF programme, it noted, would be the best place to start. What is more, the proposal highlighted that the previous Government rejected this option in favour of “home-grown solutions” that allowed the political control of public resources due to a misconception that the programme would be anti-welfare, which is not true. In regard to this concern, the proposal said that the IMF-supported reform agenda promotes fiscal adjustments alongside the proper targeting of subsidies and greater investment in health and education.

It was noted that the IMF stabilisation programme would have three pillars – the exchange rate, fiscal, and monetary reforms; unshackling the economy from direct Government intervention; and export development, including the removal of the import restriction regime regarding which the proposal said that in order to recover from the prevailing economic crisis quickly, the said reforms need to be implemented in one package and that economic governance and public financial management (e.g. public procurement rules) would also be strengthened, reducing room for corruption.

“Successfully implementing a stabilisation programme would improve stakeholder confidence, create a conducive environment for the positive revision of the sovereign credit rating, win back external financiers, and promote inward Foreign Direct Investments (FDIs).”

Meanwhile, cautioning that the said ongoing restructuring efforts will be a complex and difficult process with different types of creditors requiring different approaches, the proposal further noted that this process will take a minimum of six months if the Government co-operates with the negotiators. It further warned that otherwise, this process could even take years and that it has been complicated by the Hamilton Reserve Bank suing for immediate and full repayment of its debt in a federal court in New York, USA.

In addition, with regard to ensuring financial stability, the proposal presented several interventions, adding that there will be opportunities to attract risk-adjusted returns for FDIs, into the country’s banking system.

The short-term interventions that were suggested are: managing imports in line with current account receipts and obtaining bridge financing from friendly nations in terms of credit lines for imports, foreign currency swaps, or some innovative mechanism on barter trade; continuing to engage with the IMF with a view to obtaining a staff-level agreement leading to IMF Board approval for an EFF and DSA; proceeding with external debt restructuring with Lazard and Clifford Chance (appointed financial and legal advisors); and using all possible avenues to bring China into the negotiations at the earliest.

The proposal also presented two medium-term interventions. The first one was minimising domestic currency debt restructuring, regarding which it noted that if domestic restructuring must take place, treatment to profiling with some regulatory forbearance (this may be under the purview of the public debt office) should be limited. Regarding the same intervention, it said that Sri Lanka should consider converting to bonds and listing on the Colombo Stock Exchange (CSE) and that it is critically important to ensure financial system stability (some banks are significantly exposed to foreign exchange debt: International Sovereign Bonds and Sri Lanka Development Bonds). The second proposed intervention was creating a central public debt office, which will require highly skilled and well-paid professionals.

 

Monetary and exchange rate policy 

 

The proposal paid great attention to the monetary and exchange rate policy too, while adding that it is essential that the Government acts to stabilise the monetary environment, using measures including exchange rate and interest rate adjustments and monetary policy reforms.

Regarding exchange rate adjustments, the proposal stated that balance of payment difficulties and the black-market premium in the official forex market will be eliminated by adjusting the exchange rate to the equilibrium market level and that this can be achieved through a transitional phase of floating the currency to permit market forces to reveal the equilibrium rate, and then stabilizing that rate through Central Bank of Sri Lanka (CBSL) intervention in the forex market. However, per the proposal, there are three prerequisites in this regard – namely, removing forex restrictions on current account transactions, quantitative import restrictions, and forced conversion rules, and beginning the debt restructuring process with the IMF in order to increase confidence in fiscal/monetary discipline and to improve USD inflows, and having reserves to support the currency.

Under the same group of reforms, the proposal read that policy interest rates should have been raised significantly before the currency floated, and it would have helped to bring export proceeds into the country and compressed demand. It further said that the CBSL should not try to suppress rates by refusing to accept market-determined bids, as this would lead to money printing and inflation, and must instead obtain its weekly bill and bond funding requirement from the market at market clearing rates.

“These high rates will negatively impact growth, which will need to be addressed later, but they are needed now in order to avoid hyperinflation,” the proposal emphasised.

Moreover, the report alleged that Sri Lanka has long allowed the monetary policy to be dominated by fiscal policy and that the CBSL has printed money for the Treasury’s political objectives, leading to high inflation and the loss of competitiveness. It added that the existing Monetary Law Act (MLA) allows this, and that in this context, it is important to legislate amendments to the MLA based on the draft that the Cabinet of Ministers approved in 2018 with the most important revisions being those aimed at preventing the monetisation of Government and public sector debt.

The proposal mentioned three short-term interventions required to address this situation. They are: allowing the exchange rate to reach equilibrium market value through transitional phasing and subsequent stabilisation, raising interest rates to a level required in order to manage inflationary pressure, and moving towards obtaining the weekly bill and bond funding requirement from the market at market clearing rates.

The medium-term steps include ensuring the independence of the CBSL; passing the MLA with necessary improvements to bring an end to discretionary money printing; building the institutional independence of the CBSL; creating a legislative framework for inflation targeting; and also gradually unwinding the CBSL domestic balance sheet in a carefully sequenced manner alongside market interest rate adjustments and foreign inflows.

 

Revenue consolidation 

Pointing out the importance of reforming the fiscal sector, the proposal said that the budget deficit must be reduced by both widening the tax base and restraining spending and that there is ample room to strengthen the tax base as populist policies have resulted in Sri Lanka having one of the lowest revenue-to-Gross Domestic Product (GDP) ratios in the world (8.7%, with tax at only 7.7%). It added that efficiency in tax administration must be improved via pay-as-you-earn and withholding mechanisms, which were recently reintroduced along with revisions to the value-added tax (VAT), corporate and personal income tax, and turnover tax.

Eliminating unjustifiable tax exemptions, strictly enforcing the Fiscal Management (Responsibility) Act of 2003 with revised targets and thresholds, and systematically increasing the non-tax revenue, were some of the priorities that the proposal identified. In this regard, short, medium and long-term interventions were proposed.

Reintroducing the 2017 Inland Revenue Act with necessary amendments to address the DSA and restructuring requirements, by broadening the VAT base and withholding taxes (including capital and service payments), broadening the income tax base and reversing the decline in the number of taxpayer files, and creating a progressive corporate tax regime with the rate increase being gradual were some of the short and/or medium-term interventions. In addition, creating a task force to assess Government assets and identifying opportunities to increase non-tax revenue was recommended as a short-term intervention, regarding which the proposal further recommended increasing the revenue on Government-owned assets, fees, and returns from Government organisations and ensuring service quality improvement.

Among the medium-term interventions were formulating a long-term, stable tax policy with investment credits instead of tax incentives for FDIs while halting giving out Strategic Development Projects’ (SDP) status for new investments which will be subject to paying a 15% minimum alternative tax; improving tax collection mechanisms; becoming a signatory to the Base Erosion and Profit Shifting (BEPS) Digital Economy frameworks while introducing 15% minimum alternative tax for multinational companies; and introducing Customs reforms such as enhanced risk-based investigations, reforming of the Customs officers’ rewards’ schemes; and rationalising the penalties to address perverse incentives.

Establishing a unified revenue administration for three entities, i.e. Customs, the Excise, and Inland Revenue, was put forward as a long-term measure under revenue consolidation.

 

Expenditure control 

 

The proposal identified rationalising public expenditure, including State-owned enterprise (SOE) reforms, as another aspect of the necessary fiscal reforms, and stressed spending restraint ensures fiscal space for social safety and development spending programmes in order to facilitate sustainable and inclusive growth.

With regard to rationalising public expenditure, the proposal said that rationalisation must take place in order to eliminate waste and improve efficiency and that a revised budget should be passed immediately so as to enable at least the primary deficit in the budget to be eliminated at the earliest.

Regarding the reforming of the SOEs, it was stated: “Denationalisation is one route – the SriLankan Airlines and non-core businesses such as hotels could be released to more productive sectors. Other avenues for improving SOE efficiency, including Public Private Partnerships (PPPs), must also be explored… Many SOEs could bring the Government significant revenue if managed correctly, instead of being burdens on the State and the taxpayer.”

Among the short-term interventions in this regard are: reprioritising capital expenditure from the general budget on long-term projects such as roads and highways where possible; stopping all projects that lie outside of the National Physical Plan and were implemented without a rigorous feasibility study, financial analysis, environment analysis and/or social analysis and the imposing of hard budget constraints on SOEs; and beginning to cease capital and current transfers to them.

The medium-term reforms included – tightening the Fiscal Management (Responsibility) Act to address the prevailing fiscal numbers while also clearly defining escape clauses (justified deviations from rules), the path to recovery, and accountability measures, privatising high profile SOEs (e.g. the SriLankan Airlines), establishing PPPs where relevant, increasing the efficiency and productivity of SOEs, establishing a task force to review all SOEs and prioritise those to be divested, reorganised as PPPs, or subjected to management reforms, liberalising markets in which SOEs operate, where relevant, situating an entity responsible for the National Physical Plan in an appropriate Ministry, while ensuring adequate funding and empowerment to ensure compliance, reforming the management of airports to make them attractive for all airlines while pricing ground handling services in a manner that makes the airport attractive to low cost carriers, and liberalising up to the fifth freedom rights after the privatisation of the SriLankan Airline.

 

Public sector management 

 

In addition, Dr. de Silva’s proposal stressed that even though the public must receive health, education, social services, and civil security, and should be efficient, equitable, and of high quality for an economy to run efficiently, the public sector and the roles of the public sector employees which often overlap, are redundant, and are severely underpaid. Noting also that there is major political interference in recruitment, with election promises leading to mass employment, the proposal said that the public sector must be reformed and should go hand in hand with pension-based reforms. Many public sector functions must also be digitalised in order to improve efficiency and reduce corruption through greater transparency, according to the proposal.

As a short-term measure, it was suggested to freeze public sector recruitment, regarding which it was further recommended to calculate the personnel requirements of the State, the armed forces, and the SOEs. Any recruitment at the lower levels, it was said, requires green sheeting (hiring from within existing the State worker cadre). In addition, it was recommended to re-examine and reassess the defence expenditure regarding the same.

The medium-term interventions included engaging in capacity-building for retained public sector employees, especially for high-level staff; developing outcome-based key performance indicators (KPIs) for the public sector; contracting out the system-wide audit process; reengineering and digitalising the entire public sector which was recommended to be started with the least resistance service (or most incentivised); and beginning to improve the delivery of public service delivery through digitalisation.

The two long-term interventions included converting corporations, boards, and departments to a company to ring-fence liabilities while establishing a formal mechanism for appointment-related approvals and bringing professional-level control and regulation to key entities while conducting management audits for those that cannot be revamped, and restructuring completely or finding alternatives. Regarding the second intervention, it was suggested to amalgamate different institutions relevant to the same field or service under one institution.

 

Energy and utility reform 

 

Furthermore, with regard to pricing energy, the proposal pointed out that while petrol and diesel prices have been revised upward, a transparent, automatic, cost-reflective pricing mechanism must be reintroduced for fuel and implemented for liquid petroleum gas (LPG) and a fuel/LPG price stabilisation fund should be created to smooth out price adjustments for the consumer.

It also noted that corruption in energy and utility procurements (in power purchase agreements for electricity, or bulk procurement of fuel or LPG) is a major problem that needs urgent and comprehensive attention, as is the inefficiency of these State-owned utilities.

The proposed short-term intervention was to implement transparent, automatic, market-based energy (fuel, gas and electricity) and water pricing.

It also put forward several medium-term interventions, including: bringing all petroleum products under the Public Utilities Commission of Sri Lanka (PUCSL) regulation through legislation while entrusting price and quality regulation to the PUCSL; restructuring energy and utility SOEs, unbundling the Ceylon Electricity Board (CEB) and introducing competition in generation and distribution; separating the transmission grid to allow the necessary investments to permit the absorption of wind and solar; and investing in public transport through foreign assistance.

 

Trade, agriculture, industry, and services promotion 

 

In this regard, the proposal stated that it is also critical to strengthen the economy by promoting trade, industry, agriculture, and services through unshackling the markets from unnecessary tariffs, improving competitiveness, promoting exports and investment, integrating with Global Production Networks (GPNs), and through enhancing productivity.

The short-term measures that were put forward include fast-tracking trade facilitation reforms by removing distortions; reconsidering import controllers’ functions and by rolling back permits; and promoting an understanding of the necessity of imports for exports.

Medium-term interventions were minimising unnecessary and unsustainable anti-competitive regulations and controls; entering into trade agreements with nations with which Sri Lanka has strong trade complementarity; promoting export-oriented FDIs; restoring the Board of Investment (BOI) to its original one-stop-shop status; and enacting enabling legislation for private industrial zones and start-up facilities.

Improving the productivity of the agricultural sector through encouraging technology infusion was a long-term intervention the proposal contained.

 

Factor market reform 

 

The proposal pointed out that Sri Lanka’s labour market is notoriously inefficient, and that this situation makes the cost of retrenchment one of the highest in the world, which it said is a major disincentive for firms to expand operations in Sri Lanka as it is very costly to downsize if required. Adding that urgent steps must be taken to create an efficient labour market by enacting new legislation, it was suggested that the labour force should be prepared through education and training to take advantage of this dynamic economy, rather than being denied opportunities for growth and social mobility. Labour protection should take the form of unemployment insurance rather than archaic laws, it was further noted.

To address the situation as part of Sri Lanka’s economic revival, several medium-term interventions were suggested. Among them are promoting technical education and designing apprentice-on-the-job training schemes in collaboration with the private sector, fast-tracking unified bankruptcy laws for all enterprises, and replacing the Termination of Employment of Workmen Act (TEWA) with an Unemployment Insurance Fund.

Creating a digital land registry and completing the ongoing Bim Saviya programme were long-term measures to address the said situation.

 

Stronger social safety nets 

 

Moreover, the proposal emphasised the importance of having in place a strong social safety net, regarding which it was stated that even though there are ongoing schemes to assist people in poverty, more actions are needed.

In this regard, providing cash transfers to vulnerable sections of the population, directly to bank accounts or mobile money accounts using existing databases was proposed as a short and medium-term measure. It was highlighted that this should be linked to subsidy rationalising programmes, particularly in energy.

Among the medium-term measures aimed at addressing this situation are improving the coverage and targeting of social safety net programmes; consolidating welfare schemes under the Welfare Benefits Board and building a unified beneficiary database while designing and implementing a unique identification project with technical and financial assistance and creating funded pension schemes; and expanding pensions beyond the public sector to a national scheme.

 

Transparency and accountability 

 

The proposal paid attention to eradicating corruption and establishing transparency and accountability as well, noting that Sri Lanka ranked 102/180 in the Transparency International’s Corruption Perception Index in 2021 and that 79% of citizens believed that the Government’s corruption is a major issue. In this context, it was noted that Sri Lanka’s administration must introduce and implement strong anti-corruption legislation as one of its first actions.

To achieve this, the proposal recommended empowering the Commission to Investigate into Allegations of Bribery or Corruption (CIABOC) as a short-term intervention and enabling the implementation of the United Nations Convention Against Corruption as a medium-term intervention.

While many proposals have been put forward by various experts to resuscitate Sri Lanka’s economy, one concern that has always popped up during discussions on the economy is that proposals are not always practical in Sri Lanka’s social, economic, and political contexts and that what is practical may not always be ideal in terms of economic theories. In this context, this proposal, which is coming from an economist who is familiar with Sri Lanka’s political as well as economic backgrounds, may perhaps have a better chance of salvaging the economy.

However, as has been highlighted on many occasions after the economic crisis got out of hand, actions are what lead to real change, and the responsible political authorities should take these recommendations into account while Sri Lanka still has a chance to reverse the economic collapse.