A fine balance

Wednesday, 8 April 2020 00:33 - - {{hitsCtrl.values.hits}}

Governments caught up in the COVID-19 are having a tough time, but perhaps the toughest time is being had by developing countries with high debt and low public revenue. The virus has created a perfect storm for countries such as Sri Lanka with few solutions on the horizon.

The Sri Lankan Government late last year gave hefty tax cuts hoping to charge a growth turnaround. Fresh from an election victory, policymakers argued the time was right to boost the economy, which had seen slow growth on fiscal consolidation for several years and experienced 2.6% growth in 2019. Despite grumblings from international rating agencies that warned the tax cuts could lead to a significant drop in public revenue, the Government argued that increased business activity, stronger consumption and higher investment would compensate for the reduction.

Unfortunately, COVID-19 has changed the game drastically. Even before the virus hit, experts were concerned about the high budget deficit the Government had announced for 2019 and worries over stronger fiscal slippage both immediately and in the long term due to the recruitments to the public sector and other measures taken by the Government. Sri Lanka’s high level of debt gave even more weight to the concerns as the Government would have to repay $ 4.8 billion in 2020 and debt commitments continue for the next couple of years as well.

Fast forward just three months and it is clear the Government is struggling to effectively respond to the demands made by the economy. Not only has the promised tax revenue not appeared, almost all the major sectors are also asking for more stimulus. The Government was prompt in extending the moratorium and the Central Bank has slashed interest rates twice, in as many months, in an attempt to counter the slowdown but the reality is that, between the businesses that are pleading for support and the Government’s commitments to assisting vulnerable communities as well as the debt commitments Sri Lanka has, the going has become very, very difficult.

Facing a crucial Parliamentary Election and possible Provincial Council Elections after that, the Government cannot simply tell the people to tighten their belts and be. The fall-back position for the time-being seems to be to encourage the economy to be more closed, focus on local production and limit forex seeping out of the country. However, these are at best short-term measures for Sri Lanka’s high levels of debt and struggling exports require investment, links to global value chains in whatever format they will take on post-COVID-19, and expertise beyond local shores.

The challenges posed by COVID-19 will not be short term. The best chance for the Government now is to get the election cycle behind it and then focus on how it can assist crucial sectors of the economy. To do so, it will need significant public funds or will need to forego public earnings and therefore it is essential that clear and transparent targets are established to reduce the weight on public finance. Only by increasing public revenue will the Government be able to allocate larger budgets for healthcare, education, housing and social welfare, for which the public will have a dire need. Balancing these commitments with the right policy mix will be the only antidote to the current economic woes.