Classification conundrums

Friday, 3 July 2020 00:00 - - {{hitsCtrl.values.hits}}

On Thursday the World Bank announced it has downgraded Sri Lanka from an upper-middle income country to a lower-middle income one, just a year after it changed classification. This is not necessarily a negative for Sri Lanka, though from a political perspective it shows just how much policymakers have failed in implementing genuine reforms to take the economy forward in a sustainable manner.

The world’s economies are assigned into four income groups—low, lower-middle, upper-middle, and high-income countries by the World Bank. Sri Lanka is among 10 economies that are moving to a different category this year and is one of three countries that are moving to a lower category from the previous year. Algeria and Sudan are the other two countries moving to a lower category along with Sri Lanka.

The World Bank said Sri Lanka was downgraded as a lower-middle income country after it recorded $4,020 per capita income for 2020, in comparison to the $4,060 last year. Sri Lanka, which was struggling with high debt, limited fiscal space and slow implementation of reforms has been hard hit by the COVID-19 outbreak with the virus hitting exports and remittances at a sensitive time.

However, the reclassification should help the country get access to concessional funding, which was getting further away from its reach as it moved up the classification. This was also the reason for Sri Lanka to move more towards borrowing from international financial markets and bilateral lenders such as China in the past few years. Preferential trading facilities such as GSP+ will also likely remain with Sri Lanka for a longer period of time as it is dependent, in part, on per capita income classifications given to the country.

So what will it take for Sri Lanka to climb up these classifications sustainably? Economic reforms that have been highlighted numerous times but remain, at best, partially implemented. The fiscal consolidation mechanisms, tax reforms, profitable performance of State-Owned Enterprises (SOEs) as well as better trade and competitiveness from the overall economy. Simply put, Sri Lanka has multiple challenges such as high debt, anti-competitive tariffs and an aging population, which need to be addressed through comprehensive policy making efforts.

COVID-19 has undoubtedly made these challenges worse. Sri Lanka’s debt to GDP ratio is expected to climb to 100% next year and repayment burdens remain heavy for the next few years as well. These are weighty challenges for the Government moving forward. Boosting per capita income, which is one of the bases that the World Bank classification is based on will also be difficult in a situation where COVID-19 threatens to change global value chains and the overall global economy in ways that cannot yet be fully predicted.

According to World Bank statistics, Sri Lanka’s near-poor, which is the segment of people living immediately above the national poverty line, is as high as 40% of the population. This means that guiding growth while ensuring inequality is addressed will be crucial for sustainable development in the coming years. Without comprehensive reforms that the Government is genuinely dedicated to, Sri Lanka is likely to find climbing into the middle-income classification and beyond difficult.