Ailing growth

Despite the normalising political situation, Sri Lanka’s economy continues to be challenging, with the latest growth numbers showing the country’s economic growth in the third quarter had slumped to a historic low of 2.9% in comparison to 3.2%. The 3Q growth was lower in comparison to 3.7% achieved in the 2Q.

Anyone who has been monitoring Sri Lanka’s growth numbers over the past few years would not be surprised by this result. The only silver lining is that agricultural activities expanded favourably by 3.3%, compared to the contraction of 3.0% reported in the third quarter of 2017. The rain in the past two months also sparks hope of the fourth quarter managing to inch close to 3% or surpass it slightly, but the Central Bank has already acknowledged it is unlikely that growth will exceed 3.8% in 2018.

But why is Sri Lanka’s economic growth so persistently low? Sri Lanka is in the unenviable spot of being a low middle income country with high levels of debt. To make matters worse, challenging external changes, mainly driven by an appreciating dollar and rising interest rates, means Sri Lanka has little choice but to allow its currency to depreciate. As a country that is highly dependent on imports, it cannot allow its currency to free-fall, but as Sri Lanka has struggled to attract investment and improve exports for years, it also has moderate reserves and defending the rupee could push it over the tip into a balance of payments crisis.

Having hit a balance of payments crisis in 2015, Sri Lanka agreed to a $1.5 billion Extended Fund Facility (EFF) under the International Monetary Fund. The ambitious three year program aimed to, among other things, improve public revenue and macroeconomic fundaments by changing the tax structure, reforming State-Owned Enterprises, introduce transparent pricing formulas for fuel and power and target its subsidy structure. An inflation targeting scheme was also introduced.

One of the key goals of this fiscal consolidation process was to bolster confidence in Sri Lanka’s macroeconomic fundamentals, which is crucial for the country to borrow at moderate interest rates in international financial markets to repay debt. Fitch ratings estimates that Sri Lanka will have to repay $12 billion from 2019-2022 and riding out this time would be critical to economic stability.     

However, even though fiscal consolidation measures have been implemented to some extent, the other side of the coin, namely improving the business environment to attract investment and improve exports, have not taken off as fast as needed. Even though both exports and imports have broken records over the past three years, many economists have criticised sluggish implementation and inconsistent policies of the Government as hindering the process.

More politically challenging reforms, such as State-Owned Enterprise reforms and subsidy restructuring, have also been side-stepped or slowed down due to their unpopularity. Given that Sri Lanka is also a rapidly aging population, the country would need to transfer to high end services-linked jobs faster than other low middle income countries. This gap between people’s aspirations and their economic reality has also triggered political turmoil, which in turn feeds into the economic challenges.

Reforms are essential for Sri Lanka to grow but there are also no easy fixes for this complex situation.