ECNOMYNEXT – Governor of Sri Lanka’s Central Bank W D Lakshman spoke at the Sri Lanka Economic Summit 2021 on December 01, 2020.
The full text is reproduced here as prepared for delivery
The Post COVID-19 Economic Recovery – Global and Local
I am honoured to be invited to contribute to ‘The Sri Lanka Economic Summit 2020’, a key event in the annual calendar of policymakers, practitioners, and of course, business circles. As we know, this event brings together the movers and shakers of the country’s economy onto a single platform to review evidence and opinions about various aspects of the economic performance of the country. I am sorry that the event this year has been compelled to be on virtual basis.
Ladies and gentlemen, we are living in utterly anomalous and out of the ordinary times and amid challenges that were beyond our imagination even a year ago. The COVID-19 pandemic has battered the global economy. Every day is a struggle for everyone around the world, and here in Sri Lanka, we are still learning how to continue living with this particular coronavirus in a new normal mode. Governments and Central Banks everywhere have faced unprecedented challenges as economic conditions oscillate from one wave of infections to the next.
International financial organisations, rating agencies, many analysts in mainstream economics, and obviously, the political opposition are depicting a bleak outlook for Sri Lanka.
I am sure many in today’s panels and the audience would favour a similar point of view, in that sense putting me in a minority. We have our qualms about such negative prognoses.
It was totally unexpected and rather unfortunate that a government elected to power on an “alternative policy platform”, soon after announcing its package of tax policy, had to face the challenges of the spread of COVID-19.
The newly elected President had the political strength emanating from people’s support, but the challenges of COVID-2 19 had to be met without a Parliament in the initial period of spread of the virus, i.e. from mid-March 2020 until Parliamentary elections were held in August.
The efforts of the government had to be directed to addressing the short term issues raised by COVID–19.
The pandemic was devastating. Yet the government’s efforts to contain the spread of the virus, particularly the island-wide lockdown from mid-March 2020, completely relaxed by mid-May, produced rather quick results. During the lockdown, essential economic activities, particularly in rural areas, were allowed to continue, while the affected families and businesses were provided with required fiscal and monetary support.
The pandemic provided valuable opportunities as well, to enable the authorities to commence and proceed with envisaged changes in some of the established economic policy practices.
All this resulted in a notable recovery in economic activities as from the month of June. By the third quarter of 2020, most economic activities, including exports, transport, construction, shipping, power generation and financial services, rebounded noticeably to pre-COVID levels, in addition to agriculture related activities, communication services, goods distribution, and public services, which were less disrupted even in the second quarter.
The disturbances caused in the fourth quarter with the rise of the second wave of COVID-19 from October continue to hamper revival of the economy. Prospects for revival in the near term are not very bright. However, lockdowns during this phase have been less widespread and therefore, the severity of the economic impact is expected to be less during this second wave.
Fiscal and monetary stimulus measures will help ensure that the adverse economic impact of the second wave is short lived, particularly with the likelihood of trying out some experimental measures in the most heavily affected sector, namely tourism.
Political stability conditions are strong, leading to policy consistency and coherence, pushing up investor confidence. Investments of private capital, both domestic and foreign, are expected to begin expansion.
Despite the spill-overs of global and domestic disruptions stemming from the COVID-19 pandemic, the Government is steadfastly progressing with its agenda of socio-economic development.
The Budget presented on the 17th of November 2020 has affirmed the Government’s commitment to a people-centric economic policy.
The policy framework highlighted in the Budget statement points towards several novel alternative features. Domestic “production economy” has taken the centre stage.
Domestic production activities are promoted, with directed attention paid to selected economic sectors, with a clear focus on export as well as domestic markets. We are not surprised that most international organisations, rating agencies, as well as certain domestic quarters, which are so used to certain traditional ways of thinking, remain sceptical about these alternative policy stances without making the effort to understand the new framework.
The recent comment of Faris Hadad-Zervos, the World Bank Country Director for Maldives, Nepal and Sri Lanka after his recent visit about “a growing understanding of the Sri Lankan sustainable development storyline and aspirations” is encouraging. The current diversified World Bank portfolio in Sri Lanka has been noted as consisting of 19 ongoing projects with total commitment value of USD 3.65 billion.
The Sri Lanka economy was provisionally estimated to have contracted by 1.6 per cent in the first quarter of 2020, year-on-year. The second quarter performance would have been worse but the GDP estimates for any period after the first quarter are not yet available. High frequency data indicate a strong recovery in many areas of economic activity in the third quarter, prior to the resurgence of COVID-19 infections and resultant containment measures starting from October 2020.
As in the case of statistical agencies worldwide, the Department of Census and Statistics, is perhaps grappling with the identification of suitable statistical apparatus to properly measure value added in economic activities that have undergone significant structural changes and the increasing emergence of new ways of doing things during these COVID-19 affected times.
Compilation work has also become challenging with social distancing and office closures weighing negatively on response rates and the accuracy of surveys. The Central Bank of Sri Lanka (CBSL) had to be innovative in its forecasts and other analytical work in this data absence, constantly generating alternative statistics in response to these unusual circumstances. Using some real-time indicators, the CBSL released a brief presentation in late September with evidence of the economy’s recovery in the third quarter of the year as a result of the resumption of economic activity, having successfully combatted COVID-19.
Inflation remained broadly within the target range of 4-6% thus far during 2020, as demand conditions remained subdued and there were supply side improvements in domestic production.
Inflation is expected to remain in this range over the medium term. The Central Bank could maintain an accommodating monetary policy stance, thus helping affected businesses and providing conditions for business revival with the withdrawal of lockdowns. Low interest rate regime continues, with enhanced market liquidity, and also facilitating government expenditure programmes necessitated by COVID-19 pressures. Spill-over effects of easy monetary policy on the balance of payments were prevented by measures to manage foreign exchange flows, thus safeguarding the country’s external economic stability.
In the fiscal sector, government revenue was affected, as expected, by the policy guided reduction in taxes and the drop in economic activity level. The Budget for 2021 maintains the low tax regime.
Government expenditure in 2020 went up due to outstanding bills brought forward from the previous year, in addition to large expenses necessitated by demands of COVID-19. The budget deficit in 2020 is relatively high at 7.9% of GDP and for 2021 it is expected to increase to 8.9% of GDP with higher public investment.
Public debt will be managed in such a way the domestic to foreign component of the debt will become 55:45 in 2020 to 60:40 in 2021. This and the stated policy of not pursuing foreign debt-creating public investments will make government debt more manageable. The commitment to reduce the budget deficit over the medium term to 4% by 2025 remains.
The external sector which was severely affected at the initial stages of the pandemic, marked a notable rebound in the third quarter. The trade balance improved with a perceptible increase in merchandise exports. The external sector stability was facilitated by selective restrictions on imports and on financial outflows. Low global petroleum prices helped. The unexpected rebound in workers’ remittances since June 2020 helped cushioning the impact of the sharp decline in earnings from tourism.
Gross official reserves remained at adequate levels, and a stable exchange rate could be maintained, while the Central Bank purchasing foreign exchange from the domestic market.
Uncertainties surround the growth and stability of the economy in the fourth quarter, although we are better prepared to face this second wave with the experience of successfully containing the first wave. In any case, the spread of COVID-19 remains largely concentrated within the Western Province, which contributes as much as about half of the country’s GDP, but unlike in the time of the first wave, the lockdowns are imposed in the Province selectively by Police divisions.
Economic activity in the Province is not fully shut down, although this seems to make the containment of the pandemic more difficult. Furthermore, as lockdowns are imposed again selectively in the rest of the country the bulk of the country outside the Western Province is open for relatively undisturbed economic activity.
All these factors are likely to reduce the negative effects on economic growth during the period of the second wave of the pandemic outbreak. Globally also, the promising outcomes in relation to COVID-19 vaccines have presented hope for all, and commercial production and equitable distribution of the proven vaccines will help boost local and global growth prospects in the period ahead. A favourable domestic development, as media reported, is the collaboration between allopathic and Ayurvedic segments of medicine in the country to test and experiment the viability of medicines presented by the latter group.
While 2020 may be a lacklustre year for Sri Lanka, guided by the Budget 2021 and the farsighted array of policy measures put in place by CBSL and the Government, Sri Lanka possesses the potential to emerge as a stronger and more resilient economy in 2021 and to begin to progress on a high growth path thereafter.
COVID-19 has made us gain first-hand experience about the gravity of what Ian Goldin and Mike Mariathasan call the butterfly defect of globalization in their recent book titled The Butterfly Defect: How Globalization Creates Systemic Risks, showing how a virus, having gained pandemic proportions, could keep on crippling economies across the world for over a year.
This butterfly defect has paved the way for us to engage in introspection about our economy and economic policy. From the inception of this Government in late 2019, there has been a conviction to create a production economy.
The government’s initiatives to expand the productive potential of the economy through encouraging home-grown industries, Large as well as Small and Medium Enterprises (SMEs) spanning from agriculture and fisheries to motor vehicle assembly and shipbuilding would enable the country to sustain a high pace of growth in the medium to long-run.
Undertaking this broad and widespread array of structural reforms in a manner similar to a developmental state may equip Sri Lanka to become an economic success story, following the manner of many of its East Asian peers in the latter part of the last century.
There are two aspects of the economy which I am obliged to touch upon considering the controversies surrounding them. Firstly, the arguments that Sri Lanka’s fiscal deficits have been excessive and that its debt levels are at unmanageable levels.
Let me attempt to expand on this aspect in terms of alternative thinking in economic theory. Several countries including Japan, Singapore, and the United States have debt levels far exceeding their GDP.
Firstly, this shows that even such high levels of debt could be sustainable when domestic debt is the predominant component in the debt portfolio. It can be shown through alternative indicators that even foreign debt is more manageable than doomsayers indicate. The ratio of Government’s foreign non-concessional debt to GDP is around 23 per cent, and the remainder is either domestic debt that can be rolled over or long term concessional financing.
The annual foreign debt service payments as a percentage of export earnings and remittances stand at around 12 per cent in ‘business-as-usual’ years such as 2018. With the adoption of a fiscal consolidation path from 2021 and the increased emphasis on domestic debt when it comes to financing budget deficits, the aforementioned indicators will improve further., The fears surrounding debt sustainability indeed appear unfounded.
The other aspect of the economy to be noted here concerns import restrictions, foreign trade, and foreign economic relations.
Import restrictions on non-essential goods working along with low oil prices have provided the country with a saving of US Dollars 4 billion in import expenditure in 2020. This saving is almost equivalent to the foreign currency debt service payments we settled during the year.
Import restrictions have also provided an opportunity for our local enterprises to gather steam within the domestic market and to evaluate possibilities of expansion abroad – a mechanism used in all successful growth stories of the world.
Those who argue for so-called “debt restructuring” or “debt reprofiling” must realise that this means reforms of austerity. In my view, Sri Lanka is already undergoing some austerity, but on our terms. This is evident when the ongoing programme of import compression is considered.
In my view, Sri Lanka is introducing ground-breaking reforms to improve the domestic production economy, enhance exports and reduce foreign debt dependence. It is commendable that Sri Lanka is following this approach without being prompted by any foreign agency, while continuing to honour all its financial obligations!
As the Government spearheads the recovery process in collaboration with the Central Bank, all economic stakeholders have a vital role to play. The need of the hour is to develop the Real Sector – to revive our industries, expand our businesses, and shift the focus away from imports, whenever it is doable and effective.
This will contribute to not only the recovery of the economy but also strengthen its resilience to shocks like these.
While the ongoing second wave of COVID-19 appears to be a stumbling block to the economy’s rapid recovery, we believe that with its containment, the economy will record a sharp rebound in the not-so-distant future as it did after the first wave by the end of May/early June.
We hope our Chambers of Commerce will also encourage their members, whether in production or service sectors, to move away from the traditional “buying and selling” mindset. To put it in different words, it is time the country moves up from conditions of merchant capital dominance to those of industrial capital dominance. An approach to generate profits through improving value addition in production processes is urgently needed.
We are facing a unique window of opportunity to shape the direction of our economy. These unique circumstances give us an opportunity for alternative thinking through retrospection and introspection.
As the global economy is undertaking the ‘Great Reset,’ we also must take this opportunity to reset our thinking and our perspectives. In the current fiscal and monetary environment, there lie a myriad of opportunities for every