Sri Lanka Coronavirus shock had reduced spending, policy tight rope ahead: economist
ECONOMYNEXT – Sri Lanka’s Coronavirus outbreaks have triggered a ‘demand shock’ as people feared loss of income and jobs, an economist said, while there was a need to provide support it had to be balance against credibility and stability.
Sri Lanka’s growth prospects for 2021 had dimmed from the 5 percent levels expected in October amid a surge in Coronavirus, Dushni Weerakoon Executive Director of Colombo-based Institute of Policy Studies said.
“We have to be watchful on several fronts,” Weerakoon told an investment forum hosted by Asia Securities, a Colombo based investment bank and brokerage.
“That comes back to resources to spend and withstand a prolonged health crisis, that will drag down growth and your problems will start to multiply.
“It is very tight rope we are walking now. My sense is that the government’s inclination would be to carry on as much as possible to contain the health crisis but ensure that the economy keeps ticking.
“We are likely to see a much less rosy outlook for 2021 than the going forward compared to forecasts that were going around in October, when 5.5 percent or 5.0 percent growth was being predicted.”
She said the bigger challenges were on the macro front with deficits and debt, which had to be maintained at levels that gives some confidence to investors.
In Sri Lanka consumption had taken a hit though exports were doing well until recently, amid some uncertainty
“Covid-19 was initially supply shock but it is very much a demand shock now,” Weerakoon said.
“People are not spending because of concerns of jobs, concerns of livelihoods.”
Weerakoon said about 68 percent of the workforce were informal sector workers. There has to be a strong public sector message to convince them that their lives were not at risk.
Sri Lanka’s economy had significant downside risks, with initial success in containing Covid-19 being eroded.
“It is unfortunate that having made a success initially we made it slip up,” she said.
Tourism may see extended pain, she said with the opportunity to market Sri Lanka as a safe destination.
With a vaccine available tourists may travel, analysts say.
Neelika Malavige, a professor at Sri Jayawardenepura University said Sri Lanka would use only a World Health Organization approved vaccine, as the country has a strong immunization program which would not be compromised.
Credibility was a factor she said.
Most governments in the world were also under stress with public debt going up, deficits widening.
“Sri Lanka initial conditions were weaker,” Weerakoon said. “We are already struggling with high levels of public debt and widening fiscal deficits.
“The government has put forward a medium term policy program but we need to underwrite the with definitive plans on how we are going to claw back on these widening expenditure had revenue gaps perhaps not immediately.”
She said immediate tax increase were not possible as it would hit any recovery, but plan would give confidence to investors that there was a roadmap.
Sri Lanka has said it would not raise taxes for five years. She Lanka slashed value added taxes in December 2019 shortly before a usually cyclical recovery from a currency collapse which takes 18 to 23 months started to happen.
Since then downgrades have come and Sri Lanka is effectively locked out of international capital markets.
Weerakoon says businesses are looking at stability rather than profits and are trying to source goods from closer locations.
Many world economies were using fiscal policy to boost activity with monetary policy becoming less effective. Countries that could afford will continue, she said.
Sri Lanka had also loosened policy, which was needed in a crisis and extraordinary support has been provided, Weerakoon said.
“There are problems in how far can we can sustain that before macro-stability starts to be undermined,” she said.
“And I think when we look at the 2021 budget, clearly the fiscal support is there, it is an expansionary budget, perhaps rightly, monetary policy is – if you look at it is injecting liquidity to the market.”
She said credit to government was growing at 50 percent.
“Once private sector credit starts to pick up, maintaining this low interest rate environment is not going to be that easy.
“The second issue is on the inflation front. Money supply s growing at over 21 percent, currently it is a deflationary bias, people are not spending fear of inflation.
“But at some time if there is a recovery taking hold up it can feed into inflation, at that point monetary policy will have to be tightened. The indications are as long as possible this kind of fiscal and monetary policy efforts will be rolled out.”
Other analysts have also pointed out that once credit picks up, liquidity spills over to the balance of payments before inflation starts to hit.
Sri Lanka has a history of delayed tightening and balance of payments crises. Choices and timing is also taken away when reserves fall, or if there is default, analysts say.
Already interest rates are out of line with the financial account which can be seen from the steady run down of reserves and development s in the forward markets, where dollar yields have overtake rupee yields analysts say. (Colombo/Dec16/2020)