The Sri Lankan economy contracted by 3.6 percent year on year in 2020 compared to the 2.3 percent growth recorded in 2019. This marks the deep- est recession since the country gained independence; and it was the result of mobility restrictions imposed locally and globally to contain the spread of COVID-19, according to the Central Bank of Sri Lanka (CBSL).
CBSL notes that the services sector registered a “notable contraction due to the pandemic driven deceleration in transportation, other personal services, and accommodation, food and beverage services.”
Meanwhile, the sharp contraction in industry activities during the year was driven by a substantial slowdown in construction and manufacturing activities.
The monetary authority also states that the agriculture sector contracted during the year, “as the impact of the pandemic outweighed the positive effects of timely policy support and favourable weather conditions.”
SERVICES In calendar year 2020, services related economic activities (nearly 60% of GDP) contracted by 1.5 percent year on year in value added terms compared to the 2.2 percent increase in 2019. According to the Central Bank, the silver lining of the pandemic pointed in the direction of services – especially those related to IT and telecommunications – but it caused severe disruptions to mobility and tourism related activities. CBSL notes: “Accordingly, transportation, other personal services, and accommodation, food and beverage service activities – which were severely interrupted by restrictions on mobility – were the largest contributors to the contraction in overall service activities.” However, the Central Bank explains that IT programming and telecom services benefitted from higher demand for digital platforms and communication services, while financial services, wholesale and retail trade, human health, public administration and education services expanded during the year. INDUSTRY In 2020, the industry sector contracted by 6.9 percent in value added terms compared to the 2.6 percent growth observed in the preceding year, reflecting the adverse effects of the pandemic on construction, manufacturing, and mining and quarrying activities.
The value added from manufacturing activities contracted by 3.9 percent in 2020 – down from the 1.8 percent recorded in 2019. While electricity, gas, steam and air conditioning supply activities, and sewerage, waste treatment and disposal activities, contracted to some extent during the year, water collection, treatment and supply expanded.
AGRICULTURE Against a backdrop of a considerable decline in key activities including fishing, the growing of oleaginous fruits, tea, forestry and logging, and animal production, agriculture activities contracted by 2.4 percent in value added terms in 2020 compared to the one percent growth of the year prior.
Furthermore, CBSL notes that the “growing of vegetables, rice, cereals (except rice), fruits and spices expanded during the year, positively contributing to overall agriculture activities,” while a conducive policy environment, government actions and favourable weather also helped minimise the pandemic induced downturn.
VIEWPOINTS In its supplemental update to the Asian Development Outlook (ADO) report in December 2021, the Asian Development Bank (ADB) in its commentary on Sri Lanka states that its “growth prospects for 2022 are dampened by macroeconomic headwinds as reserves have declined and significant external debt repayments are due.”
In the second quarter of 2021, GDP expanded by 12.3 percent year on year as all sectors improved, surpassing projections to bring growth during the first half of the year up to eight percent. Agriculture expanded by slightly over eight percent, manufacturing by 26.5 percent (with textiles, wearing apparel and leather related products growing by more than 60%) and construction by in excess of 18 percent.
The services sector also expanded by 7.5 percent but with many activities continuing to recover, it did not meet expectations.
Sri Lanks’ debt and fiscal situation continued to be challenging in 2021, following central government debt to GDP increasing to 101 percent from the previous year. The regional development bank also explains that “the budget deficit is likely to be higher than expected as revenue suffers and expenditure increases amid new [COVID-19] outbreaks.”
During the first eight months of the year, inflation increased to six percent from three percent, averaging about 4.5 percent. ADB remarks: “Volatile food prices, rising global oil and commodity prices, and exchange rate depreciation will keep prices elevated in the second half of 2021. Consequently, inflation forecasts are raised to 5.1 percent for 2021 and 5.3 percent for 2022.”
As for monetary policy, the Central Bank raised its policy rates by 50 basis points in August in the wake of concerns related to inflation and external imbalances.
And while the currency had depreciated by more than seven percent in early September – from where it stood at the beginning of 2021 – foreign exchange reserves plummeted to less than US$ 1.6 billion by the end of November, covering a mere one month of imports. The merchandise trade deficit rose to 32 percent year on year during the first half of 2021 on the back of imports outpacing exports amid higher commodity prices and the relaxation of some import restrictions. Moreover, the lending authority anticipates that the cur- rent account deficit will widen to 2.8 percent of GDP in 2021 and 2.3 percent in 2022, due to lower remittances and as tourist arrivals improve.
Adding to this, ADB remarks that “the fiscal deficit for 2021 is likely to be higher than budgeted.”
In its September update to the ADO 2021, ADB states that “COVID-19 containment measures, weakness in the external sector, and heavy foreign debt repayments will suppress growth in both 2021 and 2022 below April forecasts.”
The regional development bank largely maintained this view in its supplemental update, noting that “low reserves have disrupted imports and agriculture is likely to be affected by a ban on chemical fertilisers. With these developments, growth forecasts are upgraded for 2021 but lowered for 2022.”
Meanwhile, the IMF forecasts that Sri Lanka’s economy will expand by 3.6 percent in 2021, and register growth of 3.3 percent and 4.1 percent in 2022 and 2026 respectively, according to the October 2021 edition of its World Economic Outlook (WEO) report.
While Sri Lanka approached the international lending institution for emergency financial support to help battle COVID-19 in April 2020, at a press briefing held the following March, Director of the Communications Department Gerry Rice noted that the country’s “daunting eco- nomic challenges and high public debt” led to the IMF’s assessment for support taking longer than other countries. He also stated that the IMF sought insights on how the country would fulfil the “key requirements for what could be a rapid financing instrument, which would include policies to continue ensuring debt sustainability to address the balance of payment challenges including from the COVID-19 impact on tourism and to preserve international reserves.”
In August, Sri Lanka received its share of the IMF’s Special Drawing Rights (SDR) allocation, which was equivalent to 787 million dollars. This was distributed to a number of member countries to provide additional liquidity to the global economy in the light of the pandemic, to supplement nations’ foreign exchange reserves and reduce their reliance on expensive domestic or external debt.
FISCAL AFFAIRS Government revenue increased to Rs. 482 billion in the first four months of 2021 on a year on year basis and amounted to nearly a quarter of the 1.9 trillion rupees in inflows estimated for the year, according to the Mid-Year Fiscal Position Report 2021 published by the Ministry of Finance and Mass Media.
Tax revenue during this time rose by 4.6 percent to Rs. 427.3 billion from 408.5 billion rupees in the corresponding period of 2020, as a result of higher receipts from VAT, the Ports and Airports Development Levy (PAL), CESS levy and excise duty on liquor.
However, non-tax revenue recorded a decline of 20 percent, which is largely attributable to a “reduction of Central Bank profit transfers from Rs. 24 billion to 15 billion rupees,” according to the finance ministry report.
Total revenue from income tax declined by 32 percent to Rs. 55.2 billion in the first four months of 2021 from 81.4 billion rupees in the previous year. Revenue from corporate and non-corporate income tax fell by 18.7 percent to Rs. 47 billion, which the report attributes to the mobility restrictions imposed to mitigate the spread of the coronavirus in 2020.
As economic activities picked up at the beginning of 2021, revenue from the capital gains tax increased substantially by 227 percent to 191 million rupees – from Rs. 59 million in the same period in 2020.
Meanwhile, revenue from domestic consumption-based taxes increased by almost 20 percent to 145 billion rupees in the first four months of 2021, and VAT and excise duties on domestic activities by over 31 percent and 15.6 percent to Rs. 62.4 billion and 82.7 billion rupees respectively.
Government expenditure amounted to more than one trillion rupees during these months, reflecting an increase of 7.7 percent compared to the equivalent period of the preceding year.
This included recurrent expenditure of Rs. 890 billion while capex and net lending also increased by 2.3 percent to nearly 113 billion rupees in the first four months of 2021.
The Mid-Year Fiscal Position Report 2021 notes that this was largely due to COVID-19 related expenditure on relief and livelihood support, as well as quarantine measures and the import bill on vaccinations, along with the increase in interest payments, salaries and pensions. In the January 2021 edition of LMD, economist Shiran Fernando shed light on the challenges that the economy may face over the course of 2022, explaining that Sri Lanka “will have to meet the twin challenges of building back dollar reserves as well as meeting external debt repayment commitments.”
He explained: “Sri Lanka will have to manage repaying more than 4.5 billion dollars in external debt while rebuilding its reserves, which plummeted to Rs. 2.3 billion by the end of October .”
“With dwindling reserves, the rise in imports and a sharp slowdown in remittances from overseas, the availability of essential goods has been severely impacted,” Fernando observed, pointing out that “it has also been difficult for the private sector to pursue investments, manage daily operations and consider medium to long- term strategies given the dollar shortage.”
To this end, he asserted: “While there is no single answer to this conundrum, policy makers must not only identify solutions to meet short-term debt refinancing needs but also provide a clear strategy of how they intend to repay debts (around US$ 4.5 billion on average) that are due between 2022 and 2026.”
In Fernando’s view, Sri Lanka must consider obtaining support from agencies such as the IMF to put together a credible reform package – he believes that policy makers should consider adopting a more flexible exchange rate rather than fixing it at Rs. 200-205 to the dollar.
Apart from this, he suggested that the private sector focusses on maintaining export growth in terms of goods and service, and stressed: “Sri Lanka will need to increase inflows from foreign direct investment (FDI) and tourism. However, this will depend on improvements in the local macroeconomic outlook.”
COMPETITIVENESS Sri Lanka is placed 75th in the Competitive Industrial Performance Index 2020 ranking compiled by the UN Industrial Development Organization (UNIDO), placing it among the leading countries in South Asia, behind India and Bangladesh.
Meanwhile, Sri Lanka moved up in the Doing Business 2020 index, advancing one place from the prior year to No. 99 of the 190 economies ranked. The latest rankings published by the World Bank Group reveal that Sri Lanka has achieved a Doing Business score of 61.8, which is the same as in the previous year. In the report’s analyses, the island also stands as the leader in the South Asian region when it comes to registering property, which is one of 10 topics considered in ranking an economy’s doing business environment.
Meanwhile, the LMD-Nielsen Business Confidence Index (BCI) reflected a notable improvement in biz sentiment in December as businesspeople look forward to 2022 being a better year than the previous COVID-19 impacted two years – this, despite the numerous eco- nomic challenges facing the country at this time.
POLICY REVIEW The State of the Economy 2021 publication released by the Institute of Policy Studies (IPS) in October focusses on ‘Pandemics and Policy: Protecting Health and Promoting Economic Recovery’ whereby it examines some of the critical socioeconomic issues and policy choices facing Sri Lanka.
According to IPS’ annual flagship report, the pandemic served to highlight structural issues impacting the nation that predated its outbreak: “Sri Lanka entered the crisis with an uninspiring export performance, high and rising informality in the labour market, inadequate social protection, inequities in access to education and health services and rising food insecurity amongst others.”
“The pandemic in turn has profoundly altered perceptions about the appropriate settings for economic policy to better prepare for the future,” IPS asserts.
And the policy think tank observes: “Sri Lanka will face tough tradeoffs between managing its fiscal imbalances and maintaining supportive policies to emerge from the crisis better off than before.”
“On the plus side, as vaccine rollouts accelerate, investor confidence will pick up. If at the same time, policy goals are translated into concrete projects and programmes with visible benefits for all Sri Lankans, the end of the COVID-19 crisis could mark the beginning of a resurgent phase of economic development,” it adds.
At a webinar conducted to launch the report, IPS’ Executive Director Dr. Dushni Weerakoon stated that a V-shaped recovery is likely as predicted in the previous year’s report. While a growth rate of four percent in 2021 would help the economy recover to pre-pandemic output levels, increasing this to between five and six percent, maintaining such growth in the medium term would be a challenge.
In its assessment of Sri Lanka’s standing in the global economic order, IPS highlights the opportunities in the global trade system arising from the ideological battle between US led liberal capitalism and China led state sponsored capitalism: “Sri Lanka needs to identify and take into consideration the costs and opportunities it faces in this new world order.”
Pointing out that the nation’s import restrictions can inhibit potential gains from this new order, the think tank says that “the opportunities for Sri Lanka are supply chain diversification and capitalising on trade diversion from the US-China trade war.”
Commenting on the country’s external sector performance, IPS notes: “As Sri Lanka’s export sector strategies and policies are not firmly integrated into regional and global value chains, the impact of supply chain disruptions to the country’s export sector has not been very prominent. However, the country has been facing several adverse issues related to declining demand in its major export markets.” Given this, it stresses that “the need to revive export performance with sound strategies will take on even more urgency in the wake of the pandemic to build greater resilience.”
“For a country with a small domestic consumer base, Sri Lanka has to remain competitive in international markets as a source of goods and services,” IPS adds.
It explains that “calibrating trade policies to integrate into global value chains especially in a regional context should remain an important part of the country’s medium-term recovery efforts towards a stable external sector environment that will support the country’s long-term growth and development aspirations.”
As for Sri Lanka’s approach to recovery from a fiscal perspective, the Institute of Policy Studies believes that its response has been weak relative to low income regional peers with an economic recovery likely being delayed by the third wave of COVID-19 infections that impacted the country in mid-2021.
“Due to [the] COVID-19 crisis, most economies are grappling with twin budgetary challenges of growth being hit, and the need to spend on healthcare and vaccines. Globally, a buffer role is being played by fiscal policy in mitigating the current crisis relative to past crises,” it observes.
As such, IPS suggests potential strategies for the country to undertake: “Key areas in which Sri Lanka can improve its fiscal tools whether by adopting new fiscal instruments or tweak- ing existing ones are managing debt more strategically, improving tax collection, and exploring alternative methods of disbursing cash transfers to households and firms.”
“The test lies in the country’s political will to adopt fiscal prudence and to do so in a manner that will support the transition from an economic recovery to sustained economic development in the long term,” it asserts.