LankaTalks

Advocata calls for policies to address macro economic imbalances

Advocata Institute Senior Research Fellow Dr. Roshan Perera called for policy adoption to address the macroeconomic imbalances of Sri Lanka, in particular the fiscal deficit and the external current account deficit, during a virtual press event for the launch of the Advocata Institute’s latest publication A Framework for economic Recovery

As a result of the widening trade balance, despite the continuation of import restrictions and low inflows from tourism and remittances, the current account deficit is expected to widen. And in the absence of sufficient domestic savings, Sri Lanka is forced to rely on foreign savings to bridge this current account deficit, Dr. Perera said. 

Due to Sri Lanka’s poor track record in attracting FDI, the only option available is to borrow from abroad, she added. Over the past decade, due to the loss of access to concessionary loans from multilateral and bilateral sources as a result of Sri Lanka’s assent to a middle-income nation, the country has been forced to borrow from capital markets and through ISBs. 

And such non-concessionary loans are contracted at market interest rates and typically possess short terms to maturity. As a consequence, Sri Lanka’s external debt service payments have ballooned over time and over the next five years external debt obligations stand at around $ 25 billion, according to conservative estimates. 

Meeting external debt obligations as they come due has steadily drained the country’s foreign reserves, resulting in the decrease of reserves to around $ 2.8 billion in July 2021, its lowest position since July 2009. Further, Sri Lanka has around $ 6.9 billion in foreign debt which will fall due over the next 12 months, and the current foreign reserves are grossly inadequate to service such debt. 

Therefore, according to Dr. Perera, considering the current situation of the country in order to address the macroeconomic imbalances, the Government must immediately resort to a debt restructuring programme, and a mere strict fiscal consolidation process is insufficient. She further asserted that continuous inaction is no longer sensible as there is strong possibility of default, and that the continuous drain of foreign reserves to meet foreign debt obligations as they come due over the facilitation of productive economic activity shall be detrimental to the future of the economy. 

She stated that involving the IMF in such a debt restructuring programme would be beneficial, and such a restructuring programme must be genuine and approached holistically, involving a strong macroeconomic stabilisation programme as well. 

Dr. Perera further highlighted the need for revenue centred fiscal consolidation policies to address the fiscal deficit of the country. Accordingly, the erosion of Government revenue needs to be addressed, as the tax revenue to GDP ratio of the county has plummeted to around 8% in 2020 from an average of around 15% in the late 2000s. Policies recommended to address this situation include reducing the tax threshold – which is more than four times the per capita threshold – widening the tax base, reducing excessive reliance on indirect taxes – which stood at around 80% of the tax revenue collected in 2020 – and strengthening tax administration. 

Enhancing monetary policy effectiveness was also highlighted as an effective measure to address macroeconomic imbalances. It was noted that fiscal dominance has adversely affected the independence of monetary policy, as the Central Bank is routinely called upon to finance the Government due to the widening fiscal deficit and the challenges faced in meeting foreign debt obligations. And the debt monetisation efforts of the Central Bank of Sri Lanka (CBSL) in support of the Government have led to a steady increase in inflation. In addition, it was further noted that the rapid increase in monetary expansion is also exerting pressure on the exchange rate and that maintaining the exchange rates stable to cushion the Government’s foreign debt repayment services should not be the policy priority of the CBSL. And that CBSL should focus on limiting inflation and maintaining a flexible exchange rate in order to achieve its primary objective of economic stability. 

Policies supporting trade and investment, SOE reform and public finance management were also recognised as important in addressing macroeconomic imbalances. 

Advocata’s report A Framework for Economic Recovery consists of a series of urgent macroeconomic reforms to address the present crisis. This includes the implementation of a macroeconomic stabilisation programme, prioritising fiscal consolidation and debt restructuring, public finance management, and public sector reforms. Other reforms include state-owned enterprise reform, enhancing monetary policy effectiveness, and maintaining a flexible exchange rate.