Beyond Western economic models: Navigating Sri Lanka’s economic challenges
Thursday, 18 May 2023 00:50 – – 30
Sri Lanka is a unique country with its own set of economic challenges and resources
President Ranil Wickremesinghe’s determination to address the economic crisis is obvious, but relying solely on right-wing solutions may not provide a sustainable answer to the country’s problems. The flaws of capitalism, which dominated the latter part of the previous century, have become increasingly evident worldwide. In countries like the USA and Europe, poverty and homelessness rates are soaring while the rich continue to get richer, fuelling widespread social unrest. Sri Lanka, as a developing nation, cannot afford to follow these flawed models, as the social costs of such inequality could lead to severe consequences
Sri Lanka’s economy has been hit hard by a record-high balance of payment deficit in 2021, reaching $ 4 billion, the highest in decades. This came on the heels of a $ 2.3 billion deficit the year before, which was not addressed by significant foreign borrowings. Without outside help, the Government was forced to dip into its reserves, causing a further drain on the country’s financial stability. President Gotabaya Rajapaksa had promised to avoid the mistakes of his predecessors by not encouraging foreign debt, but by early 2022, the situation had become so dire that the Government was forced to seek support from several countries.
China had already given some swap facilities, and negotiations were underway for a further $ 1.5 billion swap facility as well as a $ 1 billion loan. India had given several credit lines totalling about $ 3 billion, with further extensions being negotiated. Despite the Government continuing to meet its debt obligations, the situation was dire, and by March 2022, the Government had settled $ 3.1 billion of debt, leaving another $ 3.9 billion to be settled during the year.
The shortage of foreign currency caused a range of problems, including fuel and gas shortages, with importers unable to open letters of credit for their business requirements. The fuel shortages led to electricity shortages, and eventually, the middle class of the country took to the streets in protest. In response, President Rajapaksa made changes to his economic management team, and they decided the best course of action would be to declare bankruptcy.
While it is debatable whether bankruptcy was the right decision, it did help the Government in one way. They did not have to pay the balance of the $ 3.9 billion debt that was due in 2022, saving some dollars for essential fuel and gas. Some feel that the change in leadership played a role in eliminating gas and fuel queues, but it’s worth noting that other factors, such as the quota system, the increase in fuel prices, and the overall contraction of the industry sector, have significantly reduced fuel consumption in the country. People who switched to alternative fuel sources during the shortages and never returned also helped ease the strain on the country’s energy supply.
The fiscal irresponsibility of former finance ministers Mahinda Rajapaksa and Basil Rajapaksa, under the leadership of President Gotabaya Rajapaksa, exacerbated Sri Lanka’s already precarious financial situation. Despite the alarming budget deficit and mounting balance of payment crisis, they neglected to recognise the pressing need for reducing Government spending and controlling unnecessary imports. Instead, they engaged in a lavish money printing exercise during the COVID-19 pandemic, distributing funds without a sustainable plan.
While the new economic management team took necessary steps to tighten these areas, the budgets presented in November 2022 reveal that Government expenditure remains excessively high. This is primarily due to an incremental budgeting approach adopted by Government ministries during budget planning, rather than a pragmatic model such as zero-based budgeting, which would have enabled the elimination of non-value-adding cost items.
President Ranil Wickremesinghe’s determination to address the economic crisis is obvious, but relying solely on right-wing solutions may not provide a sustainable answer to the country’s problems. The flaws of capitalism, which dominated the latter part of the previous century, have become increasingly evident worldwide. In countries like the USA and Europe, poverty and homelessness rates are soaring while the rich continue to get richer, fuelling widespread social unrest. Sri Lanka, as a developing nation, cannot afford to follow these flawed models, as the social costs of such inequality could lead to severe consequences.
Merely introducing anti-terrorism measures and other security precautions is not a long-term solution, as suppressing grievances is not the same as addressing the underlying issues. It is essential to consider alternative approaches that prioritise equity, social justice, and inclusive growth to build a sustainable future for all Sri Lankans.
It’s evident that some of our economists, even those in opposition, are overly influenced by Western economic literature. However, there is no one-size-fits-all solution to the economic challenges faced by different countries. Each country has its unique context, and answers should be found accordingly. For instance, the model adopted by Lee Kuan Yew in Singapore and Dr. Mahathir Mohamad in Malaysia are not the same. When measuring success, one cannot use the same yardstick for every country.
During Dr. Mahathir Mohamad’s return to the Malaysian Premiership, a journalist pointed out that Singapore’s per capita income was much higher than Malaysia’s. In response, the Prime Minister questioned why the journalist didn’t compare the cost of living. Enjoying the same luxuries is far cheaper in Malaysia, and that’s why many Singaporeans are now moving there. It’s essential to consider factors beyond just per capita income when measuring success or comparing economic models. Amidst the global economic slowdown, two of our neighbouring countries are defying the trend with remarkable growth rates. India and China are currently experiencing economic miracles, leaving the world in awe. Despite the challenges posed by the pandemic and geopolitical tensions, these countries continue to push forward, recording significant growth rates that are unmatched by many developed nations.
India and China have indeed adopted different economic growth models. China’s model is often referred to as the state-led or Government-led model, while India’s is more market-oriented. In China, the Government controls many aspects of the economy, including industries, investments, and foreign trade. The Government also invests heavily in infrastructure and supports state-owned enterprises.
In contrast, India’s growth model focuses on promoting private enterprise and creating a more open economy. The Government has been steadily liberalising the economy by removing trade barriers, privatising state-owned enterprises, and promoting foreign investment.
Despite these differences, both countries have been successful in achieving high levels of economic growth. China’s economy has grown at an average rate of around 6-7% over the past few decades, while India’s has grown at an average of around 5-6%
Indigenous economic development model
Sri Lanka is a unique country with its own set of economic challenges and resources. Therefore, it is essential to identify an indigenous economic development model that works best for the country. Simply following the models of other countries may not necessarily work for Sri Lanka, as their situations and resources may be different.
Sri Lanka has always had its strengths, such as its strategic location and good climate and high literacy rate amongst people. However, right now we are facing some significant challenges, such as political instability, corruption, and deteriorating business confidence. The younger generations are fed up with the country and the brain drain seems to be at its peak. Therefore, it is crucial to develop an economic development model that takes all these factors into account.
This is where the key economic advisors to the Government and the main opposition have a role to play. They must seek ingenious solutions to our economic problems rather than totally relying on the Western models.
One of the main concerns about the IMF program which was presented by the Government as the solution for all our economic problems is the proposed local debt restructuring. Even though the politicians and the high officials in the Government repeatedly assured that there will be no local debt restructuring now it is very clear that it is going to be part and parcel of this poorly negotiated deal.
The adverse effects of domestic debt restructuring include risks to the already struggling banking system, social costs, economic instability, reduced investor confidence, damage to sovereign credit rating, and political costs. When restructuring involves “haircuts,” or reductions in the principal value of debt, it can also significantly impact the banking system and the funds managed by the banks.
Banks may struggle to maintain their required level of capital adequacy and face losses, liquidity issues, and reputational damage if they hold a significant amount of restructured domestic debt. There is also a risk of systemic failure if the banking system as a whole holds a significant amount of restructured debt.
Before resorting to haircuts, policymakers should consider alternatives such as extending the maturity of debt, reducing interest rates, and offering debt-for-equity swaps. These options can reduce the burden of debt service and provide a more sustainable solution to the debt crisis.
Renegotiation can help to reduce negative consequences and provide a more sustainable solution to the debt crisis. Unless this Government is willing to do so at least the opposition should give the assurance to the people that it will renegotiate these terms once the power switches. The Government’s attempt to grant more independence to the Central Bank is a recent development in the country’s economic management approach. The new bill that the Government is trying to pass in parliament is said to be part of the IMF agreement. However, the Supreme Court has recommended changes to over 40 clauses in the bill, raising concerns about the Government’s intentions.
Giving more independence to the Central Bank can have both positive and negative effects on the economy. On the positive side, an independent central bank can help to control inflation, maintain financial stability, and promote economic growth. By having the power to set interest rates and regulate the banking system, the central bank can steer the economy in the right direction.
However, there are also potential downsides to giving too much independence to the Central Bank. It can lead to conflicts between the Government and the Central Bank, especially when it comes to fiscal policy. The Government may want to pursue expansionary fiscal policies, such as increasing Government spending or cutting taxes, to boost economic growth. However, the central bank may see this as inflationary and may raise interest rates to counteract it, leading to tensions between the two institutions.
Moreover, granting too much independence to the Central Bank can also result in a lack of accountability. The Central Bank may make decisions that are not in the best interests of the public or may favour certain groups over others. Therefore, it is crucial to strike a balance between independence and accountability.
In the Sri Lankan context, it is essential to ensure that the Central Bank is accountable to the people and operates in the best interests of the country. While granting more independence to the Central Bank can be a step in the right direction, it should be done in a way that ensures transparency and accountability.
In conclusion, the Sri Lankan economy is facing significant challenges, and it is essential to find indigenous solutions that work for the country. While there are lessons to be learned from other countries, blindly following their economic models may not be the answer. It is vital to consider Sri Lanka’s unique context and resources and develop an economic development model that takes these factors into account. The Government and the opposition should work together to find innovative solutions to the country’s economic problems, rather than relying on Western models or making poorly negotiated deals.