The pandemic is still in its early stages but the economic fallout is likely to be far worse than the global financial crisis of just over a decade ago. Initial data points to the worst slump since the Second World War. 

 

 

According to official data, China’s GDP in the first quarter contracted 6.8 percent year-on-year (and 9.8 percent quarter-on-quarter).  Western nations seem set to fare worse. The UK’s Office for Budget Responsibility sees a decline of 35 percent in the second quarter and a decline of 12.8 percent for the year. 

 

The OECD estimates “reductions of 15 percent or more in the level of output throughout the advanced economies and major emerging-market economies. In the median economy, output would decline by 25 percent.” 

 

The IMF estimates that the global economy is projected to contract sharply by -3 percent in 2020 but this will be mostly due to the contraction in advanced economies (-6.1 percent). Emerging market and developing economies are expected to contract by -1 percent. The World Bank expects the global economy to contract by 5.2 percent in 2020.

 

The optimistic scenario is that this will bottom out by mid-year, leading to the so-called V-shaped recovery. The pessimistic, perhaps the more realistic one is that output will stagnate. 

Some parts of the world will only recover slowly, recovery being hamstrung by the current levels of debt and increasing indebtedness. The recovery may be similar to the Western rebound from the global financial crisis, which was anaemic.

 

Historically, pandemics hit the poor much harder and developing countries are hit hardest of all. The already high debt burdens around the developing world are now becoming unsustainable so significant defaults and debt restructuring are possible. 

 

In terms of policy responses, given this unanticipated shock, developed nations have resorted to massive fiscal and monetary stimulus. Developing countries cannot afford this because of much weaker public finances.

 

Past pandemics have also brought about wider economic, political and social changes. In the past, the huge short-term economic costs have been followed by lasting structural changes that prevail for decades, in societies, in economies, in the global economy and in international politics. 

 

Some of these are already underway, most importantly, a recalibration of the state market relationship. There has been significantly more state intervention around the world, domestically and in cross border transactions. Hopefully, it will be rolled back when the recovery takes place but realistically, some of it will remain into the medium and long term. 

 

Expectations have been created, entitlements are being created and it is almost impossible to pull back from this entirely. 

 

A bigger role for the state and more controlled markets is underway and will manifest in various ways: reliance on central bank interventions, fiscal stimulus, bigger subsidies or more potent domestic industrial policy and also more trade protectionism with disruption to supply chains.

 

This will hit export-oriented economies in East Asia particularly badly. Even when the recovery comes, it’s going to take time to get supply chains in good working order again.

 

 

Sri Lanka is still trying to contain the virus but initial indications are that there will be a retreat from trade and openness. Public statements from various quarters promote a return to the themes of ‘self-sufficiency’ and ‘import-substitution’ that dominated policy between 1956 and 1977. 

 

This is partly prompted by an on-going balance of payments crisis that has forced the government to impose an import ban on a wide variety of items. Although the ban is supposed to be a temporary, it has been welcomed by sections of the business community, so there will be pressure to continue this into the long term.

 

The historical record tells us that we will have a better recovery if trade is put back together as quickly as possible, so it is imperative that the trade engine starts again. This is not only a question of logistics and time but one of policy.

 

However, the existing protectionist measures that were in place before the crisis and those that are being put in place during the crisis could get worse, becoming entrenched. If this takes place globally, we will have a slower recovery around the world. Sri Lanka should therefore be advocating for greater openness globally but this becomes more difficult if it is practicing protectionism at home. 

 

Sri Lanka will also be faced with a large increase in unemployment, due to the closure of overseas markets. It will be felt most seriously in the export sector, tourism and migrant workers overseas. This will be compounded by the shrinking of domestic trade. 

 

It would be desirable to have some large projects that can generate activity quickly but the government has no funds for any stimulus. Attracting new investors in the current environment will not be easy. Therefore, it is advisable to leverage the existing investors/projects by private investors. 

 

 

In order to maintain a degree of openness, Sri Lanka first needs a sustainable macroeconomic strategy into the medium term, one that revolves around fiscal prudence and sustainable debt management. It is the macroeconomic imbalances that have contributed to the ongoing balance of payments crisis that in turn provides the impetus for protectionism, as was the case in the past.

 

Secondly, it must ensure that the economy has the enabling conditions for a productive recovery. This means not resorting to further long-term protectionism, to open up the economy further, if possible and to remove bottlenecks to enterprise in the domestic economy.  

 

The political pressure will be in the opposite direction, making it necessary to advocate for sensible policies in the short term that rely as much as possible on market instruments and argue very much against some of the more damaging policies in the medium to long term. 

 

The key is to try to keep as much productive capacity intact to take advantage of the recovery when it happens and for relief to target the most vulnerable people.

 

The service sector is less likely to be affected by trade protectionism but moving manufacturing back to the US/Europe will increase costs, which may be difficult to pass onto the consumer if the market is weak. The pressure to reduce costs can present an opportunity for Sri Lanka in the form of outsourced back office work and administrative processes. 

 

The reduction in activity gives us time to fix administrative and infrastructural bottlenecks and combined with the balance of payments crisis, there is an opportunity for reform to:

a. Increase the digitalisation/automation of processes

b. simplification of regulations/licences/processes 

 

Discussions should start immediately to explore the possibility of accelerating the two major Chinese projects: Port City and the Hambantota port. These two projects are large and offer the possibility of absorbing a significant number of workers rapidly, provided the local components can be increased. This involves no government funds, so there is no pressure on the fiscal position. 

 

Fast-tracking the East Container Terminal as a purely private investment is also advisable. This strategy of leveraging the existing projects while creating an enabling, pro-trade environment will be crucial for Sri Lanka’s recovery over the coming months.