Kerosene queue - a regular sight at fuel stations

The current economic crisis is known to be the worst economic crisis the country has seen since independence. Many experts have pointed out that one of the reasons for this is the tax cuts introduced in 2019. “Coupled with the economic mismanagement in the country, the 2019 tax cuts further downgraded Sri Lanka’s credit rating,” shared Umesh Moramudali, lecturer at the Department of Economics, University of Colombo. He shared these views during a session on ‘The Economic Crisis, Causes, Future and the Role of Citizens’ held at Citizen’s Forum, Gotagogama. The tax cuts caused a 30% reduction in the government revenue, thereby paving the way for the current crisis. However, Moramudali stressed that tax cuts was not the only cause for the economic crisis. “Since 1950s, we import more than we export, and this has become a problem because our expenditure is more than our income. When we import, we have to pay in dollars. As a country that does not print dollars, we were dependent on foreign loans to pay for the imports. However, with the credit rating getting downgraded, we lost access to international financial markets, and multilateral organizations and other countries were hesitant to give loans to us.”  

Along with the tax cuts and poor economic policies, the pandemic played a role in the economic crisis. The pandemic caused a significant drop in tourism, which resulted in lowered foreign exchange inflow to the country. “Our dollar reserves were depleting, yet we used the depleting dollar reserves to pay back the loans instead of asking for extensions or concessions,” shared Moramudali, adding that the lack of foreign exchange contributed immensely to the economic crisis as Sri Lanka imported most essentials including fuel and gas.   

"These tax reforms are a necessity as it is needed to increase the falling government revenue. Only tax reforms is not enough to solve this economic crisis but it can provide some relief"

"Along with the tax cuts and poor economic policies, the pandemic played a  role in the economic crisis. The pandemic caused a significant drop in  tourism, which resulted in lowered foreign exchange inflow to the  country"

How will the new tax reforms help?

On 31 May, the Prime Minister’s Media Division released a press release with the proposed tax reforms.Some of the tax reforms proposed were the increase of Corporate Income Tax (CIT) from 24% to 30%, increase of Value Added Tax (VAT) from 8% to 12% and decreasing the VAT registration threshold from Rs. 300M per annum to Rs. 120M per annum, reduction of tax slabs on Personal Income Tax (PIT) from Rs. 3M to Rs.1.2M and imposing tax rates from 4%- 32% on each slab.   

While welcoming the new tax reforms, Moramudali stressed the need to protect vulnerable communities “These tax reforms are a necessity as it is needed to increase the falling government revenue. Only tax reforms is not enough to solve this economic crisis but it can provide some relief. Most Sri Lankans who are eligible for the income tax do not pay or pay lower rates. Personally, I think certain tax rates can be increased however this increase should be done mindfully.”  

He also opined that the increase of taxes on import items would minimize non-essential imports and minimize foreign exchange outflow. “It is crucial we have enough forex to import essential items such as fuel, gas, medication and fertilizer,” he remarked. Responding to a question by the public, Moramudali shared that food items such as rice, sugar will not be affected by the increased VAT as these products are exempt from VAT. “Food items such as biscuit, cheese and certain items like cement, tiles would be impacted by the VAT increase.”  
He also added that the PIT would have to be paid by those who earn over Rs 150 000 a month.  

"Our dollar reserves were depleting, yet we used the depleting dollar reserves to pay back the loans instead of asking for extensions or concessions"

"IMF would put forth certain conditions such as cutting down unnecessary state expenditure, implementing sustainable economic policies that must  be followed when receiving financial assistance from them"

Rural areas already affected by the food crisis

A researcher from the North shared that the rural areas suffered the worst hit from the economic crisis. “Due to the economic mismanagement that has been occurring for decades, the people in the rural North have suffered for over 13 years. Fishermen in this village called Thambutti in Kayts have not been able to go fishing because they haven’t received fuel for over 20 days. They need the fuel for their boats to go fishing and it is their livelihood. Without being able to engage in fishing, they have been finding it difficult to survive because they do not have any income.”  

Sharing similar sentiments, a member of the farming community in Vavuniya shared that due to the fertilizer ban- the farmers were unable to cultivate their crops. “If we don’t cultivate for the next season, we will face a rice shortage in the next few months.”  
Moramudali remarked that the government should look into how the rural vulnerable communities can be protected. “I believe the government should help these communities in some way, even financially, to ensure they are able to live their day to day lives. The government should also urgently look into restoring livelihoods of the fishing community, farmers and other vulnerable communities.”  

"Country should look into improving exports and understanding what sectors/products/services can contribute to increasing exports"

"The increase of taxes on import items would minimize non-essential imports and minimize foreign exchange outflow"

Way forward

On 2 June, Prime Minister, Ranil Wickremesinghe, tweeted that the IMF negotiations are expected to conclude this month. “It’s a necessity to seek help from the IMF to solve this economic crisis to some extent but IMF won’t resolve everything. This crisis is not something that can be resolved overnight or even in months. It will take years to resolve,” remarked Moramudali adding that proper economic policies were a necessity to resolve the economic crisis.  

He also shared that IMF would put forth certain conditions such as cutting down unnecessary state expenditure, implementing sustainable economic policies that must be followed when receiving financial assistance from them. He explained that cutting down unnecessary state expenditure did not mean firing state sector employees. “It means cutting down on development projects that are not the need of the hour, cutting down unnecessary overtime pay in the state sector. This should not impact essential services such as healthcare. But in certain sectors, there is no necessity for overtime pay. Also, the state could reduce the defence budget by cutting down on unnecessary expenditure.”  

While noting that things would get worse before they can get better again, Moramudali remarked that the country should look into improving exports and understanding what sectors/products/services can contribute to increasing exports. He also shared that forex remittances are necessary for Sri Lanka to increase its forex reserves and urged that those sending money from abroad should send it via legitimate channels instead of sending through undiyal/hawala systems.   
“We need proper economic policies including anti-corruption measures to stabilize the country and prevent economic mismanagement. If we don’t have proper economic policies in place, we will continue to run into a similar economic crisis every few years,” he opined.