Sri Lankan economy not out of the woods yet Five things that could make or break it

The Central Bank last week cut the interest rates by 250 basis points, announcing the first rate cut in three years, in what appears to be a shifting of gears from taming inflation to stimulating economic growth. Last year, the CB raised the interest rates by 950 basis points and this year by another 100 points - further cuts may be in the pipeline as the inflation is cooling faster than expected, in the same way, it spiralled by nearly 70% within April and May last year. Inflation has eased to 25.2% in May from 35.3% in April. The CB expects the inflation to decline to a single digit by the end of the year, while some analysts expect the inflation to drop to around 5% by the early fourth quarter of the year and stabilize. As much as the Central Bank’s tight fiscal policies, the faster-than-expected decline in inflation is due to the higher baseline after the mammoth inflationary hike of 70 % last year.

That would also mean, while the worst of Zimbabwean, Venezuelan-styled runaway inflation is avoided, the cost of living will still be substantially higher and probably never return to the pre-crisis level.
Sri Lanka’s economic recovery, or at least management of the crisis so far, is remarkable in comparison to the experience in the countries such as Lebanon or the worst-case scenarios like Venezuela, Zimbabwe etc.  What Sri Lanka could achieve this modest success was perhaps, for the first time in its history, economic policy was detached from politics. The latter has always been parochial and cannibalized the economy. 
What is also clear is that the current fleeting success has been achieved through the intervention of a few micro-economic tools - while much of the structural problems in the wider economy remain untouched. Unless those are addressed, the Sri Lankan economy will relapse into a crisis sooner or later. Even if a full-scale collapse similar to the last year could be averted, the economy would never perform at its full potential, nor would it overcome the Middle-income trap in the foreseeable future.

Bloated Government Sector
Consider the bigger problem areas that remain untouched. A bloated public service of 1.5 million employees (which has reduced to 1.4 million last year due to the freezing of new hires and retirements). Mahinda Rajapaksa swelled the government service from 700,000 when he came to power to over 1.5 million during his two terms. It is now a money-gobbling black hole. It is also the epitome of incompetence and inefficiency. Given its sheer size, it cannot be reformed or modernized cost-effectively. Some sectors within the government sector, such as the Ministry of Defence, should see a substantial reduction as ranks and file of the armed forces enlisted in large numbers during 2005-2009 complete their 20 years in service. Their salaries now amount to one-third of the government’s payroll, though as a percentage, Sri Lanka’s defence spending is lower than the global average.
However, most seat warmers in the public sector would continue in the service for the foreseeable future without a Voluntary Retirement Program. Whereas programmes, such as five-year no-pay leave from the service to undertake foreign jobs, have little practical effect, perhaps even a negative one, as it would be the most competent of the officers in the service would go abroad, leaving their underperforming peers at home. A more sensible programme would be to offer retraining and foreign and local jobs to this lot.

SOEs
Second, the loss-making State-Owned Enterprises (SOEs) reforms are still confined to words. No gainsaying that restructuring, broad basing and even privatization of SOE should be transparent, well planned and well-regulated to prevent the usual cronies and friends of politicians from buying them at a knockdown price. However, when the economy gradually rises from its nadir, so would the usual charlatans and so-called patriots, who would renew a campaign against reforms in SOE. The government has a fine line to tread, but delaying SOE reforms would make them hard to implement.

Investment red tape
Third is the investment climate, which is a labyrinth of red tape, retrograde laws and corruption. While the government is mooting plans to reform these laws, it can also look into short-term fixes for the fundamental problem of red tape and corruption. The request for bribery turns off most foreign investors of small and medium scale.  The president can set up a special coordination office under his office so that aggrieved investors can seek redress and expedite the investment procedures. This is similar to what Saudi Prince MBS put in place. This and more concrete measures saw Saudi Arabia’s Doing Business ranking rising exponentially.

Lopsided resource allocation in education
Fourth, consider the fundamental weakness of Sri Lanka’s workforce. The primary mode of foreign remittance to the country is Sri Lankan workers, mostly unskilled and semi-skilled, toiling in the Middle East and Korea in dirty, dangerous, and demanding jobs. That is a sad mismatch between the promise and reality of a country that had invested in free education since its independence. That is because of a fundamental mismatch of resource allocation in education in the country, favouring, at best, 10% of university students at the expense of 90% of their peers. This is not a complaint against the free education at the universities, though the limited financing to public universities has resulted in the deterioration of quality and losing standing relative to international peers. The bigger concern is the vacillation of successive governments to provide equal and fee-levying opportunities for the rest of the youth due to the nihilistic opposition by university students. 
Sri Lanka’s model of resource allocation in education has failed here and everywhere. For example, see India, where a few Ivy League comparable Indian Colleges of Technology cannot hide the wasted demographic gains of a teeming, under-educated, under-qualified youth population. The government should prioritize the 90% of its youth over the 10%, create opportunities for their higher education, entice the private sector to set up universities and technical colleges and invite respectable foreign universities to open branches through tax concessions and joint ventures. The government should provide interest-free tuition fee loans for all its youth, which can be recouped after graduation. A US$ 750 million that the government plans to invest in a social welfare scheme this year would have been better utilized in something similar, though the existential economic hardships of vulnerable families need redress. Scarce financial resources, though, should be used dispassionately for the long-term well-being of all the people. 

Early elections
Fifth and probably the most concerning is the threat of Sri Lanka relapsing to its populist mood of the old times. The rationale for delaying the local government elections was exactly this fear. However, President Wickremesinghe is now mooting plans to bring forward the presidential election, which he thinks he could win. The economy may be on a path to recovery, but it is still fragile, and populism ingrained in Sri Lankan politics would derail the process at any time. An early presidential election, as some suggest, mooted for the first quarter of next year, would be inviting a disaster. Economic coherence would be lost in populist promises, investors would be scared away, and charlatans promising the sun and the moon would dominate the popular discourse. 
Sri Lanka should not go to elections while leaving an unfinished business of economic reforms. Any popularly elected government would unlikely proceed with these mandatory economic reform measures. Good economic policies are often bad for politics in the short term.
Sri Lanka’s political leadership has historically proven that they have neither conviction nor intellectual sophistication for serious economic reforms, which is why the country is currently in this mess. The vast majority of Sri Lankans themselves are sick and tired of the old economic model, having endured fuel queues and loss of disposable income. Therefore, the president has the rare opportunity to fix the economy, reform it and put it on a sustainable footing without being bothered by popular protests. The usual fringe who opposes such measures has lost their relevance for the time being. The president should make use of this historic opportunity. Instead, he also seems to have other priorities. 

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