Is Sri Lanka on the mend?

Sri Lanka, known for its scenic beauty and rich cultural heritage, has long been grappling with economic challenges that have hindered its growth potential. With the effects of the global pandemic exacerbating its pre-existing issues, Sri Lanka faced mounting debt, declining foreign reserves, and a plummeting tourism industry. Nonetheless, a combination of domestic reforms and external support has provided a glimmer of hope for the country's economic revival.

Sri Lanka's government, under President Gotabaya Rajapaksa, has implemented a series of bold policy measures aimed at stabilizing and reviving the economy. These include fiscal consolidation efforts, structural reforms, and initiatives to attract foreign direct investment (FDI). In addition, the country has successfully secured financial assistance from international lenders, such as the International Monetary Fund (IMF) and the World Bank, to alleviate its debt burden and support economic recovery. 

Moreover, export earnings have started to recover, buoyed by increased global demand and Sri Lanka's renewed focus on diversifying its export markets. Also, the resumption of international travel and tourism is expected to provide a much-needed boost to the economy, with authorities implementing measures to ensure the safety of tourists and revive the sector. With sustained efforts and effective implementation of reforms, Sri Lanka has the potential to regain economic stability, attract investment, and create inclusive growth that benefits all its citizens.
In this context, the question whether Sri Lanka is transitioning from an economic crisis to recovery has been a burning concern for economists and policymakers alike. While there have been positive changes in the Sri Lankan economy, several underlying problems still persist.

Positive Changes - Decrease in Inflation

According to the statistics department, Sri Lanka's consumer inflation rate dropped by more than half to 4.6% year-on-year in July, primarily due to lower food prices. The National Consumer Price Index (NCPI), which measures overall retail price inflation, is released with a delay of 21 days each month. In June, consumer inflation stood at 10.8%.

The Department of Census and Statistics stated that food prices decreased by 2.5% in July compared to the previous year, following a 2.5% increase in June. On the other hand, non-food item prices rose by 10.9% in July, compared to an 18.3% increase in June.

Since June, Sri Lanka's inflation has significantly decreased from previous high levels, partly due to the statistical base effect and a stronger rupee currency. These factors have reduced the costs of fuel, power, and imported food.
The $2.9-billion bailout from the International Monetary Fund (IMF) in March has helped replenish Sri Lanka's foreign reserves, which had reached record lows in early 2022, causing the country to face its worst financial crisis in over seven decades.

Udeeshan Jonas, chief strategist at equity research firm CAL, predicts that inflation is likely to remain below 5% due to the high base effect. He believes that there won't be significant demand-side pressures that could drive up inflation in the coming months.

Taking advantage of the faster-than-expected easing of inflation, Sri Lanka's central bank reduced policy rates by a total of 450 basis points in June and July this year. This came after a record increase of 1,050 basis points between April 2022 and March this year.

Analysts expect the Central Bank of Sri Lanka (CBSL) to keep rates unchanged at an upcoming meeting but may continue to lower interest rates later in the year to stimulate growth. Despite this, the crisis-hit economy is still projected to contract by 2% in 2023, following a 7.8% decline last year.

In this context, Sri Lanka has experienced steady economic growth in recent years. The government's focus on infrastructure development, tourism, and foreign investment has played a key role in driving this growth. The expansion of industries such as manufacturing, services, and information technology has also contributed to the country's economic progress.

Increased Foreign Direct Investment (FDI)

Foreign direct investment has been on the rise in Sri Lanka, indicating the growing confidence of international investors in the country's economic potential. The government's efforts to create a favorable investment climate, reduce bureaucracy, and offer incentives have attracted significant foreign capital inflows. This has not only boosted economic growth but also created employment opportunities.

Challenges in the Sri Lankan Economy

High Food Prices:
Sri Lanka has been grappling with the challenge of high food prices, which has had a significant impact on the cost of living for its citizens. Several factors contribute to the rise in food prices in the country. One key factor is the reliance on imports for essential food items. Sri Lanka heavily depends on imported staple foods such as rice, wheat, and sugar. Fluctuations in global commodity prices, exchange rates, and trade restrictions can lead to volatile food prices domestically.

Another factor is the impact of climate change and natural disasters on agriculture. Sri Lanka has experienced adverse weather conditions, including droughts, floods, and landslides, which have negatively affected crop yields. Reduced agricultural production leads to a decrease in the supply of food, driving prices higher.
Besides, inefficient supply chains and distribution networks can contribute to increased food prices. High transportation costs, storage losses, and middlemen margins add to the overall cost of food, making it more expensive for consumers.

To address high food prices, Sri Lanka needs to focus on improving domestic food production and reducing reliance on imports. This can be achieved through investment in agricultural infrastructure, technology adoption, and farmer support programs.

Furthermore, the government should work towards improving supply chain efficiencies, reducing post-harvest losses, and promoting fair trade practices. Encouraging direct farmer-to-consumer networks, such as farmers' markets and online platforms, can help bypass intermediaries and lower prices for consumers.

Addressing high food prices in Sri Lanka requires a multi-faceted approach that includes boosting domestic food production, improving supply chains, and promoting sustainable agricultural practices. By addressing these challenges, Sri Lanka can work towards ensuring affordable and accessible food for its population

Depreciation of the Rupee:

The Sri Lankan rupee has experienced significant depreciation in recent years, creating challenges for both businesses and consumers. A weaker currency increases the cost of imported goods, leading to higher prices for consumers. Businesses that rely on imported raw materials face increased production costs. The government needs to implement policies that stabilize the currency and promote exports to mitigate the adverse effects of rupee depreciation.

Brain Drain:

Sri Lanka has been grappling with the issue of brain drain, as many skilled and capable professionals choose to seek better opportunities abroad. The main factors contributing to brain drain in Sri Lanka include limited employment opportunities, low wages, political instability, and a lack of career prospects. Many highly educated individuals, including doctors, engineers, and IT professionals, seek better opportunities and higher salaries abroad, often in developed countries.

The consequences of brain drain are significant for Sri Lanka. The country invests heavily in the education and training of its citizens, only to see them leave for greener pastures. This results in a loss of skilled workers, which hampers economic development and slows down technological advancements domestically.

Moreover, the departure of highly skilled individuals creates a skills gap in Sri Lanka, as there is a shortage of qualified professionals in key sectors. This can have a detrimental impact on the quality of healthcare, education, and other essential services.

To address brain drain, Sri Lanka needs to create a conducive environment that encourages skilled individuals to stay and contribute to the country's development. This entails improving employment opportunities, offering competitive wages, fostering a stable political climate, and providing avenues for career growth.

Furthermore, the government should focus on creating a supportive ecosystem for entrepreneurship and innovation to encourage highly skilled individuals to stay and contribute to the local economy. By addressing the root causes of brain drain and creating an enabling environment, Sri Lanka can mitigate the loss of human capital and harness the potential of its skilled workforce for sustainable development.

Economic Reforms and IMF Requirements

Sri Lanka has been grappling with economic challenges, prompting the government to implement various reforms to stabilize the economy. However, there is a debate surrounding the motivation behind these reforms. Are they primarily driven by the International Monetary Fund (IMF) requirements or are they aimed at building a better future for Sri Lanka? 

Sri Lanka's economic reforms have been closely tied to the IMF's assistance program. The government secured a $2.9-billion bailout package from the IMF in March, which helped replenish the country's dwindling foreign reserves. In return, the IMF has laid out certain conditions and requirements for the disbursement of funds. These conditions often involve fiscal consolidation measures, structural reforms, and policy adjustments to address macroeconomic imbalances and promote sustainable growth.

While meeting IMF requirements is undoubtedly a significant factor in driving economic reforms, it is essential to consider the broader goal of building a better Sri Lanka. The government's reform agenda aims to address deep-rooted issues that have hindered the country's economic progress. These reforms encompass various sectors, including governance, public finance management, investment climate, and social development.

In recent times, the restoration of political stability has been a priority for Sri Lanka. The government has utilized national security laws to address security concerns and maintain political stability. However, the methods employed, such as the arrest of protest leaders and the use of force to disperse public demonstrations, have raised concerns about civil liberties and human rights.

The restoration of political stability plays a crucial role in facilitating economic reforms. A stable political environment creates an atmosphere conducive to implementing necessary changes and attracting domestic and foreign investments. However, it is vital to strike a balance between maintaining stability and upholding democratic principles, as the latter is essential for sustainable development.

The economic reforms undertaken by the Sri Lankan government are influenced by both IMF requirements and the goal of building a better future for the country. While meeting IMF conditions is important for financial stability and access to international assistance, the government also recognizes the need to address longstanding economic challenges and create a conducive environment for growth. However, the methods employed to restore political stability should be carefully evaluated to ensure that civil liberties and human rights are upheld. Ultimately, a balanced approach that combines economic reforms, political stability, and respect for democratic values is crucial for Sri Lanka's long-term development.

Domestic debt optimisation programme

The domestic debt optimization program aims to manage Sri Lanka's debt burden more efficiently by reducing borrowing costs and extending maturities. Besides, the Employees' Provident Fund (EPF) and Employees' Trust Fund (ETF) have been revamped to improve transparency and governance. These measures are expected to strengthen the financial sector and boost investor confidence.

Under the domestic debt optimization program, the government focused on issuing new bonds with longer maturities and lower interest rates to replace existing debt with higher interest rates. By refinancing debt in this manner, the government sought to reduce the annual debt servicing costs and extend the repayment period, providing more breathing space for the economy.

Moreover, the program aimed to diversify the investor base by attracting a broader range of domestic investors, including institutional investors such as pension funds and insurance companies. This diversification strategy helped reduce reliance on a few key investors and enhanced the stability of the domestic debt market.
The implementation of the domestic debt optimization program was crucial in managing Sri Lanka's debt sustainability and improving the country's fiscal position. By securing more favorable borrowing terms and extending repayment periods, the government aimed to alleviate the burden of debt servicing and create a more sustainable path for economic growth.

Way forward

Moving forward, Sri Lanka needs to adopt sound fiscal policies to ensure sustainable economic growth. This includes reducing the budget deficit, rationalizing public spending, and increasing revenue generation through effective taxation. By addressing these issues, the government can create a conducive environment for businesses to thrive and attract foreign investment.

Improving transparency is another crucial aspect for Sri Lanka's economic recovery. A transparent and accountable governance system will help instill confidence in investors and promote fair competition. This includes measures such as strengthening regulatory bodies, ensuring equal opportunities for all market participants, and enhancing the efficiency of public procurement processes.

Furthermore, Sri Lanka needs to diversify its economy to reduce dependency on a few sectors. Currently, the country heavily relies on tourism, tea exports, and garments manufacturing. By diversifying into sectors such as technology, renewable energy, and agriculture, Sri Lanka can create new avenues for growth and mitigate risks associated with highly concentrated industries.

In conclusion, while Sri Lanka has witnessed positive changes in its economy, there are still several challenges that need to be addressed. The government's economic reforms should be driven by the genuine intention to build a better Sri Lanka rather than fulfilling IMF requirements. To achieve this, sound fiscal policies, improving transparency, and diversifying the economy are essential. By focusing on these areas, Sri Lanka can transition from an economic crisis to a path of recovery and sustainable growth.