Sri Lanka Roundtable - Pathways to Economic Recovery

In March 2023, the IMF approved an extended fund facility valued at approximately US$3 billion to Sri Lanka. While some question the intentions of the IMF and there are concerns about inequitable impact, there was broad consensus among discussants that Sri Lanka needs to implement the economic and governance reforms associated with the extended fund facility. The government of Sri Lanka is now focusing on ensuring debt sustainability and implementing structural reforms in coordination with the IMF and other financial institutions. Some discussants raised concerns about the analytical basis and assumptions underpinning Sri Lanka’s current policy, including an over-optimistic revenue forecast, debt-serving ratio, and interest-to-revenue ratio. Reservations were also expressed on the impact of fiscal consolidation demanded under the extended fund facility on the poor and vulnerable segments of the population.

All discussants agreed that a crisis of governance underlies Sri Lanka’s debt crisis. Governance is foundational and pivotal, and fixing the governance crisis is a pre-condition to finding lasting solutions to Sri Lanka’s economic problems. The governance crisis has historical roots going back at least to Independence in 1948. Since then, problematic governance has deepened and spurred policymakers to be increasingly inward-looking. Today, there seems to be a groundswell of public opinion that acknowledges that these governance issues exist and that they need to be fixed.

Discussants raised concerns about corruption, including corruption associated with the customs office, which impacts imports, and tax collection, which impacts government revenue. There were also concerns surrounding a lack of transparency and neutrality of government policy, particularly around granting of tax holidays, which undermine revenue collection and trust in government.

Discussants called for certain critical functions of government to be established as independent institutions, including the central bank and a debt management body.

Sri Lanka, an upper-middle income economy, is an exception in having government revenue collections having halved in two decades, even when the economy grew. Sri Lanka’s revenue-to-GDP ratio is among the lowest in the world at 8.1 percent in 2020 (IMF, 2022, opens in a new window). As Sri Lanka’s economy has grown, its tax-to-GDP ratio has shrunk. Discussants agreed that this trend needs to be reversed and that taxation and tariff reform will be central to improving government revenue.

Taxation Reform

There are legislative policy provisions that give the Minister of Finance the discretion to declare tax holidays. Discussants argued that this provision has been used to provide overly generous tax holidays, to the detriment of revenue collection. Additionally, there are several loopholes in taxation policy that restrict revenue collection.
Reform could better target the tax base. The following tax principles were suggested as guides to taxation reform:

• Transparency
• Stability
• Simplicity
• Neutrality

In line with IMF analysis, discussants largely agreed that Sri Lanka’s government expenditure was not excessively high; however, government spending could be realigned to ensure it does not exacerbate poverty, especially for the most vulnerable segments of society.

Subsidies

Discussants called for review and reform of Sri Lanka’s state-owned enterprises using a process that is transparent and fair. State-owned enterprises are subsidised by the government of Sri Lanka, and currently carry substantial debt.

GDP growth is a core component of improving a nation’s debt sustainability. Following Sri Lanka’s debt crisis, the national GDP has shrunk: industrial production has fallen, and agricultural production is unstable. Discussants questioned how domestic production across the agricultural, industrial and service sectors could be bolstered; and growth could be inclusive. Some factors restricting growth included restrictions on importation of inputs, corruption and policy coherence.

Agricultural Sector

Discussants acknowledged that the agricultural sector, while shrinking as a portion of GDP, remains an important industry for Sri Lanka and may require reform. Sri Lanka could consider changes in food reserves, land use reform and crop mix, to shore up agricultural production and food security.

All discussants acknowledged that poverty and hardship have expanded and deepened across Sri Lanka. To ensure government spending does not exacerbate inequality, well-targeted social protection programs with safety nets could be increased. It is noteworthy that the government of Sri Lanka is currently rolling out a digitization project to identify poor households, and establishing a new welfare system, Aswesuma (Sri Lanka Department of External Resources, 2023, opens in a new window).

Since the debt crisis, the Sri Lankan rupee has fallen by 80 percent; however, this fall did not result in an uptick in exports. Discussants suggested the following factors underlying Sri Lanka’s inability to seize this opportunity:

• Lack of business confidence
• Anti-export bias
• Ineffective export marketing
• Restrictions on imported inputs
• Lack of local suppliers

Increasing non-debt-creating foreign exchange can improve the stability of the Sri Lankan rupee and the government’s balance sheet. Sectors that can grow foreign exchange include:

• Tourism
• Exports
• Remittances

Global Labour Mobility

Discussants referenced the global labour markets’ impact on the Sri Lankan workforce and remittances. There are high levels of emigration from Sri Lanka both among professionals and workers. This leads to remittances playing an important role in development and economic policy, including currency stabilization. Discussants called for reductions in bottlenecks in remittances, especially to avoid the growth of informal or “black market” remitting.

There was also a suggestion that if Sri Lanka opened their labour markets more, then there could be benefits from immigration as businesses would have access to skilled technicians and managers.