Former Central Bank Deputy Governor W.A. Wijewardena has written an op-ed for the DailyFT titled ODI Compilation: Unsolicited Debt & Transformative Growth Manual for the AKD Government, reviewing the Overseas Development Institute’s publication Sri Lanka: From Debt Default to Transformative Growth, compiled by Ganeshan Wignaraja and Dirk Willem te Velde.
The document, published in September 2024, examines Sri Lanka’s economic crisis and debt challenges. Though the publication predates the presidential election, the analysis may still help the new administration under President Anura Kumara Dissanayake (AKD) address the country’s economic issues. The publication includes 14 essays and offers policy recommendations under six broad themes. Wijewardena says the report could interest the AKD Government as it extends beyond the IMF’s policy benchmarks, addressing not just nominal stabilization but also real economic transformation.
Sri Lanka’s current crisis, identified by the Central Bank as the most severe since independence, did not emerge suddenly in 2022. It stems from low or negative economic growth, inability to meet debt obligations, weak public finances, and insufficient foreign exchange reserves. In April 2022, Sri Lanka suspended debt servicing to bilateral and commercial creditors due to inadequate reserves and a lack of ability to secure foreign financing.
The origins of the crisis are from earlier borrowing practices for low-return projects and refinancing debt through further borrowing. This approach failed to generate enough foreign exchange to service the debt, leaving the country vulnerable to disruptions in foreign borrowing. Over time, this strategy increased foreign debt in absolute terms and relative to GDP, resulting in a debt trap that became unsustainable by 2022.
Wignaraja and Velde gathered experts to analyze the causes of the country’s debt distress and propose solutions. In 2022, the economy contracted by about 8%, reducing incomes and limiting the supply of goods and services. Simultaneously, inflation accelerated to around 55%, eroding real incomes and worsening living standards.
Poverty levels are estimated to have doubled, with 25% of the population living below the World Bank’s $3.65 poverty line. When using the $6.85 threshold for upper-middle-income countries, poverty is estimated to have risen to 66% of the population.
Although Sri Lanka has made some progress in stabilizing the economy, Wijewardena argues that the current trajectory is insufficient for sustained growth. The economy cannot remain low-growth and must transform to achieve higher prosperity. To this end, the report proposes 27 policy measures under six themes to reduce debt distress and guide Sri Lanka towards long-term growth.
“Despite a few shortcomings, the volume compiled by Wignaraja-Velde provides useful guidance to the AKD administration. The government lacks a medium- to long-term plan to improve the economy. The analysis and policy recommendations in this report can help the government prepare such a plan,” Wijewardena writes.
1.The first theme emphasizes the need for a cross-party economic policy consensus that includes political leaders, businesses, trade unions, and civil society. The report recommends creating a consistent policy framework and eliminating rent-seeking behaviour through transparent decision-making. Rent-seeking occurs when individuals or entities gain from policy inconsistencies without contributing to production.
An example of rent-seeking occurs when the government reduces the special commodity levy on rice imports to lower consumer prices, benefitting consumers but hurting farmers who may push for a restoration of the levy. Importers, in turn, may stockpile rice and sell it at higher prices, gaining profits at the expense of consumers, farmers, and the government. These practices impose costs without providing benefits.
Eliminating rent-seeking requires governments to implement transparent policies based on thorough analysis. Inconsistent and opaque policymaking has contributed to Sri Lanka’s economic challenges, underscoring the need for reform to prevent corruption and inefficiencies.
2.The second theme addresses achieving debt sustainability. For domestic debt, the report recommends maintaining safe debt levels relative to government revenue and GDP with pre-planned repayment strategies. It also emphasizes prioritizing borrowing for revenue-generating projects rather than relying on refinancing.
Sri Lanka’s borrowing strategy has over-relied on non-productive investments. The country needs to focus on projects that generate revenue and foreign exchange, reducing the need for refinancing. Pre-planned debt repayment strategies will help manage debt servicing more effectively and ease pressure on foreign reserves.
3.The third theme discusses Central Bank independence, highlighting reforms like inflation targeting and professional staffing. However, the deflation issue, which the economy has been experiencing for months, has not been addressed. The Central Bank’s failure to meet its inflation target and the ongoing deflationary environment has created challenges that need attention.
If not managed, deflation can harm the economy unless accompanied by productivity growth, which is currently lacking. The Central Bank has limited tools to address deflation, and the report would have benefited from an analysis of this unexpected issue and its implications for economic policy.
4.The fourth theme focuses on fiscal sustainability. The report advocates improving public financial management and reforming state-owned enterprises. While the IMF programme emphasizes revenue generation, the essays suggest a balanced approach, including controlling expenditures to avoid further economic contraction.
To ensure fiscal sustainability, the government must improve efficiency in public spending and reduce waste, particularly in state-owned enterprises. Enhancing tax collection and eliminating tax exemptions will increase revenue and help reduce the fiscal deficit. Debt servicing should be carefully managed through debt restructuring or refinancing options, while reforms in public services and state enterprises can contribute to long-term fiscal health.
5.Economic transformation is another key area of focus. The report calls for regulatory reforms to improve the business environment, promote investment, and facilitate trade. It also highlights the need to adopt new technologies to support sustained economic growth.
For Sri Lanka to transform its economy, it must diversify and shift towards higher-value industries, investing in infrastructure, innovation, and education. Reducing regulatory barriers and streamlining business processes will foster an environment conducive to private-sector investment. Adopting complex technologies is critical to boosting productivity and improving competitiveness in the global market.
6.The final area addresses inclusive growth, pointing out that income inequality is a significant issue, with the top 20% of earners receiving 50% of the nation’s income. While the essays suggest better-targeted relief measures, they do not propose concrete solutions to address structural inequality.
To reduce income inequality, the government should focus on targeted social protection programmes and improve access to education, healthcare, and housing. Policies that raise wages and expand employment opportunities for lower-income groups will also help reduce disparities. Structural reforms like improving access to credit for small and medium-sized enterprises, promoting gender equality, and investing in rural development are also essential for more inclusive growth.
Wijewardena says Sri Lanka: From Debt Default to Transformative Growth offers a detailed analysis of Sri Lanka’s economic challenges and presents a range of policy solutions. Although some issues remain unaddressed, such as deflation and structural inequality, the policy recommendations provide a roadmap for reducing debt distress and achieving sustainable long-term growth. The AKD government should consider the proposed reforms, which focus on fiscal sustainability, economic transformation, and inclusive growth, as they align with the country’s needs for a more stable and prosperous future.