Following several years of contraction Sri Lanka’s economy has stabilized. For stabilization to become a full recovery, it will require reforms that open borders to freer trade, reforms unlocking productivity and a political will to grow the share of tax revenue, according to the World Bank Group’s Country Manager for Sri Lanka Gevorg Sargsyan. 

Locked out of global financial markets Sri Lanka has required loans from multilateral lenders like the World Bank for government budget expenditure and welfare spending. In June 2023 the World Bank approved a $700 million loan, disbursing the last $200 million tranche in October 2024. 

Sargsyan says any new budget support from the bank must come as a package following the completion of the third review of the IMF loan deal. However, the October presidential election and the delay in submitting next year’s budget to Parliament have postponed the timeline. The third review of the IMF’s $3 billion, 48-month Extended Fund Facility (EFF) was initially scheduled for completion in December 2024. 

In an interview with Echelon, Sargsyan discussed the short-term challenges and how Sri Lanka can turn the surprisingly fast stabilization into a lasting recovery. 

The World Bank is concerned about reducing poverty. In Sri Lanka, the poverty rate has risen in the last few years due to the economic crisis. Sri Lanka’s economy is now back to growing, but the setback of the crisis has not been overcome. If you were to outline some priorities to accelerate Sri Lanka’s growth, what would those be? 

The World Bank Group is an institution owned by most countries in the world and Sri Lanka and its people are our shareholders. We want to be seen as a cooperative for our members, from where they can obtain advice and international expertise tailored to local needs and an array of financing.  

Sri Lanka went through its worst economic crisis in modern history and what people went through in terms of loss of income and jobs was devastating. Despite the odds, it’s impressive to appreciate how well and fast the economy has stabilized. But stabilization is not recovery. Recovery is quite complex, and that is a narrow path. Even after debt restructuring there will still be a significant debt burden and the only way out will be sustainable growth. To use a metaphor, you have a pie to feed a family. Now if you want to ensure that everyone is well fed in equal proportions, you’ll need a bigger and more nutritious pie. This is very much the Sri Lankan economy. There are ambitious plans for development, infrastructure, services, and access, so you need a bigger economy because a bigger economy means more revenues and more expenditures. You want a more diversified and nutritious economy and you also want to make sure that everyone benefits from the economy, particularly the poor.

What are the areas for this growth? One will be value addition. Agriculture has been a big part of the Sri Lankan economy but value addition is relatively limited. Energy and electricity are another. The reforms that have been taking place create an opportunity to crowd in investments into clean energy that will help reduce the cost of energy, immediately benefiting people and businesses and providing energy security and environmental benefits. Tourism is the other. It has rapidly grown almost reaching pre-crisis levels but the sustainable and value-added aspect can still be enhanced. The second is improving governance.

Sri Lanka’s GDP has shrunk by 10%. Of the last five years, four have seen negative GDP growth. This is unprecedented even by Sri Lanka standards. You highlight several priority areas for focus. But assume we want to do some catch-up and we want to do it fast. We’ve seen the region, particularly India, growing very fast, and Southeast Asian countries like Vietnam and Cambodia are growing even faster than the South Asian average. Assume Sri Lanka now wants to unlock its potential, if that exists, what should we be doing to generate higher growth?

There are several aspects of it. One is increasing trade, particularly exports. Sri Lanka has about $10 billion equivalent untapped export potential in several sectors according to our latest economic update.

Sri Lanka’s exports are about $13 billion a year, and you’re suggesting there is a $10 billion untapped potential?  

Yes. And it means hundreds of thousands of jobs, among other things. That also means a massive addition to the revenue. The other is investments, particularly FDIs, that can boost this potential. In the last two decades, Sri Lanka has increasingly looked more inward. 

Sri Lanka’s export to GDP share has fallen from 40% to 20% in two decades. That’s a massive contraction for a country that has huge export potential. Because of its geography, it’s naturally a logistical hub between parts of Asia, Africa, and Europe. It has a good port infrastructure which can be further developed with many clusters built around it and a skilled labour force. 

If you look at Singapore, it has all these ingredients, an open economy, a high share of exports, low barriers to entry and cluster developments around the port. So, to become like Singapore, these policies need to be implemented. 

The other aspect is investments, particularly FDI. The lack of predictability, complex rules, multiple institutions that need to be dealt with, lack of transparency and a perception of corruption make it very difficult to invest in Sri Lanka. For Sri Lankan industries to export they also need to be able to import some of the inputs, because everything is not produced locally. So those are some examples of what needs to be done.

Can you explain how you arrived at that 10 billion dollar estimate?

It’s a methodology used across many countries, and we have a robust team working on this. I won’t be able to give you all the intricacies and elements of this but it looks at labour, at what markets want, your potential supply of inputs, the trajectory and vision of businesses, and so on. The report provides details and I encourage people to read it online including more about the methodology.

Can you help unpack this? Sri Lanka’s exports are low and it’s not an attractive FDI destination. Can you fix one without fixing the other? 

FDI in Sri Lanka has been hovering around 1% of GDP with most of these in construction. For example, transport and logistics are off-limits for investment in Sri Lanka. I don’t understand why. But this is one of the areas of high potential. 

The other is creating a single window not only for FDIs but for all investors and Sri Lankan exporters and importers so that all documents can be processed and permits obtained through one window. That also removes many of the layers and potential misuse of power. This is consistent with what this current government wants to do. 

The Economic Transformation Act does provide a foundation for many of these elements. It is about boosting competitiveness, simplifying the cost of doing business and creating institutions to facilitate this. For example, the Board of Investment, which is mandated to encourage investments has only 1% of its staff working on facilitating investments. The remaining 99% work on some form of regulations, production zones, and so on. It’s a very skewed incentive scheme. Those are a few examples of specific things that can be done quickly and have a massive effect. 

Sri Lanka’s government revenue is low. Recently, tax revenue was the equivalent of 8% of GDP. That ratio has risen somewhat now. However, it remains around half the level as in those countries in a similar state of development. You’re talking about removing trade barriers and that would lower government revenue. How can this help when we are already a low-government-revenue country? 

Sri Lanka has a social protection system mimicking Nordic countries and a taxation system of Hong Kong which is one of the lowest in the world. The tax-to-GDP ratio used to be 7% during the crisis and is up to 13% now. Most countries, even in the region, will be closer to 20% and that’s where Sri Lanka needs to be.  

Sri Lanka has been very proud of its health and education achievements, and rightly so, but it needs significant funding to continue. Eliminating the special exemptions given to both foreign and local companies and addressing the tax administration, can generate between 3% to 5% of taxes per GDP. This also includes the administration of the customs. Encouraging trade will generate more revenue through direct and indirect taxation. Increasing indirect taxes like VAT is not a solution because they penalize the poor more than the rich. Instead, a progressive system of taxation, fixing income taxes and asset declarations, ensuring the rich pay their fair share is best.

Widening the tax net has been the objective of every administration for decades.  Why do you think we have failed at this? 

It’s easier said than done. Political will is 80% of that solution. The independence and strength of revenue agencies are also crucial. The Economic Transformation Act calls for the strengthening or creation of some of these institutions. We supported strengthening the Central Bank’s legislation to help it avoid failure of the government and the functioning of the banking sector in the future to minimize risks of 2022. I think those are the two main elements and if they come together then you can make a major advancement in that area.

You said Sri Lanka’s economy has stabilized, but the path to recovery is long and fairly narrow. Hopefully, Sri Lanka will strike a deal with its commercial creditors soon to restructure its debt. Assuming we are no longer in default, what changes do we need for the longer term, on top of the short-term changes that have already been made?

A big part is about growth and policies around growth. Entering into free trade agreements with several countries will be very beneficial given Sri Lanka’s unique location and potential. We will still have many people remaining poor for a while. In the last few years, we have seen poverty more than doubling from 11% pre-crisis to 26%. Every fourth Sri Lankan is poor and millions are a stroke away from poverty. In our projection in the best-case scenario, poverty will be at 20% for several years. It’s important to make sure that these policies support and protect these people through a robust social protection system and much more efficient and well-targeted socialist assistance. 

There are so many social protection programmes that often administration costs can be as high as what is actually distributed. We believe that cash transfer is one of the most effective ways because it allows people to prioritize what they need. We have a lot of other programmes and the fertilizer programme is one of the most expensive. I think it requires a lot of attention in terms of better targeting. Again, we’re very keen to support you. 

The second block of things in the medium term that needs to be addressed is education, vocational training and higher education, and how it all comes together. The third part is the governance of which a big part is SOE (state-owned enterprise) reforms. Unfortunately, SOEs have been part of the problem and to some extent even contributed to the crisis for several reasons. Lack of transparency, and the fact that many of them were loss-making and state-owned banks were often probably pressured or encouraged to finance these losses. As a result, they have accumulated a lot of debt that is hard to recover and they may not have been providing the services to the population that one would expect. 

Usually, when we go to a supermarket to get milk, we don’t want one brand, we want multiple brands. That goes for everything, even a service. We want competition. I think there is great potential to introduce more competition in these areas.

Competitive and transparent procurement is absolutely essential. It’s a level playing field for businesses to participate in and benefits everyone. Going back to this government’s manifesto, digital government is a part of it and is an essential part of improving governance. 

Strengthening and empowering anti-corruption institutions will be another important element.  So, in the medium term, these are the three big blocks of priorities that will help the country to walk through that narrow path we talked of, avoid repeating the same mistakes, and more importantly, create shared prosperity for its people. People have all the right to demand it, and this country has all the potential to deliver it. 

Previously over 80 SOEs engaged in commercial activities were identified. Among them were Sri Lankan Airlines, Sri Lanka Telecom and several government-owned hotels. It was the policy then to sell these assets to private investors. From the World Bank’s point of view, what should the government do with these commercial SOEs?

I don’t think the World Bank has a one-size-fits-all solution. The reason why prioritization is often good is the ability to mobilize both expertise and financing. In Sri Lanka, the fiscal space is very limited. Taxation is small, about 13%, needs to increase, and there are so many programmes like social protection and infrastructure that need to be funded. The government cannot be expected to finance all of these. Where does the money come from? It has to come from the market. 

In theory, you can have very efficient SOEs that are able to raise money from the market. It’s difficult, but it is one way to go. There are several other models of bringing the private sector in. One doesn’t need to privatise. One can go into concessional arrangements. That means that while the asset remains with the government it is managed and invested in by a private sector entity. There are several other ways, but again, we will engage with the government and see how we can help. SOE reforms are essential and different SOEs will require different approaches. There may be multiple solutions for each of them, but the bottom line is efficiency needs to be improved, and governance, transparency, and the ability to operate as fully commercial entities is critical. 

Sri Lanka has tried on several occasions, to set up holding companies to help manage these SOEs and shield them from the pressures that come from various actors who are associated with the government. We don’t seem to have succeeded. And if you look at the last crisis, electricity, petroleum, and the national airlines’ losses contributed significantly to the weakening of the state balance sheet. 

What is the definition of insanity? Doing the same thing and expecting different results. 

Success will come from political will. You can actually try a solution, but if you research properly and then implement the impact can be powerful. Sri Lanka’s cost of electricity is one of the highest in the region, and it doesn’t have to be because it has huge potential for renewable energy, but it has not had much competition in the sector. 

What most people don’t know is that you spent several years in Sri Lanka working in the electricity sector. Sri Lanka now has a new law that unbundles the Ceylon Electricity Board. There is also an independent regulator in place. What is necessary for success and to give lower electricity prices to consumers?  

I had the privilege of managing our energy programme for Sri Lanka between 2008 and 2012. That’s when I fell in love with Sri Lanka. I travelled throughout the country because that’s where we were supporting the small and micro hydro industry for solar and wind investments. 

So, it’s a very exciting moment, in a way, that now we have this electricity Act with a clear timeline on how to implement and what to do. And unbundling, or separating the functions into generation, transmission and distribution will bring transparency and create competition between generation companies even if they are state-owned, and create the ability for the regulator to have a benchmark when comparing services provided by distribution companies. It also brings competition for human resources and talent. The Act has many other important provisions. It’s a pathway to opening the market in a phased way. It also has provisions for transparent procurement; mandating that all new procurement of generation be done in a competitive way. We are very keen to support the government and have had discussions with the Ministry of Power on how we can help the government move in that direction. 

Some large-scale projects, including for renewable energy haven’t been procured competitively. Should Sri Lanka re-look at some of the decisions that have been made in particular? 

I know for sure moving forward, doing it in a competitive way, will yield the benefits of low costs and high-quality services. I don’t have enough knowledge of past procurements. I understand that they are now being subject to some scrutiny, and some of them may or may not go through. Based on my three months in Sri Lanka, I don’t have enough knowledge to say whether or not any of this should continue. I believe that there will be due process. 

By the way, you mentioned the ‘regulator’. This Act also empowers the regulator and makes it much stronger. The role of the regulator is critical because it is a balancing power to protect the interests of both consumers and investors. And finding the right balance and depoliticizing the sector is a very complex thing and the role of the regulator is to also partially do that. From my experience in other countries, if you have a market, then the regulator plays a much more effective role unlike regulating one giant entity which is much harder. 

Can you give us some background on what the World Bank has done to support Sri Lanka in the last few years?

I’m very proud of what my colleagues here have done and I cannot claim any credit for it. We restructured our existing portfolio. We had about $3 billion and we immediately channelled a significant chunk of it to support the purchase of fuel, food, medicine and fertilizer. This was one big part of what we have been doing. The other was immediately engaging with the government to support stabilization efforts,  bringing in some of the expertise for advising. There was also significant funding to stabilize the budget.

We also helped to look at how poor and vulnerable people could be protected by better targeting and distribution of funding, cash transfers, and so on, helping to strengthen the social benefit system, and then focusing on areas that can start generating growth. We’ve started looking at some of these areas and investments. We are discussing a climate-smart agriculture programme that also allows the private sector to add value in agri-processing while discussing the potential of scaling up renewable energy investments.  

The World Bank just disbursed a $200 million budget support loan. Money which the government can use for everyday expenses approved in the budget. That follows up on a previous $500 million loan for budget support.

It was a package of several tranches. This was $200 million and I believe $300 million before.  We’ve supported government reforms like the Electricity Act, the Economic Transformation Act, the improvement of tax administration, and debt management all being part of it. How it works is, that when these policies are implemented, against them we disburse funding into the general budget, which is then used to cover expenditures.

Sri Lanka, as you said, is still heading towards recovery. So, it’s conceivable that we may still require some support from multilateral lenders like the World Bank. Should Sri Lanka require that support, is it imperative that we have an active IMF programme in place for a multilateral lender like the World Bank to give budget support?

The budget support, in the current environment, is packaged.

So there has to be a corresponding IMF agreement in place?

In the current environment, yes. But we do have other support regardless of any programmes. But I see a seemingly strong commitment to continue with the IMF programme and there are many benefits because a lot of the ideas in the programme are homegrown. As the Chinese proverb goes, every crisis is an opportunity. 

There’s been a delay in the review for the next tranche of the IMF programme, due to elections and the delay in submitting a budget. But there’s a good two years to run on this IMF programme. Should Sri Lanka run with the IMF programme for the next two years to unlock the potential aid from the World Bank?

The government is actively engaged with the IMF and I’m not privy to these discussions, so I’ll let them respond to this question. I think there are many benefits from continuing the path of the reforms that are part of that programme. There are also financial benefits and financial inflows in the environment where access to markets is limited.

If Sri Lanka is going to have a difficult time funding the budget deficit over the next few years, it’ll require grant or loan assistance from the World Bank and other multilateral agencies. You said we had a set of prior actions that now Sri Lanka has completed to unlock $500 million recently for budget assistance. You highlighted those prior actions. What areas do you feel Sri Lanka’s economy can benefit the most from with reforms that will then result in the World Bank coming forward with further budget assistance? 

When we prepared our strategy called Country Partnership Framework, it was done in 2023 and it is a four-year strategy. The plan was that for 18 months the focus would be on stabilizing the economy. It has been fairly successfully completed in a time frame that not many expected. 

The second phase is, assuming that stabilization happens, we support sustainable green growth and this is very much where we are right now. We now have new leadership and we’ll have a new government after the parliamentary elections. So, this is a very good time for us to discuss the next phase of the strategy. In the coming months, we’ll be engaging with the government to discuss the priorities that they’d like us to support. 

They have a multitude of areas they want to move forward and many of them in the economic area resonate with us. We’ve covered several of them, value-added agriculture, sustainable tourism and renewable energy – they have a 2 Gigawatt target within four years of added capacity to the electricity grid. Then the whole governance and anti-corruption infrastructure, competitiveness, and SOE reforms are all areas that we are very keen to support. What are the instruments? It depends. It can be a combination of investments and budget support but it’s important to keep in mind that these funds are limited now that the country has reverse graduated to the special concessional window called the International Development Association (IDA). That means more concessional funding, but this funding is also relatively limited. Using these funds in a smart way to support the right policies, improve revenue collection, grow the pie, and encourage private investments, is how we make an impact, not just by our money that can do relatively little for the very ambitious plans that the government has or the public expects.

If you look at World Bank support over the last 10 years, has the Bank given significantly more support during the crisis than it had on trend in the past, even when Sri Lanka had access to both IBRD and IDA?

It definitely disbursed money immediately, providing much more money than in the past, and especially under very concessional terms. Usually, our projects take several years to plan, procure, and so on, but here we moved very quickly with massive disbursements to help stabilize the economy and help minimize the pain people were enduring. Of course, it still is very, very painful and many of them continue enduring it.

Sometimes people feel there is nothing in the reforms that benefit them and they are critical about the trickle-down economics. Once you change something the benefits will somehow trickle down to everybody in the economy. What would you say to somebody who is sceptical about the reform programme and its ability to help the 26% of Sri Lankans who are below the poverty line?

Trickle-down economics has a formal definition. I don’t know if this is the one you are using. It is usually about providing tax benefits to big businesses thinking that trickles down. I am not a big supporter of trickle-down economics and I don’t think many economists are. This might be more of a sort of vested interest theory because that trickling down is not necessarily happening all the time. 

On a broader note, people have every right to be sceptical and impatient. Their experience, in a way, allows them to be so. Yes, they have seen stabilization but the quality of life for many hasn’t improved. It’s not even at pre-crisis levels. Many of the policies have been put in place, but implementation is still ahead of us. I would advise the leadership to focus on things that can be delivered quickly. Some will be costly, but there are areas like eliminating some of the loopholes, the tax exemptions, tax administration, and e-government, and moving quickly with some of the important investments like renewable energy, which can help reduce costs at a fairly rapid pace. Implementation of these policies, and implementation is more important than the policy itself in a way because there have been so many policies that were never implemented. So, that is the focus, and that’s when people will start seeing and feeling it.