• Can see some stabilisation of economy and some economic recovery
• Key 2024 challenges are debt restructuring, ensuring growth, elections
• Long-term challenges are migration and impact on health and education
• Impact on education, health, savings, debt, overall aspects concerning
• Key now is how to protect poor and vulnerable and where we will head
• Difficult to achieve fast recovery when you’re in a post-default situation
• As difficult and unpopular as they sound, tax increases were necessary
• Sri Lanka yet to sufficiently develop capacity of tax collection agencies

Key challenges in the coming year will include finalising Sri Lanka’s debt restructuring, ensuring growth, and the national elections, while the two biggest long-term challenges are migration and the impact on health and education, said Economist Umesh Moramudali, in an interview with The Sunday Morning. 

Looking back at 2023, he said that while there had been some stabilisation of the economy and some economic recovery, there were concerns as well, especially in terms of how the crisis had affected the people, particularly the poor and vulnerable. 

“It’s not merely about the drop of income and the subsequent social effects, but also the impact on education, health, savings, debt, and overall aspects, which is concerning. But the economy is certainly in a better position compared to 2022,” added Moramudali, who is a Lecturer at the Department of Economics, University of Colombo.

Commenting on taxes, which have been the talk of the town in the face of the upcoming Value-Added Tax (VAT) hike, Moramudali noted that although the tax burden was not fairly distributed at present – with a largely indirect tax based system – there were other issues at play: “First, we have a very small population that falls under the high income bracket. Second, you are trying to tax an economy which is heavily based on the informal sector. Third, there is a chunk of people who earn but don’t pay enough taxes. Fourth, there were many tax exemptions given to companies.” 

In the course of the interview, he also spoke on the upcoming elections, protecting the people, and his hope for Sri Lanka as we enter a new year.

Following are excerpts of the interview:

At the end of 2023, how would you assess the country’s overall economic performance?

You can see some stabilisation of the economy and some economic recovery, but we still also see concerns – for example, how the crisis has affected the people, particularly the poor and vulnerable. It’s not merely about the drop of income and the subsequent social effects, but also the impact on education, health, savings, debt, and overall aspects, which is concerning. But the economy is certainly in a better position compared to 2022. 

While there has been some recovery where you can carry out businesses and engage in day-to-day economic activity, it does not mean that everything was okay during the year. The key now is how to protect the poor and vulnerable and where we will head now. There are still unresolved issues in the economy and there is uncertainty in terms of debt restructuring and other laws and taxes, etc.

What more do you think could have been done in 2023 to ensure economic recovery?

It’s very difficult to achieve a fast recovery when you’re in a post-default situation. There can be different opinions, but the reality is that it is difficult. I wouldn’t expect a big recovery soon after declaring a sovereign default and while implementing a series of economic reforms. 

The key in 2023 has been making sure that you get the International Monetary Fund (IMF) money to come in and then, thanks to that, get the other multilaterals to send money. It’s more about surviving. There were very limited options in 2023 in terms of growth. Growth was not the key and I don’t think it should be the key factor either. When you are trying to carry out reforms and recover, you need to address the structural issues first. 

However, there is a catch. When you have such a low growth or negative growth, which means contraction of the economy, it affects the poor and vulnerable the most. As a result of economic contraction, poverty rates have risen, people have lost jobs, students are struggling to go to school, and there is no medicine in hospitals. Therefore, protecting such segments of society is key during a time of economic reforms. I don’t think it was done to a sufficient degree in 2023. Paying more attention to how the welfare schemes work should have been done better.

We had ‘Aswesuma’ and there was a push from the IMF and World Bank as well to do that, but I would have liked to see more enthusiasm from the Government’s end to make it work better. It doesn’t mean that I expect a perfect welfare system or a perfect social management system to fall out of thin air after the crisis, but I feel it could have been done better and that the Government should have given it a little more priority and attention. 

The Government should own the social protection reforms. It shouldn’t be about merely fulfilling the conditions of the IMF or pleasing other multilateral donors such as the World Bank or the Asian Development Bank (ADB) for the time being. They are just there to provide support and it is the Government’s job to ensure that the poor and vulnerable are protected. 

Other things, as difficult and unpopular as they sound – for example, the tax increases – were necessary. How such increases were done could have been better. For example, tax slabs on income tax and upcoming VAT changes could have done differently.

Do you feel that the tax burden is fairly distributed?

Not currently. We have a largely indirect tax based system, where a large chunk of tax revenue comes from indirect taxes. But it is important to understand that a shift is also difficult in a country like Sri Lanka. That doesn’t mean it is fair to increase taxes through indirect tax increases such as VAT.

First, we have a very small population that falls under the high income bracket. That’s why you see the middle class and the professionals protesting that it is difficult for them to pay taxes and so on. They seem to think that they don’t really belong to the top 20% or 10%. The reality is that a large number of people don’t earn much and they cannot be taxed via direct means and as for those who earn, when you tax them, it’s difficult to squeeze them too much. As I mentioned earlier, new tax slabs have put a lot of pressure on professional groups. 

Second, you are trying to tax an economy which is heavily based on the informal sector. Therefore, you need to have many more mechanisms to capture the informal economy into the tax net, which isn’t easy. You cannot do this in a month or two and it is more of a long-term approach. Provided it is done correctly, you could get better distribution of the tax burden.

Third, there is a chunk of people who earn but don’t pay enough taxes – wealthy individuals or businesspersons who evade taxes using different ways and means. We now see some measures being taken to get them into the tax net – for example, if you buy land or own a vehicle, you have to open a tax file. They are trying to get more people to open tax files and are making it compulsory, which is a good thing. But this has to go beyond, to investigate and collect taxes from the ‘big fish’.

Fourth, there were many tax exemptions given to companies. For example, through the Strategic Development Projects (SDP) Act, tax exemptions were given to many companies based on the whims of those who were in power. These concessions resulted in the reduction of potential tax revenue. Remember that companies pay tax on profit, thus they do not need to pay taxes if they don’t make profit, so giving such tax exemptions must be stopped. 

Regarding overall issues pertaining to taxation in Sri Lanka, including fairness, there are two underlying factors. One is the political connection to the elite, be it businesses or individuals or trade unions. That is a political question to answer. Second is the issue of capacity in tax collection. Sri Lanka has not sufficiently developed the capacity of the tax collection agencies to expand the tax nets and or increase tax collection. 

If I specifically refer to the capacity of the Inland Revenue Department (IRD), I don’t think that has received enough attention. If you see the countries that have developed good tax systems or increased tax collection, particularly direct tax collection, that takes effort. That comes with increasing the capacity of the IRD and making sure you have a strong pool of public servants who are compensated enough to do a thorough job of tax collection. That is an immediate reform that needs to be done.

Currently you don’t see that much fairness, but we saw some measures towards increasing direct tax collection in 2023. The proposed VAT increase slightly changes this direction. The reason for increasing VAT is because it’s easier and it brings a lot of businesses into the tax net. It’s a lot easier than collecting income taxes.

In my opinion, this measure also boils down to the capacity problem. If we don’t invest enough in capacity and make sure we have a pool of resources to ensure smooth tax collection, we are going to fall into the trap of having to rely on VAT, which is neither a good thing nor a sustainable thing. 

What are the key economic challenges you see in the coming year?

In the coming year we will first have to look at how to finalise the debt restructuring, for which I think the bilaterals will come first. It’s not a very straightforward process – when you look at Zambia, the commercial creditors’ proposals were rejected by the bilaterals; in the case of Sri Lanka also, the initial proposals from commercial creditors were rejected. Finalising this is going to be the first hurdle.

Secondly, now we are in an era where we need some growth. How do you ensure growth and from which sectors? That is also important to make sure that people’s income will increase. 

Thirdly, the biggest challenge is that we will have elections. In an election year, how will the economy reshape or change with a potential government change or amidst an election? Who will promise what? What policy changes will be brought? How will this affect the debt restructuring process and the IMF programme? 

Some parties have already claimed that they will renegotiate the IMF agreement; how will that go? That’s the biggest challenge to the economy and we have to work with that uncertainty but there seems to be common consensus that the IMF programme is important.

When you look at the larger picture, the two biggest long-term challenges are migration and the impact on health and education, which really put pressure on the economy’s human capital. Where are you going to find the people to drive the growth? Human capital is a key element. If we don’t put enough into the health and education systems, that raises questions about our future human capital and labour force. 

Now that elections have been announced, do you think that the current Government will have the will to see through the necessary economic reforms or will there be election promises that impact economic stability?

It’s a tough question, because it raises many questions on what we refer to as the ‘current Government’. We see former President Mahinda Rajapaksa saying that ‘we want to be in government,’ which leads to the question of who is in the Government – are we referring to President Ranil Wickremesinghe and a few of his allies as the Government?

It seems to me that the President is keen on carrying on with the reforms. Despite the elections, it also depends on what political plans he has and whether he wants to have the legacy of taking the country out of the economic crisis by carrying out the unpopular reforms. At the moment it seems like he is committed to that, which is why you see even the VAT changes that are coming in. 

However, you also see Mahinda Rajapaksa saying that taxes are too high and that taxes will be reduced under his government. What does he mean by his government when it is his party’s people who voted for these changes?

I think the President is committed to the reforms, one reason being that he wasn’t really elected as the president and is keen on carrying out the reforms and owning the reforms. However, how the Sri Lanka Podujana Peramuna (SLPP) behaves on some of this is quite unclear to me. A lot depends on how SLPP parliamentarians vote in Parliament. 

How long do you think the people will have to face burden upon burden? At which point in the future can they expect any relief?

It’s a difficult question to answer because a lot depends on what policy measures we take. If you make too many policy blunders, it could lead to another default. People could have disagreements on what form of a default we are talking about, but it could lead to another default or another economic crisis. It all depends on the policy measures. It is a difficult thing to see and a difficult thing to hear but for the foreseeable future, things will be difficult. 

For people to feel better, their income has to go up or the cost of living has to come down. I don’t see income rising substantially. There will be small increases – for example, you will see a Rs. 10,000 increase for public servants in April and then some increments for the private sector – but these won’t really compensate for the price increases we have experienced. 

I don’t see the cost of living coming down either, with prices of goods and services dropping. There is a very important distinction to make between inflation and price levels. We will have lower inflation – maybe 9-10% or maybe even less depending on the VAT impact – but price levels will still be high.

For people to feel better and have an easier way to live, they would ideally like to see a reduction of prices – say for a packet of milk, for rice, for most essential items. The reduction of price levels is called deflation; for prices to drop, you will have to have negative inflation and that is very difficult. 

How are people going to make it? That’s where programmes like ‘Aswesuma’ are very important. Such programmes ensure the protection of the poor and vulnerable, particularly at times like this. They may not have jobs, or those jobs may not be stable or provide a sufficient income. Identifying those who are in need and providing them with sufficient monetary support is very important.

As we welcome a new year tomorrow, what is your hope for Sri Lanka?

I hope that the debt restructuring will be finalised very soon and that we will see some investments and foreign inflows coming in so that the economy will be further stabilised. 

I hope that the Government will have the wisdom to invest more in building State capacity to ensure that we are able to face challenges. 

I hope that whatever the election manifestos or results will be, there won’t be too much deviation from the recovery. 

I hope that a large chunk of the population will be protected while carrying out reforms and that they don’t suffer through something like what we experienced in 2022. Towards that end, I hope that issues relating to ‘Aswesuma’ will be fixed to protect the poor, which should be treated as a priority.