• Says Govt. must improve revenue raising alongside revisiting tax structure
• Calls for the reduction of unproductive State expenditure

Sri Lanka needs to move quickly to reduce wasteful State expenditure and take robust measures to enhance its exports to make the most of the current economic climate which has improved to a moderate standing, says former Director for Development Economics and Chief Economist for the Middle East, Africa, and South Asia at the World Bank Prof. Shantayanan Devarajan.

Speaking to The Sunday Morning on Sri Lanka’s current economic climate and how the new Government needs to navigate the complex situation the country is facing, Prof. Devarajan, who is currently Professor of the Practice of International Development at Georgetown University’s Edmund A. Walsh School of Foreign Service, said three priorities needed to be met, and quickly, to sustain growth and ensure debt sustainability. 

He advocates greater trade openness, increasing tax revenues and its administration to enable greater public investment and social spending, and reforming public expenditures by reducing unproductive expenditure and waste.

Following are excerpts from the interview:

What is your take on the current economic climate of Sri Lanka? 

The current economic climate is moderately favourable. The country has seen positive economic growth for three consecutive quarters. Inflation is in the low single digits. Reserves are rising and exceeding targets. 

I say ‘moderately’ because the economic growth has to be a lot higher to restore incomes from the deep recession of 2022-’23, especially for the poor who have suffered immensely, and to ensure that Sri Lanka’s debt is sustainable.

The World Bank projected a higher growth rate for Sri Lanka. Now that the nation has elected a new President, do you think that with the country’s new economic path, it will be able to sustain the growth projected by the WB?

It will depend on the policies that the new Government undertakes. The most important of these is greater trade openness, so that Sri Lankan entrepreneurs can compete in world markets without the handicap of trade protection. 

To boost exports, they need to get imports without restrictions. When Sri Lanka did this back in the late 1970s, the economy boomed, and unemployment fell to below 4%. Over the past 15 years, there have been increasing trade restrictions and the trade ratio (exports plus imports divided by GDP) has been falling. 

In addition, these trade restrictions lead to corruption; the Customs Department is one of the two Government agencies that, in the International Monetary Fund’s (IMF) words, have the least integrity. 

The second set of policies have to do with increasing tax revenues to enable greater public investment and social spending. Sri Lanka’s tax-to-GDP ratio is around 9%, which is still too low (it used to be 20%). Improving tax administration (a large number of statutory taxes go uncollected), a tax on wealth, and taxing foreign investors are all ways of increasing tax revenues without burdening the poor. 

Finally, Sri Lanka needs to reform public expenditures by reducing unproductive expenditures such as some loss-making State-Owned Enterprises (SOEs) – SriLankan Airlines being the most prominent) – as well as making public expenditures more pro-poor by replacing fuel and energy subsidies (most of which go to the rich) with targeted cash transfers. 

President Anura Kumara Dissanayake and the Caretaker Government have informed the IMF that they wish to revisit the tax structure and explore providing more welfare support to the public. Do you think that, given where Sri Lanka is today in terms of its economy and earning, such changes are feasible? And can it be done within the parameters of the Extended Fund Facility (EFF)?

Yes, there are reforms to the tax structure that could reduce the burden on the poor and middle class while keeping revenues constant. Improving tax administration, a wealth tax, and taxing foreign investment, as mentioned earlier, are three examples. 

Reducing unproductive or pro-rich expenditures, such as fuel and energy subsidies and loss-making SOEs, are other ways of making fiscal policy more pro-poor while keeping the fiscal surplus constant.

The new Government has signalled that it is diverging from the agreed SOE reforms agenda. How will that impact Sri Lanka’s economy and is it a wise move?

It is possible to restructure the SOEs differently from the way that the previous Government proposed and achieve favourable results. The key point is that some restructuring is necessary. The status quo is not desirable.

The Dissanayake Government has introduced new welfare relief measures and plans to expand the social safety net. Can such measures be implemented in a sustainable manner – especially given that Sri Lanka has not met its revenue targets yet?

A lot can be done to better target the social safety net at the poor. The most recent estimate of ‘Samurdhi’ was that it reached only 40% of the poor (and 16% of the non-poor). I am sure we can do better than that. 

What is important is to ensure that the new programme, ‘Aswesuma,’ does not get politically captured, as its predecessor was. A transparent and simple eligibility criterion and the use of electronic transfers makes this more likely. 

How do you think the IMF will view the welfare system and tax structure being revisited by the Government in relation to the agreed outcomes of the EFF? 

My view is that revisions to the welfare system and tax structure that are pro-poor while maintaining the fiscal surplus are worth pursuing.

How will Sri Lanka’s economy be impacted if the country fails to meet the parameters of the EFF? 

If the country fails to meet the parameters by a large margin, the review will be delayed, as will the disbursement of the latest tranche of the loan. More importantly, it will be a loss of confidence by the investor community, who are anxious to see the programme succeed so they can resume investing in Sri Lanka.

How a continued negotiation with the IMF over proposed changes wanted by the new Government impact the nation’s debt restructuring programme?

The IMF has already determined that the debt restructuring agreement between Sri Lanka and its official and private creditors is consistent with the macroeconomic targets that Sri Lanka met at the last review. 

Most of the negotiations with the IMF now are over structural measures, including some governance reforms, that are unlikely to affect the contours of the debt restructuring programme. These governance reforms are, however, important for the sustainability of Sri Lanka’s debt in the future (i.e. to avoid another debt crisis).

How do you think the new Government’s messaging will impact investor and creditor confidence? 

I think the message of respecting the broad parameters of the IMF-financed EFF while trying to make changes to better protect poor people will be seen positively by investors and creditors. Having the support of the poor and middle class is crucial for the programme to succeed.

What is the best path Sri Lanka should follow in its ongoing economic recovery?

The best path is one that is geared towards accelerating economic growth and a critical first step is opening the economy to foreign trade. The second step is increasing tax revenues by taxing the wealthy (and lowering taxes on the poor) and reforming pro-rich public expenditures such as fuel and energy subsidies and loss-making SOEs.

Finally, Sri Lanka needs to reform the agricultural sector, which for too long has been keeping poor farmers poor. One way is to reform the Paddy Lands Act and allow farmers to grow any crop that they wish rather than constraining them to grow paddy, which is the least productive and least lucrative crop.