• Sri Lanka needs ‘adjustment with a human face’ as it recovers
• Two-pronged domestic policy approach needed alongside IMF bailout
• Need consensus on a 10-year vision for national economic development
• Large loss-making SOEs need to be transparently disinvested
• SL must closer align its foreign relations with its economic policy

While the signs of a recovery are encouraging and things have improved in 2024 compared to the dark crisis days – with inflation falling to single digits, useable foreign reserves building up to about $ 3 billion, the exchange rate appreciating, and moderate growth being possible – Sri Lanka is not out of the woods yet, said Economist Dr. Ganeshan Wignaraja, in an interview with The Sunday Morning.

However, he emphasised that the projected growth of 1.5-2% in 2024 was insufficient for reducing the high poverty levels today and paying off the external debt.

“A two-pronged domestic policy approach is needed for Sri Lanka alongside an International Monetary Fund (IMF) bailout. To put it simply, Sri Lanka needs ‘adjustment with a human face’. The two policy objectives to guide economic policy under this heading are: (1) earn much more foreign exchange than in the past and (2) reduce poverty. Public patience is needed for these policies to show results as it could take Sri Lanka a decade to come out of this crisis,” he explained.

To continue on the road to economic recovery, Dr. Wignaraja stressed on the need for consensus on a 10-year vision for national economic development for Sri Lanka being reached among political parties, businesses, trade unions, and civil society.

He also pointed out that exploiting the economic dynamism of a globally-rising India may be a pragmatic foreign relations choice for Sri Lanka. “Growing at 6-8% per year and with a large middle class of consumers, India is the new magnet for foreign investment from the West and East Asia. It would be unfortunate if Sri Lanka, growing at only 1-2% in 2024, misses the ‘Indian growth boat,’” he warned. 

Following are excerpts of the interview:

It’s been two years since Sri Lanka defaulted on its debt. How do you assess the journey since then?

The year 2022 was probably the worst moment in Sri Lanka’s history from an economic point of view. The country defaulted on its foreign debt of over $ 50 billion. There was only some $ 20 million in foreign reserves at the Central Bank of Sri Lanka, which is just a couple of hours of import capacity, and there followed a terrible economic crisis, with inflation spiralling to 70% (September 2022) and some 5.8 million people falling into poverty at $ 3.65 a day.

This crisis was brought about by a combination of Covid-19 hitting an economy that was already weak, reeling from the legacy of a 30-year civil war, high public expenditure well more than revenue generation, investment in infrastructure projects by China – many with low rates of economic return such as the Mattala Airport, and economic mismanagement by the previous regime under then President Gotabaya Rajapaksa. 

This combination of factors was quite toxic and the economy collapsed. 

Following Gotabaya Rajapaksa’s resignation, the new Government formed in mid-2022 under President Ranil Wickremesinghe acted decisively. It jacked up interest rates to control inflation, removed some of the subsidies on petroleum and opened the petroleum market to foreign suppliers, concluded an IMF bailout of $ 3 billion, and attracted Indian aid worth $ 4 billion. Thus, the recovery is due to policy, supported by international assistance. 

Things have improved in 2024 compared to the dark crisis days: inflation has fallen to single digits, useable foreign reserves have built up to about $ 3 billion, the exchange rate has appreciated to around Rs. 300 to a dollar, and moderate growth is possible.

In 2022 the economy had negative growth of -7.8% and today, in 2024, 1.5-2% is possible. 

While the signs of a recovery are encouraging, Sri Lanka is not out of the woods yet. For instance, a steep rise in poverty and child malnutrition is creating untold social misery. The foreign debt must be restructured and eventually repaid. Sri Lanka’s international reputation as an inward investment destination has been tarnished. 

How do you view the current status quo, in the backdrop of Sri Lanka rejecting the bondholders’ proposal to restructure debt, which would also impact continuity of the IMF programme?

During sovereign debt restructuring negotiations like Sri Lanka, one attempts to balance the interests of the official creditors, which includes China and India, and private holders of international sovereign bonds. 

Private bondholders are required to take a haircut, which means they take a reduction of outstanding interest payments or a portion of a bond payable that will not be repaid. That’s the issue: they lose money. The details are sketchy as debt restructuring talks with private bondholders have occurred behind closed doors.

Media reports suggest that proposals discussed include Macro-Linked Bonds (MLBs) and Governance-Linked Bonds (GLBs), which tie the repayment terms to Sri Lanka’s growth performance and better governance (such as anti-corruption measures). Differences in views about Sri Lanka’s outlook for reforms, the reluctance of bondholders to lose money, and political uncertainty have led to a stalemate in the talks. 

Why it matters is that the third tranche of the IMF money is partly dependent on showing tangible progress in debt restructuring talks and an IMF programme review is due in June. The IMF’s good housekeeping approval is necessary to attract foreign investment, foster business confidence, and to begin to grow. This is where things stand.

What approach should Sri Lanka adopt in order to ensure recovery and make its foreign debt sustainable?

Although controversial, the IMF programme has been supportive of the nascent economic recovery in 2024 and must be continued after the Presidential Elections. However, projected growth of 1-2% in 2024 is insufficient for reducing the high poverty levels of today and paying off the external debt. 

A two-pronged domestic policy approach is needed for Sri Lanka alongside an IMF bailout. Put simply, Sri Lanka needs ‘adjustment with a human face’. The two policy objectives to guide economic policy under this heading are: (1) earn much more foreign exchange than in the past and (2) reduce poverty. Public patience is needed for these policies to show results as it could take Sri Lanka a decade to come out of this crisis. 

Achieving (1), means making the economy more friendly to tourism inflows, remittances, exports, and foreign investment. Prudent macroeconomic management is fundamental and involves controlling inflation, shifting available Government spending towards growth-enhancing activities, and ensuring that the banking system is robust. 

Large loss-making State-Owned Enterprises (SOEs) also need to be transparently disinvested as making them commercially viable has proven difficult. Cumbersome red tape hampering business and citizens must be cut and procedures significantly digitised. Corruption vulnerabilities need attention as they raise costs to the economy and deter investors. 

Food security is a priority for (2) and involves growing more food, importing cheap food, and improved food distribution to reduce post-harvest losses. Education, health, and social protection schemes should be better targeted to the poorest in a fair and transparent manner. 

What does this mean for Sri Lanka’s foreign relations?

Sri Lanka must closer align its foreign relations with its economic policy to foster recovery. Another debated area is the costs and benefits of closer ties with neighbouring India to increase Sri Lanka’s inward Foreign Direct Investment (FDI), tourists, and trade. 

Exploiting the economic dynamism of a globally-rising India may be a pragmatic foreign relations choice for Sri Lanka. Growing at 6-8% per year and with a large middle class of consumers, India is the new magnet for foreign investment from the West and East Asia. It would be unfortunate if Sri Lanka, growing at only 1-2% in 2024, misses the ‘Indian growth boat’. 

Located just a few miles off our northern coast, Sri Lanka could benefit from FDI, tourism, and trade spillovers from India. Proactive tourism promotion, joint ventures with Indian firms, more Business-to-Business (B-to-B) exchanges, and concluding a deep bilateral trade deal are some steps. 

It is also worth recalling that Indian aid acted as a lifeline to the defaulted Sri Lankan economy, enabling it to import food and fuel in 2022, while other countries were arguably less forthcoming in providing bilateral aid to Sri Lanka. 

Speaking to The Sunday Morning mid-last year, you warned that experimentation with economic policy at this crucial juncture could result in a ‘lost development decade’ in Sri Lanka. With elections looming and divisive campaigns underway, this is a very real threat. How can it be addressed?

To continue on the road to economic recovery, a consensus on a 10-year vision for national economic development for Sri Lanka should be reached among political parties, businesses, trade unions, and civil society. Think tanks and the media can facilitate frank discussions on the merits of alternative recovery policies in uncertain global economic times. 

Areas of agreement should be codified into a national economic development vision document for the next decade outlining: 1) economic development achievements and failures; 2) realistic economic development targets; 3) an outward-oriented, market-friendly policy agenda; and 4) risks to implementation. 

To raise public awareness of the national vision for economic development, outreach activities should be conducted. The success stories of Singapore, South Korea, Malaysia, and the UAE provide lessons in preparing and implementing such national visions.

As things stand, how likely is Sri Lanka to meet its targets and receive the third tranche of the IMF programme?

I think the third IMF tranche will be granted subject to some discussion behind the scenes on Sri Lanka’s mixed progress towards IMF programme targets, but there could be a lot more scrutiny on such targets to release future IMF tranches, particularly for a new administration.

As Presidential Elections are scheduled for late 2024, I do not think anyone would want to add to the election-related political uncertainty facing the Sri Lankan economy. Thus, IMF Board approval for the third tranche to Sri Lanka is likely, conditional on improvements and reforms in revenue administration, customs, and other things, as well as some progress on privatisation.