• People don’t have trust in system across the board
• Hard policy reforms need people’s support
• Set up framework for debt restructuring soon
• Need external support to survive till IMF agreement
• Move fast on budgetary reforms with interim budget
• Budget deficit resolution has to be primarily tax driven
• Focus on apparel, tourism, IT/BPO, value-added agri 

By Marianne David Sri Lanka is facing a complete collapse in people’s trust and confidence in the system across the board, asserts Economist Chayu Damsinghe, noting that “as long as people don’t have confidence in the economy and systems functioning properly, even external support is difficult to achieve”. “A system that people don’t trust is not one in which hard policy reforms can be put in place. Therefore, an absolutely critical step that the Government needs to take is to restore confidence,” he emphasised, in an interview with The Sunday Morning. Pointing out that Sri Lanka’s economy is currently in a “terrible place” with the crisis created by a series of bad policy decisions over the past few years and exacerbated by a delay in taking remedial action, Damsinghe said the country was possibly going through the most acute phase of the crisis right now – with shortages, galloping inflation, and the start of job losses. “After the current situation clears, which might be a few more months, things should start a pathway towards recovery. However, there will still be lots of pain on the ground and recovering from the bottom is still going to be very, very difficult,” he added, speaking in his personal capacity, not reflecting the views or thoughts of Frontier Research, where he is currently Product Head – Macroeconomic and Thematic Research. In the course of the interview, Damsinghe also spoke on where things stand with the International Monetary Fund (IMF), engaging with bilateral and multilateral partners, debt restructuring, the tax regime, the importance of focusing on export-oriented sectors Sri Lanka is already good at, and the ‘People’s Struggle’. Following are excerpts of the interview: Prime Minister Ranil Wickremesinghe, who took up the position nearly two months ago warning of tough times, now says Sri Lanka’s economy has completely collapsed. How do you view the state of the economy right now? Where do things stand and what can we hope for? Sri Lanka’s economy is definitely in a very terrible place – the crisis that was created by a series of bad policy decisions over the past few years and exacerbated by a delay in taking remedial action has really taken the country to a very tight spot. We’re likely going through the most acute phase of the crisis now, with shortages, galloping inflation, and the start of job losses as well. The direction of the economy getting bad was likely set in motion a few months ago with bad policy actions continuing, and, scary as it is, it’s quite possible that if the policy reversals that started in March were delayed even further, things would be far, far worse. However, that is not to say that the policy changes taken were all perfectly handled – there are still a lot of delays. From here on, what Sri Lanka needs to do is to speed up action as much as possible, and remove any barriers that cause these delays. After the current situation clears, which might be a few more months, things should start a pathway towards recovery. However, there will still be lots of pain on the ground and recovering from the bottom is still going to be very, very difficult. Where do things stand with the IMF right now? Prime Minister Wickremesinghe told Parliament on Tuesday (5) that discussions with the IMF had ended successfully and the next step was to submit a report on debt restructuring. How do you view this? How long will it take before we see a return to some semblance of normalcy? That sounds about right. The IMF negotiations at this stage are less to do with ‘negotiating’ what Sri Lanka should/shouldn’t do, since it’s clear to all that what we need to do is reverse the bad policy that got us here. What is holding things up is likely the fact that our debt is ‘unsustainable’ and the IMF cannot financially support us in that background. In order to move forward, Sri Lanka likely needs to show progress towards fixing this, which would be first on starting the debt restructuring negotiations, so setting up a framework for restructuring is a key first step here, and second on moving with budgetary reforms with an interim budget. The sooner we can have these two implemented, the sooner we can move forward on a deal with the IMF, though it might require more progress to actually get a deal finalised and receive money from the IMF. Afterwards, as more money gets unlocked from other sources as well, Sri Lanka should then be able to start its journey towards recovery. Given what we have gone through, it is likely that Sri Lanka will be significantly poorer as a country compared to a few years ago, but the recovery path should hopefully put us in line towards a more sustainable growth path in the future. Given Sri Lanka’s crisis situation, many delegations have been in town over the last few weeks, including a high-level IMF team, a team of top Government officials from India, and a high-level US delegation, while China has also been making overtures. How do you view all this and what are the outcomes we can hope for? Sri Lanka engaging with our bilateral and multilateral partners is absolutely critical right now. As mentioned earlier, getting an IMF agreement will take time and therefore Sri Lanka definitely needs external support to survive the months until then. Hopefully these negotiations will bring about actual results and financial support in the short term and anything reasonable needed to get these across is implemented as well. Amid its reaching out to the international community, the Government has also initiated a dialogue with Russia to get cheap fuel and fertiliser supplies. How do you view this turn to Russia? Is it in our best interest? Sri Lanka needs whatever support we can get. I’m not convinced we can get a lot of support from Russia, since the foreign currency liquidity issue affects Sri Lanka regardless of what country we deal with. From what I know, there are also supply chain difficulties in getting a significant amount of refined petroleum from Russia directly and our refinery doesn’t really have the capacity to refine enough crude to meet Sri Lanka’s needs. Therefore, I think the overall size of support we can expect from Russia is quite small, given that it also has issues accessing international financial networks given sanctions. As long as we don’t try to directly evade specific sanctions, I don’t think merely buying oil or getting support will affect us negatively – but this is something that I’m not a real expert on. What are your expectations of the interim budget due in August and the National Budget due in November? And is Sri Lanka to just bumble along till August, hoping for more handouts and credit lines? The interim budget is far too late, it should have already been passed in Parliament. Interim budgets are short-term measures and all the revenue and expenditure measures expected in such are already available in some form or the other, so the delay in actually passing the budget is worrying. One possible reason is that the Finance Minister is not confident that Parliament will actually pass the budget – which could explain the delay. The interim budget will anyway not affect our USD inflows directly, but be a crucial step in our IMF process. The 2023 Budget will be more important for longer-term stability and what that looks like will be an essential part of what forms the basis for discussions with creditors as well, since it will show Sri Lanka’s path towards a primary surplus in the budget (revenue exceeding expenses due for the year, excluding interest payments), which is a key part of Sri Lanka’s debt sustainability. What steps should the Government take immediately to ensure some form of stability, in the backdrop of endless queues, school closures, rising shortages, and reports of violence – especially by armed forces against the people? What has worked elsewhere that you think will work here? What are the lessons we can take and apply locally? Once the economy has barrelled down to this level, there’s little that local authorities can do, in my view. Specific shortages might be cleared out by resorting to specific action, but an overall quick resolution very much depends on external support. Therefore, what a government should critically do is whatever that allows for that external support to flow in. However, another key issue that Sri Lanka faces is a complete collapse in people’s trust and confidence in the system. We see this across the board – from fuel queues not working properly and Parliament having an impression of not functioning properly, to corruption at high levels and black markets popping up. As long as people don’t have confidence in the economy and systems functioning properly, even external support is difficult to achieve – since a system that people don’t trust is not one in which hard policy reforms can be put in place. Therefore, an absolutely critical step that the Government needs to take is to restore confidence. If this requires a change in governance, a change in the political structure, an election – whatever choice it requires needs to be taken, in my view, as it will become increasingly difficult to enact any policy measures or get any external support without public buy-in for these reforms. Given that we actually have no money, how should Sri Lanka approach its debt restructuring and how can we eventually bridge our budget deficit? Our debt restructuring negotiations are anyway likely to drag on for a while and expecting a quick resolution of that is overoptimistic, I believe. Within this, what we should try to avoid as much as possible are actions that are more harmful than helpful for the debt situation as well as the local situation. For example, restructuring Treasury bills and bonds might not help debt at all if it requires the Government to issue new debt to stabilise the local financial system. Our budget deficit resolution has to be primarily tax driven. Sri Lanka’s tax ratio is absolutely terrible and among the worst in the world (the worst if we exclude countries with oil/commodity revenue and those with different tax collection structures). How bad our tax numbers are cannot be overstated and if I were to point to one reason why Sri Lanka is where it is, it would be our abysmal taxes. One problem with the tax issue being so bad is that meaningful results will take time. My view is that we shouldn’t try to cut expenditure in harsh ways, but rather look at areas where expenditure is completely irrational and deal with it in those areas only; in other areas, just limit the rise in expenditure for the future. The main reason I’m opposed to massive expenditure cuts is because first, Sri Lanka’s expenditure isn’t very high compared to peers, and second, in that context I think the social costs (given that we don’t have unemployment schemes, retraining schemes, or social mobility schemes) are worse than the benefits (which are only short term – since the low tax issue will mean the problem remains even with expenditure cuts). What are the key industries you think will help Sri Lanka’s recovery and how should the State assist? I think there’s a misconception that industrial growth can help Sri Lanka on its own. For a country without a lot of natural raw material resources, any industrial growth will mean imports have to grow – and Sri Lanka doesn’t have a large enough population for domestic consumption alone to incentivise better products. Also, why bother improving your product if the Government is protecting your business after all and the market is too small for competition? If you look at countries where this approach works, it went hand-in-hand with massive social costs – in the West during the Industrial Revolution this meant absolutely terrible working conditions to the point of exploitation and in the East like in China/South Korea, etc., the ‘sweatshop’ environment as well as forced poverty of people were key elements of this. In any case, Government support requires massive taxation to have enough money to actually invest in things, otherwise it just leads to huge corruption and cronyism. What I think Sri Lanka should focus on is things Sri Lanka is already good at. Apparel, tourism, IT/BPO, value-added agriculture – these are all things Sri Lanka already has a market and an advantage in, along with the potential to grow massively, and incorporate the existing workforce into it. It feels a no-brainer that these profitable and export-oriented sectors should be focused on. Where the Government comes in is in two places, in my view. First, to make the investment and business environment in Sri Lanka actually attractive to new entrants. Sri Lanka is notoriously bureaucratic and corruption is a constant in the system, so acting to remove or at least reduce this will help businesses move into these sectors. Second, to create a proper social welfare system that both protects workers and those left behind by the system (for example, creating a publicly-funded unemployment insurance scheme rather than hope that companies always act out of the goodness of their hearts) and to encourage movement and training between industries so that more people can actually move into these high-growth sectors. Amidst all of the ongoing shortages and sacrifices, how should the poorest be protected? What are the most practical and immediate steps the Government should take on behalf of the most vulnerable? Social safety nets are critical and an absolute essential part of recovery. In fact, it is a condition that the IMF has consistently mentioned that Sri Lanka needs to improve drastically on in recent reports. I would argue it’s better to be overgenerous with this now and clean up later, rather than be too careful and end up missing people. Of course it takes time, so we’ll have to start with the systems we have, but it is essential to expand these as soon as possible and deal with the mistakes within these. What we should definitely avoid are measures that seem to help people in the short term but massively hurt them beyond that; for example, printing money to give fuel subsidies, which gives short-term cheap fuel, but massive inflation that harms the poor terribly beyond the short term. What are your thoughts on the ‘Aragalaya’ or ‘People’s Struggle’? In many countries that have gone through this sort of crisis in the past, there have been mass people-led protest movements, which have often been a key reason that pressure was put on political structures to change track. Sri Lanka’s seems to be the same and given that a key issue in Sri Lanka’s crisis is a complete collapse of confidence in systems, I feel that the mass protests have an important role to play to force a political structural change that will result in restoring confidence.