• Short-sighted decisions, structural problems pushed SL into deep crisis
• Authorities delayed approaching IMF until well past the 11th hour
• Rapid deterioration in food security among Sri Lankan citizens
• 41% of households spending more than 75% of money on food
• People cutting down on medicine and education to be able to afford food
• Human capital flight common during times of economic crises
• Interim budget should cut down all ‘non-essential’ expenditure
• Govt. must not be hostile and unresponsive to people’s demands
• Important to establish a robust social safety net programme

By Marianne David Short-sighted decisions coupled with Sri Lanka’s structural problems pushed the country into a deep crisis, said Economist Rehana Thowfeek. “Despite the dangers posed to the economy, the Government, its officials, and advisors decided not to seek an IMF intervention until well past the 11th hour. These short-sighted decisions, coupled with our structural problems, have sent us into deep crisis – and the worst part is that much of this could have been avoided,” she asserted, in an interview with The Sunday Morning. Now, as Sri Lanka finds itself sitting on a ledge, she emphasised that we do not have to wait for an International Monetary Fund (IMF) programme to undertake vital economic reforms to reset the country’s trajectory, outlining steps that should be taken now. Thowfeek also noted that the ongoing crises had resulted in food inflation reaching a record high in Sri Lanka, leading to a rapid deterioration in food security among citizens. In terms of navigating out of this crisis, Thowfeek said that while an IMF programme would outline the macroeconomic plan for Sri Lanka to follow, the reforms programme was more important. However, in the backdrop of the ongoing crackdown on dissent by the State, she warned that it would be difficult to get the people’s buy-in on a reform programme if the Government was seen as hostile and unresponsive to people’s demands. Following are excerpts of the interview: Sri Lanka finds itself staring down the barrel of a gun on the economic front. What were the key policy decisions that led the economy into such dire straits? There are two ways to understand what happened. First, we must understand that Sri Lanka’s economy has long-term structural problems that have not been fixed. As a result, for several decades we ran on twin deficits – a budget deficit and a current account deficit – taking on debt to pay for these deficits. So fundamentally, we were sitting on a ledge.  Second, the policy decisions made within the past two years before Sri Lanka announced its default really tipped us over that ledge. The tax cuts of 2019, which caused a loss of Rs. 600 billion to the Government, signalled to international observers that we were abandoning the path of fiscal consolidation we had undertaken during the 2016 IMF programme. We failed to complete the IMF programme we undertook in 2016 as a result and lost out some funds which we were meant to get. Sri Lanka was downgraded in the international finance markets and locked out of borrowing further internationally. To finance the massive fiscal deficit (Rs. 1.6 trillion in 2020 and Rs. 2 trillion in 2021), the Central Bank stepped in. Broad money supply, which measures the amount of money in circulation, expanded by approximately 40% within these two years, despite production slowdowns from Covid. Moreover, the Government decided to keep servicing foreign debt, even though foreign reserves were plunging, tourism earnings were down, and Sri Lanka was still recovering from Covid. It also fixed the exchange rate and we ended up losing about $ 1.6 billion of worker remittances inflows. Low interest rates were enforced despite the expansion in money supply, putting a lot of pressure on the rupee. Despite the dangers this posed to the economy, the Government, its officials, and advisors decided not to seek out an IMF intervention until well past the 11th hour. These short-sighted decisions, coupled with our structural problems, have sent us into a deep crisis, and the worst part is that much of this could have been avoided. What immediate course correction measures are needed to keep that gun from going off? What would an ideal economic reform package look like? We don’t have to wait till the IMF programme comes to undertake some of the economic reforms needed to reset Sri Lanka’s trajectory. The newly-appointed Government is supposed to present an interim budget soon, which I hope will address some of the immediate measures that need to be undertaken. Firstly, the matter of tax revenues needs to be addressed to ease the pressure on the need to borrow and print money to meet Government expenses. Sri Lanka’s tax revenues are abysmal and is one of the main reasons we are in this mess. In the last two years, we had one of the world’s lowest tax-GDP ratios. We need major tax reforms for a more equitable and progressive tax system.  Second, we need to look at Government expenditure and a main aspect of that is reforming our State-Owned Enterprises (SOEs). An assessment of these SOEs, their economic role, the rationale for their existence, and cost-efficiency needs to be done for such decisions to be made. Reforming SOEs can come in different ways: market liberalisation and introducing competition, divestiture, privatisation or even closing down non-viable ones. There is no one-size-fits-all solution.  The Government also somehow needs to find the fiscal space, albeit in a limited pool of resources, to help the poor and vulnerable citizens to face the crisis. Then we need to start thinking seriously about trade liberalisation. Sri Lanka is a highly-protectionist country; this has led to a misallocation of resources towards protected industries and created powerful vested interest business groups. However, to become a truly export-oriented economy so that we can eventually achieve a balance of payments surplus, we cannot be afraid of international competition. Investments need to be made in infrastructure and people, while education and labour market reforms need to be undertaken to increase the production of export goods and services. Therefore, an ideal reform package should address the immediate and longer-term strategies to correct Sri Lanka’s two fundamental structural problems. Food prices are at record highs, amid skyrocketing food inflation. What is the impact this has had on the average Sri Lankan citizen; how has it affected their lives in terms of meals and wellbeing? Food inflation is at a record high, 58% nationally and 80% in the Colombo District. A recent food security survey by the World Food Programme (WFP) in Sri Lanka found that 61% of households in Sri Lanka are using food coping mechanisms to deal with the rising cost of food; that means they are reducing the amount they eat either in portion sizes or in the number of meals and consuming cheaper, less nutritious alternatives. There are reports of people consuming just one meal a day at times.  Malnutrition was a pervasive problem in the country before the crisis as well. About 35% of women of reproductive age were anaemic, about 16% of newborns had a low birth weight, and about 21% of children below the age of five were underweight. So you can imagine the impact that the rising unaffordability of basic food items will have on these health outcomes.  This survey also found that just 10% of Sri Lankan households were ‘food secure’; in 2009 a similar assessment found that 88% of households were food secure. There is a rapid deterioration in food security among Sri Lankan citizens.  Malnutrition affects people well into their later lives, even children’s educational outcomes. It is a cycle and unfortunately will be much worse now. At the very least we need an immediate and adequate cash transfer programme for the poor and vulnerable groups to help them bridge the gap between their incomes and the rising cost of living.  What are people prioritising in terms of spending as purchasing power falls, in which areas are they making sacrifices, and what kind of an impact will this have on society? Earlier the understanding was that people would spend about 30-50% of their household income on food and the rest on other expenses like education, transport, recreation, etc. But the WFP assessment found that 41% of households are now spending more than 75% of their money on food alone. This is higher in the estate sector (60% of households). People are cutting down on other expenses like medicine and education just to be able to afford food.  We are already seeing the impacts; for example, many people are migrating from Sri Lanka as they do not see a future for them and their children in the country. Then we are also seeing the impacts of inadequate nutrition, both among adults and children, which can increase susceptibility to illnesses.  Despite comments to the contrary by the President, it looks like an IMF programme will take several more months to materialise. Until then, how should Sri Lanka navigate the ongoing crises to ensure survival? While a finalised IMF programme will take time, as we have to first conclude the debt restructuring negotiations with our creditors, a staff-level agreement with the IMF will come sooner.  A staff-level agreement essentially means that IMF technical staff and Sri Lankan officials agree on the macroeconomic plan that has to be implemented. Once this agreement is reached, it will signal to other nations that there is now an acceptable economic plan for Sri Lanka. This will help Sri Lanka secure bridge financing – that is, funds to run the country in the foreseeable future from friendly nations. It is essential that the Government works towards finalising this agreement and boosting international confidence in Sri Lanka. Will an IMF programme alone be enough given the magnitude of the crisis in Sri Lanka? An IMF programme is important because it will outline the macroeconomic plan for Sri Lanka to follow; the reforms programme is more important than the direct financial support that will come from the IMF. Additionally, an IMF programme will also boost international confidence in Sri Lanka; it will help us get access to bridge financing and access back into international capital markets to help us tide things over.  However, the reforms programme is the most important part of the deal. Sri Lanka must implement deep, structural, and sometimes radical reforms to reset our economy. We have been to the IMF 16 times before and we are going for the 17th time with a default under our belt. I am afraid that if we do not undertake these reforms properly and instead do a shoddy job of it, or worse, reverse course once things settle down a bit (which is what we usually do), then undoubtedly, we will be back for an 18th IMF programme too. How should we deal with our debt – not only in terms of debt restructuring, but also in terms of avoiding making the same mistakes repeatedly? I think we must restore independence to Sri Lankan institutions so that decisions like how much to borrow and what to spend it on are made with technical consultations and not merely with political influence and ambition. There is nothing wrong with borrowing, but it is important to borrow sustainably and prudently, and to invest these borrowed funds into areas which give an actual return to the country.  For example, we should not be using borrowed funds to repeatedly meet the Government’s recurring expenses like salaries or use these funds to build an airport that no one wants to use.  We should be investing in public transport, education, health, and other infrastructure that is really needed in the country. What are the areas the upcoming budget should focus on and prioritise? Definitely the most important thing is taxes. I think the plan is to try to bring it up to the level that it was in 2019, which is good for a start, but it should not stop there. In 2019 too we had the same structural problems as we do now, so addressing the fiscal deficit in the long run is vital and that means implementing tax reforms to widen the tax base and increase tax revenues. As this is a ‘crisis budget,’ cutting Government expenditure is also important. Some argue that the Government does not spend a lot; I agree that it does not spend a lot overall, but if we look at where the Government has been spending its money, there is a lot of expenditure on maintaining the status quo and maintaining highly-inefficient Government institutions and SOEs. The interim budget should aim to cut down all ‘non-essential’ expenditure, which can include some recurrent expenditure as well as most capital expenditure planned.  It is important to use the limited funds the Government has to provide social assistance to people, especially the poor and vulnerable who are severely affected by the ongoing crisis. In addition, the budget must focus on how it will implement any reforms that the Government hopes to take.  The ongoing crackdown on protesters has led to a climate of fear, which is worsening daily amid reports of bodies washing up, arbitrary arrests, and shootings. How will this impact Sri Lanka's recovery? Will people support austerity measures amid such conditions? I think it will be difficult to get people’s buy-in on a reform programme if the Government is seen as hostile and unresponsive to people’s demands. The reforms will be tough, because it is about fundamentally changing the existing systems in the country, so there can be some pushback even in the best case scenario. It is important for the Government to communicate to the people what the reforms programme is, why these reforms are needed, and how it will impact their lives.  I also think it is important to pace out reforms. For example, the fuel price adjustment was very abrupt and the knock-on impacts, such as the impact on food prices, were severe. It is difficult for people to adjust so rapidly. In some instances, reforms should be paced out to smoothen the transition. But I think, for the most part, people understood why the fuel price adjustment was needed. There will be varying and competing opinions and interests from the private sector, trade unions, the public, etc., but it is important to do what is best for the overall economy and more importantly to communicate it to everyone. Amid job losses and the rising cost of living, increasing numbers of people are looking to leave Sri Lanka, leading to a massive brain drain. The impact has been especially visible in the IT industry, a key forex earner for Sri Lanka. What are your thoughts on this exodus? Unfortunately, brain drains are not something new to Sri Lanka. We have had multiple waves of migration and we are experiencing another one now. Many highly-skilled workers like IT workers are extremely disillusioned with the state of the country. It is understandable that people do not want to live in uncertain and unstable economic conditions. Everyone has experienced a breakdown in their standards of living and will therefore look for greener pastures. This kind of human capital flight is common during times of economic crises. In Lebanon for example, the Port of Beirut blast amidst its economic collapse saw the outmigration of 1,000 health professionals. Human capital flight is detrimental to economic recovery, especially as it is the young and skilled workers or those who can contribute to the economy through taxation or by setting up new export businesses, for example, who are most keen on leaving. A recent survey found that 30% of those aged 18-29 years had made plans to migrate. Sri Lanka is an ageing society, so we really need young people to stick around, but it is increasingly difficult to ask them to do this given that their economic aspirations cannot be met.  For lower skilled workers, it is worrying because they may be seeking out highly-precarious job opportunities abroad that can put their safety and health at risk. They might also be leaving behind young children or aged parents, which has its own negative impacts. Sadly, they might even prefer these dangerous jobs over staying in Sri Lanka because of the extreme economic difficulties.  As we look towards reforms and recovery, how can we ensure the protection of the most vulnerable segments of society? As part of medium- to long-term reforms, we need to seriously look at establishing a robust social safety net programme.  There is a misconception in Sri Lanka that social assistance is for the poor or that it is a ‘handout’ and as a result the existing social assistance programmes are poorly designed, inadequately funded, poorly targeted, and politicised. But social safety is meant for everyone; in advanced societies, social assistance programmes cater to all contingencies in life: illness, unemployment, disability, maternity, old age, etc. They are meant to ensure that everyone has a minimum income protection at every stage of their lives.  I think such a programme is very important for Sri Lanka in the long term. During Covid we saw how people lost their jobs and found it difficult to get by, so the Government responded with ad hoc cash transfer programmes – this is not an adequate social safety net response. We need the systems in place. Sri Lanka does not have a pensions programme except for civil servants; there is no unemployment benefits programme; and social assistance to disabled persons and other vulnerable groups is done on an ad hoc basis. Even the civil pension scheme is very costly and non-contributory, so Sri Lanka really cannot afford to keep this pensions programme going the way it is. Reforming these is important. A social safety net programme that is funded through taxes and contributions is essential to protect Sri Lankans and is also a vital component of economic development.