Sri Lanka Brief
FeaturesChange economic policies drastically and urgently

Change economic policies drastically and urgently


The six and a half decades since independence have been characterised by economists as one of missed opportunities. The end of the war in 2009 was considered another opportunity for an economic resurgence. As in the past, the four years since the war ended has proved to be another missed opportunity: an initial expectation turning sour.
Premachandra Athukorala, professor of economics at the Arndt-Corden Department of Economics, College of Asia and the Pacific, Australian National University, made an analytical assessment of Sri Lanka’s economic performance.
He demonstrated the need for change in economic policies to cope with the global challenges when delivering the Prof. S. Gunasekera Memorial Oration at the University of Peradeniya on Friday. He said Sri Lanka must change its economic policies drastically and urgently to cope with the huge development challenges.

“The end of the ethnic conflict in Sri Lanka in 2009 generated widespread expectations of a period of sustained economic growth, building on the achievements of the liberalisation reforms sustained over three previous decades. However, recent developments have dampened that optimism, rekindling fears that Sri Lanka’s tale of missed opportunities may continue,” is a succinct synthesis of Prof. Athukorala’s analytical paper amply supported by statistical analysis, policy pronouncements and the unfolding experience.

Return to failed policies

Prof. Athukorala demonstrated that the economic performance over the past decade indicated a return to the failed past policies of inward-oriented development strategies. These policies, he said “do not offer viable solutions for the problems confronting Sri Lanka — a small, capital-and resource-poor country — in today’s globalised world.”

Sri Lanka, he emphasised, must change its economic policies drastically and urgently to cope with the huge development challenges. “It would be a tragedy if Sri Lanka were to forget the bitter lessons of the past. It is no longer the pioneering liberalising country of the late 1970s. It is now forced to compete for foreign investment and export markets with the giant labour rich economies of China and India, as well as with countries such as Vietnam and Bangladesh.”

He reminded us that Sri Lanka “faces a global economy that is in deeper trouble than at any time since the 1930s. In these difficult circumstances, there is no longer room anymore for using the state as the ‘employer of last resort”. The country must face up to these hard realities to prevent a slide into economic deceleration.

Economic statistics are often falsely interpreted to paint a rosy picture of the country’s economic performance. Such interpretations lead to complacency and inaction and are stumbling blocks to corrective action. One such statistic bandied about is the doubling of per capita income. Despite economists pointing out the fallacy of this due to the “money illusion”, the country’s economic performance is interpreted as a spectacular achievement as it has doubled per capita income in a short period.

Prof. Athukorala pointed out that “the doubling of per capita income in current US$ terms during this period partly reflects domestic inflation and artificial stability of the exchange rate of the Sri Lankan rupee against the dollar. When the data are expressed in real (2000) prices in order to allow for these factors, the increase in per capita income in 2010 (US$ 1240) was only 30% higher than that in 2004 (US$ 959)”.

Similarly, the causal factors for the decline in employment are ignored. Prof. Athukorala said that “the decline in the unemployment rate was partly due to an increase in public sector recruitments and increase in overseas employment of Sri Lankans. In a dramatic reversal of the contraction in the size of the public sector workforce maintained over the previous decade, total employment in the public sector increased from around 900,000 (11.1% of the total labour force) in 2005 to over 1.2 million (14.%) in 2012 (Ministry of Finance 2013).”

“Over the past ten years (2002-2012)”, he said “on average a quarter of a million Sri Lankans have been leaving annually for overseas employment, with the number increasing every year. The total number that left during 2008-2012 was 1307 thousands, up from 1078 thousands during the previous five years (Ministry of Finance 2013). A tentative estimate suggests that the total stock of Sri Lankan overseas contract migrant workers had reached 2 million by 2011, amounting to over 14% of the total working-age population of the country”.

External payments

The external finances position continues to be characterised as favourable. The facts, however, do not warrant much optimism. “The external payments position of the country has deteriorated over the past three years. The trade deficit, which had come down 7.4% of GDP in 2009 from over 10% during the previous five years, increased to a historical high of 15.8% in 2013. Exports as a share of GDP declined from 30% in 2004 to 17% in 2010, while imports continued around 35% of GDP. In 2012, total imports were double the size of export earnings. Limited trade restrictions were not sufficiently effective to address the widening current account deficit even in the short term.” Despite these glaring facts, the public are told that the external finances are strong.

The adequacy of the country’s external reserves is a controversial issue. Prof. Athukorala points out: “By 2012, total gross official foreign reserves (US$ 8.6 billion) were adequate to cover 5.4 months of imports. However, according to the IMF estimates net reserves (after netting out short-term borrowings from gross reserves) amounted to only 4.1 billion or 2.6 import months.

 He makes the pertinent point that “import-month equivalent is not an appropriate indicator of reserve adequacy given that the country has now integrated into global capital markets through foreign borrowing…..What is required is to assess the reserve levels in relation to the volume of short-term foreign-currency liabilities…. reserves as a percentage of the volume of accumulated short-term debt is by far the most appropriate indicator of reserve adequacy.”

This measure, which he calls the reserve adequacy index (RAI), has declined from 143.5 per cent in 2010 to 85 per cent in 2012, when gross reserves are used as the reserves are measured in gross terms. When the IMF figures of net reserves are used in the calculation, the comparable figure for 2012 is just 41%; the end-of-year reserves in 2012 was adequate to cover only 41% of the existing volume of accumulated short-term foreign debt (‘volatile capital’). Several unsatisfactory indicators in external finances and public finances clearly show the weaknesses in the economy.

Main thrust

The main thrust of Prof. Athukorala’s oration was that the market-oriented policy reforms initiated in 1977 led to far-reaching changes in the structure and performance of the Sri Lankan economy. He emphasised that what has been achieved in Sri Lanka under liberalisation reforms occurred while the civil war persisted for much of the period. “In addition to its direct debilitating effect of political risk on investor perception, the civil war constrained capturing the full benefits of economic opening through delays and inconsistencies in the implementation of reform process and macroeconomic instability emanating from massive war financing.”

“In this context, the Sri Lankan experience can be explained as the outcome of trade liberalisation that increased the potential returns to investments, which apitalize on the country’s comparative advantage. Despite political risk and policy uncertainty, rapid export growth was consistent with this policy configuration as it ensured a handsome profit in labour intensive export production, which is usually characterised by a short payback period in a labour abundant economy. Interestingly, the Sri Lankan experience over the past three decades has clearly demonstrated that an outward-oriented policy regime can yield a superior development outcome compared to a closed-economy regime, even under severe strains of political and macroeconomic instability.”

Recent policies

Prof. Athukorala points out that: “Viewed against this backdrop, recent developments in the Sri Lankan policy scene do not augur well for the future of the Sri Lankan economy. After showing remarkable resilience during decades of war and conflict the Sri Lankan economy has failed to capitalise on the window of opportunity presented by the end of the military conflict. Sri Lanka’s tale of missed opportunities continues.”

The oration was a comprehensive analysis of the country’s performance that should be read by the country’s policy makers and all those interested in an authoritative assessment of the economy.

They must heed his advice that: ” Sri Lanka can benefit from continuing growth in the Asian region, only if it can articulate and implement a development strategy that enables it to leverage its comparative advantages, attract investments and participate in international production networks to generate productive mass employment. Policies based on the past paradigm of inward oriented, state-centred and directed economic development offer no viable long term solution to the huge challenges facing Sri Lanka or other small, capital and resource poor countries.”

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