How SL can survive the upcoming recession and come out stronger: A 2-year to-do list

Sri Lanka and the world are facing an unprecedented crisis. We are all pushed to a corner to rethink the adequacy of our border control, public health, economic and social safety policies as we know them. 

The pharmaceutical and healthcare sectors which prioritised efficiency above all were left unprepared to meet the demands of a pandemic of this magnitude, and have now pushed the world populace to the confines of their homes to buy time and soften the blow. 

It is difficult, and frankly, unfair to criticise the Sri Lankan Government’s approach so far to handle this crisis. An unprecedented crisis requires unprecedented extremes of intervention; and for the most part, the government has actively taken measures to curb its spread. 

There is much debate and commentary on the trade-off between suppression and mitigation and comparisons to countries like South Korea, Singapore, and Taiwan who were able to mitigate the pandemic to a large extent without resorting to a complete shutdown. However, those countries were equipped with the infrastructure necessary to identify and isolate the problem early through mass testing and contact tracing that allowed them to not have to resort to levels of suppression seen in Sri Lanka and some of its regional friends. 

Sri Lanka pursuing a mitigation strategy would have led to many more deaths; the Government has made the right call choosing a suppression strategy instead. What they do next to isolate the virus through aggressive testing will play a crucial role in making sure the lockdown pays off. It’s time to set political divides aside and work together; because, after the rain of this pandemic, we need to braise ourselves for a much bigger, harsher storm. 

The looming recession is unavoidable. America, our largest export buyer, has been hit the hardest- the death toll is skyrocketing and the dow has been plummeting- and is equipped with a worst-case scenario for a President to guide them through this crisis. When the American market crashes, it causes a domino effect on the world financial markets; even the strongest economies get injured and the weakest ones get gobbled up. 

There’s speculation that the pandemic could lead to the November (US) elections getting postponed; Trump, like FDR, may stay on for longer. When the pandemic finally subsides and the recession blows through the world, unlike in 2009, we may not have an Obama to come and bail out the financial sector and save the world economy from crashing further down. 

It cannot be stressed enough just how much of a walk in the park the 2008 Great Financial Crisis (GFC) will be made to feel like when compared to the recession ahead of us. 

In past financial crises, central banks across the world developed a time-tested tool kit to rescue national economies. With countries overcoming the pandemic at different speeds, it is unlikely that efforts to address this recession will be as coordinated as the GFC; even as I write this, there is no sign of any G20 or ASEAN intervention. 

The nation-state is very much back; each country is left to defend itself. Unlike with the GFC, stimulus design for a recession triggered by a pandemic will be much more complicated; its impact will be felt on many different segments of the economy, not just a few key sectors. 

Also, again, unlike in the GFC, this recession will be complemented with a major behavioral change in consumers, even those with incomes not directly impacted by the recession will minimise exercising their purchasing power on certain luxuries (travel, personal care services, cosmetic medical expenses like dental care, etc.) for personal safety. Sri Lanka’s tourism industry will take a much bigger hit than it took in 2008 or 2019. 

Global Foreign Direct Investment is on track to decline by 40% this year. Falling oil prices in the global market will mean that the local energy consumer will benefit and the oil import bill will be lighter. But let’s not forget that foreign remittances to Sri Lanka cover about one-third of our BOP’s exports; a crash in oil-producing economies could also mean job losses for major foreign currency earners in Sri Lanka. 

Data points to the worst slump since the second world war. In a best-case scenario: this will hopefully bottom-up by mid-year and have a v-shaped bounce back recovery, but a more likely scenario is a u-shaped slump with a slow fallout and a slow recovery. 

What should the Sri Lankan Government do to prepare for this financial crisis? This article will discuss how we can cushion our economy in the lead up to the recession, and help our markets remain productive and our vulnerable remain protected during the slump of the recession.

April 2020

There are a couple of things we need to do with immediate effect (within one to two weeks) to 1) stop further depreciation of the currency, and 2) prevent a possible famine. 

First among them, is to halt both printing money/buying treasury bonds and further lowering of policy rates. Total overnight market liquidity jumped to Rs. 118 billion on 3 April from Rs. 58 billion just a week earlier (27 March). This sort of helicopter drop liquidity shocks can hurt us more than help. It further depreciates our currency, making dire essentials of the moment such as medical imports much more expensive, increasing our debt to GDP ratio and BOP deficit. 

Moreover, lowering policy rates is causing investors to pull out. Quantitative easing as a means to finance deficit spending is causing a serious blurring of the line between fiscal and monetary policies. As a nation preparing to face a recession, it is important to minimise unhealthy fiscal dominance of monetary policy. (Any future support from the IMF, will likely come with its previously bowtied string of a Monetary Law Act. This is a good thing; it will force on to us the economic discipline we need to get through the next few years.)

While halting further liquidation will minimise further exacerbation of the current debt crisis, without a serious intervention it will not subside. Bilateral currency swaps (with India, China and perhaps even Japan), and a generous bailout package from multilateral creditors will need to be negotiated. 

As severe as the debt crisis is, it is invisible to citizens. In the meantime, a more visible crisis is boiling to a simmer; a logistics failure is about to lead to a massive food shortage across the country: domestic consumption/food security must be restored by redirecting supply chains. The Government must work with the logistics industry to create a dashboard of warehouse stocks and distribution channels to ensure that industrial supply chains are redirected to households/consumers. The dashboard can allow the State to monitor supply flow and ensure that essentials are circulating in all parts of the country. If done right, this alone can save us from a looming famine and stabilise consumption levels to a good extent. 

May-August 2020

In the short term (one to three months) we need to cushion our economy for looming shocks by focusing on getting the market to work, restructuring and expanding social safety nets, and sharpening the data tools we need to map our way through the recession. 

Also, this is the time to do everything in our power to salvage and expedite the MCC grant; a $480 million investment in the next five years will be a godsend. 

It is important that the nonessential import ban is revisited. If the blanket ban on nonessential imports is replaced with a selective ban, giving clearance to HS codes that bring down raw material for export and domestic industries, the economic activity levels could be restored to an extent. As the debt crisis stabilises, it is vital to completely phase out the import ban. While BOP stabilisation is important, we cannot forget that consumption is the main driver of GDP. Restoring consumption levels is equally (if not more) important in the economic cushioning process. If people are unable to leave their homes, we must expedite the process of bringing the market to them. 

Instead of imposing excessive controls, it is healthy to empower and facilitate market competition, removing barriers, holding players accountable for anti-competitive practices, and creating room for market pricing. Lowered interest rates may help new players in the market. In the months leading to the slump, improved productivity levels can provide a much denser cushion than a fiscal stimulus package.

Of course, this is easier said than done and we cannot simply hope for productivity levels to catch up; and even if they do, it won’t be enough. ILO estimates the post-pandemic recession could cost the world up to 25 million jobs globally (compared to GFC’s 22million). Underemployment will rise much more. Sri Lanka’s apparel industry with a workforce of nearly one million, depends on the US, UK, and Italy as their top three buyers; all three have been badly affected by the pandemic. There are already reports of order cancelations without liabilities. 

Mass layoffs will be inevitable. There are two approaches a Government can take when addressing unemployment; one is to use tax relief and other incentives to convince employers to hold on to their workers. The other is to allow labor markets to adjust naturally and provide unemployment benefits to those who lose jobs. Any stimulus package design will have to find the right balance of a combination between these two approaches.

Taxing the incomes of the rich and redistributing wealth is important for the economic health of a country in general and can be a massive lifeboat in an economic crisis such as the one we are expecting. The helicopter drop liquidity injections discussed above are being made to offset the shrinking tax revenue caused by the aggressive slowdown of economic activities in the past few weeks, and the slashing of VAT, PAYE taxes in the fiscal stimulus package given out earlier this year. 

From Q3, (i.e. July 2020) it would be helpful to reinstate the pre-2020 PAYE taxation scheme which applies to those earning above 100,000 per month (unlike the current band that applies to those making over 250,000 per month). A substantial amount of tax revenue could be accumulated just by making this simple change. As this revenue is accumulated (Come end of Q3/September) It can be effectively reinjected into debt installments and social safety net projects that directly impact low-income brackets.

None of this can be done right if we don’t have the correct data to guide us. The central bank on several occasions (including in their annual report) have flagged concerns regarding the accuracy of data produced by the Department of Census and Statistics (DCS). Last year, the Ministry of Economic Reforms and the Central Bank found that our current GDP calculation methodology overlooks many aspects of our economy (the construction sector, the gig economy, economic activities of the Colombo Port City, among others). 

Many experts (including those of the Central Bank) agree that Sri Lanka’s GDP and growth rates are severely underestimated. In our preparation for the recession, it is important to equip the DCS with the necessary tools to restructure and modernise itself; this could also improve the speed of delivery and quality of multiple other vital data resources that we rely on the DCS for (such as the labor survey, the Household Income and Economic Survey, NCPI/CCPI, etc. ). 

With the right political and administrative will to genuinely get this done, and done right, it can be done before the Q1 GDP release in June or at least by Q2 release in September. A modernised DCS can be a guiding light in helping Sri Lanka find its way out of the slump of the recession. 

August 2020-April 2022

In the medium to long term (the next three to 24 months) continuing to improving productivity, maintaining a sustainable trade policy and stimulating domestic consumerism and re-distributing wealth effectively through a progressive yet aggressive income taxation scheme will help us resist and persevere through the shocks of the recession. 

The logistics dashboard will help the Government recognise supply chain and storage gaps. This is a good time to build a network of perishables warehouses around the country; starting with the completion of the Dambulla warehouse currently under construction. Previous studies on the matter have identified Katunayake, Keppetipolla, Jaffna, Embilipitiya, Welimada, and Trincomalee as potential locations for warehouses. It will also help to provide tax relief to the logistics industry to import logistics equipment (freezer trucks, pallettes, sorters, etc.).

The Government has previously had discussions with the industry leaders including John Keells Logistics, Finlays, Dilmah, and even platforms such as PickMe Food regarding this; these discussions can be revived. A PPP-based model can be adapted to build and operate these warehouses. This can help ensure food security, alleviate post-harvest loss and create many potential export sector opportunities. 

While the apparel industry will take some time to recover, the food/agri industry will likely bounce back faster. It is important to work with the private sector to expand the infrastructure that we need to expand our trade potential and domestic food security. In an ideal situation where the MCC begins to roll out its infrastructure projects by 2021, we can expect a much faster recovery.

A trade policy that reopens our economy to the global market will speed up recovery. Providing industries with the assurance of long term open economic conditions will give them the confidence they need to get back up. Protectionism will slow us down. In the long term, policy sustainability- a sustainable macroeconomic strategy and sustainable debt management- will be the main enabling condition for long-term recovery. 

For decades our approach to financial crises is to provide moratoriums to SMEs and tax relief for big businesses. While these slow down the fall, they do not catalyse recovery. It’s time to rethink this strategy and focus on how to implement effective social security programs, even during a recession. It may seem impractical to think of expanding social safety nets given our current fiscal situation; but with a series of aggressive income tax reforms, it is absolutely possible. 

Social safety nets pay off; they help stimulate economic activity and alleviate poverty levels. Portions of new tax revenue can be funneled into direct cash payments to families that require assistance (daily wage earners, and recently unemployed). 

Divisional Secretariats can be empowered with enforcing community-based support programs (meal or nutrition pack deliveries, welfare check-ins, etc.) to families with elders, children, and individuals with special needs. This is also a great time to begin restructuring already existing social security programs such as Samurdhi to ensure that the most vulnerable families in the country receive the benefit. 

Ironically, our strength in this crisis will be the fact that we have historically underestimated our economic capacity; we were running under capacity way before the pandemic or recession. We have been literally underestimating our GDP and growth rates. If we catch up on our productivity, build up the fiscal discipline we need to stay afloat and start thinking creatively about ways to create an edge for ourselves in the global market, we may come out of this crisis stronger. 

If we use this moment that we are pushed to a corner to find ways to fund social security, to enforce an aggressive income tax and a wealth redistribution system, we can come out of the recession a more equitable nation. Past pandemics and recession show us how they have reset national economies forever, with short-term economic costs leading to lasting reforms. 

The next two years will be tough, but we’ve persisted through deadly wars and natural disasters; we will persevere through this as well. Our ancestors didn’t slave for this country, and our parents didn’t bleed for this country, for us to give up on it. We will fight back; we will fight smart, and we will come out stronger. 

(The writer is an author and a public policy PhD candidate at the University of Colombo. She was the Lead Analyst of the Ministry of Economic Reforms, and the Assistant Director of Sustainable Development to President Sirisena.)