SL-Korea Business Council forum sheds insights to future scenarios and challenges

By Michelle Therese Alles

The Sri Lanka-Korea Business Council last week hosted a top-level panel discussion under the theme ‘Sri Lanka’s future: forecast, scenarios and challenges’, which delved into pressing topics concerning the country.

The panel was addressed by Advocata Institute Chairman Murtaza Jafferjee, Verite Research Executive Director Dr. Nishan de Mel, Senior Economist and former Central Bank Assistant Governor Dr. Anila Dias Bandaranaike, and Hatton National Bank Managing Director and CEO Jonathan Alles. The session was moderated by Advocata Institute CEO Dhananath Fernando.

The discussion and insights shared included economic forecast, business impact, socio-economic vulnerabilities and necessary actions, challenges and consequences, current economic status and impact of policy deviations.

 Needs for multifaceted approach

 Sri Lanka stands at a critical juncture as compounding debt, weakened state capacity, and the enduring grip of elite capture threaten to undermine its economic future, warned Advocata Institute Chairman Murtaza Jafferjee. In his analysis, Jafferjee stresses the urgent need for a multifaceted approach—one that addresses the root causes of the country’s economic woes while implementing sustainable solutions.

At the heart of the crisis is the unsustainable growth of Sri Lanka’s debt, exacerbated by soaring interest rates and a depreciating currency. Jafferjee observed that the nation’s debt burden has ballooned because debt growth has consistently outpaced economic growth, creating a vicious cycle that has made it increasingly difficult to manage financial obligations.

This escalating debt-to-GDP ratio is a clear sign of fiscal mismanagement, driven by factors like sharp rupee depreciation, excessive government borrowing, and rising interest rates. Jafferjee warned that if these issues are not addressed, Sri Lanka’s debt will continue to spiral out of control, leaving future generations to bear the brunt of this financial crisis.

The situation is further compounded by the lack of state capacity. Despite efforts to restructure debt, including controversial moves affecting superannuation funds, the state’s ability to manage its financial obligations remains weak. Jafferjee emphasised the need for significant reforms, noting that Sri Lanka’s inability to outgrow its debt underscores the need for a stronger, more focused state apparatus.

Adding to these challenges is the issue of elite capture, where a small group of economic and political elites has historically controlled decision-making, prioritising their interests over the broader population. This concentration of power has stifled growth and exacerbated inequality, making it difficult to implement the necessary reforms to stimulate economic development. “As long as a small elite controls the levers of power, true economic reform will remain out of reach,” Jafferjee warned.

Moreover, the stress tests conducted on Sri Lanka’s debt levels under various economic scenarios highlight the fragile nature of the economy. While baseline projections show a potential decline in the debt-to-GDP ratio, Jafferjee cautioned against complacency, noting that external shocks or natural disasters could easily derail any progress. He called for prudent economic management to navigate these challenges and avoid past mistakes.

Crisis bonds, issued during times of economic distress, are another burden weighing heavily on Sri Lanka’s finances. These high-interest bonds are draining the national budget and limiting the government’s ability to invest in critical services, underlining the need for more sustainable financing options and a rethinking of how economic crises are managed.

The wild swings in real interest rates from 2019 to 2022 reflect broader instability within the economy, making it nearly impossible for businesses and consumers to plan effectively. This environment of uncertainty stifles growth and innovation, highlighting the need for stable economic policies that provide a predictable framework for all.

Looking ahead, Jafferjee noted that the IMF’s projections for GDP growth from 2024 to 2029 offer a glimmer of hope. However, this modest growth of around 3% per year is contingent upon Sri Lanka’s ability to navigate ongoing challenges without major disruptions. Jafferjee called this a fragile optimism that requires disciplined economic management.

Sri Lanka’s Central Bank faces the daunting task of maintaining price stability while ensuring the stability of the financial system. This dual mandate is challenging even in the best of times, and more so given the current economic turmoil. The Central Bank’s decisions in the coming years will be critical in determining whether Sri Lanka can achieve the balance needed for sustainable growth.

Jafferjee also stressed the importance of maintaining strict prohibition against monetary financing—essentially printing money to cover government deficits—as a necessary measure to prevent runaway inflation. While there are exceptions for emergencies, such as natural disasters or severe economic crises, these must be tightly regulated to ensure that temporary measures do not jeopardise long-term economic stability.

Sri Lanka’s high level of external liabilities, particularly as a percentage of GDP, is another significant risk that cannot be ignored. Jafferjee urged that reducing this burden to below 30% of GDP should be a top priority to safeguard the nation’s economic future, warning that failure to do so could leave the country vulnerable to external shocks and potential crises.

Ongoing challenges in achieving a sustainable current account balance exacerbate the debt problem, placing further pressure on Sri Lanka’s foreign exchange reserves. Jafferjee emphasised the critical need to address these imbalances to ensure long-term economic stability.

Understanding the interconnectedness of GDP, savings, investment, and the current account balance is essential for effective policy making, according to Jafferjee. These relationships are complex, but must be managed carefully to avoid economic pitfalls and ensure that policies are aligned with long-term growth objectives.

The mixed performance of various sectors in early 2024 highlights the need for targeted support in areas that are lagging. While some sectors like manufacturing and construction show positive contributions, others are struggling. Jafferjee urged the government to identify these weaknesses and provide necessary support to ensure balanced growth.

Reviewing growth trends from 2021 to 2024, Jafferjee painted a picture of an economy in flux, with some sectors adapting well while others fall behind. Understanding these trends is crucial for shaping economic strategy and ensuring that the country supports sectors with the most potential for future growth.

Sri Lanka’s reliance on hydroelectric power makes the nation particularly vulnerable to changes in rainfall patterns, with significant implications for energy production. Jafferjee urged steps to mitigate this vulnerability, perhaps by diversifying energy sources and investing in more resilient infrastructure.

As environmental changes increasingly impact critical sectors like agriculture and energy, Jafferjee called for a more integrated approach to planning, incorporating detailed data on regional rainfall trends to avoid being caught unprepared.

The Chairman also pointed out that higher labour productivity, technical progress, and economic restructuring are key drivers of growth that Sri Lanka must focus on. He urged the government to prioritise policies that enhance these factors to sustain long-term economic development and remain competitive on the global stage.

Sri Lanka’s rapidly ageing population presents one of the most significant challenges to the economy, according to Jafferjee. The increasing number of elderly individuals will place tremendous pressure on healthcare and pension systems. He called for proactive policy development to address these challenges before they overwhelm the country.

Furthermore, the gender gap in labour force participation is a missed opportunity for economic growth. Jafferjee argued that encouraging greater female participation in the workforce is not just a matter of equity but an economic imperative, suggesting that closing this gap could unlock significant potential for growth and innovation.

Jafferjee also pointed to lessons from Korea’s trade dynamics as valuable for Sri Lanka. By studying these dynamics, he suggested, the country could better manage its own trade balances and foster stronger economic relationships that would benefit the economy in the long run.

The depreciation of currencies in emerging markets, particularly in Turkey, should serve as a warning to Sri Lanka, Jafferjee noted. The parallels to the local situation are clear: economic mismanagement and the loss of investor confidence can lead to severe consequences. He stressed the importance of rebuilding confidence in the Sri Lankan economy.

Jafferjee also highlighted the damaging effects of inflation, which at its peak neared 70%. This has eroded purchasing power, increased poverty, and placed immense pressure on businesses. He emphasised the need to address the root causes of inflation to restore economic stability.

The sharp contraction in GDP in 2022 serves as a stark reminder of the severity of Sri Lanka’s economic crisis. Compared to other countries, the nation is facing an unprecedented challenge. Jafferjee called for significant effort and a commitment to comprehensive reform to reverse this trend.

Sri Lanka’s structural balance reveals the extent of fiscal mismanagement, Jafferjee warned. Without urgent reforms, these imbalances will continue to undermine the economy, making it critical to confront these issues head-on and implement necessary changes to restore fiscal health.

Demographic changes, particularly the shrinking working-age population and growing elderly population, present significant challenges, according to Jafferjee. He urged the government to prepare now by developing policies that address the economic and social impacts of these shifts.

The decline in foreign exchange reserves is another clear sign of economic distress, Jafferjee noted. Without sufficient reserves, Sri Lanka risks a currency crisis that could further destabilise the economy. He emphasised that restoring these reserves must be a top priority.

Rising unemployment is a direct result of the economic struggles, and as more people find themselves out of work, the social and economic consequences will only worsen, Jafferjee warned. He called for policies focused on job creation and skills training to address this growing crisis.

Finally, Jafferjee proposed a series of policy recommendations aimed at addressing these challenges, including fiscal, monetary, and structural reforms essential for stabilising the economy and paving the way for sustainable growth. He concluded with a call for bold action to secure Sri Lanka’s economic future.

Navigating Sri Lanka’s debt sustainability: four scenarios for the future

 Verité Research Executive Director Dr Nishan De Mel offered a critical analysis of Sri Lanka’s debt restructuring efforts, emphasising the importance of sustainable policies and effective governance. 

Dr De Mel began by acknowledging the progress made in addressing the country’s debt crisis but stressed that the key question remains: is the current restructuring sustainable? He outlined four potential scenarios that the nation could face as it moves forward.

Scenario 1: Status quo on targets and implementation

 The first scenario maintains the current targets and implementation methods. Dr De Mel highlighted that the existing debt sustainability analysis (DSA) by the International Monetary Fund (IMF) sets fiscal and governance targets essential for a successful program. However, he pointed out that the government has consistently fallen short of its revenue targets due to poorly formulated policies. For instance, last year’s revenue projections fell short by 13%, a figure that was predictable due to the unrealistic expectations set by the budget. Dr De Mel also emphasised that attempting to achieve these current targets would likely fail to ensure debt sustainability, as they were based on assumptions, such as domestic yields, that have not materialised.

Scenario 2: Status quo on targets, better implementation

 In the second scenario, while the targets remain unchanged, there is a stronger focus on better implementation. Dr De Mel suggested that well-formulated policies could enable the government to meet its fiscal and governance targets. However, he warned that even with better implementation, Sri Lanka might still struggle with debt sustainability unless domestic yields are significantly reduced.

Scenario 3: Enhanced targets and better implementation

The third scenario proposes not only better implementation but also enhanced economic and fiscal targets. Dr De Mel argued that achieving a 4.5% growth rate, combined with a 20% revenue-to-GDP ratio, and reduced yields could place Sri Lanka on a more sustainable debt path. He cautioned, however, that this approach would still require careful navigation through a ‘knife-edge’ pathway to avoid economic shocks.

Scenario 4: Updated debt sustainability plan

The final scenario involves updating the current debt sustainability plan. Dr De Mel suggested that Sri Lanka could benefit from a deeper restructuring, potentially revisiting terms with bilateral and multilateral creditors. He noted that the IMF’s current DSA for Sri Lanka has been widely criticised and could be improved to provide a more realistic pathway to debt sustainability.

Dr De Mel concluded by emphasising the importance of sound analysis and rational policy making, warning against ‘magical thinking’ that ignores the harsh realities of economic management. He called on Sri Lanka’s leaders to adopt a more sensible and sustainable approach to navigating the country’s debt challenges.

Panel discussion

Q: If we were to continue with the status quo, even with improved fiscal management and governance reforms, there would still be a significant social impact, particularly on the women and labour force. While the politicians may unite and implement some reforms, more needs to be done, especially on the labour front. What are your thoughts on this and what would you recommend?

Dr. Bandaranaike: The elephant in the room is the labour market dynamics and linked to that is the stagnation of the formal private sector. To meet the future commitments, the economy has to grow with stability but it can’t go without the workers. We have a labour force participation rate of below 50%, where only one in every three women joins the labour force. It is not worth the women joining, when their salaries can’t even support their child and elderly care expenses. Over 200,000 to 300,000 leave overseas each year for employment and every business complains of employee shortages but for the last so many years, only 30% of our employees and labour force have jobs in the formal private sector companies. So, why is the formal private sector stagnant and does not expand? I have identified three key reasons. First, archaic regulation, completely outdated labour laws. 

Second, according to the long overdue wage reports, as an example, the national minimum wage in this country, officially was raised by Rs. 5,000 to Rs. 17,500 a month. Since 2022, we have something called an official poverty line. The monthly income to just be at the poverty line for a family of four is Rs. 60,000. So, if a family of four has one earner, that man or woman has to earn Rs. 60,000 a month to be at the poverty line. If you are lucky enough to have two wage earners, the minimum wage should be Rs. 30,000, just to get to the basic needs. The laws and regulations have to reflect the 21st century, not the dark ages. 

Then there is the bloated public sector. We have one and a half million employees – 15% of our labour force, in 1,300 institutions. As an example, there are 90 Government institutions supporting agriculture and we know how badly that sector is doing. The Government has to rationalise its workforce.

The third factor: The unrealistic low formal private sector wages. Among the listed businesses and in other sectors, the starting salaries for youngsters with degrees and now after raising the wages, it is between Rs. 30,000 and Rs. 40,000 a month.

This is the scale after the recent wage increases. In 2022-2023, the salaries ranged from Rs. 15,000 to Rs. 25,000. Do businesses really expect employees to live in poverty? It’s no wonder they prefer jobs abroad in greener pastures. Wages have to be linked to productivity and businesses have to watch the bottom line. I accept but they really must pay decent wages to employees. You circumvent outdated laws that no longer serve the current economic landscape. It is better to prioritise revising these laws, making it a win-win situation. I also recommend that professional private sector institutions lobby hard for Government downsizing.

Dr. De Mel: One of the things that is keeping women from the workforce is actually discriminatory hiring and this is seen in the surveys done by the Census and Statistics Department because it’s more costly to hire a woman than a man. You have to pay four months of maternity leave every time there is a child in the family. Now what is fascinating is, there are 159 countries in the world that don’t make the company pay maternity leave.

The ILO convention says, in no event shall we put the burden of maternity leave on the employer because it’s well understood that when you do that, you will incentivise the employer to hire a man rather than a woman for the same job.

There are plenty of research studies that show where there’s high discrimination, like in Sri Lanka. The labour force participation can increase by at least 10% for women when the state takes on the cost of maternity benefits. If it’s a small cost, it used to be Rs. 3 or 4 billion; it went up to Rs. 6 billion. It’s still under Rs. 7 billion. It is peanuts compared to what they spend on other social welfare.

But interesting is, this was on a Budget. I think now I see it in the Ceylon Chambers recommendations to the Government. But you know, there are not enough women perhaps in the private sector leadership to ask for something so simple and obvious that most of the world does, which costs so little, which is, by not doing, very violation of an international agreement that we have signed up for over 30 years. Which is that the state pays the maternity leave benefits or you have a general taxation that does that. It is a small amount of money but it fundamentally changes the dynamic with regard to hiring women and increasing opportunity.

Second, we did research on the cost of women going to work. What we found is, the care economy, the cost of child and elderly care, cost of outsourcing or the difficulty of outsourcing is so high that women find it better to stay at home than go to work and earn what they do.

And of course, other countries overcome it in multiple ways. But there is an opportunity here. To build care facilities, this is an entrepreneurship opportunity. If you can build credible care facilities for child and elderly care, there’s a huge business case. If we can get the care economy going in the marketplace and even the state can pay for maternity leave, these are two ways I think, that very, very, very concretely create a huge opportunity to release the ability for women to be more productively engaged.

Q: How do you see the banking sector? Because in the first debt restructuring, it was more towards the superannuation funds. Of course, we are yet to see some of the impacts on the banking sector. If it’s the case, if it’s a scenario of a secondary restructuring, what would be the case of the banking sector? What reforms can we do in the meantime to avoid the impact of minimising?

Alles: We were not happy the first time around as well as the banking sector, the opportunity that there was to look at the high interest rated T-bills, T-bonds, etc. Where the bankers were coming from was that it is a primary instrument, as it is a regulatory instrument, where it actually invests in bills and bonds, whether it is rupees or dollars, mainly as a Liquidity Adequacy Requirements (LAR) component. Now LAR is not there in the new Banking Act. So, it is more the Liquidity Coverage Ratio (LCR). It is done for that purpose. If we were given a choice, it’s not as if that’s the first instrument that we would want to invest in. 

To be fair, three years, five years down the road, we never looked at the dollar bond. We never looked at, International Sovereign Bonds, etc., except when the NRFC and expatriate remittances were picking up. There were very little dollar disbursement opportunities. The SLDBs were drying up and at that time, there weren’t other instruments that met the LAR requirement that prevailed at that stage.

And there was a blessing all around to actually invest in sovereign bonds. But now, if you say that this is at risk and you know, everybody might need to participate in further haircuts, which the first time around, maybe we got away unscaled in terms of a haircut.

But there was a Net Present Value (NPV) in terms of the rescheduled new bonds that were issued at the longer tenure and at the lower rate. We all had to take a hit on P&L. We need to look at new instruments. The Sri Lanka Banks Association, and CEOs will need to have discussions at an early stage with the Central Bank and others. Given a choice, we would want to invest it in; we would want to start giving the loans. We would like to evaluate credit for the customers and give loans to them. Would you give a loan to somebody if you know that there’s a potential for it to be defaulted a year down the road and is this what we are actually talking of now? 

If you say no, you’ve got to meet requirements; you’ve got to sort of invest in your bills and bonds but you also have a chance of losing 30% of it. Why do you have to do that? Let’s look at alternative products that actually then make the necessary Net Stable Funding Ratio (NFSR), Stable Funding Requirement (SFR) and the LCR requirements for banks. It would not be fair to knowingly invest shareholder funds and depositors’ funds at the end. Just remember, at the end of the day, all those international funds and creditors gave money after evaluating the credits.

Now ours is basically depositors’ funds that are put here. Every haircut that you perceive of a bank, let’s say Treasury bill or one has, that is a customer deposit. A small part of it is the shareholder funds.

In terms of what needs to be done, three areas that I broadly look at are basically already mentioned. Small Government, it was mentioned there is no capacity, no capability, to run. So, then, why spread your tentacle? Why do things that you cannot do other than for the pure interest of greed, corruption and wanting to make money everywhere you put your fingers in, right? So, basically, be as small as possible and only play the role that you’re supposed to play, right?

Diversify away the things that you are not supposed to, which you don’t have the capability and grow the private sector with that; divest the staff, excess staff that you have into those areas. You can actually encourage the private sector to, you know, absorb some of these. You know, staff, wasteful expenditure. Get rid of the unnecessary tamashas. Bring in the frameworks, governance on corruption as well as bribery and put a stop to it.

In terms of economic development, which is key in terms of whether it’s exports, manufacturing, whether it’s health, education, housing, tourism, digitalising for transparency, IT services driving SME, driving microfinance and entrepreneurship and the Government creates the framework for all this to be done in order, basically, is that you need to sort of look at the banking sector very closely, because at the end of the day, we are trying to save every single dollar for the country and I see where everybody is coming from. But what are we saying? How did we get in here? It’s because the country couldn’t do anything for the last half a century and we are trying to save money back for them to do the same thing. You give them $ 1 and think they will use it for the betterment of the country? It will go to their pockets again, right? So, we leave it with the people who can do something for the country. If you want to have any hope of the IMF program working, if you want to have any hope of development taking place, keep the private sector to perform the final part.

In case we have to face another scenario, I would say hopefully we don’t have to, the financial sector must strongly empower them to drive this economy along with the other sectors and make it happen for Sri Lanka and for the people of Sri Lanka.

Q: You are working with the State Owned Enterprises Restructuring Unit and I am unsure if the bids have geopolitical influence or not. What is your solution in navigating between China, India and the Quad?

Jafferjee: We have to frame it to our economic challenge, which is, we have to grow. So, in order to grow, we have to increase productivity. The most important driver of productivity improvement is commercial. So, whatever we do, it has to be framed in the context of how we increase competition in the economy. Now, if geopolitics dictates that there are external powers who want to do so, discuss it, let them come on a competitive basis.

We can’t give unsolicited things. I don’t believe it is Government-to-Government. It’s all nonsensical. I have said this before and I want to say this again. I’m in the renewable energy sector. So, I have some understanding. When you bid out power projects on a competitive basis, the prices have come down 40%.

I started engineering. I pivoted to economics. Both are studies of constraint optimisation. If you want to do any kind of projects, if you have scarce resources, if you’re constrained, you have to really be innovative and create how to do more with less. In the case of this wind power tender, which I have spoken about, we are trying to award tenders at 8.2 cents for people who are doing similar projects in India, at 3.36 cents. So, how can geopolitics dictate energy security and affordability?

Q: You mentioned the option of revising the debt sustainability analysis. How practical is it? And all candidates had said that either they are going to bring some amendments to the IMF agreement or stick with it. How practical is it with the political environment?

Dr. De Mel: If there is an agreement on the debt restructuring tomorrow, the official creditors agree with the private creditors, we have to close it. This train has travelled too fast. There is a small risk that we will not get the agreement. The official creditors could really reject the private creditors’ offer. If that happens, you get into another cycle. If you do, don’t see that as a disaster; see it as an opportunity. If you don’t, accept it and then work to have better targets than the IMF is giving you. If you don’t fix the Government, you can’t fix it.

If we imagine that we are going to fix this thing without fixing the Government and political leadership, and act in a way for the interests of the few rather than the many, it may be quite hard to get there. One might ignore the main constraints or constraint optimisation. But here’s a constraint; you have really got to reduce this constraint? The constraint is too much. We need a far better ability and commitment in the Government.

Q: If you have a single advice for the presidential candidates, what would it be?

Alles: Have a policy and implement it strictly. Have a policy that is a statement of intent of anybody who wants to be part of them, about honesty, integrity and a culture of no corruption.

Dr. Bandaranaike: Look at the labour laws, labour regulations and wage system and see what can be done to make the women join the labour force.

Q: The presidential candidates say they all agree on one single thing. What is the one thing they should agree on?

Jafferjee: Abolish the executive presidency. It is designed for Lee Kuan Yew.

Q: You have been quite vocal about governance and let’s imagine you’re running an advertising agency and you are given the task to write the payoff line on the governance reform that all presidential candidates have to follow.

 Dr. De Mel: Independent corruption prosecutors as independent as our Central Bank.

Pix by Shehan Gunasekara