IPS’s SOE 2024: Manual of growth strategies for AKD

SOE 24 has been released by IPS at a time when Sri Lanka has reached a watershed in its economic policy strategies following a Presidential election in which a left-oriented politician, namely, Anura Kumara Dissanayake or AKD, has been picked by voters to occupy this high post. AKD is also seeking the mandate of the people for Parliamentary majority to implement his policy at a general election to be held in mid-November 2024. AKD’s left orientation and inclination for the expansion of the State sector, known as statism or dirigisme, has come to be tested at a pragmatic level immediately after he was sworn in as the President

State of the Economy in 2024

Sri Lanka’s State of the Economy for 2024, known as SOE 24, has been released by the Institute of Policy Studies or IPS in early October 2024. This is an early bird because it is the first comprehensive analysis of the state of the economy. The other two documents on the economy, the Central Bank’s Annual Economic Review and the Finance Ministry’s Annual Report are to be released in the early part of the next year. Hence, for anyone to learn of the current state of the economy and its future direction, this is the best document available. 

Conversion of AKD to neoliberalism

SOE 24 has been released by IPS at a time when Sri Lanka has reached a watershed in its economic policy strategies following a Presidential election in which a left-oriented politician, namely, Anura Kumara Dissanayake or AKD, has been picked by voters to occupy this high post. AKD is also seeking the mandate of the people for Parliamentary majority to implement his policy at a general election to be held in mid-November 2024. AKD’s left orientation and inclination for the expansion of the State sector, known as statism or dirigisme, has come to be tested at a pragmatic level immediately after he was sworn in as the President. 

A high-level IMF team, headed by its Asia-Pacific Director, visited him in person to discuss the destiny of the extended fund facility or EFF and the proposed foreign debt restructuring program. During the election campaign he had promised the voters that he would renegotiate EFF and go for a new debt restructuring under an amended debt sustainability analysis or DSA. However, after the meeting with the high-level team, it was announced that the new Government will go along with both EFF and debt restructuring. 

As I had argued in my previous article (available at: https://www.ft.lk/columns/Voters-should-select-from-neoliberalism-modified-neoliberalism-or-anti-neoliberalism-on-21-September/4-766238), the IMF policy package is based on now abandoned neoliberal economic policies. Hence, by accepting the IMF’s EFF and debt restructuring under its supervision, AKD has been converted overnight from a statist to a neoliberal. In this context, SOE 24 comes handy for AKD.

A broad analysis of the economy in SOE 24

This year’s SOE has analysed the economy under four broad areas, namely, economic stability and resilient growth, socio-economic disparities and equity, jobs and human capital, and competitiveness and productivity, which are burning issues in contemporary Sri Lanka. They are being dealt with in 14 detailed chapters. The first broad area on economic stability and resilient growth covers the economic policies which Sri Lanka should adopt to get out of the current crisis, and the present state of the economy. Socio-economic disparities and equity section contains four detailed analyses. One deals with the need for progressive taxes and the designing of welfare systems to support the poor. The second is on access to food and nutrition. The third is on how to establish a universal health coverage system for Sri Lankans. The fourth chapter is on multiple economic crises faced by the Sri Lankan households leading to a sudden increase in the pawning of assets to generate the needed cash for day-to-day expenditure needs. 

The section on jobs and human capital deals with access to quality education, having good jobs, balancing the job creation by the public and private sectors, and how to cope with the challenge of human capital flight, known as brain-drain. The broad section on competitiveness and productivity is a forward-looking economic policy strategy to promote economic growth to required high levels. It covers new regional economic cooperation agreements, how agriculture should be modernised, the need for diversifying exports and promoting minor export crops, and how Sri Lanka should design policies to tackle climate changes, introduce appropriate pricing system for exports, and promote competitiveness in the export sector. 

Strict adherence to IMF sponsored policies to generate macroeconomic stability should simultaneously be accompanied by a special program acceptable to all for providing relief to vulnerable groups. SOE 24 was written before the Presidential election. But the results of the election have proved its point

Policy perspectives

It is sufficient for any policymaker to read through the Policy Perspectives section of SOE 24 to know of the nature of economic issues faced by Sri Lanka and the appropriate policies to be adopted to overcome the same. Hence, in this review, I will focus on the salient recommendations in that section. 

Rise of poverty

Beginning from Q1 of 2022, Sri Lanka had had a negative growth over six consecutive quarters, qualifying being called that it was in recession officially. Since Q3 of 2023, the growth has been positive but not at rates desired by citizens. SOE 24 has called this rebound a fragile one. Though the Central Bank has projected a growth of over 5% based on partial information on the increase in the Western Province based Purchasing Managers’ Index or PMI and slight growth in private sector credit, the World Bank has upped the projection for 2024 to 4.4% but maintained a growth of 3.5% for 2025. It is a fragile state and there is uncertainty associated with this fragile state. That uncertainty is the killer of the potential growth prospects because it palls the private sector consumption, savings, and investment. SOE 24 has warned that the political strength to be established after the Parliamentary elections should “carry through and implement (necessary) policy agendas”. 

It has also highlighted: “In conditions where incomes have shrunk, poverty has risen, and many Sri Lankans have been compelled to seek better opportunities abroad”. The danger in this situation is the political parties resorting to promise attractive palliatives to voters. But once in office, due to resource scarcities and other development priorities, they may not be able to keep to these promises. This will keep the electorate frustrated and, though SOE 24 has not highlighted it, it will lead to a polarisation of the citizens from the growth agendas being followed by the successive governments. This polarisation is inimical to the country’s future growth prospects. 

Danger of importing economic policies

The danger of importing economic policy packages without considering the prevailing local conditions has also been highlighted by SOE 24. A case in point is the following of the policy package recommended by IMF under its extended fund facility or EFF by Sri Lanka today. Says SOE 24: “The harsh reality is that for countries in debt-default, fixing over-extended fiscal positions via adjustments to how a government taxes and spends and tackling the accumulated debt stock can only be done under IMF oversight. This ‘outsourcing’ of the policy model for recovery leaves little or no room for ‘heterodox’ policies”. 

It also says: “The social impact of these measures has been painful. They include the removal of subsidies on fuel; a wage freeze on the public sector; tax increases, removal of tax concessions and imposition of new taxes, amongst others”. These are hard economic policies but implementation of them without regard for the brewing social and political unrest will surely make them unsustainable in the medium to long-run. The risk is that a possible policy reversion causing the country to sacrifice all the hard-earned results. What this means is that strict adherence to IMF sponsored policies to generate macroeconomic stability should simultaneously be accompanied by a special program acceptable to all for providing relief to vulnerable groups. SOE 24 was written before the Presidential election. But the results of the election have proved its point. 

As SOE 24 has presented, it is essential that the improvement in the budget position should come from a mixture of a program involving increased revenue supported by a greater amount of reduced expenditure. Otherwise, the consequential debt accumulation will compromise the real welfare of the people in the medium to long term

Favouring capital while disregarding labour

IMF type neoliberal policies favour capital owners and take the labour for granted. As a result, all the policies are designed to protect the rights of the capital owners. For instance, the primary account surplus which is followed religiously in IMF loan conditions is set for protecting the interest income due to external creditors. For long-term fiscal sustainability that would help the country to boost economic growth is the requirement to have a surplus in the revenue account of the government. That surplus is an indication of government savings that will top up the private savings, thereby reducing the savings-investment gap. Larger this gap, higher the need for borrowing from foreign sources to finance the investment requirements. But it will increase the debt stock leading to a foreign debt trap and eventually, to difficulty in servicing such debt that could be done only by a tight austerity program by the local population. IMF quantitative targets are silent on this need. But the primary account surplus that represents the excess revenue over expenditure excepting the interest payments is a guarantee that the interest will be paid without failure.

In 2023, it has been reported that Sri Lanka had had a surplus of 0.6% of GDP as the primary account surplus. On the surface, this is considered as an achievement. However, the devil is in the details and this surplus has been attained by drastically cutting the capital expenditure from a budget figure of Rs. 1,220 billion to an actual expenditure of Rs. 657 billion. This is a window-dressing, and its negative impact will be on the long-term economic recovery. The same development seems to be taking place in 2024 as well. The budget has approved Rs. 1,260 billion as capital expenditure, but the actual expenditure up to July 2024 had amounted to Rs. 361 billion, about half of the budgeted figure for the period. Hence, the artificially created book figure of the surplus in the primary account is not an achievement about which either IMF or the Sri Lanka Government can be proud of. 

The more appropriate fiscal consolidation

The fiscal sector improvement under IMF’s EFF has been to improve the budget position through an increase in the revenue, known as ‘revenue based fiscal consolidation’. Presently, this goal is being achieved by Sri Lanka by increasing both the income taxes – personal as well as corporate – and taxes on goods and services, mainly the value added taxes, excise duties, and import taxes. Compared to 2023, the attainment in 2024 is going to be impressive: according to the data released by the Ministry of Finance, during the first seven months of 2024, the government revenue has increased from Rs. 1.5 trillion to Rs. 2.2 trillion or 47%. But if the government expenditure also goes up faster, the improvement in the budget becomes illusive. 

There should be a similar adjustment on the expenditure side as well. SOE 24 has the following comment on this: “Fiscal policy adjustments, however, should not be confined only to revenue consolidation, especially in crises. A reallocation of public expenditure from high cost, low social impact investments is warranted-for instance, from defence-related spending to those on health and education. The broad trajectory of public expenditures in Sri Lanka suggests that there has been a very limited success in curtailing spending as a share of GDP, with total expenditure at 19.4% in 2023 against 17.5% in 2019.” 

But this relates to net expenditure in which the Government takes out the cost of maturing public debt out of the budget on the assumption it can be refinanced. But the ghost in the budget is not this net expenditure but the gross expenditure which is the real burden to the economy. The total gross expenditure in 2023 amounted Rs 10.7 trillion or 39% of GDP; When the suspended debt of Rs. 2 trillion is added, it increases to 46% of GDP. The budgeted numbers for 2024 presents a similar picture: Gross expenditure amounts to Rs. 11.3 trillion or 36% of GDP and when the suspended debt of Rs. 3 trillion is added, it will remain at 46% of GDP. 

Going by the breakthrough presentation of the 19th century English economist David Ricardo who said that it is the total gross expenditure that matters for assessing the burden on citizens, the share of the burden per citizen in 2023 amounted to Rs. 577,272 or 46% of the average income per head. In 2024, this is expected to increase to Rs. 665,000 or 50% of the estimated average income per head for the year. Hence, as SOE 24 has presented, it is essential that the improvement in the budget position should come from a mixture of a program involving increased revenue supported by a greater amount of reduced expenditure. Otherwise, the consequential debt accumulation will compromise the real welfare of the people in the medium to long term. 

The solution for Sri Lanka, as argued by SOE 24, is to have durable, strong, and lasting growth. It will generate new jobs leading to stronger employment that in turn will fuel income and spending further boosting economic growth. It will also address the current high level of poverty and associated misery of many low and lower middle-income earners. Many Sri Lankans are leaving the country causing an unwarranted human capital flight which has the same negative impact on the economic growth as the physical capital flight. The essential requirement in this situation is to promote the domestic investment and the encouragement of foreign direct investments. It requires the new Government to create suitable conditions for these investments to flourish in the economy

Need for durable, strong, and lasting growth to create jobs

Hence, the solution for Sri Lanka, as argued by SOE 24, is to have durable, strong, and lasting growth. It will generate new jobs leading to stronger employment that in turn will fuel income and spending further boosting economic growth. It will also address the current high level of poverty and associated misery of many low and lower middle-income earners. Many Sri Lankans are leaving the country causing an unwarranted human capital flight which has the same negative impact on the economic growth as the physical capital flight. The essential requirement in this situation is to promote the domestic investment and the encouragement of foreign direct investments. It requires the new Government to create suitable conditions for these investments to flourish in the economy. 

In my view, it behooves AKD as well as his economic policymakers to study SOE 24 from cover to cover and incorporate its recommendations in their economic strategy framework.

(The writer, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at [email protected].)