On 28 September, Moody’s Investors Service downgraded Sri Lanka’s sovereign rating by two notches to Caal1 from B2. Among the key reasons for the downgrading were,
1. Sri Lanka’s weak debt affordability
2. High budget deficit
3. Public opaqueness
4. Weakening institutions and governance
Following this move, Dr. Harsha de Silva at a press conference on 29 September noted that this recent downgrading was the lowest rating given to Sri Lanka. He blamed the incumbent administration for this outcome by implementing “weak” fiscal policies. The negative effects of the wide-ranging tax cuts and the exemption of VAT failing to produce expected impact on public were exacerbated with the impact of the COVID-19 pandemic.
He warned that the country was heading into a serious economic crisis unless multilateral support was secured. The Gotabaya Rajapaksa administration must urgently implement economic reforms and seek assistance from organisations as the IMF. Failure to do so would lead the country facing outright import ban by next year and even severe international pressure to adapt austerity measures, he said.
Citing Moody’s report he stated that, “Sri Lanka may need to restructure its debt.” He observed that this was not a step that Sri Lanka had to take even during the aftermath of the 2004 Boxing Day tsunami.
It is still the same wine
Interestingly, the island’s current finances are being navigated by more or less the same team that rescued the country’s economy following the devastating tsunami. Almost a year had passed since the tsunami when Mahinda Rajapaksa assumed office as the new President in November, 2015. Yet, the country, already under siege from terrorism, was still reeling from the devastation. The national debt to GDP ratio at the time was over 100%.
As President, Mahinda Rajapaksa embarked on an ambitious economic revolution that reversed a collapsing economy to a promising one. Even before the war on terrorism was concluded, he increased both the investor and lender confidence. Thus, Sri Lanka began to attract low interest rates with longer payment schedules. This allowed a host of long overdue projects including the Hambantota Port and the Southern Highway and even new ideas like the Colombo Port City.
The then President Mahinda Rajapaksa, then Secretary to Treasury and Finance Ministry Dr. P.B. Jayasundera and then Central Bank Governor Ajith Nivard Cabraal are no longer holding the same positions. However, Mahinda Rajapaksa as the incumbent Prime Minister and Finance Minister, Dr Jayasundera as Secretary to President and Cabraal as State Minister of Money and Capital Market and State Enterprise Reforms are still the dominant decision makers in the country’s finances.
Pandemic worse than a tsunami
Team notwithstanding though, the situation with regard to the tsunami and the ongoing COVID-19 is starkly different. The destruction that the pandemic is causing is more of an ongoing ripple effect than the one-time gigantic wave.
The 2004 Boxing Day tsunami affected only the coastal regions of the Asian and African continents. This enabled the West to help the tsunami affected countries. Conversely, the whole world is fighting the virus and its second wave is proving to be much worse than the first. It is obvious that until a vaccine is found, which is expected to take around another two years, the world must adjust to a ‘new normal’.
This ‘new normal’ is demanding social distancing, which according to Golden Sachs Group Inc will cost the global GDP almost 7.8%. A global recession is expected at -4%.
When the pandemic first broke out, there was a rush to move supply chains out of China. This spelt opportunity and cost, especially for the neighbouring countries. However, the epicentre of the virus is no longer China, but Europe. US is expecting a negative economic growth of -4% while it could be -10% for UK. Obviously, unlike in the aftermath of the tsunami, the West is not in a position to help anyone right now.
What does the pandemic spell for Sri Lanka’s economy?
Sri Lanka is one of the few countries that have thus far managed the pandemic well. Even though the virus has re-emerged and the current cluster is the largest the Island had to deal with until now, the situation is still under control.
However, Sri Lanka’s economy is heavily entrenched in the US and EU export markets and remittances from the Middle East, which is also badly affected by the pandemic. Sri Lankan expatriates are desperate to return home. Other important financial revenues as tourism have also nosedived. Obviously, Sri Lanka’s success against the pandemic alone is not enough.
The economy the Gotabaya administration inherited
Dr. Harsha de Silva for political reasons, may like to place Moody’s downgrading at the doorstep of the Gotabaya Rajapaksa administration. However, as an economist he cannot ignore the fact that the economy Gotabaya administration inherited was not a robust one in the first place.
As a State Minister, Dr. Silva was a financial navigator in the Yahapalana Government. Due to reasons that can be better explained by Dr. Silva, the Yahapalana Government during this tenure could not agree on a single financial strategy. Over the course of three years, the Yahapalana Government struggled with nine different financial plans.
Yet, they could not arrest the retarding economic growth rate. Growth rate that was at an average of 6.8% during the Mahinda Rajapaksa administration fell to,
- 5.0% in 2015
- 4.5% in 2016
- 3.6% in 2017
- 3.3% in 2018
- 2.3% in 2019.
Unable to take the economy forward, the Yahapalana Government lost the confidence of both foreign and local investors. Their exit resulted in nearly half a million losing their livelihoods.
The national debt to GDP ratio that was at 72.3% in 2014 jumped to 86.6% by 2019. During this tenure the country did not gain a single asset but lost the Hambantota Port on a 99-year lease. Yet the Government expenditure continued to increase and the taxes rose by 80%. The rude interruption of gas supply for over two weeks and the inability to assure adequate electricity supply that resulted in emergency purchases at high rates had a strangling effect on businesses. With the Easter Attack, the robust tourism industry too wobbled.
It is ironic that Dr. de Silva should fault the Gotabaya administration for its tax cuts. The Yahapalana Government too reduced taxes when they assumed office in 2015, but on imported commodities. In addition, they increased the public sector salaries, which resulted in the Government footing a whopping one billion dollar bill per year. The increased buying power brought on by lowered prices and increased salaries resulted in a drain in the country’s forex.
The fiscal deficit that year increased to 7.6% of the GDP, observed Dr. Kenneth de Zilwa at Hard Talk, Derana. The deficit continued to widen and pressure the exchange rate, causing the rupee to depreciate by an unprecedented 18%. Dr. Silva’s professional opinion at the time was that the depreciation was good for our exporters.
This is of course debatable when the country’s expenses increased by almost one trillion rupees. With more rupees needed to equate to the US dollar rate, our debt burden also rose.
Moody’s downgrading was prompted by the worry that Sri Lanka would be unable to meet its debt commitments. Therefore, it is rather mischievous of Dr. Silva to ignore the contribution to our debt by this rupee depreciation. As one who supported the rupee depreciation, Dr. Silva must now explain this consequence of increased commitment in relation to Moody’s grading.
Does Gotabaya Rajapaksa’s economy deserve Moody’s rating?
Moody claims that “public opaqueness” and “weakening institutions and governance” of the incumbent Administration also influenced its opinion of Sri Lanka’s economy. Interestingly, during the entire Yahapalana Government tenure, Moody’s confidence was not as rattled despite inconsistent financial plans and procedures.
The fuel formula price introduced by the then Minister of Finance Mangala Samaraweera severely stressed the country. Even the commissions established via the 19th Amendment were openly partisan to the then government and not independent from political influences as promised. Yet, as Dr. Silva notes, the country’s ratings were not downgraded then as it is being done now.
When President Gotabaya Rajapaksa took office in November 2019, the economy was in dire straits. Investors, entrepreneurs and the workforce were almost in a comatose state. For the entire five years, the per capita income increased by only $ 33 (approximately by $ 6 per year). During Mahinda Rajapaksa administration the per capita income for a year increased on average of $ 286.
Foreign reserves at the end of 2014 were $ 8.2 billion. Mahinda Rajapaksa Administration was targeting to increase this to $ 15 billion by 2020, Minister Cabraal stated at a press conference on 6 October. However, by end 2019, the foreign reserves had fallen to $ 7.6 billion. The national debt from Rs. 7 trillion in 2014 increased to over Rs. 13 trillion by 2019.
As Dr. Silva highlighted, the Gotabaya administration too reduced taxes. However, the objective was to encourage domestic production and increase export competitiveness with quality, branding and value additions, explained Dr. Kenneth de Zilwa at Hard Talk, Derana. Incentives were given to help local entrepreneurs to become global players. Even during the worst of the lockdown, the focus never shifted from restoring the economy. Thus sectors such as agrarian, finance and industrial sectors continued to operate.
These policy changes have already begun to yield results, despite the unprecedented challenges brought on by the pandemic. The paddy production this year is the highest recorded, ensuing food security.
Sri Lanka’s exports have surpassed that of pre-pandemic days. In September, the exports surpassed $ 1 billion for the third consecutive month this year. This is an increase of 5.6% compared to the $ 953.8 million to the corresponding period in 2019.
The rupee management is indeed admirable. Exports were put on a tight leash and the Central Bank continued to intervene in the domestic foreign exchange market to build the gross official reserves. By end September 2020, the CB had absorbed $ 255.1 million on a net basis.
As a result, this year the rupee has only depreciated by 1.4% against the US dollar. During the Yahapalana Government, the rupee depreciated by an average of 6.7% per year. The Yahapalana Government could not recover from it.
Within weeks of the lockdown, the rupee dipped to an alarming Rs. 200 against the USD. The Gotabaya administration quickly reacted and saved the rupee. By mid-April, the rupee was already recovering.
A positive outcome of the lockdown was that the country actually began to use online services. For a long time, we had the infrastructure, knowledge and facilities for online services from banking to shopping. However, the transition to online services never took root. With the lockdown, most services – including education moved online and work from home became a new norm.
Even the barometer of the economy – the Colombo Stock Exchange – became digital. With the lockdown in mid-March, the CSE too was closed down and was only reopened on 11 May 2020. Yet despite the unusual challenges the CSE daily activity quickly returned to the pre-pandemic days.
In September, there was a growth of 12% and its ASPI surpassed all other global Stock Exchange markets. The addition of Rs. 279.6 billion to the total market capitalisation is very significant. As a daily average, around 20,607 transactions took place during September. This shows the growing enthusiasm of the investors, CSE officials noted.
This hive of activity in the CSE is noteworthy as it comes at a time when foreign investors are exiting the market. This means the local investors are trading confidently, observed Minister Cabraal to this writer. He also noted that the foreign investor is exiting because of the issues faced in his own domestic economy. The CSE continues to outperform despite the ongoing ‘Brandix cluster’.
In the coming months, the rupee might depreciate again warn the experts. The administration is already gradually loosening its grip on import controls. Also, importers on a six-month credit period will soon have to honour for the orders placed before the import restrictions in April 2020.
However Minister Cabraal, responding to Moody’s pessimistic ratings pointed out that Sri Lanka has increased its income avenues. The CSE value that was hovering at around Rs. 1 billion has already increased to three billion. Soon, investments to the Port City will flow into the country. Foreign reserves are also building up, he noted.
Time will tell if Moody’s was correct in its downgrading Sri Lanka’s ratings. The pandemic continues to be challenging and unpredictable – the two components that make any investor run a mile. Yet, notwithstanding the negative rating or the prevailing uncertainty, the stock market performance – the barometer of the economy – is very positive.
By Shivanthi Ranasinghe