A subdued parliamentary election campaign is in sharp contrast to the horrors that await the new government; the pandemic, fiscal problems, foreign debt and a low growth economy. This is a perfect storm that will prove a severe test although these critical issues were ignored during the election campaign to elect a new legislature. Start with the pandemic; the health crisis is bad enough but the COVID-19 economic crisis originates largely with the lockdown and curfew preventing the pandemics spreading out of control in the community.
Although the lockdown is now lifted, restrictions on movement, changes in consumer behaviour stemming from fear of infection (avoiding socialising), the closure of overseas markets and restrictions on imports, continue. There could be several reasons why a discussion about the budget deficit, debt rollover, how to generate economic growth and the future of jobs, was absent on the campaign trail.
None of these questions have easy answers. After Covid The government has done a great job in containing the current outbreak but new cases are emerging. If borders are opened there may be further outbreaks. This is a medium-term problem. If further curfews or lockdowns are contemplated then the associated trade-offs must be considered.
The Central Bank’s last published medium term debt management strategy is based on assumptions of 5% GDP growth, a budget deficit of 3.5% and inflation of 5%. These no longer hold
As The Economist notes, “The trade-off between saving lives and saving livelihoods is excruciating”, but not one that policymakers can shy away from.
Norman Loayza of the World Bank sums up the dilemma: “We are facing an acute public health, economic, and humanitarian crisis. What makes managing this health emergency so challenging is that if unattended, it could lead to countless numbers of fatalities—yet if drastic measures to contain the spread of the virus are imposed, it can produce a deep recession with business closures, mass unemployment, and poverty.”
We need to understand the medium term health strategy because this will shape the trajectory of the economy. The credit rating agency, Fitch, has flagged several critical issues for the medium term.
First, the country’s external liquidity ratio (defined by Fitch as liquid external assets as a percentage of liquid external liabilities), at around 60% in 2019, is among the lowest in its rating category. The higher the ratio the better.
Second, Fitch forecasts a wider budget deficit, at 9.3% for 2020 (Min Of Finance estimates it to be 8.5%), and third Fitch estimates debt-to-GDP ratio will increase to around 94% in 2020, far above the ‘B’ rating median of 66%.
Fourth, Sri Lanka’s debt servicing obligations over 2021-2025 are substantial, amounting to an average of $4.3 billion per year. Some of the challenges aren’t as apparent as the deficit. The impact on government revenue of import controls is something that has not been quantified. Customs, which collects import taxes, contributes a little over half of all government revenue. In the event import controls are to extend in the medium term then how will the resulting shortfall in revenues be met?
The Central Bank’s last published medium term debt management strategy is based on assumptions of 5% GDP growth, a budget deficit of 3.5% and inflation of 5%. These no longer hold and the asking yields on Sri Lanka’s bonds have increased. A fresh IMF programme may be unavoidable to create the confidence but what are the likely commitments that this will entail? Managing the economic fallout The curfew has been lifted but the impact of the curfew continues. Most businesses faced a complete halt in activity during the curfew.
Without revenue, they met fixed costs like salaries and overhead like rent by dipping into reserves or by borrowing. To try to manage with limited resources many also imposed salary cuts and/or shed staff. Result: businesses face a working capital crunch.
Most salaried employees who retained their jobs have seen reduced income; those who have lost jobs have no earned income. Those affected by salary cuts and job losses have resorted to reserves or borrowed to survive the curfew. Informal sector workers suffered a complete loss of income surviving on charity, borrowings and whatever reserves they may have had.
The BOI firms employed around 1.2m with 35% directly employed. JAAF announced that 100,000 jobs are at risk. The construction sector employs around 650,000. An industry spokesman said at least 100,000 will be unemployed if work did not resume quickly. The World Travel and Tourism Council estimates around 470,000 to be directly employed in the sector in 2018 with nearly as many employed indirectly
The upshot of these factors is a contraction in aggregate demand which is worsened because even people who are financially unaffected have altered their behaviour and spending. Moreover, because of import restrictions, even those businesses that have some demand are unable to supply imported goods for sale. However, the full impact on the imports sector will be only visible once stocks run out.
Job losses As per labour force survey 4Q 2019: unemployment was 4.5% (387,460) of the workforce of 8,181,442. This rose to 5.7% in 1Q 2020, a level not seen since 2009. This was before the major impact of the curfew, what are we likely to see by the year-end?
The BOI firms employed around 1.2m with 35% directly employed (420,000). The Joint Apparel Association Forum (JAAF) announced in June that around 100,000 jobs are at risk. The construction sector employs around 650,000, an industry spokesman said in June that at least 100,000 will be unemployed if work did not resume quickly. The World Travel and Tourism Council estimates around 470,000 to be directly employed in the sector in 2018 with nearly as many employed indirectly.
With the industry at a standstill, many of these jobs are at risk. Job losses among migrant workers overseas have the same impact on a family as the loss of a job domestically. Over a million workers are overseas, remittances were down 23% in May 2020 compared to the previous year. This has a direct impact on local consumption. This is just the formal sector, in Sri Lanka about 60-65% of all employment is informal with some 1.5m in agriculture. Trishaw drivers, day labourers, street vendors have all lost income.
Although Sri Lanka has only 4.1% below the national poverty line ($1.90 per day) nearly one million people live just 20% above the NPL. The pandemics fallout will push, below it, many of those just above the poverty line. Some long-term relief measures may be necessary but the question is how will they be funded? As a result of collapsing demand, if many businesses are wiped out the economy may prove incapable of rebounding, even when global markets recover.
The government has provided relief to businesses through the banking sector, by some estimates almost half the loan books of the banks are subject to the moratorium. The recoverability of the loans under moratorium will only be known once the moratoria run out. If the bad loans mount, there is a possibility that the crisis may spill over to the financial sector particularly the non-bank financial sector.
Will current levels relief to businesses be sufficient to contain the problem of business collapse? In the event of spillover to the financial sector, what strategies are in place to manage this? Sri Lanka’s policymakers will be facing some of the toughest questions in decades.
And they need to find solutions in a world facing the worst slump since the Second World War.
The writer is an independent consultant