Pathfinder Foundation

Public sector employment in Sri Lanka has been increasing since the 1960’s, despite a decline in the size of government. Total public expenditure as a percentage of GDP has declined substantially from 1976 to 2011. There has seen a decline in the services provided by the government e.g. the removal of the food subsidy. Over the years, a few attempts have been made to arrest the growth of the public sector, including reductions in new recruitment and voluntary retirement schemes. Such policies were also promoted and supported by the multilateral donor agencies, such as the IMF and WB. 

Key Targets

It is encouraging that the Budget Speech 2013 sets out a fiscal framework that seeks to continue the trajectory of much-needed fiscal consolidation. If successful, it will address a perennial problem that has plagued macroeconomic management in Sri Lanka for over four decades. The budget also announced several measures to strengthen the supply-side of the economy (i.e. boost domestic production) in relation to SMEs, agriculture, other import substitutes and capital markets. The capital account of the balance of payments was also liberalized further. Despite these measures, the prospects of achieving the following two outcomes that are built into the budgetary framework are likely to prove extremely challenging:

The Challenge- from borrowed to earned reserves and beyond

The challenge for Sri Lanka is to develop a policy framework that would stabilize the economy; boost investment and growth; and earn rather than borrow reserves. All shades of political opinion are now focused on these issues. The Pathfinder Foundation (PF) is, therefore, raising a number of issues in this piece to stimulate thinking and debate.

By 4Q 2011, it had become apparent that the country was headed for a serious balance of payment crisis. This may be attributed to adverse external developments and a misaligned macroeconomic policy framework involving an overvalued exchange rate, expansionary monetary policy and an unsustainable fiscal deficit (particularly when the 2% of GDP losses of SOE’s are included in the government balance sheet).

Commendable Achievements

Over the years Sri Lanka has gained a considerable reputation for its achievements in social development. It punches above its weight on the UNDP's Human Development Index. It has also performed very well in meeting the internationally agreed Millennium Development Goals (MDGs) which focus on indicators related to poverty, health, education and gender parity.

There is also a positive narrative on poverty. The latest household income and expenditure survey (HIES) records that absolute poverty has declined to 8.9 per cent. This is an impressive figure for a country at Sri Lanka's stage of development. In addition, relative poverty, inequality, as measured by the Gini Coefficient, has remained steady at a time when there has been a sharp rise in inequality in countries ranging from the US to China. In fact, the Asian Development Bank has identified increasing inequality as the greatest threat to Asia's rise and the prospects of this being Asia's century. Recently, there has also been a trend towards greater regional balance in development across the country with the Western Province's share of national GDP declining.

Declining Trend

The Treasury has recently indicated that the country’s economic growth this year will be around 6.5%. As the recorded growth rate of the first half of this year was 7.1%, this means that growth in 2H 2012 is being estimated at 6%. The growth momentum will inevitably slow down steadily during the course of this year, as the restrictive measures, particularly the 18% credit ceiling set for banks (23% where they have been able to borrow the incremental funds from abroad), take effect. The re-phasing of public expenditure, announced recently, will further dampen economic activity.

Taking these developments into consideration, it is highly likely that the rate of growth will settle in the 5% - 5.5% range in the last quarter of this year. This is around the average growth rate achieved during the course of the conflict period. Hence, 5%-6% growth in post-conflict Sri Lanka is tantamount to no growth at all. It is also unlikely that growth impulses will be significantly stronger next year, particularly as tight macroeconomic policies will have to be continued due to the persistence of inflationary and balance of payment pressures. Recovery in the global economy is also expected to be sluggish. It is, therefore, now apparent that the government’s own medium-term growth target of 8% is unlikely to be a reality in 2012 and 2013. This is really an amber light (danger signal) that needs the urgent attention of the political leadership and policy-makers.

This article is based on selected extracts from an analytical study from the McKinsey Global Institute (MGI), research arm of McKinsey & Co. The goal of the research conducted by MGI is to provide leaders in the commercial, public and social sectors with the facts and insights on which to base management and policy decisions. MGI research combines the disciplines of economic and management, employing the analytical tools of economics with the insights of business leaders.

Current research focuses on six themes: productivity and growth, financial markets, technology and innovation, urbanization, labour markets and natural resources.

The Standard and Poor’s (S&P) Rating Services assigned a score of 8 (very high risk) to the Sri Lankan economy and banking industry last week. The role of ratings agencies in the lead-up to the global financial crisis (2008) was certainly highly questionable. There are also issues related to their accountability. Despite this, and setting aside the merits or otherwise of S&P’s assessment, this episode serves to highlight the following: