After elections, where to for Sri Lanka’s battered economy?

Sri Lanka’s September 2024 presidential elections can be read as a verdict on those held responsible for its 2022 economic crisis and the painful adjustment measures introduced to stabilise the downward spiral.

Accordingly, the Sri Lanka Podujana Peramuna (SLPP), led by Mahinda Rajapakse, a former prime minister, lost out hugely and incumbent President Ranil Wickremesinghe failed to convince voters to stay on course for a slow but steady economic recovery under the guidance of an International Monetary Fund (IMF) program. The winner – albeit with a plurality vote of 42% – was Anura Kumara Dissanayaka, the candidate from a Marxist-oriented Janatha Vimukthi Peramuna (JVP) party.

Mr. Dissanayaka’s winning message was that the JVP, as a fresh entrant, is best placed to tackle corruption and governance weaknesses that have been widely blamed for contributing to economic mismanagement. The message clearly resonated with the Sri Lankan public amid widespread anger at the economic deprivations of the past two years. The crisis-related inflationary episode eroded wages and savings; the subsequent fiscal adjustments via higher taxes ate further into disposable incomes. The neediest were offered some support as poverty doubled, but those on low-to-middle incomes especially – the squeezed middle – have seen their standards of living drop substantially.

In response, all presidential candidates, including Mr. Dissanayake, held out promises of tax relief, public sector wage increases, and bigger welfare handouts to tap into pent-up voter discontent. The challenge facing the new president is how to meet those expectations without derailing Sri Lanka’s hard-won economic recovery.

The orthodox macroeconomic stabilisation measures demanded under an IMF Extended Fund Facility (EFF) are never popular nor easy to implement. Harsh austerity measures draw even more opposition when implemented when an economy is contracting sharply. However, for a country in default, there is no option other than to sign on and begin the arduous process of sovereign debt restructuring negotiations with its creditors. Following the commencement of the March 2023 IMF program, a domestic debt restructuring deal was concluded in July 2023. By June 2024, a debt treatment agreement was reached with bilateral creditors, including India and the Export Import Bank of China. In September 2024, the final leg of securing an agreement in principle with bondholders and the China Development Bank was completed, awaiting sign off from official creditors on comparability of treatment.

The relatively speedy negotiating process, despite the complex creditor composition, was helped by Sri Lanka’s commitment to stay on course with its EFF commitments. The fiscal and monetary policy reforms have brought gains – inflation is low and stable, the exchange rate has steadied, and output growth is strengthening. Sri Lanka will likely end 2024 with a GDP growth rate of around 4%, double the IMF’s 2% projection.

The finer details of Mr. Dissanayake’s economic policy direction is expected to be spelt out after the parliamentary elections in November 2024. For now, the government has announced its intention to go along with the EFF. Indeed, there is hardly any choice in the matter. The only two options are to (a) rehash tax and spending at the margin without materially altering EFF targets and timelines or (b) seek a more thorough overhaul that will disrupt targets and timelines. The latter course of action has been the habit-forming prelude to Sri Lanka’s previous 16 IMF programs. This time around the risks are far higher. Disruptions to the IMF program review and approval process will curtail even the very limited access to foreign finance that Sri Lanka enjoys at present. Accumulated US dollar reserves since the crisis cover only 2.8 months of imports as of August 2024 and is insufficient to weather even a mild economic shock.

With the antecedents of the 2022 crisis still relatively fresh in the public’s mind, there is room for the government to adopt more measured and orderly adjustments to tax and spending policies without disturbing the fiscal framework. These can be shaped to bring distributional and productivity concerns to the forefront and build the necessary degree of consensus required. If investors are reassured of macroeconomic stability, the downward drift in interest rates will further support private investment and more durable economic growth. With the economy still operating well below its potential output, there is still considerable room for the current growth momentum to persist. Indeed, it is crucial that this momentum is not lost because productivity enhancing deregulatory reforms are likely to stall or be put aside for the foreseeable future. These reforms are more ideologically entrenched and if the voting patterns at the presidential elections are mirrored in November without any one party obtaining a strong majority, consensus building around economic policy will take time.

The popular discontent with mainstream politics that brought the untested Anura Kumara Dissanayake and the JVP to office means that the hopes for improved living standards, less corruption and a fairer society cannot be ignored. There is sufficient economic tractability to meet these aspirations through prudent policy setting for a measured and steady recovery that can be self-sustaining. What must be avoided is a rush for quick fixes that risks taking Sri Lanka back to an era of crisis management.

Dr Dushni Weerakoon is executive director of the Institute of Policy Studies of Sri Lanka.