Sri Lanka: Economy

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Chandrima Banerjee, March 24, 2022: The Times of India

Annual GDP per capita growth, Sri Lanka, 1970-2020
From: Chandrima Banerjee, March 24, 2022: The Times of India
Revenue collected by the Government of Sri Lanka, 1938- 1953; Revenue from international trade, 2010- 2019
From: Chandrima Banerjee, March 24, 2022: The Times of India
Share of subsidies (as %) in Sri Lanka government's current payments, 1968- 80; Subsidies, grants and other social benefits as share (%) of Sri Lanka government expenses, 1990- 2015
From: Chandrima Banerjee, March 24, 2022: The Times of India
Average annual growth (as %) of gross fixed capital formation, 1960- 2020
From: Chandrima Banerjee, March 24, 2022: The Times of India
Share of military expenditure (%) in Sri Lanka's GDP, 1960- 2020
From: Chandrima Banerjee, March 24, 2022: The Times of India

Life is trudging along in a stop-start mode in Sri Lanka. The military is overseeing distribution of fuel at filling stations. A cup of milk tea will now cost Rs 100 (from Rs 25 in October 2021), with exactly three teaspoons of milk powder, and be no more than 200ml (imported milk powder is now Rs 1,945 a kg). School exams were cancelled because Sri Lanka ran out of paper (the government later announced it was going ahead anyway). And two senior citizens died waiting in line for fuel, one of them for four hours.

It’s the fallout of a crumbling economy at its extreme, fuelling a slow burn.

The economy is at its worst since the country became independent in 1948. But beyond the glaring big-picture indicators of economic dissolution and the much-debated ‘ debt trap’ is the narrative of what this means for the social indicators of a country that had been doing, by far, the best in south Asia. And how Sri Lanka’s continued short-term attempts at maintaining them may have condemned it to a cycle of sporadic economic stagnation — annual inflation is at its highest in 14 years and share of working people at its lowest in 30 years.

This crisis has played out before

The Sri Lankan economy has shrunk at least thrice earlier. It recorded negative growth in 1971-72, almost ground to a halt by 1987 and plunged again in 2001. In 1971, it was right after partial liberalisation when export demand did not pick up the way Sri Lanka thought it would. In 1987 and 2001, it followed ethnic conflict and a need to suddenly step up defence expenditure. Each time, Sri Lanka found itself unprepared.

Around the time Sri Lanka gained independence, it did three things that codified welfare as the core of its policymaking. It implemented a free education policy in 1945, set up a department of social services in 1948 and passed the Health Service Act in 1953.

In the financial year of 1947-48, social services accounted for 52% of Sri Lanka’s expenses. Education, sustenance and health care were taken care of — as they should be in any country with good governance.

It translated into brilliant social indicators. The life expectancy at birth that India reached in 2019, for instance, was what Sri Lanka had achieved by 1997. India’s infant mortality rate now is what Sri Lanka’s was in 1984. India’s adult literacy rate is still not what Sri Lanka’s was in 1979. By 1970, of every 10 children old enough to be in primary school, six were studying. In India, that was four of 10.

These were actual meaningful changes. But how was Sri Lanka funding it?

Plantations, for at least three decades after Independence. Tea, rubber and coconut. Their exports got the country “90% of its foreign exchange earnings,” wrote Sri Lankan economist Saman Kelegama in 2000. “The bulk of these earnings was used for food imports.”

Of those food imports, Kelegama added, rice alone accounted for about 25% of the imports in the 1950s. Part of that rice would be distributed in subsidy schemes. That meant the slightest disturbance in plantation exports could potentially disrupt the government’s welfare plans. But the government could not have allowed that. (Elections are won and lost on subsidy promises. In 1953, Prime Minister Dudley Senanayake had to resign after massive protests over the decision to reduce food subsidies.) So, to reduce export dependence, it turned to import substitution — meaning, create the thing you need in your own domestic market. In 1971, it cut rice import volume by 39%. That did not go too well.

The point of government welfare is to support its people and create an environment where they can eventually take care of themselves. But Sri Lanka was trapped in a cycle — announce subsidies, fund it with money from plantation exports, try to find import substitutes when exports tank so that handouts could continue.

Meanwhile, in the decades of plantation-backed prosperity, Sri Lanka had not spent too much on infrastructure — plants, machinery, roads, railways, industrial buildings, and so on. In fact, in the first five years since Independence, its highest allocation to “development of national wealth” was 18.5%. So, when its import policy was suddenly altered to let only essentials in, the situation “ reduced to a most inadequate level the imports of industrial raw materials and capital equipment” by 1972.

Sri Lanka opened up its economy in 1977. Its food imports dropped immediately. Industrial investment flowed in. Machines needed for production could be acquired. Exports picked up. But by the 1980s, there was another fire to put out. Ethnic conflict between the Sinhalese majority and the Tamil minority. The Sri Lankan Civil War that started in 1983 would continue till 2009. Sri Lanka had to suddenly divert its resources to the military as militancy emerged. Investors pulled out. A slow recovery was again pushed back by a drought in 2000 (agricultural output dropped) and a terrorist attack by the LTTE on the Katunayake International Airport in 2001 (tourism withdrew).

It led to the biggest collapse the Sri Lankan economy had been through, in 2001. Until now.

But even while these shifts challenged Sri Lanka’s economy over and over, no government experimented with the subsidy plans too much. Even at its lowest, in 2012, subsidies accounted for 19% of the government’s expenses when goods and services took up just 10% of government expenses.

Is welfare to blame then?

The unplanned spending alone is not the problem — its effectiveness is.

“Pensions account for most transfers, but not surprisingly given the public service background of pensioners, less than half of them are in the bottom 40%,” a World Bank report said in 2015.

“Fertilizer subsidies are the least well-targeted transfer, with only 45% of the benefit being devoted to the bottom 40%,” the report added. In fact, “a third of spending on social transfers goes to the richest 60% of the population.”

And why is that? “Programs rely on manual registration and identification, and lack a capability to actively search for excluded individuals. Although some programs have categorical eligibility criteria, more than half of Sri Lankans living below the poverty line receive no benefits from existing social assistance or social welfare programs (though they may benefit from free health and education).”

The irony of the Sri Lankan economic planning over eight decades is that subsidies set off a cycle that ended up pushing most essentials out of reach for people. Onions would cost Rs 70 a kg last year. Now, they cost Rs 128. A kg of tomato would cost Rs 100. A year on, it costs Rs 230. Eggs cost double what they used to (from Rs 15 to Rs 30) and dal shot up from Rs 173 a kg to Rs 400.

Meanwhile, power cut schedules are announced every day (though all lines were up and running when President Gotabaya Rajapaksa had to make an address). Colombo could not clear its garbage because trucks could not refuel. Fewer buses will run in the country because there isn’t enough fuel. The poultry industry has said it can’t afford chicken feed and will “collapse by April”.

And while Sri Lanka keeps expanding its import ban list — cars, turmeric, milk products, fruits, fish — businesses, especially smaller ones, are shutting down.

Which means Sri Lanka spent a large part of its resources on subsidies, drained its reserves and did not quite help the people who needed it most — its welfare backfired.

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