Sri Lanka Development Update: Creating new opportunities and managing risks “critically important” in ensuring sustainable development

The most recent edition of the World Bank’s Sri Lanka Development Update—which analyses key developments in Sri Lanka’s economy over the past six months—finds the country at a critical moment in time. Now firmly in the post-war era, the island nation must look to the future, embracing every opportunity to combat poverty, create new jobs and build a resilient, robust economy.

Its best chance of success lies in an ambitious and challenging shift from a public investment, non-tradable sector-driven growth model to a more private investment, tradeable sector-led model. It is a sea change that will allow the country to benefit from its location close to some of the largest, fast-growing economies in the world.

The second Development Update for 2017, the report begins by noting that corrective policy measures taken in the monetary and fiscal fronts have led to gradual stabilization, and that overall, Sri Lanka’s economic performance remained broadly satisfactory in the first half of 2017.

A particularly noteworthy milestone on the road to sustainable, revenue-led fiscal consolidation came in the form of a new Inland Revenue Law, passed by Parliament in September 2017. Value Added Tax (VAT) reforms, in their first year of implementation, are expected to drive fiscal consolidation. Supported by a small primary balance, the overall fiscal deficit is expected to fall to 5.1 percent of GDP for 2017, thanks mainly to the implementation of revenue measures. As a result, the debt-to-GDP ratio is expected to stabilize in 2017 compared to 2016, having risen continuously since 2012.

The country also regained tariff-free access for most exports under the Generalized System of Preferences Plus (GSP+) from the European Union in May 2017—though it is yet to be in full compliance.

While such successes indicate progress, vital reforms are lagging behind, caution the report’s authors. Among these are the One-Stop Shop for FDI, reforms to the investment climate and trade, and SOE reforms such as for Sri Lankan Airlines. In addition, meaningful progress is yet to be made on the debt management agenda and passing of the Audit Act.

Sri Lanka has ambitions of graduating to upper middle-income country status but to realise its full potential, the island will have push the reform agenda and revitalise its economy.

Laying out the challenges ahead, Ralph van Doorn, the Senior Country Economist for Sri Lanka and the Maldives, said: “To get there, Sri Lanka must maintain macro-fiscal stability and increase its resilience to natural disasters. While pursuing structural reforms to promote competitiveness and attract more FDI, the country cannot afford to forget its poor or vulnerable. Policy instruments are the answer here—innovatively deployed, they can support structural adjustment, protect those adversely impacted by reforms, and provide transparency and accountability.”

This edition of the SLDU takes for its special focus the importance of integrated risk management in ensuring sustainability. As Sri Lanka moves toward a more private-investment driven, export-led economy, the country will become more resilient to many macroeconomic risks, but will simultaneously be exposed to new ones. The report explores how these risks can be managed at different levels of society, breaking it down by households, firms, the public sector and the macro-economy.

Below are some other key messages from the report:

1. Growth is expected to pick up, public debt levels are projected to fall

Growth is expected to reach 4.6 percent in 2017 and increase marginally over 5.0 percent beyond, driven by private consumption and investment growth. The report notes that successful implementation of reforms should help the country to switch from its current reliance on non-tradable sectors to productive, tradable sectors in the long run. Inflation is expected to stabilize toward the end of 2017.

While public debt levels are projected to fall, it is with the caveat that fiscal consolidation remains on track. If successful and barring any severe shocks, this continued fiscal consolidation is projected to bring the public debt burden to a downward path again in 2017, ending a 5-year consecutive rise.

2. Staying on the fiscal consolidation path is a key priority.                   

The SLDU emphasises that urgent action is needed to manage the downside risks of public debt. Various reforms will prove critical, but when it comes to managing state spending, Sri Lanka must prepare for future shocks. One notable instance is disaster preparedness.

In 2017, evidence of disasters can be seen everywhere in the macroeconomic data: drought’s impact on the agriculture sector makes for a contraction in the GDP and triggers food price inflation; there is decline in revenue due to temporary removal of duties on essential goods; expenditure reallocation; increased imports of essential goods; increased imports of oil (due to the 2016/17 drought’s impact on hydro power) and reduced exports due to damage and losses in the productive sectors.

It is also critical that country brace for a serious demographic transition. With one of the fastest aging populations in the region, planning for expanded pension coverage, old-age health and long-term care will be key to Sri Lanka’s economy.

The authors report note that a reduced fiscal deficit will also limit exposure to global financial markets, which are expected to gradually become tighter. This move would also free up much needed credit for Sri Lanka’s private sector.

3. Managing risks and creating new opportunities is critically important in ensuring sustainable development.

Drawing on the risk management framework introduced by the 2014 World Development Report, the SLDU argues that integrated risk management is a powerful instrument for development. Anchored in the understanding that risk is an inherent part of pursuing opportunities for development, it considers how to confront risk successfully through public and private action. Some risks are of course beyond the scope of individuals, but all risk management requires a proactive, systematic, and integrated risk approach.

Reforms, both those currently underway and those in the planning stages, and improved management of risks are expected to produce many positive outcomes, including increased and sustained growth, new and better paid jobs, minimised impact from natural disasters, more business opportunities, more exports, better infrastructure and a more stable macroeconomic environment. However, what costs arise for those affected negatively be reforms must be sensitively managed through public policy.

The SLDU notes that the impact of fiscal and trade policy reforms on households can be mitigated through a strengthened and well-targeted social safety net, retraining programs and transferable pension arrangements. Improving the business environment, including improving trade facilitation, will make it easier for firms and workers to benefit from growing sectors.

Download previous editions

June 2017: Unleashing Sri Lanka’s trade potential 

October 2016: Structural challenges identified in the Systematic Country Diagnostic