Reforms Urgent but need careful balance to limit cost to the Poor
Despite both internal and external challenges, Sri Lanka was able to report a broadly satisfactory performance in 2016, says the World Bank’s latest Sri Lanka Development Update. The report lists some of the country’s landmark achievements, such as the passing of the Right to Information Act, and the regaining of the General System of Preferences Plus (GSP +). The country also improved its public finances by narrowing the deficit in fiscal accounts. With a strengthening global growth outlook, the report projects an improved outlook for Sri Lanka country, provided the government remains committed to the implementation of the ambitious reform agenda.
The Sri Lanka Development Update also highlights how the construction sector’s rapid recovery, supported by a strong rebound in investment, was able to offset some of the damage done to the agriculture sector by floods and droughts in recent months.
“However, our report identifies some key challenges ahead,” says Ralph van Doorn, the Senior Country Economist for Sri Lanka and the Maldives. “There is a need to improve the pace of reform implementation, which, if not, would place at risk future economic growth and stability. On the other hand, despite strong tourism receipts and stable remittance flows, Sri Lanka faces a weak external account with large bond redemptions coming up from 2019.”
As part of its special focus, this edition of the Sri Lanka Development Update also considers how the country could sustain growth, strengthen its structurally weak current account, and create new, productive jobs in the private sector. To make the island attractive to foreign investors, the report says, the legal framework must evolve to address concerns around issues like investor protection and policy predictability.
Cautioning against adopting piecemeal solutions, the report notes that the key challenges are inter-linked and require a comprehensive and coordinated reform approach. Although the island nation must cope with a turbulent external environment and domestic political considerations, a strong political will and the support of the bureaucracy could help advance the reform agenda, the report concludes.
Some key messages from the report:
Tackling challenges through reforms is crucial for sustained and equitable growth
The report notes that one of the key highlights is the improvement in public finance. In 2016, increased profits and dividend income from State Owned Enterprises (SOEs) helped increase revenues. A key challenge going forward is to structurally increase tax revenue, while relying less on non-tax revenue.
Deep and far-reaching reforms are needed for Sri Lanka to shift its growth model to a private investment-tradable sector-led model, and plug into global value chains. And while new reforms are needed, those that have already been approved by parliament - such as the Right to Information Act - need attention if they are to be successfully implemented.
In the face of adverse weather, Sri Lanka needs to increase both physical and financial resilience
Floods and droughts that affected wide swathes of the country had an adverse effect on the economic growth and exports performance. Although fewer people were impacted than in previous floods, the damage caused by the 2016 floods and landslides was more than twice as high in US dollar terms than the worst flood disasters between 1992 and 2011.
The World Bank is supporting the government’s Climate Resilience Improvement Project (CRIP). Its recommendations include, among others, identifying current and future climate risks and immediately implementing risk mitigation projects, risk-informed new development and risk reduction investments in high target areas.
In terms of bolstering financial resilience, there are some options that could help the government increase its immediate financial response capacity against natural disasters and better protect its fiscal balance. These include short term strategies like streamlining damage-and-loss data collection and reporting systems and developing a national disaster risk financing strategy.
Medium term solutions could include strengthening the agricultural insurance program and establishing a National Disaster Reserve Fund as a fast-disbursing mechanism for the financing of post-disaster operations.
The impact of fiscal consolidation on the poor is a key policy consideration
While extreme poverty has declined, moderate poverty remains high in Sri Lanka. In 2012/13, nearly 15 percent of the population, and a quarter of the estate sector, lived on less than $3.10 per day. Furthermore, pockets of poverty persist in the north and east of the country, as well as in the Estate sector and Moneragala district. At the same time, spending on social assistance has declined relative to GDP between 2004 and 2014 in real terms. Inefficient targeting means that the money spent does not always go to those who need it most.
While Sri Lanka has made significant strides in poverty reduction, it is important to consider how the upcoming reforms will impact different segments of the economy. While there will be significant gains for the majority, there will be sectors, firms, and workers who will suffer from the surge in competition and declining protection for domestic industries.
One way is to carefully assess the impact and distribution of new taxes to help offset the negative repercussions for the poor. An example of this might be the structure of the current VAT exemptions - virtually all VAT exemptions are less efficient in helping the poor, since wealthier households account for the majority of consumption on almost all specific items. The report notes that replacing them by targeted expenditure under the social safety net could be a more efficient way to protect the poor at a lower fiscal cost, while simplifying the VAT system. Such steps will help Sri Lanka ensure that those who are negatively affected by reforms are not left behind.