Troubled Sri Lanka’s economic growth records a negative 7.8 % in 2022: Report

Crisis-hit Sri Lanka’s annual gross domestic product (GDP) or economic growth, as forecast recently, was a negative (-) 7.8 per cent in 2022, against (+) 3.5 per cent in 2021, according to the Central Bank’s annual report for 2022 released on Thursday.

The report was released after it was handed over to President Ranil Wickremesinghe who is also Minister of Finance, by Central Bank Governor Dr. Nandalal Weerasinghe on the same day (April 27)

In a statement, the Central Bank said:

“The Sri Lankan economy faced its most onerous year in its post-independence history in 2022, comprising severe economic hardship that led to both public anxiety and political upheaval. The impoverished conditions in the economy warranted immediate and coordinated policy initiatives by the Government and the Central Bank to preempt a further escalation of the situation. Although the corrective measures affected the vast citizenry in the near term, they were necessary to safeguard the economy and economic agents from potentially devastating consequences of unrestrained economic instability, such as hyperinflation, collapse of economic activity to a much deeper level, and a complete disconnect of the country from the rest of the world, with far worse consequences to the people and businesses. The outcomes of these efforts have eventuated since late 2022. The country managed to transition to a workable equilibrium in the near term, focused on restoring socio-economic stability, while the envisaged assistance from the international financial institutions begins to materialise.

Having run an unsustainable macroeconomic model in tandem with the longstanding deficits in the budget balance and the external current account, the economy had fully exhausted its buffers by early 2022 as it was straddled by a myriad of vulnerabilities that emanated from both global and domestic sources. Several inherent weaknesses of the economy, further exacerbated by policy lapses, steered the country towards a multifaceted disaster. Ill-timed tax reductions, an ill-equipped attempt to swiftly adopt organic agriculture, the depletion of the country’s official reserves amidst futile attempts to maintain an untarnished debt servicing record, the delay in the exchange rate adjustment, and the failure to pay heed to several early warning signals caused tremendous shockwaves across the economy. Consequently, the economy was battered by excessive balance of payments (BOP) pressures with acute shortage of foreign exchange liquidity and pressured exchange rate, spiralling inflation and dampened economic activity amidst mass loss of livelihoods, large fiscal imbalances, public debt reaching unsustainable levels with extraordinarily high risk premia, devastating sovereign rating downgrades that constrained access to external finance, unprecedented heightening of socioeconomic and socio-political tensions, and rapidly deteriorating business confidence, among others. Businesses and the general public alike were in severe distress amidst shortages and rationing of essentials, the ballooning cost of living and cost of production, and the loss of welfare and livelihoods. Consequently, the rapid unfolding of social unrest resulted in political instability, warranting an urgent need for redefining policy priorities to steer the economy away from further turmoil.

Amidst mounting BOP pressures, the exchange rate was allowed a measured adjustment in early March 2022. However, the subsequent floating of the exchange rate resulted in an overshooting, fuelled by speculative activity. The Central Bank adopted aggressive monetary policy tightening in April 2022 to rein in demand pressures, complemented by a robust communication strategy aimed at anchoring inflation expectations, while taking measures to stabilise the exchange rate amidst exhausted levels of useable reserves by April 2022. Meanwhile, the Central Bank provided foreign exchange to the market to meet the demand for essential imports to the greatest extent possible amidst a dearth of foreign exchange inflows and significantly low levels of official reserves. Moreover, the Central Bank initiated measures to prioritise essential imports and restrict capital outflows through appropriate control measures, while continuing the requirement for the mandatory sale of foreign exchange to the Central Bank by licensed banks, based on the conversion of repatriated foreign exchange, and commenced providing daily guidance on the exchange rate to curtail undue intraday volatilities. Moreover, the Central Bank’s continuous financial sector oversight and adoption of appropriate regulatory measures along with effective communication ensured financial system stability amidst severe socio-economic distress.

The Government initiated measures in early 2022 to seek assistance from the International Monetary Fund (IMF) after months of indecisiveness. The IMF had already assessed that Sri Lanka’s public debt had reached unsustainable levels, hence, any funding assistance from the IMF needed to be preceded by efforts to restructure public debt. Subsequently, when it reached a critical point of inability to service debt payments, the Government announced a debt standstill in mid-April 2022, thereby suspending the servicing of external debt, mainly bilateral and commercial debt, as an interim measure, while soliciting support from official and private creditors to restructure outstanding debt. Simultaneously, several initiatives were made by the Government to enhance government revenue, curtail expenditure, introduce reforms to major State Owned Enterprises (SOE), implement import controls, and ration energy supply, while exploring bridging finance from bilateral and multilateral partners for essential expenditures as well as supporting the most vulnerable segments. In September 2022, a staff level agreement was reached for an Extended Fund Facility (EFF) from the IMF, followed by efforts to secure financing assurances from official creditors towards the restructuring of debt, in line with the debt sustainability targets envisaged under the IMF-EFF supported programme. In March 2023, the Executive Board of the IMF approved the EFF supported programme of 48-months, amounting to approximately US$3 billion, along with an economic adjustment programme that was aimed at putting Sri Lanka back on a recovery path, while addressing structural impediments that constrained the country’s growth potential over the past decades. With a multitude of goals to be achieved under the IMF-EFF arrangement, restoring public debt sustainability through the debt restructuring process will be one of the key milestones in the path towards attaining a sustained growth in the economy. However, debt restructuring could pose near term challenges in the financial sector that need to be addressed proactively by the Government and Central Bank, thereby reinforcing the financial system stability in the period ahead.

Policy measures and reforms implemented by the Government and the Central Bank have yielded notable success thus far. Inflation returned to an impressive disinflation path following a historic peak in September 2022, and the exchange rate remained stable and registered an appreciation in early 2023, having depreciated sharply during the first half of 2022. Further, the external current account deficit remained modest alongside the gradual accumulation of official reserves, thereby enabling the reinstatement of exchange rate flexibility from early March 2023. The envisaged normalisation of foreign exchange flows and the completion of the debt restructuring process during 2023, and the sweeping reforms in the public sector, are expected to pave the way for the country’s progress towards improved and sustainable economic prospects.

The socio-economic crisis in 2022 underlined many lessons that the country failed to grasp, despite the recurrence of such macroeconomic failures throughout its post-independence history. This economic episode reiterated the essentiality of data-driven policymaking; devastating implications of ad hoc policy experiments; crippling welfare impacts of myopic populist policies; and the cost of policy delays, disregarding evidence-based policy analysis, well-established economic fundamentals and expert opinions. The general public and businesses at large had to bear the cost of a one-time adjustment of delayed structural reforms. Against this backdrop, the Government, the Central Bank, and all other stakeholders need to extend their support towards the implementation of essential reforms at this juncture, to resolve the structural hindrances that have rooted in the economy over the last seven and a half decades. Failing to execute such reforms would lead to perpetual bailouts, endless cycles of external borrowing and recurring debt restructuring alongside unsustainable and highly volatile business cycles, which would cause undue pressure on citizenry, preventing the country from achieving longstanding economic progress and prosperity. Hence, in the country’s efforts to emerge from the current crisis, consistent and well-coordinated policies, including those outlined in the IMF-EFF supported programme, should be executed in a timely manner to avert another crisis in the period ahead.”