DEFICIT MANAGEMENT HOLDS THE KEY

Shiran Fernando delineates what’s in store for year 2024

Sri Lanka received IMF board approval for the second tranche of its Extended Fund Facility (EFF) in December. This will help boost confidence among international donors in the short term as it affirms that the once bankrupt nation is on the path to reformation.

However, this path is challenging given the expectation of elections this year, and impact that some of the tax and cost reflective tariff pricing measures are having on the public.

As seen in past programmes with the International Monetary Fund however, the stabilisation component of the reform agenda is usually carried out well but its continuance for lasting impact rarely eventuates.

It is necessary therefore, to review some of the key areas of growth and external sector stability in the reform process.

ECONOMIC GROWTH Following six quarters of economic contraction, the third quarter of 2023 (July-September) registered 1.6 percent growth. Though unimpressive at a headline level, this saw the agriculture, industry and services sectors registering growth.

Despite concerns about drought conditions in the latter half of the second and early third quarters, agricultural activities grew by three percent. This was driven by production in the rice and fisheries subcategories.

The services sector saw a modest 1.3 percent growth in the third quarter of 2023, which was supported by an improvement in tourism and its impact on related sub-activities.

Industry advanced marginally (by 0.3%) but this was the first sign of growth following steep contractions in the past six quarters. This improvement was due to the manufacture of food and beve­rages, while apparel and construction remained in negative territory.

Relative to the double digit contraction in cons­truction over the last few quarters, growth declined by 5.5 percent, highlighting the fact that a reduction in activity could be bottoming out. To support this, the Purchasing Managers’ Index (PMI) for the construction industry reached its neutral threshold of 50 in October – after 20 months of contraction.

It’s expected that the resumption of some govern­ment funded projects on a limited scale will boost activity in early 2024. However, the slowdown in apparel exports is expected to continue with weak growth in key markets.

Expectations by most forecasters for Sri Lanka’s GDP growth in 2024 are under two percent. This level of growth is not ideal and policy makers need to target an acceleration of three percent or more, led by unlocking reforms that will stimulate the ease of doing business, nontraditional exports and investments.

A stronger year for tourism – similar to 2018 – can boost services. An increase in construction at the national level will have an organic lift but it won’t be back to the level it was prior to 2020 given the lack of fiscal space for government spending.

DEFICIT MANAGEMENT The country managed its trade deficit in 2022 due to the healthy growth of exports and by curtailing imports. Last year, the export momentum reversed with a 12 percent contraction in the first 10 months, led by a fall in exports of apparels, rubber and so on although agricultural exports remained neutral.

As a result, a trade deficit ensued – particularly in October, which widened to US$ 682 million. The current account in 2023 was supported by strong performances in tourism and remittances, which grew by 71 and 66 percent respectively, albeit from a weak base.

If the price of oil remains below the 90-100 dollars a barrel range this year, Sri Lanka will be able to mitigate the potential increase in imports. However, there is uncertainty due to several ongoing global conflicts.

A resumption of construction activities could potentially increase investment in imports, which has eased in recent years owing to a slowdown in consumption. Managing the current account deficit will be the key to ensuring currency stability as well.

REFORM MEASURES The recent increase in value added tax (VAT) and removal of VAT related exemptions will have an impact on consumption and inflation, and this increase will likely be passed onto consumers.

As such, reform measures related to energy and state-owned enterprises (SOE) are needed to deliver material benefits to consumers. For example, energy reforms related to improvements in forecasting and the addition of renewable energy to the grid can potentially lead to lower tariffs in 2024.

A formulaic approach to fuel and gas can pass on benefits from global prices if the downward trend for oil – in particular, in the latter part of 2023 – continues.

Beyond this, improving productivity in SOEs and revenue administration, and a few divestments in the first half of 2024, could help support the revenue measures. It may also help ease certain tax measures if higher revenue streams are garnered.

Implementing some of the recommendations by the IMF on governance and corruption will also help boost confidence that the reform momentum is underway… and here to stay.