Economic challenges 2019 - Seven dangers loom | Sunday Observer

Economic challenges 2019 - Seven dangers loom

The economic environment in which Sri Lanka ushered in 2019, is clearly the most unfavourable in recent history.

First, economic growth has been decelerating in the past few years as the Government’s economic management did not function effectively due to political instability within the government.

Second, foreign investments in emerging market economies including Sri Lanka have been flowing out to the US due to the tight monetary policy implemented by the US Federal Reserve (Central Bank of the United States), in 2018 through sharp increase in interest rates by 1% and reduced supply of dollars to the market and protectionist economic policy implemented by US President Donald Trump.

Therefore, Sri Lanka confronts a considerable shortage of funds, rise in Interest rates and excessive depreciation of currency (more than 19%) due to heavy outflow of foreign investments.

Third, another round of high Interest rates is caused by the downgrade of the Sovereign credit rating of the country.

Fourth, a considerable reduction in the foreign reserve to below US$ 7 bn is a threat to the international economic stability of the country.

Fifth, consequent to the increase in Interest rates and shortages of funds in the market, new borrowings of the government to service the debt stock in 2019 are challenging. Therefore, the possible use of foreign reserves to settle Sovereign Bonds of US$ 1 bn (due this month) will be a threat to the economy.

Sixth, the Government’s promise of several concessions to the public would cause further deterioration on the Fiscal front.

Seventh, the Central Bank (CB) has failed to control the excessive depreciation of the currency and maintained local Interest rates at subsidised levels through printing of money.

This will cause further depreciation of the currency though imports financed by new money printing at subsidised interest rates. Therefore, the CB has not been able to maintain the economic stability of the country.

Economic challenges

This challenging economic environment won’t be easy to fix in 2019. New challenges will arise in 2019. First, the US Fed has updated its economic forecasts and communicated another Interest rate hike of at least 0.5% in 2019.

Several European central banks including the European Central Bank have indicated a tightening of their Monetary policies in 2019 and beyond after following ultra-loose monetary policies during the past decade to recover from the global financial crisis of 2007/09.

Along with the monetary tightening and global trade tensions between the US and China, targets for world growth in 2019 have been revised downward, and the global monetary tightening will adversely affect economic activities and prices in Sri Lanka, through further shortages of funds and increase in Interest rates.

Second, continued currency depreciation caused by the outflow of foreign investments will raise prices of imports and domestic prices in general.

Third, as three elections are due this and next year, the fiscal policy would be more inclined to consumer concessions than economic development. As a result, the rise in fiscal expenditure/deficit will cause further increase in Interest rates and prices in the country.

Fourth, public debt stock and debt burden will rise further.

Fifth, to control further depreciation of the currency, a considerable increase in domestic Interest rates from the present subsidised levels is urgently required to re-attract foreign capital which has already fled the country and to reduce the demand for credit so as to discourage imports.

For example, a similar currency turmoil in 2000 was resolved by raising policy interest rates to 20%-23% (by 10%-11%) between March 2001 and January 2000 supported with several direct exchange and credit controls. Government securities yield rates rose above 18% in 2008 and 11%-13% in 2012 faster than the increase in policy interest rates effected to address similar concerns on foreign trade deficit and reserves.

Sixth, high interest rates will drag the economy into further deceleration/downturn.

Seventh, the economic downturn will be further fueled by less active public servants generally seen during times of political instability and national elections.They show a general reluctance to propose or implement new policies/reforms to avoid diverse political allegations and post-election investigations against them.

For anything and everything in government, allegations are levelled against public servants, especially high-ranking officials who implement decisions of the incumbent government as their public duties. Public servants are there to implement government policies and not to obstruct the Government.

Therefore, no positive thinking on confronting the above economic challenges can be expected until a strong government (which can be brave, take policy decisions, and implement them) is elected towards the middle of 2020.

As a result, there is a high risk of the country suffering stagflation (low growth and high inflation) in the next few years. Although the fiscal expansion to provide consumer concessions may help activate economic growth, the resulting increase in the demand and credit expansion will be Inflationary.

Although the cost of living can be reduced/controlled through concessionary prices and controlled/subsidised interest rates, the actual inflation in the country will increase due to underlying economic pressures.

New policy framework needed

The only way to fight such complex economic challenges is the implementation of a new policy framework of fiscal, monetary and foreign exchange under a strong government to target/facilitate an economy which can compete in global markets for investments, use of resources and trade.

All public economic services and regulations in the country should be innovated to facilitate the new policy framework. The launch of policy framework will take two to three years, provided that a strong government is established.

No mathematical formula for Economic managment -

In democratic countries, it is natural to have divided-views on such policy frameworks. Although economics and business subjects are studied with the help of mathematics, economic management is not mathematical.

There are no model-based/mathematical solutions to win economic challenges. All policies are discretionary and debatable. What matters is the implementation of them with subsequent fine-tuning to achieve targets while minimising the side effects.

The success of economic policy management depends on the levels of business development, generation of new employment, and promotion of income and living standards of the public relative to peer countries. We know of many poorer countries who developed through policy frameworks supporting foreign investments and trade during the past four decades. Sri Lankan new policy framework and economic development that drove in 1980s have subsequently been sluggish due to such ideological conflicts.Therefore, the best solution would be to present a policy framework with annual macroeconomic development targets for consent of the public in forthcoming elections.

Then, all public servants will have to leave aside their own ideologies and implement the policy framework of the elected government. Further, the room to introduce sudden policies that become subject to political allegations will be minimised. Therefore, the new economic policy statement will help promotion of good economic democracy.

The success of new economic policies will primarily depend on the extent of the control of present pressures on currency depreciation, re-inflow of foreign capital, disappearance of credit/liquidity shortages, reduction in interest rates and improvement in investor sentiments, provided with political stability.

Otherwise, an economy managed through fiscal front and rising public debt, would be catastrophic to future generations. Further depletion of foreign reserves and excessive currency depreciation are the immediate risks that could drag the economy into crisis, and that can be prevented only by raising the Foreign Borrowings of the Government at a high cost.

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The writer is a former Deputy Governor of the Central Bank and Chairman and a member of several Statutory Boards. 

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