Originally appeared on The Morning
By Dhananath Fernando
In Buddhism, there is an anecdote on treating a seriously injured patient: “When a man gets injured with a poisoned arrow, there is no time to investigate from which direction the arrow came and who sent the arrow. The sensible decision is to urgently treat the patient before the situation becomes serious.” Our economy is at such a critical stage that we have no time to point fingers at each other. We have to enact reforms as soon as possible, particularly to protect our most vulnerable and impoverished citizens.
With the currency flotation and the rapid and sustained LKR depreciation, the wellbeing and survival of less well-off Sri Lankans has become a serious question.
Those who have little knowledge of economics have started complaining that the currency depreciation is at fault, forgetting or not knowing what led to the currency depreciation.
As this column has highlighted for the last few years, our inappropriate policy decisions have led to the rapid depreciation in the first place. Maintaining low interest rates, continuous expansionary monetary policies (money printing), poor management of public finances, and compromising government income has caused a balance of payment crisis (commonly known as a lack of USD/foreign currency) to the extent that we now cannot even afford to import essential goods such as food items, gas and oil. Since the Central Bank can no longer artificially raise the value of the currency by spending reserves (due to very low level of reserves), the banks were asked to manage the exchange rate based on their forex demand and supply.
Simply put, a currency float is where we allow markets to determine the exchange rate to obtain the market value of a currency. However our ‘floating currency’ was not a true float as the Central Bank had regulations for banks to sell 25% of their forex and regulations on exporters to convert their forex proceedings within a stipulated time. Such regulations will not encourage forex inflows and will create excess demand by more importers who attempt to buy forex due to uncertainty. Further, the absence of a proper reform plan from the Government of Sri Lanka (GoSL) simply kept the markets more uncertain and led to firms and individuals holding on to their forex currency. As a result, the currency depreciated, since the more we maintain a situation of uncertainty, the greater the pressure on the currency.
So, what can we do to solve the problem of higher cost of living, particularly for poorer people? When the currency depreciates, people in sectors of the economy that are particularly sensitive to price hikes, including taxi drivers, fishermen, poor households that use LP gas, etc. are affected. The sensitivity to price hikes is higher the more those sectors and people are closer to the poverty line. Simply put, the people who stay just above the poverty line risk falling below and pressure on daily survival for many will continue to increase.
To avoid inflationary pressures we have to increase interest rates further. In economies which are functioning dynamically and smoothly, the interest rates are kept at low levels. But in a country where we have done a significant amount of money printing, keeping the interest rate low is going to worsen the balance of payment crisis. When interest rates are kept low, access to money will be easier, so people will try to consume more, which will add more pressure on forex outflows.
While interest rates are increased, we have to immediately revamp the welfare system and create a new social security network with proper targeting. That is one of the main reforms we need to implement in order to overcome the economic crisis. In fact, we should have had a better social security system in place before we floated the currency, but our situation was so critical that we cannot manipulate our currency further.
There are too many people in the current Samurdhi programme who don’t deserve to be in the system, and the programme has become extremely political. The withdrawal pattern shows that some of the Samurdhi recipients withdraw money only once or twice a year as a nice bonus during the New Year season or during the Christmas season. At the same time, there are a lot of genuinely vulnerable people outside the Samurdhi programme who actually deserve to partake.
Abolishing an existing programme and setting up a new programme in a short time may also not be very easy as there may be resistance from within. Particularly with politically connected beneficiaries, resistance may mount up against any new programme that better targets recipients. Secondly, the social security benefit should be adjusted based on market prices. For example, when the global market prices increase, the allowance should increase accordingly and when the prices come down, the allowance should also come down. At the same time, there should be an exit mechanism from the programme. The objective of a social safety net is to provide a fair opportunity for poor people to work hard and rejoin the economy as productive members of society. If the social security safety net is not adjusted for market prices, it is very likely that undeserving people will join the programme and resources will be wasted.
The next question is where we are going to find money, as our Government is already tight for cash. Our budget deficit is ballooning. One option is to perform more quantitative easing (money printing) and find money to run the programme, but obviously, it would add more to inflationary pressures. So that option is out. The second available option for financing is to do away with loss-making State-Owned Enterprises (SOEs). The allocation for Samurdhi (and pension entitlements of farmers and fishermen) is about Rs. 50 billion combined. About 25% of this is administration costs. The losses of Sri Lankan Airlines alone in 2020 was Rs. 47.2 billion. So clearly we have to save money by letting go of some of the SOEs which are colossal loss-makers with minimum value addition, to save our poorer citizens during this challenging time. We have many such SOEs which individually make losses that are many times the budget of the Samurdhi programme. The other option is to adjust the tax system to increase revenue. Mainly taxes such as VAT can easily be amended. This is why all the reforms have to take place simultaneously with good coordination, as simply conducting reforms in isolation may only bring resistance and non-action.
Another option that we can consider is a Universal Basic Income (UBI) model where we cut down all subsidies provided for utilities and other sectors and have an allowance for every citizen for their survival. However, we have to make sure that all other subsidies are eliminated if we move to UBI, as we definitely can’t afford to maintain both.
Sri Lanka’s situation is getting worse by the day and our survival is dependent on our ability to find solutions. Procrastination will only worsen the situation. Even though it is already late, it is imperative to begin reforms now.
The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.