Fixing the checkout bottleneck

By Dhananath Fernando

Originally appeared on the Morning

• Time to modernise e-commerce taxation

Delays in delivery and regulatory confusion around e-commerce platforms have become a pressing concern for consumers and small businesses across Sri Lanka. As parcels pile up at Customs and prices surge unexpectedly, it is time to take a step back and understand the root of the problem – and the economics behind it – before rushing to find solutions.

Many wonder how e-commerce platforms like Temu, AliExpress, and eBay offer such a vast variety of goods at prices far below those in local retail shops. The answer lies in a concept known as ‘long tail economics,’ popularised by Chris Anderson in 2004. 

Unlike traditional retail models that rely on selling large quantities of a few popular products, long tail economics thrive by offering a wide range of niche items in small volumes. Digital platforms are well suited for this, as they don’t bear the physical storage and shelf-space constraints that burden brick-and-mortar stores.

In conventional retail, stocking niche items is often unprofitable; they take up space and sell slowly. But online marketplaces can list millions of such products without significant overheads. Their costs are further reduced by economies of scale in shipping, especially when handling a large number of small parcels.

Until recently, Sri Lanka allowed such parcels to enter under a simplified flat-rate tariff system – typically around Rs. 850 per parcel – based on weight rather than the Harmonised System (HS) code. For low-weight or low-value items, some tariffs were not imposed at all. 

This system made cross-border e-commerce accessible and affordable, and in doing so, empowered many Sri Lankan entrepreneurs and gave consumers access to a wider variety of goods at lower prices.

However, it also led to concerns. The simplified system was being exploited by some to bring in commercial-scale shipments disguised as personal use, thereby bypassing higher taxes. Customs officials and industry stakeholders raised questions about revenue loss and the legality of weight-based tariffs under the Customs Ordinance. 

As a result, authorities moved to tighten the rules: now, all parcels must be declared by HS code and taxed accordingly, regardless of weight.

The unintended consequence? Long delays at Customs, consumer frustration, rising costs, and uncertainty for both consumers and e-commerce platforms. The system, simply put, is not ready to handle such granular processing at high volumes.

So what is the way forward?

The answer isn’t to block e-commerce; it’s to build a smarter system.

Create a legal framework for vendor tax collection

Globally, many countries have adopted a vendor collection model, where e-commerce platforms collect taxes at the point of sale and remit them to the authorities. But in Sri Lanka, this isn’t legally possible yet. First, the Government must establish a clear legal mechanism for platforms to collect tariffs and remit them to Customs or the Inland Revenue Department.

In implementing a vendor collection model, Sri Lanka can also introduce a minimum threshold, requiring only platforms that handle a certain number of parcels per month to participate in the scheme. This ensures that the system is manageable and initially applies to larger platforms with sufficient volume and technical capacity, avoiding undue burden on small or infrequent operators.

Integrate Customs tariff systems via API

Even if legally allowed, platforms must be able to accurately determine the applicable tariff at the time of purchase. That is where Application Programming Interface (API) integration becomes essential. 

Most e-commerce platforms already tag products with HS codes. If Sri Lanka Customs’ Automated System for Customs Data (ASYCUDA) system is integrated with these platforms via API, tariff rates can be automatically calculated during checkout. 

The buyer would then see the full landed price, including taxes, before paying. The platform would act as a collection agent and remit the amount to Customs, minimising leakage and increasing transparency.

Simplify and rationalise tariffs

At the heart of the issue lies another critical challenge: Sri Lanka’s tariff structure is overly complex. We apply Customs duty, PAL, CESS, and VAT, often with wildly varying rates depending on product specifications. 

For example, tissue paper and wet wipes carry different rates, and the difference is even starker between wet wipes with fragrance and those without. This complexity makes compliance difficult and systems integration nearly impossible.

A long-term solution would be to rationalise and simplify tariffs, bringing rates down and harmonising classifications. Simpler tariffs would mean lower prices for consumers, less room for manipulation, and more efficient revenue collection. In fact, a digital tax model could bring in more transparent revenue over time.

Let the consumer decide

Some argue that e-commerce platforms threaten local manufacturers or offer low-quality goods. But quality is a judgement for the consumer to make. If an item is poor in quality, buyers won’t return to it. 

Attempts to block platforms in the name of protectionism will hurt entrepreneurs who use these platforms and rob consumers of choice. A better approach is to let competition and transparency decide what thrives in the market.

The real issue isn’t e-commerce; it’s outdated regulation. With the right legal and technological framework, Sri Lanka can embrace global trade, empower local businesses, and ensure fairness in taxation. It’s time to stop punishing what works and modernise the system that supports it.

Electricity reform: The battle between control and competitiveness

By Dhananath Fernando

Originally appeared on the Morning

The amendments to the Sri Lanka Electricity Act of 2024 have once again stirred public discourse, as key international development partners – namely the Asian Development Bank (ADB), World Bank (WB), and Japan International Cooperation Agency (JICA) – have raised serious concerns about their implications.

Sri Lanka’s power sector reform journey, particularly the unbundling of the Ceylon Electricity Board (CEB), has been a prolonged and often politically fraught conversation. The recent economic crisis made one thing clear: inefficiencies and structural rigidities in the energy sector are no longer sustainable. 

In response, a new bill was passed, aiming to restructure the sector by unbundling the CEB into generation, transmission, and distribution entities. This was intended to facilitate grid upgrades, improve renewable energy absorption, and lower costs while improving service delivery.

Yet, the devil – as always – is in the details. The accompanying table contains a summary of the four key concerns raised by development partners, along with the corresponding responses from the Director General of the Power Sector Reforms Secretariat.

On the surface, the responses summarised in the table seem to address concerns. But policy isn’t judged by intentions; it is judged by results. And to get results, legislation must be clear, enforceable, and resistant to misuse by future governments. Unfortunately, the Electricity Act still leaves many grey areas, which could cause more problems than it solves.

Take permanent Government ownership, for instance. The Government says it will only hold on to generation and distribution companies for now, but there is no clear legal path or timeline for opening up future entities to investment. Without clear guarantees, this could become a case of kicking the can down the road, keeping control within State hands while blocking much-needed capital and innovation. 

Then there is the issue concerning a National Transmission Network Service Provider (NTNSP). Even if the NTNSP won’t directly handle power generation, it will still own companies that do. This undermines the principle of unbundling, which is all about separating who generates power from who transmits it, so that the playing field is fair for everyone. You cannot say you are de-merging the system while letting one player wear two hats.

On the question relating to the Lanka Electricity Company (LECO), the response says only the CEB’s 55% stake is involved and that LECO will remain independent. But the act gives enough flexibility for future decisions that could quietly erode LECO’s autonomy. Without explicit protections written into law, these assurances are only as strong as the next government’s intentions.

Finally, on tariffs: while the regulator is supposed to have the final say, the phrase “in consultation with the Ministry of Finance” in legal terms can mean joint decision-making. That could politicise price-setting, delay reforms, and discourage private investment. What investors want is clarity; ambiguity is their biggest fear.

In public policy, it is not the intent but the outcome that matters.

At the heart of all four concerns lies a common thread – control over market dynamics and decision-making. Two underlying fears appear to drive the insistence on Government ownership: the fear of losing control over a strategic sector and the pressure from trade unions worried about losing the privileges that come from monopoly protection. These are not unfounded concerns, but they are not sufficient justifications to resist reform.

Strategic interest is best preserved not through outright ownership but through strong regulation. Maintaining Government ownership over generation and distribution does not guarantee better outcomes for consumers. Instead, a robust, independent regulator and a competitive market architecture are more likely to deliver efficiency, lower costs, and innovation.

Moreover, modernising our grid is critical not just for absorbing renewable energy but also for positioning Sri Lanka to eventually export electricity, especially through grid connectivity with India – a long-term but strategic goal.

Another key principle is that legislation should be designed not just for today’s leaders but to guard against potential misuse by future actors with less noble intentions. A vague clause, even with the best current leadership, can become a tool for rent-seeking or manipulation down the line. 

The ambiguity around the Ministry of Finance’s involvement in tariff setting, for instance, opens the door for potential political interference, even if unintentional.

The political economy of reform is such that ambiguity breeds resistance, from investors and insiders alike. Leaving grey areas in legislation invites both capital flight and capture by vested interests.

Ultimately, the Electricity Act must be evaluated on its ability to foster competition that is regulated, not ownership that is politicised. The objective should be clear: maximise consumer benefit in terms of price, reliability, and national security. In chasing control, we risk losing all three. 

Concerns and responses 

Summary of concerns by WB, ADB, and JICA

Response by Director General of the Power Sector Reforms Secretariat

1. Permanent Government ownership

Legislating 100% permanent State ownership for key electricity entities limits flexibility, deters private investment, and increases the long-term burden on the Government.

The Government of Sri Lanka will retain 100% permanent ownership only in the generation and distribution companies created through the preliminary transfer. Further unbundled entities, except for hydropower, will not be subjected to this restriction.

2. Concerns with National Transmission Network Service Provider (NTNSP) structure

Including LTL Holdings and Sri Lanka Energies under the NTNSP undermines unbundling, risks conflicts of interest, and reduces transparency.

The CEB’s stakes in these entities are classified as assets to be transferred to the NTNSP. The NTNSP will be limited to transmission functions. No re-bundling will occur, and power purchase agreements will be managed competitively by the National System Operator (NSO).

3. Distribution company risks

Merging LECO into the new distribution company disregards operational and governance structures, risking reversal of previous efficiency gains.

Only the CEB’s 55% stake in LECO will be affected. LECO will remain a separate legal entity, with the freedom to pursue private investment. There will be no full absorption.

4. Tariff-setting ambiguity

Changing “after consultation” to “in consultation” with the Ministry of Finance in tariff-setting risks undermining regulatory independence.

Although tariffs are now to be set “in consultation with the Ministry of Finance,” the regulator retains final authority, in accordance with national tariff policy.

Milking the Tax System: Why VAT Exemptions Sour the Market

By Tormalli Francis, Research Analyst at Advocata Institute

A VAT-free litre of milk or cup of yoghurt may feel like relief at the checkout, which is in fact a silent distortion of lost revenue, stifled competition, and a marketplace where not all producers compete on an equal playing field. The government’s VAT exemption on locally produced milk and yoghurt is presented as a move to improve child nutrition and support local dairy farmers. On the surface, it appears humane and sensible — after all, what government wouldn’t want to make nutritious food more affordable while reducing dependence on imports?

But public policy, like milk, can curdle if left unchecked.

Milk production in Sri Lanka is a long-standing traditional industry that has endured for thousands of years producing over 500 million litres of milk [1] annually (Figure 1) with more than 130,000 farmers [2] (Figure 2) contributing to the production of milk islandwide. Yet this exemption, packaged with its good intentions highlights a recurring policymaking problem in the Sri Lankan economy: sacrificing long-term efficiency for short-term optics. In reality, VAT exemptions — however well-intentioned often distort the tax system, weaken the fiscal base, and may ultimately harm both consumers and the very farmers they are meant to protect.

Figure 1: Trend of total annual local milk production (Million Litres), 2015 - 2024

Source: Livestock Statistics, Department of Census and Statistics.

Figure 2: Number of dairy farmers by district, 2024

Source: Livestock Statistics, Department of Census and Statistics.

Equal Tax, Equal Opportunity

In a sound tax system, neutrality is essential — similar goods should be taxed in similar ways, and the system should not favor one product or producer over another. Exempting only locally sourced milk and yoghurt breaks this principle. It grants preferential treatment to domestic producers, while imported milk powder which is still a staple in many urban Sri Lankan households remains subjected to VAT. This selective exemption can hinder fair competition, discourage innovation, misallocate resources, ultimately compromising market efficiency.

This distorts market dynamics. Producers of other dairy products such as cheese, butter especially curd face a cost disadvantage, not because of inefficiency, but because of policy. The exemption becomes a de facto subsidy, not through open direct government expenditure but through hidden distortion in the tax system.

A country case example of a similar situation is seen in Georgia [3], where VAT exemptions apply to domestically produced milk and dairy products, but not to imported or reconstituted alternatives.  While intended to support local farmers and consumers, this approach creates an uneven competitive environment. Producers who rely on imported inputs including those making value-added dairy products face rising costs without benefiting from the exemption. 

Such policies also break the VAT chain, as inputs are subjected to VAT and outputs are exempted. This raises production costs, especially for downstream manufacturers, distorts price signals, and leads to inefficient resource allocation across the sector. 

Undermining Revenue for Reform

In the context of Sri Lanka's fiscal challenges and commitments to international financial institutions like the IMF, the Advocata institute emphasizes the importance of broadening the tax base. VAT exemptions reduce potential government revenue, which could otherwise be allocated to essential public services or targeted welfare programs. Maintaining a wide array of exemptions complicates tax administration and undermines efforts to achieve long-term fiscal sustainability.

When tax revenue is eroded by such sector-specific exemptions, this shifts the burden elsewhere — either to other goods or services or to government borrowing. Sri Lanka is in a period of fiscal crisis, with IMF-backed reforms requiring revenue generation. Exemptions reduce tax income from a high-volume essential product, limiting funds for healthcare, education, or infrastructure. Ad hoc policy changes and weak tax administration have been the major contributors towards the decline in tax revenue which have brought in fiscal challenges. A well developed tax system is an efficient revenue instrument, but exemptions and reduced rates erodes its performance. Basic commodities as milk and yoghurt are often the options for exemptions or reductions in most Low Income Developing Countries (LDICs), in 2020 the VAT exemptions in these countries amounted to 1.3 percent of GDP [4]. Revenue loss from such policies tends to outweigh the actual gains for the vulnerable groups.

Better Tools for Better Targets

A key justification for exemption on milk and yoghurt is to improve nutrition and support dairy farmers — by making these products more affordable for vulnerable groups and increasing farmer incomes. The dairy industry has been identified as the priority sector for development among the other livestock sub sectors in the country [5] for its crucial role reducing nutritional deficiencies across all age groups, and serving as a key source of affordable, high-quality nutrition for the population. 

But VAT exemptions are an imprecise way to deliver support. While they aim to make basic commodities more affordable, the Advocata institute highlights that such blanket policies often result in an imbalance as higher-income households benefit more than the intended low-income groups. As a greater proportion of basic commodities are consumed by the richer households, with greater purchasing power as they are likely to capitalise on these tax breaks. This misalignment highlights the inefficiency of VAT exemptions as a tool for social welfare. It is, in essence, a regressive subsidy disguised in the language of progressivism.

With exemptions having a progressive impact, they are poorly targeted ways to help low-income households, showcasing that directly targeted mechanisms will be better tools to address distributional concerns [6]. If the goal is to improve nutrition among the most vulnerable and farmers' livelihoods – Sri Lanka should focus on strengthening targeted, transparent support systems. Direct transfers to low-income households, investment in school milk programs, input subsidies to farmers, and upgrading the dairy industry infrastructure would deliver an efficient and equitable alternative. These measures ensure that support reaches those who need it most—without distorting market signals or undermining long-term efficiency.

Conclusion

Sri Lanka’s VAT exemption on locally produced milk and yoghurt may feel like a compassionate move — and in some ways, it is. But ultimately, it’s a fiscal quick fix, not a structural solution. A neutral tax system with broad based rates and minimal carve outs helps maintain fairness, supports productive specialisation and sustains government revenue. 

If we want to nourish our economy as well as our children, we must move from tax distortion to targeted policy. Milk can be good for the bones, but only when it doesn’t weaken the backbone of the economy.

[1]  Milk Production Statistics. Livestock Statistics. Department of Census and Statistics. Available at: https://www.statistics.gov.lk/Agriculture/StaticalInformation/MilkProduction#gsc.tab=0

[2] Milk Producing Farmers. Livestock Statistics. Department of Census and Statistics. Available at:https://www.statistics.gov.lk/Agriculture/StaticalInformation/MilkProducingFarmers#gsc.tab=0

[3]  Study of Value Added Tax (VAT) Exemption Impact for Increasing the Competitiveness of the Georgian Dairy Sector. Available at: chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://iset-pi.ge/storage/media/other/2021-10-06/32dcec80-2670-11ec-9a47-851d3f3d5dcf.pdf

[4] The Global Tax Expenditures Database (GTED) Companion Paper. A. Redonda et. al. Available at: https://www.researchgate.net/profile/Christian-Von-Haldenwang/publication/352539392_The_Global_Tax_Expenditures_Database_GTED_Companion_Paper/links/61291b602b40ec7d8bca280d/The-Global-Tax-Expenditures-Database-GTED-Companion-Paper.pdf

[5] Sri Lanka’s Dairy Sector: Where to Move and What to Do – Prediction and a Trend Analysis. D. A. P. R. Damunupola. Available at: chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://sljae.sljol.info/articles/74/files/submission/proof/74-1-413-1-10-20220706.pdf

[6] VAT Exemptions, Embedded Tax,  and Unintended Consequences. World Bank Group. Available at: chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://www.joserobertoafonso.com.br/wp-content/uploads/2025/05/IDU-8b2c8bb9-1d8f-4d67-b704-8dec2f14a832.pdf

When goods don’t cross borders, soldiers will

By Dhananath Fernando

Originally appeared on the Morning

• The hidden costs of the Israel-Iran war for Sri Lanka

The escalating conflict between Israel and Iran carries serious repercussions for Sri Lanka on multiple fronts. 

In economic terms, there is no winner in any war; all parties, including those not directly involved, will suffer. Unfortunately, Sri Lanka is likely to be one of those casualties.

Humanitarian impact

An estimated 20,000 Sri Lankans live and work in Israel. If the conflict escalates and lives are lost, the Government will be under pressure to intervene and repatriate citizens. 

This would strain an already tight budget and add pressure to the national balance sheet. However, human life must take priority and any necessary rescue operations must be conducted swiftly.

Beyond the immediate human toll, loss of life could trigger political tensions at home, affecting community relations and domestic stability.

Exports and trade

Both Israel and Iran are key export markets for Sri Lanka. In 2023, exports to Israel were valued at approximately $ 90 million, with key products including bulk tea, rubber products, seafood, and coconut-based goods. Meanwhile, Iran accounted for $ 67 million in Sri Lankan exports, primarily bulk tea.

However, the bigger risk lies beyond these direct trade flows. As major markets like the US, UK, and European Union (EU) align themselves with different sides of the conflict, global trade dynamics could shift dramatically. Increased military expenditure, market polarisation, and slower consumer demand in Western economies could impact Sri Lanka’s export growth across the board.

Meanwhile, our imports from Israel – mainly tech products, plastics, and precious stones – amount to roughly $ 100 million annually. Some of these are intermediary goods essential for local production. 

Imports from Iran are smaller (about $ 25 million), largely fertilisers and food items, but equally vulnerable to disruption. War-driven supply chain breakdowns and rising costs will further strain sectors already under pressure.

Fuel prices and economic slowdown

Middle Eastern instability typically drives global oil prices higher. Already, crude and refined oil prices are rising – the Murban crude variant used at our Sapugaskanda Refinery is up by nearly 10%. Higher global prices must be transparently reflected in local pump prices to avoid market distortions.

It is vital that the Government allows these price signals to flow through while maintaining prudent monetary policy. Artificially low interest rates could lead to currency depreciation, accelerating inflation and further compounding the fuel price shock. If managed correctly, we can minimise the fallout. If not, we risk another wave of inflation at a critical juncture.

In addition, falling remittances and a global economic slowdown will directly impact one of the most critical requirements for Sri Lanka’s debt sustainability – economic growth. Weak growth could force the country into a second round of debt restructuring, and even a modest external shock could be enough to trigger a crisis, given the fragile fundamentals of our economy. 

The only solution is to accelerate economic reforms – removing trade barriers, restructuring State-Owned Enterprises (SOEs), and pursuing sound monetary policy – to build resilience and minimise risks.

Remittances

Sri Lanka receives about $ 40 million in remittances from Israel per quarter. Any major disruption to employment in Israel could directly impact these inflows. 

Moreover, broader instability in the Middle East could affect other labour markets where Sri Lankans are employed, reducing remittance income – a crucial source of foreign exchange for debt servicing and stabilising the currency.

Geopolitical risks

As global powers take sides, Sri Lanka faces new geopolitical challenges. The late Iranian President Ebrahim Raisi visited Sri Lanka last year to inaugurate the Uma Oya project, funded by Iran. Iran also donated the Sapugaskanda Refinery, a longstanding symbol of economic ties.

Israel, in turn, remains an important partner, offering employment opportunities and a growing trade relationship. But with key allies like the US and UK backing Israel, and powers like China and Russia leaning towards Iran, Sri Lanka risks being caught between competing camps.

We must now carefully manage these pressures. Maintaining neutrality while safeguarding national interests will require skilled diplomacy.

A wake-up call

This war is a stark reminder of the importance of global trade and the value of building strong, diversified economic relationships. The situation echoes the famous quote: “When goods and services do not cross borders, soldiers will.”

For Sri Lanka, the lesson is clear: deeper economic engagement and robust reforms are not just about prosperity, they are essential to protecting national stability in an uncertain world. 

Time to rethink export diversification – with India in mind

By Dhananath Fernando

Originally appeared on the Morning

The call to diversify Sri Lanka’s export basket is not new; it’s a conversation that has spanned decades.

For the most part, our approach has relied on supporting Small and Medium-sized Enterprises (SMEs), extending credit, and helping companies find overseas buyers – largely driven by the Export Development Board (EDB).

During the ‘Yahapalana’ Government, Sri Lanka unveiled a comprehensive National Export Strategy (NES) targeting six promising sectors:

• Information and Communication Technology (ICT) and Business Process Management (BPM)

• Wellness tourism

• Boating and shipbuilding

• Electrical and electronic components

• Processed foods and beverages

• Spices and concentrates

In addition, four cross-cutting areas were introduced to complete the export ecosystem:

• Logistics: streamline supply chains and reduce time-to-market

• National Quality Infrastructure (NQI): upgrade testing, certification, and compliance standards

• Innovation and entrepreneurship: promote R&D, tech adoption, and startup growth

• Trade information and promotion: enhance market intelligence, branding, and buyer linkages

This strategy was widely appreciated at the time. Even the EDB Chairman appointed under President Gotabaya Rajapaksa’s administration pledged to take it forward. But strategies need to evolve. And now, the context has shifted.

A case in point is how Ceylon Cold Stores (CCS) – a subsidiary of John Keells Holdings (JKH) – has taken a new route into India. Rather than exporting directly, as it unsuccessfully attempted in the past due to India’s non-tariff barriers, it has now partnered with Reliance Consumer Products. Through this partnership, CCS products will be distributed across 18,000 Indian outlets.

If the venture proves successful, we could see CCS expanding operations further, either producing in Sri Lanka for export or even setting up shop in India. This is a powerful lesson; if we are truly serious about diversifying exports, India is a market we can’t afford to ignore. But the route may not always be direct; it could mean partnerships, joint ventures, or becoming part of Indian supply chains.

And it’s not just consumer goods. While CCS is expanding into India, some Sri Lankan banks, now holding excess US Dollar reserves, are looking to partner with the Gujarat International Finance Tec-City (GIFT City).

Several bank CEOs in Sri Lanka who have already invested have stated that their goal is to support Sri Lankan companies investing in India – or even Indian companies operating here. In fact, many Sri Lankan service sector firms are already functioning in India. This is a clear signal: the momentum has shifted. The landscape is changing and we are slow to adapt.

Meanwhile, India is also reshaping the global trade map. It has already signed a Free Trade Agreement (FTA) with the UK, and is in the final stages of a similar deal with the European Union (EU). Under the UK deal, 99% of Indian exports to the UK will be tariff-free, and 90% of UK goods will get similar access to India – significant reductions even for alcohol products.

Once the EU deal is signed, exporters will have even more incentive to route products from India, especially given Sri Lanka’s uncertain GSP+ status. So, if we try to compete head-on with India in the same markets, we may be setting ourselves up for disappointment. Instead, we should look at how we can complement India – join its supply chains and offer what India alone cannot.

One such overlooked area is electricity exports. Back in 2016-’17, when the NES was developed, the potential of renewable energy in Sri Lanka was limited. Today, that picture has changed dramatically. Solar and wind investments have surged, and with the right policy push, electricity exports to India could become a serious reality.

This example illustrates a broader point: strategies must be dynamic. Markets evolve, technologies advance, and regional power equations shift.

India, for instance, is integrating rapidly with global and regional markets. Sri Lanka can ride that wave, or watch others benefit in our place. With geopolitical winds also shifting – particularly with the West looking for reliable partners in the region – India is too big to be left out of any serious trade or investment plan.

If we play our cards right, Indian growth could also drive investment into Sri Lanka, especially in sectors that support exports. But to unlock that opportunity, we need serious structural reforms:

• Industrial lands must be made available, ideally through private sector-led zones with minimal red tape and a streamlined Board of Investment

• Electricity sector reforms are non-negotiable – both to reduce domestic costs and to enable energy exports

• Trade facilitation through a modernised Customs act is essential to attract investors eyeing India via Sri Lanka

• Debt sustainability must be maintained – no investor will bet on a country flirting with default

• State-Owned Enterprises (SOEs) must be restructured to reduce the fiscal burden and unlock productivity

In short, if we are serious about export diversification, we must acknowledge that the rules of the game have changed. Old models won’t work in a new world. India is no longer just a neighbour; it is a gateway, a competitor, and a partner all at once.

The question is: will we adapt fast enough to matter?

Why SL’s electricity sector keeps failing its users

By Dhananath Fernando

Originally appeared on the Morning

The tug of war between the Ceylon Electricity Board (CEB) and the Public Utilities Commission of Sri Lanka (PUCSL) is not new to Sri Lankans – or to taxpayers. 

At one point during President Maithripala Sirisena’s tenure, a Cabinet meeting was called off until the CEB and PUCSL reached an agreement on tariff revisions. In another bizarre chapter, the CEB even organised a special pooja to invoke rain gods, hoping to avoid power cuts and tariff hikes.

Now, the conversation has returned, with the International Monetary Fund (IMF) insisting that electricity tariffs must be cost-reflective as a condition for the release of the next tranche of funding. While there is a lot of noise about tariff hikes and methodologies, the critical push for structural reform remains absent. Once again, electricity users find themselves on the receiving end, with little clarity on a long-term path to reduce costs.

Concerns have deepened with proposed amendments to the Electricity Act that threaten to roll back past reforms. The outcome? Consumers and industries may have to bear higher electricity costs, whether as tariffs, taxes, or inflation.

Understanding the basics: What drives tariff structures?

There are three core principles when it comes to setting electricity tariffs:

Electricity is a homogeneous product: One kilowatt (kW) of electricity provides the same energy, regardless of whether it comes from coal, wind, or solar. While the cost of generation varies, the energy output is identical.

The cost of electricity varies by time of use: Although electricity is a homogeneous product, its cost fluctuates based on demand. Peak-hour electricity typically costs more, as it relies on expensive and quick-response generation sources.

Electricity is hard to store: Unlike other commodities, storing electricity is extremely costly. This means supply and demand must be balanced in real time, making pricing and grid stability critical.

Cost-reflective pricing is currently the principle we follow, largely in line with IMF recommendations. But cost-reflectivity alone is not enough. If the system’s inefficiencies remain unaddressed, then reflective prices will only continue to rise. 

Previously, we ignored this reality by allowing the CEB to operate at a loss. These losses didn’t vanish; they resurfaced as taxes, inflation (when financed by money printing), or higher interest rates (when financed through debt).

Why are costs high?

One of the main reasons for persistently high electricity costs is our outdated grid infrastructure. Our failure to connect to India’s electricity grid also leaves us with missed opportunities. A grid connection with India could help us stabilise our own grid and export surplus electricity – particularly solar power – thereby reducing domestic costs through offsetting.

Worse yet, the new amendments to the Electricity Act propose rebundling generation, transmission, and distribution, undoing previous reforms that sought to separate them. Unbundling improves accountability and productivity; rebundling risks taking us backward.

What should be done: Now and long-term

Long-overdue transmission upgrades require significant capital. For that, we need a structure that welcomes private investment while ensuring strong regulatory oversight. Currently, the regulator is weak, and the CEB, as a State monopoly, easily passes cost increases onto consumers without consequence.

Electricity reform is complicated and takes time. But while we figure out long-term changes, here are a few short-term, actionable steps that could help manage the situation:

1. Unify user categories: Sri Lanka currently maintains multiple user categories – domestic, religious, Government, etc. – violating the principle of homogeneity. A single unit of electricity cannot and should not be priced differently at the same time for different consumers. Instead of offering cross-subsidised tariffs, direct cash transfers should be used to support vulnerable consumers. This will promote demand-side efficiency and encourage responsible energy use.

2. Abolish Rate 1 and adopt Time-of-Use (TOU) pricing: The Rate 1 category for bulk users must be eliminated. Instead, TOU pricing should be applied universally. Uniform pricing flattens important price signals and discourages efficient energy use. TOU pricing, on the other hand, encourages load shifting, optimises grid use, and better reflects real costs.

3. Improve cost transparency: When reporting its cost structure, the CEB must clearly separate:

• Generation costs: Disaggregated by plant, including fuel, labour, maintenance, and capital, along with justifications for deviations from least-cost dispatch principles

• Network costs: Covering transmission and distribution infrastructure

• Overheads: Including administration, billing, metering, and customer services

Similarly, losses must be broken down into:

• Technical losses: From grid, transformers, and substations

• Commercial losses: From theft, faulty meters, or billing errors

• Collection losses: From non-payment or delays

Transparency will shine a light on inefficiencies, allowing policymakers and the public to demand reform based on evidence.

Cost-reflective pricing is necessary, but not sufficient. What matters more is reducing the cost itself. And that cannot be done by regulation alone. It requires competition, productivity, and bold structural reforms. 

Until we summon the political courage to tackle these long-standing issues, the electricity sector will remain trapped in a cycle of inefficiency, passing the burden from the State to the citizen, again and again.

(Source: Advocata submission to PUCSL on electricity tariffs)

Salt, sun and shortages: The real cost of govt. interference

By Dhananath Fernando

Originally appeared on the Morning

In economics, shortages often arise from one of two sources: price controls or government interventions. Sri Lanka’s ongoing salt shortage, while not caused by price caps as in past crises with rice or eggs, is still rooted in State interference – just in a different form.

Sri Lanka consumes around 180,000 MT of salt annually. Producing salt requires vast expanses of flat land near the sea, combined with long dry spells and strong winds to support natural evaporation. Regions like Hambantota, Elephant Pass, and Puttalam are ideally suited for this. However, unusually high rainfall last year – linked to shifting climate patterns – disrupted the crystallisation process, which typically requires over 40 uninterrupted days of dry weather.

Ironically, the same rains that hampered salt production helped boost agricultural yields and hydroelectric output, allowing for an electricity tariff cut that helped tame inflation and fuel at an impressive 5% economic growth rate. But the question remains: Sri Lanka has faced excessive rains before, so why a salt shortage now?

The answer lies in how markets respond to supply shocks. Typically, when local production falters, imports fill the gap. But in this case, the Government attempted to monopolise salt imports via a Cabinet decision mandating that only State entities handle them. Unsurprisingly, the bureaucracy involved led to delays and supply gaps. Unlike private sector importers, who are faster and more efficient, State procurement systems are slow, opaque, and often mired in red tape.

This is not a new story. The same importation challenges were in existence when the Government tried to import rice. The same way the Government imposed a tariff of about Rs. 60 per kilo of rice, salt is also liable for a tariff, making prices higher for the end consumer. 

Nearly 50% of domestic production is under State management, and, true to form, productivity suffers. Even with optimal natural conditions, we barely meet local demand and export almost nothing.

Salt is not just a kitchen staple. It’s a key industrial input for sectors like confectionery, pharmaceuticals, and chemicals. Yet our salt industry remains underdeveloped. The reliance on expansive land-based evaporation ponds competes with tourism and urban development, reducing land-use efficiency. Although sunshine – our key production input – is free, we have failed to prepare for climatic variability or invest in resilient infrastructure.

There is, however, one thing the Government got right this time: it refrained from imposing price controls. Had it done so, scarcity would have worsened. Prices have indeed risen, but at least salt remains available. Market forces, though imperfect, have managed to balance supply and demand better than the State could.

The Government belatedly opened the door for private sector imports, but the damage had already been done. Consumers bore the brunt of higher prices and uncertainty, while the State’s credibility took another hit.

Salt production, like many sectors, is vulnerable to climate and policy risks. What we need is not more State control, but a bold vision to turn salt into an export-oriented industry driven by private enterprise. Value-added products, better land use, and climate-resilient production methods could unleash its potential.

As always, the fundamental rules of economics don’t bend for salt or automobiles. Shortages are almost always man-made – products of misguided interventions. As Milton Friedman once quipped: “If you put the federal government in charge of the Sahara Desert, in five years there would be a shortage of sand.” Sadly, that seems to ring true for Sri Lanka – an island blessed with saltwater and sunshine, yet still somehow short of salt.

After the ballot, before the fall

By Dhananath Fernando

Originally appeared on the Morning

In the aftermath of Sri Lanka’s Local Government Elections, political parties across the spectrum are rushing to claim victory. But amid the noise of celebration, one hard truth emerges: the real losers could be the citizens of Sri Lanka.

While the National People’s Power (NPP) has secured control over a notable number of local councils, the final outcome paints a picture of fragmentation, not consolidation. In many councils, no single party holds a clear majority – opening the door for instability. Power shifts at the local level, particularly during budget votes and council sessions, could become common, driven by crossovers and shifting alliances.

This instability is no minor issue. In Sri Lanka’s governance structure, local government leaders wield significant administrative power, from approving housing plans to managing grassroots-level infrastructure. When political disruption seeps into this tier, it directly stalls economic activity in towns and villages across the country.

Further complicating the picture, the President recently remarked that the Government would “think more than 10 times” before allocating funds to councils not under its control. If this sentiment translates into action, we risk seeing small-scale development projects stall, limiting rural and urban-level economic dynamism at a time we need it most.

Beyond the numbers, this election signals a larger shift. The ruling party appears to have lost over two million votes compared to last year’s General Elections. Even accounting for changes in voter turnout, the decline as a percentage of total votes is significant. This drop weakens the Government’s political capital, an essential currency for pushing through unpopular but necessary reforms.

Unfortunately, the first 100 days of the current administration have not delivered on the momentum of reform many had hoped for. While no major missteps have been made, there has been little visible progress on the growth-enhancing reforms promised earlier. Instead, much of the current economic trajectory is the result of groundwork laid in 2022-2023, including debt restructuring and the continuation of the International Monetary Fund (IMF) programme.

However, it must be emphasised again: the IMF programme is a stabilisation package. It is not a growth agenda. Economic growth is – and must be – Sri Lanka’s own responsibility. Despite a modest rebound in 2024, projections for 2025 show expected GDP growth in the range of just 3.5-3.9%, according to the World Bank and Asian Development Bank.

This slower-than-expected recovery poses a major threat. Without strong growth, Sri Lanka’s ability to meet its debt obligations from 2028 onwards becomes increasingly uncertain. And growth will not come without bold reforms, particularly in State-Owned Enterprises, land, labour, investment climate, and public sector governance. These are politically sensitive areas, and advancing them requires a government willing and able to expend political capital.

The recent election results, however, suggest that the administration may become more cautious. Reforms could be further delayed, either due to internal hesitancy or increased resistance from an emboldened Opposition. In such a scenario, the price of political caution is paid by ordinary citizens: fewer jobs, slower income growth, and delayed improvements in living standards.

History tells us what happens when governments, under pressure, prioritise political survival over economic transformation. Reform fatigue sets in. Investor confidence fades. Informal sectors swell. In fragile economies like ours, uncertainty quickly breeds stagnation – and even criminality – at the local level.

Politics and economics are inseparable. Those in power must deliver change. But when reform is stalled, the pressure doesn’t disappear – it rebounds. And in the end, it’s not parties that bear the real cost; it’s the people – the farmers, workers, small business owners, and students who hoped for something better.

The best-case scenario is still within reach: a government that recognises the warning signs and takes swift, decisive steps on the reform path. But if that doesn’t happen, and reform inertia persists, it won’t matter who wins at the ballot box.

In the long run, we all lose.

Real cost of schooling is what we fail to fix

By Dhananath Fernando

Originally appeared on the Morning

The GCE Advanced Level Examination results were released last week, and – as expected – social and mainstream media have been flooded with advertisements by tuition masters claiming credit for the top-performing students. While the spotlight remains firmly on the winners, a critical conversation is missing: the economics of education in Sri Lanka.

Sri Lanka’s A/Level education system has become fiercely competitive, but this competitiveness masks a deeper structural issue: our current education model is financially unsustainable.

Government school teachers are underpaid, and the State lacks the resources to attract and retain high-quality educators. As a result, many teachers rely on private tuition to supplement their incomes. Consequently, students prioritise tuition classes over regular school, often attending school merely to fulfil attendance requirements.

When results are announced, both schools and tuition providers share in the credit, but in truth, the system is fundamentally broken. While we congratulate the students who achieved excellent results, we must also acknowledge that many equally talented individuals may have been left behind due to systemic shortcomings.

This issue is not confined to A/Level education. Similar inefficiencies exist in both primary education and the university system. The extreme competitiveness of the A/Levels is driven largely by the limited number of seats available at State universities, especially in Science, Technology, Engineering, and Mathematics (STEM) fields where education is offered free of charge.

Yet the broader educational ecosystem is underperforming. At the school level, funds raised by school development associations and through Grade 1 admissions are often invested in infrastructure. However, these facilities are grossly underutilised. Schools remain closed for around three months annually and on all weekends. Even on regular school days, the maximum operating time is about eight hours. As a result, school infrastructure lies idle for more than half the time.

This is not to say that schools must operate 24/7, but there is enormous potential to repurpose existing resources. Facilities could be used for after-school childcare programmes or vocational training – services that not only meet real societal needs but also generate revenue for reinvestment in education. For example, improved after-school childcare could help increase female labour force participation, allowing more mothers to remain in the workforce.

The same logic applies to universities. While underfunded, Sri Lankan universities face immense demand – demand that forces many families to sell assets or incur debt to send children abroad, often to Australia. If public universities were allowed to accept fee-paying private students under a fair loan scheme, it would expand access without compromising free education. Moreover, opening up to foreign students could bring in much-needed revenue and foster academic and cultural exchange.

The presence of a university already creates a micro-economy – boarding houses, food vendors, photocopy services, and transport providers all thrive around campuses. Imagine the added economic benefits of attracting international students: increased demand for lodging, travel, tourism, and services, creating a ripple effect across sectors.

According to the Central Bank of Sri Lanka’s (CBSL) Annual Economic Review for 2024, Sri Lankan students spent approximately $ 194 million on education abroad. This figure highlights the untapped potential to build a robust local education market that not only retains students but also attracts others from the region, particularly from countries like India and the Maldives.

Ultimately, the economics of education must move beyond celebrating exam toppers. It must consider the majority who struggle in a system that offers limited choices. Expanding those choices will lead to greater economic activity and long-term growth.

Education is one of the most powerful tools for upskilling our labour force and accelerating national development. Yet, under our current model, we are allowing human capital to slip away, along with the economic opportunities it could bring, simply because we fail to make better use of what we already have.

Sri Lanka’s economic turnaround: The power of policy, not politics

By Dhananath Fernando

Originally appeared on the Morning

The Central Bank of Sri Lanka (CBSL) released its Annual Economic Review for 2024 a few weeks ago. At first glance, the dashboard of key macroeconomic indicators paints a remarkably positive picture – so positive, in fact, that some may wonder if the numbers have been massaged. But scepticism fades when you step into a grocery store or speak with a small business owner. The improvement in economic stability and the business environment is palpable.

What is particularly striking is that the new Government, while not having introduced bold new reforms, has also not derailed the stability programme set in motion over the past two years. This continuity, though passive, has helped preserve the gains made.

Amid the political contestation over who deserves credit for the economic stabilisation, one truth stands out: Sri Lanka’s turnaround is rooted not in politics, but in the application of sound economic policy.

Let us not forget the chaos of the recent past. During the Covid-19 crisis and its aftermath, policies such as import controls, arbitrary currency pegging, and a misplaced reliance on Modern Monetary Theory (MMT) for deficit financing led us to the brink of collapse. We banned imports of everything from vehicles to turmeric and foreign reserves fell to critically low levels. In 2022, inflation peaked at a staggering 70% and we defaulted on our sovereign debt.

In contrast, 2024 tells a very different story. Imports have been liberalised, the Sri Lankan Rupee has appreciated, and annual inflation has dropped to just 1.2% – a sharp fall from the 42% recorded in 2022. Foreign reserves have risen to $ 6.1 billion and investor confidence is slowly returning.

If import bans and deficit monetisation were truly effective tools for reserve accumulation and currency stability, today’s numbers should be worse, not better. What changed is not just the numbers but the mindset.

The real driver behind this turnaround has been institutional reform and disciplined economic policy-making. The passage of the CBSL Act of 2023, which established the institution’s independence – though not perfect – was instrumental. It marked a break from the belief that the CBSL should finance the Government or steer economic growth through monetary accommodation. Restoring the CBSL’s credibility and prioritising price stability has laid the foundation for today’s macroeconomic stability.

However, we are far from the finish line. Stability is a prerequisite, not a destination. Without deeper structural reforms, this fragile recovery can quickly unravel.

Reforms in land use, labour markets, and immigration are essential for long-term growth. The Economic Transformation Act, parts of which are yet to be implemented, must be expedited to attract foreign investment and create job opportunities for Sri Lankans.

Meanwhile, we must interpret some headline statistics with caution. For instance, Sri Lanka’s per capita GDP is now estimated at $ 4,500 – a significant increase. But this is partly due to demographic shifts; population growth has slowed, with increased emigration and declining birth rates. The Department of Census and Statistics now estimates the population at just over 21 million. Additionally, a stronger exchange rate and subdued inflation have boosted the dollar value of nominal GDP.

Yes, economic growth in 2024 stands at 5%, but we must be mindful of the base effect. Following two consecutive years of contraction, this figure reflects a rebound from a low base, not a high-growth trajectory.

Still, the numbers on inflation, reserves, and interest rates underscore a clear commitment to macroeconomic stabilisation. Even the returns to the Employees’ Provident Fund (EPF) have improved, an indirect benefit of preserving the value of money, or what economists call ‘sound money.’

The bottom line: this recovery is the result of disciplined policy, not political manoeuvring. But policy cannot stand alone. Without a resilient institutional framework, good policies can be reversed with the next election cycle. We often adopt ‘scientific policy’ only when a crisis forces our hand. That culture must change.

As the country prepares for the upcoming Local Government Elections, it is crucial for the Government to demonstrate that it is serious about reforms and institutional strengthening. Assuming that 2025 will bring equally good numbers by doing more of the same is not just naive, it is dangerous. Without changing gears, we risk reversing the progress made and returning to instability.

Patriotism isn’t protectionism

By Dhananath Fernando

Originally appeared on the Morning

Ask any Sri Lankan what we should do to develop the country, and most will say we need to improve our exports. The same majority will also suggest that we must cut down imports to achieve this. While the need to grow exports is true, the belief that reducing imports is the way to do it is where things start to fall apart.

Many Sri Lankans even see boycotting imported goods and shifting to locally produced alternatives as an act of patriotism. The logic is simple: buying local helps local producers generate a surplus, which can then be reinvested to expand internationally. 

It is an emotional argument, but one that is deeply flawed when translated into policy. This sentiment often influences governments to raise import tariffs or impose outright bans on products that can be locally produced, believing that this will encourage domestic industry and, over time, boost exports.

But this approach misunderstands how exports work. Take the Donald Trump administration, for example. It also embraced this worldview, failing to recognise a basic economic truth: the ability to export doesn’t come from blocking imports, it comes from being competitive in price and quality. 

When we restrict better quality and lower-priced imports, we don’t support patriotism; we harm it. We shield local industries from global standards, stifle innovation, and force both consumers and other businesses to bear higher costs, weakening their global competitiveness in the process.

From an economic theory standpoint, protecting one sector of the economy often comes at the cost of others that are already competitive globally. 

Here is a simple example to illustrate this fact. Suppose Sri Lanka produces 100 coconuts a month. We consume 80 and have 20 left to export. But if we allow coconut substitutes or cheaper imported coconut oil for industrial use, we might reduce domestic consumption to 70, freeing up 30 coconuts for export. Better still, we could use imports for industrial purposes and reserve our highest-quality coconuts for premium export products like virgin or desiccated coconut.

All that we import is not final consumer goods. In fact, most of our imports are intermediary or investment goods. For instance, if the price of steel is high due to protectionist policies, it increases costs across all industries that rely on steel, from construction to manufacturing. The resulting job losses across those industries far outweigh the jobs ‘saved’ in the protected steel industry. 

In Sri Lanka’s case, nearly 80% of our imports are intermediary or investment goods. When we restrict these, it doesn’t help the economy – it hurts it. This is yet another reason why protectionism is not patriotism, but quite the opposite.

If we block these types of imports, domestic consumption remains high, and we are left with fewer coconuts – or fewer resources in general – to export or reinvest. This is the irony of protectionism; it reduces our export potential. 

We do a triple disservice: first, we make our exports uncompetitive, second, we increase the burden on local industries and consumers, and third, we create long-term dependency where protected industries lobby to maintain their privileges, making it politically costly to remove trade barriers even when they no longer make sense.

This is why governments find it so difficult to roll back import restrictions. Once protection is in place, it breeds cronyism. Protected industries band together, fund political campaigns, and perpetuate a cycle where economic power is concentrated in the hands of a few politically connected elites. In the name of ‘patriotism,’ we end up creating an unproductive, anti-competitive economy.

Another key misconception is the belief that a negative trade balance is caused by high imports. At face value, it seems logical since the trade balance is calculated as the difference between exports and imports. But in reality, imports and exports are not opposing forces; they are interconnected. Blocking imports hampers exports.

Let’s return to the example of coconuts. If we produce 100 coconuts, consume 80, and export 20, we might choose to invest 10 of those coconuts in planting new trees, increasing future production and export capacity. But we can only save and invest if we consume less. And we can only consume less if we have access to cheaper or more efficient alternatives, often through imports.

In economic theory, the trade balance is ultimately the difference between national savings and investment. Consumption is determined by the price of money – interest rates. This is why artificially lowering interest rates to stimulate growth can be disastrous. It increases consumption, and with it, imports, but without the productive capacity to match. 

When the situation inevitably unravels, we blame imports and turn to protectionist measures, instead of recognising that the true culprit is excessive consumption and insufficient savings.

The result? We reimpose import restrictions, raise tariffs, worsen the situation, and end up back at the International Monetary Fund (IMF) for a bailout. Then we repeat the same cycle, creating a class of politically connected cronies who thrive not by being competitive but by being protected.

And again, we tell ourselves we need to boost exports by cutting imports. It’s a tragic loop, reinforcing the very problems we claim we want to solve.

This is why protectionism is not patriotic. In fact, it is the exact opposite.

Challenge of cost of construction

By Dhananath Fernando

Originally appeared on the Morning

Tourism is one of the key sectors driving Sri Lanka’s economic recovery. It has long been a pillar of the economy, yet few seem to fully grasp the basic economic logic required to elevate the industry to the next stage.

One critical component of the tourism value chain is lodging. The hospitality experience is largely built around where tourists stay – whether in a hotel, boutique property, or small guesthouse listed on platforms like Airbnb or Booking.com. 

Lodging often accounts for the largest share of total tourist expenditure and supports a wide range of ancillary services including restaurants, entertainment, and transport.

Lodging, however, is a capital-intensive industry. The investment is heavily front-loaded: before hosting the first guest, the property owner must invest significantly in construction, infrastructure, and setup. 

In Sri Lanka, the cost of construction is approximately 40% higher than in other countries in the region. This means that hoteliers need significantly more capital just to get started. To make matters worse, the cost of capital (i.e. borrowing costs) is relatively high and utilities like electricity are more expensive than in competing destinations.

These higher input costs drive up room rates, making Sri Lanka’s tourism product less competitive. Much of this is due to protectionist tariffs on essential construction materials such as cement, steel, tiles, bathroom fittings, and more. As a result, hoteliers pass these costs on to tourists.

Moreover, the hotel industry requires refurbishment every five years to maintain standards. The high cost of construction makes this cycle financially challenging and erodes competitiveness over time. Although Sri Lanka aims to attract high-spending tourists, price remains a key lever in travel decision-making and high costs significantly squeeze hotelier profit margins, especially for small and medium-sized establishments, which account for the majority of room inventory.

Labour and productivity challenges

Labour is another critical component of the hospitality equation. Typically, the industry recruits unskilled workers and trains them to deliver services. Wages are structured so that service charges make up a significant portion of employee income. 

However, if there is labour redundancy – more employees than needed – the service charge gets divided among more people, reducing individual earnings. This can lead to moonlighting and low productivity, as employees seek secondary sources of income.

Staff attrition is also common, with employees constantly on the lookout for better-paying opportunities. Productivity is measured through revenue per employee; fewer employees delivering the same service increases profitability and also boosts staff take-home pay via higher service charges.

A compelling case study is Cinnamon Red, presented by Hishan Singhawansa at the Advocata ‘Ignite Growth’ conference. He demonstrated how productivity improvements could increase revenue per employee. Cinnamon Red operates with an employee-to-room ratio of 0.75, compared to the industry average of 0.8-1.6, depending on hotel category (luxury vs. budget).

The hotel’s employee hours per occupied room are around five – roughly twice as productive as peers in the same category. As a result, revenue per employee is double that of competitors, and service charges are 1.6 times higher than other hotels and resorts. This shows that productivity gains translate into higher earnings for employees and better outcomes for businesses and consumers alike.

Cinnamon Red achieved this by removing unnecessary human intervention and embracing automation and self-service: self-check-in kiosks, vending machines, digital concierge services, and self-ordering systems. This transformation was part of a broader strategic repositioning, focused on multitasking and culture change.

The path forward for SL

If Sri Lanka is serious about transforming its tourism industry, reforms are essential. 

Key steps include:

1. Reducing protectionist tariffs on construction materials to lower costs and improve competitiveness

2. Improving labour productivity across the board, ensuring that skilled workers are retained and better rewarded

3. Investing hotelier margins into delivering world-class experiences rather than simply covering high operating costs

There is also a need for a global tourism campaign, eased visa regulations, the removal of price floors for five-star hotels, and other policy changes, but none of this will matter unless we first understand the economic logic of tourism.

At the same time, we must recognise that tourism is highly vulnerable to external shocks. In recent years, Sri Lanka’s tourism sector has suffered due to:

• The constitutional crisis in 2018

• The Easter Sunday attacks in 2019

• The Covid-19 pandemic (2020-2021)

• The economic crisis in 2022

These events underscore the risk of over-reliance on a single sector. While tourism can be a powerful engine of growth, it should not be the sole driver of economic recovery. A balanced, diversified economy is essential for long-term resilience. 

Monthly employee earnings (LKR) vs. estimated living wage

(Source: Slides presented by Hishan Sinhawansa at the Advocata ‘Ignite Growth’ conference)

A new era or more turbulence?

By Dhananath Fernando

Originally appeared on the Morning

• The challenges facing Sri Lanka’s next president

The Presidential Election has been announced. Ideally, by 22 September, there will be a new president with a new mandate from the people.

Sustaining power will be more difficult than winning the election. Generally, from the very first day after assuming office, things start to fall apart. This will be the first election after the ‘Aragalaya,’ and we do not know the ground reality.

The last power transition wasn’t smooth. While there was a democratic element in appointing the eighth President after the resignation of the former, that episode had many dark elements, including a massive economic contraction and impact on human lives.

Focus on economics and corruption

Previous elections had a national element, but this time the focus is completely on economics and corruption. The good news is that the path forward is well defined, including macro targets. The International Monetary Fund (IMF) Governance Diagnostic has provided the main reforms needed to curtail corruption, with timelines and responsible institutions. Most of these are non-controversial.

This time, all candidates will also have to declare their assets electronically. We, as the people, should demand that the Commission to Investigate Allegations of Bribery or Corruption (CIABOC) enforces this.

The new president must deliver on anti-corruption promises because the demands of the ‘Aragalaya’ have not been met yet. However, some promises, like recovering assets overseas, are not easy to execute. Therefore, delivering on the anti-corruption sentiment is challenging.

Delivering on the economic front is equally tough. After debt restructuring, our interest rates will likely remain high. When interest rates are high, the cost of capital is higher, slowing down investment.

For instance, buying a computer to automate manual work becomes difficult when money is hard to source due to high interest rates. As a result, our economy will not grow. If the economy is slow to grow, it invites another crisis. Simply put, if the economy doesn’t grow, our debt will not be sustainable.

In other words, if the economy is slow to grow, it indicates that we are heading towards another debt crisis. The next leader must ensure both growth and stability.

The second piece of good news is that we at least have an idea of what targets we need to achieve on the economic front. Our debt-to-GDP ratio must gradually come down to 95% and our revenue must increase by improving our tax net.

Many promises about increasing Government sector salaries and public sector expenditure are good, but will be difficult to keep.

Limited options

In this context, there are two limited options available to increase money and productivity.

The first is improving productivity in what we already do. Simply working harder and putting in more effort can help. For example, reducing the number of holidays by 10% should increase the economy’s momentum because people will work more. But this race cannot be won solely by working harder. We must also look into channels for improving productivity without capital investments.

One such area is opening up business ventures that change the business format. For example, app-based taxi companies have significantly improved the productivity of both passengers and drivers by connecting potential riders with drivers. Companies like Booking.com connect tourists looking for lodging with small-scale lodging options.

Changing the business model has increased income for many people, reduced expenditure for many, and decreased waiting times, increasing overall productivity. The new leader must leverage this productivity lever.

The second option is to reform State-Owned Enterprises (SOEs) to attract capital. Allowing SOEs to undergo privatisation and Public-Private Partnerships (PPPs) can attract capital through investments. Additionally, rather than incurring losses, private entities can generate revenue for the Government through taxes and improve productivity.

The third option is to release land to improve productivity and circulate capital. Providing land ownership to people allows them to use it as security to unleash capital from the banking system, improving productivity.

Beyond these three options, any president will have limited choices. Relying on geopolitical powers in a highly volatile geopolitical environment may also be unfeasible.

Therefore, the challenge for the new president extends beyond getting elected. The real challenge is navigating the period after the election, which will undoubtedly be tougher than getting elected.

Delaying elections threatens political and economic stability

By Dhananath Fernando

Originally appeared on the Morning

Whenever there is an election, there is always a conversation about delaying it. Already, Provincial Council Elections and Local Government Elections have been delayed. This was the case in 2004/2005 and again in 2019.

One rationale is that, having just achieved stability after a massive economic crisis, we need more time to complete some structural reforms and ensure political stability. On the flip side, how can we execute any reform without the mandate of the people? Operating without the people’s mandate means political stability is the first thing to go out the window.

After the resignation of the former President, the process of appointing a new President followed a democratic process. While it may not have been perfect, there was a democratic element involved. Political parties with a mandate from the people were able to contest, and the candidate who could command a majority of confidence through votes was given the responsibility to lead the country for the remaining term of the previous President.

Despite its flaws, this democratic element brought political stability, which led to economic stability. With the President’s support from Parliament, it was possible to enter into an agreement with the International Monetary Fund (IMF) and continue discussions with external and internal creditors for debt restructuring. The political stability that came through the democratic element in the power transition process made it possible to achieve some level of economic stability.

Uncertainty and economic growth

However, the same democratic process has clear guidelines on the expiry time of the mandate. If we do not follow this process, the system that brought stability will push us towards instability again.

Delaying or attempting to delay elections often prompts political parties and their supporters to demand elections, creating instability as people seek to test the mandate of the public. Delaying an election in the hope of completing unfinished reforms rarely works as planned.

Moreover, postponing elections increases uncertainty. Even holding an election carries some uncertainty, but postponing it intensifies this uncertainty. The biggest enemy of any economic development is uncertainty.

After debt restructuring, the only way out for the country is economic growth. According to agreements with bondholders, we start repaying our interest from September onwards. A year of uncertainty will hinder even the small growth potential we have.

For economic growth, we need investments, and in an uncertain economic environment, attracting investments will be difficult. Falling behind our growth targets due to political uncertainty will challenge our debt repayments and credit rating updates.

International support may not be as easy to secure if the legitimacy of the Government is questioned over a delayed national election. It is true that elections themselves have an element of uncertainty. Especially post-Presidential Elections, if Parliamentary Elections result in fragmented party compositions, we risk returning to a scenario similar to President Chandrika Bandaranaike Kumaratunga’s era, with a Coalition Government barely holding a majority.

Passing bills during a time when growth and structural reforms are needed could face resistance and pushback, leading to maintaining the status quo rather than shifting gears for growth and development.

Having a majority or even two-thirds power does not guarantee that all decisions will be right or fast. As we witnessed, a two-thirds majority Government was short-lived due to misguided economic policies. However, a diluted majority will also bring instability and frequent power changes, causing things to go back and forth.

The solution: A common reform programme

If we think about the country and the people, the only solution is a common minimum reform programme where parties agree on a baseline level of reforms. This ensures that regardless of who comes to power, progress continues. The common minimum programme can start with implementing the IMF Governance Diagnostic, which has recommended significant structural reforms for fiscal, monetary, anti-corruption, and State-Owned Enterprise (SOE) sectors.

If we can at least implement the IMF Governance Diagnostic Report as a common minimum programme, even in case of a drift, it will be slow. Delaying elections, however, will accelerate the drift and slow down existing reforms and growth.

The real challenge will be for whoever comes to power next. If the next government cannot drive economic growth through improving productivity, investment, and efficiency, another collapse is inevitable. A common agreement on reforms is required because the common people care less about who rules the country and more about how their future and standard of living will improve.

Bouquets and brickbats for Economic Transformation Bill

By Dhananath Fernando

Originally appeared on the Morning

We all agree that Sri Lanka’s economy requires transformation. Can we transform an economy solely through an Economic Transformation Bill? No. Can we do it without a bill, without a proper legal framework and institutional structure? Again, the answer is a definite no.

Overall, the bill essentially unbundles the Board of Investment (BOI) into three main parts: establishing a powerful Economic Commission to decide and drive investment strategy at a national level, improving the investment climate for investors, and setting up Invest Sri Lanka to attract investors.

The current zones managed under the BOI have been transferred to a new organisation, with options for establishing industrial zones in collaboration with the private sector. This aims to resolve land issues and improve facilities for investors. The new institution is focused purely on trade agreements and economic integration with global supply chains.

A Productivity Commission, modelled after Australia’s, is proposed to enhance market efficiency and prevent anti-competitive practices. Lastly, a type of Government think tank is proposed to provide research services and analytics on trade and investment.

The bill also appears to compile six ideas into one comprehensive piece of legislation. Incorporating debt-to-GDP ratio targets, export-to-GDP ratio targets, and gross financing needs expectations seems to be another objective, as outlined in the preamble.

Risk of political interference

On the flip side, the appointment of members for the Economic Commission and other institutions falls directly under the president’s purview. In instances where the president is also the minister of finance, significant economic powers are concentrated in the hands of a single individual. Given that the majority of members can be appointed by the president, there is a significant risk of political interference in the business and investment climate.

We can set up numerous institutions, but real reform and transformation occur not when the bill is passed but rather when capable individuals drive real change. If we have flawed provisions for the appointment of members to the Economic Commission and other institutions, allowing for political interference, we risk creating another ineffective BOI.

Ideally, appointments should be nominated or approved by the Constitutional Council (CC). Additionally, representation from professional bodies such as the Institute of Chartered Accountants of Sri Lanka (CA Sri Lanka) could ensure adherence to ethical standards.

Steps in the right direction

The new bill proposes six key institutions:

Economic Commission (EC)

Invest Sri Lanka (Invest SL)

Zones Sri Lanka (Zones SL)

National Productivity Commission (NPC)

Office for International Trade (OIT)

Sri Lanka Institute of Economics and International Trade (SIEIT)

The idea of establishing a separate entity to manage investment zones is a step in the right direction. A 2018 study by the Harvard Center for International Development revealed that 95% of BOI investment zones were occupied and investors had identified land availability as a constraint.

Rather than having the BOI run industrial zones, there are many private sector players who can provide better services to investors. Zones SL should collaborate with the private sector to open new zones, providing infrastructure as landlords rather than managing the zones themselves.

The Productivity Commission is another positive policy step, provided it is implemented correctly. Its role should be to ensure a data-driven approach to productivity in each sector, promote competition, and encourage international competitiveness.

The commission should work with industry experts, as productivity expertise varies by sector. Australia’s experience with its Productivity Commission demonstrates the importance of maintaining focus on competition and avoiding mission drift, as seen with the Consumer Affairs Authority, which has deviated from its original purpose.

The OIT aims to address the lack of capacity in trade negotiations. The bill’s overall concept targets structural issues that hinder exports and Foreign Direct Investments (FDIs). However, it does not guarantee the intentions of politicians or ensure that everything will improve after the passage of the bill. The appointment process and selection of competent individuals for committees are crucial.

Implementation challenges

The key challenge for Sri Lanka will be execution. A large government with poor capacity is likely to result in political appointees populating these commissions, given the current appointment structure and salary scales. There is little incentive for qualified individuals to join at the current salaries offered.

Moreover, the Government lacks the capacity to offer higher salaries, and doing so for one segment could lead to demands for salary increases across the board or protests during a politically sensitive period. Phased reforms to reduce the State’s workforce are necessary to improve State capacity and manage these institutions effectively.

When the BOI was established, it was intended to be a one-stop shop for investors. However, it has become another bureaucratic hurdle. We risk repeating this mistake with all six proposed institutions if the wrong individuals are appointed. Conceptually, the policy is in the right direction, but its success depends on the implementation and the people driving it.

Nearing debt negotiation deal amid economic uncertainty

By Dhananath Fernando

Originally appeared on the Morning

Sri Lanka is hopeful that we can reach a debt negotiation before the first half of the year. Many are focused on the potential for reductions in principal and interest rates or extensions of debt maturities.

According to a recent update from the Ministry of Finance, we are yet to finalise a settlement with our bondholders, although we are close to an agreement. The Internal Rate of Return (IRR) for the Sri Lankan Government’s proposal is about 9.7%, while the bondholders’ proposal is 11.51%. The total cash outflow according to the bondholder proposal for 2024-2028 is approximately $ 16.6 billion, compared to $ 14.7 billion for the Government’s proposal. Ideally, we should reach a settlement close to the Government’s proposal if all goes well.

Both the initial and revised proposals indicate that bondholders are reluctant to reduce the interest accrued during the suspension of debt repayments. In both proposals, there have been no haircuts on $ 1,678 million of accumulated interest. Only a 4% interest rate has been proposed for 2024-2028.

Bondholders have suggested a 28% reduction on existing bonds, reducing the total bond value from $ 12,550 million to $ 9,036 million. Both parties appreciate the depth of the haircut, particularly with respect to economic growth. These adjustments depend heavily on adhering to the International Monetary Fund’s (IMF) baseline projections. If we fail to achieve the necessary growth rates, we will receive a deeper concession, and vice versa.

Achieving the best debt restructuring plan for Sri Lanka is crucial and our future hinges on economic growth. The debt level must be compared with the size and growth of the economy because only growth can ensure our ability to repay our debt. Our debt sustainability can only be secured through high growth rates, not solely through the debt relief offered by bondholders.

Economic and governance reforms are essential for growth. Notably, bondholders have proposed an innovative idea called Governance-Linked Bonds (GLB), where Sri Lanka would receive an additional benefit of 50 basis points on two selected bonds, each worth $ 800 million, if we implement two key governance reforms – one qualitative and one quantitative. The quantitative target is to reach a 14% tax-to-GDP ratio in 2026 and 14.1% in 2027.

A list of qualitative targets primarily focuses on publishing procurement contracts and tax exemptions, both of which are included in the IMF Staff-Level Agreement. However, the governance linked bonds, according to the proposal, would only apply to two bonds maturing in 2034 and 2035, each worth about $ 800 million.

While GLBs are an excellent idea, it is questionable whether the incentive is sufficient to encourage a strong governance programme. The savings from a 50 basis point cut in interest for $ 1,600 million would be about $ 80 million. Given that our accumulated interest is also about $ 1,600 million, there is a risk that governments could easily deviate.

Nevertheless, GLBs would send a strong signal to the market that the Sri Lankan administration is committed to governance reforms, which would enhance confidence in Sri Lanka.

Sri Lanka’s real challenge is avoiding a second debt restructuring. We can only achieve this by taking necessary steps and reforms to grow the economy, not solely relying on debt restructuring agreements.

Even if we secure a 30% haircut, our debt-to-GDP ratio in 2032 would still be approximately 95%. Over 50% of countries that have undergone a first debt restructuring have experienced a second. In Sri Lanka’s case, a second debt restructuring would be extremely painful for the population.

Moreover, our interest rates must remain high to meet the Government’s debt servicing requirements, attracting more funds. However, high interest rates discourage investment as people prefer to deposit their money in banks, leading to a low investment environment that could slow down growth. This slowdown would bring us back to the challenge of managing debt sustainability. This vicious cycle must be avoided.

Growth can only be achieved through improved productivity in a competitive environment, which arises when people are incentivised to perform. When the State dominates business and we try to manage everything independently, people do not become competitive.

Ultimately, growth is the only viable solution. Sadly, it is the only solution. Growth occurs when markets function effectively.

Beyond profit margins and scandals

By Dhananath Fernando

Originally appeared on the Morning

Blaming imports and importers has long been ingrained in Sri Lankan culture, often seen as a root cause of the country’s economic issues. This perspective not only overlooks the fact that many importers are also exporters, but also fails to recognise that imports and exports are fundamentally interconnected components of the global trade system.

Despite this, it is crucial to acknowledge that not all imports are conducted ethically or transparently. Recent scandals, such as the sugar scam, misinvoicing, bribery, and procedural irregularities at Customs, highlight the darker aspects of importation. However, casting imports in a universally negative light and fostering resentment based on ideological reasons could prove to be more harmful than beneficial.

Recent investigative reports have revealed staggering profits made by importers on essential commodities like green gram, B-onions, and potatoes. Some profit margins have been reported as high as 280% when comparing the Cost, Insurance, and Freight (CIF) value to the market prices of these goods.

Before rushing to judgement on these profit margins, it is essential to delve deeper into the circumstances surrounding these imports. For example, the importation of green gram has been severely restricted since the onset of the Covid-19 pandemic, requiring special approval from the Ministry of Agriculture. As a result, the quantity of green gram imported in 2023 has been minimal.

Thus, comparing the CIF value at the port to market prices can be misleading, as it does not accurately reflect the profits made by importers. This situation raises questions about the high market prices for green gram, pointing to inefficiencies in local production rather than exorbitant profits by importers.

The scenario with undu, a staple food item, is similar. With a Rs. 300 import tariff, the market price for 1 kg of undu ranges between Rs. 1,500-1,700. This high cost is partly because importers cannot bring in undu without approval from the Ministry of Agriculture, despite the imposition of tariffs.

Allowing imports could potentially reduce the price of undu to around Rs. 700 per kg, even after tariffs. The restriction on undu imports exacerbates price inflation, making it unaffordable for many, particularly those in estate regions and the northeast, leading to food insecurity among vulnerable populations.

During the recent economic crisis and the consequent shortage of foreign exchange, many imports were facilitated through informal payment channels and ‘open papers’ in undiyal markets. This practice, aimed at evading high tariffs and taxes through under-invoicing, underscores the complexity of Sri Lanka’s tariff structure and the urgent need for its simplification.

The report by the Ways and Means Committee suggests that focusing solely on the cost of goods at the port does not provide a complete picture of the import value, especially considering the prevalence of informal payments. This approach to calculating profits, based solely on declared document values, overlooks additional costs borne by importers, thus distorting the perception of their profit margins.

Moreover, the perishability of essential food items, along with the significant costs associated with storage, wastage, and the impact of rising fuel and electricity prices, further complicates the economic landscape. These factors, combined with high inflation rates, have significantly influenced the cost structure of both the wholesale and retail markets, affecting pricing and profit margins.

The impact of export controls on certain commodities, such as B-onions by India, has also played a role in inflating global prices, illustrating the complex interplay of international trade policies and local market dynamics.

This situation underscores the phenomenon of unintended consequences in economic policy, where well-intentioned policies can lead to outcomes that are diametrically opposed to their original goals. Sri Lanka’s intricate tariff structure and monetary instability have inadvertently encouraged informal payment methods on one hand and escalated costs on the other, placing the poorest members of society in an increasingly precarious position.

While it is undeniable that practices like misinvoicing represent clear violations of the law and must be addressed through appropriate legal channels, attributing the entirety of Sri Lanka’s economic challenges to importers overlooks the broader systemic issues at play. Simplifying the tariff structure, as this column has long advocated, could lead to increased Government revenue and minimise systemic leakages, offering a more sustainable solution to the economic challenges faced by importers and consumers alike.

In conclusion, while illicit practices within the import sector must be rigorously tackled, the solution to Sri Lanka’s economic dilemmas lies not in vilifying importers but in addressing the complex policy and structural issues that underpin the nation’s trade dynamics. A comprehensive approach, focusing on policy reform, tariff simplification, and enhancing local production efficiencies, is essential for creating a more stable and equitable economic environment.

Unveiling the true culprit behind economic woes

By Dhananath Fernando

Originally appeared on the Morning

Sri Lankans have a very negative view of imports, which are often portrayed on TV as the problem behind the economic crisis. Not only politicians, but also those who have opinions on our economy subscribe to the idea that imports are the problem.

Our politicians’ favourite pastime is to blame imports and impose various tariffs or ban imports. Banning imports also makes for a very pro-Sri Lankan image, because a common excuse provided is that high imports are damaging to local industries. Accordingly, the banning of imports has been portrayed as a measure to help develop local industries.

A favourite area when it comes to cutting down imports is food imports. Often, media headlines and politicians comment aggressively, even quoting figures on the value of food imported. The middle class, upper middle class, and wealthiest of society often make the argument of needing to save valuable foreign exchange by cutting down food imports.

However, when we consider the data, it indicates the exact opposite. The middle class, upper middle class, and the wealthiest are the ones who consume the most amount of imports in the form of fuel, mainly through personal vehicles and as energy. About 27% of our imports in January was fuel. Fuel is the largest component of our import basket as a single commodity.

What we have imported as food is less than 11% of our total imports. Non-food consumer goods are just 8% of our total imports. Most pharmaceutical products and medicines for patients fall under the non-food consumer goods category, which are primarily consumed by the most vulnerable people in society.

Imported food items are also consumed by the most vulnerable sections of society. Food items such as canned fish, maize, green gram, lentils, black gram, sprats, b-onions, potatoes, and wheat flour are critical food items for the poorest of the poor.

Firstly, these can be stored without a refrigerator, which saves their energy cost. Secondly, they are easily available and affordable compared to many other items of food they consume. Therefore, the request of politicians and academics to cut back on these food items, which comprise less than 11% of our total imports, is nearly impossible to fulfil, and reducing these imports further is tantamount to asking the poor to live in hunger and their children to suffer from malnutrition.

Thirty-seven percent of our import basket comprises intermediate goods, besides food. These are goods required for exports and to produce many things without interrupting the supply chain. For instance while our main export is apparels, our main import is also apparels. Therefore, asking to reduce apparel sector imports amounts to reducing our valuable exports.

In reality, while there persists a belief that imports have to be reduced, it is not the solution it is touted to be. If we have to cut down on food imports, it will lead to increased malnutrition, hunger levels, or food costs for Sri Lankans.

Ways of reducing imports

If we want to bring down our imports, cutting down on fuel is one way to consider. A World Bank study revealed that 70% of the fuel is consumed by the wealthiest 30% of society. Therefore, it only makes sense to maintain fuel prices at market price.

As indicated in the graphs, there is a correlation between high fuel prices and fuel imports. Our fuel imports have decreased when prices are high as people use it sparingly. Compared to January 2023, our fuel imports had declined by about $ 100 million per month by January this year. With the expansion of the economy, this number is expected to slowly grow. Prices can bring imports down without import bans or tariffs.

Another way to reduce fuel imports is by improving public transport. Most of our fuel is wasted in traffic jams as a result of our poor public transportation infrastructure. If we invest in public transport, not only will it reduce fuel imports, but it will also uplift many Sri Lankans and provide significant relief in terms of their purchasing power. Many middle class Sri Lankans pay a 200% tariff to buy a second-hand vehicle at an interest rate of above 12% because they have no other choice but to commute.

Saving foreign exchange

Sri Lanka has been offered many grants, including for the Light Rail Transit (LRT) project, which we turned down on numerous occasions, leading to geopolitical tensions. When people spend less money on commuting and waste less time in traffic congestion, it will not only improve productivity but also their purchasing power, creating many jobs and generating income.

It is an inalienable truth that we need more food imports with different varieties of protein sources for the benefit of the impoverished. Foreign exchange has to be earned through exports, tourism, and remittances.

Saving foreign exchange is a function of the monetary policy or the supply of the Sri Lankan Rupee to the financial system rather than a function of imports and exports. When the rupee becomes expensive, the US Dollar demand decreases automatically because people buy the latter using rupees that they could have used in an alternative manner.

Asking the public to cut down on food imports, which are mainly consumed by the poor, at the expense of allowing the use of more fuel-driven vehicles cannot be justified and borders on cruelty.

Steering clear of divisive politics and economic populism

By Dhananath Fernando

Originally appeared on the Morning

I was recently invited to moderate a session by the European Chamber of Commerce of Sri Lanka (ECCSL) on diversity, equity, and inclusion. Foreign Minister Ali Sabry was one of the Chief Guests and he shared two things we should not do, based on his experience over the past few years in managing a few key portfolios as the Minister of Justice, Finance, and Foreign Affairs.

The event focused on unleashing the power of diversity, equity, and inclusion for businesses in Sri Lanka. Keeping aside the political colours, Sabry’s message on the things Sri Lankans should not do is very apt given the current status of our affairs. These two exhortations were to never play divisive politics and never play with populist economic policies.

The final victim of divisive politics has been none other than our economy and our people. If Sri Lanka is serious about economic development, having a diverse culture is important, as highlighted by Prof. Ricardo Hausmann in his Harvard Growth Diagnostic study on Sri Lanka in 2016-2017. The economic theory behind it is that a diverse culture is capable of creating more combinations of ideas which translate to products, services, and exports.

He provided the example of Silicon Valley – most tech entrepreneurs in Silicon Valley are immigrants to the US, which is one reason a high degree of innovation takes place there. Unfortunately, in Sri Lanka, our politics is used to dilute this strength, which has led to where we are today. At one point, ethnic tensions led to mass migration and we are very slow to include all our ethnicities and religions in our culture.

The divisive politics is now at a level that goes beyond ethnicities. It is now ranged against certain countries, trade agreements, and imports from certain countries. Some good examples are the Suwa Seriya ambulance service and the trade agreement between India and Sri Lanka.

We almost rejected Suwa Seriya on the grounds that it was an Indian invasion and that Indian Intelligence services wanted to collect intelligence data through the ambulance service. This is a service primarily impacting the poorest of the poor and has now been recognised as one of the fastest services in the region by the World Bank.

Divisive politics is now beyond ethnicities and religions. We created the same tensions with trade agreements and claimed that the Free Trade Agreement (FTA) with Singapore would result in foreigners taking over our jobs. Instead, most Sri Lankans left the country for jobs overseas due to the economic crisis and we now beg people to visit us.

We also created similar tensions over the India-Sri Lanka Free Trade Agreement by claiming that the agreement would cause more imports to flow into Sri Lanka, worsening our trade balance. The data shows the exact opposite taking place.

We have a trade surplus with India under the FTA and our trade deficit with India comes from outside the FTA. However, comparing trade balances between countries is completely misleading, since what we need to keep in mind is the budget deficit rather than the trade deficit, because the budget deficit arising from Central Bank lending is what leads to a trade deficit.

At one point, by playing divisive politics, we wanted to boycott our Islamic community. We also wanted to boycott Indian products and chase away Chinese and Japanese investments. To make diversity a strength, we need to look beyond borders and capitalise on the strengths of all communities and all countries.

Minister Sabry’s second directive was to never play with populist economic policies. However, we repeatedly witness political parties engaging in populist politics. We are building resistance against the International Monetary Fund (IMF) programme without any alternative suggestions. Without the IMF programme, even 0.1% of debt relief is not possible. Many funds by many international partners like the Asian Development Bank (ADB), World Bank, and bilateral creditor will evaporate in seconds.

On the other hand, growth reforms are almost non-existent. Not a single State-Owned Enterprise (SOE) reform has been implemented yet and the SOE Bill has been shelved. On the growth front, a complicated tariff structure remains. The establishment of the Central Bank’s independence was the main reform we have undertaken and we can see the results. It is a pity that the Central Bank completely ignored the optics and raised its staff salaries, even at the risk of some policymakers requesting the reversal of the hard-earned reform of the bank’s independence.

While Minister Sabry has correctly understood what exactly should not be done, unfortunately, our politics remains divisive at a new level and populist economic policies have taken a new turn. We still have a long way to go.

The other side of parate execution suspension

By Dhananath Fernando

Originally appeared on the Morning

In India, there was a particular type of cobra that was causing havoc due to snake bites. People were protesting and social pressure was building. The then British Government had a brilliant idea to counter cobra bite-related deaths and bring down the reptiles’ population – it announced an incentive scheme for every dead cobra.

In essence, people in India were encouraged to kill cobras and hand over the animal’s dead body to established Government offices in India and collect cash in return. In the first few weeks, things worked out very well, but later the Government realised that the number of cobras being handed over was increasing exponentially.

Upon investigation, the Government realised that Indians had become somewhat entrepreneurial. They had started cobra breeding houses at homes and killing cobras as a means of revenue generation for the family. At one point, the Government withdrew the cash incentive system given the misuse of the entire scheme.

Since there was no incentive for people to maintain cobra breeding houses, they released the reptiles into the jungle. The cobra population then multiplied several fold more than what it was initially as a result of the same policy being implemented to reduce the cobra population. This is called the Cobra Effect.

The Government decision to suspend parate execution as a relief for Micro, Small, and Medium-sized Enterprises (MSMEs) is no different. It is true that MSMEs are going through a difficult time as a result of higher inflation, high interest rates, and economic contraction. It is necessary to protect the MSMEs as they comprise about 99% of business establishments and about 75% of employment in Sri Lanka.

However, whether the suspension of parate is really for MSMEs is a question; 557 parate executions have been undertaken as of November 2023. The total value of the parate executions was just Rs. 38 billion, which stands at just 0.4% of total loans and a mere 2.7% of total impaired loans. From the numbers, it is clear that most MSMEs have not been impacted by parate executions.

Effect on MSMEs

Parate is an execution power on the part of banks under the Recovery of Loans by Banks (Special Provisions) Act, No.4 of 1990, where lending banks can recover non-repaid debt by borrowers by selling assets without going through the judicial processes. In 1961, this power was only granted to People’s Bank and the Bank of Ceylon, and in 1985, the power was extended to regional rural development banks as well.

If MSMEs are not affected, what could be expected to happen when parate executions are suspended until December by the Government? This is likely to backfire on MSMEs given the nature of the banking industry, akin to the Cobra Effect.

Banks lend depositors money. Parate was a safeguard for depositors’ money in case someone was not repaying loans they had taken, giving banks a final resort to recover that money so they could honour the depositors.

Now with parate suspension, banks have a higher risk of not being able to recover the money from the loans extended, so they have to charge a higher risk premium when borrowing for anybody, including MSMEs. Therefore, if MSMEs want to borrow money now, they have to pay higher interest rates, which means further contraction of the economy at a time when it needs to grow.

Triple whammy

On the flip side, this will encourage borrowers to default as they now know the banks cannot execute parate even if they were to willfully default. Additionally, borrowers who are honouring their loan repayments with the greatest difficulty during this economic crisis will be discouraged, because their hard work in honouring the dues will not be rewarded. This does not mean that even the Rs. 38 billion through parate execution has to be understated, but it has to be addressed separately without changing a law which affects the entire banking sector.

The Government declared a Rs. 450 billion bank recapitalisation in Budget 2024 given the instability of the banking sector as losses and loans of State-Owned Enterprises (SOEs) have to be absorbed. On the other hand, licensed commercial banks including State banks are being exposed to sovereign debt restructuring, which is at its final stage. Accordingly, this is detrimental to the stability of the banking sector.

On the depositors’ end, they may be reluctant to deposit money as their risk is now higher on recovery.

Parate execution generally takes place at the last stage of recovery and must go through a court process. Suspension of parate without even consulting banks may provide wrong signals for the ongoing International Monetary Fund (IMF) review, since the IMF initially advised to conduct an assessment on the stability of the banks, although the context has now changed after a few months.

The Non-Performing Loan (NPL) ratios of banks are also on the rise, so banks basically face a triple whammy with this parate suspension – having to charge risk premiums, high NPL, exposure to sovereign default, and now difficulties in recovering money and incentives for not servicing existing loans.

However, the need to protect MSMEs is paramount, which requires a separate sequence of actions. Setting up a bank specifically to absorb bad loans, setting up bankruptcy laws, or moratoria on some of the bad loans under parate executions are options. Changing the entire parate system will indeed bring consequences similar to the Cobra Effect in India.