Rebuilding without derailing reforms

By Dhananath Fernando

Originally appeared on the Morning

The Government is proposing an additional Rs. 500 billion supplementary budget for 2026 to manage expenditure linked to Cyclone Ditwah.

Obviously, we have to spend money to restore damaged civil infrastructure, livelihoods, and businesses. But we also need to remember that some reforms were already delayed, and now the cyclone has arrived on top of that.

The economic stability we have achieved, including 5.4% growth and the performance of the stock market, rested on five key pillars of reforms. We cannot compromise those reforms on one side. On the other, we must actively push the next set of reforms needed for growth. The cyclone should not become an excuse to pause the growth agenda.

The Central Bank independence law, the Public Financial Management Act, the Anti-Corruption Act, the setting up of the Public Debt Management Office, and cost-reflective pricing for fuel are five pieces of key legislation that helped rebuild stability. Now, with a new Rs. 500 billion supplementary budget, we are looking at amending the Public Financial Management Act and the 13% primary expenditure limit as a percentage of GDP.

Yes, we need to spend. But before we go to the full stretch of a supplementary budget, we must first be serious about repurposing existing allocations and redirecting budgets to rebuilding priorities. With higher expenditure being planned, revenue performance in 2026 may also weaken.

The main tax measure announced was to bring the Value-Added Tax threshold down, which may broaden the base. Still, the cyclone will affect consumption, production, and compliance in ways that are hard to predict. If revenues underperform while spending expands, we risk a wider budget deficit at the very moment we thought we had regained control.

We also need to be careful about what it means to relax the primary expenditure limit from 13% to 14.4%. This does not mean we should never amend the limit. Exceptional events require flexibility. But once we loosen a fiscal anchor, we should be clear-eyed about the political economy.

If another unexpected event happens within the next few months, the risk is that expenditure drifts further and discipline becomes harder to restore. The right sequence matters: repurpose first, tighten implementation, and then expand only what is absolutely unavoidable.

A wider budget deficit will also create pressure on other safeguards. When fiscal policy slips, monetary credibility comes under strain. The temptation then is to reopen backdoors, delay hard decisions, and use inflation as a silent tax. Even when intentions are good, this is often how political systems behave during shocks.

That is why defending the credibility of the Central Bank independence framework and the fiscal rules-based approach is not a technical obsession. It is the firewall that prevents emergencies from becoming permanent instability.

At the same time, we must move ahead with the reforms that were already pending: strengthening the social safety net through better targeting, land reforms, public transport reforms, and, most importantly, State-Owned Enterprise reforms. These reforms can unlock existing assets, reduce losses, and lift growth without continuously leaning on taxpayers.

Alongside this, trade and investment reforms are necessary for sustained growth. Simply lowering tariff rates, simplifying the tariff structure, and fixing Customs processes are not optional anymore. In fact, the cyclone opens a reform window for the Government, but the reforms must aim beyond merely returning to where we were before the disaster. Rebuilding should mean building better systems, not just repairing broken structures.

The immediate risk is that the national conversation narrows to cyclone recovery and, conveniently, forgets recovery from the economic crisis. Of course, if we fail to recover from the cyclone, another economic crisis is inevitable. But the reverse is also true. If we recover from the cyclone but abandon the economic reforms, we may still slide back into crisis, only with a different trigger.

The only way out is economic reform-led recovery, and we need to move quickly.

At the moment, there is talk of an international donor conference and an International Monetary Fund (IMF) Rapid Financing Instrument to support recovery. These can help, and Sri Lanka should pursue them with urgency and credibility. But the real game changer is defending the reforms that brought stability and executing the reforms that generate growth.

Donor support works best when paired with reforms, because the donor community understands our real weakness: after every external shock, we struggle not because we lack sympathy or even financing, but because we delay hard economic reforms once the immediate pressure eases.

Let us hope this cyclone becomes a turning point not only for relief and reconstruction, but also for the fundamentals of growth. And let us hope the donor community connects its support to long-delayed reforms that can prevent the next shock from becoming the next crisis.

The thin line between gaining power and triggering crises

By Dhananath Fernando

Originally appeared on the Morning

The game has begun. The familiar auctioning of non-existent resources during election season is in full swing. Candidates are making various promises without considering the repercussions they will face whether they win or lose.

Candidates are likely contemplating two things: first, promise now, gain power, then deal with the aftermath of those promises. Secondly, if they know they’re not going to win, they might promise the impossible, thinking they won’t have to deal with the consequences. Neither of these approaches is without significant risks and either can lead to disastrous consequences.

Elections and governing a country go beyond mere promises and their execution; it’s about managing people’s expectations with available resources.

After the economic crisis, all indicators suggest we are slowly recovering, thanks to stringent measures. Interest rates have soared to record highs to curb inflation. Urban poverty has tripled, rural poverty has doubled, and the already impoverished estate sector has seen a 1.5-fold increase in poverty.

Apart from our parliamentarians, all citizens have compromised their wealth and earnings. The public has reluctantly understood that tough sacrifices are necessary.

Impossible promises

The promises being made now are simply impossible to deliver. One such promise is a 25-50% salary increase for Government employees. Even the last Budget’s cost of living allowance increment is yet to be fully implemented. According to the 2023 Budget, Government salaries and wages total approximately Rs. 939 billion. Therefore, a 25-50% increase would require an additional Rs. 230-460 billion next year.

Our annual revenue from Advance Personal Income Tax (APIT) is at most Rs. 160 billion. This means that the proposed salary hike would require almost 1.5 to three times APIT. Is the private sector ready to shoulder an additional 150-300% in tax or revenue hikes for these Government salary increases?

Just in July, the Government rejected a proposed Rs. 20,000 salary hike for State workers, stating that it would need an additional Rs. 275 billion, which would require increasing the Value-Added Tax (VAT) by 4% to proceed.

Making matters worse, there are suggestions to amend VAT and many other tax rates by different candidates to align with their earlier pitches.

The danger of these promises is that whoever becomes the candidate who comes into power will need to fulfil all these promises, even those made by their competitors, which are unattainable.

The losing candidate, who will then be in the opposition, will always pressure the government to fulfil these unsustainable promises, raising public expectations for things that cannot be delivered. When expectations are unmet, it typically results in a political crisis, or if they try to fulfil what was promised and it is not economically viable, we will end up in an economic crisis.

That is why elections are not just about gaining power but also about managing people’s expectations.

Making promises responsibly

A salary hike for senior Government officials is necessary, but it is only feasible through a complete restructuring of the Government cadre and our military.

Currently, about 48% of our salary expenditure is for the defence sector, with about 32% going to the military. Restructuring the military is complicated and sensitive. A salary hike without restructuring will disincentivise staff who are expecting to leave, adding a massive burden on Government pensions and leading to a pension crisis.

With the new Central Bank of Sri Lanka (CBSL) Act, the Treasury cannot borrow money from the CBSL or print money. Therefore, if the Government borrows more from the market, interest rates will rise and the overall cost of capital will skyrocket.

The proposals to revise VAT are no different. VAT is a reasonable tax system because it only charges for the value added, unlike other indirect taxes like the Social Security Contribution Levy (SSCL), which has a cascading effect. VAT is easier to collect and it creates minimal distortions. Additionally, high-income earners contribute a higher amount of VAT as their consumption is greater.

The discussion about renegotiating the International Monetary Fund (IMF) agreement needs to be approached with caution. In every IMF review, it is clear that adjustments or shifts in timelines are made based on our performance.

However, trying to renegotiate the entire IMF agreement and its structural benchmarks could invite unnecessary complications. Not only Sri Lanka, but our bilateral partners including China, Japan, and India; multilaterals such as the Asian Development Bank (ADB) and Japan International Cooperation Agency (JICA); and our bondholders have all based their calculations on the existing IMF agreement.

It took over a year to negotiate our current terms. Another renegotiation would be time-consuming, and by the time we reach a settlement, the accumulated interest would be unbearable and market confidence would likely falter.

The damage our candidates are collectively doing is by making promises that cannot be delivered during this crucial time, and people’s expectations are a combination of all these. Whoever wins may have to deliver most of these pledges, which is not feasible. If the winner cannot deliver, a political crisis is certain, or if the winner tries to implement what was promised, another economic and social crisis is assured.

While people must vote carefully, candidates must make their promises responsibly; otherwise, they will start losing power from the very first day they receive it.

Not cost of living but quality of life

Originally appeared on The Morning

By Dhananath Fernando

The gentleman who cleans and repairs my roof every month is the breadwinner of a family of four, and a father to two children who are still schooling. He earns a living working for a company for an end-of-the-month salary, but it is paid based only on his working days. I often ask him: “How is life?” He always grins and provides me with the same answer: “On payday Rs. 5,000 is worth just Rs. 50. One week before payday, Rs.50 is worth Rs. 5,000.” 

I recalled what he said when recently, a Minister stated in Parliament that “the Rs. 5,000 was given for a month, not to be spent within a week”. Things took an emotional turn following this statement and social media castigated him for being tone-deaf and being detached from ground realities. 

This makes complete sense from the receiver’s point of view. Rs. 5,000 is not adequate for a family of four! A simple calculation breaks it down as follows: Rs. 1,250 per person per month, which means about Rs. 42 per person a day, and about Rs. 14 per meal, even if the calculation is based on the rather broader and irrational assumption that the money is only spent on food.

According to the Household Income and Expenditure Survey by the Department of Census and Statistics, Sri Lanka’s mean household expenditure per month is Rs. 54,000.  In the estate sector, which is in the lowest part of the income pyramid, it is about Rs. 34,000. On average in Sri Lanka, food expenditure is Rs. 19,140 per month and even in the estate sector, it is at Rs. 16,890. This is according to data for the year 2016. Bearing this in mind, if we add 5% inflation every year, the expenditure must be significantly higher today.    

It is painfully obvious that an allowance of Rs. 5,000 is not at all adequate for a month’s expenditure. However, in defence of the Government, it was communicated that the Rs. 5,000 was not a stipend and is adequate for a month as a supplement for people whose livelihoods are affected. The Government reiterated that this was a form of financial assistance to help them keep their nose afloat in these trying times. It is no secret that the Government is running a massive budget deficit to the extent of 8.9% of GDP in 2021. Therefore, providing Rs.5,000 is also a challenging task, given the strained and limited financial resources. 

This points to just one conclusion; that nobody but poverty is to be blamed for the current circumstances. Sadly, as a country, we are in denial of this fact.   

Let’s look one step further. Our inability to tackle poverty is our own doing. We have failed over and over again, from one successive government to another, to set our fundamentals in the right direction. Unfortunately, we still continue to drift ignorantly in the same wrong direction.  

Sri Lanka’s workforce is highly state-dependent and the island’s massive inclination towards a welfare state is far beyond our affordability or financial capacity. Politicians promise long lists of free supplies from fertiliser to sanitary napkins and to even jobs in the government sector. It is a vicious cycle of politicians cheating people and people cheating themselves, owing to their enormous reliance on the State. This unsustainable codependency has today shoved the island to one of its worst economic calamities since independence.

Starvation-driven crowds protest in the streets of Colombo requesting for more money. The Government is struggling to make repayments to our external creditors; $ 4 billion on average over the next four years. Our reserves stand at $ 5 billion in total with the Government still running a significant trade deficit.

Why is the cost of living high?

Our cost of living has always been a much-discussed topic over the decades. The real reason why it’s high is because we are very unproductive as a country. Despite low labour costs, our production tends to be expensive and unproductive. We spend about 20-50% more than the average price on some essential goods. In certain product categories, it goes beyond 100%, which is almost double. Our products are not competitive on a global scale. Consecutive governments have failed at making reforms that are required to make them competitive. Our tax structure is 80% indirect tax and 20% direct tax, where most of the basics, including food items, are subjected to a tariff. That is one reason why most of the gazette notifications which are released are on tariff revisions. When this happens, every government becomes the victim of their own policies when the cost of living starts rising.  

 We often look at increasing local production but fail to consider improving local manufacturing and competitiveness. Global benchmarks are forgotten. We continue to ignore the consumer. As a result, higher incomes become meaningless in Sri Lanka as our quality of life continues to deteriorate. For example, even if you have a vehicle, it is difficult to commute and if you are in business, there are way too many interventions and bureaucracy. If you use the courts as a means of conflict resolution, the matter takes decades to be resolved. Thus, we don’t really meet the basic requirements for a satisfying quality of life or ease of doing business. 

Solution

There is only one solution – hard reforms to make Sri Lanka’s products competitive. We can make products competitive through competition. We can compete and be competitive only if we increase productivity. Darwin’s theory of evolution that only the fittest survive is still very much valid. The problem is that we have failed to grasp the reality that we must evolve with the changing times.

If we continue to disregard the need to evolve our fate, it will be catastrophic and a payday where we feel that Rs. 5,000 is actually worth Rs. 5,000 will be a distant dream. If the hard reforms are not prioritised and pushed through, all Sri Lankans will live forever in that week before payday, just like that nice gentleman who cleans and repairs my roof. 

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.