Why is the Sri Lankan Rupee depreciating?

By Dhananath Fernando

Originally appeared on The Morning

Why has the Sri Lankan Rupee depreciated over the last few days? Many people want to know the reason. Many also want to predict where the exchange rate will stabilise.

In simple terms, the exchange rate is the price we pay in rupees to buy one US Dollar. It is similar to buying a cake of soap from a shop. If the price of soap increases, we say soap has become more expensive. Likewise, when the price of a US Dollar increases in rupee terms, we say the rupee has depreciated.

Like any other good, the price of the US Dollar is determined by demand and supply.

On the supply side, dollars come into the banking system through merchandise exports, service exports, tourism earnings, worker remittances, foreign direct investments, and other capital inflows.

The real trick is in understanding the demand side. Dollars are demanded for merchandise imports such as raw materials, fuel, vehicles, and medicine. Dollars are also needed for outbound tourism expenditure, foreign salaries, profit repatriation, and outward remittances. In addition to importers and individuals, the Central Bank too buys dollars from the market to build reserves.

So, when the demand for dollars exceeds the supply of dollars, the rupee depreciates. In other words, the price of the dollar goes up.

But there is one important point many people miss. Demand for dollars is created through rupees. If there is more rupee liquidity in the banking system, and if that liquidity is converted into credit, it can create more demand for imports and therefore more demand for dollars.

How USD demand is created: Story of excess credit

Everyone who goes to a bank to buy dollars either pays in cash or obtains a loan from the bank.

If banks lend from depositors’ money, it does not necessarily create excess demand. This is because someone has already saved money by reducing consumption. That saved money is then lent to someone else with interest. In that case, overall demand in the economy does not increase in the same way.

But the situation is different when the Central Bank buys dollars from the market to build reserves.

The Central Bank does not collect deposits from the public like a commercial bank. When the Central Bank buys dollars, it pays rupees into the banking system. In simple terms, it creates new rupees.

One may then ask: is it wrong for the Central Bank to buy dollars and build reserves? The simple answer is no. The Central Bank must build reserves, especially after a crisis. It has to buy dollars from the market to do so.

However, when the Central Bank buys dollars, new rupees enter the banking system. Over the last three years, the Central Bank has bought a cumulative $ 6,528 million from the market, injecting rupees into the banking system in the process.

Once this additional rupee liquidity is in the banking system, banks cannot earn much by simply keeping it idle. They have two options:

They can deposit the money back at the Central Bank and earn interest – This is linked to what we call the overnight policy rate. At present, if banks deposit excess money at the Central Bank, they earn about 7.25% interest.

They can lend this money to customers – These loans can take many forms: letters of credit for imports, credit cards, housing loans, overdraft facilities, business loans, and other forms of credit.

When banks extend loans using this additional rupee liquidity, credit in the economy expands. Part of this credit eventually moves into imports because people and businesses buy more goods, many of which are imported. This creates additional demand for dollars.

According to the Central Bank’s Annual Economic Review 2025, private credit expanded sharply. Credit growth increased from around 25%, and in value terms, credit expanded from about Rs. 790 billion in 2024 to about Rs. 2,000 billion in 2025. This means the economy created more demand for dollars through credit expansion.

When the economy is growing strongly, new rupee liquidity may not immediately create trouble because the new money is also used to produce and consume more goods and services. But when credit expands faster than dollar inflows, the economy becomes vulnerable. Usually, the pressure becomes visible after an internal or external shock.

In simple terms, while Sri Lanka had excess dollars in the market for some time, excess rupee liquidity and credit expansion continued to create demand for imports. That import demand eventually created pressure on the exchange rate.

Speculation effect

The second reason for the recent depreciation is speculation.

When the currency starts to depreciate, those who bring dollars into the market may hold back, expecting the rupee to depreciate further. Exporters, remitters, and others who have dollars may delay conversion.

At the same time, those who need dollars try to buy them as early as possible to avoid a further loss. Importers and businesses rush to cover their dollar needs.

As a result, demand increases while supply is delayed. This can push the exchange rate up quickly.

If this continues, informal markets can also get activated. When people feel they cannot access dollars easily through the formal banking system, or when they expect the rupee to depreciate further, they may start looking for dollars outside the formal market.

That creates another problem. The informal rate can move above the official rate, more dollar holders may delay bringing money into the formal system, and confidence in the exchange rate can weaken further.

Fuel price adjustments and vehicle import ban

Adjusting diesel prices to market prices is essential to contain dollar demand. Fuel is one of our largest import items. In March, fuel accounted for about 23% of our imports. Therefore, fuel prices have to reflect market costs.

If fuel prices are kept artificially low, consumption does not adjust. People continue to consume fuel as if global prices have not changed. But the country still has to find dollars to pay for those imports. That is how a fuel subsidy becomes an exchange rate problem.

There is another argument that vehicle imports should be banned again to save dollars. This sounds attractive, but it does not solve the real problem.

If vehicle imports are banned while excess rupee liquidity remains in the banking system, banks will lend that money to other sectors. Credit may then move into construction, electronics, consumer goods, or other import-heavy categories. So while vehicle imports come down on one side, imports in another category can increase.

Therefore, banning one import item does not necessarily reduce overall import demand. It only shifts demand from one category to another.

If the objective is to reduce overall import demand, the real tool is interest rates. When market interest rates increase, banks have a better incentive to deposit money at the Central Bank instead of lending aggressively to customers. Higher interest rates also discourage people and businesses from taking new loans. Consumption slows down, credit slows down, and import demand comes down.

Of course, this is not painless. When interest rates go up, the economy slows. Businesses face pressure. Small and Medium-sized Enterprises (SMEs) face a difficult time. Borrowers feel the pain.

But this is the difficult choice in economic management. Either we adjust early through prices and interest rates, or we are forced to adjust later through a currency crisis.

The real reasons for exchange rate depreciation are a mix of global shocks, credit expansion, and speculation. The tools available are also clear: fuel prices must be cost-reflective, and interest rates must be used when credit expansion creates pressure on the currency.

Both actions are politically unpopular. But if we fail to adjust to reality, the reality we will face later will be far more unpopular.

Fuel subsidies are not social protection

By Dhananath Fernando

Originally appeared on The Morning

This column previously warned that when prices lie, crises follow. Sri Lanka learnt that lesson the hard way in 2022. Yet today, we are once again moving towards the same dangerous path by moving away from cost-reflective fuel pricing.

The Government has now effectively admitted that fuel is being subsidised by around Rs. 100 per litre for diesel and around Rs. 20 per litre for petrol. Sri Lanka consumes roughly 180 million litres of diesel a month and a similar volume of petrol. Even if this subsidy applies only to fuel sold through the State-owned Ceylon Petroleum Corporation (CPC), the cost is staggering. The monthly subsidy bill could easily exceed Rs. 15 billion and amount to Rs. 150–200 billion annually.

To put that into perspective, Rs. 200 billion is equivalent to building nearly two expressway phases of Rambukkana to Galagedara or financing several major infrastructure projects. Instead, we are distributing that money through subsidised fuel largely to those who consume the most energy.

The reality is simple. The non-poor consume far more fuel than the poor. Around 70% of Sri Lanka’s fuel consumption comes from higher-income groups and commercial users who are relatively capable of absorbing price increases. In effect, the subsidy becomes a transfer of public money to people who can already afford to pay market prices.

The bigger issue

The President recently stated at a meeting that, according to CPC calculations, diesel prices should be around Rs. 720 per litre, while it is currently being sold at around Rs. 392. Even after accounting for the estimated Rs. 100 subsidy, there still appears to be a significant gap between the actual cost and the selling price.

The bigger issue, however, is not merely the subsidy itself but the pressure it creates across the entire economy. The President himself acknowledged that Sri Lanka’s monthly fuel import bill, which was previously around $ 200–300 million, was now expected to rise towards $ 500 million.

Artificially low prices encourage higher consumption, especially among those who can afford it. The likely Government strategy may be to hold prices down temporarily in the hope that global oil prices will eventually decline, allowing losses to be recovered later. Unfortunately, this is exactly the same mistake Sri Lanka made before the economic crisis.

Fuel and electricity were both sold below cost for prolonged periods based on political calculations rather than economic reality. Once subsidies are introduced, politics makes it extremely difficult to reverse them. Politicians facing elections and public pressure continue postponing necessary price adjustments, and temporary subsidies slowly become permanent fiscal burdens.

Severe consequences

The consequences do not stop there. Fuel and vehicle-related taxes remain among the Government’s largest sources of revenue. With vehicle imports already constrained, the resulting tax shortfall will eventually need to be filled either through new taxes, lower tax thresholds, or wider tax collection efforts.

It is far more transparent and economically rational to allow consumers to pay the true market price for fuel at the point of purchase rather than recovering the same money later through additional taxes on income, consumption, or businesses.

Sri Lanka’s agreement with the International Monetary Fund clearly emphasises the importance of cost-reflective pricing for fuel and electricity. Even if the Government argues that subsidies can be financed through alternative revenue streams, the signal sent to investors, businesses, and international lenders is deeply concerning. It suggests that Sri Lanka is beginning to drift away from the very stability framework that restored confidence after the crisis. The same concerns apply to delays in electricity tariff revisions.

There is also a dangerous monetary risk beneath the surface. Subsidising fuel for those who do not need support eventually creates pressure on the Government to seek financing elsewhere. Historically, that ‘elsewhere’ has often been the Central Bank.

Today, with greater Central Bank independence, direct monetary financing is no longer easily possible. But political pressure can quickly emerge to weaken those safeguards. Once people are convinced that printing money can keep fuel prices low and distribute more subsidies, the pressure to dilute hard-earned reforms becomes politically attractive. That is precisely how Sri Lanka entered the spiral that led to the 2022 collapse.

Without some level of demand contraction through market pricing, fuel consumption will continue increasing, placing greater pressure on the dollar market. Sri Lanka will then face two painful choices: allow the rupee to depreciate sharply or spend down scarce foreign reserves defending the currency.

Both options carry severe consequences. A weaker rupee pushes inflation and fuel prices even higher, creating a vicious cycle. Meanwhile, depleting reserves damages investor confidence, weakens creditworthiness, and raises concerns about debt sustainability.

None of this means high fuel or electricity prices are desirable. Prices should come down. But sustainable price reductions can only come through productivity improvements, competition, efficiency gains, and better management, not through unsustainable subsidies.

At the same time, rising energy prices do hurt the poorest households disproportionately. The solution, however, is not universal subsidies that benefit the wealthy most. The correct approach is targeted social protection. Sri Lanka must strengthen its social safety nets and increase direct cash transfers for the poorest families rather than subsidising fuel consumption for those who can comfortably afford market prices.

In simple terms, subsidies should protect the poor, not cheap fuel consumption for the rich.

Graph

VAT, taxes and the real cost of government

By Dhananath Fernando

Originally appeared on The Morning

The recent amendments to the Value-Added Tax (VAT) have once again brought taxation into the national conversation.

Contrary to what many initially assumed, the VAT rate itself has not increased. What has changed is the VAT registration threshold, which has been reduced from Rs. 60 million to Rs. 36 million in annual turnover. As a result, many micro, small, and medium-sized businesses will now fall into the VAT net.

This has naturally triggered criticism that Sri Lanka is relying too heavily on indirect taxes instead of expanding direct taxation. That concern is understandable. Yet when comparing taxes, VAT remains one of the more reasonable forms of taxation despite its imperfections.

That does not mean VAT rates should keep increasing. It simply means that, compared to many other taxes imposed in Sri Lanka, VAT is economically less damaging and comparatively more transparent.

VAT is on the value added

The important principle behind VAT is that the tax is only charged on the value a business adds at each stage of production or distribution.

Take a bicycle manufacturer selling a bicycle for Rs. 10,000. With an 18% VAT, the final selling price becomes Rs. 11,800. The manufacturer collects Rs. 1,800 as VAT on behalf of the Inland Revenue Department (IRD).

However, the manufacturer may have already paid VAT on inputs used to produce the bicycle. Assume tyres, rims, and spokes cost Rs. 5,000 before VAT. With VAT included, the manufacturer pays Rs. 5,900 to suppliers. That means Rs. 900 has already been paid as VAT earlier in the supply chain.

When settling taxes with the IRD, the manufacturer only pays the balance Rs. 900 because the earlier VAT payment can be claimed back as an input credit. In simple terms, VAT is ultimately charged only on the additional value created by the manufacturer, which in this case is the increase from Rs. 5,000 to Rs. 10,000.

This is very different from taxes such as the Social Security Contribution Levy (SSCL), which creates a cascading effect. Under the SSCL, every stage of production pays tax without the ability to deduct what was paid earlier. The supplier pays it, the manufacturer pays it again, and eventually the tax compounds through the entire production chain.

That cascading effect quietly increases costs across the economy. Compared to such taxes, VAT is economically cleaner and less distortive.

Is it impacting the poor the most?

A common criticism against VAT is that it affects the poor disproportionately. The argument usually goes like this: if both a wealthy individual and a poor individual buy one kilogramme of dhal, they both pay the same VAT amount.

On the surface, that sounds unfair. But VAT is fundamentally a consumption tax. Those who consume more pay more. Wealthier households consume significantly more goods and services than poorer households and therefore contribute more VAT overall.

The real issue is not VAT alone. The heavier burden on poor households often comes from Sri Lanka’s complex web of import tariffs, para-tariffs, cess duties, Ports and Airports Development Levy (PAL), and Customs taxes that silently increase the prices of essential goods.

Take construction materials such as cement, steel, wall tiles, or floor tiles. These taxes raise the cost of housing, infrastructure, and business investment. Unlike VAT, these taxes become embedded in the full cost structure. Businesses then finance those inflated costs through expensive loans, which further compounds prices across the economy.

In many sectors, the real cost drivers are tariffs and para-tariffs rather than VAT itself. If policymakers genuinely want to reduce pressure on low-income families, tariff reform deserves far greater attention.

VAT is only charged when a transaction happens

Another reason VAT is comparatively more reasonable is that it is linked directly to transactions.

Unlike personal income tax, where the Government takes a portion of earnings before individuals even decide how to spend them, VAT is only paid when consumption takes place. In that sense, consumers still retain a degree of choice.

If someone decides not to purchase a product or service, no VAT is charged. That transaction-based structure makes VAT comparatively more transparent than many other forms of taxation.

Not charging VAT can also distort competition

High VAT thresholds can also create an uneven playing field between businesses.

Take the poultry industry. Poultry products sold through supermarkets are often subject to VAT, while products sold through informal wet markets may escape it altogether. As a result, supermarket prices appear higher, even when the businesses involved are complying fully with the tax system.

Yet many of these supermarket suppliers are also the companies maintaining hygiene standards, investing in large-scale production, and building systems compatible with export markets. When compliant businesses lose competitiveness because others remain outside the tax net, the incentive to reinvest and expand weakens.

A functioning tax system must also preserve neutrality. Taxes should not unfairly reward one group while penalising another.

That said, widening the tax net does not automatically justify high tax rates. Sri Lanka must also remain regionally competitive. Corporate taxes are already around 30%, while the highest personal income tax bracket stands at 36%.

If the country continues broadening the tax base, it becomes even more important to ensure overall tax rates remain competitive with global and regional standards.

Taxes alone cannot develop a country

No country has become prosperous purely through taxation. Taxes are necessary to fund public services, but economic growth is what ultimately lifts people out of poverty.

The uncomfortable reality is that as government expenditure continues to rise, governments will continuously search for ways to increase taxes, expand tax nets, or introduce new levies.

If Sri Lanka genuinely wants lower taxes in the long run, the conversation cannot only be about taxation. It must also be about government expenditure, efficiency, and fiscal discipline.

Without controlling expenditure, the country will remain trapped in a cycle where every fiscal problem eventually becomes a tax problem. That is the real conversation Sri Lanka needs to have.

When ownership isn’t ownership: How special land regimes undermine property rights

By Tirani Kulathunge

Originally appeared on Daily FT

• Deeds are a problem; titles are a solution but in a fragmented land system, even titles can fail to protect private ownership.

Sri Lanka’s deed-based land registration system remains one of the largest source of insecurity in the property market. Proving ownership through decades long chains of deeds is slow, costly, and vulnerable to fraud, leaving households and businesses unable to fully use land as collateral or investment capital. Land titling, through the Bimsaviya program, was designed to resolve this by replacing uncertain deeds with State-guaranteed titles. But titling alone is not enough. When titles are issued into a landscape governed by multiple overlapping land regimes (planning authorities, development zones, infrastructure corridors, and special statutory powers), private ownership remains exposed to post-title intervention, delay, and uncertainty. In such a system, ownership security depends not only on what the title says, but on which authority asserts control after the title is issued.

This concern is already recognised in policy discussions around accelerating Bimsaviya. Advocata’s Policy Recommendations for Budget 2026 note that after more than 25 years, fewer than 1.06 million parcels have been titled out of an estimated 16 million, creating a confusing dual system where deeds and titles coexist, undermining trust among citizens, banks, and legal professionals.

The report argues that Bimsaviya’s stagnation is not merely technical, but rooted in institutional fragmentation, weak coordination, and political-economy constraints that prevent titles from delivering real economic value. While accelerating titling is essential to unlock “dead capital” and restore confidence, the effectiveness of this reform ultimately depends on whether titles are protected from being quietly overridden by parallel land regimes. Without addressing how multiple authorities interact with titled land, faster titling risks reproducing insecurity in a new legal form rather than resolving it.

On paper, private land ownership is protected through formal titles, registration, and due process. In reality, those rights operate inside a maze of special regimes; investment zones, tourism areas, urban development corridors, strategic projects, reclamation authorities. Each of these is governed by its own rules, authorities, and exceptions. The result is a system where land may be privately owned, yet never fully secure.

This is not a fringe problem. It is one of the central reasons why land titles fail to deliver confidence, credit, or investment, despite years of reform efforts (de Soto, 2000; World Bank, 2017).

Special regimes are often justified in the name of speed, growth, or national importance. And in isolation, many of these objectives are legitimate. But taken together, they have created a parallel land governance universe in which ordinary rules do not apply consistently, and where ownership certainty depends less on title than on which authority claims jurisdiction at a given moment. Governance scholars have long warned that such institutional fragmentation weakens the credibility of formal rights even when laws exist on paper (North, 1990).

For private landowners, this means living with permanent uncertainty.

A land parcel can be legally titled and yet subject to rezoning without notice, redevelopment powers without proper communicated consent, acquisition without predictable compensation, or usage restrictions that emerge only when an application is made. The problem is not always expropriation; more often it is opacity. Rights are not clearly extinguished but neither are they clearly protected. Empirical land governance research shows that predictability, not the absence of regulation, is what sustains confidence in property systems (FAO, 2012).

This ambiguity is especially damaging because it is uneven. Two landowners with identical titles can face radically different realities depending on whether their land falls within a tourism development area, a strategic project zone, an urban redevelopment boundary, or a reclamation authority’s jurisdiction. In such a system, property rights are no longer universal; they are conditional. That conditionality has real consequences.

Banks hesitate to lend against land where post-title intervention is unpredictable. Investors discount land values where use rights can change overnight. Citizens delay building, selling, or improving property because the rules are unclear. Over time, land becomes economically sterile. This is not because ownership is absent, but because certainty is. Markets are unforgiving in this respect; they price institutional risk quickly and bluntly (de Soto, 2000; World Bank, 2017).

What makes this particularly troubling is that these special regimes rarely operate through the land registry itself. Decisions are often taken elsewhere, recorded elsewhere, and enforced elsewhere. Titles remain unchanged even as their substance erodes. The registry tells you who owns the land but not how fragile that ownership may be. This disconnect between registries and governing authorities is a well-documented failure mode in fragmented land systems (OECD, 2015).

This is why land titling alone cannot fix the problem.

Issuing titles into a system dominated by exceptional regimes is like handing out passports in a country where borders keep shifting. The promise of certainty collapses at the moment a parallel authority can override, qualify, or delay the exercise of ownership without transparent rules or timelines. Legal reform without institutional integration simply displaces risk rather than removing it (North, 1990).

To be clear, this is not an argument against development, investment, or planning. It is an argument against governance by exception.

Special regimes should not replace the land system; they should sit transparently within it. If land is subject to special conditions, those conditions must be visible, searchable, and legally ranked. Owners should know that before they buy, build, or borrow what actually applies to their land, and under what process it can change. International best practice increasingly recognises that integrated land information systems, rather than proliferating exceptions, are key to balancing development and rights protection (FAO, 2012; World Bank, 2017).

Instead, Sri Lanka has allowed special regimes to proliferate without integration, creating a hierarchy where “special” quietly trumps “private,” and discretion trumps predictability.

The deeper risk is not just economic; it is institutional. When property rights depend on which authority you negotiate with, rather than on a clear and consistent system, trust erodes. People could stop believing that titles mean what they say. And when that happens, no amount of digitisation or legislative amendment will restore confidence (North, 1990).

Land reform cannot succeed in a landscape where exceptions are the rule.

If Sri Lanka is serious about protecting private land ownership while pursuing development, it must confront this uncomfortable truth: special regimes need limits, transparency, and integration, not unchecked precedence. Until then, private land ownership will remain conditional, contested, and quietly weakened by the very systems meant to accelerate progress.

“The problem is not always expropriation; more often it is opacity. Rights are not clearly extinguished but neither are they clearly protected. Empirical land governance research shows that predictability, not the absence of regulation, is what sustains confidence in property systems”

What needs to change

1. One authoritative land system: At the core of the problem is a simple absence of hierarchy. Sri Lanka does not lack land institutions; it lacks a single system that all of them must ultimately answer to. The most basic reform principle is therefore this: there must be one authoritative land system. Special regimes can exist, but they cannot exist outside the land system. As long as planning authorities, investment bodies, infrastructure agencies, and reclamation authorities can independently alter or constrain land rights without reference to the registry, ownership certainty will remain conditional. A title can only mean what it says if no parallel authority can quietly rewrite it.

2. Bring special regimes through the registry: This principle becomes meaningful only if special regimes are required to operate through the land registry rather than around it. That does not mean stripping agencies of their powers. It means that any restriction, reservation, acquisition, or override they impose should become legally effective only once it is recorded, ranked, and visible in the land system itself. If land is subject to a development zone, an infrastructure corridor, or a strategic reservation, that fact should be discoverable before a transaction takes place, not after. When special regimes bypass the registry, they create invisible risk. When they pass through it, they create predictability.

3. Discipline exceptional powers with time and process: Finally, exceptional powers must be disciplined by time and process, not left to operate indefinitely. Many special regimes begin as temporary measures but evolve into permanent uncertainty. Restrictions should expire unless explicitly renewed, delays should trigger consequences rather than silence, and prolonged interventions should activate predictable compensation. Procedural tools such as time-bound decisions, deemed approvals, and parallel processing are not technical fixes; they are governance safeguards. Without them, delay remains the safest option and reform remains vulnerable to quiet resistance.

The reform challenge is not to abolish special regimes, but to discipline and integrate them. Sri Lanka needs a single, authoritative land system in which every special condition affecting land from planning controls, development zones, acquisition corridors, environmental buffers, or strategic reservations that is legally ranked, digitally visible, and procedurally time bound. Special regimes should no longer operate as parallel systems that override private ownership invisibly; instead, their powers must be exercised through the land registry itself, with clear triggers, timelines, and compensation rules. Where land is subject to exceptional treatment, that exception should be knowable before purchase, finance, or development and not discovered after the fact. Until special regimes are brought back into a unified land governance framework, land titles will remain formally issued but substantively insecure, and private ownership will continue to depend less on law than on discretion (North, 1990; FAO, 2012; World Bank, 2017).

From airlines to electricity: The cost of ignoring markets

By Dhananath Fernando

Originally appeared on The Morning

Last week offered two clear reminders of a lesson Sri Lanka keeps learning the hard way.

Markets discipline decisions. Governments struggle to run businesses. The cost of ignoring this distinction is paid by taxpayers and consumers.

SriLankan: A repeating cycle

The first story was the resignation of the Chairman and several board members of SriLankan Airlines. This is not a story about individuals failing. It is a story about systems failing. Even capable professionals cannot succeed when incentives, governance, and political pressures are misaligned.

We have seen this cycle before. Successive governments have been persuaded that the airline can be ‘turned around’ with the right people and a new plan.

When the current President assumed office as both President and Finance Minister, his first Budget allocated Rs. 20 billion to support the airline based on the board’s recovery plan. Eighteen months later, we have not even managed to appoint a permanent CEO to run a highly technical, fast-moving industry that depends on precision and commercial agility.

This is not new. As far back as the time of J.R. Jayewardene, advice from Lee Kuan Yew was clear: do not run an airline as a state enterprise. Singapore structured its National Carrier under Temasek Holdings, separating ownership from political control and embedding commercial discipline.

Sri Lanka has done the opposite. From one administration to another, the pattern has been the same. Political ownership, weak governance, and repeated capital injections. The debt of roughly $ 510 million was absorbed by the Government, transferring the burden from the airline’s balance sheet to the public. Yet the core problem remains unresolved.

Every new board arrives with a familiar script. Fleet expansion. Optimistic projections. A promise that the airline is ‘rescuable’. But without basic building blocks such as professional management and independence from political interference, these plans collapse. If a government cannot appoint a CEO for its own airline, it raises a more fundamental question. Can the State effectively run any commercial enterprise?

Today, there is discussion of injecting another Rs. 20 billion as the airline struggles to remain a going concern. This is the trap of State ownership. Entering is easy. Exiting is nearly impossible. Selling is politically sensitive. Closing is economically disruptive. The result is a perpetual drain on public finances.

Energy pricing: The real risk

The second story was the electricity tariff revision. It is understandably unpopular, but the real risk lies not in raising prices but in failing to do so.

Energy pricing in Sri Lanka has long been disconnected from market realities. When global prices rise and domestic tariffs remain unchanged, the losses accumulate within institutions such as the Ceylon Petroleum Corporation. These losses do not disappear. They are financed through borrowing, money printing, or delayed payments, all of which eventually return to the public in the form of inflation, currency depreciation, or shortages.

At present, diesel pricing illustrates the problem clearly. Based on current global prices, diesel is being sold at a significant loss, estimated at around Rs. 163 per litre. Even if the Government were to remove the entire tax component, there would still be a gap. This is not sustainable.

Meanwhile, private players such as Lanka IOC and Sinopec are operating under the same administered pricing structure. The sharp increase in super diesel prices to around Rs. 600 signals that underlying costs are much higher than the retail price of standard diesel.

At the refinery level, the difference between diesel and super diesel is relatively small, often in the range of $ 0.05–0.15 per litre. In rupee terms, this would typically translate to a gap of around Rs. 45–50. The current price difference of nearly Rs. 190 suggests that standard diesel prices are significantly underpriced.

Underpricing has consequences. It creates implicit subsidies that are neither targeted nor efficient. In Sri Lanka, around 70% of fuel is consumed by the wealthiest 30% of the population. When diesel is sold below cost, the benefit disproportionately accrues to those who consume more, while the cost is borne by the broader population.

This is why the real conversation should shift. While prices must be adjusted to reflect market realities, the policy effort should focus on strengthening the social safety net. The objective is not to suppress prices artificially, but to protect the most vulnerable directly.

We cannot protect the poorest of the poor by keeping prices low. In fact, rising food prices, especially of essentials like rice, have already hit them the hardest. Broad subsidies on fuel do little to help them. Instead, they drain public resources.

The better approach is targeted support. Increase cash transfers to the poorest households so they can weather this period of high prices. Strengthen the social registry. Improve targeting. Ensure that assistance reaches those who genuinely need it, rather than being spread thinly across the entire population.

This also preserves fiscal space. Instead of subsidising consumption for higher-income groups, resources can be redirected to those who are most vulnerable. It is both economically efficient and socially just.

The link to electricity is direct. As water levels decline and hydro generation falls, the system shifts towards thermal power, relying on diesel and coal. If diesel prices remain artificially low, the losses in the energy sector widen. If prices are corrected, electricity tariffs must adjust accordingly. The alternative is power cuts or a return to the fiscal and monetary instability that triggered the last crisis.

The uncomfortable truth is that market-reflective pricing is not a choice. It is mandatory. Ignoring it does not protect consumers. It postpones the cost and amplifies it.

The high price of ignored signals

Both stories from last week point in the same direction. Governments are not designed to run commercial enterprises. When they try, inefficiencies and losses accumulate. Prices that ignore market signals create distortions, shortages, and fiscal pressure.

The solution is not complicated, though it is politically difficult. Exit from commercial activities where the State has repeatedly failed. Establish clear, rules-based pricing mechanisms for energy that reflect global costs. At the same time, build a stronger, better targeted social safety net that protects the poorest from the impact of these adjustments.

Markets are not perfect. But they are far better at signalling reality than administrative decisions. When those signals are ignored, reality eventually asserts itself, often at a much higher cost.

(The writer is the Chief Executive Officer of Advocata Institute. He can be contacted via dhananath@advocata.org)

(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)

The dollar myth we keep getting wrong

By Dhananath Fernando

Originally appeared on The Morning

There is a persistent belief among Sri Lankans that because we import more than we export, we borrow dollars at high interest rates to bridge the gap. 

Many still assume that our external debt is simply the result of financing this trade deficit. The same fear resurfaces every time global oil prices rise. If fuel becomes expensive, people assume we must borrow more dollars to pay for imports. 

This is a compelling story. But it is largely wrong. Let’s take this myth apart step by step. 

It is true that Sri Lanka runs a deficit in merchandise trade. When we look at physical goods such as tea, apparel, rubber, coconut, and fuel, we import more than we export. In January for instance, the country exported goods worth $ 1,148 million and imported goods worth $ 1,803 million. That leaves a merchandise trade deficit of $ 654 million. 

But this is only one part of the picture. 

The flow of dollars into and out of a country is not limited to goods. There is also trade in services, including, but not limited to IT, logistics, insurance, and tourism. Even in a simple tea export, the value recorded at the port is only the ‘free on board’ price. Insurance and freight are counted separately as services. 

In January, Sri Lanka exported $ 734 million in services and imported $ 328 million, generating a surplus of $ 406 million in the services account. When you combine goods and services, the overall trade deficit shrinks significantly, to around $ 248 million. 

But the story does not end there. 

The current account also includes income flows. This is where remittances play a major role. In January this year, Sri Lanka received $ 740 million in inflows such as worker remittances, while outward payments including interest and other transfers amounted to $ 122 million. This leaves a net income surplus of $ 617 million. 

When you combine goods, services, and income, Sri Lanka actually recorded a current account surplus of about $ 369 million for the month.  

This is the critical point – the economy, in that month, generated more dollars than it spent. Therefore, the idea that we automatically borrow to bridge the import-export gap is misleading. 

Now consider a scenario where global fuel prices spike to around $ 120 per barrel due to the Middle Eastern tensions. Yes, the cost of fuel imports will rise. But that does not mean the country will automatically face a dollar shortage. 

Why? Because the economy adjusts. 

If more dollars are spent on fuel, there is less capacity to spend on other imports. Consumption shifts. If tourism declines, dollar earnings fall, but so do the associated dollar expenses. If remittances decline, household consumption reduces accordingly, lowering import demand. 

In short, both inflows and outflows adjust. The total volume of dollar transactions may shrink, and people will feel the pressure, but this does not automatically translate into a balance of payments crisis. 

Crises emerge not from price movements, but from policy failures. 

The real risk arises when domestic policy distorts this natural adjustment. When the Central Bank expands the money supply excessively – beyond what the economy can absorb – it artificially boosts demand. That demand spills into imports, increasing the need for dollars without a corresponding increase in inflows. 

This is why Central Bank independence matters. Its primary objective must be price stability. The moment it tries to chase short-term growth through money printing, the result is temporary expansion followed by currency pressure and instability. 

Similarly, fiscal discipline is critical. A large budget deficit injects excess liquidity into the economy, driving consumption and imports. Reduce the deficit, and the pressure on the external account eases naturally. The trade deficit is not an isolated problem. It is deeply linked to fiscal and monetary choices. 

This is also why price adjustments, including fuel pricing, are essential. Prices carry information. They signal scarcity. When prices are artificially suppressed, consumption does not adjust, and imbalances widen. Allowing prices to reflect global realities ensures that the economy self-corrects. 

The lesson is simple. 

Sri Lanka’s vulnerability does not come from importing more than it exports. It comes from how we manage our policies in response to that reality. External shocks such as oil price increases are inevitable. But whether they turn into crises depends entirely on our internal discipline. 

If we get the fundamentals right, the economy will adjust. If we don’t, even a small shock can push us back into instability. 

The real battle is not in global markets. It is at home, in our policy choices. 

When prices lie, crises follow

By Dhananath Fernando

Originally appeared on The Morning

The only certainty about the crisis in the Middle East is its uncertainty. Recent attacks on Iranian and Qatari gas infrastructure are already pushing global Liquefied Natural Gas (LNG) and energy prices upwards, and these pressures are unlikely to ease anytime soon.

Many Sri Lankans fear that our economy could collapse because of this crisis. There is some truth in that concern. But if the economy does collapse, it will not be because of the Middle Eastern crisis alone; it will be because of how we respond, or fail to respond to it.

At the heart of this response lies one critical decision: whether we adjust domestic energy prices in line with global realities.

In his address to Parliament on Friday (20), the President signalled the need to revise fuel prices again mid-month. Given the volatility of global markets, even weekly or daily revisions may be justified. This is not policy overreaction; it is economic discipline.

Prices are the most effective tool we have to manage scarcity. When prices rise, demand contracts – that is how markets signal reality. With global energy prices skyrocketing, price adjustments are not optional; they are the first line of defence.

Yet, the pressure to increase prices remains politically constrained. Sri Lanka currently has a degree of buffer, both in foreign reserves and domestic liquidity. This creates the illusion that we can delay adjustments. Governments often hesitate, fearing the political cost of passing global price shocks to consumers.

Keeping prices artificially low, however, has consequences. It encourages consumption beyond what we can afford. Every litre consumed above sustainable levels is paid for with scarce dollars. Eventually, this pressure will hit the exchange rate.

At that point, the Government will face an even harsher choice: either allow the rupee to depreciate sharply, or burn through reserves to defend it. Both paths are far more damaging than timely price adjustments.

If we choose to defend the currency while keeping fuel prices artificially low, we will simply deplete our reserves. If we float the currency under pressure, the impact will be economy-wide higher inflation, eroded savings, and a deteriorating investment climate.

None of these are better alternatives.

That said, fuel price hikes are not painless. They are not a perfect solution, nor a silver bullet. Higher fuel prices will ripple across the economy; raising transport, food, and other essential costs. Given the relatively inelastic nature of fuel demand, the burden will be felt widely, especially by the poorest.

This is precisely why price adjustments must be accompanied by targeted cash transfers. The answer is not to suppress prices for everyone, but to support those who truly need it. Well-targeted assistance can cushion the vulnerable without distorting the entire system.

It is also important to understand this: even if fuel prices rise to Rs. 1,000 in line with global markets, the economy will adjust. Growth may slow, but stability will be preserved.

The alternative, on the other hand, is far worse. If we avoid price adjustments, the gap between real costs and subsidised prices does not disappear, it accumulates. And eventually, society pays the price through currency depreciation, inflation, and another full-blown economic crisis.

We have seen this movie before.

The decision to allow private companies to import fuel is a step in the right direction. The President noted that five licences had already been issued. These players will likely enter the market at higher, more realistic prices. That, in itself, is a signal.

Higher prices attract supply. They also discipline demand. Both are necessary in a constrained environment.

Our hard-earned reserves should not be used to defend an artificial exchange rate. Nor should our hard-earned primary surplus be used to subsidise fuel consumption, especially when, as data suggests, nearly 70% of fuel is consumed by the top 30% who can afford higher prices.

Even mechanisms like the QR code system are, in effect, hidden price controls. Long queues, waiting time, and even informal payments to bypass quotas are simply non-monetary forms of price increases.

If we are serious about reform, we must go further. Price caps imposed on private players such as Sinopec, Lanka IOC, and Shell should be removed. These companies must have the incentive to import and supply fuel based on market conditions. Ceylon Petroleum Corporation (CPC) prices, too, must adjust accordingly.

The real test for the Government is simple: can it allow prices to reflect reality?

If it fails, the Middle Eastern crisis will not remain external; it will become our own economic crisis.

If it succeeds, the economy may slow, but it will endure.

And in times like these, survival with discipline is far better than collapse with denial.

Navigating Sri Lanka’s maritime governance in an era of conflict

By Dhananath Fernando

Originally appeared on The Morning

The war in the Middle East has come uncomfortably close to Sri Lanka. Quite apart from the macroeconomic consequences that may unfold depending on the length of the conflict, the recent torpedo attack on an Iranian ship within Sri Lanka’s Exclusive Economic Zone (EEZ) should have sent a shockwave through our policy establishment. It should have felt almost as serious as a direct strike within our territorial waters.

The reason is not that Sri Lanka must choose sides in this war. Nor is it only about the possible economic ripple effects through oil prices, shipping costs, tourism sentiment, or remittances.

The real alarm bell is something deeper: Sri Lanka still does not have a clear Standard Operating Procedure (SOP) governing research vessels and other sensitive maritime activity within our EEZ.

This is not simply a diplomatic oversight. It is a strategic blind spot. Sri Lanka’s EEZ is roughly 7.8 times larger than our land mass. In maritime terms, Sri Lanka is far bigger than we often think. Yet our national conversation still treats the ocean as empty space rather than a strategic economic frontier.

Within that maritime zone lies enormous potential. Fisheries, marine biodiversity, ocean science, seabed resources, and new opportunities linked to the emerging blue economy. But resources alone do not create prosperity. Economics teaches us that prosperity comes from clear rules, defined rights, and institutions capable of managing resources productively.

Navigating geopolitical complexities

Property rights matter on land. They matter just as much at sea. The problem is that governing an ocean space of this scale is not easy for a small state. Sri Lanka’s enforcement capacity is limited. Monitoring marine scientific research, regulating foreign vessels, and ensuring compliance with national conditions requires technical expertise, institutional coordination, and consistent policy.

The difficulty, however, does not end there. Sri Lanka also operates in a complex geopolitical neighbourhood. This means we cannot simply permit any research vessel access to our waters without considering wider security implications.

If a scientific mission is perceived as compromising India’s security interests or regional stability, the consequences for Sri Lanka could be serious. At the same time, refusing access arbitrarily can damage relations with other major powers.

We have already seen this dilemma play out. On several occasions Sri Lanka found itself caught in a diplomatic crossfire when Chinese research vessels requested permission to operate near our maritime zone, triggering strong concerns from India.

When a country lacks a clear framework, every decision becomes a political crisis. If Sri Lanka allows the vessel, India is displeased. If Sri Lanka refuses, China is unhappy.

Both countries are critical economic partners. Both are far larger powers than Sri Lanka. But Sri Lanka’s objective should not be to please everyone in the moment. The objective should be to protect sovereignty while maximising the economic value of our maritime space. The only sustainable way to do this is through clear rules.

A shift from reaction to preparation

Sri Lanka needs a well-defined Standard Operating Procedure governing research vessels and other sensitive maritime platforms entering our waters. Such a framework should specify what types of activities are permitted, under what conditions, and with what safeguards.

Any marine scientific research conducted in Sri Lankan waters should be subject to strict conditions. Research data must be shared with Sri Lankan authorities. Sri Lankan scientists must participate in the research. Equipment and research objectives must be disclosed in advance. And the Government must retain the right to halt activities that violate agreed conditions.

If these requirements are unacceptable to a foreign vessel, permission should simply not be granted. This is not about confrontation. It is about governance.

Fortunately, the global legal framework for such governance already exists. The United Nations Convention on the Law of the Sea (UNCLOS) provides the legal architecture for managing maritime zones and regulating marine scientific research. Sri Lanka, India, and China have all ratified this convention.

The task before Sri Lanka is therefore not to invent new law but to translate existing international principles into clear operational rules tailored to the country’s national interests.

Sri Lanka also has a proud legacy in shaping global maritime law. The late Shirley Amerasinghe, one of Sri Lanka’s most distinguished diplomats, chaired the Law of the Sea Conference until his death in 1980. It is no coincidence that soon afterwards Sri Lanka established the National Aquatic Resources Research and Development Agency (NARA), under the leadership of Dr. Hiran Jayewardene, with the intention of building national expertise in marine science and maritime governance.

That vision remains relevant today. Unfortunately, Sri Lanka’s institutional capacity has not kept pace with the strategic importance of our maritime domain. We are still reacting to events instead of preparing for them.

If domestic capacity is insufficient, Sri Lanka should draw on partnerships with countries that possess strong maritime research systems. Nations such as Norway and others with advanced ocean governance frameworks could support Sri Lanka in building technical capacity, developing institutional structures, and training local experts.

An untapped economic opportunity

Strengthening maritime governance is not merely a defensive exercise. Done properly, it can generate economic benefits.

Sri Lanka can capture knowledge rents through shared research data about the Indian Ocean. We can build expertise by training Sri Lankan marine scientists and expanding opportunities for research institutions and private sector collaboration. Ports can generate additional commercial revenue through logistics, services, and maritime support activities. And the country can position itself as a credible neutral hub for humanitarian maritime services in the Indian Ocean.

In short, maritime governance is not just about security. It is also about economic opportunity. This is why it would be a mistake to view the Middle Eastern conflict only through the narrow lens of tourism losses or remittance risks.

Sri Lanka’s strategic thinking must go deeper. The real question is whether we are capable of turning our geography into an advantage rather than a vulnerability.

Because the uncomfortable truth is this: Sri Lanka’s greatest vulnerability is not that we refuse to choose sides. It is that we continue to operate without a rulebook. And in an increasingly contested Indian Ocean, that is no longer a luxury we can afford.

Tariff reform vs. the high-tariff lobby

By Dhananath Fernando

Originally appeared on The Morning

There was a recent news story that the Government is considering a new tariff policy. That may sound technical. It is not. It goes to the heart of how expensive life is in Sri Lanka.

A tariff, in simple terms, is a tax imposed by a government on goods imported from another country. The definition is straightforward. The system is not.

Millions of products cross borders every year. In Sri Lanka, each of these items is taxed at different rates at the point of entry. Every product that crosses the border is classified under what is known as an HS Code – the Harmonised Commodity Description and Coding System developed by the World Customs Organization (WCO).

At the global level, goods are identified using a six-digit code. Countries can then add additional digits to create more detailed classifications. That is where complexity begins. With eight or 10 digits, categories become narrower, rates become different – and discretion enters the system.

There are generally two types of tariffs. The first is an ad valorem tariff – a percentage of the value of the good. For example, a vehicle may be taxed at 20% of its declared value. The second is a specific tariff – a fixed amount per unit, such as a certain number of rupees per pair of shoes or per kilo of cement.

Not all tariffs are created equal. In principle, tariffs discourage trade. Governments justify them either as revenue measures or as tools to protect domestic industries. But when tariffs become excessively high, they stop being revenue instruments. They become barriers. Products simply do not enter the market because, after taxes, they are no longer affordable.

The type of tariff also matters. A specific tariff can disproportionately hurt lower-income consumers. Imagine a flat Rs. 500 tax on a pair of shoes. A pair worth Rs. 1,000 faces a 50% tax. A pair worth Rs. 30,000 faces less than 2%. The burden falls heavier on those buying lower-value goods. That is not progressive policy; that is distortion.

Sri Lanka’s deeper problem, however, is structural. We have operated for decades with a highly complex, cascading tariff system. Multiple rates across thousands of HS codes. Para-tariffs layered on top of Customs duties. Different treatment depending on how a product is classified.

Complexity creates discretion. Discretion creates room for corruption. When tariff rates differ significantly between similar HS codes, the official determining the classification holds enormous power. A small change in classification can mean a large difference in tax payable. That gap becomes fertile ground for rent-seeking.

But that is only one side of the story.

The real push for high tariffs does not primarily come from customs officials. It comes from vested interests within the private sector.

There are companies in selected industries that mainly serve the domestic market. If cheaper or better-quality imports were allowed to enter freely, many of these firms would struggle to compete. Instead of improving productivity or innovating, they lobby for protection.

Construction materials are a clear example. Tariffs in some segments go as high as 70% or 80%, often through para-tariffs such as Commodity Export Subsidy Scheme (CESS) and Ports and Airports Development Levy (PAL).

Over time, the high-tariff lobby has become highly organised. It operates almost like a cartel. It finances political campaigns across party lines. It frames the narrative around ‘saving dollars’ and ‘protecting local industry’ while consumers quietly pay the price. Many of these protected industries function as monopolies or oligopolies, operating in near-cartel structures with limited competition.

To further entrench protection, many of these products are placed on what is known as the ‘negative list.’ Even when Sri Lanka signs a free trade agreement, items on the negative list are excluded from tariff reductions. In effect, the agreement becomes hollow for those sectors.

The proposed new tariff policy seeks to address this. It is expected to introduce a simplified structure, perhaps four tariff bands such as 0%, 10%, 20%, and 30%, and to remove para-tariffs like CESS and PAL. If implemented properly, this would be one of the most significant trade reforms in decades.

But reform in Sri Lanka is never a straight road.

Lobbying groups typically use three tactics to dilute such reforms. First, they demand long phase-out periods of three to five years, arguing that the industry needs time to adjust. In practice, those years allow political pressure to build and reforms to stall.

Second, they push to expand the negative list, adding more items under protection so that even with a simplified tariff structure, meaningful competition never materialises.

Third, they invoke anti-dumping measures to reintroduce barriers through another door, effectively recreating protection under a different label.

Many governments have attempted tariff reform. The fact that we are still debating simplification after decades is itself evidence of how strong vested interests are.

Moving towards a four-band tariff system and eliminating para-tariffs is commendable. But it must be done decisively. Without expanding the negative list. Without excessive phasing. Without hidden backdoors.

Every delay strengthens cartels. Every compromise keeps prices high. And every year of hesitation quietly squeezes consumers, especially the poor, by denying them access to affordable goods and better living standards.

Tariff reform is not a technical adjustment. It is a test of political courage. The question is simple: do we design policy for protected producers, or for the broader public?

The answer will determine whether Sri Lanka remains a high-cost economy trapped by interests or becomes a competitive one driven by opportunity.

India signs, Sri Lanka hesitates

By Dhananath Fernando

Originally appeared on The Morning

India has been playing well, not only on the cricket field, but increasingly on the trade field too. Its recent trade agreement with the European Union (EU) will have implications far beyond New Delhi and Brussels. It will have consequences for Colombo as well.

For years, Sri Lanka benefited from the EU’s Generalised Scheme of Preferences Plus (GSP+) scheme. Under GSP+, developing countries such as Sri Lanka are granted zero or preferential tariffs when exporting to the EU, provided they comply with international conventions on human rights, labour standards, environmental protection, and democratic governance.

That preferential access created a clear incentive. Indian investors, who did not enjoy GSP+ access, saw Sri Lanka as a gateway to the European market. Apparel, seafood, rubber products, and several manufacturing segments directly benefited. Some firms chose Sri Lanka precisely because of the tariff advantage offered under GSP+.

But the landscape is changing.

India’s expanded access

With India now signing a comprehensive trade agreement with the EU, the relative advantage Sri Lanka enjoyed under GSP+ becomes less meaningful. If manufacturing in India now receives comparable or preferential access to Europe, the tariff incentive that once distinguished Sri Lanka begins to narrow. Moving a plant to India versus Sri Lanka may no longer differ significantly in terms of EU tariff treatment.

There is also a structural difference worth noting. GSP+ is a unilateral, discretionary concession granted by the EU. It can be withdrawn. A Free Trade Agreement (FTA), by contrast, is a negotiated, reciprocal arrangement between two sovereign governments. It carries a different level of predictability and legal certainty.

Not many people remember that India’s very first FTA with Sri Lanka was the India-Sri Lanka Free Trade Agreement (ISFTA), which was signed in 1998 and came into force in 2000. At that time, both countries were at roughly similar stages in their trade liberalisation journey.

Since then, India has moved decisively, signing agreements covering nearly 60 countries and major economic blocs. The EU deal itself took nearly two decades of negotiation. Meanwhile, Sri Lanka signed agreements with Pakistan, Singapore, and later Thailand, yet questions remain about the depth, utilisation, and consistency of these arrangements. The contrast in trajectory is clear.

India’s expanded access to the EU may even influence other global players. Trade relationships are strategic; one agreement often triggers recalibration elsewhere. When a major market opens up to India, others take note.

Sri Lanka’s reality

For small economies like Sri Lanka, FTAs are valuable tools for securing market access. But we must also be realistic.

Sri Lanka’s economic backbone consists largely of Small and Medium-sized Enterprises (SMEs). Compliance with rules of origin, certification requirements, and documentation under FTAs can be costly and complex. For many SMEs, the administrative burden itself becomes a barrier. Signing an agreement does not automatically translate into utilisation.

FTAs tend to attract larger-scale investors more than smaller domestic firms. Yet even large investors do not come only for tariff concessions. They come for stability, predictability, and policy credibility. A trade agreement cannot compensate for macroeconomic instability or regulatory uncertainty.

That is why Sri Lanka must go beyond simply negotiating more FTAs. We need unilateral liberalisation, simplifying imports and exports, reducing para-tariffs, rationalising Customs procedures, and creating a predictable trade regime. If we are serious about trade-led growth, openness cannot depend solely on negotiations abroad; it must be embedded at home.

India, of course, enjoys structural advantages Sri Lanka does not. It has scale, a vast labour pool, and a large domestic market that lowers production costs. Sri Lanka lacks that scale. But that reality is not an excuse for hesitation; it is precisely why we must integrate faster and deeper into global trade networks.

A simple lesson

One of the greatest advantages of an FTA is predictability. In countries like Sri Lanka, where governance structures are often weak and policy reversals are frequent, even unilateral tariff reductions can be undone with a change of government or pressure from lobbying groups. A binding agreement provides discipline. It locks in reform.

There are also widespread misconceptions about existing agreements. Take the ISFTA. Many assume it benefits India disproportionately. Yet the data tell a more nuanced story.

In 2021, Sri Lanka exported about $ 815 million worth of goods to India. Of that, roughly $ 525 million, around 64%, entered under ISFTA preferences. In the same year, Sri Lanka imported about $ 4.4 billion from India, but only around $ 208 million, less than 5%, came in under the FTA framework.

In other words, most Indian exports to Sri Lanka do not rely on ISFTA concessions; they enter under normal tariffs. By contrast, a significant share of Sri Lankan exports to India depends on the agreement. Even if one believes exports are ‘better’ than imports, the structure of the agreement clearly provides Sri Lanka meaningful access. Removing or weakening it would likely hurt Sri Lankan exporters more than Indian ones.

A similar pattern can be observed under the Pakistan-Sri Lanka Free Trade Agreement.

In this context, the Government’s proposal to remove para-tariffs such as cess and the Ports and Airport Development Levy (PAL) and move towards a four-band tariff structure is commendable. Rationalisation is long overdue. But reform must be consistent. While simplifying tariffs, we must avoid expanding negative lists, the products and services excluded from trade agreements. Expanding exclusions defeats the purpose of liberalisation.

India, for all its political rhetoric, has gradually opened its economy with limited and clearly defined sensitive sectors such as agriculture. In fact, India’s former Chief Economic Adviser recently wrote in The Economist that the country may be on the verge of becoming one of the world’s most open major economies.

For Sri Lanka, the lesson is simple. In a small island economy with limited domestic scale, there is no sustainable alternative to trade reform. Protection may feel safe in the short term, but isolation shrinks opportunity. The solution is not hesitation. The solution is faster, deeper, and more predictable integration into the global economy.

Trade is not a luxury for Sri Lanka. It is a necessity. And the reforms cannot wait.

Tourism, like cricket, needs better fundamentals

By Dhananath Fernando

Originally appeared on The Morning

Sri Lanka tourism is a lot like Sri Lanka cricket. For cricket, everyone has an opinion. Who should be captain, what the team should look like, what the game plan should be. Tourism is the same. Almost everyone has a different idea of how to ‘fix’ it.

And, like cricket, tourism is emotionally connected to the hearts and minds of people. That is why we get disappointed so easily after even a small setback, and why we bounce back so quickly too. The love for the game and the industry is real.

Tourist arrivals are now picking up and we are hitting record highs. But estimated earnings are declining. We need to remember that ‘earnings’ are an estimate. We calculate earnings by multiplying the number of arrivals by average length of stay, and then by average spending per night. The most sensitive part of that equation is average spending, which is based on surveys of tourists, on what they spend on categories such as accommodation, travel, shopping, and so on.

A few months ago, the Sri Lanka Tourism Development Authority (SLTDA) with Australia’s Market Development Facility (MDF) launched results of a survey with a sample of about 11,000 inbound travellers and 5,000 outbound travellers, covering about 50 countries.

According to those results, average spending per tourist is now $ 148, down from the earlier $ 171. That shift alone helps explain why earnings can fall even while arrivals rise. The same survey shows that about 18% of visitors are repeat visitors and 58% are women. Of total spending, 55% goes to accommodation. Interestingly, 46% of travellers booked through Online Travel Agents (OTAs) and 62% are non-package travellers.

In this context, another SLTDA study has made headlines: out of about $ 3 billion in earnings in 2024, around $ 900 million is said to have “leaked,” and the Government is now trying to prevent this leakage. According to the study, around $ 500 million is leaking through inbound travel operators and another $ 250 million through accommodation. Based on these findings, there is a renewed push for measures to minimise leakage.

The obsession with leakage

The intentions are good. But the problem is the way we are diagnosing the disease. In my view, there is a poor understanding of monetary economics behind this obsession with ‘leakage.’

Yes, OTAs charge commissions. Yes, some payments are settled overseas, so not every tourism dollar will enter Sri Lanka through our banking system. But the idea that regulating OTAs or tightening rules on parts of the tourism value chain will meaningfully ‘save’ dollars is not first principles thinking. Oversight matters. Compliance matters. But oversight is not a monetary strategy.

Here is why.

Leakage of dollars is largely a function of excess rupees in the system, not simply the behaviour of tourism stakeholders. When we create excess rupees, people will try to convert those rupees into dollars. The most common way this happens is through imports.

Let’s simplify it. When we buy a mobile phone, we are effectively buying dollars with rupees. We pay the shop in rupees. The shopkeeper goes to the bank, buys dollars using those rupees, and pays the overseas supplier. The transaction is initiated by rupees. If we have excess rupees the demand for USD is higher.

Now imagine we ban mobile phones, thinking those dollars will stay in the country. They will not. The bank will sell those dollars to someone else who wants to import something else, because banks are in the business of converting currencies, and because demand for dollars does not disappear simply because one item is restricted. If there is excess rupee liquidity, the dollars will find a way out through whatever channel is available.

The same logic applies to tourism. Even if you restrict OTAs or tighten certain import segments, there will be no ‘dollar saving’ if the rupee side remains loose. Any dollars entering the market will still leave as long as there is excess rupee liquidity chasing foreign exchange. Restrictions shift routes. They do not remove the pressure.

At the same time, we should be honest about why some businesses prefer to keep foreign currency outside Sri Lanka. It is not only about commissions or convenience. It is also about the difficulty of moving money across borders when regulations are heavy, approvals are unclear, and conversion rules are tight. If you are running a cross-border business, you will naturally park funds where transactions are smoother and risk is lower. That is exactly what is happening.

There is another reality we cannot ignore: there is a limit to how much import content we can cut in tourism without damaging the product.

A visitor expects a basic standard. Rooms need air-conditioning. Air-conditioners are imported. Tourism transport needs reliable vehicles and fuel. Vehicles and fuel are imported. There is a minimum quality bar in a competitive global market, and trying to cut our way below that bar will not save us; it will simply push tourists elsewhere.

Even in services, ‘local only’ is not always practical. World-class restaurants and wellness experiences often depend on specialised inputs and, sometimes, specialised talent. In some cases, salaries have to be paid in foreign currency.

You cannot run a top-tier Japanese restaurant or a great Thai experience with good intentions alone. We need talent from those countries to be located here for an authentic experience. If we attempt to ‘save dollars’ by lowering quality, we will end up losing the very customers who bring the dollars in the first place.

So what should we focus on?

Instead of hunting ‘leakage’ like it is the main villain, we should focus on value creation. If tourists see value, they spend more. Higher spend improves earnings, supports better jobs, and creates stronger businesses that can invest in quality.

The path to stronger tourism earnings is not to squeeze the system tighter; it is to make Sri Lanka a place where people are happy to spend, and businesses are confident to bring money in and reinvest.

And this is where monetary stability becomes central. If we stabilise the monetary system, avoid excess rupee creation, and reduce unnecessary friction in capital flows, tourism earnings will naturally improve. Yes, there will always be some money that is paid abroad, just as Sri Lankans will always spend money abroad too. That is normal in an open economy.

The solution is not to treat tourism stakeholders as the problem. The real fix is to get the monetary foundations right and make Sri Lanka easy to do business with. Otherwise, we will keep arguing about captains and game plans while losing the match in the middle overs.