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. 

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.