Permits, privilege, and the price we all pay

By Thamirran Chuciyanthan

Originally appeared on Daily FT

“There will be no permits. The permit culture must end in Sri Lanka.” This was the resounding declaration from President Anura Kumara Dissanayake as he presented the 2026 Budget proposal. The plan to supply vehicles to Members of Parliament (MPs) on a strictly “return-after-term” basis echoes a long-overdue escape from a system that has, for decades, quietly drained public coffers. It is a system that has rewarded privilege over performance, entrenched inequality, and undermined the credibility of the state.

The Advocata Institute welcomes this decision. It is a vital critique of a “permit culture” that is a remnant of a feudal past, not a modern economy. A permit is, by definition, a special approval granting selected groups privileged access to benefits unattainable to the general public. It creates an inherently regressive, two-tier system: one for ordinary citizens, and another for those afforded special treatment.

When we examine the case of vehicle permits in Sri Lanka, the dynamic becomes disturbingly stark.

The anatomy of an exemption

To understand the magnitude of this reform, one must understand the distortionary nature of the “permit.”

According to Finance Ministry officials, since 2020 alone, 25,508 duty-free vehicle permits have been issued to Government employees. Even during the economic constriction of recent years, the flow continued: 6,062 permits in 2024 and 2,043 in 2025.

In Sri Lanka, vehicles are expensive because of import tax – a policy imposed and strengthened by Parliament since the 1960s. Issuing exemptions (permits) is, therefore, a fundamentally flawed rationale. It’s the equivalent of penalising an entire class, with no basis for the punishment to begin with, before releasing the favoured students from sanction – all the while cleverly disguising the exemption as a so-called “benefit”. And who are the first beneficiaries? The very policymakers responsible for the high taxes.

Evolution of privilege: From compensation to commodity

Originally introduced as compensation for low nominal salaries, the permit system morphed into a transferable asset and a reliable source of campaign financing. By importing vehicles at the fraction of its taxable price, or by selling the permit itself, MPs were able to generate substantial profits, untaxed, to fund electoral activities. In the decades that followed, eligibility expanded well beyond Parliament. The privilege was extended to senior civil servants and a wide array of public-sector professionals, including but not limited to doctors, university professors, State engineers, and directors of State corporations.

Eventually, permits had become a normalised perk in the public sector, issued as frequently as once every five years. However, this perk was driven not by performance gains, but lobbying pressure. No circular or audit report has ever tied permit eligibility to measurable performance. Entitlement was purely based on title or years of service, thus, creating a dangerously perverse incentive structure.

The result? Permits turned into a predictable political asset, attached to a significant transferable cash value. As vehicle import taxes increased over the years, the value of the permit increased proportionally. The permit itself became an appreciating asset, detached from its initially stated purpose, and thus began the trading of permits too.

In December 2010, Transparency International Sri Lanka revealed that the majority of 65 newly elected Parliamentarians, including 2 Cabinet Ministers, sold their duty-free vehicle permits for as much as Rs. 17 million each, when adjusted for inflation using Department of Census and Statistics figures, that windfall is equivalent to which adjusted for inflation sits at approximately Rs. 48 million today.

In December 2012, in an event the Sunday Times classified as a “Christmas Bonansa for MPs,” the Government granted permission for MPs to openly sell their duty-free permits. At the time, they sold for Rs. 20 million each, which adjusted for inflation sits at approximately Rs. 50 million today.

Consequently, we saw a worsened repetition of this in 2016.

Nagananda Kodituwakku is an attorney-at-law and rights activist, who formerly headed the Customs Revenue Task Force. On 28 October 2016, he wrote to the Commissioner General of Motor Traffic, naming 75 MPs who imported luxury vehicles, including BMWs, Mercedes-Benz, Land Cruisers and even a Hummer. The total tax waived per MP ranged from Rs.30 million to Rs. 44.7 million. In today’s terms, this range approximately translates to between a staggering Rs. 66 million and Rs. 98.5 million.

The numbers speak for themselves.

Since the permit artificially lowers the price of a vehicle for a specific group, they benefit from a subsidised (concessional) price. The relative price of a vehicle falls for members of this group, so demand rises, but this rise is not attributed to market forces. The sudden rise in vehicle purchases among permit holders is not a reflection of genuine need; it is a rational response to a market distortion. They buy not because they must, but because the tax exemption makes it financially irrational not to.

Mechanics of the loss

When a permit holder imports a vehicle, the State suffers a “double blow” to its revenue stream. First, the Treasury forfeits the revenue at the border. The list of waived taxes is exhaustive and compounding:

1. Customs Import Duty (CID)- Calculated as a % of Cost, Insurance and Freight (CIF)

2. Excise Duty (XID)- Calculated using engine capacity, fuel type, vehicle category

3. Social Security Contribution Levy (SSCL)

4. Luxury Tax (LTMV) – Applied when value or engine capacity exceeds specific thresholds

5. VAT (charged on a cascading* tax base: CIF + CID + XID + LTMV)

*This means this tax is calculated on top of the previous taxes, not just the original value of the vehicle.

Second, the State loses on income tax. In most tax systems around the world, law requires the benefit to be assigned an imputed monetary value, so that it may be taxed, just like income. But Sri Lanka’s duty-free vehicle permits have escaped this entirely.

The cost to the citizen

Sri Lanka’s cascading, multi-layered tax structure drives effective import taxation on most passenger vehicles into the 125%–250% range, with the Vehicle Importers Association of Sri Lanka placing some models in the 200%–300% bracket. It is, by any comparative standard, one of the most punitive vehicle-tax regimes in the world.

The macroeconomic consequences are visible everywhere:

Inequality: Middle-income families are priced out of car ownership; mobility becomes a privilege, not a right.

Inefficiency: High tariffs keep the national fleet old and costly to maintain. Older vehicles burn more fuel, produce higher emissions, and compromise road safety. As a result, public transport absorbs pressure it was never designed for

No industrial rationale: Sri Lanka does not manufacture cars, so these tariffs serve no protectionist purpose. These taxes function solely as revenue extraction, and our citizens and economy pay the price.

Tax compliance deteriorates. Consumer choice shrinks. Economic participation weakens.Productivity sours.

A future without exemptions

The move to a “return-after-term” model is the correct economic and ethical step.

Looking forward, the Government must adopt a centralised fleet-management framework. We should look to models like Australia’s, which utilises a single regulated system ensuring consistent pricing, transparent leasing, and the timely replacement of aging units to reduce maintenance costs.

The President’s declaration promises an end to a distortionary era. However, the future relies on vigilance. Citizens, media, and Parliament must ensure this commitment is honoured through transparent procurement and a permanent end to exemptions. The “permit culture” was a price the economy could never afford; it is time we stopped paying it.

Sources

Duty-Free Permits system under scrutiny | Print Edition - The Sunday Times, Sri Lanka

1991 Public Administration Circular No: 14/91

Scheme for Issuance of Motor Vehicle Permits on Concessionary Terms Nos. 01/2016, 01/20

Transparency International Sri Lanka

UNP MPs silent over daylight robbery: Sale of duty free car permits? | The Sunday Times

List of 75 MPs and their Luxury Vehicle Imports | Colombo Telegraph

Ceylon Public Affairs - Vehicle Import Tax Structure

Chapter 87, Motor Vehicle 2025 Tariff Guide

Quantification of Values for Non-Cash Benefits in calculating Employment Income

Ceylon Public Affairs - Vehicle Import Tax Structure

Chapter 87, Motor Vehicle 2025 Tariff Guide

Quantification of Values for Non-Cash Benefits in calculating Employment Income

Fleet Management - The Morning

Appendix

CCPI | Department of Census and Statistics

“Today” = Oct 2025. For inflation calculations, we chain-link across base changes:

1. Within a base, inflation factor between month A and month B =

Factor = Index(B) / Index(A) (same base series).

2. Across base changes, pick a bridge month that appears in both series. Multiply factors in sequence (“chain link”).

3. Multiply the historical amount by the product of factors to get the “today” value.

(The author is an Economic Researcher at the Advocata Institute. The opinions expressed are the author’s own.)

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.

When relief meets reality

By Dhananath Fernando

• Sri Lanka’s construction cost problem

The Government has announced Rs. 5 million for houses completely destroyed by Cyclone Ditwah and up to Rs. 2.5 million for houses that are partly damaged. Bridges and a lot of civil infrastructure have been damaged.

On the other side, the Government has announced a Rs. 200,000 initial relief package for Micro, Small, and Medium-sized Enterprises (MSMEs). The Central Bank of Sri Lanka has also requested Licensed Commercial Banks (LCBs) to offer a loan moratorium of 3–6 months for affected businesses.

These measures are meant to help people rebuild their lives and restart the economy. But there is one vital reform missing from the response. If we ignore it, even well-intended relief will deliver less than promised.

That reform is lowering the cost of construction.

This crisis has created a rebuilding requirement at a scale that no one can ignore. As per released data, about 5,000 houses have been completely destroyed and about 87,000 houses are partly damaged. More than 40 bridges have been affected, and flood waters have reached more than 720,000 buildings, including schools and hospitals.

The damage goes far beyond housing and bridges. A further 1,777 tanks, 483 dams, 1,936 canals, and 328 agricultural roads under the Department of Agriculture have been damaged.

You do not need to be an economist or a financial analyst to understand what this means. Rebuilding will require an enormous volume of construction work. Even the smallest repair job requires materials. A partially damaged house may need new switches, repainting, replacement tiles, and electrical wiring checks after floods. Public buildings will need similar work, while roads, canals, tanks, and dams will need steel, concrete, and heavy repair inputs.

This is precisely why Sri Lanka’s cost of construction becomes the real litmus test of our crisis response.

Sri Lanka’s cost of construction is higher than the region. Worse, the tariff rates on basic construction materials are so high that one can only describe them as inhumane. Housing is a basic need, especially in a disaster. Yet we continue to push up prices through taxes and para-tariffs that make rebuilding unnecessarily expensive for families and for the State.

Consider just a few examples. The total tariffs on steel bars is 33%. The total tariff for cement is 64%. Tariffs on wall tiles are 80%. Sanitaryware is 46%. Aluminium is about 50%. When these numbers sit on top of a massive rebuilding effort, it becomes obvious that a large share of what the Government allocates for construction-related rebuilding ends up as taxes and para-tariffs embedded in prices.

Some may argue that these tariffs help raise revenue to redistribute to cyclone-affected people. But the reality is different. Many of these tariffs are not designed primarily as revenue measures. They are designed to block competition.

Just think about it: why would anyone import when there is an 80% tariff rate? Yet in some sectors, imports still happen even at such rates, because even after paying the tariff, the imported product is cheaper than some local items protected behind these same barriers.

That should tell us something uncomfortable. If the Government does not reduce construction-related tariffs, a significant portion of ‘relief’ becomes indirect support for unproductive, protected businesses. In other words, the country attempts to rebuild after a disaster while keeping policies that quietly inflate the bill and reward rent-seeking.

During the crisis, there was a powerful story that Welikada Prison inmates contributed one meal for those affected. Even prisoners were willing to compromise. Now imagine, at the same time, the State maintaining a policy environment that creates room for excessive profits for protected sectors in one of the worst crises Sri Lanka has faced. That is not just bad economics. It is morally indefensible. It will not pass the test of any moral compass.

There is also an international dimension that the Government cannot keep dodging. The World Trade Organization (WTO) does not permit customs duty in excess of 30%. Sri Lanka imposes the Ports and Airports Development Levy, the Commodity Export Subsidy Scheme (CESS), Value-Added Tax (VAT), and Social Security Contribution Levy (SSCL), all of which have a cascading impact.

These layers are used to find loopholes in WTO guidelines, but the economic outcome is simple: higher prices, lower competitiveness, and a heavier burden on citizens at the worst possible time.

So the question of whether the Government is willing to change tariffs on construction is not just a test of the influence of certain rent seekers. It is a test of common sense and a test of our humanity. If we are serious about rebuilding after the cyclone, the Government must remove these additional tariffs and bring the cost of construction down for all those affected.

If we fail, we will not only fail families trying to rebuild homes. We will fail as a nation trying to recover with dignity.

A turning point for a more resilient economy

By Dhananath Fernando

What Sri Lanka faced with Cyclone Ditwah is unprecedented. The loss of human lives and the damage to homes, roads, and livelihoods cannot be captured in a single-rupee figure.

There is very little value in the blame game now. The only useful response is to ask how we can build better, not simply build back. Our strategy has to be better than before.

This is not easy. We are coming out of a painful debt restructuring and a severe economic crisis.

The first step is a decision. If we aim only to put things back to where they were, we will almost certainly fail. If we decide to build better, we must accept that the main bottleneck will not be money alone. It will be the way the State works.

Governments can find money. Multilateral agencies and friendly countries can support us. But delays come from bureaucracy and procedures.

After the tsunami, Sri Lanka had more than enough funds on paper. The real problem was spending it on time. Files moved slowly, approvals were stuck, and people waited.

Transparency and good governance are essential. Yet too many layers, too many signatures, and too much fear of taking a decision can cause more harm than good.

Four pillars

To avoid repeating the same mistake, we need four pillars to work together.

The first is the strategic layer, led by the President and the Cabinet. They must set clear priorities and identify the main areas for rebuilding. Roads, bridges, schools, hospitals, tanks, and other public infrastructure that are critical for mobility, education, health, and agriculture need immediate attention. This is a macro-level decision. The Government must say clearly which districts, which sectors, and which projects are first in line and publish that list.

The second is the Treasury and finance layer. This is where funds must be released quickly and predictably. The good news is that in the first 11 months of 2025, revenue performance has been better than expected. That gives some room. But the key is not only how much money we allocate. It is how fast we transfer it to the agencies that can actually spend it. Districts that are hardest hit must get advance allocations linked to the priorities decided at the top, with simple formulas and simple reporting.

The third is the operational layer. Here the district and divisional secretariats, provincial authorities, and local councils are in the front line. Their spending limits need to be raised for emergency work. Their procedures to call bids for urgent repairs must be simplified. If we wait for a central mechanism in Colombo to clear every road, tank, dam, culvert, and minor bridge, recovery will drag on for years. Many of these tasks can and should be done at the local level, with standard price schedules, simple contracts, and strict but reasonable timelines.

The fourth is the governance and transparency layer. Faster spending does not mean a free-for-all. The Auditor General’s Department should be involved from the start, not at the very end only to write a critical report. Clear guidelines on emergency procurement and reconstruction can be issued for all district and divisional secretariats so they act as one team. Major bridges and A-class roads can remain under central ministries. But cleaning debris, repairing rural roads, restoring minor irrigation, and helping affected households should be decentralised.

The work of rebuilding

To make this work we have to trust our officials, empower them, and hold them accountable. If the State worries about capacity, we can invite professional bodies such as the Institute of Chartered Accountants of Sri Lanka and engineers’ associations to support audit, monitoring, and technical approval. This will improve both speed and credibility.

Support to affected households should also be as close to the ground as possible. Cash transfers, vouchers, or material assistance should be handled at local level using existing social protection lists, with space to update them after proper verification. People who have lost everything should not have to travel from office to office, or from district to Colombo, to prove that they are victims.

If any regulatory changes are needed to relax procedures in the short term, the Government has the numbers in Parliament to act. Emergency regulations and amendments with sunset clauses can be used for a limited period, with clear publication of all contracts and major payments.

At the same time, the Government must revisit the 2026 Budget. Some spending planned for less urgent areas will need to be repurposed towards rebuilding and repair. This will also mean a conversation with the International Monetary Fund (IMF). Some targets and benchmarks may have to be adjusted so that the revised budget remains consistent with the programme while giving space for essential recovery spending.

In the medium and long term, ‘building better’ must be tied to structural reforms. Ditwah has shown again how vulnerable our people are. Food tariffs that keep prices high hurt poor households during and after a disaster. Construction sector tariffs on cement, steel, tiles, and fittings raise the cost of rebuilding houses, bridges, and factories. Land and labour market rigidities slow investment and job creation when people need work the most. State-owned enterprises that control key inputs like electricity and fuel must also be part of a serious reform agenda.

Usually, a government has a reform window of three to six months after coming to power. A crisis of this scale opens another window of three to six months. People understand that change is necessary when their lives and livelihoods are at stake. If the Government chooses to lead, Ditwah can be not only a tragedy but also a turning point for building a stronger, fairer, and more resilient Sri Lankan economy.

The economics of floods we keep forgetting

By Dhananath Fernando

Natural disasters and national emergencies do not arrive every day. But when they do, if we are unprepared, the damage can shape our lives for years. As floods intensify across the country, we hope our readers and all Sri Lankans are safe. Our thoughts are with everyone affected.

A familiar pattern repeats during every crisis. In the middle of the emergency, there is no shortage of commentary, ideas, and expert panels. Yet once the water recedes, our attention recedes with it. Reports gather dust, committees dissolve, and we wait for the next disaster to teach the same lesson again.

But natural disasters have an economic side that we rarely discuss. Managing them is not a simple Government-versus-private sector debate. It requires everyone – State, private sector, communities, and individuals – to play a part.

The first pillar is identification and prevention. This lies mainly with the Government. Investing public funds in proper disaster management systems is essential, not optional. A modern system must include accurate weather forecasting, river and reservoir monitoring, rapid communication tools, and tsunami alert networks.

With climate change intensifying extreme weather, Sri Lanka must prioritise floods, landslides, and coastal hazards. The encouraging news is that many global partners stand ready to help, if we can present a credible plan and maintain continuity in implementation.

The second pillar is understanding risk and preparing people. After the 2004 tsunami, Sri Lanka built some capacity: drills, awareness programmes, and clear guidance in risk zones. These efforts are not perfect, but they show we can act when we learn from tragedy.

We now need the same commitment for floods, landslides, and droughts. Risk maps must be updated regularly, zoning laws enforced, and evacuation routes rehearsed. But identifying risks alone does not guarantee safety.

The Koslanda landslide is a painful example. The area had been identified as high risk and equipment had been issued, yet the system failed. Telling people to evacuate is easy. Convincing them is difficult. Many fear theft, losing their valuables, or damage to their homes.

In every major flood near the Kelani River, we see hesitancy to leave, even when the danger is clear. For a family with limited assets, their home is everything. Walking away without assurance of security feels impossible.

This is where community-level solutions matter. Secure storage points, community-managed watch systems, and support from local Police can give people confidence to evacuate early. Temporary safe locations must be identified, tested, and publicised long before an emergency. These systems do not require large budgets, only coordination and trust.

The third pillar is insurance as a financial buffer. In Sri Lanka, the first responders are the armed forces, Government officers, and volunteer groups. Their role is essential. But in a well-prepared system, insurance absorbs a significant part of the financial loss.

Insurance is not only about payouts. When insurers assess a property, they analyse its disaster risk. This creates clear price signals. High-risk zones face higher premiums, discouraging settlement in vulnerable areas. Better data allows insurers to price risk accurately, which encourages investment in monitoring and early-warning systems. It creates a virtuous cycle where good information has real economic value.

Sri Lanka’s insurance penetration is low, and it is unrealistic to expect every household to be covered. But even partial coverage builds resilience. Insurance spreads risk, supports recovery, and funds the very information systems that reduce future losses.

Disaster management, the rule of law, and proper regulation are core responsibilities of the State. When government performs well here, the whole country benefits. Unfortunately, over successive administrations, the State has often done what it should not do, and failed to do what only it can do. Unlike many other areas of governance, disaster management has no private sector substitute.

Ignoring the economic logic of disaster preparedness is itself a silent disaster. If we continue to treat floods and landslides merely as humanitarian events, and not as recurring economic shocks that can be managed and reduced, we will keep paying the price in lives, in property, and in opportunities lost.

Disasters may be natural. Their impact, however, is shaped by the choices we make long before the rains begin.

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

By Dhananath Fernando

Originally appeared on the Morning

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

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

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

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

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

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

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

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

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

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

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

After the ballot, before the fall

By Dhananath Fernando

Originally appeared on the Morning

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

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

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

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

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

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

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

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

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

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

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

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

In the long run, we all lose.

Economics of tyre imports and import controls

By Dhananath Fernando

Originally appeared on the Morning

The recent discussion on restricting tyre imports to boost local production, with the stated objective of saving USD outflow from the country, requires closer examination. 

In Sri Lanka, import restrictions are often perceived as a measure to promote exports, but in reality, they have the opposite effect. Restricting imports discourages exports and reduces the productivity of local manufacturing. 

Moreover, this strategy burdens consumers with higher prices and fosters corruption among Government officials and politicians. Ultimately, it is a strategy with no winners, leaving everyone worse off in the long run.

A deep dive into the tyre market

Sri Lanka is a leading exporter of solid tyres, holding approximately 25% of the global market share. Solid tyres, used in heavy-duty vehicles like tractors and forklifts, represent a key segment of our exports. 

However, even as a global player in this industry, we rely on importing raw materials such as metal to remain competitive. Across all rubber products, Sri Lanka imports approximately $ 200 million worth of raw materials annually, as local rubber production is insufficient. In 2019, the total export value of rubber products was approximately $ 1 billion.

Typically, industries add about 30% value through their processes. In the case of pneumatic tyres, the current tariff structure includes a 20% general duty, a 10% Ports and Airport Development Levy (PAL), an 18% Value-Added Tax (VAT), a 25% or Rs. 330/kg Commodity Export Subsidy Scheme (CESS), and a 2.5% Social Security Contribution Levy (SSCL). 

The cumulative tax burden amounts to 75.5% on paper, but due to the cascading effect of VAT applied on top of other taxes, the effective rate is significantly higher.

Sri Lanka has approximately five million vehicles, including tuk-tuks and motorcycles, which are often referred to as a ‘poor man’s transport’. These high tariffs or import bans effectively double the price of tyres, placing a disproportionate burden on ordinary consumers. 

For instance, the tax relief provided by expanding the tax-free threshold from Rs. 100,000 to Rs. 150,000 results in a monthly saving of just Rs. 3,500 – an amount easily offset by the additional cost of a single tyre. 

High tyre costs also drive up transportation expenses across the board, including bus fares, tuk-tuk fares, and freight costs, cascading through the economy without any corresponding productivity improvements.

Moreover, the new generation of Electric Vehicles (EVs) requires specialised, high-quality tyres. Import restrictions could limit access to these products, reducing the efficiency and viability of EV adoption in Sri Lanka.

Supporting local production the right way

Does this mean local production should not be supported? Absolutely not. However, support should come in the form of reducing structural barriers rather than imposing tariff protections. 

For instance, the high cost of energy is a major driver of manufacturing expenses in Sri Lanka. Addressing this issue through energy sector reforms would make local products more competitive. Alternatively, the Government could share the risk by subsidising loan interest rates, enabling manufacturers to compete globally and focus on exports rather than relying on protectionist tariffs.

High tariffs only serve to make local production uncompetitive, forcing consumers to bear the cost of substandard products. Instead, removing barriers to business and fostering an export-oriented industrial strategy is the way forward.

The problem with CESS and import tariffs

The CESS was introduced by the Export Development Board (EDB) to encourage value-added exports and discourage raw material exports. Ironically, this tax on exports has been extended to imports, significantly inflating tariff burdens. Few people realise the original intent of the CESS and its unintended consequences on trade.

Debunking protectionist arguments

Two common arguments are often made in favour of high import tariffs:

Infant industry argument: The idea is that new industries require time to establish themselves. However, the tyre industry in Sri Lanka dates back to the 1970s – well past its ‘infant’ stage. After more than half a century, it should be thriving without protectionist crutches.

Comparisons to India and the US: While India and the US impose some high tariffs, these nations have vastly different contexts. India, with a population of over a billion, and the US, with 300 million high-income consumers, can leverage economies of scale to make protectionism viable. Even in these countries, protectionism has shown its limits, and they increasingly focus on global competitiveness.

The tragedy of corruption through protectionism

Another significant downside of protectionism is its susceptibility to corruption. Sri Lanka has already witnessed scandals such as the sugar and garlic scams, where the Special Commodity Levy (SCL) was manipulated overnight through ministerial powers. 

Similarly, protectionist tariffs can be arbitrarily increased by corrupt officials, allowing certain companies to gain undue advantages. These benefits can even be funnelled into campaign financing, creating a vicious cycle of corruption.

The International Monetary Fund (IMF) Governance Diagnostic Report highlights the vulnerabilities associated with protectionism, emphasising how such policies open the door to corrupt practices. By simply raising tariffs, policymakers can distort market dynamics, favouring a few while imposing costs on the wider public. This undermines the principles of fair competition and good governance.

The misguided USD savings argument

The notion that import restrictions save USD is flawed. Imports are driven by the ability to borrow in LKR rather than by direct dollar demand. With an appreciating currency and improving reserves, Sri Lanka has imported more without destabilising its economy. Restricting tyre imports could inadvertently increase wear and tear of other spare parts, like shock absorbers and rubber bushes, leading to higher overall costs.

If Sri Lanka continues to pursue import bans as a strategy to develop industries, it risks destroying exports, raising the cost of living, and undermining local industries’ competitiveness. Instead, we should focus on removing barriers to business and enabling local manufacturers to compete globally. 

Protectionism not only creates losers but also fosters corruption, making it an unsustainable and counterproductive strategy. A competitive, export-driven approach benefits everyone, ensuring a prosperous future for the economy. 

Mapping Sri Lanka’s growth strategy

By Dhananath Fernando

Originally appeared on the Morning

With the final stage of Sri Lanka’s debt restructuring scheduled for next year, the focus must shift decisively towards economic growth. In this context, President Anura Kumara Dissanayake’s recent visit to India is particularly timely.

Over the past two years, Sri Lanka has been largely engaged in stabilisation efforts. Higher interest rates and increased taxes were central to this stabilisation agenda, which is fundamentally about avoiding bad decisions rather than actively pursuing the right ones.

Using a cricket analogy, stabilisation is like a No. 11 batsman in a Test match defending the wicket – the goal is simply to avoid getting out, not to score runs.

The next phase, however, demands a proactive growth strategy. Economic growth is less about avoiding pitfalls and more about taking the initiative and making bold moves. If stabilisation is about survival, growth is about thriving; it’s like playing a T20 match where you must play shots, protect your wicket, and actively score runs.

Connectivity represents a key area where Sri Lanka can catalyse growth. Connectivity to the Indian Ocean through maritime routes has been discussed for decades, but connectivity to India deserves equal, if not greater, attention.

India’s rapidly growing middle class presents significant economic opportunities for Sri Lanka. If we are serious about growth, enhancing connectivity with India is a necessity, not an option. Unfortunately, Sri Lanka has been slow to respond over the years. This time, we must be proactive and get the work done.

There are already Sri Lankan companies like Damro, MAS, and Brandix, as well as service-sector organisations, that have successfully expanded to India. The fear that Sri Lanka might be at a disadvantage due to its smaller market size is unfounded. In fact, the small size of our market is precisely why we need to integrate with the Indian market.

Among the proposals discussed during the President’s State visit to India, connectivity projects related to energy, transport, and trade stand out as the most crucial. These initiatives provide Sri Lanka access to a market of over one billion people.

Grid connectivity, for instance, has been a topic of discussion for decades but has yet to be realised. Such connectivity would reduce energy costs and create opportunities to export surplus energy, particularly solar power generated during the day.

With South Indian states experiencing peak energy demand during the day due to industrialisation, Sri Lanka could sell excess electricity and, conversely, purchase electricity during the evening when its own demand peaks. This business model would encourage renewable energy investments in Sri Lanka, given the potential to export to India.

Lower energy costs would benefit Sri Lankan industries, including tourism, by reducing production expenses and enhancing global competitiveness. Similarly, an underwater pipeline for petroleum products could significantly cut transportation costs by enabling direct access to South Indian refineries.

A proposed land bridge could also integrate a rail line, telecommunications cables, and grid connectivity, excluding petroleum pipelines, which are expected to connect to Trincomalee’s oil tanks. These connectivity projects will require years of development, substantial investment, and careful geopolitical considerations to avoid supply chain disruptions or tensions.

Economic connectivity with India, particularly in factor markets such as land, labour, capital, and entrepreneurship, would drastically reduce production costs and provide access to a larger market. Connecting to bigger markets is essential for economic growth, and India, as a neighbouring economic giant, offers a ready opportunity.

Concerns about independence and fears of interdependence are common among Sri Lankans, but history reveals that Sri Lanka’s culture, including Buddhism, has been profoundly influenced by India. Even today, India accounts for the largest number of tourists to Sri Lanka.

The Government of Sri Lanka must establish competitive investment policies to attract foreign investments with clear cost-benefit analyses. Reviewing joint statements from past State visits shows recurring references to connectivity projects such as the land bridge, Trincomalee oil tanks, and investments. What has been missing is the political will and proactive action to turn these plans into reality.

If Sri Lanka fails to capitalise on this opportunity for economic growth, a second default may become unavoidable, leading to yet another request for assistance from India. The stakes are too high for inaction.

Supporting MSMEs requires more than parate suspension

By Dhananath Fernando

Originally appeared on the Morning

The Government has decided to extend the suspension of parate law until 31 March 2025, aiming to support Micro, Small, and Medium-sized Enterprises (MSMEs) as they recover from the setbacks of the economic crisis.

Parate execution is a Roman-Dutch law that allows Licensed Commercial Banks (LCBs) to sell mortgaged property kept as collateral. The term ‘parate’ originates from Dutch and means ‘immediate’.

Under the Recovery of Loans by Banks (Special Provisions) Act No.4 of 1990, parate execution empowers banks to recover unpaid debts by selling assets without undergoing judicial processes.

The previous Government introduced the suspension and the current Government appears to be continuing the policy without fully recognising the potential harm it could cause to the MSME sector. While the suspension has been extended until March 2025, there is a high likelihood of further extensions being requested in subsequent months.

Data accessed up to November 2023 indicates that only 557 parate cases were executed in 2023 (although the MSME Chamber claims the actual figure is 1,140 cases). The total value of these executions was Rs. 38 billion, which represents just 0.4% of total loans and only 2.7% of total bad loans. Even if the number of cases were doubled, the overall value remains insignificant.

Based on these statistics, it is evident that the suspension of parate execution does little to support MSMEs, as the affected segment represents a very small portion of the sector.

MSMEs are the backbone of Sri Lanka’s economy, constituting 99% of business establishments and contributing to 75% of employment. Supporting MSMEs requires broader initiatives beyond suspending parate execution, which is essential for safeguarding depositors’ funds in the current financial framework.

Banks primarily lend using depositors’ money. Therefore, when loans go unpaid, banks face significant challenges in recovering funds to repay depositors. Parate execution has historically served as a legal safety mechanism for banks, albeit not an ideal solution.

On the flip side, when parate execution is suspended, it discourages the majority of borrowers who struggle to repay their loans on time. These borrowers, who represent the largest segment of customers, may question why they should meet their obligations when a smaller group is granted exemptions. 

This creates a moral hazard and could encourage new loan applicants to skip payments, knowing the repercussions for non-payment are minimal.

Furthermore, if depositors perceive that banks lack sufficient legal provisions to ensure the security of their funds, they may seek alternative channels for their savings and become increasingly reluctant to deposit money in banks. This could destabilise the financial system over time.

In the absence of parate execution, banks may take precautionary measures, such as tightening lending criteria, raising interest rates for riskier sectors, and prioritising lending to existing or prime customers. 

These steps could harm new entrants to the MSME sector, limiting their access to credit or burdening them with high interest rates, which reduces their competitiveness and stifles economic growth.

The Central Bank of Sri Lanka’s Financial Stability Review for 2024 highlights that while Non-Performing Loans (NPLs) are declining, the rate remains high at over 13% as of Q2 2024, with more than Rs. 1,200 billion classified as non-performing. 

Although the tourism sector is booming, industries like transportation and manufacturing continue to report significantly higher NPL ratios than the industry average.

In the long term, the Government needs to prioritise the introduction of bankruptcy laws, enabling struggling businesses to efficiently settle liabilities and pivot to new ventures without undue delays. Such a framework would balance the interests of borrowers, banks, and depositors more effectively.

The continuation of the suspension of parate execution risks undermining the banking sector, endangering depositors’ funds, and harming MSMEs by fostering higher interest rates and restricted access to credit. 

It is time for policymakers to consider alternatives that promote sustainable economic recovery while maintaining financial stability

Graph 1 

Economic sectors with high NPL ratios 

Graph 2 -

NPL ratio

Are plans to lift vehicle import ban truly wise?

By Dhananath Fernando

Originally appeared on the Morning

Many Sri Lankans, including myself, are products of a failed middle-class dream. We aspire to be doctors, lawyers, and accountants because that path seems to promise a reasonable house and a decent vehicle.

Yet, bad economics has turned us into a generation of frustrated, failed middle-class citizens. Among the middle class, one of the most debated topics is vehicle imports – a key symbol of socioeconomic aspirations – which has recently resurfaced as a contentious issue.

While the Government has not clarified its stance on vehicle imports, the economic consequences of restricting them are evident. A black market emerges and people are forced to pay exorbitantly high prices for second-hand vehicles that are 5-10 years old. The economic impact of such inflated vehicle prices often goes unrecognised.

When someone spends three times the vehicle’s actual value, they lose the ability to invest the same amount in other life priorities – building or expanding a home, starting a business, pursuing professional or children’s education, or supporting leisure and the arts. This ripple effect stifles personal aspirations and reduces income opportunities for micro, small, and medium-sized businesses.

While I strongly advocate for relaxing vehicle import restrictions (or any import restrictions), the reasoning often used to justify such relaxation is flawed. Many argue that importing vehicles would boost Government revenue through increased border taxes, especially given the International Monetary Fund’s (IMF) target of raising Sri Lanka’s revenue to 15% of GDP.

However, relying on border taxes for revenue sets a dangerous precedent, making our economy less competitive. This logic paves the way for protectionist measures like tariff hikes, a strategy that failed us during the 30-year war when high tariffs funded fiscal deficits but left our exports uncompetitive and fostered corruption.

Instead, the Government should focus on sunsetting unnecessary tax concessions, eliminating vehicle permit schemes for public servants, and broadening the tax net through investments in digitising the Inland Revenue Department.

The concerns: Currency depreciation and congestion

The two main arguments against vehicle imports are currency depreciation and increased congestion.

Currency depreciation

Currency depreciation is often wrongly attributed to imports. During the Covid-19 pandemic, Sri Lanka banned most imports, including essential medicines, yet the currency depreciated from Rs. 180 to Rs. 360. Before the ban, vehicle imports amounted to around $ 1 billion annually, while fuel imports, at $ 3 billion, should theoretically have had a greater impact on currency depreciation.

In reality, currency depreciation and reserve depletion occur when the Central Bank increases rupee supply by artificially lowering interest rates. When interest rates are kept low, borrowing becomes cheaper, prompting higher demand for credit – for vehicles, housing, and business expansion – which in turn drives up import demand. As a result, people demand more dollars from banks, leading to currency depreciation.

If the Central Bank refrains from artificially suppressing interest rates, banks will need to redirect credit for vehicle purchases from other sectors, naturally balancing the flow of rupees in the economy. Higher interest rates would curb excessive consumption, including vehicle purchases.

Unfortunately, the Central Bank has historically enabled excessive consumption by maintaining artificially low interest rates, which leads to higher import demand and ultimately depletes reserves as it attempts to defend the currency.

Thus, vehicle imports have little direct impact on currency depreciation or reserve depletion. Instead, the focus should be on managing interest rates to balance economic activity. That said, a phased approach to relaxing vehicle imports is advisable to avoid shocks to the economy. Notably, despite import relaxations, the Sri Lankan Rupee has appreciated by approximately 11%.

Congestion

Concerns about increased congestion due to vehicle imports are valid. However, the solution lies in improving public transportation. Significant investment in public transport infrastructure would reduce the demand for personal vehicles. Additionally, mechanisms for exporting used vehicles could help mitigate congestion.

Excessive taxes on vehicles will not develop public transport. On the contrary, such taxes exacerbate issues by suppressing aspirations, limiting personal choices, and further deteriorating the public transport system.

Developing public transport requires policy shifts, such as cancelling the restrictive route permit system, engaging the private sector, and relaxing price controls on bus fares. These reforms, not 300% vehicle taxes or outright bans, will address congestion effectively.

Way forward

Vehicle import restrictions and excessive taxes have far-reaching implications that go beyond economics, affecting aspirations and everyday lives.

While phasing out restrictions and ensuring fiscal discipline are essential, the Government must prioritise structural reforms and long-term solutions like public transport development and tax base expansion. Only then can we create an economy that balances growth, equity, and personal freedom.

Market-driven solutions for climate resilience

By Dhananath Fernando

Originally appeared on the Morning

It is disheartening to see many areas and lives in Sri Lanka affected by severe weather conditions. The postponement of Advanced Level exams and the broader impact on human lives impose costs that cannot be measured in purely economic terms.

Unfortunately, in Sri Lanka, discussions on climate-related solutions tend to occur only during extreme events like floods or droughts. This article, admittedly, follows a similar trend.

The approach to solving natural disaster challenges in Sri Lanka has often been fragmented, relying heavily on the expertise of individual professions rather than adopting a holistic perspective. For instance, lawyers may frame the issue solely within a legal context, IT professionals may focus on technological solutions, and economists often emphasise financial and economic aspects. This siloed approach overlooks the need for an integrated strategy.

Additionally, many solutions in Sri Lanka depend heavily on Government intervention, creating inefficiencies due to limited governmental capacity and placing a burden on taxpayers. Unfortunately, market-driven solutions for climate and environmental challenges receive inadequate attention in public discourse. There are misconceptions that market-based systems are at odds with climate action, whereas, in reality, markets offer numerous innovative solutions.

Immediate vs. long-term solutions

In the short term, the Government must provide support to those affected by climate-related disasters. Generally, funds are allocated for this purpose in every national budget. However, for long-term solutions, incorporating climate risks into pricing mechanisms is crucial. The market system is not inherently complex; it simply needs to reflect the scarcity value of resources through proper pricing.

Currently, there is no effective way to associate climate risk with specific high-risk areas in Sri Lanka. If we had a digital land registry, we could assign risk values to lands based on factors such as flood, drought, or tsunami risks.

Similar to how platforms like Booking.com rate accommodations for cleanliness, food, and accessibility, land prices could reflect natural disaster risks. This would enable individuals to make informed decisions when selecting locations for agriculture or residence, ultimately reducing property damage and loss of life on a macro scale.

This approach could also encourage financial markets to extend quality credit for low-climate-risk properties within the existing collateral-driven credit system.

Infrastructure and investment prioritisation

The Government could prioritise infrastructure investments in canals and irrigation based on areas with the highest impact, rather than acting on an ad hoc basis. With risk data, disaster relief support could be incentive-based, aligning resources with identified risks.

The concept of property rights and reflective pricing for climate-resistant land can encourage optimal use and sustainable development. Ideally, integrating social safety net information and national identity cards would streamline rescue efforts and improve the efficiency of reaching the most affected people.

Catastrophe bonds

Catastrophe bonds (CAT bonds) represent another market-based solution. These bonds are typically issued through a Special Purpose Vehicle (SPV) by insurance companies to cover large-scale natural disaster risks.

Investors purchase CAT bonds, which provide funds to cover damages in the event of a disaster. If no disaster occurs during the bond’s term, investors receive higher returns. Returns and coupons vary depending on the type of natural disaster covered.

In the event of a catastrophe, investors may lose some or all of their capital. However, the relatively high returns reflect the associated risks. The issuance of CAT bonds also incentivises extensive research and investment in climate event analysis. Early identification of potential disasters not only minimises property damage but also saves lives by enabling timely alerts and evacuations.

With CAT bonds, investors have a financial incentive to invest in areas prone to climate risks, as they see potential returns. For investors, CAT bonds offer diversification opportunities and returns that are less affected by traditional stock market fluctuations or macroeconomic changes. Additionally, CAT bond returns are comparatively higher than those of other types of bonds.

The role of insurance and data

A mature insurance market can significantly mitigate climate risks. One of the main challenges for Sri Lanka’s insurance and capital markets is the lack of comprehensive data.

A digital land registry that integrates weather patterns and risk factors would enable insurance companies and banks to better assess investment risks for businesses and agriculture, in addition to considering the applicant’s credit history.

This would enhance the productivity of the financial sector and improve access to capital. Importantly, it would encourage businesses and agriculture to relocate to low-risk, high-productivity areas, enhancing overall efficiency.

Addressing climate challenges in Sri Lanka requires support from multilateral organisations, particularly for developing markets. However, it is crucial to avoid relying solely on Government interventions or over-regulating productive sectors.

By setting the right incentives and disincentives, and focusing on fundamental, long-term strategies, Sri Lanka can create sustainable solutions beyond ad hoc responses to climate events.

Sri Lanka’s rice dilemma

By Dhananath Fernando

Originally appeared on the Morning

High rice prices, shortages of nadu rice, and the monthly importation of around 70,000 MT of rice have once again become key topics in national discussions.

As this column has highlighted previously, Sri Lanka’s per capita rice consumption is twice the global average. Yet, paradoxically, farmers remain poor and the market remains underdeveloped despite this significant consumption. The core issue lies in the complex and flawed economic dynamics governing the rice industry.

Low productivity and farmer incentives

One primary challenge is low paddy productivity. Farmers lack incentives to improve yields due to market dynamics. When production increases and supply exceeds demand, prices drop, negating any potential income gains for farmers.

Conversely, if yields fall, prices may rise, but the total crop volume decreases, leaving farmers with the same or even lower income. This discourages efforts to boost productivity, creating a cycle of stagnation and poverty.

Mismatch in rice varieties and market demand

Sri Lanka predominantly grows short-grain rice, while global demand favours long-grain varieties such as basmati and jasmine rice. Transitioning to long-grain cultivation presents challenges related to soil conditions and high production costs.

Moreover, the current pricing structure for rice does not reflect the true cost of production. Producing one kilogramme of rice requires approximately 2,400 litres of water, a resource for which farmers are not charged. Even accounting for a modest 20 LKR cents per litre, the true cost of rice would be significantly higher.

Market dynamics and oligopoly of millers

The paddy market is dominated by a few large-scale rice millers who have the financial capacity to purchase in bulk and maintain extensive storage facilities. Small and medium-scale millers often offer better prices but lack the scale to buy large quantities.

This oligopolistic structure limits competition and contributes to high consumer prices. While the Paddy Marketing Board has some storage capacity to intervene in the market, it is insufficient compared to the resources of large millers.

Implications of rice imports

Importing rice can benefit consumers by preventing shortages and stabilising prices. However, this strategy poses risks to small and medium-scale millers, who may struggle to secure sufficient paddy for milling if imported rice dominates the market.

The Government’s plan to import and distribute rice through State-run retailers, such as Sathosa, aims to control prices but introduces its own set of challenges.

Potential for corruption and market distortions

Government-led importation efforts create opportunities for corruption. The State must invest significant funds upfront and ensure that imported rice meets quality standards. Large-scale imports also raise the risk of mismanagement and unethical practices.

Additionally, limiting imported rice sales to Government outlets like Sathosa may inadvertently encourage private retailers to purchase and resell it at higher prices, undermining efforts to keep costs low for consumers. Imposing purchase limits at Sathosa could lead to long queues and inconvenience for shoppers.

Policy considerations and long-term solutions

There is no simple solution to Sri Lanka’s rice crisis. Addressing the issue requires long-term, multifaceted strategies.

Improving rice productivity and diversifying the buyer base beyond millers through strategic investments is essential. Establishing farmer associations with adequate storage facilities could enhance competition and stabilise the market. Allowing private sector rice imports without restrictive licensing could also promote fair competition and reduce corruption risks.

However, price controls or excessive Government intervention in the market are unlikely to resolve the underlying issues of consumer affordability or farmer poverty.

Ultimately, a sustainable solution involves balancing productivity improvements, market diversification, and transparent policies to ensure fair competition and equitable outcomes for all stakeholders in Sri Lanka’s rice industry.

Lanka’s fuel price tug of war: Who really pays the price?

By Dhananath Fernando

Originally appeared on the Morning

Fuel prices and fuel price revisions have always been a political football. Statements by various politicians on the taxes imposed on fuel and the scope for reducing fuel prices have come under renewed scrutiny with the 31 October price announcements.

Adding to the confusion, a statement by the Ceylon Petroleum Corporation (CPC) Chairman – that the CPC must compensate for the losses of other players if deviating from the price formula – has sparked fresh controversy. It’s essential to unpack these issues one at a time.

According to Central Bank data, we imported approximately $ 1.5 billion in refined petroleum and $ 0.5 billion in crude oil in the first half of the year. Assuming demand and prices remain steady, total fuel imports this year will be around $ 4 billion.

About 70% of fuel is consumed by the top 30% of high-income earners in Sri Lanka who can actually afford higher fuel prices. Naturally, energy consumption rises with income, as wealthier households use personal vehicles, high-energy appliances, and consume more overall. Only 30% of the total fuel is consumed by the remaining 70% of the population, which includes fishermen, public transport users, and service providers.

Thus, if we artificially lower fuel prices through a subsidy, it effectively subsidises the wealthiest families in Sri Lanka. While a low-tax regime might be ideal, given our fiscal situation and the International Monetary Fund (IMF) programme, Government revenue must increase to about 15% of GDP. Lowering fuel taxes would thus provide tax relief to the wealthiest 30% of households and incentivise excessive fuel consumption.

Imperative to adhere to fuel formula

Instead of being swayed by popular demands to reduce fuel prices, especially with rising tensions in the Middle East, the Government should first review its balance sheet to ensure adequate revenue with minimal market distortions to achieve debt sustainability.

If the Government aims to lower fuel prices for the public transport and fisheries sectors, the best approach would be a direct cash transfer rather than lowering all fuel prices, which would mitigate the impact of high fuel prices on essential goods and services.

It is imperative that we stick with the fuel formula and strengthen it if necessary. Unfortunately, there is limited information regarding the recent controversy over agreements between fuel suppliers on price revisions. If, as the Chairman claims, there is a clause to compensate private players for losses, this would be unreasonable if true.

In the absence of the full report, the only available information is a post on X from the former Minister of Power and Energy, who claims the CPC only pays the difference when the Government provides a subsidy or other mechanism to deviate from the price formula. In fairness to private players, if only the CPC receives a fuel subsidy, it creates an unlevel playing field, as petrol and diesel would be cheaper at CPC stations than at private ones.

Although the subsidy benefits consumers, it primarily benefits the wealthiest 30%, and rising demand could drastically increase the total subsidy cost for the Government. Therefore, a fuel subsidy is not advisable, as it essentially transfers Treasury funds to the wealthiest households in Sri Lanka.

Another issue has arisen: one supplier has reportedly requested about Rs. 82 million as compensation for deviations from the fuel price formula. It is difficult to assess this claim fully, as the original documents are not publicly available, but if true, it raises questions about whether recent price revisions adhered to the formula.

In particular, price adjustments before and after the elections require examination. Data on whether the September and October price revisions complied with the formula has also not been published; making this information available would reduce information asymmetry, essential for a functioning market economy.

Providing consumers with the best price

A further question is whether only a Government-owned CPC can reduce prices, and why prices are not decreasing with private players like Lanka IOC, Sinopec, RM Parks, and United Petroleum in the market.

The answer is not straightforward. The CPC is already heavily in debt, with high financing costs that must be covered. Moreover, prior to the latest revision, Sinopec’s diesel prices were actually lower than others, illustrating how competition can bring prices down.

However, prices depend on global crude and refined oil rates, and sometimes on the efficiency of refineries. When a price formula is in place in a small market, players often charge similar prices, but more competitors could introduce value propositions, including price variations based on global fluctuations.

For example, Lanka IOC offered an environmentally friendly fuel at a higher price, while Sinopec sold diesel at a lower price. To remain competitive, each player must offer something unique, which may not always be a lower price but can include quality or convenience.

The final point is that the new administration has requested a flat dealer margin instead of a percentage tied to global fuel prices, which is a positive move. Dealer costs are mainly influenced by inflation rather than global prices. The purpose of the price formula is to account for both variable and fixed costs to prevent losses and provide consumers with the best price.

In a market system, the consumer is at the centre. To prioritise consumer needs, we must ensure multiple players and transparency in pricing to minimise information asymmetry. Publishing the final fuel price revision calculations for the past two months and the full price revision agreement with private players would be a constructive first step.

Central Bank Defends Liquidity Injections Amid “Money Printing” Controversy

By Dhananath Fernando

Originally appeared on Ada Derana Business

A fresh controversy has erupted following reports that Sri Lanka’s Central Bank (CBSL) injected nearly 100 billion rupees into the banking system by October 25. Given that money printing was the major cause of the country’s financial crisis, this news has sparked considerable attention. CBSL has defended its actions, arguing that these liquidity injections do not equate to money printing.

What is the CBSL’s Argument?

CBSL asserts that these liquidity injections were necessary to address persistent imbalances among banks. Despite an overall surplus of funds in the banking system, this liquidity is unevenly distributed. Foreign banks operating in Sri Lanka hold significant liquidity surpluses but remain cautious about interbank lending due to strict risk management guidelines. As Sri Lanka’s sovereign rating is still ‘Default, this limits their exposure to local financial institutions. As a result, foreign banks deposit excess rupees with the Central Bank rather than in the interbank market.

While this was a serious problem in the midst of the crisis things have improved since: interbank call market (clean or unbacked) trading volumes, once as low as zero 1-2 billion rupees daily, has now returned to Rs10bn to Rs20bn (averaged 10 billion last month). Repo volumes (backed by T-bills) are back around 30 to 70 billion rupees, which is higher than pre-crisis levels.

Notably, auction data shows the central bank offering more than what banks bid for, with some banks bidding close to the deposit rate, indicating a willingness to lose bids—yet CBSL still provided new funds.

Given the much healthier interbank volumes, the CBSL should avoid undermining the working of the interbank market. The CBSL should be the last resort for a bank facing a liquidity crunch, not the first.

The Core Issue: Temporary vs. Longer-Term Impact

The debate centers on whether these injections are temporary or enduring. If CBSL swiftly withdraws the new money by selling Treasury bills or foreign exchange, the money supply remains stable. However, if these short-term purchases are repeatedly rolled over, the increase in money supply could become more long-term. Critics warn that this scenario is no different from lending money to the government, potentially triggering balance of payments problems and inflation, thus jeopardising the ongoing economic recovery.

A Matter of Terminology

CBSL’s reluctance to label this as “money printing” is essentially terminological. Regardless of whether the funds are lent to banks or the government, the impact on the money supply is fundamentally the same. Therefore, interventions must uphold the principle of currency stability, given the grave consequences of unchecked money creation.

Acknowledging CBSL’s Efforts

It is It is important to acknowledge that since September 2022, the CBSL has done an admirable job in restoring monetary stability. The critical task now is to maintain this hard-won stability. These points are presented to promote a healthy academic debate on an issue of great importance, not to cast blame on any specific entity or person.

Potential Alternative Strategies

What alternatives could CBSL have considered?

Purchase Foreign Exchange from Banks: Where balance of payments conditions permit, CBSL could continue the practice of buying foreign exchange, injecting rupees but reducing foreign currency in the If the injected rupees were later used for imports, CBSL could sell foreign exchange back, maintaining balance and avoiding exchange rate issues.

Use the Standing Lending Facility: Lending at the Standing Lending Facility Rate of 9.25% would ensure banks only borrow for urgent liquidity needs. As this penal rate is higher than the interbank rate, it discourages long-term dependency and helps avoid a lasting increase in the reserve money supply.

Reduce the Standing Deposit Facility Rate: If the CBSL wishes to lower rates, it could reduce the rate on deposits held at the Central Bank, which would encourage banks to lend more in the interbank market. However, this would also lower overall interest rates and must be carefully managed. To support reserve accumulation, interest rates need to remain at an appropriate level to curb credit and keep imports in check.

The Balancing Act

CBSL faces the difficult task of supporting the banking sector while safeguarding monetary stability. Any intervention must be carefully weighed to mitigate risks such as inflation and currency destabilisation.

Fuel deal without bidding sparks fears of economic instability

By Dhananath Fernando

Originally appeared on the Morning

On Wednesday (16), a daily newspaper reported that the new Government was planning to strike a fuel supply deal between the Ceylon Petroleum Corporation (CPC) and the Ceylon Electricity Board (CEB) for power generation.

Following this report, there was significant discussion on social media questioning why the Government would deviate from the competitive bidding process (a few Government representatives have personally informed us over the phone that the facts in the news story are incorrect and that the Government plans to clarify details through a press conference).

If the news is true, it would mean that the CEB would no longer engage in competitive bidding when purchasing fuel from the CPC. Fuel purchases, including hydrocarbons like naphtha and heavy fuel oil, are key input costs in electricity generation.

Regardless of the news story’s accuracy, the main concern for businesses is that bypassing the competitive bidding process in fuel procurement could lead to significant risks for CPC and CEB financial stability with corruption vulnerabilities. If the CPC and CEB start incurring losses or attempt to cover up losses by increasing tariffs, it could destabilise the economy.

To put this into perspective, the CPC’s revenue for 2023 was approximately Rs. 1,300 billion and the CEB’s about Rs. 679 billion. In comparison, Sri Lanka’s total tax revenue, including Value-Added Tax (VAT) for 2023, was around Rs. 3,000 billion.

Together, these two institutions manage a cash inflow that amounts to nearly two-thirds of the country’s total tax revenue. Even a minor financial misstep could result in a major crisis for the Government, leading to a complete economic collapse.

Avoiding the competitive bidding process creates a vulnerability to corruption. Competition is a crucial tool for preventing corruption, as it automatically introduces checks and balances through price signals on the supplier side. Without competitive bidding, any corruption within the CPC or CEB would likely manifest as significant financial losses in their balance sheets. Unlike other institutions, losses at the CPC and CEB have massive spillover effects, as has been seen under successive governments.

Typically, the CPC sells naphtha – a byproduct of its refinery – at a price higher than the market rate to the CEB. This is one way the CPC tries to offset its own inefficiencies or cover losses when the Government mandates fuel sales below production cost. However, when the CPC charges more for naphtha, electricity generation becomes more expensive, prompting the CEB to seek tariff increases.

On top of this, the CEB often delays payments to the CPC when it experiences losses, which forces the latter to borrow money from banks at high interest rates. These costs, in turn, are passed on to consumers, affecting industries across the board – from rice mills to poultry farms and even hotel operations, as energy costs are a major expense (CEB tariff hikes impact the water bill and many other industries, including through increasing inflation).

The CPC also sells jet fuel to SriLankan Airlines at inflated prices, similar to how it overcharges the CEB for naphtha. Jet fuel is a significant cost for the aviation industry and the high prices can push airlines into losses. When the CPC, CEB, and SriLankan Airlines all incur losses, they ultimately turn to the Treasury for bailouts.

It is no secret that the Treasury’s budget deficit has remained massive for years, compared to the country’s GDP. Consequently, the Government then turns to State-owned banks like the Bank of Ceylon (BOC) and People’s Bank (PB) to cover the losses. In many cases, the Government provides Treasury guarantees, sometimes even in US Dollars, for fuel purchases.

These banks, in turn, are forced to lend depositors’ money to these institutions, often at a high risk due to the prime lending rates. Ultimately, the financial mismanagement of the CPC and CEB trickles down to depositors’ hard-earned savings.

In the last Budget, the Government allocated Rs. 450 billion, equivalent to three years of Advance Personal Income Tax (APIT, previously the Pay-As-You-Earn [PAYE] tax), to recapitalise the banking sector, mainly with State banks. In addition, the Government absorbed $ 510 million into the Treasury to address losses at SriLankan Airlines, largely caused by the CPC’s inflated prices.

If the CPC indeed moves away from competitive bidding, it is a clear signal of poor governance and a warning of future economic hardship, potentially affecting depositors’ savings. When the CPC and CEB incur losses, the Government typically has to either increase the prices of electricity and fuel beyond what is set by price formulas or continue providing subsidies – both of which lead to higher taxes or interference with key economic indicators, thus creating political pressure.

This cycle has been ongoing for years, which is why the business community and others are deeply concerned about the CPC leaving the competitive bidding process. If the news is false, we can be relieved. But it is essential to understand the grave risks of abandoning competitive bidding, as it extends far beyond corruption; it threatens to bring about complete financial instability.

Scrambled supply: How maize, markets and policy cracked egg prices

By Dhananath Fernando

Originally appeared on the Morning

Just after the election, social media chatter quickly shifted to egg prices, which had dropped by about Rs. 10. Many speculated that a kickback had ended, causing the price drop. However, a few days later, the prices shot up again by Rs. 10 and memes started circulating, joking that now the hens were taking the kickback.

But there is a deeper story behind egg prices and the poultry industry in Sri Lanka. The primary cost in poultry is the cost of feed, with maize being the main ingredient, making up about 60% of the feed by weight. The cost of maize accounts for around 45-60% of the total cost of poultry production.

In Sri Lanka’s poultry market, 40% is through wet markets while 60% is through formal markets, which maintain high standards to supply to hotel chains. At one point, we were even exporting poultry products to the Maldives.

When it comes to eggs, however, the cost factors are front-loaded. Layer chickens must be imported and raised to maturity, which takes longer than broiler chickens. The cost of feeding these layer chickens, especially with maize prices being so high, significantly increases production costs.

After the economic crisis, inflation caused maize prices to soar from Rs. 45 to Rs. 165 per kg, pushing up poultry product prices. Our local maize market, which is the main cost driver for the poultry industry, is tricky.

While Sri Lanka requires about 500,000 MT of maize annually, we only produce 300,000 MT, leaving a shortfall of 200,000 MT, which is imported through a licensing process. This system creates a cartel of importers, driving up maize prices and, consequently, chicken and egg prices.

Maize imports are also heavily taxed, including Ports and Airport Development Levy (PAL), Value-Added Tax (VAT), and Customs duty, further increasing costs. Meanwhile, local maize production is inefficient, yielding only about 1.5 MT per hectare compared to the global average of 2.5 MT per hectare. This low productivity forces farmers to encroach on forests to increase their yield, creating environmental challenges.

In response to the crisis, the Government imposed price controls on eggs. Since farmers had already invested in layer chickens, they were unable to maintain them under the price controls and ended up selling the chickens for meat. This led to a reduction in egg production, driving prices higher.

In the formal market, producers with thin profit margins halted capacity improvements, keeping production stagnant. As a result, we were unable to expand exports, as there was no capital to fund growth. The combination of price controls, maize import licensing, and high tariffs led to low production and high prices.

Eventually, the Government resorted to importing eggs from India. This highlights how distortions in the maize market, coupled with tariffs and inefficient agriculture, have hurt Sri Lanka’s poultry industry.

Despite all the costs, including shipping, insurance, and handling, the cost of an imported egg is still cheaper than locally produced eggs, mainly due to irregularities in the maize market.

Over time, the market began to stabilise. The drop in egg prices right after the election was likely due to lower demand during election week, especially from eateries and bakeries. As eggs are perishable, the surplus likely drove prices down. However, as soon as prices fell, people began buying more than usual, which quickly drove demand back up and prices along with it.

While it’s possible that some farmers and wholesalers may have hoarded eggs, the primary reason for high egg prices lies in Government interference in the maize market and price controls. The well-intentioned move to make protein more affordable through price controls has had the opposite effect – something that happens with many policy decisions.

The new Government must focus on making decisions based on data, facts, and economics, not just good intentions. In economics, good intentions don’t guarantee good outcomes.

The first 200 days: Can the new government lead or will it be overtaken?

By Dhananath Fernando

Originally appeared on the Morning

• Sri Lanka’s new Government faces critical early decisions

The first 100-200 days are critical for any new government. Being prepared to assume power is essential because if a government expects to prepare after getting to power, it risks being overtaken by circumstances.

This is particularly true in a country like Sri Lanka, where uncertainty is the only constant. Governments here face numerous internal and external shocks, and there is little time to prepare or adjust once in power. When a new president or government takes charge, it is akin to boarding a fast-moving train.

Many previous governments have been reactive, merely responding to crises rather than controlling the situation. If a new government fails to take command, the situation will inevitably take control of it.

During his second term, President Mahinda Rajapaksa’s Government was overtaken by corruption and inefficiency before it could address core issues. The ‘Yahapalana’ Government came to power unprepared, only drafting its Vision 2025 plan after a Cabinet reshuffle, including changes to the Ministry of Finance. By then, its primary mandate for rule of law, good governance, and economic transformation had already faded.

President Gotabaya Rajapaksa’s Government faced the unexpected Covid-19 pandemic. While somewhat prepared, its policies were misaligned with sound economic principles. The more policies it implemented, the more unpopular it became, given the delicate balance between economics and politics.

Learning from these past lessons, one hopes the current Government avoids the same mistakes. Its challenge is navigating back-to-back elections. While elections may strengthen the Government’s political power, delaying essential economic reforms could be disastrous for a fragile economy like Sri Lanka’s. Delays in reforms could take years to recover from, and in the meantime, other pressing issues may spiral out of control.

While the plan for economic stability continues, economic growth reforms are equally vital. According to the National People’s Power (NPP) manifesto, simplifying the tariff structure is a good starting point. A simplified tariff would not only boost growth and competition but also reduce corruption, benefiting consumers by lowering prices. The Government should see an increase in revenue as informal money leaks caused by a complex tariff system decline.

However, timing is crucial, and reforms need to be implemented quickly within the first 100-200 days. Simplifying the tariff structure will see resistance from trade unions and stakeholders benefiting from the corrupt system. The best way to minimise resistance is to act early. Some local companies, which profit from targeting only the domestic market, may resist the changes, as will officials who have benefitted from the complexity of the system.

The second key reform the new Government should prioritise is anti-corruption. In fact, it received a strong mandate for this. While addressing corrupt politicians and officials is important, the Government also needs to reduce the potential for future corruption by adjusting or removing certain regulations.

Even if the Government is not entirely prepared to tackle corruption vulnerabilities, the International Monetary Fund (IMF) Governance Diagnostic is ready with specific actions, responsible divisions, and timelines. By committing to this framework, Sri Lanka can also secure financial and technical support from bilateral and multilateral sources. More importantly, it would significantly reduce the country’s corruption vulnerabilities.

The Government must also avoid certain pitfalls. Delaying economic growth reforms in favour of focusing solely on anti-corruption would be a mistake. Both reforms need to move forward simultaneously, and the Government must be proactive rather than reactive.

Another mistake to avoid is the overuse of relief packages and price controls. When governments fail to deliver on promises, they often impose price controls as a last resort, covering everything from eggs and milk powder to hotel rooms. While intended to protect consumers, price controls often lead to unintended consequences. If the controlled price is lower than production costs, sellers lose the incentive to sell, creating black markets.

We hope the Government can maintain stability, grow the economy, and continue its anti-corruption drive in parallel. Failing to do so will only lead to further losses for all.

Why we won’t be able to find the thieves after the election

By Dhananath Fernando

Originally appeared on the Morning

If you ask the average person the reason for our economic crisis, they would probably say one word: ‘corruption’. The idea of corruption was hyped so much that it became the main theme of the people’s movement – the ‘Aragalaya’. 

However, the truth is a little different. This doesn’t mean there hasn’t been corruption; it means corruption is more of a symptom than the root cause. Corruption is like a fever, while the real infection lies elsewhere. The problem is, we don’t fully understand how corruption occurred, and if we don’t know that, it’s unlikely that we can fix it either. 

Even when we look at the election manifestos of political parties, they talk about eliminating corruption, but corruption isn’t the main focus. Instead, they place more emphasis on proposals for exports, business environment reforms, social safety nets, and debt restructuring.

Why don’t we know?

The way many Sri Lankans calculate corruption is simple: they take the total value of loans we have taken over the years, compare it with the asset value of infrastructure projects, and conclude that the difference equals corruption. 

However, most of the money we borrowed was not for infrastructure. In fact, since 2010, about 47% of the loans were taken just to pay interest. Another 26% of the debt increase came from currency depreciation. This means that from 2010 to 2023, about 72% of the total loans was used for interest payments and dealing with currency depreciation. 

Therefore, comparing the value of infrastructure projects to the total debt doesn’t give a clear picture of corruption because we have been borrowing mostly in order to pay interest. As a result, the debt keeps growing and we remain stuck in the same place.

Does that mean there’s no corruption?

This doesn’t mean there has been no corruption. It simply means we don’t fully understand how it took place. As a result, the solutions proposed for corruption only address the symptoms, not the root cause. 

Corruption has taken place during procurement. Most of the projects we conducted have been priced far above their actual value. 

For example, a project that should have cost $ 1 million was priced at $ 3 million. We then borrowed money at high interest rates for that inflated amount. The project is completed, but we’re still paying interest on an inflated value and the interest keeps snowballing. Now, we’re borrowing more just to pay the interest, which only pushes the total debt higher.

How to fix it

This problem needs to be fixed at the beginning, not at the end. Most anti-corruption methods focus on the aftermath – finding thieves and recovering stolen money. Of course, we should recover stolen money and hold people accountable for misuse of public funds. But on a policy level, the real need is for transparency in procurement and competitive bidding. 

Digital procurement systems and a proper procurement law can take us to the next stage. Otherwise, it’s akin to closing the stable door after the horse has bolted. Without competitive bidding, we may never even know the true value of projects or how much was stolen. Recovering stolen money becomes incredibly difficult if we don’t know the amount or the method used to steal it.

The solution is upfront disclosure of the values of large infrastructure projects, as well as clear financing methods and guidelines.

The graph shows the impact of State-Owned Enterprise (SOE) losses on debt. The contributions of Ceylon Petroleum Corporation (CPC) and SriLankan Airlines to the debt are clear; in 2024, we will see more debt from SriLankan Airlines, the National Water Supply and Drainage Board (NWSDB), and other entities.

Simply put, we borrowed too much at high interest rates with short maturities for infrastructure projects that didn’t generate enough revenue to even cover the interest payments. As a result, the interest compounded and we have been continuously borrowing to pay off that growing interest, leaving the debt in place and forcing us to keep borrowing.

Albert Einstein put it wisely when he said: “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”

Sri Lanka’s next leader faces a web of crises

By Dhananath Fernando

Originally appeared on the Morning

In two weeks, a newly-elected president and government will take charge of steering the country.

At the beginning of the forex crisis, we warned that an economic crisis often comes as a package of five interconnected crises.

Balance of payments crisis

A balance of payments crisis occurs when excessive borrowing from the central bank (money printing) leads to inflation. In countries like Sri Lanka, where the local currency is not a reserve currency and the economy relies heavily on imports, printing too much money increases the demand for goods and services – many of which are imported.

If exports, remittances, and Foreign Direct Investments (FDI) fail to keep up with this increased demand for imports, we run out of foreign exchange reserves, causing the currency to depreciate.

Debt crisis

When foreign currency reserves are depleted, the country struggles to meet its obligations to creditors. While borrowing from international markets might offer temporary relief, credit rating downgrades make this option limited, triggering a debt crisis. On 12 April 2022, Sri Lanka officially declared it could no longer service its debts, despite having the intention to do so.

Banking crisis

If local banks have provided significant loans to the government and the government defaults, a banking crisis can unfold. Sri Lanka narrowly avoided this scenario.

Humanitarian crisis

With debt defaults and depleted foreign reserves, imports become limited. Inflation makes basic necessities unaffordable for the poorest segments of society. In Sri Lanka, poverty numbers surged from three million to seven million, pushing more than 30% of the population below the poverty line.

Political crisis

When a government faces multiple crises such as these, political instability inevitably follows, as we have seen in Sri Lanka. The President was ousted, the Prime Minister and Finance Minister resigned, and an interim Government was formed.

Although the political crisis continues, it is only one phase in an ongoing cycle of instability, with the Presidential Election being a milestone in this process.

Current political landscape

The incumbent President has introduced significant relief measures, including raising public sector salaries, forgiving agricultural loans, and making other promises. However, if re-elected, he will struggle to deliver on these promises within the limited fiscal space, potentially leading to a deviation from the International Monetary Fund (IMF) programme.

Alternatively, he might be forced to raise taxes or borrow more, which would increase interest rates and add to the economic strain.

If another candidate is elected, they will face the same fiscal limitations and may have to reverse salary increases to maintain fiscal discipline.

In the case of a Samagi Jana Balawegaya (SJB) government, the challenges are compounded. The Economic Council within the SJB sends mixed signals about achieving revenue targets to support proposed expenditures. Additionally, the broad alliance of political factions under the SJB presents internal challenges, especially concerning sensitive reforms like State-Owned Enterprise (SOE) restructuring and maintaining Central Bank independence.

Not all factions have aligned views based on previous voting records and public statements. Managing these internal differences will be critical for an SJB government, especially in the context of carrying forward the relief measures introduced by the current President.

Similarly, in a National People’s Power (NPP) government, the same challenges apply. The NPP, primarily led by the Janatha Vimukthi Peramuna (JVP), advocates for a more State-led development approach, but many professionals in the party’s outer circle lean toward market-driven policies. This could lead to internal conflict, making reforms difficult to implement without alienating part of the party.

This situation resembles the ‘Yahapalana’ Government, where the President and Prime Minister held differing ideologies. As a result, governance became more about managing stakeholders than effective government operation.

If you recall, the Prime Minister made economic decisions through the Cabinet Committee on Economic Management (CCEM), which was later replaced by the National Economic Council appointed by then President Maithripala Sirisena. Stakeholder management within an NPP government could prove just as challenging.

On top of these internal struggles, Parliamentary and Provincial Council Elections are expected to follow, adding even more political promises that will further constrain the fiscal space. Reforms tend to slow down during election periods, making debt restructuring more difficult and putting the IMF programme and long-term debt sustainability at risk.

While we may see temporary relief from one or more of these crises, the interconnected nature of these issues means that one crisis could easily trigger the others. The risk factors remain extremely high, underscoring how difficult and sensitive sovereign debt restructuring and recovery can be. There is always a risk of setbacks before we see real progress.

The path forward

Whoever takes office, the best-case scenario involves continuing with reforms aimed at growing the economy, with all political parties supporting these efforts with transparency and accountability.

Stakeholder management will be crucial, but there is no other way to avoid the complete package of five crises. Economic growth, fiscal discipline, and political unity are essential if Sri Lanka is to emerge from this difficult period.