By P. K. Balachandran

COLOMBO – In its pre-budget note on the state of the Sri Lankan economy, the Collective for Economic Democracy (CED) has recommended the government stop relying on austerity measures, export promotion and Foreign Direct Investment to shore up the COVID-19 hit economy. The CED favours deficit financing, State investment, encouragement for domestic investment and measures to boost local demand to meet the unprecedented domestic and global crisis.

The Sri Lankan Prime Minister and Finance Minister, Mahinda Rajapaksa, is to present the budget for 2021 in Parliament on Tuesday (17).

“Given that Sri Lanka is facing a massive economic crisis, it is extremely urgent that Budget 2021reflects the changes that must be made to get the economy onto a sustainable track,” the reports says, noting that the  crisis exposes long-standing trends both in the global economy and Sri Lanka’s economy. “President J.R. Jayewardene’s 1977 neoliberal policy promised people the horizon of untapped global markets. Now, more than forty years later, it is becoming clear that the open economy policy worked primarily for the richest Sri Lankans. Even then it could only function in a relatively prosperous global environment. But in the tight of the COVID-19 pandemic and its economic fallout, it appears that global moment is closing fast.”

Three pillars of neo-liberalism

During the 1990s,the period of neo-liberalism, the global economy was built on three main pillars: (1) Free trade (2) Financialization, and (3) Privatization. But all three have proved to be shaky.

Free Trade

In terms of free trade, the global economy under neo-liberalism was far less stable than it appeared. For one thing, it relied on growing exports from places such as China to sustain US debt-driven consumption. US consumers took on massive amounts of debt, even as real wages stagnated. But the period looked relatively bright for export-producing countries such as Sri Lanka. These countries repressed workers’ wages while looking for Western markets that could consume the goods they were producing, because workers in those countries themselves could not afford them.

However, in 2008, the first bubble popped, and it became clear that US consumer debt was unsustainable. The housing market collapsed. Americans faced the biggest economic crisis at the time since the Great Depression of the 1930s.

Financialization

Financialization exacerbated the economic collapse. Although globalization advocates promised a wave of Foreign Direct Investment (FDI) for poorer countries such as Sri Lanka, the reality is that much of it remained concentrated among Western countries and a select few Asian countries such as China. Instead, because of the emphasis on promoting capital markets, financial speculators brought money in and quickly took money out of countries.

Much of the speculative investment was in real estate and other areas of the economy that failed to create sustainable foundations. ‘Hot money’ triggered explosive shocks such as the Mexican debt crisis of 1982, the Asian Financial Crisis of 1997, the Argentinean crisis of 2000, and now the most recent crisis triggered by the COVID-19 pandemic.

Sri Lanka saw a wave of financial speculation from the late 2000s onward. This has contributed to the sovereign debt bubble that looks set to burst.

Privatization

Privatizing public assets was proposed as a solution to recurring crises. Because of unsustainable debt in both Western countries and ‘emerging economies’, powerful global institutions such as the International Monetary Fund (IMF) and the World Bank (WB) initially proposed painful structural adjustment measures. They pushed “austerity” as a way of enabling countries to settle their debts. Social services were slashed, and in places such as Greece, after the 2008 crash and the resulting Euro crisis, unemployment skyrocketed.

However, the IMF and World Bank have recently begun backing away from their recommendations, realizing that the cure is worse than the disease, although they are still quietly backing ‘fiscal consolidation’ in countries such as Sri Lanka.

By the end of 2019, 47% of Sri Lanka’s external debt was raised in financial markets and mostly large private institutional investors such as hedge funds own this debt (Finance Ministry Annual Report 2019).

Thus, Sri Lanka will find it difficult, if not impossible, to negotiate the kinds of settlements it can pursue with bilateral creditors, including countries such as China.

The IMF projects the global economy will contract by 4.4% and the WTO projects global trade to fall by 9.2% in 2020. If global trade grew three times as fast as global GDP during the decade of hyper-globalization in the 1990s, it is declining more than twice as fast as the shrinking global economy.

According to UNCTAD, global flows for FDI are projected to fall by 40% this year and are not likely to recover until 2022. In other words, the model of export-led growth wit hFDI support has to be rejected due to the global economic realities.

Impact of COVID-19

The COVID-19 pandemic and its economic fallout have accelerated the trends outlined above. The world is descending into another severe economic depression. This is characteristic of a capitalist crisis long in the making and that has been pushed over the cliff by the pandemic.

Consequently, the global order is going through tremendous changes. China is for the moment the exception having controlled the spread of COVID-19 within its borders. It has been able to continue with positive GDP growth for 2020 on the order of 4%.

However, despite its large domestic market along with its own major Belt and Road Initiative (BRI) abroad over the recent years, China’s surplus capital requires investment possibilities around the world, there are likely to be fewer takers with the depression. As the pent-up demand for its consumer products slows with the continuing fall in global trade, pressures are likely to mount on China’s economy as well.

Solutions for Sri Lanka

The challenges for Sri Lanka are extremely urgent. Given that the country is experiencing so much pressure, it is necessary to disaggregate the consequences in terms of two major issues: 1) the external-facing economy, and 2) the internal-facing economy.

Sri Lanka is facing an unprecedented debt crisis. In 2019, the country’s total debt as a proportion of GDP was 87% (Finance Ministry), and is likely to rise to nearly 100% over the coming year. As a consequence, Sri Lanka will have to pay approximately 6% to 7% of GDP on interest alone without including the capital repayment, which becomes the lion’s share of the 10% of GDP in expected government revenue in2020 and 2021. Government revenue was already under pressure before the crisis, and that trend looks set to accelerate.

The external sector in particular, with approximately 50% of government debt owed to external sources and imports in Sri Lanka, being historically twice the value of exports, is likely to put tremendous pressure, including fears of default. These dynamics have accelerated with foreign earnings from tourism reduced to zero, and a great fall in foreign remittances, both of which supported the trade imbalance in recent times.

These pressures on the external sector have become evident with rating agencies, the voice of global capital, downgrading Sri Lanka’s debt to junk bond status and Sri Lanka having to look to bilateral and multilateral donors for support. Rolling over past debt with new debt has become difficult if not impossible.

Sri Lanka’s economy is likely to contract by between 5-10%. Earlier estimates in the year were ignored or downplayed by the government.

The Central Bank claimed that exports have rebounded to US$ 947 million in August 2020, just 9% below August 2019, but this was most likely due to excess inventory and pent-up demand due to logistical disruptions during the previous months. Since then, the awareness of the larger crisis is becoming clearer to policy makers.

Sri Lanka gets around 80% of its revenue from indirect taxes such as the consumption-based VAT tax, which means that as the economy declines and people spend less, government revenue will also decline.

Moreover, import duties which are a significant chunk of revenue are under pressure due to import restrictions to try and contain the external shock to the foreign reserves that are needed for debt repayment.

Without more investment, the negative effects will accumulate, further slowing down future growth despite rosier estimates for next year. Declining consumer demand due to job layoffs is likely to create a vicious cycle for the domestic economy.

With the private actors unlikely to invest during a depression, the only way out is government spending combined with renewed efforts to reallocate capital among vital sectors of the economy, especially far greater investment in agriculture, which currently contributes only to 7% of GDP. Such investment in agriculture is also critical for food security, with food systems disrupted by the pandemic and the depression.

One solution to the revenue question is stepped up wealth and property taxes. It cannot raid working people’s assets, such as distributing 20% of the EPF funds, so it has to look elsewhere.

Austerity is no solution to the current crisis, especially when the very real possibility of famine among vulnerable groups exist. At the same time, the government is afraid of alienating its elite business constituencies. But the reality is that when capitalism experiences this level of crisis, the only solution is to dramatically reorganize production, to prevent capitalists from cannibalizing each other’s market shares and further depressing the economy. That will require an incredible level of state intervention to promote investment and subsidize domestic demand.

The upcoming budget will have massive implications for Sri Lanka’s near to long term trajectory, and time is ticking. The government has a choice: either 1) it pursues dramatic measures, including wealth taxes and unprecedented deficit spending to increase investment with a new set of priorities focusing on people’s real needs and to get the economy going again or 2) it provokes an even worse fall by wasting precious time and pursuing dilettantish proposals for foreign investment and export led growth, which will supposedly appear out of thin air.

 -P K. Balachandran is a senior Colombo-based journalist who in the past two decades, has reported for The Hindustan Times, The New Indian Express and the Economist