The Great Lockdown and the Sri Lankan Economy

The Great Lockdown and the Sri Lankan Economy

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All-new 2020 started with some prospects of global recovery after a sluggish growth in previous year. On March, WHO categorised COVID-19 outbreak as a pandemic. It has shocked the global economy and made things even worse with the measures taken to prevent the disease from spreading. But it was necessary, where many economists stated that there was no positive trade-off by re-opening the most of economies before the estimated date. 

As specified by the IMF, ‘The Great Lockdown’ may lead to a global recession in 2020 which could be worse than the one triggered by the Global Financial Crisis. Simultaneous shocks in both real and monetary sectors would drag down the economy where the depth of the recession would depend upon the time line of the COVID-19 epidemic curve. To start with, it all depends on the policy response and how fast the actions taken by the Governments. Fiscal Affairs Department of IMF has quantified near term Fiscal measures that Administrations need to adopt, but not limited to; 

  1. Increase spending for prevent, detect, control, treat and provide basic services to people that affected by the epidemic. 
  2. Provide temporary and timely relief packages for targeted people and firms that are most affected until recovery begins; e.g. wage subsidies, increase social transfers, provide tax relief, etc. 
  3. Form a business endurance plan for period of the epidemic. This plan should focus on to coordinate and facilitate manufacturing value chains, service providers and importers. 

Comparatively low interest rates have provided an opportunity for advanced economies to use fiscal measures more actively to strengthen the demand. The OECD Interim Economic Assessment in early March has suggested following approaches under fiscal space by targeting the medium term of the markets. 

  1. Additional stimulus measures need to be implemented with consideration of debt sustainability of the economies. 
  2. Economies with larger debt to GDP ratios and budget deficits could integrate structural changes to existing spending measures where it could direct towards to sectors and areas that will help to overcome the distresses of the pandemic and assist near term economic growth. 
  3. Quasi-fiscal measures should adopt under well determined scope with considerations of Constraints, this is specifically necessary for emerging and developing market economies. 

Although, unlike the 1929 Great Depression and 2008 Great Recession, fiscal stimulation will be very challenging as the epidemic would hit households, businesses, financial institutions, and markets all at same time. However, it is too early to fathom COVID-19’s long-term implications for global high powers and emerging markets even with trillions of dollars stimulation package. 

Sri Lankan Economy 

The Sri Lankan economy is structured as formal and informal sector, where it segmented with three key GDP drivers, agriculture forestry and fisheries, industries, and services. The production of these sectors has enabled both domestic consumption and export market. 

Both formal and informal sectors would be seriously affected by this pandemic in the context of exports, imports, domestic production and services. But real danger is associated with most unexplained parts of the informal sector. 

Export destinations 

In a recession time, production for exports triggers with a dual effect, factors of production and features of export destinations. In the setting of trade account in Sri Lanka, main export destinations are the US 25%, U.K 8%, EU 22% and India 6%. 

More than 70% of exports to the US are women’s undergarments, knit and non-knit suits, sweaters, shirts and gloves. This market is shaped with purchase habits of the consumers and such would solely depend upon subjective and objective factors, for example changes in expectations of the relation between current and future income as a subjective factor and building a reserve against unforeseen contingencies as an objective factor in a recession time. 

Between 15 to 29 March the initial jobless claim rate in the US increased by more than 60 times. Longer the restriction period for Americans to attend movie shows, gymnasiums, musical shows, Super Bowl, etc., the deeper the downturn due to the structure of the US economy. Some estimations show that nearly half of job gains after the 2008 recession would evaporate due to the pandemic. 

The UK is also a major destination for garments and textiles. The National Institute of Economic and Social Research has forecasted that the UK economy would shrink 15%-25% in the second quarter of 2020 if the lockdowns are continued. 

In addition, recent survey reports show the uncertainty of consumer confidence has increased with lower wages. Retail and wholesale deterioration of 6%-10% would directly affect the fashion and lifestyle industry, where it signals a faded exports destination for Sri Lanka. 

Comparatively, exports to the EU have diversified with other major productions such as rubber products, machinery, mechanical appliances and tea. Major states that received domestic exports are Germany, Italy, Belgium and France. Germany’s key exports, autos (where main markets are US, rest of EU and UK) and investments goods have declined prior to COVID-19 epidemic, while weakening the new business investments. Also, short-term forecasts didn’t display any clear rebound in the manufacturing sector of Germany. In such a setting, the current state of the world economy would make things even worse for Germany. 

Italy met with some of the worst impacts of the pandemic. The European Central Bank has performed a $ 810 billion asset purchased program which would help to raise Government spending and offer guarantees on bank loans for careworn business. At the time of the writing, Italy still hasn’t announced any strategy to avert the effects of the economy for the rest of the quarter. France and other Scandinavian destinations displayed somewhat weakening manufacturing sector and slowdown of corporate investments even before the pandemic, this was mainly due to effects of global trade tension in previous year. 

Accordingly, Sri Lankan industrial exports to the EU region would be covered with a grey forecast for the rest of this year. 

India is the major diversified export destination for Sri Lanka that comprises 32% agriculture and more than 45% industrial exports. The Indian economy has decelerated in recent years due to various factors like structural issues and credit growth, although there are some improvements in PM Index and FDIs (16% of increase) which are major indicators for Indian economy. If the measures taken by the Indian Government work out as planned, it may prevent the distress created for green shots that were visible prior to the epidemic. It will be good news for Sri Lanka. 

The beverage price index expected to increase by 2% in 2020 followed by spiralled downward due to pressure on tea prices in previous years. Since Sri Lanka is a price taker with numerous constraints on further production, it would only leave local producers to form expectations on traditional beverage prices to increase in world market. 

Imports and exchange rate 

Imports are used as factors of production for both domestic and export markets. Also, its cast-off domestic consumption in terms of immediate and durables. Most intermediate and investment imports are used as inputs for production processes and inputs for value chains. 

The top imports origins of Sri Lanka are India 20%, China 17%, Singapore 7.9%, UAE 7% and Japan 4.8%. Such domestic markets are not severely affected by the epidemic. But there are three dimensions that would affect the economy in terms of imports, namely global price level, domestic inflation and exchange rate pressure. 

There are many theories that fit into particular schools of economics to determine the price level, but still we are not in a position to forecast the future price level due to intangible or unforeseen factors caused by this epidemic. Nearly $83 billion cash outflows have been recorded in emerging markets, putting pressure on their exchange rate regimes. 

The USD/LKR also hit the 200 mark in April. This was mainly due to the responses of market actors related with formed expectations with reference to the pandemic and by taking risk averse positions in their balance sheets. The risk of such overshooting of the exchange rate is that the market rate would settle down at a higher bound and will continue without any downward pressure in respect of weak cash inflows to Sri Lanka. 

Under the pessimistic scenario, Sri Lanka would face dual effect on inflation, increase in global prices of inputs for domestic production and imported inflation due to higher exchange rate. This will reduce the real wealth of consumers and would affect the demand. 

Domestic production/services 

Nearly half of the economic activities of the country explained by the informal sector. Informal sector employment recorded as 68% of total employment. Major composition is in Agriculture, forestry and fishing 88%, followed by construction and other industries 77%, hotel and accommodation 55% and manufacturing 46%. Directly affected division in domestic market by cause of pandemic is the informal sector. 

In recent studies, rationalise that globalisation has positively contributed for development of the informal sector, especially informal trade. Such would show how strong the linkages between global trends and local level activities. Accordingly, under any deceleration of global activities would directly affect the local activities of informal sector and consequently reduce GDP of the country. All MSMEs value chain actors from input providers to service providers would be distressed under such a situation. 

Long-running issues such as absence of decent work standards in informal jobs, lack of occupational safety and health, social insurance, assistance and welfare schemes would make things even more depressing than expected. In addition, lack of information, data and validity of existing data of the informal sector would make it difficult for policymakers to track any changes and introduce countermeasures for the majority segments of this sector. 

Short-medium term strategies 

Sri Lanka inherited a fragile economy integrated with a sequence of long-running economic despairs such as poverty, unemployment, inflation, trade balance, budget deficit, income inequality, poor socio-economic infrastructure and many more. The current state of the global catastrophe suggests that our short-term policy reformation should be centred around a process of converting our weaknesses into strengths. 

Sri Lanka ranked 101th in the Economic Complexity index and 61 on the GINI index, where recent studies show that the lower the economic complexity coupled with significantly higher level of income inequality, subsequently majority of working population, specifically the informal sector, will be more vulnerable to any type of hazard that may arise. Recent tax cuts, prior spending programs and debt obligations have left us with a narrow space for further proactive fiscal stimulus. Consequently, the Government would be attentive on other strategies in a given fiscal space. 

There are many existing programs run by the Government, NGOs and other non-profit institutions by targeting the informal sector of the country, where such can be assimilated with new strategies to be formed by the authorities. Government may entail to use existing fiscal space to direct funds towards following programs to provide some relief for most affected sectors, but not limited to; 

  1. Business and entrepreneurship development in terms of coaching, counselling and mentoring. This can be adopted as a business lifecycle approach. 
  2. Picking up inactive and potential actors by using product space framework. Accordingly, such actors would link with active value chains of the area. Main benefit of this process is, it would pressingly create and strengthen the integrated value chains. 
  3. Enhance existing space for safety nets. Authorities can increase benefits of prevailing welfare programs at least for a shorter period of time, where there are more than 35 programs in the country. 
  4. Consumption is a large but relatively stable fraction of GDP. In a recession time it is unlikely to increase consumer confidence. The Government can relax some import restrictions for a limited time frame in order to reduce the price of selected non-durables, where it would have some spiral effect on consumption as whole. 
  5. Proper administrative level coordinating systems should be established to function the tasks design by the National Government, e.g. Presidential Task Force. 

Everything depends on the policy decisions taken by the Government in a time of depression like this. As individuals we also have a responsibility to cooperate within our capacity to avert any market failures that are likely to occur. Also, we all need to be more productive than ever before by being optimistic. Such a collaborative approach may lead to determining the bounce back shape of the country. 

~ Bhadraja Mullegamgoda

Source: www.ft.lk

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