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Sri Lanka’s Macroeconomic Crises

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In May 2022, Monika Gupta discusses how Sri Lanka faced its worst economic crisis since its 1948 independence from Britain.

Image courtesy of interviewee. January 24, 2024

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This video video is a detailed analysis of the economic situation in Sri Lanka, focusing on the country's historical context before the crisis and the factors that led to its economic collapse. The speaker is associated with the SPJ Institute of Management and Research in Mumbai, India, and discusses a case study co-authored with Dr. Prita George.

Key points include:

1. **Economic Overview Before the Crisis**: Sri Lanka enjoyed a strategic geographical position, majorly exported tea, had a high per capita income, and a strong human development index. The country also benefited from a young, English-speaking population and significant contributions from tourism and remittances.

2. **Crisis Factors**: Over time, political corruption, inefficient governance, and reliance on populist policies led to economic mismanagement. The government's heavy borrowing resulted in unsustainable public debt, exacerbated by external shocks like COVID-19 and a controversial fertilizer ban.

3. **Crisis Unfolding**: The government was unable to adapt its policies effectively, leading to increased import bills, reduced agricultural output, and a significant rise in external debt. This video video led Sri Lanka to become the first country in the Asian Pacific to default on its debts.

4. **Immediate and Long-term Solutions**: Reforms are needed to reduce unnecessary expenditures, improve transparency, reverse harmful policies, restructure the economy towards privatization, and enhance the service sector, particularly in education and technology. Attracting foreign investment and improving the efficiency of government functions are also critical.

5. **Educational Objective**: The case study serves an educational purpose, illustrating the interconnectedness of macroeconomic variables and providing a practical framework for understanding macroeconomic concepts through real-world applications.

Overall, the text underscores the importance of sound economic policies and governance in maintaining a country's financial stability, using Sri Lanka's recent history as a cautionary tale.

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X-TIMESTAMP-MAP:LOCAL=00:00:00.000,MPEGTS=900000

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I'm, currently associated with SPJ Institute

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of Management and Research, also known as S-P-J-I-M-R,

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located in Mumbai, India.

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So, Dr.

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Prita George and I, my co-author,

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and I have written this case around a year ago

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and later on, our case research published

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with Ivy Publishing.

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Uh, so starting, with the first question that

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where SSRI Lanka was standing

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before the crisis, so that is something interesting

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to discuss about SSRI Lanka.

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So if you look at the South Asian region,

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which comprises the developing economies like India,

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Bangladesh, Pakistan, ssri, Lanka, Mauritius,

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and few other countries.

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So, so they all are kind of emerging and developing,

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and especially if you take the case of SSRI Lanka.

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So first, let's take the geographical condition.

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So it has, has a very strategic condition in terms of trade.

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It is passing through the, various important sea roots.

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Sometime it was also considered a pearl of Indian ocean.

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So it is rich in flora and fauna.

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And, so this is about the natural beauty

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and the geographical thing.

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Now, let's, let's look at the other part,

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which is more economic part.

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So that was also very good.

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It was, once upon a day,

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it was a high second highest larger, you know, exporter

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of tea in the world.

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It was, it was having second highest per capita income in

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the region in terms of purchasing per parity,

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and also the highest human development index in the region,

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which is around 0.7, on a scale of zero to one.

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So this is all about the good things

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of SSRI Lanka having a very young age population.

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65% people are in young age, most

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of the population is English speaking.

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Literacy is almost full.

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And, and if I talk about the historical point of view, so

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that is the third aspect.

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So Sri Lanka, like the other countries,

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they have a very peaceful independence from the,

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British Empire in 1948.

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After that, they were good on the, you know,

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restructuring part, though they adopted inward

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policy, but they were doing good.

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They focused on their natural capacity,

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the agriculture part, and also they've opened their economy.

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They have very high role of tourism in their GDP.

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It is around 12%.

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The SSRI lankans abroad have been very generous

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and he has a great share of remittances in the GDP.

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So these were all very good things about SSRI

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Lanka before the crisis.

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So now let's talk about a case. What is a case?

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Cases is something which has become an outlier.

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So having a journal positions, and suddenly it got reversed.

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So that's what happened in case of SSRI Lanka.

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So as I told you, they have very smooth transition

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of power from Indi, after independence,

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and they were doing good.

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I also highlighted few important

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factors, which was positive.

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The only major challenge they were facing was the LTTE,

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that is the militant group, liberation tigers of thermal.

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And what happened in 2009, the, Raja family.

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So Raja Mahinda Raja,

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they have a very instrumental role in defeating

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this, militants.

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They were also sometime known in the

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country as terrorist group.

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And after that, they become hero.

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In 2009, they, they become victorious.

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So it was the war between the government where Gu Raja Pak

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and the Mahinda Raja Pak has an in very important role.

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On the other hand, it was this militant group.

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So these, these people have instrumental role in defeating

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this particular group, which was quite violent.

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And after that, they become hero.

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So, they,

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after that, they were in par around two years, 20, 20 years,

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two decades, they ruled in the country.

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So they did some, some policy measures,

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but over the period of time they become corrupt.

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So the whole country was ruled by this family, the,

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the these two brothers and their clans.

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And if you look at all the major ministries,

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primarily the six major ministries, finance, ministry,

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defense ministry, home ministry,

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were all there under their control.

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And in, if you look at in terms of economic numbers, the 70%

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of the budget of the country was under control

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of these, this family.

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So they were not as usual,

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they were not worry about the progress

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and the structural reforms, which was much required.

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They become correct. There was a inefficiency.

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All the major enterprises were under government control,

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and they spent heavily,

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and that led to the deficits in various years

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and accumulated the public debt, which, which

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during the crisis it was around 120% of the GTP.

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And now when, when the government is not accountable,

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and every time they're sure they're coming back in the park,

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they're not accountable to anyone.

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So they're spending heavily

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and adopting the populist policy.

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So, you know, if you see,

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so usually I say the crisis around the world.

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Now the crisis of the economy is

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the failure of the government.

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Just look at the Greece crisis and the crisis.

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Similar thing happened in case

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of sing was the government failure.

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And so since they want to win the election, they want

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to come back in the park.

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So they, they did the populist measure.

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So for example, in 2019, they took a measure debate decision

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to, reduce the taxes

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and taxes are the major sources of revenue.

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They were spending heavily on the infrastructure projects.

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And those are like dirt investments

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because they were not helpful in generating the investment.

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So usually we say that, you know,

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in infrastructure investment is good,

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it is a capitalist in a capital infras,

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investment capitalist, expenditure.

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But macroeconomics is all about designing the policy.

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So one policy may be good in case of us in case of India,

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but that may not be good in case of SSRI Lanka.

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So they did investment in infrastructure.

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They built a hamman tota airport and then hospital.

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But what they did, they choose the

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location, which was not good.

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So it was their hometown and there was no market.

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So this investment not helpful in generating my income

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to pay back the debt or,

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moreover to pay back the interest.

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So this was getting accumulated over the period of time.

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So this was the main reason.

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That is the internal debt that is known as fiscal debt.

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The government debt, on the other hand, there was a,

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there was a huge problem from the external sector

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that is known as the capital account deficit.

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So that's what that case talk about, the twin deficit.

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So twin deficit is actually not a problem.

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Most of the countries, US has twin deficit.

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India has twin deficit. But when these two debts become

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unsustainable, then it led to the problems.

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And that's what happened in case of SSRI Lanka.

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So internal debt, I already explained.

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Let's talk about the external debt.

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So, they were pioneer in the exports of tea,

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rubber and textiles.

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So if you look at this kind of exports,

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initially it was good because it was agriculture production.

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They were having kind of competitive advantage.

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But when you look at such exports over the period

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of time in international market, they're not competitive.

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They have to face huge competition.

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They get low prices in the international market,

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they have low terms of trade,

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and then there is additional cost in the

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procurement and storage.

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So what happened though, they were, they were,

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they were earning well,

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but over the period of time they were losing their power

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and they have not much diversified.

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It's not that these are the few products,

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there were other parts, no.

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So they, they were, this,

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these products a huge role in the exports.

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And they were not diversified even though the condition was

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good because they was earning huge money from the ex,

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export of the services like tourism and remittances.

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But now what happened then on, in 2020

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and 2021, we have two black swan events.

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One was the COVID-19, and what happened?

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The first thing got ha affected, which was,

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which was the service sector, and especially the tourism.

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So this bubble in terms of the government inefficiency,

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mismanagement, corruption, less structural reform,

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low diversi diversification, they all got burst

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during the first pandemic, the pandemic in 2020.

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So it was like adding fuel

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to the fire when in 2021 they announced a controversial

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policy of fertilizer ban the chemical fertilizer

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and pesticide ban.

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Now, it was an overnight decision.

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There was not well thought behind it.

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So people were thinking, what is the reason behind that?

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So there, there was some saying the prime reason behind

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that, that they were facing huge challenges

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because in the international market, due to escalation

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of the Russo Ukrainian war, the energy prices were going up,

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and ska was not no exception.

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So they were import bill was continuously increasing.

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And since they have imposed this policy and

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because they want to curtail the import of such thing,

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these was kind of easy to target,

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but it has an osi you know, outcome

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because they, they, they started having low cultivation

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because the country was not ready

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to move towards the organic farming.

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Okay? It requires a lot of effort.

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It, it'll go slow movement, slow productivity.

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And ultimate, on the other hand, you are also dependent

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for the exports for the agriculture related sector.

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So there was a two-way pressure in the international market.

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They were importing fuel, which was getting cost clear.

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And energy prices were high because of this policy.

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They were also from net exporter.

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They become net importer of the food

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and the other essential items like medicine.

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So there was the huge import of food, fuel and medicine.

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It was a one-way, pressure two-way pressure.

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They have not diversified this exports

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and tourism got hit remittances

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because people were not in a position

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to send the money back.

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They already, there's a lot

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of crisis in international market.

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So the external deficit got fueled earlier.

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It was also there, but it, you know,

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it was a sudden increase in that.

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So it's a two-way pressure.

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And then there's another interesting point in case

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of SSRI Lanka, that if you look at the, you know,

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population structure

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of the developing nations in South Asia region,

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they're consumption driven economy

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because the young population

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and, they're in a,

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they're under a grow growth path, developing economy.

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So the same thing in case of SSRI Lanka.

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So usually income is the additive function

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of the consumption and saving.

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So in case of SSRI Lanka,

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they're also consumption driven economy.

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So they don't must save.

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So if they're not saving much,

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and from the same pool, everyone is in the,

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the economy is borrowing.

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And if government started borrow heavily, what happened?

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It'll crowd out private investment.

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Because first of all, saving pool is faced second,

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all the people in the economy,

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all the sectors in the economy are borrow

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from the same pool.

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So first, the savings will not be available.

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Second, if it is available, the borrow cost will increase.

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That is the high interest rates.

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So that particular phenomena is known as crowding out.

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So they were crowding out private investment.

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And even though since the deficit was too high,

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it was not sufficient.

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So then ultimately they were borrow heavily

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from the external market.

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So other pressure in terms of the interest rate payments

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and dollar denominated bonds, which led to,

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you know, which they were,

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which were having continuous pressure on their currency

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and currency was depreciating.

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And now even though your euro, you know, in an

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absolute manner, your import bill may be constant,

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but in, in relative, when you convert in you

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because your currency is losing its value,

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it was con continuously skyrocketing.

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It was increasing. So these two deficits were the prime

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issue, which, which led this bubble burst

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and made the SSRI Lanka from the pearl of Indian nation

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to the economic crisis.

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It's a major crisis.

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And you can see the zone of this crisis were,

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the seeds of this crisis were sewn way back.

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And this, this two blacks aren't even just

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stimulate that particular crisis.

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Now, obviously this cannot be sold in few days, few months

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now, now what to do?

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So we all have seen the television last year when all the

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whole, the big mob have attacked on the pre

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presidential houses.

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And, in May, 2021, then go

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Gbe 2022, when, ran Raja Pshi became as prime minister,

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there was again, revolt against him.

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So he stepped down, and then in July, 2022,

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he became the president.

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So ran Kuma, sang is continuously heading the country

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and trying to, get the country out of this crisis.

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So, and the good thing is

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that they got the bailout package from IMF

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because when re Senge joined in,

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May, 2022, I, I think it was March

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or May, there was a biggest cushion, in front of him was

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to, pay the import bill around 1 million and something

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and the immediate payment of, $2 billion,

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loan repayment, which was due in July.

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So this was the two immediate question in front of him.

14:14.785 --> 14:16.565
Now, if you look at again,

14:16.805 --> 14:18.525
SSRI Lanka was a very disciplined borrower.

14:18.525 --> 14:20.805
It was not at Srilanka, was not borrowing,

14:21.225 --> 14:23.605
but suddenly from the discipline borrower,

14:23.605 --> 14:26.925
they become the first Asian Pacific country to default.

14:28.065 --> 14:30.725
And then they said, yes, we can't pay

14:30.785 --> 14:34.245
and they have to ask for help from IMF.

14:34.665 --> 14:36.205
And they got the 3 billion package

14:36.305 --> 14:37.885
and they got the two tran.

14:38.025 --> 14:40.405
So we were, you know, checking the news

14:40.425 --> 14:42.885
and we found that there was a delay in the second launch

14:42.885 --> 14:44.565
because they were not,

14:44.565 --> 14:47.565
very much successful in negotiating with China in terms

14:47.565 --> 14:48.965
of debt restructuring.

14:49.065 --> 14:50.245
So IMF recommended

14:50.345 --> 14:55.005
and they, they also tried to convince their borrower

14:55.065 --> 14:57.685
to have a 30% haircut on the debt,

14:58.705 --> 15:00.445
but China was reluctant about that.

15:00.545 --> 15:01.885
But there was some ways.

15:01.945 --> 15:03.765
And the second launch they got, now

15:03.765 --> 15:05.885
what are the immediate actions which they can.

15:06.265 --> 15:09.245
So they are two, two ways to look at the problem,

15:09.325 --> 15:10.965
remedial measures or the solution.

15:10.965 --> 15:13.285
What is the short term measure? Short term, medium term.

15:13.625 --> 15:14.885
And second is the long term.

15:15.745 --> 15:18.725
So reform will start from the internal part.

15:18.745 --> 15:20.285
The very first thing they have

15:20.285 --> 15:22.365
to reduce their unnecessary expenditure.

15:23.105 --> 15:25.885
So currently there's no need of infrastructure,

15:25.885 --> 15:27.845
because they have all already done so much.

15:28.545 --> 15:30.245
And second, the,

15:30.625 --> 15:33.325
the transparency in the government expenditure, they have

15:33.325 --> 15:35.805
to adopt some fiscal austerity measures of fiscal,

15:36.145 --> 15:37.325
you know, discipline.

15:38.605 --> 15:41.895
They have to revoke their tax rebates, which they have given

15:41.895 --> 15:42.895
during the elections

15:43.085 --> 15:45.095
through which they can increase their revenue

15:45.095 --> 15:47.015
because that is the most important part.

15:47.755 --> 15:49.615
And just they need to look at it,

15:49.715 --> 15:52.255
how they can reduce the expenditure

15:52.255 --> 15:55.335
and increase the revenue so that they can bridge this gap.

15:55.795 --> 15:58.295
And that is also one of the requirements of IMM

15:58.315 --> 16:00.175
to show the primary surplus.

16:00.235 --> 16:04.655
So what is primary self surplus revenue minus expenditure,

16:04.675 --> 16:07.655
having surplus, excluding the borrowing ex,

16:07.655 --> 16:09.055
excluding the interest payments.

16:09.055 --> 16:11.335
Because interest payment has always huge role

16:11.335 --> 16:14.855
because these countries are in debt trap, they were deficit,

16:15.205 --> 16:16.775
they borrowed, there was a debt,

16:16.775 --> 16:17.855
there is an interest payment

16:17.995 --> 16:19.535
to pay the interest they again borrow.

16:19.535 --> 16:22.295
So it's like a debt trap. So this is one thing.

16:22.715 --> 16:24.535
And how can they do that again?

16:24.555 --> 16:25.815
Uh, they can reduce the taxes.

16:26.875 --> 16:29.135
You, they have to reduce the subsidies.

16:29.135 --> 16:31.695
There is enormous subsidies in the energy sector,

16:31.765 --> 16:33.375
free electricity, free water.

16:34.075 --> 16:36.855
So they have to reduce this unnecessary subsidies.

16:37.555 --> 16:39.575
And there should be transparency

16:39.575 --> 16:41.815
because there's a lot of corruption.

16:42.635 --> 16:46.095
Now at this point of time, they cannot have any new taxes

16:46.165 --> 16:48.415
because people are still suffering

16:48.475 --> 16:50.815
and they're not yet on the recovery path.

16:51.195 --> 16:52.535
But they need to see that,

16:52.555 --> 16:55.575
how can they increase the tax base so

16:55.575 --> 16:59.135
that more people can contribute in the tax, you know,

16:59.155 --> 17:00.255
tax, collection.

17:00.795 --> 17:04.535
So what is the meaning that, that people who are avoiding

17:04.915 --> 17:08.255
and evasion their taxes made them accountable.

17:08.395 --> 17:10.615
So ensure transparency, reduced corruption.

17:11.275 --> 17:14.095
The first thing, second thing, their airline was a loss,

17:14.095 --> 17:15.455
which was under state control.

17:15.595 --> 17:18.135
It got bankrupt, so they have to sell it

17:18.135 --> 17:19.175
to the private sector.

17:20.255 --> 17:23.595
Second thing, reverse that policy of the fertilizer ban

17:23.705 --> 17:25.995
because they were doing good on agriculture front.

17:26.055 --> 17:27.995
And it's not good that the country has

17:27.995 --> 17:31.195
to depend on a general sector, especially for food

17:31.415 --> 17:34.475
and medicine, given you have such rich flora and poll.

17:35.455 --> 17:38.875
So, the second thing is that to strengthen your sector,

17:39.855 --> 17:41.995
these are few medium term yes,

17:42.675 --> 17:45.835
increase the interest rate in the sense that they have

17:45.835 --> 17:48.315
to adopt the contractionary monetary policy.

17:49.065 --> 17:51.245
So recently in the news we have also written in the case,

17:51.245 --> 17:52.645
and recently it was in the news

17:52.675 --> 17:54.845
that they have some five days bank holiday

17:55.385 --> 17:57.485
to re restructure the monetary policy.

17:58.265 --> 18:00.085
So if they increase the interest rate,

18:00.085 --> 18:02.885
they can country curtail the inflation, which is very high.

18:02.945 --> 18:04.165
So in case of food

18:04.165 --> 18:06.325
and fuel was around more than a hundred percent.

18:07.265 --> 18:09.125
So if they can increase the interest rate,

18:09.125 --> 18:11.365
they can attract the foreign investor.

18:12.615 --> 18:14.595
So then if you look at medium to long-term

18:14.655 --> 18:18.475
or long-term solution, you know, sell the estate enterprises

18:18.475 --> 18:21.035
to the private sector, privatization is the key,

18:21.045 --> 18:23.795
which in India we also adopted in 1991

18:23.795 --> 18:26.875
because private sector is more efficient, more competitive.

18:27.375 --> 18:28.835
And if you do that, you would able

18:28.835 --> 18:30.795
to attract the foreign direct investment.

18:32.455 --> 18:34.475
And if you have good, financial sector,

18:34.575 --> 18:37.795
you can also attract the foreign institutional investor

18:37.795 --> 18:39.555
through the investment in the stock markets

18:39.975 --> 18:41.355
and the other capital markets.

18:41.935 --> 18:43.195
So these are the two way,

18:43.195 --> 18:45.035
because government is not efficient

18:45.055 --> 18:46.995
and government cannot control every sector

18:47.695 --> 18:50.635
and top of that government is facing huge deficits.

18:50.855 --> 18:53.515
So it's good now to involve the private sector.

18:54.055 --> 18:56.875
So it's another thing, the very important thing

18:57.375 --> 18:59.115
or the potential which the country has,

18:59.115 --> 19:01.995
which they have not utilized till now, is the highly

19:02.515 --> 19:04.355
educated English speaking population.

19:05.415 --> 19:07.515
So if you look at the tourism remit remittance,

19:07.515 --> 19:09.915
they were not resilient towards the external shocks.

19:10.535 --> 19:13.435
But if just like India, you have huge exports

19:13.575 --> 19:16.755
of the services in terms of it, telecommunication

19:17.415 --> 19:18.435
and financial sector.

19:18.575 --> 19:22.115
So, so these three sectors interestingly have

19:22.255 --> 19:25.155
around 20% growth rate during the crisis

19:25.605 --> 19:28.955
where economy was facing minus 3.5% growth rate.

19:29.735 --> 19:33.915
So these sectors have huge potential internally, externally,

19:33.915 --> 19:36.035
so they should focus on this particular sector.

19:36.575 --> 19:38.795
And you know, given though English speaking population,

19:38.825 --> 19:41.475
they can go outside, they can work, they can, you know,

19:41.475 --> 19:44.115
invite ncss for the foreign foreign debt investment,

19:44.565 --> 19:46.355
there must be cheaper labor cost.

19:46.765 --> 19:48.435
First, I would like to start

19:48.435 --> 19:50.155
with why we have written this case.

19:51.015 --> 19:52.675
So as an economic instructor,

19:53.085 --> 19:55.035
especially when we teach macroeconomic

19:55.985 --> 19:57.555
student face difficulty,

19:57.965 --> 19:59.995
especially in the macroeconomic level,

20:00.255 --> 20:01.275
all things are connected.

20:01.305 --> 20:03.555
Just take the example of SSRI Lanka,

20:03.555 --> 20:05.915
everything was connected, the tax code,

20:05.915 --> 20:07.795
the government deficit, the external debt,

20:07.815 --> 20:10.955
the currency depreciation, you know, that was piling up.

20:11.455 --> 20:13.835
So, in in macroeconomic framework,

20:13.835 --> 20:16.075
everything is connected and students sometimes face

20:16.075 --> 20:17.835
difficulty to understand the same.

20:18.495 --> 20:20.835
But when we bring the case, when,

20:20.835 --> 20:22.715
when bring such cases in the class,

20:23.255 --> 20:24.635
it enhance their interest,

20:26.555 --> 20:28.365
they contribute in the discussion.

20:28.365 --> 20:31.645
They sometime also do some extra, you know, readings,

20:31.755 --> 20:33.965
they watch videos, they, what happened later on.

20:34.505 --> 20:37.685
And they, and the takeaway is the concept concepts are clear

20:37.905 --> 20:38.965
and they remember always.

20:40.065 --> 20:42.765
So we, we enjoyed a lot while writing this case

20:42.765 --> 20:44.285
because this phenomena was quite

20:44.285 --> 20:45.685
burning, it was burning issue.

20:46.225 --> 20:47.565
And when we also, you know,

20:47.565 --> 20:49.965
discussed some other people we presented in u

20:49.985 --> 20:51.205
in a conference in us.

20:51.305 --> 20:53.285
So everyone was so excited about the case.

20:53.905 --> 20:55.525
And then when we also did

20:55.525 --> 20:57.365
before the publication, we did a pre-test.

20:57.745 --> 21:00.005
So we found very good opinion from the student.

21:00.385 --> 21:03.285
So the one purpose that we enjoy writing this case a lot,

21:03.285 --> 21:06.045
second, it's, it's helpful in learning

21:06.115 --> 21:09.285
that very complicated macroeconomic applied macroeconomic

21:09.325 --> 21:12.205
concepts in a very easy way and interesting way.

21:12.545 --> 21:14.645
So these are the two motives through which we write.

21:15.265 --> 21:18.485
Now, if you want to conclude that, yes,

21:18.485 --> 21:20.525
there is a major takeaways from the case in terms

21:20.525 --> 21:22.125
of the theoretical implication.

21:22.905 --> 21:26.325
So macro, unlike microeconomics, which is like a science,

21:26.455 --> 21:28.885
there is an inverse relationship between quantity,

21:29.205 --> 21:30.445
moderate enterprise, which is always,

21:30.985 --> 21:33.325
but when you talk about the macroeconomics, it's,

21:33.325 --> 21:34.845
it's not a science, it's the art

21:34.905 --> 21:37.525
of designing the policy given the country

21:37.795 --> 21:38.965
need and circumstances.

21:39.745 --> 21:42.365
So as I told you, some policy was successful.

21:42.625 --> 21:45.165
So for example, organic farming may be successful in a

21:45.165 --> 21:47.765
Scandinavian country, but may not be good at this point

21:47.765 --> 21:48.925
of time for SSRI Lanka.

21:49.425 --> 21:51.405
So then we have to look at what is the art

21:51.405 --> 21:54.645
of designing the policy, how monetary policy

21:54.665 --> 21:56.965
and policy, fiscal policy have to work together,

21:57.785 --> 22:00.325
how much we should depend on the external sector.

22:00.325 --> 22:03.445
Because for example, in case of China, when there was a,

22:03.625 --> 22:06.045
the currency was depreciating, there was an internal crisis,

22:06.855 --> 22:08.005
their face value

22:08.025 --> 22:11.205
of government born towards decreasing, like anything.

22:11.305 --> 22:12.845
So they become like junk paper

22:13.615 --> 22:16.705
because it's a huge external risk, currency risk.

22:17.285 --> 22:20.825
And their, the international bodies have downgraded,

22:20.835 --> 22:23.065
their rankings, the credit rankings.

22:23.765 --> 22:27.425
So that's why, what is the, what is the connection?

22:27.885 --> 22:30.825
So one is step taken by the government is very important.

22:30.885 --> 22:31.985
So government people might think,

22:32.065 --> 22:34.465
I might not be in the power, let's enjoy the revenue,

22:34.595 --> 22:38.705
let's exploit, but that create a spiral effect in future.

22:38.965 --> 22:40.865
And that's what happened in case of Sri Lanka.

22:41.325 --> 22:44.305
So yes, there's an implication in terms of crowding out role

22:44.305 --> 22:45.465
of saving an investment.

22:46.125 --> 22:48.065
So I would, take this example.

22:48.165 --> 22:50.385
So as I told you that there is a saving

22:50.565 --> 22:52.265
and consumption additive function

22:52.565 --> 22:54.505
and that both contributes in the income.

22:55.005 --> 22:56.705
So if a country saves, well,

22:57.405 --> 22:59.185
it affects their growth and investment.

22:59.325 --> 23:01.185
So let's take a case of Japan.

23:01.885 --> 23:05.545
So actually Japan is the most indebted country in the world.

23:05.845 --> 23:08.985
232% debt of the GDP.

23:09.485 --> 23:10.905
But we don't talk about Japan.

23:11.085 --> 23:14.105
Greece got failed because of the SSRI Lanka failed.

23:14.105 --> 23:16.065
But we, why we don't talk about Japan

23:16.215 --> 23:19.545
because most of the debt of Japan is internally financed,

23:19.895 --> 23:22.425
whereas in case of SSRI Lanka, it was financed heavily

23:22.685 --> 23:24.425
by China and Japan.

23:25.935 --> 23:28.755
So then, the role of saving is important.

23:28.855 --> 23:31.315
Why Japan, even though they are having high debt,

23:31.455 --> 23:33.315
is not an issue because they internal finance.

23:33.495 --> 23:35.915
Why the internal finance? Because people save a lot.

23:36.745 --> 23:38.395
Another good example of China.

23:39.295 --> 23:41.515
So people save a lot in case of China

23:41.515 --> 23:44.475
because of saving, they can always invest in bulk

23:44.475 --> 23:45.485
when they're investing.

23:45.545 --> 23:48.965
So if the savings are high, the cost of borrow will be low,

23:49.285 --> 23:51.565
interest rate is low, you can invest in your country

23:51.625 --> 23:53.645
and also you can go invest in other countries.

23:53.795 --> 23:56.045
What Japan is doing, so in case of China,

23:56.045 --> 23:59.845
they're actually investing in a mass way producing surplus.

23:59.905 --> 24:02.085
So they also export, not only they're exporting,

24:02.085 --> 24:05.605
they're exporting it a cheaper cost, cheaper prices

24:05.605 --> 24:07.645
because they're producing at a cheaper cost,

24:07.665 --> 24:08.685
the mass production.

24:09.105 --> 24:11.845
So this is the role of saving, the key role of saving.

24:12.345 --> 24:14.725
So there is a, there are economics radome,

24:14.815 --> 24:17.965
which has propagated of, a relationship between growth

24:17.985 --> 24:19.165
and saving and investment.

24:19.945 --> 24:23.685
So they say assume the capital efficiency in a country is

24:23.965 --> 24:26.085
constant growth become the function of saving rates.

24:27.425 --> 24:29.245
So that, that is again important.

24:29.345 --> 24:31.045
So it's not that you need not to consume,

24:31.045 --> 24:32.085
but there should be a balance.

Sri Lanka's Economic Journey Before Crisis

00:00:00 - I'm, currently associated with SPJ Institute of Management and Research, also known as S-P-J-I-M-R, located in Mumbai, India. So, Dr. Prita George and I, my co-author, and I have written this case around a year ago and later on, our case research published with Ivy Publishing. so starting, with the first question that where SSRI Lanka was standing before the crisis, so that is something interesting
00:00:33 - So if you look at the South Asian region, which comprises the developing economies like India, Bangladesh, Pakistan, ssri, Lanka, Mauritius, and few other countries. So, so they all are kind of emerging and developing, and especially if you take the case of SSRI Lanka. So first, let's take the geographical condition. So it has, has a very strategic condition in terms of trade. It is passing through the, various important sea roots.
00:01:09 - So it is rich in flora and fauna. And, so this is about the natural beauty and the geographical thing. Now, let's, let's look at the other part, which is more economic part. So that was also very good. It was, once upon a day, it was a high second highest larger, you know, exporter of tea in the world. It was, it was having second highest per capita income in the region in terms of purchasing per parity,
00:01:40 - which is around 0.7, on a scale of zero to one. So this is all about the good things of SSRI Lanka having a very young age population. 65% people are in young age, most of the population is English speaking. Literacy is almost full. And, and if I talk about the historical point of view, so that is the third aspect. So Sri Lanka, like the other countries, they have a very peaceful independence from the,
00:02:11 - After that, they were good on the, you know, restructuring part, though they adopted inward policy, but they were doing good. They focused on their natural capacity, the agriculture part, and also they've opened their economy. They have very high role of tourism in their GDP. It is around 12%. The SSRI lankans abroad have been very generous and he has a great share of remittances in the GDP. So these were all very good things about SSRI
00:02:43 - So now let's talk about a case. What is a case? Cases is something which has become an outlier. So having a journal positions, and suddenly it got reversed. So that's what happened in case of SSRI Lanka. So as I told you, they have very smooth transition of power from Indi, after independence, and they were doing good. I also highlighted few important factors, which was positive. The only major challenge they were facing was the LTTE, that is the militant group, liberation tigers of thermal.

Political Influence and Economic Decline in Sri Lanka

00:03:19 - So Raja Mahinda Raja, they have a very instrumental role in defeating this, militants. They were also sometime known in the country as terrorist group. And after that, they become hero. In 2009, they, they become victorious. So it was the war between the government where Gu Raja Pak and the Mahinda Raja Pak has an in very important role. On the other hand, it was this militant group.
00:03:48 - this particular group, which was quite violent. And after that, they become hero. So, they, after that, they were in par around two years, 20, 20 years, two decades, they ruled in the country. So they did some, some policy measures, but over the period of time they become corrupt. So the whole country was ruled by this family, the,
00:04:19 - And if you look at all the major ministries, primarily the six major ministries, finance, ministry, defense ministry, home ministry, were all there under their control. And in, if you look at in terms of economic numbers, the 70% of the budget of the country was under control of these, this family. So they were not as usual, they were not worry about the progress and the structural reforms, which was much required. They become correct. There was a inefficiency.
00:04:52 - and they spent heavily, and that led to the deficits in various years and accumulated the public debt, which, which during the crisis it was around 120% of the GTP. And now when, when the government is not accountable, and every time they're sure they're coming back in the park, they're not accountable to anyone. So they're spending heavily and adopting the populist policy.
00:05:20 - so usually I say the crisis around the world. Now the crisis of the economy is the failure of the government. Just look at the Greece crisis and the crisis. Similar thing happened in case of sing was the government failure. And so since they want to win the election, they want to come back in the park. So they, they did the populist measure. So for example, in 2019, they took a measure debate decision to, reduce the taxes
00:05:52 - They were spending heavily on the infrastructure projects. And those are like dirt investments because they were not helpful in generating the investment. So usually we say that, you know, in infrastructure investment is good, it is a capitalist in a capital infras, investment capitalist, expenditure. But macroeconomics is all about designing the policy. So one policy may be good in case of us in case of India,

Sri Lanka's Debt Crisis and Mismanagement

00:06:22 - So they did investment in infrastructure. They built a hamman tota airport and then hospital. But what they did, they choose the location, which was not good. So it was their hometown and there was no market. So this investment not helpful in generating my income to pay back the debt or, moreover to pay back the interest. So this was getting accumulated over the period of time. So this was the main reason. That is the internal debt that is known as fiscal debt.
00:06:57 - there was a huge problem from the external sector that is known as the capital account deficit. So that's what that case talk about, the twin deficit. So twin deficit is actually not a problem. Most of the countries, US has twin deficit. India has twin deficit. But when these two debts become unsustainable, then it led to the problems. And that's what happened in case of SSRI Lanka. So internal debt, I already explained. Let's talk about the external debt.
00:07:28 - rubber and textiles. So if you look at this kind of exports, initially it was good because it was agriculture production. They were having kind of competitive advantage. But when you look at such exports over the period of time in international market, they're not competitive. They have to face huge competition. They get low prices in the international market, they have low terms of trade, and then there is additional cost in the procurement and storage.
00:07:59 - they were earning well, but over the period of time they were losing their power and they have not much diversified. It's not that these are the few products, there were other parts, no. So they, they were, this, these products a huge role in the exports. And they were not diversified even though the condition was good because they was earning huge money from the ex, export of the services like tourism and remittances. But now what happened then on, in 2020
00:08:35 - One was the COVID-19, and what happened? The first thing got ha affected, which was, which was the service sector, and especially the tourism. So this bubble in terms of the government inefficiency, mismanagement, corruption, less structural reform, low diversi diversification, they all got burst during the first pandemic, the pandemic in 2020. So it was like adding fuel
00:09:06 - policy of fertilizer ban the chemical fertilizer and pesticide ban. Now, it was an overnight decision. There was not well thought behind it. So people were thinking, what is the reason behind that? So there, there was some saying the prime reason behind that, that they were facing huge challenges because in the international market, due to escalation of the Russo Ukrainian war, the energy prices were going up,

Sri Lanka's Economic Crisis and Structural Challenges

00:09:37 - So they were import bill was continuously increasing. And since they have imposed this policy and because they want to curtail the import of such thing, these was kind of easy to target, but it has an osi you know, outcome because they, they, they started having low cultivation because the country was not ready to move towards the organic farming. Okay? It requires a lot of effort. It, it'll go slow movement, slow productivity.
00:10:11 - for the exports for the agriculture related sector. So there was a two-way pressure in the international market. They were importing fuel, which was getting cost clear. And energy prices were high because of this policy. They were also from net exporter. They become net importer of the food and the other essential items like medicine. So there was the huge import of food, fuel and medicine. It was a one-way, pressure two-way pressure. They have not diversified this exports
00:10:41 - because people were not in a position to send the money back. They already, there's a lot of crisis in international market. So the external deficit got fueled earlier. It was also there, but it, you know, it was a sudden increase in that. So it's a two-way pressure. And then there's another interesting point in case of SSRI Lanka, that if you look at the, you know, population structure of the developing nations in South Asia region, they're consumption driven economy because the young population
00:11:11 - they're under a grow growth path, developing economy. So the same thing in case of SSRI Lanka. So usually income is the additive function of the consumption and saving. So in case of SSRI Lanka, they're also consumption driven economy. So they don't must save. So if they're not saving much, and from the same pool, everyone is in the, the economy is borrowing. And if government started borrow heavily, what happened? It'll crowd out private investment. Because first of all, saving pool is faced second,
00:11:44 - all the sectors in the economy are borrow from the same pool. So first, the savings will not be available. Second, if it is available, the borrow cost will increase. That is the high interest rates. So that particular phenomena is known as crowding out. So they were crowding out private investment. And even though since the deficit was too high, it was not sufficient. So then ultimately they were borrow heavily from the external market. So other pressure in terms of the interest rate payments and dollar denominated bonds, which led to,
00:12:19 - which were having continuous pressure on their currency and currency was depreciating. And now even though your euro, you know, in an absolute manner, your import bill may be constant, but in, in relative, when you convert in you because your currency is losing its value, it was con continuously skyrocketing. It was increasing. So these two deficits were the prime issue, which, which led this bubble burst and made the SSRI Lanka from the pearl of Indian nation

Crisis Management and Economic Reforms in Sri Lanka

00:12:50 - It's a major crisis. And you can see the zone of this crisis were, the seeds of this crisis were sewn way back. And this, this two blacks aren't even just stimulate that particular crisis. Now, obviously this cannot be sold in few days, few months now, now what to do? So we all have seen the television last year when all the whole, the big mob have attacked on the pre presidential houses. And, in May, 2021, then go
00:13:25 - there was again, revolt against him. So he stepped down, and then in July, 2022, he became the president. So ran Kuma, sang is continuously heading the country and trying to, get the country out of this crisis. So, and the good thing is that they got the bailout package from IMF because when re Senge joined in, May, 2022, I, I think it was March
00:13:58 - to, pay the import bill around 1 million and something and the immediate payment of, $2 billion, loan repayment, which was due in July. So this was the two immediate question in front of him. Now, if you look at again, SSRI Lanka was a very disciplined borrower. It was not at Srilanka, was not borrowing, but suddenly from the discipline borrower,
00:14:28 - And then they said, yes, we can't pay and they have to ask for help from IMF. And they got the 3 billion package and they got the two tran. So we were, you know, checking the news and we found that there was a delay in the second launch because they were not, very much successful in negotiating with China in terms of debt restructuring. So IMF recommended and they, they also tried to convince their borrower
00:14:58 - but China was reluctant about that. But there was some ways. And the second launch they got, now what are the immediate actions which they can. So they are two, two ways to look at the problem, remedial measures or the solution. What is the short term measure? Short term, medium term. And second is the long term. So reform will start from the internal part. The very first thing they have to reduce their unnecessary expenditure. So currently there's no need of infrastructure,
00:15:28 - And second, the, the transparency in the government expenditure, they have to adopt some fiscal austerity measures of fiscal, you know, discipline. They have to revoke their tax rebates, which they have given during the elections through which they can increase their revenue because that is the most important part. And just they need to look at it, how they can reduce the expenditure and increase the revenue so that they can bridge this gap. And that is also one of the requirements of IMM

Strategies for Economic Recovery and Transparency

00:16:00 - So what is primary self surplus revenue minus expenditure, having surplus, excluding the borrowing ex, excluding the interest payments. Because interest payment has always huge role because these countries are in debt trap, they were deficit, they borrowed, there was a debt, there is an interest payment to pay the interest they again borrow. So it's like a debt trap. So this is one thing. And how can they do that again? they can reduce the taxes. You, they have to reduce the subsidies.
00:16:31 - free electricity, free water. So they have to reduce this unnecessary subsidies. And there should be transparency because there's a lot of corruption. Now at this point of time, they cannot have any new taxes because people are still suffering and they're not yet on the recovery path. But they need to see that, how can they increase the tax base so that more people can contribute in the tax, you know,
00:17:00 - So what is the meaning that, that people who are avoiding and evasion their taxes made them accountable. So ensure transparency, reduced corruption. The first thing, second thing, their airline was a loss, which was under state control. It got bankrupt, so they have to sell it to the private sector. Second thing, reverse that policy of the fertilizer ban because they were doing good on agriculture front. And it's not good that the country has to depend on a general sector, especially for food
00:17:35 - So, the second thing is that to strengthen your sector, these are few medium term yes, increase the interest rate in the sense that they have to adopt the contractionary monetary policy. So recently in the news we have also written in the case, and recently it was in the news that they have some five days bank holiday to re restructure the monetary policy. So if they increase the interest rate, they can country curtail the inflation, which is very high.
00:18:04 - and fuel was around more than a hundred percent. So if they can increase the interest rate, they can attract the foreign investor. So then if you look at medium to long-term or long-term solution, you know, sell the estate enterprises to the private sector, privatization is the key, which in India we also adopted in 1991 because private sector is more efficient, more competitive. And if you do that, you would able to attract the foreign direct investment. And if you have good, financial sector,
00:18:37 - through the investment in the stock markets and the other capital markets. So these are the two way, because government is not efficient and government cannot control every sector and top of that government is facing huge deficits. So it's good now to involve the private sector. So it's another thing, the very important thing or the potential which the country has, which they have not utilized till now, is the highly educated English speaking population.

Maximizing Economic Growth in Sri Lanka

00:19:07 - they were not resilient towards the external shocks. But if just like India, you have huge exports of the services in terms of it, telecommunication and financial sector. So, so these three sectors interestingly have around 20% growth rate during the crisis where economy was facing minus 3.5% growth rate. So these sectors have huge potential internally, externally, so they should focus on this particular sector.
00:19:38 - they can go outside, they can work, they can, you know, invite ncss for the foreign foreign debt investment, there must be cheaper labor cost. First, I would like to start with why we have written this case. So as an economic instructor, especially when we teach macroeconomic student face difficulty, especially in the macroeconomic level, all things are connected. Just take the example of SSRI Lanka, everything was connected, the tax code, the government deficit, the external debt,
00:20:11 - So, in in macroeconomic framework, everything is connected and students sometimes face difficulty to understand the same. But when we bring the case, when, when bring such cases in the class, it enhance their interest, they contribute in the discussion. They sometime also do some extra, you know, readings, they watch videos, they, what happened later on. And they, and the takeaway is the concept concepts are clear
00:20:40 - So we, we enjoyed a lot while writing this case because this phenomena was quite burning, it was burning issue. And when we also, you know, discussed some other people we presented in u in a conference in us. So everyone was so excited about the case. And then when we also did before the publication, we did a pre-test. So we found very good opinion from the student. So the one purpose that we enjoy writing this case a lot, second, it's, it's helpful in learning that very complicated macroeconomic applied macroeconomic
00:21:12 - So these are the two motives through which we write. Now, if you want to conclude that, yes, there is a major takeaways from the case in terms of the theoretical implication. So macro, unlike microeconomics, which is like a science, there is an inverse relationship between quantity, moderate enterprise, which is always, but when you talk about the macroeconomics, it's, it's not a science, it's the art of designing the policy given the country need and circumstances.
00:21:42 - So for example, organic farming may be successful in a Scandinavian country, but may not be good at this point of time for SSRI Lanka. So then we have to look at what is the art of designing the policy, how monetary policy and policy, fiscal policy have to work together, how much we should depend on the external sector. Because for example, in case of China, when there was a, the currency was depreciating, there was an internal crisis, their face value of government born towards decreasing, like anything.

Government Actions Impact Economic Stability

00:22:13 - because it's a huge external risk, currency risk. And their, the international bodies have downgraded, their rankings, the credit rankings. So that's why, what is the, what is the connection? So one is step taken by the government is very important. So government people might think, I might not be in the power, let's enjoy the revenue, let's exploit, but that create a spiral effect in future. And that's what happened in case of Sri Lanka.
00:22:44 - of saving an investment. So I would, take this example. So as I told you that there is a saving and consumption additive function and that both contributes in the income. So if a country saves, well, it affects their growth and investment. So let's take a case of Japan. So actually Japan is the most indebted country in the world. 232% debt of the GDP. But we don't talk about Japan. Greece got failed because of the SSRI Lanka failed.
00:23:16 - because most of the debt of Japan is internally financed, whereas in case of SSRI Lanka, it was financed heavily by China and Japan. So then, the role of saving is important. Why Japan, even though they are having high debt, is not an issue because they internal finance. Why the internal finance? Because people save a lot. Another good example of China. So people save a lot in case of China because of saving, they can always invest in bulk
00:23:45 - So if the savings are high, the cost of borrow will be low, interest rate is low, you can invest in your country and also you can go invest in other countries. What Japan is doing, so in case of China, they're actually investing in a mass way producing surplus. So they also export, not only they're exporting, they're exporting it a cheaper cost, cheaper prices because they're producing at a cheaper cost, the mass production. So this is the role of saving, the key role of saving. So there is a, there are economics radome,
00:24:31 - and saving and investment. So they say assume the capital efficiency in a country is constant growth become the function of saving rates. So that, that is again important. So it's not that you need not to consume, but there should be a balance.

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