Tuk-tuk economy: Where algorithms meet asphalt

By Dhananath Fernando

Originally appeared on the Morning

In mainstream media, clashes between app-based ride-hailing taxis and traditional taxis are frequently reported, especially in tourist hotspots such as Kandy, Sigiriya, and even at the Bandaranaike International Airport. 

However, many Sri Lankans, including tuk-tuk drivers, do not fully understand the economic logic behind this. Often, the debate centres on high commissions taken by app companies or the notion that international ride-hailing platforms repatriate profits overseas.

At the ‘Ignite Growth Conference’ organised by the Advocata Institute, PickMe Founder Jiffry Zulfer shed light on the economic transformation driven by platforms like PickMe and its main competitor, Uber.

The core concept of ride-hailing apps is the ability to match demand and supply within a limited geographic radius in real-time. According to Zulfer, PickMe facilitates around 20 rides every second, striving to ensure that passengers always have a ride available and that drivers remain engaged and productive.

This matching of demand and supply has created significant market efficiency. On average, a driver using the app completes around 17 hires per day, compared to just 7-10 hires for a driver waiting at a tuk-tuk stand or roaming the streets. As a result, app-based drivers utilise their vehicles approximately 81% of the time, compared to just 39% for traditional drivers.

From an economic perspective, this availability of information – knowing who needs a ride and who can provide one – drives greater efficiency, not just for passengers and drivers, but for society at large as well. According to Zulfer, PickMe has covered over one billion passenger kilometres and now transports more people daily than Sri Lanka’s railway system.

Early investors in PickMe saw returns of up to 300 times their original investment, and it is likely the Government benefited as well, collecting around 30% in taxes. App-based drivers now earn on average 40% more than traditional taxi drivers, transforming the lives of 30-50% of tuk-tuk drivers in a population of 1.2 million tuk-tuk owners in Sri Lanka. 

In essence, the biggest beneficiaries of this shift have been ordinary working-class drivers, passengers, investors, and the Government.

PickMe is now listed on the Colombo Stock Exchange, opening the door for broader public investment and shared benefits.

It is crucial to recognise that when demand and supply are allowed to interact freely, it creates a win-win outcome for all stakeholders, unlike Government-run businesses, which often favour one group at the expense of others.

Zulfer also categorised tuk-tuk drivers into three groups based on their engagement: a large segment contributes less than three hours per day, a second tier less than six hours, and only a minority works full-time (over eight hours) through the platform. Interestingly, more women are now joining the platform, unlocking new income opportunities and increasing female participation in the workforce.

The PickMe Founder further explained that when adjusting for inflation, ride prices had decreased, providing passengers with real financial benefits beyond mere convenience. At the time of launch, the app’s per-kilometre rate was Rs. 33, compared to the Rs. 40 charged by traditional meter taxis. This holds true across other ride-hailing platforms as well. 

Unfortunately, many policymakers still struggle to grasp the fundamental economic principles at play – how market forces, when allowed to operate freely, can uplift the average citizen.

Ride-hailing services have since expanded into motorbike transport, courier services, and food delivery. These platforms are now among the largest ‘restaurant’ operators in the country, despite not owning a single restaurant. 

The same model has given rise to the ‘dark kitchen’ phenomenon, enabling home-cooked meals and micro-businesses to reach a wide customer base. This has changed food habits, offered consumers more choice, and encouraged families to spend more time together with the convenience of food delivery.

Zulfer’s economic logic applies beyond transportation. It holds true for other network-based platforms like Booking.com, Airbnb, and others. The average person, especially those with entrepreneurial spirit, stands to benefit the most.

In Sri Lanka, the majority of room inventory is offered by micro and small-scale lodge owners. Online platforms have empowered them to tap into the tourism ecosystem and earn foreign income, something that was previously out of reach.

Understanding the economic logic of network-based industries is crucial for Sri Lanka’s growth. These platforms enhance productivity, generate opportunities, and create wealth. While foreign direct investment and trade policy are important, we must also pay attention to the power of networking demand and supply.

Imagine a world where the same happens to our entire public transport system. Things will not be perfect, but they definitely would be in a much better form than it is at the moment.  

By simply enabling the right environment – often by not interfering – governments can allow these industries to flourish, driving economic efficiency, opportunity, and prosperity for all.

Meeting pricing equilibrium during the fuel crisis

(Source: Slide presented by PickMe Founder Jiffry Zulfer at the ‘Ignite Growth Conference’)

From Sri Lanka to Singapore

By Dhananath Fernando

Originally appeared on the Morning

A 100-year journey or a 40-year leap?

For many Sri Lankans, one of the most common points of comparison is Singapore. We have heard time and again how Singapore once lagged behind Sri Lanka in terms of GDP per capita but eventually surpassed not only Sri Lanka but also many other developing nations worldwide. 

Given that both countries are in Asia and that Singapore once looked to Sri Lanka as an aspirational model, it is natural for Sri Lankans to frequently draw comparisons between the two.

Recently, at the Advocata Institute’s ‘Ignite Growth Conference,’ Central Bank of Sri Lanka Assistant Governor Dr. Chandranath Amarasekara presented a slide illustrating how long it would actually take for Sri Lanka to reach Singapore’s current GDP per capita under different growth scenarios.

Dr. Amarasekara projected the timeframe based on Sri Lanka’s GDP per capita growth at 3%, 5%, 6%, and 8% annually. For context, GDP per capita is a commonly used measure to gauge a country’s economic prosperity. Currently, Sri Lanka’s GDP per capita stands at approximately $ 3,800, while Singapore’s is around $ 84,000.

The calculation estimates the number of years it would take for Sri Lanka’s GDP per capita to grow from $ 3,800 to $ 84,000, assuming compound annual growth at different rates:

• 3% growth rate: 105 years

• 5% growth rate: 64 years

• 6% growth rate: 54 years

• 8% growth rate: 41 years

The challenge of comparing Singapore and SL

In my view, comparing Singapore and Sri Lanka directly is difficult because the two nations offer entirely different value propositions. Singapore is essentially a city state with a population of six million, whereas Sri Lanka is over 3.5 times larger in terms of population. 

The demographics, political landscapes, and economic structures are vastly different. However, from an economic perspective, an average Singaporean is 21 times wealthier than an average Sri Lankan.

To put it in simple terms:

• Singapore, with just six million people, generates an economic output of $ 500 billion

• Sri Lanka, with 21 million people, produces less than $ 90 billion

Learning from Singapore without copying 

While it may not be meaningful to copy Singapore’s model outright due to fundamental differences in culture and circumstances, there are key economic principles Sri Lanka can adopt.

A rock-solid monetary framework

One of Singapore’s greatest strengths is its monetary stability. The country’s financial system remains robust thanks to sound economic policies developed under visionary leaders like Goh Keng Swee.

A stable currency is crucial because wealth is stored in the form of money. For example, if a farmer produces 100 kg of rice and sells it for Rs. 20,000, depositing that money in a bank means converting his labour into a universally accepted currency. If inflation erodes the value of that currency over time, it discourages productivity. A monetary system that fails to preserve value will ultimately undermine economic progress.

Many admire Singapore’s modern infrastructure, but what they often overlook is the country’s strong monetary foundation. Interestingly, the same Dr. Goh who helped shape Singapore’s economy also advised Sri Lanka, but his recommendations were never fully implemented.

The right policy framework

While reaching Singapore’s current economic level may seem like a monumental task, the key lies in laying the right policy framework. If the right economic policies are put in place, progress will follow naturally. It is not about chasing Singapore’s end results but rather about focusing on the right processes to achieve sustainable growth.

Instead of fixating on when Sri Lanka will become like Singapore, we should prioritise fundamental economic reforms in areas like trade, investment, and labour policies. If we get these right, the rest will take care of itself.

(Source: ‘Ignite Growth Conference’ presentation by Dr. Chandranath Amarasekara)

Bracing for Trump’s tariff storm

By Dhananath Fernando

Originally appeared on the Morning

US President Donald Trump’s second term seems to be keeping all people around the world on their toes. The changes and policies, along with their implications, will be complicated, and we have to do our homework to gain an advantage or at least survive in this game.

The new Trump administration has suggested reciprocal tariffs, meaning the same tariff rates applied to each country that they charge for US products. 

Already, a 10% tariff is in effect for non-energy products from Canada and a 25% tariff on energy-related products from Canada. Additionally, a 25% tariff has been imposed on Mexican products, alongside an additional 10% tariff on Chinese products, bringing the total tariff on Chinese products to 21% (from around 11% previously).

SL’s opportunities and challenges

Before Sri Lanka gets affected by any reciprocal tariff, we first need to understand our total exports, including services. 

According to Harvard’s Atlas of Economic Complexity, we export about 21% to the United States. When it comes to apparel, about 40% of our apparel exports are destined for the US. 

Accordingly, the first line of impact for Sri Lanka would be potential consumption contraction in the US. With high tariffs even against Canada, China, and Mexico, as well as increased prices of essential products, the US consumer will likely reduce spending on non-essential items such as seasonal clothing. It is normal consumer behaviour to postpone purchasing decisions if expenditure on essentials like energy and rent increases.

The second line of impact has both positives and negatives. China and Mexico also supply apparel to the US. If relative prices of Sri Lankan apparel become lower following the 25% tariff for Mexico, we might gain an advantage. 

Similarly, we could become more competitive than China, which now faces an overall 21% tariff. Therefore, we must be cautious and prepared, recognising it is not just tariffs on Sri Lanka directly but also tariffs on others that can bring us opportunities or challenges.

The danger lies in the final stage if the US imposes reciprocal tariffs. The US would consider imposing the same tariffs for Harmonised System (HS) codes as the other trading country imposes on US products. 

There is discussion that the US might not only consider customs duties but also other tariff barriers and even non-tariff barriers. In that case, Port and Aviation Levy (PAL), Commodity Export Subsidy Scheme (CESS), Social Security Contribution Levy (SSCL), and Value-Added Tax (VAT) might be considered, according to some reports. 

This decision depends entirely on the Office of the US Trade Representative (USTR) defining ‘unfair trade practices.’ Media reports indicate that the USTR is expected to analyse all data and make a decision on reciprocal tariffs by 1 April.

We must recognise that Sri Lanka’s average tariff rates are significantly higher than those proposed by the US to China, Mexico, and Canada. A 25% tariff in Sri Lanka is considered low, as our effective tariff rates reach nearly 100%, and for vehicles with excise duties, it exceeds 200%. It is joked that even Trump would become confused if he learnt about Sri Lanka’s tariff structures and that he might learn a tough lesson from us.

In the context of reciprocal tariffs, price-sensitive product categories such as food, apparel, and rubber products may face higher prices in US markets. Ultimately, the real impact will depend on how other competing export markets are affected by US tariffs and non-tariff barriers and how these affect US consumption and global economic growth under new trade dynamics.

Meanwhile, Europe and other powerful countries are targeting the US with reciprocal tariffs, which could trigger global supply chains to consider relocation and create new incentive structures. This can present either an opportunity or a disaster for Sri Lanka.

Solutions

To attract new supply chains and assembly components, we must quickly work on basic factor market reforms. Having adequate land ready for industry and a flexible labour force with business consciousness is essential. Secondly, simplifying and lowering our tariff structure is critical, even though it might be somewhat late. 

Additionally, exploring exports towards East Asia and the Indian market is increasingly vital. Whether our US market shrinks or not, we should prepare to explore other markets, primarily India and East Asian countries. Strengthening foreign relationships, activating business chambers, and intensifying diplomatic missions to strengthen ties is necessary. 

Accelerating regional free trade agreements and conducting market sentiment research can help Sri Lankan entrepreneurs expand their exports. Fundamentally, economics never expires – even during trade wars or crises, strong economic fundamentals provide the best way to survive and thrive. We must move from hope to action.

Where did Sri Lanka export all products to in 2022?

Source: Harvard Atlas of Economic Complexity

Where did Sri Lanka export textiles to in 2022?

Source: Harvard Atlas of Economic Complexity

NPP’s maiden Budget

By Dhananath Fernando

Originally appeared on the Morning

The National People’s Power’s (NPP) maiden Budget will be presented to Parliament tomorrow (17). Ideally, a budget should not contain surprises – neither on the income front nor on the expenditure front. Government expenditure is the real tax burden on people; they ultimately bear the cost through taxes, inflation, or both.

Generally, a budget consists of two key components. The first is revenue and expenditure, while the second is the policy direction of the Government. This time, the business community is particularly focused on the latter, as it is evident that income and expenditure must align with the International Monetary Fund (IMF) programme.

Adhering to IMF targets 

The 2025 Budget has no alternative but to adhere to the parameters set by the IMF. While micro-level details and specific projects may change, key indicators such as gross financing needs, Government revenue-to-GDP ratio, primary balance, and debt-to-GDP ratio must be maintained as agreed under the IMF programme.

Additionally, the previous Government introduced new legislation under the economic transformation framework, covering many of the IMF’s targets. Achieving a Government revenue target of 15.1% of GDP will be a major challenge. Value-Added Tax (VAT), corporate tax, and income tax have already reached their upper limits, leaving limited scope for further increases. The Government is likely to bridge part of the revenue gap through vehicle importation.

When governments face revenue shortfalls, ad hoc taxes or sudden tax increases are common, often targeting sin industries such as tobacco and alcohol. However, the Budget must adhere to sound tax principles, ensuring simplicity, transparency, neutrality, and stability. 

The focus should be on simplifying the tax system and improving the efficiency of tax administration, as poor administration is as harmful as a bad tax system. Any unexpected changes in revenue policies could harm businesses, erode investor confidence, and slow down the economy. The best way to achieve the 15.1% revenue target is through efficiency measures and broadening the tax base.

Over 50% of recurrent expenditure towards interest payments

Sri Lanka has little control over its expenditure, with over 50% of spending allocated to interest payments. In 2023, approximately 90% of tax revenue was spent on interest payments. 

Currently, Sri Lanka has one of the highest interest payment-to-revenue ratios in the world, raising concerns about the possibility of a second debt restructuring. Post-debt restructuring, the Government has minimal room for fiscal adjustments.

While Government employees and various sectors may expect relief packages, the reality is that there is no fiscal space to accommodate such demands. It is true that salary structures for senior Government positions need improvement to attract the right talent, but this can only be achieved by restructuring the lower levels of the public service, which absorb the bulk of the salary bill.

Another solution is to drive economic growth and increase labour force participation, reducing the proportion of Government employees relative to the total workforce. Blanket salary increments are difficult to implement without compromising capital expenditure, which is crucial for long-term development. 

Currently, 20% of recurrent expenditure is allocated to salaries and wages, while pensions account for approximately 8%. Given this context, expecting significant relief packages is unrealistic, and any attempt to provide them could lead to long-term economic instability.

Investment should prioritise healthcare, education, social protection

Government spending should prioritise critical sectors such as healthcare, education, and talent development. However, expenditure in these areas – including the ‘Aswesuma’ social safety net – was lower than expected last year. 

The IMF has pointed out that Sri Lanka did not fully allocate the funds intended for ‘Aswesuma,’ which serves as the primary social safety net for the country. Ensuring proper allocation to these essential sectors is crucial.

Focus should be on structural reforms

Rather than solely focusing on balancing income and expenditure, the Government should use the Budget as an opportunity to set a clear policy direction. 

Key areas requiring structural reforms include land policies, labour laws, the export sector, and energy markets. These reforms are fundamental to Sri Lanka’s economic growth, as the country’s challenges are largely structural rather than issue-specific.

We will have to wait until tomorrow to see the extent to which the Government seizes this opportunity. Instead of expecting widespread relief measures, the public should push for meaningful policy reforms – an essential step for securing Sri Lanka’s future

(Sources: CBSL, Advocata Research)

(Sources: CBSL, MOF Annual Report, Advocata Research)

The power of know-how over industry selection

By Dhananath Fernando

Originally appeared on the Morning

In most of our export strategies, the starting point has been the Government deciding which industries should drive exports – some of these decisions are data-driven. 

Accordingly, we examine current export figures and sometimes focus on expanding existing product segments. Secondly, we target additional industries with the expectation that exports can be boosted. While both approaches seem logical at first glance, we need to understand the broader framework of how to grow exports effectively.

Most of the time, we perceive exports as industry-specific, but in reality, exports are about know-how. Know-how becomes a product, and know-how makes a product competitive. However, know-how is not just knowledge – it is sometimes tangible, existing in tools, but more often, it is intangible. 

It is akin to Lasith Malinga’s bowling action and his ability to deliver pinpoint yorkers. We can analyse Malinga’s technique, attempt to replicate his action, and even learn from his strategies through interviews or YouTube videos. Yet, even with all this information, it is extremely difficult to replicate his unique skill set. 

Malinga possesses tangible components such as his slinging action, run-up, and release style, which can be considered tools. He also has knowledge that he shares through various platforms. However, his true know-how – what makes him exceptional – remains elusive, even to himself. 

This difficulty in transferring know-how is likely why the Mumbai Indians recruited Malinga both as a player and later as a coach in the Indian Premier League. If we consider Malinga as a product, he is export-competitive and his value lies in a combination of factors, primarily his unique know-how.

When a country seeks to expand exports, the know-how ecosystem is what determines success or failure. Our apparel manufacturers, for example, possess specialised knowledge that enables them to produce garments at the lowest cost while maintaining high quality. 

Initially, their products were relatively simple, but over time, they evolved in complexity. The industry experimented with various approaches – ethical garment production, lean manufacturing, and women’s empowerment – learning from both successes and failures to refine a sustainable model.

Today, Sri Lanka’s apparel exports are not merely about physical products but also the know-how that allows us to compete globally. Know-how thrives within an ecosystem that supports industries. 

For this to develop, the Government must provide entrepreneurs and businesses with the freedom to access and test resources – what economists refer to as factor markets. Land, labour, and capital must be available with minimal restrictions on a level playing field. 

This is why licensing requirements can be detrimental to exports; they obstruct access to essential resources, thereby stalling know-how development. For instance, if land acquisition is difficult, apparel firms may struggle to operate or innovate. Similarly, excessive labour regulations can increase operational costs, making products uncompetitive and disrupting the know-how ecosystem. Such obstacles discourage exports.

Another common discussion on boosting exports revolves around diversifying the export basket. To understand how diversification occurs, we can refer to Harvard’s Center for International Development, where Prof. Ricardo Hausmann uses the analogy of monkeys and trees in a forest.

In a forest, monkeys do not leap from one end to the other; they move from branch to branch. Similarly, export diversification does not occur in giant leaps but through adjacent product categories. Existing exporters and individuals within the know-how ecosystem expand into related fields. 

For instance, if we excel in gemstone exports, an adjacent category would be jewellery. This is why Government intervention in selecting export industries with large targets is often ineffective – diversification and expansion naturally occur within adjacent categories.

In making more complex products for export, Prof. Hausmann employs an economic theory likening diversification to a Scrabble board. If we have only three letters, our word combinations are limited. However, with four letters, the number of possible words increases exponentially. 

Therefore, minimising restrictions on factor markets – such as land and labour – enables more access to ‘letters,’ allowing for greater diversification.

Additionally, some ‘letters’ contribute significantly to forming words, like the letter ‘A,’ which is more versatile than a letter like ‘Z’. Similarly, removing barriers to factor markets increases the potential for new export combinations.

In Sri Lanka, our export strategy has traditionally relied on the Government selecting industries for growth. While this approach may work to some extent, if we seek rapid export expansion – like Vietnam – we must focus on the framework rather than forcefully pushing selected industries.

In today’s global economy, no country manufactures all its products on its own. Most nations produce parts, components, and assemblies, relying on international trade to complete final products. If we fail to open our economy to trade, our export ambitions will remain unfulfilled. Trade enhances competitiveness and provides access to multiple ‘letters’ at optimal costs.

Foreign Direct Investments (FDIs) are another crucial element in this equation. FDIs bring in individuals with specialised know-how, much like acquiring a player of Malinga’s calibre. They also introduce advanced technology, enabling the creation of more ‘letters’ and exponentially increasing the potential for new products over time.

If Sri Lanka is serious about exports, we need to focus on the process and the journey. We hope that the upcoming Budget will establish key milestones to guide us in the right direction.

Overcoming structural barriers to achieve export growth

By Dhananath Fernando

Originally appeared on the Morning

Sri Lanka has been trying to solve its export puzzle for a long time, with a new export target set at $ 36 billion by 2030. 

As of November 2024, the country had approximately $ 11.6 billion in merchandise exports and $ 3.1 billion in services exports, totalling around $ 16 billion. Over the next five years, exports are expected to double, requiring an annual compounded growth rate of approximately 14%.

Many policymakers define Sri Lanka’s export challenge as a lack of diversity in the export basket, limited access to international markets, or insufficient value addition. While these factors are valid, the core issue is that Sri Lanka is not competitive. 

This lack of competitiveness is not due to an inherent incapability but rather the result of policies and structural inefficiencies that have rendered the country uncompetitive. Often, this fundamental issue is misdiagnosed as a lack of targeting, leading to constant shifts in focus towards different sectors or products every three years without addressing the root causes of uncompetitiveness.

Addressing competitiveness 

Addressing public policy challenges is inherently complex, as solutions impact various stakeholders, making change management difficult. 

One of the primary mistakes governments and policymakers make is attempting to target specific sectors for export growth. Instead, focus should be placed on sectors where Sri Lanka has a competitive advantage. 

The only way to determine competitiveness is through practical application – by actively engaging in export activities rather than relying solely on theoretical projections. In the modern economy, competitive advantage extends beyond specific products to elements such as design, lead times, and supply chain efficiencies – factors that may not be immediately evident to a single decision-maker.

The global trade landscape is shifting from finished products to parts and components within value chains. However, when the Government plans around traditional industry categories, it often overlooks this evolving reality. 

For any product or component to be manufactured competitively, key resources – land, labour, capital, and entrepreneurship – must be accessible and efficient. Sri Lanka’s export underperformance, poor diversification, and lack of market access stem largely from bottlenecks in these factor markets. 

When essential factors of production do not function effectively, innovation stagnates, restricting export diversification and the development of components for various products, including value-added goods. 

If businesses can achieve higher margins through value addition, they would naturally do so. If they choose to export raw materials instead, it suggests the presence of barriers, misaligned incentives, or a competitive disadvantage in value-added production.

To illustrate this, consider the hypothetical case of exporting iron ore. A country rich in iron ore but burdened with high energy costs will find exporting raw ore more advantageous than converting it into steel. Conversely, a country with lower energy costs, proximity to industrial zones, and high steel demand will have a competitive advantage in steel production. 

This principle applies across all industries – cost structures, infrastructure, and resource availability dictate competitiveness.

A complex problem   

Compounding the problem is the interconnected nature of these issues. Solving one aspect alone will not fix the broader export challenge. 

In Sri Lanka’s case, high energy costs place any export industry at a price disadvantage. Subsidising energy is often proposed as a solution, but ultimately, taxpayers bear the cost. 

Similarly, labour costs remain high due to regulatory barriers. For instance, if a major tech company wanted to relocate its regional office to Sri Lanka, the country lacks an adequate pool of IT graduates. Addressing this would require either allowing foreign professionals to work in Sri Lanka or significantly upskilling the local workforce.

Export development also requires capital and entrepreneurship. Capital can be acquired through debt or equity, but debt financing is currently not a viable option for Sri Lanka. Equity investment remains possible, but attracting such investment necessitates improving Sri Lanka’s investment climate. This highlights the urgent need for reforms within the Board of Investment (BOI). 

Additionally, facilitating foreign entrepreneurs’ ability to enter Sri Lanka – through streamlined visa processes and work permits – is essential. The Department of Immigration and Emigration must play a role in this.

For capital to flow, investors require developed lands with ready-to-use infrastructure, minimising lead time and operational delays. Without addressing these factor market inefficiencies, traditional export strategies will continue to fail. The global export market is now highly fragmented, with the future lying in the production of components and participation in global value chains rather than focusing solely on finished products.

Ultimately, the export sector is too complex for any single individual or institution to plan entirely. It is an organic, competitive field where businesses strive to add value through quality and cost efficiency. 

The role of the Government should be to facilitate this process by removing barriers and creating an environment conducive to competition. If the right conditions are in place, export growth will naturally follow and Sri Lanka will achieve its ambitious targets.

Why economic reality matters more than honesty

By Dhananath Fernando

Originally appeared on the Morning

At least once a week, we find ourselves blaming corruption and criticising how corrupt our current and former leaders are.

Blaming dishonesty and corruption often suggests that honesty alone could solve all our problems. Honesty, integrity, and transparency are universal values that we must all uphold. However, these values alone cannot guarantee success, especially if we lack an understanding of economics and how the world truly works.

The world operates on incentives. People naturally prioritise their self-interest, even when their actions seem altruistic. A common mistake is believing that policies based on good intentions will always lead to good outcomes.

However, in economics and public policy, success is measured by consequences, not intentions. A well-meaning policy, even when created by an honest person, can have disastrous outcomes. Good intentions alone are not an excuse for poor results in economics.

Take the example of the rice, coconut, and egg markets in Sri Lanka. In the case of rice, many believe that a mafia of rice millers hoarding stocks is the root cause of the problem. To address this, price controls were imposed with the honest intention of lowering prices. Instead, this led to shortages in the rice market and the creation of a black market.

When rice imports were allowed, the landing cost was around Rs. 130 per kilo. It was assumed that traders would add a profit margin if the imports were sold without price controls, so a tariff of Rs. 65 was imposed to limit their earnings.

This, however, resulted in consumers paying an additional Rs. 65 per kilo at a time when approximately 25% of the population lives below the poverty line. This demonstrates how well-intentioned policies can backfire when basic economic principles, like how price controls create shortages and tariffs burden the poor, are ignored.

A classic example of unintended consequences is the subsidy for kerosene. The subsidy was introduced to provide an affordable fuel source for poor households. At the refinery level, kerosene is a byproduct closely related to jet fuel.

The subsidy made kerosene so cheap that it created excessive demand, prompting industries to convert boilers and heat-generating systems to run on kerosene. Even tuk-tuks and long-distance buses began mixing kerosene with fuel to cut costs and boost performance. Once again, good intentions resulted in undesirable consequences.

The maize market provides a similar example. To encourage local maize farmers, a licensing system and high tariffs were introduced. This policy led to inflated maize prices, which significantly impacted the poultry industry since maize is a primary ingredient in animal feed.

As feed costs soared, chicken and egg prices increased, driving up the cost of bakery items. At a time when 25% of the population lives in poverty, the policy intended to protect maize farmers ended up raising food prices for everyone, disproportionately affecting the poor.

Even in the coconut market, the story is no different. Coconut imports are prohibited, forcing domestic production to meet all demands, including those for coconut oil and other byproducts. If imports of specific varieties were allowed, the prime coconuts could be reserved for export, potentially increasing export revenue.

While transparency, honesty, and integrity are essential values, they are not substitutes for sound economic principles. Economics operates on incentives and consequences. In public policy, we must focus on outcomes rather than intentions. That’s why, in economics, honesty alone is not enough – it must be accompanied by an understanding of how systems work.

Rethinking tax policy in Sri Lanka

By Dhananath Fernando

Originally appeared on the Morning

• The case for adhering to tax principles

Many Sri Lankan budget speeches are essentially discussions on Government expenditure. Revenue proposals are often introduced piecemeal before the budget and frequently fail to align with basic principles of taxation. 

Under the current International Monetary Fund (IMF) programme, Sri Lanka has committed to achieving a revenue target of 15% of Gross Domestic Product (GDP) by 2025, increasing to 15.5% by 2026. Additionally, a primary balance target of 2.3% in 2025 must be met and maintained. 

While we have already exceeded the primary balance target, this achievement has come at the cost of cutting capital expenditure, which will likely impede long-term growth.

Tax revenue has met targets, primarily through record-high import tariffs collected at the border by Sri Lanka Customs, amounting to Rs. 1,500 billion. However, relying on such high border tariffs impacts both the cost of living and the cost of raw materials, adversely affecting exports and local production.

The need for adhering to tax principles

It is crucial that the Government prioritises adherence to fundamental principles of taxation when implementing revenue measures. Over-reliance on border taxes is not a sustainable strategy for achieving a higher tax-to-GDP ratio.

Why border taxes are problematic

Generating revenue through border taxes disproportionately affects importers, as they incur significant costs upfront, even before generating profits. In contrast, profit-based taxes are levied only after profits are realised, making them less burdensome from a cash flow perspective. The time value of money amplifies the impact of upfront border tariffs on profitability.

Sri Lanka’s import basket comprises approximately 80% intermediate and capital goods, with only 20% being consumer goods. Tariffs on these critical imports drive up production costs, ultimately increasing the price of exports and even domestic goods. For example, the Rs. 65 tariff on rice accounts for about 50% of its production cost, leading to a nationwide increase in meal costs by approximately the same margin.

A tax base built on three pillars

Globally, taxes are traditionally levied on three bases:

What you earn (e.g. income tax, corporate tax)

What you buy (e.g. Value-Added Tax, or VAT)

What you own (e.g. property tax)

Principles for an effective tax system

Simplicity: Taxes must be simple for taxpayers to understand and for authorities to collect and enforce. Overly complex tax structures with numerous thresholds lead to lower compliance, reduced revenue, and enforcement challenges. A standard and straightforward tax system is key to maximising efficiency and minimising leakage.

Transparency: Transparency in taxation fosters trust and reduces opportunities for corruption. For instance, Sri Lanka’s import tariff system, based on Harmonised System (HS) codes, lacks transparency due to its cascading structure. Similarly, ambiguities in income tax policies create doubts and complications. Transparency is especially critical for tariffs, which, even when necessary, must be clear and predictable.

Neutrality: Taxes should not create winners and losers by favouring or penalising specific industries, products, or sectors. For example, in 2015, Sri Lanka imposed taxes on profits from the previous year, undermining the fairness of the system. The primary purpose of taxation is revenue generation, not market distortion. Lowering tax rates can expand the tax base, ultimately increasing revenue and minimising evasion.

Stability: Tax rates should remain consistent over time to provide predictability for taxpayers. Frequent changes to tax rates, such as the numerous adjustments to VAT in Sri Lanka, create uncertainty, open avenues for corruption, and undermine economic stability. Temporary taxes and tax holidays should also be avoided to maintain consistency and fairness.

Taxes on property: A case for caution

Among all forms of taxation, taxes on property ownership are particularly burdensome. This is because taxpayers often have to forgo another revenue source to meet their property tax obligations. 

If a property generates income, that income is already taxed under income tax laws. Imposing an additional property tax not only constitutes double taxation but also discourages wealth creation. Such policies can deter investment and economic growth, undermining broader development objectives

Balancing revenue generation and expenditure

Sri Lanka urgently needs to increase tax revenue due to its high expenditure, particularly on interest payments, which account for approximately 50% of total expenditure. This is not repayment of debt but merely the cost of servicing bad debt. While room for expenditure cuts is limited due to the predominance of recurrent spending, hard restructuring is necessary to reduce this burden.

Although the Government has achieved a primary surplus by reducing capital expenditure, this strategy will have adverse long-term effects on growth. Therefore, adhering to fundamental tax principles is critical to improving Government revenue sustainably without jeopardising the country’s economic prospects.

Source: CBSL, Advocata research 

Source: CBSL, Advocata research 

Economics of tyre imports and import controls

By Dhananath Fernando

Originally appeared on the Morning

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

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

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

A deep dive into the tyre market

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

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

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

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

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

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

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

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

Supporting local production the right way

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

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

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

The problem with CESS and import tariffs

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

Debunking protectionist arguments

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

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

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

The tragedy of corruption through protectionism

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

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

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

The misguided USD savings argument

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

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

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

Mapping Sri Lanka’s growth strategy

By Dhananath Fernando

Originally appeared on the Morning

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Market-driven solutions for climate resilience

By Dhananath Fernando

Originally appeared on the Morning

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

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

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

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

Immediate vs. long-term solutions

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

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

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

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

Infrastructure and investment prioritisation

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

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

Catastrophe bonds

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

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

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

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

The role of insurance and data

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

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

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

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

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

Price Regulation on Three-Wheelers and School Vans: A Recipe for Transport Troubles

By Gurubaran Ravi & Chanul Singharachchige

Price is fundamental in determining the manner in which market forces influence both patterns of demand and the chains of supply. Price is a manifestation of what economist Adam Smith termed the ‘invisible hand’ which naturally allocates scarce resources in accordance with the laws of supply and demand and requires near zero intervention. The question now lies: what happens when this unneeded intervention is implemented regardless? By manufacturing limitations around prices, the government disrupts the natural balance between supply and demand. With the government planning to introduce a series of price controls on the three wheelers , school and office transportation sector - upon which almost all of us rely - it is worth revisiting what the adverse consequences of such an act can and will look like, how they will most definitely exacerbate already existing problems, and finally, prevent the economy from finding its own equilibrium.

Essentially, price controls entail putting restrictions as to how high or low prices can be set for a certain good or service via ‘price ceilings’ and ‘price floors’ respectively. Conceptually speaking, the implementation of price controls is often for a given purpose, whether it be to control inflation or protect consumers, the government simply tries to artificially balance distortions within the market creating a great deal of uncertainty in the economy itself.

However, not all that is expected to come into fruition in theory can be seen in the outcomes found in objective reality. For example, despite the immediate benefits price controls may provide, they distort the natural dynamics of the market leading to unintended consequences such as supply shortages, the reduction in the quality of goods and services, and the prevalence of underground black markets. This tends to be because producers struggle to cover the costs associated with providing products at pre-established prices. The ultimate harm done to both consumers and producers through the implementation of such regulation - though often well-intentioned - outweighs any temporary benefits that may be reaped. 

Now, let us take a closer look at what the landscape of how the transport market for three wheelers in Sri Lanka looks like and behaves. Nowadays, three-wheelers, school vans, and office vans have become integral parts of the Sri Lankan transportation system - especially with the deterioration of the public transportation system. The three-wheeler segment comprises a significant portion of Sri Lanka’s transport sector with more than 300,000 three-wheelers in operation. These vehicles have made it possible for millions of people to have their means of private transport for daily use, particularly in rural areas and other hard-to-reach places. In the backdrop of an economic crisis, where operating costs become extremely high, the proposed price regulation policy is likely to jeopardize this important service. Such regulation could reduce the number of providers as the financial pressure on operators rises, the availability of transport decreases, and transport fares rise. This impact would be most severely experienced in regions where choices of public transport are already few, possibly leaving many with no affordable means of transport. 

The transport sector for three-wheelers is also mainly composed of individual operators, but recently a few companies like PickMe and Uber have utterly revolutionized Sri Lanka's transport market. They have managed to heighten efficiency, promote route optimization, and enhance service quality, whilst simultaneously providing alternate employment opportunities for a vast and diverse array of people. However, any proposed regulations that stifle the freedom with which price can move will inevitably disrupt the market dynamics fostered by these platforms. Experts warn that such constraints will undermine the flexibility and efficiency of the sector, distort supply and demand, and potentially reverse the benefits of market-based pricing models. This could lead to diminished levels of availability of service, hindrances in the pace of innovation within the industry, and a rollback of the advancements made in respect to meeting needs of consumers - particularly those of low-income earners. 

The free market fosters levels of competition that incentivize providers to one-up one another at every opportunity. In the service-based industries - such as transport - this is best accomplished through the provision of high quality services at as low a price as possible in order to attract consumers. Therefore, if price controls are implemented on the three-wheeler, school,  and office transportation sectors, they stifle the capacity as well as the incentives that providers have to improve levels of flexibility and provide a variety of options to consumers, particularly affecting low-income individuals. These price controls also significantly enlarge an industries’ reaction time - and hence inefficiency- when making adjustments in respect to pricing and supply when faced with fluctuations in economic conditions such as shifts in the levels of inflation or a fuel crisis. Experts in the field have shared similar concerns, emphasizing the fact that while these regulations may be passed in order to provide temporary relief to a select few, they risk the destabilization of the entire market and jeopardize the efficiency of the entire market system.

However, it is impossible to turn a blind eye to the fact that there are certain factors that are crucial to these price controls. The government has to consider how it will be able to oversee and regulate thousands of independent operators across the country, especially in a sector that is as fragmented as the transport sector. The adoption of such regulations would likely require a high administrative cost, which would likely shift attention from other important sectors. Moreover, given the fact that the three-wheeler, school, and office transportation sectors are composed of many small participants, it remains doubtful whether such enforcement can be achieved in the first place. For instance, it may be hard to enforce compliance in rural regions and in urban regions with dissimilar levels of economic development. This may lead to a situation where only some or even a part of the controls are being implemented, thus aggravating and distorting the market more than it is at the moment. The efficiency of these measures is furthermore rather questionable, which leads to questions of whether or not these measures can be implemented without causing more problems than they are solving.

However, the three-wheeler, school, and office transportation sectors are far from the only sectors that have known the weight associated with the adverse consequences of price control implementation. It should be highlighted that LP gas, cement, bread, rice and eggs, have all been subject to similar limitations. These policies have frequently caused significant market distortions. In 2023, in order to combat a sharp rise in the prices of eggs, the Sri Lankan government made the decision to impose price controls on eggs. Despite this intervention aiming to resolve the dilemma, it instead devastated the industry and led to severe shortages in the supply chain with producers failing to sustain costs. The restrictions on LP gas and bread supplies appear to have influenced supply chain disruptions and market fluctuations. Moreover, there is news that cement may be the next to be affected by further price regulations, which will exacerbate the situation in the building and construction industry. Such stopgap regulations impair the normal functioning of free market economics, send misleading signals to actual price factors, and cause more instability in the economy, by providing only short-term relief while exacerbating long-term structural issues.

While the debate around price controls is critical, it raises a more significant question: The public transport system needs to be improved based on the government’s long-term vision of how it plans on fixing the system’s problems. While exercising the price control mechanism may give some relief to commuters and public transporters in the short run, it cannot address the structural issues that are inherent in the public transport system in Sri Lanka. The real solution is to create an integrated plan to upgrade public transport infrastructure and to improve service delivery so that the public transport system becomes the first choice of the transport user. In this regard, it would be possible for the government to ease the burden from the private transport sector, including three-wheelers and school vans, etc., and thereby develop a more balanced transport system. The provision of mass transit systems offers not only the purpose of decreasing reliance on private automobiles but also social justice, optimum resource utilization, and preservation of the earth.

On a more conclusive note, history teaches us a clear lesson: the fundamental importance of allowing prices to reflect supply and demand naturally simply cannot be understated and any intervention in this intricate relationship can have dire direct and indirect consequences.While interventions like price controls may provide temporary relief to a select few, they often just exacerbate already convoluted issues when considering the longer term.  A free market system is pivotal in order to maintain economic equilibrium where efficient resource allocation can be best fostered. In such a system, it is price that serves as the principle signal to guide both consumer and producer behavior. The self-regulating nature of this system not only promotes innovation and competition but helps mitigate market distortions that may arise from intervention or excess regulation.

Sri Lanka’s Productivity Push: Exploring Policy Pathways for the Proposed National Productivity Commission

By Tilani Jayawardhana

Why Does Productivity Matter for Sri Lanka?

Productivity is not just a technical measure of economic efficiency; it is fundamental to improving living standards, sustaining economic growth, and ensuring the long-term prosperity of society. Evaluating and enhancing the productive forces of the economy is crucial for informed policymaking, targeted investments, and achieving sustainable development. For Sri Lanka, focusing on productivity is key to overcoming economic challenges and realizing its potential in the global economy.

Sri Lanka should increase productivity across the economy if it wants to successfully compete in the global value chain. Improvement in productivity will reduce the costs and place the country in a better position to supply to the global markets at competitive prices. 

Productivity growth has to be a top priority of all the successive governments. Without productivity growth, the country’s production system, be it agriculture, industry, or services, will be displaced in the global system.  Therefore, the role of the NPC should be to ensure a data-driven approach to productivity in each sector, promote competition, and encourage international competitiveness. 

Sri Lanka’s productivity has to be built up through investments in physical capital stock, human capital and the diversity and dynamism of our industries. To ignite productivity growth, new business investment and workforce capabilities will need to improve in ways that respond to the changing shape and nature of the economy. Investments in physical capital are expected to continue to drive Sri Lanka’s productivity potential. International evidence shows that about two-thirds of labour productivity growth since the early 1970s has been due to capital deepening. This is because when the amount and quality of capital available to workers increases, they are generally able to produce more per hour worked. As the industrial mix changes, investment in growing industries and effective adoption of new technologies, including digital technologies, will be essential.

The productivity challenges and opportunities that we will face in the future will be different to what we have seen in the past. Improving productivity in the large and growing services sector will be increasingly important, as it will have an outsized impact on Sri Lanka’s overall productivity outcome. Country’s productivity agenda needs to respond to current economic circumstances and identify modern strategies to advance enduring policy goals.

Rationale in establishing the National Productivity Commission (NPC)

An economy’s ability to use labour, capital and other resources efficiently is the essence of productivity and it is when this efficiency increases a country’s economy would expand. In a bid to revive the country’s struggling economy, Sri Lanka has implemented a comprehensive economic reforms agenda. The government has initiated several key recovery strategies, with the establishment of a National Productivity Commission (NPC) being a flagship project under the Economic Transformation Bill. The proposed NPC is expected to help address the productivity enhancement needs of the domestic industrial sector as they are struggling to come out of the economic crisis and exposed to greater international competition. The government of Sri Lanka has taken this correct step forward and acknowledged that higher productivity growth has the advantage of raising average living standards by increasing GDP per capita. 

Productivity growth is an important aspect of economic and social development of a country. Moreover, increasing productivity enhances competitiveness, making it a crucial factor in attracting foreign investments and boosting international trade. Productivity drives economic growth and helps realize improved living standards. 

Though Sri Lanka’s output structure shows a shift to services (with an average share of 59.2% during 2016–2022) and away from agriculture (8.5%), a large share of the employed are still in agriculture (26.4%), where productivity is about 31% of the national average. Furthermore, its manufacturing sector—a sector widely regarded as one that can gainfully employ semiskilled workers—lags in labor productivity. Though Sri Lanka’s manufacturing labor productivity is one of South Asia’s highest, it is roughly half of that in the Philippines and Thailand, and about one-third of that in Malaysia and the People’s Republic of China (ADB Country Partnership Strategy: Sri Lanka, 2024–2028).

Sri Lanka's aging population presents a significant challenge to sustaining high economic growth, while boosting productivity is the key solution to overcoming this hurdle. Sri Lanka is “growing old” before becoming “rich” and thereby there is an urgent need in preparing for an aging society that will require increasing labor force participation and productivity of the workforce. Productivity improvements can offset the economic impacts of a shrinking workforce by enabling the remaining labor force to produce more. This is crucial for sustaining economic growth in the face of demographic challenges. Therefore, establishment of the NPC is a clear step forward in the correct direction. 

Overview of the Proposed NPC

The broad objective of the proposed NPC is to promote economic growth through increased productivity for the improvement of wellbeing of people in a sustainable manner. The NPC will be an independent body which is accountable to Parliament. 

The main duties and functions of the NPC shall be to: 

• Make recommendations to the relevant authorities based on evidence and comprehensive analysis in order to increase productivity and economic performance by; streamlining regulation of productivity, promoting healthy competition and contestable markets, catalysing structural transformation and encouraging international competitiveness

• Make recommendations to the Government on introducing a national competition policy and advise on subsequent revisions as needed from time to time

• Conduct public inquiries and evidence-based research on issues related to productivity, either in-house or contracted out, and disclose the methodologies used for such inquiry or research

• Carry out, performance, monitoring, evaluation and benchmarking on the productivity

• Report annually to Parliament on the productivity trends within the first four months of the following year

• Advocate on the need for productivity improvement 

Although the objectives of the NPC cover a wide range of responsibilities, from streamlining regulation to promoting competition and international competitiveness, this broad scope might dilute the focus and effectiveness of the NPC. It is important to narrow the focus to specific, high-impact areas initially, such as catalyzing structural transformation or enhancing international competitiveness. Clear prioritization of tasks could improve the efficiency and outcomes of the commission’s work. NPC’s work and policy orientation should address the country's on-going productivity issues, it also should carry a longer-term perspective in achieving the development goals of the country.

In addition, conducting inquiries and evidence-based research in-house might lead to biased outcomes, especially if the NPC faces political or administrative pressures. This issue can be resolved through the establishment of an independent research unit within the NPC with a clear mandate. 

NPC should Advocate for the development of standardized productivity metrics and benchmarks, perhaps aligned with international best practices to facilitate performance monitoring, evaluation and benchmarking. 

It is also important to have within the NPC mandate to promote public advocacy and engagement. The mandate to advocate for productivity improvement is broad, and without a clear strategy, these efforts might not reach the right audience or create the desired impact. Development of a targeted communication and advocacy strategy that includes specific campaigns for different sectors, public education initiatives, and collaboration with media and civil society to raise awareness should be taken into consideration.

Concerns on the proposed NPC and some policy recommendations

• The process of appointing the chairman and five members to the NPC is under presidential authority, which raises concerns about potential political interference and the practicality of the level of independence of the commission. Even if the commission operates under an independent entity, the inherent structure would not warrant it to operate at arm’s-length from politicians and other public agencies. 

• The two core features of the NPC has to be its transparency and its economy-wide perspective. The commission’s activities should encompass all levels of government and all sectors of the economy, with the core values of independence, transparency and community-wide perspective, including social and environmental aspects. 

• The NPC should have permanent staff that has the capacity to evaluate all aspects of the public sector operational activities with special emphasis on macroeconomics and competition policy. Their work should be overseen by independent commissioners appointed for a fixed term. 

• The NPC must be geared to contributing by providing quality, independent advice and information to the government, and on the communication of ideas and analysis. - The commission ideally should be an agency of the Government of Sri Lanka, located within the
  Treasury portfolio, covering all levels of government and encompass all sectors of the economy, as well as social and environmental issues 

• National performance monitoring system has to be based on the Total Factor Productivity (TFP). TFP is referred to as the productivity measure involving all factors of production. Most often productivity measurement is based on Partial Factor Productivity, where one or more outputs are measured relative to one particular input (eg. Labour productivity is a ratio of output to labour input). Therefore, unlike labour productivity (or capital productivity), which considers only the labour input (or capital input), TFP is a comprehensive measure of productivity. TFP is usually calculated as the ratio of the total output to the combined inputs of labor and capital. Partial productivity measures are widely used as they are simple to calculate. However, partial factor productivity should be interpreted with caution.  

Regulatory Power of the NPC.The NPC’s mandate to "streamline regulation" and "promote healthy competition" might be limited if the commission does not have sufficient authority to enforce its recommendations. Without enforcement powers, the NPC could become merely an advisory body, with its recommendations being ignored or delayed by the government.

How Trade Restrictions are Inflating Urban Housing Costs in Sri Lanka

By Ashanthi Abayasekara and Yasmin Raji

A glance at Colombo’s (and suburban) housing prices will quickly establish that buying or renting a house is expensive for a vast majority of Sri Lankans. Advocata Institute in a study found that 70% of Sri Lankans cannot afford to own even a basic 500 square foot house in their lifetime. But what is driving up urban housing prices making house ownership unaffordable?

A recent study by Advocata Institute on the ‘Impact of Anti-Competitive Practices in the Construction Industry on Affordable Housing in Urban Sri Lanka’, reveals that urban housing prices are inflated partly due to restrictive trade policies and anti-competitive practices in the markets for housing construction materials.

The study examined the tiles, cement, and aluminum markets, all essential inputs in urban housing construction. These industries were found to be highly concentrated, with few firms involved. Barriers to entry are high due to substantial capital requirements and the need for economies of scale, which new entrants cannot afford. Additionally, market players benefit from significant trade protection through high import tariffs, cementing the dominance of domestic players.

In the case of domestically produced cement, the raw material used in the production of cement, clinker, has been subjected to a cumulative tariff ranging between 16% and 25% from 2014 to 2022. In comparison, importers of bulk and bag cement—the direct competitors of domestic manufacturers—have faced an additional para tariff of CESS consistently over the same period, ranging between 8% and 14%. This put cumulative tariffs for bulk and bag importers significantly higher than for clinker importers, ranging between 27.5% - 38.5% and 26% - 32.5% for bulk and bag cement importers respectively..

Figure 1: Changes to quantity of cement imported, prices, and tariff structures

A similar situation can be observed in the tile market, where imported tiles have been subjected to a total tariff rate ranging between 79% and 89.5% from 2013 to 2022 while tile raw materials were only subjected to a VAT of 8%. This discrepancy in tariff rates creates an uneven playing field, giving domestic manufacturers an unfair advantage over their importing counterparts. 

In addition to the high border tariffs, quantity restrictions have also been utilized to curtail imports. This was predominantly observed in the sweeping import restrictions imposed in April 2020 owing to the foreign exchange shortage prevailing at the time. This saw the quantity of bag cement imported reducing by 65% and tiles reducing by 87%. While most of these restrictions were placed as an attempt to conserve foreign exchange during the forex crisis, the inconsistent way in which these policies have been implemented has disproportionately benefited the larger domestic players in the markets. 

Apart from its implications on the producers and importers of construction materials, the high border tariffs coupled with import suspensions (protectionist trade policies) have resulted in a limited supply of construction materials available for customers, not only limiting their choices but more importantly, driving up the prices of goods exponentially. For example, high tariffs and import restrictions in the tile market led to customers being subjected to price increases of 93%-123% by August 2022 compared to April 2020. Customers also reported waiting times of over a year to receive the goods. 

So how does all of this impact housing affordability? With rising prices of construction materials due to these protectionist trade policies and the lack of competition in the domestic market, the cost of constructing a house has also seen a significant increase over the years, making it unaffordable to a vast majority of Sri Lankans. 

Given these impacts on necessities like housing, the corrective action would be to abolish tariffs altogether as soon as possible, and boost competition in construction material materials. However, due to Sri Lanka’s constrained fiscal space, reducing tariffs and removing trade restrictions should be done gradually. This approach will steadily increase the import of these goods, boost their supply, gradually drive down prices, and ultimately minimize housing affordability issues.

A new era or more turbulence?

By Dhananath Fernando

Originally appeared on the Morning

• The challenges facing Sri Lanka’s next president

The Presidential Election has been announced. Ideally, by 22 September, there will be a new president with a new mandate from the people.

Sustaining power will be more difficult than winning the election. Generally, from the very first day after assuming office, things start to fall apart. This will be the first election after the ‘Aragalaya,’ and we do not know the ground reality.

The last power transition wasn’t smooth. While there was a democratic element in appointing the eighth President after the resignation of the former, that episode had many dark elements, including a massive economic contraction and impact on human lives.

Focus on economics and corruption

Previous elections had a national element, but this time the focus is completely on economics and corruption. The good news is that the path forward is well defined, including macro targets. The International Monetary Fund (IMF) Governance Diagnostic has provided the main reforms needed to curtail corruption, with timelines and responsible institutions. Most of these are non-controversial.

This time, all candidates will also have to declare their assets electronically. We, as the people, should demand that the Commission to Investigate Allegations of Bribery or Corruption (CIABOC) enforces this.

The new president must deliver on anti-corruption promises because the demands of the ‘Aragalaya’ have not been met yet. However, some promises, like recovering assets overseas, are not easy to execute. Therefore, delivering on the anti-corruption sentiment is challenging.

Delivering on the economic front is equally tough. After debt restructuring, our interest rates will likely remain high. When interest rates are high, the cost of capital is higher, slowing down investment.

For instance, buying a computer to automate manual work becomes difficult when money is hard to source due to high interest rates. As a result, our economy will not grow. If the economy is slow to grow, it invites another crisis. Simply put, if the economy doesn’t grow, our debt will not be sustainable.

In other words, if the economy is slow to grow, it indicates that we are heading towards another debt crisis. The next leader must ensure both growth and stability.

The second piece of good news is that we at least have an idea of what targets we need to achieve on the economic front. Our debt-to-GDP ratio must gradually come down to 95% and our revenue must increase by improving our tax net.

Many promises about increasing Government sector salaries and public sector expenditure are good, but will be difficult to keep.

Limited options

In this context, there are two limited options available to increase money and productivity.

The first is improving productivity in what we already do. Simply working harder and putting in more effort can help. For example, reducing the number of holidays by 10% should increase the economy’s momentum because people will work more. But this race cannot be won solely by working harder. We must also look into channels for improving productivity without capital investments.

One such area is opening up business ventures that change the business format. For example, app-based taxi companies have significantly improved the productivity of both passengers and drivers by connecting potential riders with drivers. Companies like Booking.com connect tourists looking for lodging with small-scale lodging options.

Changing the business model has increased income for many people, reduced expenditure for many, and decreased waiting times, increasing overall productivity. The new leader must leverage this productivity lever.

The second option is to reform State-Owned Enterprises (SOEs) to attract capital. Allowing SOEs to undergo privatisation and Public-Private Partnerships (PPPs) can attract capital through investments. Additionally, rather than incurring losses, private entities can generate revenue for the Government through taxes and improve productivity.

The third option is to release land to improve productivity and circulate capital. Providing land ownership to people allows them to use it as security to unleash capital from the banking system, improving productivity.

Beyond these three options, any president will have limited choices. Relying on geopolitical powers in a highly volatile geopolitical environment may also be unfeasible.

Therefore, the challenge for the new president extends beyond getting elected. The real challenge is navigating the period after the election, which will undoubtedly be tougher than getting elected.

Delaying elections threatens political and economic stability

By Dhananath Fernando

Originally appeared on the Morning

Whenever there is an election, there is always a conversation about delaying it. Already, Provincial Council Elections and Local Government Elections have been delayed. This was the case in 2004/2005 and again in 2019.

One rationale is that, having just achieved stability after a massive economic crisis, we need more time to complete some structural reforms and ensure political stability. On the flip side, how can we execute any reform without the mandate of the people? Operating without the people’s mandate means political stability is the first thing to go out the window.

After the resignation of the former President, the process of appointing a new President followed a democratic process. While it may not have been perfect, there was a democratic element involved. Political parties with a mandate from the people were able to contest, and the candidate who could command a majority of confidence through votes was given the responsibility to lead the country for the remaining term of the previous President.

Despite its flaws, this democratic element brought political stability, which led to economic stability. With the President’s support from Parliament, it was possible to enter into an agreement with the International Monetary Fund (IMF) and continue discussions with external and internal creditors for debt restructuring. The political stability that came through the democratic element in the power transition process made it possible to achieve some level of economic stability.

Uncertainty and economic growth

However, the same democratic process has clear guidelines on the expiry time of the mandate. If we do not follow this process, the system that brought stability will push us towards instability again.

Delaying or attempting to delay elections often prompts political parties and their supporters to demand elections, creating instability as people seek to test the mandate of the public. Delaying an election in the hope of completing unfinished reforms rarely works as planned.

Moreover, postponing elections increases uncertainty. Even holding an election carries some uncertainty, but postponing it intensifies this uncertainty. The biggest enemy of any economic development is uncertainty.

After debt restructuring, the only way out for the country is economic growth. According to agreements with bondholders, we start repaying our interest from September onwards. A year of uncertainty will hinder even the small growth potential we have.

For economic growth, we need investments, and in an uncertain economic environment, attracting investments will be difficult. Falling behind our growth targets due to political uncertainty will challenge our debt repayments and credit rating updates.

International support may not be as easy to secure if the legitimacy of the Government is questioned over a delayed national election. It is true that elections themselves have an element of uncertainty. Especially post-Presidential Elections, if Parliamentary Elections result in fragmented party compositions, we risk returning to a scenario similar to President Chandrika Bandaranaike Kumaratunga’s era, with a Coalition Government barely holding a majority.

Passing bills during a time when growth and structural reforms are needed could face resistance and pushback, leading to maintaining the status quo rather than shifting gears for growth and development.

Having a majority or even two-thirds power does not guarantee that all decisions will be right or fast. As we witnessed, a two-thirds majority Government was short-lived due to misguided economic policies. However, a diluted majority will also bring instability and frequent power changes, causing things to go back and forth.

The solution: A common reform programme

If we think about the country and the people, the only solution is a common minimum reform programme where parties agree on a baseline level of reforms. This ensures that regardless of who comes to power, progress continues. The common minimum programme can start with implementing the IMF Governance Diagnostic, which has recommended significant structural reforms for fiscal, monetary, anti-corruption, and State-Owned Enterprise (SOE) sectors.

If we can at least implement the IMF Governance Diagnostic Report as a common minimum programme, even in case of a drift, it will be slow. Delaying elections, however, will accelerate the drift and slow down existing reforms and growth.

The real challenge will be for whoever comes to power next. If the next government cannot drive economic growth through improving productivity, investment, and efficiency, another collapse is inevitable. A common agreement on reforms is required because the common people care less about who rules the country and more about how their future and standard of living will improve.

Bouquets and brickbats for Economic Transformation Bill

By Dhananath Fernando

Originally appeared on the Morning

We all agree that Sri Lanka’s economy requires transformation. Can we transform an economy solely through an Economic Transformation Bill? No. Can we do it without a bill, without a proper legal framework and institutional structure? Again, the answer is a definite no.

Overall, the bill essentially unbundles the Board of Investment (BOI) into three main parts: establishing a powerful Economic Commission to decide and drive investment strategy at a national level, improving the investment climate for investors, and setting up Invest Sri Lanka to attract investors.

The current zones managed under the BOI have been transferred to a new organisation, with options for establishing industrial zones in collaboration with the private sector. This aims to resolve land issues and improve facilities for investors. The new institution is focused purely on trade agreements and economic integration with global supply chains.

A Productivity Commission, modelled after Australia’s, is proposed to enhance market efficiency and prevent anti-competitive practices. Lastly, a type of Government think tank is proposed to provide research services and analytics on trade and investment.

The bill also appears to compile six ideas into one comprehensive piece of legislation. Incorporating debt-to-GDP ratio targets, export-to-GDP ratio targets, and gross financing needs expectations seems to be another objective, as outlined in the preamble.

Risk of political interference

On the flip side, the appointment of members for the Economic Commission and other institutions falls directly under the president’s purview. In instances where the president is also the minister of finance, significant economic powers are concentrated in the hands of a single individual. Given that the majority of members can be appointed by the president, there is a significant risk of political interference in the business and investment climate.

We can set up numerous institutions, but real reform and transformation occur not when the bill is passed but rather when capable individuals drive real change. If we have flawed provisions for the appointment of members to the Economic Commission and other institutions, allowing for political interference, we risk creating another ineffective BOI.

Ideally, appointments should be nominated or approved by the Constitutional Council (CC). Additionally, representation from professional bodies such as the Institute of Chartered Accountants of Sri Lanka (CA Sri Lanka) could ensure adherence to ethical standards.

Steps in the right direction

The new bill proposes six key institutions:

Economic Commission (EC)

Invest Sri Lanka (Invest SL)

Zones Sri Lanka (Zones SL)

National Productivity Commission (NPC)

Office for International Trade (OIT)

Sri Lanka Institute of Economics and International Trade (SIEIT)

The idea of establishing a separate entity to manage investment zones is a step in the right direction. A 2018 study by the Harvard Center for International Development revealed that 95% of BOI investment zones were occupied and investors had identified land availability as a constraint.

Rather than having the BOI run industrial zones, there are many private sector players who can provide better services to investors. Zones SL should collaborate with the private sector to open new zones, providing infrastructure as landlords rather than managing the zones themselves.

The Productivity Commission is another positive policy step, provided it is implemented correctly. Its role should be to ensure a data-driven approach to productivity in each sector, promote competition, and encourage international competitiveness.

The commission should work with industry experts, as productivity expertise varies by sector. Australia’s experience with its Productivity Commission demonstrates the importance of maintaining focus on competition and avoiding mission drift, as seen with the Consumer Affairs Authority, which has deviated from its original purpose.

The OIT aims to address the lack of capacity in trade negotiations. The bill’s overall concept targets structural issues that hinder exports and Foreign Direct Investments (FDIs). However, it does not guarantee the intentions of politicians or ensure that everything will improve after the passage of the bill. The appointment process and selection of competent individuals for committees are crucial.

Implementation challenges

The key challenge for Sri Lanka will be execution. A large government with poor capacity is likely to result in political appointees populating these commissions, given the current appointment structure and salary scales. There is little incentive for qualified individuals to join at the current salaries offered.

Moreover, the Government lacks the capacity to offer higher salaries, and doing so for one segment could lead to demands for salary increases across the board or protests during a politically sensitive period. Phased reforms to reduce the State’s workforce are necessary to improve State capacity and manage these institutions effectively.

When the BOI was established, it was intended to be a one-stop shop for investors. However, it has become another bureaucratic hurdle. We risk repeating this mistake with all six proposed institutions if the wrong individuals are appointed. Conceptually, the policy is in the right direction, but its success depends on the implementation and the people driving it.

Nearing debt negotiation deal amid economic uncertainty

By Dhananath Fernando

Originally appeared on the Morning

Sri Lanka is hopeful that we can reach a debt negotiation before the first half of the year. Many are focused on the potential for reductions in principal and interest rates or extensions of debt maturities.

According to a recent update from the Ministry of Finance, we are yet to finalise a settlement with our bondholders, although we are close to an agreement. The Internal Rate of Return (IRR) for the Sri Lankan Government’s proposal is about 9.7%, while the bondholders’ proposal is 11.51%. The total cash outflow according to the bondholder proposal for 2024-2028 is approximately $ 16.6 billion, compared to $ 14.7 billion for the Government’s proposal. Ideally, we should reach a settlement close to the Government’s proposal if all goes well.

Both the initial and revised proposals indicate that bondholders are reluctant to reduce the interest accrued during the suspension of debt repayments. In both proposals, there have been no haircuts on $ 1,678 million of accumulated interest. Only a 4% interest rate has been proposed for 2024-2028.

Bondholders have suggested a 28% reduction on existing bonds, reducing the total bond value from $ 12,550 million to $ 9,036 million. Both parties appreciate the depth of the haircut, particularly with respect to economic growth. These adjustments depend heavily on adhering to the International Monetary Fund’s (IMF) baseline projections. If we fail to achieve the necessary growth rates, we will receive a deeper concession, and vice versa.

Achieving the best debt restructuring plan for Sri Lanka is crucial and our future hinges on economic growth. The debt level must be compared with the size and growth of the economy because only growth can ensure our ability to repay our debt. Our debt sustainability can only be secured through high growth rates, not solely through the debt relief offered by bondholders.

Economic and governance reforms are essential for growth. Notably, bondholders have proposed an innovative idea called Governance-Linked Bonds (GLB), where Sri Lanka would receive an additional benefit of 50 basis points on two selected bonds, each worth $ 800 million, if we implement two key governance reforms – one qualitative and one quantitative. The quantitative target is to reach a 14% tax-to-GDP ratio in 2026 and 14.1% in 2027.

A list of qualitative targets primarily focuses on publishing procurement contracts and tax exemptions, both of which are included in the IMF Staff-Level Agreement. However, the governance linked bonds, according to the proposal, would only apply to two bonds maturing in 2034 and 2035, each worth about $ 800 million.

While GLBs are an excellent idea, it is questionable whether the incentive is sufficient to encourage a strong governance programme. The savings from a 50 basis point cut in interest for $ 1,600 million would be about $ 80 million. Given that our accumulated interest is also about $ 1,600 million, there is a risk that governments could easily deviate.

Nevertheless, GLBs would send a strong signal to the market that the Sri Lankan administration is committed to governance reforms, which would enhance confidence in Sri Lanka.

Sri Lanka’s real challenge is avoiding a second debt restructuring. We can only achieve this by taking necessary steps and reforms to grow the economy, not solely relying on debt restructuring agreements.

Even if we secure a 30% haircut, our debt-to-GDP ratio in 2032 would still be approximately 95%. Over 50% of countries that have undergone a first debt restructuring have experienced a second. In Sri Lanka’s case, a second debt restructuring would be extremely painful for the population.

Moreover, our interest rates must remain high to meet the Government’s debt servicing requirements, attracting more funds. However, high interest rates discourage investment as people prefer to deposit their money in banks, leading to a low investment environment that could slow down growth. This slowdown would bring us back to the challenge of managing debt sustainability. This vicious cycle must be avoided.

Growth can only be achieved through improved productivity in a competitive environment, which arises when people are incentivised to perform. When the State dominates business and we try to manage everything independently, people do not become competitive.

Ultimately, growth is the only viable solution. Sadly, it is the only solution. Growth occurs when markets function effectively.

Beyond profit margins and scandals

By Dhananath Fernando

Originally appeared on the Morning

Blaming imports and importers has long been ingrained in Sri Lankan culture, often seen as a root cause of the country’s economic issues. This perspective not only overlooks the fact that many importers are also exporters, but also fails to recognise that imports and exports are fundamentally interconnected components of the global trade system.

Despite this, it is crucial to acknowledge that not all imports are conducted ethically or transparently. Recent scandals, such as the sugar scam, misinvoicing, bribery, and procedural irregularities at Customs, highlight the darker aspects of importation. However, casting imports in a universally negative light and fostering resentment based on ideological reasons could prove to be more harmful than beneficial.

Recent investigative reports have revealed staggering profits made by importers on essential commodities like green gram, B-onions, and potatoes. Some profit margins have been reported as high as 280% when comparing the Cost, Insurance, and Freight (CIF) value to the market prices of these goods.

Before rushing to judgement on these profit margins, it is essential to delve deeper into the circumstances surrounding these imports. For example, the importation of green gram has been severely restricted since the onset of the Covid-19 pandemic, requiring special approval from the Ministry of Agriculture. As a result, the quantity of green gram imported in 2023 has been minimal.

Thus, comparing the CIF value at the port to market prices can be misleading, as it does not accurately reflect the profits made by importers. This situation raises questions about the high market prices for green gram, pointing to inefficiencies in local production rather than exorbitant profits by importers.

The scenario with undu, a staple food item, is similar. With a Rs. 300 import tariff, the market price for 1 kg of undu ranges between Rs. 1,500-1,700. This high cost is partly because importers cannot bring in undu without approval from the Ministry of Agriculture, despite the imposition of tariffs.

Allowing imports could potentially reduce the price of undu to around Rs. 700 per kg, even after tariffs. The restriction on undu imports exacerbates price inflation, making it unaffordable for many, particularly those in estate regions and the northeast, leading to food insecurity among vulnerable populations.

During the recent economic crisis and the consequent shortage of foreign exchange, many imports were facilitated through informal payment channels and ‘open papers’ in undiyal markets. This practice, aimed at evading high tariffs and taxes through under-invoicing, underscores the complexity of Sri Lanka’s tariff structure and the urgent need for its simplification.

The report by the Ways and Means Committee suggests that focusing solely on the cost of goods at the port does not provide a complete picture of the import value, especially considering the prevalence of informal payments. This approach to calculating profits, based solely on declared document values, overlooks additional costs borne by importers, thus distorting the perception of their profit margins.

Moreover, the perishability of essential food items, along with the significant costs associated with storage, wastage, and the impact of rising fuel and electricity prices, further complicates the economic landscape. These factors, combined with high inflation rates, have significantly influenced the cost structure of both the wholesale and retail markets, affecting pricing and profit margins.

The impact of export controls on certain commodities, such as B-onions by India, has also played a role in inflating global prices, illustrating the complex interplay of international trade policies and local market dynamics.

This situation underscores the phenomenon of unintended consequences in economic policy, where well-intentioned policies can lead to outcomes that are diametrically opposed to their original goals. Sri Lanka’s intricate tariff structure and monetary instability have inadvertently encouraged informal payment methods on one hand and escalated costs on the other, placing the poorest members of society in an increasingly precarious position.

While it is undeniable that practices like misinvoicing represent clear violations of the law and must be addressed through appropriate legal channels, attributing the entirety of Sri Lanka’s economic challenges to importers overlooks the broader systemic issues at play. Simplifying the tariff structure, as this column has long advocated, could lead to increased Government revenue and minimise systemic leakages, offering a more sustainable solution to the economic challenges faced by importers and consumers alike.

In conclusion, while illicit practices within the import sector must be rigorously tackled, the solution to Sri Lanka’s economic dilemmas lies not in vilifying importers but in addressing the complex policy and structural issues that underpin the nation’s trade dynamics. A comprehensive approach, focusing on policy reform, tariff simplification, and enhancing local production efficiencies, is essential for creating a more stable and equitable economic environment.

Unveiling the true culprit behind economic woes

By Dhananath Fernando

Originally appeared on the Morning

Sri Lankans have a very negative view of imports, which are often portrayed on TV as the problem behind the economic crisis. Not only politicians, but also those who have opinions on our economy subscribe to the idea that imports are the problem.

Our politicians’ favourite pastime is to blame imports and impose various tariffs or ban imports. Banning imports also makes for a very pro-Sri Lankan image, because a common excuse provided is that high imports are damaging to local industries. Accordingly, the banning of imports has been portrayed as a measure to help develop local industries.

A favourite area when it comes to cutting down imports is food imports. Often, media headlines and politicians comment aggressively, even quoting figures on the value of food imported. The middle class, upper middle class, and wealthiest of society often make the argument of needing to save valuable foreign exchange by cutting down food imports.

However, when we consider the data, it indicates the exact opposite. The middle class, upper middle class, and the wealthiest are the ones who consume the most amount of imports in the form of fuel, mainly through personal vehicles and as energy. About 27% of our imports in January was fuel. Fuel is the largest component of our import basket as a single commodity.

What we have imported as food is less than 11% of our total imports. Non-food consumer goods are just 8% of our total imports. Most pharmaceutical products and medicines for patients fall under the non-food consumer goods category, which are primarily consumed by the most vulnerable people in society.

Imported food items are also consumed by the most vulnerable sections of society. Food items such as canned fish, maize, green gram, lentils, black gram, sprats, b-onions, potatoes, and wheat flour are critical food items for the poorest of the poor.

Firstly, these can be stored without a refrigerator, which saves their energy cost. Secondly, they are easily available and affordable compared to many other items of food they consume. Therefore, the request of politicians and academics to cut back on these food items, which comprise less than 11% of our total imports, is nearly impossible to fulfil, and reducing these imports further is tantamount to asking the poor to live in hunger and their children to suffer from malnutrition.

Thirty-seven percent of our import basket comprises intermediate goods, besides food. These are goods required for exports and to produce many things without interrupting the supply chain. For instance while our main export is apparels, our main import is also apparels. Therefore, asking to reduce apparel sector imports amounts to reducing our valuable exports.

In reality, while there persists a belief that imports have to be reduced, it is not the solution it is touted to be. If we have to cut down on food imports, it will lead to increased malnutrition, hunger levels, or food costs for Sri Lankans.

Ways of reducing imports

If we want to bring down our imports, cutting down on fuel is one way to consider. A World Bank study revealed that 70% of the fuel is consumed by the wealthiest 30% of society. Therefore, it only makes sense to maintain fuel prices at market price.

As indicated in the graphs, there is a correlation between high fuel prices and fuel imports. Our fuel imports have decreased when prices are high as people use it sparingly. Compared to January 2023, our fuel imports had declined by about $ 100 million per month by January this year. With the expansion of the economy, this number is expected to slowly grow. Prices can bring imports down without import bans or tariffs.

Another way to reduce fuel imports is by improving public transport. Most of our fuel is wasted in traffic jams as a result of our poor public transportation infrastructure. If we invest in public transport, not only will it reduce fuel imports, but it will also uplift many Sri Lankans and provide significant relief in terms of their purchasing power. Many middle class Sri Lankans pay a 200% tariff to buy a second-hand vehicle at an interest rate of above 12% because they have no other choice but to commute.

Saving foreign exchange

Sri Lanka has been offered many grants, including for the Light Rail Transit (LRT) project, which we turned down on numerous occasions, leading to geopolitical tensions. When people spend less money on commuting and waste less time in traffic congestion, it will not only improve productivity but also their purchasing power, creating many jobs and generating income.

It is an inalienable truth that we need more food imports with different varieties of protein sources for the benefit of the impoverished. Foreign exchange has to be earned through exports, tourism, and remittances.

Saving foreign exchange is a function of the monetary policy or the supply of the Sri Lankan Rupee to the financial system rather than a function of imports and exports. When the rupee becomes expensive, the US Dollar demand decreases automatically because people buy the latter using rupees that they could have used in an alternative manner.

Asking the public to cut down on food imports, which are mainly consumed by the poor, at the expense of allowing the use of more fuel-driven vehicles cannot be justified and borders on cruelty.