”: Economic impact of COVID-19 on Sri Lanka
Kithmina Hewage
Over
a quarter of the world’s population is currently under movement restrictions. For
the first time in recent human history, coronavirus
has shattered the myth that the economy must come first. While public
health concerns, undoubtedly, should take precedence over all other
considerations when dealing with the COVID-19 pandemic, it would be unwise to
ignore the economic costs of the current situation. Reviving an economy where production
grinds to a halt in a hitherto unprecedented manner is not an easy task, and if
not done properly, will lead to further damage. Small economies such as Sri
Lanka, in particular, whose economic backbone is made up of micro, small, and
medium sized enterprises (MSMEs), dependent on export revenue for foreign
currency generation, and is simultaneously managing a critical debt and fiscal
crisis, are going to be particularly vulnerable. This blog provides an overview
of the economic impacts of COVID-19 on the Sri Lankan economy and explores potential
measures that could be taken in the short and medium to long run.
The Big Picture: Impending Global Recession
The
economic implications of COVID-19 are unprecedented. The most recent pandemic
that spread to this extent was the Spanish Flu in 1918. The nature of economics
currently, however, is vastly different from a century ago. Economies are much
more interlinked with each other through supply chains, migration, and vast
volumes of international trade. As a result, countries are much more vulnerable
to external shocks now than ever before. Under such circumstances, the economic
implications of COVID-19 on Sri Lanka, hinge not only on the situation within
the country, but also on critical markets such as the United States, Europe,
and China. It may well be that the world is yet to experience the worst of the
pandemic, and the global economy will see further significant turmoil in the
months to come.
Most
recessions are caused by a (i) demand shock (e.g. post 9/11 downturn), (ii)
supply shock (e.g. OPEC oil embargo in 1973), or (iii) financial shock (e.g.
Great Recession in 2008). Covid-19 promises
to cause all of them in one blow. As entire populations move into lockdown,
and consumer demand falls drastically, the demand shock is clear. Some initial
data suggests that global
GDP may have fallen by as much as 5% during the first quarter of 2020. Similarly,
as noted earlier, supply chains around the world have been severely disrupted,
creating supply shocks. Even as China restarts its economic activities, the
situation in Europe and US will likely cause continued disruptions in the
supply chain. Finally, amidst a push by governments to pass stimulus packages,
MSMEs that work on small margins and very little reserve cash are likely to
face a liquidity crunch, leading to foreclosures and bankruptcy. The US Federal
Reserve has already injected
US$ 500 billion into the repo market, which suggests that there are
concerns regarding an impending financial shock. As such, an imminent global
recession is inevitable.
High
Risk of Unemployment in the Sri Lankan Export Sector
A
global recession is likely to significantly reduce the demand for Sri Lanka’s
exports, and lead to considerable job losses. During the Great Recession from
2008 to 2010, an estimated
90,000 Sri Lankans lost their jobs due to downsizing amongst manufacturing
firms, especially in the apparel sector. Sri Lanka is also susceptible to
delays in accessing raw materials for manufacturing from China. Moreover China’s
economic slowdown could severely inhibit a major source of foreign direct
investment (FDI) to the economy. In fact, in a recent
research paper by the Overseas Development Institute (ODI), Sri Lanka was
identified as one of the most vulnerable middle-income countries due to the
impacts of COVID-19 and a resulting Chinese economic slowdown.
In more
bad news, the current crisis will gravely affect the tourism sector. In January
and February alone, tourist arrivals to Sri Lanka fell by
6.5% and 17.7% respectively, compared to
2019. The closing of the Sri Lankan border for foreign passenger arrivals in
mid-March, combined with global travel restrictions, will undoubtedly lead to
further losses. Combined with the loss of revenue last year following the
Easter Sunday attacks, the drop in global travel will lead to further job
losses both in the formal tourism sector as well as ancillary informal
services. Moreover, unlike the Great Recession and other recent external shocks,
both developing and developed countries are likely to face significant economic
downturns during the pandemic. Therefore, given the scale and cross-sectoral
nature of the crisis, its economic impact is assumed to be greater than during
the 2008 financial crisis. Even more worryingly, unlike in 2009, there does not
appear to be a coordinated global response to minimise the effects of a global
recession.
Social
Distancing, Curfews, and the Domestic Economy
Meanwhile,
enforcing the necessary social distancing measures, and subsequently, curfews
have effectively stalled the local economy. Whilst some economic activities
that can be carried out remotely continue, particularly in the services sector,
manufacturing and retail services have effectively come to a standstill.
Moreover, even though the government has allowed agricultural production to
continue unhindered, uncertainties surrounding temporary lifting of curfew
hours and means of distributing essential goods to households result in wastage
and a slowdown in the supply and storage of perishable agricultural goods.
Whilst
many will feel the economic hardships, the exact short-term impact is difficult
to estimate just yet. Daily wage earners and MSMEs, including those in the
informal sector, are going to be disproportionately affected during the current
crisis. MSMEs account for 52% of total
GDP and 45% of national employment. Meanwhile, nearly a half
of the population is employed in the non-agricultural informal sector.
Therefore, the absence of any meaningful economic activity for an entire month,
and possibly longer, will severely affect the wellbeing of those involved. Since
many MSMEs operate on thin margins and low levels of reserve savings, a
prolonged lockdown without adequate support would lead to unemployment and
foreclosures, with few surviving until the resumption of economic activities.
Policy
Solutions Unlike Any Other
As
noted earlier, the public health considerations and the economic stakes of the
current situation are unprecedented. Therefore, the government should be open
to unique policy solutions to address a unique crisis. Thus far, the government
has taken several measures to ease the burden on the public with an emphasis on
low-income households. During the past week alone, the Central Bank has
announced additional liquidity measures and downward adjustments to policy
interest rates, the government has issued debt moratoriums for SMEs in
identified vulnerable sectors such as tourism and construction, debt
moratoriums to the self-employed, relief on personal loans and credit card
payments, and reduced
the prices of some essential goods, to name a few. Further measures may be
introduced. The government has also requested debt-relief, in the form of
suspending debt repayments for a time period, from its lenders in an effort to
gain greater flexibility to address the current crisis. These measures have
created some breathing space by easing up an element of financial constraints
for firms and workers, and crucially injecting a measure of liquidity into the economy.
That
said, these measures do not necessarily create a swift cash flow into the hands
of vulnerable groups such as daily wage earners and most MSMEs, especially
those in the informal sector. Therefore, a mechanism to provide cash flows will
be needed, in addition to policies such as price reductions, since the
continuation of curfew or a lockdown would severely constrain disposable income
amongst these groups and heighten difficulties in accessing basic essentials.
The broader challenge for the government, however, will be to design an
effective fiscal response that allows businesses to sustain themselves through
this period and minimise job losses, whilst simultaneously managing a
constrained fiscal landscape. The high level of government expenditure required
for such stimulus packages, alongside an approximately
Rs. 650 billion revenue loss due to tax cuts introduced following the
Presidential election last year, as well as delays in revenue collection during
this crisis will all create a significant fiscal burden. An economic relief
package may not help all small businesses, but will at least reduce the
potential for a cascade of small business defaults, high rates of unemployment,
and a resulting domestic financial crisis.
Importantly,
this situation has to be managed as a public health crisis. Countries should be
careful not to move too fast in trying to ease restrictions on social
distancing measures to restart the economy without realistically containing the
likelihood of the virus spreading again. China is currently attempting to
approach this delicate balance, but Sri Lanka is not close to that point yet. Failure
to contain the possibility of community spread before easing restrictions will
only lead to a catastrophic burden on the national health system and will
inevitably lead to greater economic losses. This is unchartered territory for
all, and uncertainty regarding the pandemic as well as global and domestic
economic effects will pervade all policies made at least during the next six
months. However, it is in Sri Lanka’s best interests to prepare for the future
and enact proactive policy measures to mitigate potential economic costs as
much as possible.
(Kithmina Hewage is a Research Economist at
the Institute of Policy Studies of Sri Lanka (IPS). To talk to the authors,
email kithmina@ips.lk. To view this article online and to share your
comments, visit the IPS Blog ‘Talking Economics’ – http://www.ips.lk/talkingeconomics/)