IPS Policy Insights: COVID-19, Global Economy & Sri Lanka’s External Sector Outlook
Global economic developments have impacted Sri Lanka’s external sector performance, and the economy overall. While Sri Lanka managed the first wave of the COVID-19 outbreak imposing lockdown measures for two months (March to May 2020), it has since been hit by a second outbreak since October 2020 and a third wave in April 2021. The latter is leading to a substantial increase in active cases of COVID-19, along with higher numbers of deaths, disrupting the gradual economic recovery witnessed from the second quarter of 2020. Merchandise exports, tourism earnings, and foreign direct investment (FDI) inflows are all bearing the brunt of the resultant fallout, except for remittance inflows into the country.
Merchandise Trade
Along with the considerable disruptions to world trade, Sri Lanka’s merchandise trade flows also proved to be fairly volatile, with the overall result being weakened exports and imports during the pandemic. Even prior to the pandemic, Sri Lanka’s long-term export growth rate was on a declining trend, albeit with some improvements in the immediate pre-COVID-19 years. In 2020, the pandemic amplified this long-term decline. Merchandise exports contracted by -15.6% in 2020 compared to the previous year, reflecting both demand and supply shocks.
Overall, as Sri Lanka’s export sector strategies and policies are not firmly integrated into regional and global value chains (GVCs), the impact of supply chain disruptions to the country’s export sector has not been very prominent. However, the country has been facing several adverse issues related to declining demand in its major export markets. Sri Lankan exports traditionally target product markets in a few destinations such as the US, UK and some EU countries. Its export basket too remains rather limited, with overwhelming dependence still on T&G and a few agricultural products. The need to revive export performance with sound strategies will take on even more urgency in the wake of the pandemic to build greater resilience.
As countries adjust to the economic fallout of the pandemic, existing global supply chains will change. Sri Lanka too must be prepared to change direction in favour of strengthening regional linkages. The Asian region is expected to recover swiftly, led by China’s resurgent economy. Whilst India is struggling to bring its latest COVID-19 spread under control, the Indian economy too can be expected to record a strong bounce back eventually. Against these developments, Sri Lanka must exploit potential integration opportunities with the Asian region, to better connect to trade, technology and FDI flows.
Compared to exports, Sri Lanka’s import expenditures fell even more sharply in 2020, contracting by as much as -19.5%. A part of the decline was no doubt a reflection of weakened private investment, declining oil prices and subdued consumer demand. However, a large quantum of the drop in import expenditures is due to restrictions imposed on ‘non-essential’ merchandise imports such as motor vehicles, as well as restrictions on import substitute sectors such as agriculture and processed agricultural food products.
Sri Lanka’s fuel
import bill accounts for the country’s largest import category. The expenditure
on fuel contracted by -34.7% in 2020 compared to 2019.[1]
Weakened oil prices in the global market and the sharp decline in domestic
demand supported this contraction. While the oil price war between Organization of the Petroleum Exporting Countries
(OPEC) and Russia, and declining global oil demand created this decline in
prices, a continuation of these advantages cannot be expected as global demand
picks up and oil producing countries agree to curb oil supplies.
Tourism and Remittances
In the aftermath of
the Easter Sunday attacks in April 2019, Sri Lanka’s post-war tourism sector
recovery came to an abrupt halt. In response, several strategies were
implemented, including financial assistance to the sector as well as
promotional campaigns to secure visitors. The mobility and physical containment
measures imposed with the onset of COVID-19 dealt a further blow to the Sri
Lankan tourism industry. With the suspension of tourist arrivals from all
countries with effect from mid-March 2020, tourist arrivals came to a complete
halt more or less for nine months (April to December 2020). International
arrivals to the Sri Lankan border saw a sharp decline of -73.5% in 2020.
By contrast, Sri
Lanka’s worker remittance inflows have performed much better than what had been
forecast. Remittances had been experiencing a consistent decline over the past
few years, reflecting external and internal developments related to foreign
employment. In 2020, after an initial brief drop, remittances grew by 5.5% to
USD 7.1 billion. The increase is perhaps explained by Sri Lankan migrants who
may be remitting larger amounts as coping mechanisms for their households, as
well as those remitting funds in preparation for returning to Sri Lanka owing
to loss of employment in host economies. Additionally, the pandemic conditions,
including limited mobility and greater uncertainty may have encouraged the
diversion of remittances from informal to formal channels.[2]
Capital Flows: FDI and Capital Market Trends
Even though Sri Lanka
is argued to have a strategic geographical advantage straddling major shipping
routes in the Indian Ocean, the country has not yet been able to convert this
to substantive progress in attracting FDI inflows. FDI inflows saw some improvement
in the post-war period and reached a peak in 2018 but has been on a declining
trend thereafter. The pandemic has amplified this shrinkage.Retaining investor confidence through
sound policy decisions, ensuring domestic security measures, and providing a
transparent and accountable regulatory environment are vital to attract more
FDI to the country.
The government is
attempting to facilitate foreign investments into favourable locations in the
country such as the Hambantota industrial zone, the Colombo Port City, as well
as easing regulatory constraints to address time taken to set up a business in
Sri Lanka, etc. The priority in these efforts appears to hinge on the Colombo
Port City which will be granted special tax dispensations and other inducements
to kick-start FDI inflows into mixed development projects and other
infrastructure dominant sectors. The urgency to attract more FDI is partly
related to the governments stated policy intention to move away from debt
creating capital inflows to non-debt creating sources such as FDI. In the
context in which Sri Lanka is struggling to access international capital
markets in a COVID-19 environment, an enhanced inflow of FDI will provide
relief on the external front.
Looking Ahead
For a country with a
small domestic consumer base, Sri Lanka must remain competitive in
international markets as a source of goods and services. Calibrating trade
policies to integrate into re-fashioned GVCs, especially in a regional context,
should remain an important part of the country’s medium-term recovery efforts
towards a stable external sector environment that will support the country’s
long-term growth and development aspirations.
* This Policy Insight is based on the comprehensive chapter on “COVID-19, Global Economic Developments and Impact on Sri Lanka” in the ‘Sri Lanka: State of the Economy 2020’ report – the annual flagship publication of the Institute of Policy Studies of Sri Lanka (IPS). [1] Central Bank of Sri Lanka. (2021,
January). External Sector Performance.
Colombo: Central Bank of Sri Lanka.
[2] Weeraratne, Bilesha. (2021, January 28).
How Sri Lankan Remittances are Defying
COVID-19. Retrieved April 8, 2021, from
East Asia Forum: https://www.eastasiaforum.org/2021/01/28/how-sri-lankan-remittances-are-defying-covid-19/