Lankan economy driven by budget deficit: Economist

The Sri Lankan economy is largely driven by the budget deficit and that is precisely the reason why as soon as it gets to 6 percent it gets overheated, a leading economist in the country opined.

Observing a strong correlation between the budget deficit and the economic growth in Sri Lanka, Dr. Indrajit Coomaraswamy noted that public expenditure has driven the economy to a significant extent.

“If you look back at the last 35 years, we have had this repeating cycle.

When the country’s economic growth surpasses 6 percent, it starts to overheat and we need to put breaks and it will eventually come down to 6 percent,” Coomaraswamy said, identifying it as the short-term economic challenge the policymakers are facing today.

He also noted that during these years, policymakers were primarily dependent on demand management strategies to manage the economy, where they tried to control the interest rates and foreign exchange rates.

“After the end of the war, there was a great pressure for the authorities to deliver peace dividends. So, they took short cuts; they brought down interest rates and allowed the exchange rate to be over-valued (by 20 percent). In fact, they forgot one of the fundamental laws of economics and of course we paid for it.”

The authorities had to take tough and painful reforms in February and March of 2012 to address the dwindling reserves in view of defending the rupee. The currency peg was abandoned; energy prices and excise duties were increased and even went to the extent of imposing a ceiling on credit, while keeping the policy interest rates up.

Dr. Coomaraswamy, who is also an ex-Director of the Commonwealth Secretariat’s Economic Division, does not believe that the country can achieve and maintain the 8 percent growth with just demand management strategies, which were in fact proved ineffective in 2010 and 2011, instead he called for structural changes.

“Can we get to 8 percent with only demand management mechanisms such as shifting interest rates up and down and moving exchange rates a bit? I would like to say, we need structural changes,” he remarked.

He further stressed that the country’s growth should be driven by exports. “What you really want is the current account of the balance of payment (BoP)-driven growth, which has a fancy name called ‘exports’, through which the Eastern and South East Asian countries have already made progress,” said Dr. Coomaraswamy.