Evaluating Sri Lankan Economic Performance and Supply Side Policies

This report, submitted by Rajawardena Patabendige Thejani, provides a comprehensive analysis of Sri Lanka's economic performance, focusing on the causes of the economic recession, government policies, and potential solutions. The report begins by defining economic recession and outlining its impact on the Sri Lankan economy, including contractions in GDP, rising unemployment, and issues in financials like inflation. It then reviews the literature on the causes of the recession, including external shocks, and analyzes key economic indicators such as inflation rates, savings, investments, and unemployment. The discussion section evaluates the effectiveness and suitability of current government policies and activities, including supply-side policies, to overcome macroeconomic challenges. The report also includes recommendations for supply-side policies to expedite economic growth, such as trade reformation, tax reductions, privatization, infrastructural developments, improved healthcare, and increased education and training. The report concludes with a summary of the findings and a bibliography of the cited sources.

INTERNAL
Date of Submission – 21| 05| 2021
Business Economics AAF045-6 2019936
1
Business Economics (AAF045-6)
By
Rajawardena Patabendige Thejani 2019936
Individual
Report
Assessment- 2
Word count- 3072
(Excluding table of contents & References)

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Business Economics AAF045-6 2019936
2
Evaluating Sri Lankan economic
performance & impact of supply
side policies

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Table of Contents
1.0 Introduction..........................................................................................................................5
1.1 Problem Statement – Economic Recession......................................................................5
1.2 Problem vs Objective of Sri Lankan Economy..................................................................6
2.0 Literature Review............................................................................................................7
2.1 causes identified to the Economic Recession in Sri Lanka...............................................7
2.2 Major Downside Risking Financials.............................................................................7
2.1.1 Inflation & Exchange Rates.......................................................................................7
2.1.2 Savings & Investments.........................................................................................8
2.1.3 Supply side shocks................................................................................................8
2.3 Under performance of Expected vs Real GDP..................................................................8
2.4 Unemployment Rate...................................................................................................9
3.0 Discussion on effectiveness & Suitability of policies..........................................................10
3.1 Government interference to overcome Macroeconomic Circumstances.........................10
3.1 Current Government policies & activities taken to overcome the economic
disturbances.........................................................................................................................10
4.0 Practicing Supply Side Policies as an essential ingredient to expedite economic growth of
Sri Lanka...................................................................................................................................11
4.1 Trade reformation..........................................................................................................11
4.2 Reducing taxes...............................................................................................................12
4.4 Privatization & PPP.........................................................................................................12
4.3 Infrastructural & Transport Developments as an interventionist.................................13
4.4 Improved health care as an interventionist...................................................................13
4.5 Increasing education & training.....................................................................................14
4.6 Limitations of Supply Side Policies.................................................................................14
5.0 Conclusion..........................................................................................................................14

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Bibliography.............................................................................................................................16
List of Figures & tables
Figure 1 Economic Growth.........................................................................................................7
Figure 2 Savings & Investment Rate 2016- 2020.......................................................................8
Figure 3 GDP Growth Quarterly.................................................................................................8
Figure 4 Expenditure Current market prices..............................................................................9
Figure 5 Production (Constant 2010 prices)..............................................................................9
Table 1Inflation & Exchange Rates.............................................................................................7
Table 2 Investment Variations...................................................................................................8

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1.0 Introduction
1.1 Problem Statement – Economic Recession
The Recession is calculated as the economic downturn (Decline of Gross Domestic Product-
GDP) contracting the economy for two consecutive years. It is generally identified that a
recession take place on a period which has reduced output and significant increase in
unemployment rate. (Businessinsider.com , 2020) According to the NBER, there are a
broader set of indicators- GDI, Whole sale retail sales, industrial production, inflation, real
person consumption expenditures etc.; which typically represent the negative development
of the economy. (NBER.org, 2020) These fluctuations determined under the contractionary
phase in a business cycle which trigger two types of recessions.
I. Indicated due to weak output & increased unemployment (low household spending
& business investment, public incapability to pay back loans, sales slowdown)
II. Technical recessions (Weak but positive GDP growth, Volatile components of GDP,
GDP being a subjective measure)
Economic recession is caused mainly due to economic shocks, loss of consumer confidence,
high interest rates, deflation & asset bubbles. Increasing recession results for economic
hardships in the long-term effecting on health, national achievements, investments, net
exports, supply chain & social mobility with a permanent loss of output destructing the
productive capacity. Further, recession can also have a considerable impact on nation’s
public debt as governments need to spend on social welfare to support local businesses.

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1.2 Problem vs Objective of Sri Lankan Economy
Sri Lanka is categorized as a lower-middle-income country with a population of 21.8Mn
located in South Asia. The geographical position of Sri Lanka is naturally an easy placement
to enhance connectivity and earn foreign exchange mainly through the only transshipment
hub port of South Asia based on Indian Ocean. (ADB Institute, 2014)
As of 2020, GDP per capita is identified as 683,106LKR. Amidst of COVID, Sri Lanka has
contracted GDP by -3.6% leading to economic recession (consecutive 5th year below than the
projected growth rate) which is declared as the worst economic downturn after 73 years.
The negative GDP emphasis major downturns of Agriculture (-2.4%), Industry (-6.9%),
Services (- 1.5%), Net Exports (-6.4%) while the unemployment rate is positive with 5.5. GNI
has indicated
-5% after 2001 (-1.47%) (Central Bank of Sri Lanka, 2020).
Despite the adverse impacts of the external environment, Economy is expecting a growth of
GDP by 4.1%, inflation rate changes forecasted under a minimal percentage of - 0.5% and to
reduce unemployment rate by 0.6% within the year of 2021. (Trading Economics, 2021)
Therefore, this report will provide frameworks and theoretical applications to understand
the current issue of the country and economic activities taken place in the country and
identify the effectiveness of the respective policies. Also, major supply side policies which
can be implemented to achieve government aims and other recommendations to eliminate
the limitations.

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Economic Growth
8
6
4
2
0
-2
-4
-6
5 4.5 3.6 3.3 2.3
201520162017201820192020
-3.6
Economic GrowthLinear (Economic Growth)
2.0 Literature Review
2.1 causes identified to the Economic Recession in Sri Lanka
Sri Lankan economy is adversely
affected due to the Easter Sunday
attack in 2019 and 2020 with COVID
pandemic at a stretch. Despite the
external shocks, economy
experience on an average
underperforming the expected rate
in 2019 & 2020 with a new record
of contraction after decades. Figure 1 Economic Growth
According to Central bank of Sri Lanka it is identified that Sri Lanka is at a risk of facing deep
economic recession which has a strong focus on issues such as falling supply & demand,
negative net exports, fast collapsing tourism industry draining remittances from foreign
employment collapses business environments, unemployment while Sri Lankan rupee is
further depreciating. (Daily FT, 2020) Below is a further analysis of major components
emphasizing the factors Sri Lanka’s economic recession over the years.
2.2 Major Downside Risking Financials
2.1.1 Inflation & Exchange Rates
Sri Lanka has marked extremely low inflation until early 1970s and up to 2009 as a double-
digit inflation and as at now, grows with an annual rate of 4%- 7.5% YoY. Inflation rate has
majorly impacted with the reluctance to depreciate resulted in rapid changes in exchange
rates which largely put pressure on widening budget deficits creating massive
macroeconomic imbalances. A country maintaining a mid-single digit has been extremely
challenging as the country went over droughts & floods resulting crop failure in agricultural
seasons, Easter attack and COVID consecutively. (Central Bank of Sri Lanka , 2021)
year 2015 2016 2017 2018 2019 2020
Inflation Rate (YoY %) 4.6 4.5 7.2 2.8 4.8 4.7
Exchange Rate (in LKR) 151.0 161.8 172.4 191.8 200.1 190.2
Table 1Inflation & Exchange Rates
GDP Annual Variation in %

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8Figure 3 GDP Growth
GDP Per capita USD
2020 3682
2019 3831
2018 4074
2017 4075
2016 3871
20153839
34003600380040004200
Series 1Linear (Series 1)
2.1.2 Savings & Investments
In past five years, investment have had a significant growth till 2017 and from 2018; a
contraction of investment expenditure exceeding the decrease happened in National
Savings in 2019 by -6.1% & 2020 by -6.4%. Investments through FDI & portfolio decreased
due to global uncertainties. (openknowledge, 2019)
Investment
Variation in
%
Year %
2015 3.8
2016 5.0
2017 8.2
2018 6.6
2019 -9.5
2020
Table 2 Investment Variations
2.1.3 Supply side
shocks
Figure 2 Savings & Investment Rate 2016- 2020
Continuous domestic supply disruptions and severe movements in international commodity
price cycles has a major impact on inflation & recession. Over past years disturbance
emerged with paddy & crops (Tea, Rubber, Coconut) with considerable declining in several
activities with the effect of Easter attack in 2019 & COVID pressure in 2020.
2.3 Under performance of Expected vs Real GDP
The lowest values of GDP and other economic activities have had a major slow down during
the second quarter of with the impact of nationwide lockdown in 2020 & Easter Sunday
attack in 2019. (world bank, 2021)

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Taxes less
subsidies
Agriculture
7.0%
8.8%
Gross Value
Added
91.2%
25.5%
58.7%
Services
Industry
Government
Consumption
Net Exports Gross Domestic
Expenditure
10.4%
-6.4%
Gross
Domestic Capital Formation
25.2%
Private
Consumption 70.7%
The main contracted activities of the national output impacting country’s production &
expenditure activities and causes in 2019 & 2020 are analyzed as follows. (Central Bank, 2021)
 Production – Constant (2010) Prices  Expenditure – Current Market Prices
Figure 5 Production (Constant 2010 prices) Figure 4 Expenditure Current market prices
Increase of food expenditure by 1% under
private consumption & increase of
expenditure on Health & public order safety
by 9.8% has empowered GDP up to a
respective level. But the significant
contraction in gross domestic fixed capital
formation by -6.2% has been one of the major
impact to economic recession. The net
exports being one of the negative factors
throughout the years (-3.5%) has become one
of the major reasons for recession levels.
Under services, major contraction happened
with transportation by -1.5% in comparison
to the growth recorded in 2019 (-1.7%).
Industrial contraction in construction is -6.9%
which is drastically under capacity utilization
(43%). Agriculture reports major contraction
in fishing (-2.4%) while all other agricultural
attributes performing behind the estimated
level has a significant impact on economic
recession over the years.
2.4 Unemployment Rate
After 2015, unemployment rate began to fall consecutively from 4.5%, but again the raise of rate
began after 2019. (2019- 4.8%, 2020- 5.5%). This decline is particularly identified from industry
and services. But the agricultural employment recorded a growth during lockdown period
ensuring food security. Labor force participation has also slowdown from 2019 (52.3%) to 2020
(50.6%). Also, Sri Lanka is identified as a country with limited labor and mobility creating lacuna
in labor supply. (Christof Baron, 2021)

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3.0 Discussion on effectiveness & Suitability of policies
3.1 Government interference to overcome Macroeconomic Circumstances
Below detail will consist information on Sri Lanka’s economic objectives and their economic
practices to minimalize the issues identified under 2.0 effective for next five years. Within
the next five years government is focusing on achieving below economic objectives to bring
the country in line with economic stabilization. (Central bank of sri lanka, 2021)
1. Passing economic growth rate by 6.0 before 2025. (Current – 3.6%)
2. Reducing unemployment least up-to 4.0 > below by 2023. (Current 5.5%)
3. Maintaining inflation rate less than 5% (current 4.7%)
4. Increase GDP revenue up-to 14% by the end of 2025.
5. Maintaining budget deficit below 4% of GDP
6. Decreasing the debt rate at 75.5%
7. Maintain a single digit interest
8. Ensuring stabilization over exchange rate
3.1 Current Government policies & activities taken to overcome the economic disturbances.
In order to achieve the above objectives midst of the economic disturbances &
underperformed values of economic factors, government & Central Bank has taken
extraordinary steps with a three-pillar policy reforming Fiscal, investment & monetary policy
being a major interference to restructure and mitigate socioeconomic & macroeconomic
impact. In Summary, Central Bank expedites a high monetary policy since 2016 to manage
supply & demand driven inflationary pressures & inflation expectations. Adopting monetary
policy framework for flexible inflation targeting which has been quite successful till 2019 and
disrupted in 2020 due to COVID. With the support & changes done focusing lowering cost &
maintaining liquidity in money market Central bank has relatively achieved to keep the
business and domestic expenditure continuity during this period. Reduction of Key policy
interest rates up-to 5%, decreasing statutory reserve ratios of Licensed commercial banks &
loan schemes for affected businesses to raise capital has contributed to regain the growth
momentum. (Central Bank of Sri Lanka , 2021)

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To manage the constant contraction happening in GDP with the significant slowdown
happening in manufacturing, construction, agriculture & service activities government
provided support via new policy implementation in order uplift the supply of the economy.
Mobility restrictions par with the lockdown to enhance exports for the particular period &
also stopped curtail non-essential imports to reduce expenditure of imports which gave a
notable improvement to trade deficit. Policies also reformed for expenditure rationalization
& debt management to strengthen minus government revenue collection. Inflation targeting
road map with institutional, legal & technical reformation extending fund facilities via LMF-
EEF.
4.0 Practicing Supply Side Policies as an essential ingredient to expedite economic growth
of Sri Lanka
In simple terms, supply side policies are to decrease and minimalize cost and enhance
productivity & efficiency and to develop international competitiveness of an economy by
expanding the GDP rate without experiencing economic inflation. Considering the
performance levels of GDP growth in Sri Lanka, government needs to invent a chain of
supply side policies to bring a positive macroeconomic environment to condition a
sustainable peace, high aggregate supply and demand, lowered inflation, low interest rates,
local business confidence & stable fiscal performance. The impact of correct supply side
policies will automatically enhance employment rate facilitating labor mobility via business
and market expansion. These policies will focus on improving long term performance of the
respective economy. As a country with a recession, Sri Lanka needs attention on both
market led & government intervention to eliminate the deep market failure. (Economics
online , 2020)
4.1 Trade reformation
Lack of diversification of export markets fundamentally being a “homegrown” has create a
major concern for net export/ trade balance to have minus figures consecutively. (2018 -
11.8, 2019 -9.4, 2020 -7.4) in order to reform, trade should attract the best type of foreign
direct investment by managing supply side and by addressing business improvements. Sri
Lanka’s free market has a drastic decrease since 2000 with the openness for imports and
slow growth of trade exports. The current escalating tariff structure in practice has the

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downfalls due to