P Nandalal Weerasinghe: Sri Lanka's sustained economic growth
Keynote speech by Dr P Nandalal Weerasinghe, Governor of the Central Bank of Sri
Lanka, at the 37th OPA Annual Conference "Sri Lanka's Sustained Economic Growth",
Colombo, 26 August 2024.
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It gives me great pleasure to be joining you all today at this event and I extend my best
wishes to the Organisation of Professional Associations of Sri Lanka (OPA) on the
occasion of the Annual Conference themed 'Sri Lanka's Sustained Economic Growth'.
I think it is a very relevant and timely topic
This gathering comes at a pivotal moment as Sri Lanka emerges from one of the
most challenging economic crises in its post-independence history. Despite these
hurdles, the economy has regained its normalcy to a greater extent within a
shorter period. This progress is not by chance but is the result of coordinated,
transparent, and robust measures undertaken by the Central Bank of Sri Lanka
and the Government, supported by numerous public and private stakeholders
even like OPA as well as international agencies and lenders and our creditors. A
key driver of our progress has been restoration of macroeconomic stability,
achieved through a sound monetary policy measure, strong fiscal consolidation
measures and implementation of long-overdue structural reforms. These efforts
have created a conducive environment for growth as we move forward.
Consequently, the Sri Lankan economy broke a six-quarter streak of contractions
in the second half of 2023 and has recorded positive growth since then. Leading
indicators signal that this growth momentum is set to continue, underpinned by
strong macroeconomic fundamentals.
On the inflation front, inflation, which had peaked at an all-time high in September
2022 to 70 per cent, reverted to single digit levels within a year as a result of
monetary policy tightening and inflation remained closer or below the targeted
level since then. Considering the low inflation, well-anchored inflation expectations
and moderation of external sector pressures, the Central Bank began its monetary
policy easing in mid of 2023 with a view to supporting the economy reaching its
potential. The Central Bank's monetary policy stance continues to be
accommodative aligning with softened inflationary pressures. As per the current
projections based on available information at present the inflation is expected to
be well below the target of 5% until first quarter of 2025 before stabilising around
the targeted level later in 2025. Though, it is technically inflation target miss on the
lower bound which is 3%, the economy could benefit from this extended period of
low inflation as it is coming out of the deepest crisis, after recoding historic level of
inflation. The low inflation environment has been providing comfort and stability to
both livelihoods and business activity, contributing to a continued rebound in
domestic economic activity as well seen so far. This favourable environment has
alleviated a significant bottleneck previously faced by various economic sectors
for them to conduct smooth business.
Improved fiscal performance under consolidation efforts and turnaround in
financial performance of key state-owned-business enterprises have enabled the
banking sector to reduce its exposure to the government sector and allocate the
freed-up resources for lending to the private sector. Under the current low interest
rate environment, we observed a gradual pickup in private sector credit in the
recent period and going forward, we expect there would be a notable expansion in
lending to productive sectors, particularly those focused on exports, as well as to
Small and Medium Enterprises (SMEs), which have long been the backbone of
the economy.
I wish to emphasise that the enactment of the Central Bank of Sri Lanka Act in
September 2023 was a milestone achievement, enabling the formal recognition of
Flexible Inflation Targeting as the Central Bank's monetary policy framework,
complemented by a flexible exchange rate policy. Additionally, increasing the
autonomy of the Central Bank has been accompanied by enhanced accountability
towards the Parliament and the general public for the Central Bank's policy
actions. The independence of the Central Bank has been reinforced by limiting
monetary financing and ensuring independent decision making without the
influence from the fiscal authorities, thereby strengthening both monetary policy
formulation and governance and accountability.
On the other hand, improvements on the external front, primarily driven by
workers' remittances and tourism inflows and also exports, have resulted in a
relatively stable exchange rate and enabled the Central Bank to rebuild gross
official reserves. Moving forward, the expected inflows from the services sector
are expected to sustain this positive momentum in the external sector and provide
a buffer against external shocks. Under the flexible exchange rate regime, the
Central Bank has allowed the exchange rate to be determined by the market
forces and the Central Bank's interventions in the market is limited only to prevent
undue substantial volatilities in the market and to rebuild the external buffers. The
reserves which depleted to a very low level have now reached US dollars 5.7
billion with the gradual purchase of forex by the Central Bank. External sector
stability supports the enhancement of market sentiments.
On the fiscal front, positive impacts of fiscal policy reforms are becoming evident
in the government's finances, marked by a significant increase in tax revenue
collection, while the implementation of cost reflective pricing mechanisms has
helped improve the financial performance of State-Owned Business Enterprises.
The Government's steadfast commitment to a revenue based fiscal consolidation
path, in conjunction with the continued execution of the economic reform
programme aligned with the IMF-EFF arrangement, is expected to continue. Since
most of the tax policy reforms are frontloaded in this reform process, the revenue
enhancement in the forthcoming period would be more focused on improving tax
administration and widening the tax net rather than increasing taxes.
Key pieces of legislations related to public financial management, public debt
management, and anti-corruption have been enacted recently, which are pivotal
to strengthen prudent management of public finance and debt, transparency and
accountability. In addition, reforms in state-owned business enterprises (SOBEs)
and divestment of non-strategic investments would reduce the burden of SOBEs
on the government budget. Alongside the successful external debt restructuring
process, these measures are expected to facilitate the achievement of
mediumterm fiscal targets and ultimately restoring long term fiscal sustainability which is
prerequisite for medium term growth. Enhanced fiscal discipline along with the
improved financial performance of the key State-Owned Enterprises (SOEs)
would help to free up more funds available in the banking system towards
productive purposes of the private sector.
The financial sector, which endured difficult macroeconomic conditions in recent
years, remained resilient amidst the crisis owing to proactive and prudent
regulatory actions of the Central Bank and the compliance and crisis
preparedness of the financial institutions. Central Bank provided regulatory
guidance to the banks and non-bank financial institutions during the crisis time to
ensure their resilience with adequate capital and liquidity. An Asset Quality
Review was conducted as part of the bank diagnostic exercise and the Central
Bank developed a roadmap to address issues related to capital and foreign
currency shortfalls based on the AQR, expected impact of debt restructuring and
forward-looking stress testing. On that basis we expect the financial sector's
resilience to improve further as macroeconomic vulnerabilities dissipate in the
upcoming period. Also, an array of structural, legal, and policy level reforms and
innovations will continue to be mobilised to ensure the stability of the financial
system.
As you all know, the ongoing reform agenda comprises measures that are
expected to augment the resilience and stability of the economy which is needed
for the long-term economic growth. Maintaining macroeconomic stability is a
prerequisite to ensure sustained growth trajectory in the medium to long term.
Although these reforms are painful in the short term, it is crucial for all
stakeholders to remain committed and ensure the swift implementation of these
long overdue reforms to set the economy on a path towards sustained, inclusive,
and sustainable growth. Despite all such efforts, any political or social
uncertainties or reversals of hard-earned achievements that exert significant
pressure on the reform agenda could lead to a deviation from the intended policy
trajectory, potentially resulting in adverse and irreversible impacts on the economy
and recurrence of the economic and social crisis that we experienced in the past
two years.
At the same time, policies for macroeconomic stability itself would not be sufficient
to propel the economy to a high growth path that would take Sri Lanka to an
advance country status within a short time. With the current sovereign debt crisis,
the Government does not have any fiscal space to drive the economic growth
through higher spending or lower taxes as in the past, since reinstating fiscal and
debt sustainability is the need of the hour at present and for the future. Therefore,
going forward, the growth should be driven by the private sector and the
Government's role would be to create a facilitating and conducive environment for
the private sector to thrive.
Sri Lanka's growth potential has been constrained in the past due to structural
issues in the factor markets and these issues need to be addressed expeditiously
in tandem with the current reform programme. The issues related to skill
mismatch in the labour force, stringent labour laws, archaic laws related to land
markets have prevented efficient resource allocation in both labour and land
markets. Given the looming challenge of aging population, the education system
should be reformed to produce a more efficient labour force who can easily adapt
to the dynamic needs of the industries in order to sustain the growth in the long
run. In addition, special policy focus is needed to address the issue of low female
labour force participation to harness the under-utilised labour force for productive
purposes, thereby expanding the growth potential of the country. In addition,
policy initiatives such as development banking, business incubators and credit
registry would enable the SME sector and innovators to access the financial
markets at competitive rates to expand their businesses.
Apart from the current reform agenda, Sri Lanka needs to embrace digital
transformation through initiatives to foster a knowledge-based economy.
Expanding digital services, including banking, payments, and e-government, will
boost efficiency, productivity, and financial inclusion. This transformation will also
streamline government operations, reduce corruption, and improve transparency
and accountability, addressing issues like tax evasion, the large and vulnerable
informal economy, and growing inequalities. Further, improved access to digital
technologies and data will drive innovation, attract foreign investment, and
strengthen global competitiveness of our businesses. For this transformation to
succeed, a supportive regulatory environment and active participation from the
private sector are essential in bridging the digital divide and fostering long term
economic development.
The Sustainable Development Goals (SDGs) are integral to Sri Lanka's sustained
growth in the long term, by addressing critical issues in key sectors such as
health, education, poverty reduction, and infrastructure development. Sri Lanka's
progress under specific SDGs is commendable, with achievements such as
reduced maternal mortality, high literacy rates, and strengthened social safety
nets. However, to ensure continued progress and avoid any reversals of these
gains, Sri Lanka should focus on reinforcing development strategies that
emphasise social protection networks, food security, and health and education
reforms. Aligning these efforts with international frameworks and addressing
regional disparities will be essential for achieving resilient, long term economic
stability and growth.
I wish to take this opportunity to emphasise the need for fostering as I already
mentioned the transition of Sri Lanka's economy towards a green economy, as
highlighted in international agreements. Given the country's environmental
vulnerabilities as an island nation and escalating global challenges, advancing
green initiatives is essential. Greening the industrial activities would be imperative,
going forward, especially for our export sector, as there is a growing recognition
for sustainable production by the importing countries. Sri Lanka is making
progress through efforts to achieve 70 per cent of electricity from renewable
sources, promote green financing aligned with the Central Bank's Sustainable
Finance Roadmap, and implement conservation programmes with local and
international partners. Supporting the development of environmentally sustainable
businesses, advancing clean technologies, and expanding access to green
financing are crucial strategies for fostering an economy that is resilient, resource
efficient, and sustainable.
Conclusion
Sri Lanka has rebounded faster than expected from the economic crisis. However,
building a stronger, more resilient economy requires a collective effort. Sustained
growth depends on consistent reforms, targeted policies, and addressing grassroot
level challenges. Events like this provide valuable platforms for discussing these gaps
and identifying collective and effective strategies amid ongoing macroeconomic
developments. To ensure the success of these efforts, it is imperative that professionals
across various fields actively engage in creating a resilient and prosperous future for Sri
Lanka. I extend my heartfelt wishes to the OPA and look forward to our joint efforts in
achieving sustained economic growth.