What could another global recession mean for Sri Lanka, and how could the next President deal with it? Dr. Ganeshan Wignaraja (Lakshman Kadirgamar Institute of International Relations and Strategic Studies) explains the challenges and facing the winner of the 2019 President election

Global stock markets seem jittery once again. After substantial rallies during the first half of 2019, stock markets have given back much of their gains over the last few months. Against fears over a global recession, an intensifying trade war between the US and China, and an increased likelihood of a disorderly Brexit, stock markets plummeted in the US, Asia and Europe in August.

Asian equities dropped by 4 per cent during the month, whilst European and US equities were subject to a 1.8 percent decline. The above developments, alongside globally falling manufacturing outputs and rising public debt levels in emerging markets have added to a shift towards less risky stocks and government securities. Small open South Asian economies like Sri Lanka have been beset by macroeconomic imbalances and political uncertainty since the global financial crisis and end of the 26-year civil conflict. Sri Lankans will vote on 16 November 2019 for a new President who will assume office a few days later. The critical policy questions for the next Sri Lankan President are whether fears of another global recession are being overstated by international financial markets, and how vulnerable Sri Lanka is to such a challenging economic event.

Intensifying Global Economic Risks

There is little doubt that the global economy in November 2019 is experiencing a phase of slower growth beset by heightened risks. This is not a new phenomenon but rather a continuing shift to a new normal world economy that evolved from the global financial crisis of 2008-2009. To various degrees, advanced Western economies are experiencing what former US Secretary of the Treasury Larry Summers calls “secular stagnation” or a long-term economic slump. Chinese growth is also slowing faster than expected and could converge over time to levels seen in advanced economies. Indian growth has also slowed to a six-year low and some like former Chief Economic Advisor to the Indian Government Arvind Subramaniam are questioning whether its previously reported fast growth was properly measured in the first place.

These changes in the pattern of global growth largely reflect underlying structural factors like low investment, a shortage of labour due to an ageing population and disruptive technological change. Lower consumer confidence and high levels of household debt have contributed to waning demand. The tit-for-tat tariff escalation between the US and China, other countries’ global interconnectedness with these two superpowers, and the prospect of a disorderly Brexit have probably made matters worse for the fragile global economy. Business and investor confidence are fragile in advanced countries and emerging markets.

That said, the world’s central banks and finance ministries are monitoring the situation closely, and still have some firepower for counter-cyclical monetary and fiscal policies. The Bank of Japan and European Central Bank recently confirmed that they would employ further monetary easing in an attempt to stimulate the economy should the need arise. The International Monetary Fund (IMF) and regional financial institutions are also gearing up. Whether there is scope for national action backed by international policy coordination on a scale seen during the 2008-2009 crisis remains an open question. The independence of central banks in the US and the UK seem to be under threat, with political leaders criticizing their actions on interest rates and quantitative easing. At the same time, the IMF is in a leadership transition and it will take some time for its new Managing Director, Kristalina Georgieva, to come to grips with the complex financial institution.

Implications for Sri Lanka

The dark clouds hanging over the global economy are a mixed blessing for Sri Lanka, which was re-classified by the World Bank as an upper-middle income economy in 2019. On the one hand, it could spell more bad economic news for Sri Lanka which is still in recovery mode following the Easter Sunday bombings and downturn in the second half of 2019. The country must look at a comprehensive national response that involves an integrated set of security, governance and development policies to mitigate some of these political and economic risks.

An external shock emanating from the global economy could add to Sri Lanka’s economic woes. As a small open economy and a foreign borrower, Sri Lanka is intricately linked to the global economy. A global economic downturn shock could hit the country’s trade, tourism, and worker remittances. Inward foreign investment and domestic business confidence could also be affected. Financial markets and exchange rate volatility may affect the terms of foreign borrowing, external debt repayments and the capacity to import. Indeed 2019 and 2020 could see tough economic times for Sri Lanka.

On the other hand, some of the disruptions in the global economy and price reductions in Sri Lanka means that some new business opportunities could come the country’s way. For instance, the tourism sector could benefit from an influx of Chinese and Indian tourists seeking bargain-basement prices. Garment and tea exporters are currently under pressure from foreign buyers to reduce prices, and hence margins. But, export volumes could rise if supply conditions hold and export promotion efforts are stepped up.

More generally, the silver lining for Sri Lanka is that an opportunity exists for a new economic agenda for inclusive growth after the cycle of Presidential and Parliamentary elections in 2019-2020. The two main Presidential candidates, the United National Party’s Sajith Premadasa and the Sri Lanka Podujana Peramuna’s Gotabaya Rajapaksa, have advocated economic plans with varying degrees of state intervention, traditional welfarism and market-friendly reforms. Sadly, there is no quick fix to Sri Lanka’s underperforming economic growth and lack of competitiveness. An agenda for long-term growth and competitiveness should leverage the country’s strategic location in the Indian Ocean and proximity to the large Indian market. This means accelerating the upgrading ports and logistics infrastructure as well as reducing barriers to the expansion the services sector by investing in skills, upgrading digital infrastructure and opening up to foreign investment. The country also needs to effectively manage macroeconomic imbalances and the debt overhang, whilst doing some house-keeping work on the trade and investment regime. Undertaking pro-active export promotion towards the Indian and Chinese markets and concluding free trade agreements (FTAs) with them would help export diversification. Over time, the agenda should extend to the more challenging areas of boosting agricultural productivity and irrigation systems, creating a more flexible labour market and restructuring loss-making state-owned enterprises.

A Last Word

The near-term gloomy forecasts of economists are sometimes wrong. However, if one subscribes to the best case forecast of a mixed economic outlook for Sri Lanka in 2019 and 2020, then consensus building for a new growth and competitiveness agenda should begin as soon as the dust settles on the Presidential elections. After all, the country’s economic prosperity depends on it.

This article gives the views of the author, and not the position of the South Asia @ LSE blog, nor of the London School of Economics. Featured image: Black, Blue and Red Graph. Credit: Burak K, Pexels

Dr. Ganeshan Wignaraja is the Executive Director of the Lakshman Kadirgamar Institute of International Relations and Strategic Studies (LKI). The opinions expressed in this article are the author’s own and not the institutional views of LKI, and do not necessarily reflect the position of any other institution or individual with which the author is affiliated.

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