COVID-19 manifested a new economic shock

The World Bank’s recent report on Sri Lanka highlights the devastating impact the corona virus has had on the economy; with the country experiencing its worst growth rate on record. The report states that amid the COVID-19 pandemic, Sri Lanka’s economy contracted by 3.6 percent in 2020, the worst growth performance on record, as is the case in many countries fighting the pandemic. Swift measures enacted by the government in the second quarter helped contain the first wave of COVID-19 success-fully, but these measures hit sectors like tourism, construction, and transport especially hard, while collapsing global demand impacted the textile industry. Job and earning losses disrupted private consumption and uncertainty impeded investment. As a result, the economy contracted by 16.4 percent (y-o-y) in the second quarter. The economy began to recover in the third quarter as the first wave was brought under control and containment measures were relaxed. The momentum continued in the fourth quarter as the economy was broadly kept open despite a second wave of COVID-19 infections.

The Central Bank of Sri Lanka (CBSL) significantly contributed to the crisis response. It under-took considerable monetary policy easing, for which there was room given benign inflation, and additional measures to increase liquidity in the market and support businesses. It also introduced financial sector regulatory measures, like a debt moratorium for COVID-19 affected businesses and individuals. However, despite these efforts, bank lending to the private sector remained low. By contrast, credit to the government and state-owned enterprises surged and accounted for 80 percent of the total credit in 2020. The pandemic likely exacerbated pre-existing financial sector vulnerabil-ities, although the full impact of COVID-19 cannot yet be observed.

Growth is expected to recover to 3.4 percent in 2021, mainly reflecting a base effect and FDI inflows. Gradually normalizing tourism and other economic activities as well as already signed investments will support growth. However, the subdued global recovery may dampen export demand.

With jobs lost and earnings reduced, the $3.20 poverty rate is projected to have increased from 9.2 percent in 2019 to 11.7 percent in 2020. The poorest experienced the largest proportionate earnings shock while the smallest proportionate income losses were suffered by the richest. The latter tend to have formal, secure jobs and better access to digital technology that allows them to conduct wage work or business operations remotely.

Unequal opportunities to work from home have introduced new economic and spatial divides as working remotely is nearly exclusively an option for high-income earners, and small and me-dium-sized enterprises were unlikely to adopt digital technologies. In the medium to long-term, digital technologies could become an important engine for job growth. However, despite widescale ownership of cellphones in Sri Lanka, the digital revolution will fall short of expectations without expansion of high-speed networks and accessible data on the whole island.

The COVID-19 shock came against the backdrop of pre-existing weaknesses. Growth averaged only 3.1 percent between 2017 and 2019. Structural reforms to shift the growth model towards wider private sector participation, export-orientation, and integration into global value chains progressed slowly and, in addition, frequent macroeconomic shocks disrupted economic activity. Before the COVID-19 outbreak, the economy started recovering from the Easter Sunday Attacks that caused GDP growth to decelerate to 2.3 percent in 2019, the lowest in two decades.

COVID-19 manifested a new economic shock with unparalleled economic consequences. The pandemic also compounded Sri Lanka’s difficult fiscal and debt positions. Low tax revenues (the tax revenue-to-GDP ratio is one of the lowest in the world) combined with high levels of non-discretionary expenditures leave little room for critical development spending, including on health, education, and infrastructure. High fiscal deficits over the last years have resulted in mounting debt. As a share of GDP, Public and Publicly Guaranteed (PPG) debt rose from 78.5 percent in 2015 to 94.3 percent in 2019.

The COVID-19 crisis induced widespread losses in livelihoods, leading to a significant increase in poverty. The sharp economic slowdown is estimated to have increased the $3.20 poverty rate from 9.2 percent in 2019 to 11.7 percent in 2020, leading to more than 500,000 additional poor people. The economic impact of the pandemic is expected to be felt broadly. (World Bank)

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