Last week’s topsy-turvy local government election result has triggered uncertainty in whether the authorities will pursue with the IMF-led, painful but crucial economic reforms. At the Colombo stock market, normally the first sector to react to political developments, share prices fell but were seen, cautiously rallying.
Speaking to the Business Times, economists, stock market analysts and senior government officials, agreed that foreign investment and economic reforms would be affected in the short term.
“Some outflows were seen in most foreign traded blue-chip counters over the last few days following the elections. However, after the initial downtrend, the market is settling down as the political circles are also settling down,” said Dimantha Mathew, Head of Research at First Capital Holdings PLC.
It is widely believed that the government’s reversal at the poll was because it failed to respond to growing frustration in the rural countryside on issues like prolonged droughts, costly fertilizer and rising living costs. The glyphosate ban was a big issue among tea smallholders in the south.
Acknowledging these issues, a senior Finance Ministry official said the government will have to regain the confidence of masses by increasing welfare measures and giving handouts in the face of upcoming provincial council and general elections. “The Treasury has been sucked into a process of ‘funambulism’ (tight-rope walking) under the present circumstances,” he said, stressing on the word ‘funambulism” to explain the government’s dilemma.
While welfare measures amidst a massive debt burden, cash flow problems with dwindling revenue and foreign direct investment (which could be less than target), is a recipe for disaster, the government has a daunting task of balancing the sentiment of the people and fulfilling its promise to the International Monetary Fund (IMF), the official said explaining the crisis.
Economics Prof. Sirimal Abeyratne from the Colombo University believes the election verdict is a result of an administration not doing anything substantial for the past three years. “It was even clear from the sluggish economic performance. The election result has added more to the uncertainty; investors are likely to extend their wait and see’ attitude further,” he said.
The need for political stability for accelerated growth and foreign investment inflows was also espoused by Central Bank (CB) Governor Dr. Indrajit Coomaraswamy when he met journalists on Thursday.
He warned that Sri Lanka’s economic consolidation risks losing its current momentum if political instability continues but noted that economic reforms and other monetary policy measures “will have to continue” in accordance with the CB’S 2018 roadmap.
First Capital’s Mr. Mathew said that since there were signs (as of Friday) that there is unlikely to be any major change (in the coalition government), foreigners are likely to return to the market but at a much slower pace compared to the aggressive pace witnessed during the January 2018 when the market was on overdrive.
“The primary reason for this (slower pace) is some doubts being created whether the Government can still go ahead with some of the tough reforms that lies ahead as part of the IMF agreement,” he noted.
How would the IMF react if reforms are put on hold or slowed down? Prof. Abeyratne believes donor approaches are different. “They always work cordially and collaboratively with the governments. Even though they do not approve subsidies and handouts, they may not confront it unless we (desperately) want IMF help,” he explained.
The government is confronted with a dual approach of pursuing reforms while also providing some handouts. “You can always postpone the issues by sweeping these under the carpet. In such an instance even without any help from the government, the economy will move slowly and become resilient to the shocks at the end of the day,” Prof. Abeyratne said.
After a meeting of the Monetary Board, the CB decided to continue its policy of keeping interest rates high to reduce consumption, a decision which appears to have worked against the Government’s popularity.
Several businesses have been struggling with high interest rates which has affected the cost of funds and forced an increase in the prices of goods which in turn triggered a drop in demand. These mostly, wholesale traders have been trapped in a web of payments, borrowing from banks and then borrowings from money-lenders to pay off debt.
On the future of FDI, Mr. Mathew said they expect a slowdown in the first quarter of 2018 as investors wait and see whether the Government will go ahead with the economic reforms, specifically the (fuel) pricing formula which is due in March.
He said the initial expectation that FDIs may beat last year’s figure as well as reach about US$2.5 billion would be a tough call with the latest developments.