Thread by @advocatalk

🇱🇰has entered the deepest crisis in its history. The shortages and rising prices we face today are only the first inkling of what lies ahead. Unless the right steps are taken things can go into a destructive tailspin.

Here is a 🧵 about where we are and what we need to do:

The new @CBSL governor has taken only the first step on the path to stabilization, yet more needs to be done. An IMF programme together with concrete steps towards repairing public finances will start to restore some confidence and pave the way for some "bridging finance"

Bridging finance will relieve some of the shortages that are choking the economy. Returning to stability and growth will only come slowly if the structural issues within the economy are addressed.

A major cause of the imbalances in the economy was money printing by the Central Bank. Money has been printed to finance government expenditure. The first step to addressing the problem of money printing is to borrow from the domestic market instead of the Central Bank.

The Govt needs to offer a sufficiently high interest rate to attract the required quantum of funds. This is why rates have been raised sharply. Higher rates will reduce consumption by the private sector (which also reduces imports) but may also affect investment.

Keeping rates high is not a long term solution. For rates to reduce the levels of Govt borrowing must reduce. This means cutting the deficit.

This will have to be approached in two ways, an increase in taxes and a reduction in expenditure.

Increasing tax revenue has the following effect:

It reduces the budget deficit → Reduces Govt. borrowing requirement → Reducing the pressure on interest rates.

Higher taxes may also curtail private consumption including imports but may also impact savings.

Cutting expenditure is the other option, but recurrent expenditure is very rigid (mainly salaries, interest and pensions) so reducing non-essential capital expenditure is more feasible. This includes infrastructure projects.

Reducing the drain from state enterprises and the disposal of idle underutilised assets are other avenues to close the deficit.

Some trimming of unnecessary current government expenditures can increase available fiscal space for social transfers for vulnerable people.

The imbalances will be resolved due to a combination of factors: demand contraction due to higher interest rates and higher prices which result from the adjustment of prices to the realistic exchange rate.

Prices will need to rise, critically energy prices.

This however delivers a huge negative shock so it will need to be cushioned with social transfers. A functioning social safety program ideally through cash transfers that goes beyond the highly politicized Samurdhi Program, will be essential.

These are purely stabilisation measures. If carried out properly this can restore the economy to its state in 2019 but with much higher price levels, much higher unemployment, much lower levels of output and overall much greater levels of poverty.

Many in the middle class will find that their living standards are significantly lowered, and the poor will find themselves in poverty. These are the consequences of compounded bad economic policies that are now unavoidable.

Only economic growth can reverse this predicament, for that we need to go through the painful process of stabilization and recovery, and address the problems that impede growth.

If people are to have some hope then growth needs to be restored which means addressing the problem of productivity. Productivity growth is induced by trade, regulatory reforms and institutional changes.

Trade reforms must reduce the bias against exports and allow imports of raw materials and spare parts to help industries and agricultural enterprises have access to import of inputs, seeds, and good extension services.

We have little prospect of a better life unless growth return.

We must use this moment to rally around and do the difficult, painful, yet necessary economic reforms we have neglected for 20 years.

#ReformNow