In the story of Sri Lanka's changing economic scenarios since independence the change of government in 1994 was very significant. For the first time since independence, despite a change of government, a continuity of economic policies was assured.
The new government announced its commitment to continue market friendly open economic policies and characterized its strategy as "Open economic policies with a human face". In contrast to the economic policies of previous SLFP-led governments, it gave private enterprise the lead role in economic activity and pledged to support private enterprise. In fact the government reversed several economic policies of previous SLFP led governments.
Economic policy statement
The first economic policy statement of the government made this policy quite clear. It announced that it would follow market-friendly policies and that the principal engine of growth would be the private sector.
"The Government stands committed to building strong national economy within a market framework. The principal engine of growth is expected to be the private sector, both domestic and foreign. The role of the State is to provide an institutional framework that is wholly supportive of rapid private sector development. In order to do this effectively, the Government will pursue "market-friendly" policies that support rather than supplant markets. Accordingly, government intervention will be limited to areas where markets fail to function effectively. And therefore need to be strengthened or supplemented, so that they serve the welfare of the people."
This was in sharp contrast to the policies of previous SLFP led governments of 1956-65 and 1970-1977. One could characterise the new policies as pragmatic rather than ideological. Several economic policies pursued by the previous SLFP governments were reversed. This was especially so with the privatisation programme of the government that went further than the privatisation undertaken by the previous UNP government. It gave further incentives for foreign investment and embarked on a far-reaching programme of privatisation. The government privatised, inter alia, the plantations, telecommunications, gas, insurance, the National Development Bank and Air Lanka.
The government policy placed an emphasis on fiscal discipline and reduction of the Budget deficit to reduce inflationary pressure. The reduction of inflation was considered a pre-requisite for growth and a cornerstone of fiscal and monetary policy. The economic policy statement made this clear when it said:
"The eventual goal of policy would be to continue to reduce the overall fiscal deficit from a level of 8 per cent of GDP in 1993 to a level of 3 to 4 per cent of GDP well before the year 2000, which would both be consistent with a significant reduction in inflation, and be sufficient to absorb a reasonable amount of concessional aid. In order to accomplish this goal, budgetary revenue will, as mentioned, be buoyed up by rapid economic growth and tax reform. A substantial current account surplus will be generated both by the significant reduction of military expenditure and by curtailing unnecessary and wasteful current expenditures, both through the improved targeting of welfare programmes and reducing the role of the public sector in the economy. The long run objective would be to run an overall surplus in the Budget so as to enable the retirement of the high stock of public debt outstanding."
These commendable intentions were exemplified in the Fiscal Management Responsibility Act of 2002 that set goals to reduce the fiscal deficit. Despite these pronouncements on fiscal discipline and the Act on fiscal responsibility that set maximum amounts for fiscal deficits, fiscal discipline remained in the realm of rhetoric then and afterwards. Fiscal deficits were high in the ten year period 1995-2004, with the deficit rising to as much as 105 percent of GDP in 2002.
The government liberalized trade further by decreasing tariffs. It reduced corporate and personal taxation to a maximum of 30 per cent. The corporate tax rate was reduced to 15 per cent for enterprises in agriculture, fisheries, livestock and tourism. The government also gave incentives for garment industries to be established in the regions and introduced a number of measures to assist agriculture.
The high interest rate regime that prevailed for many years was reversed in 1997. The Central Bank reduced the statutory reserve requirement of commercial banks several times. In August 1999, the Central Bank's statutory reserve requirement was reduced to 11 per cent. This increased commercial bank liquidity and reduced their cost of funds. Treasury bill rates declined and commercial bank lending rates decreased owing to the actions of the Central Bank.
The government introduced Samurdhi, a new safety net for the poor, which was similar to the earlier Janasaviya programme. This, like the earlier programme, was poorly targeted, At one time, over 50 percent of households received benefits. Studies disclosed that many of the beneficiaries were not those eligible, while a good proportion of the needy did not receive Samurdhi benefits.
Economic performance 1994-1998
During the 1994-98 period, the economy grew by an annual average of 5.2 per cent. In 1996 the economic growth rate declined to 3.8 per cent from around 5.5 per cent in the two previous years. Deterioration in the security situation, drought conditions, which reduced paddy and food crop production and caused power cuts, which in turn disrupted industrial production, were mainly responsible for the depressed economic conditions.
Tourism too suffered a setback and business confidence weakened. In 1997 the economy bounced back to record a GDP growth of 6.3 per cent. In 1998 adverse global conditions affected the economy and resulted in economic growth declining to 4.7 per cent. In 2001, economic output declined by 1.5 percent.
The economy achieved this growth despite the Asian economic crisis, due to a continued growth in garments, tea exports and increased paddy production. This period witnessed a resurgence of tea production, which increased by 21 per cent. Garment exports too increased significantly to contribute to an average industrial growth of about 8 per cent per year. In fact manufacturing grew by over 9 per cent in each of the years except in 1996.
The rate of inflation subsided and was single digit except for 1996 when it was 15.9 per cent. The rate of inflation was 9.4 per cent in 1998. The rate of unemployment is also estimated to have declined from 13.8 per cent in 1993 to 9.1 per cent in 1998 and dipped below 9 per cent by mid 1999. The incidence of poverty decreased only marginally from 26 percent of the population in 1990-91 to 23 percent in 2002. Poverty increased in the rural and estate sectors, while urban poverty decreased significantly.
The decade from 1994 was noteworthy for the continuity of economic policies and the economic reforms undertaken. The privatisation of key enterprises led to improved efficiency, improvement in services and increased production.
It also relieved the public finances of some key loss making enterprises and privatisation proceeds enhanced government revenue. One of the conspicuous improvements was in telecommunications whose services were improved and expanded. There was a spurt in tea production after the management of state plantations were handed over to private companies. Industrial production increased owing to the greater business confidence generated by the continuation of policies that encouraged private enterprise.
Despite these gains there were serious constraints to economic growth. The war conditions added much uncertainty and production of several sectors were hampered by security conditions. This was especially so with respect to tourism, agricultural production and fisheries. It was also a period when there were several elections. These distracted the country from economic activities and added a degree of uncertainty.
To compound the problem there were severe shortages of power that crippled industry in particular. Global conditions too were a factor in depressing economic performance. The Asian financial crisis and its effects on trade and exchange rate volatility were serious challenges that the Sri Lankan economy faced. Owing to these reasons it was a period when the economy underperformed.
This experience illustrates how numerous factors affect economic performance. Although the policy thrust provided incentives for investment and was in the correct direction, electoral politics, security conditions, war expenditure, economic dislocation and external shocks affected the country's economic performance. The gains in economic development could have been much greater had these constraints not hampered the economy.