Comment on “The Sri Lankan Economy: From Optimism to Debt Trap”

Athukorala (2025) offers a critical examination of Sri Lanka's economic trajectory, tracing its evolution from a period of postindependence optimism to its current situation plagued by a sovereign debt crisis, which has been worsened by the COVID-19 pandemic. Athukorala attributes this crisis to both policy missteps and the pandemic, but also identifies a deeper vulnerability to external shocks, exacerbated by debt-driven development following the civil war. Athukorala argues that significant structural reforms, particularly to address anti-trade biases, are necessary for Sri Lanka to achieve sustainable and inclusive growth. The paper is well-regarded for its insightful analysis and clarity. I find myself in agreement with the majority of Athukorala's points. Nonetheless, in order to refine and enhance the paper further, I plan to provide some suggestions:

First, while Athukorala provides a detailed historical overview of Sri Lanka's economic trajectory, it could benefit from a deeper analysis of the causal relationships between historical events, policy decisions, and economic outcomes. For instance, rather than solely describing policy shifts, it could consider exploring the underlying factors driving those shifts and their impact on economic performance.

Second, a Athukorala (2025) argues that a significant shift in policy toward inward-looking policy, which began in the early 2000s, played a critical influence in defining the current economic situation. The period from 2005 to 2014 was notable for its strong economic growth and a fairly stable current account deficit, which marked the high point of Sri Lanka's economic performance. However, the fiscal situation has been a source of concern, particularly the rising debt service-to-tax revenue ratio, which was driven by declining tax revenues. This situation stems from the Sri Lankan government's policy misjudgment, particularly the significant tax cuts that have compromised fiscal sustainability. A crucial question is whether the crisis would have occurred if the Sri Lankan government had not made blunders in fiscal and monetary policies, as well as the occurrence of a pandemic. This question will help us provide information about how to mitigate the economic crisis.

The critique draws from Indonesia's 1998 economic crisis to question the International Monetary Fund's strategy of applying a broad set of reforms, some of which did not directly address the core issues. Should Sri Lanka's reforms focus on fiscal and monetary aspects in the short term, with structural issues addressed later? This is an extremely crucial question because the government's ability to implement the reform maybe limited. In my opinion, the sequence and priority of these reforms is critical, as attempting to implement a wide range of changes can be overwhelming. Successful big bang reform requires an extensive amount of political capital (Basri, 2017). Further thoughts from the author on these topics would be useful.

Third, Athukorala's (2025) figure 2 illustrates that the economic crisis has caused the real effective exchange rate (REER) to fall dramatically since 2020. This weakening of the REER will result in more competitive Sri Lankan exports, which will somewhat offset Sri Lanka's anti-trade bias policy (as seen in the figure). Aside from that, initiatives aimed at reducing Sri Lanka's budget deficit can assist keep the currency rate competitive and eliminate anti-trade bias. How much would this policy benefit in the short term? Does devaluation have a contractionary or expansionary influence on the Sri Lankan economy?

Fourth, Athukorala did not touch into detail about the role of monetary policy in current economic reforms. In fact, several factors that pushed the crisis came from monetary policy, such as excessive money printing, mismanagement of foreign exchange reserves, and failure to address external imbalances by attempting to maintain a fixed or tightly managed exchange rate for too long without addressing the fundamental issues of trade deficits and dwindling inflows. The eventual depreciation of the Sri Lankan rupee was both late and abrupt, aggravating the economic upheaval. The central bank's management of interest rates has also been challenged. Interest rates were kept artificially low for an extended period of time in order to boost economy. However, this policy resulted in overheating and excessive inflation. When the central bank finally hiked interest rates to battle inflation, the move came too late, as inflation had already blown out of control, and the economy was in a downturn, making the impact of high interest rates more severe for businesses and consumers, lacking independence and political pressure.

Despite all these comments and questions, in sum, Athukorala (2025) is worth reading and offers an important contribution for the study of Sri Lankan economy. Furthermore, various lessons can be drawn from this paper, particularly a comparative study with other countries with similar problems.