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Economic and Poverty Impact of COVID-19 2 Sri Lanka Development Update 2021

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Economic and Poverty Impact of COVID-19 2 Sri Lanka Development Update 2021 Sri Lanka Development Update 2021 PHOTO BY: © RUWAN WALPOLA/SHUTTERSTOCK.COM RUWAN © BY: PHOTO Economic and Poverty Impact of COVID-19 2 Sri Lanka Development Update 2021 The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The International Bank for Reconstruction and Development/ The World Bank encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly. For permission to photocopy or reprint any part of this work, please send a request with complete information to the Copyright Clear- ance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, USA, telephone 978-750-8400, fax 978-750-4470, http://www.copyright.com/. All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA, fax 202-522-2422, e-mail [email protected]. Photo Credits: Cover: Ruwan Walpola/Shutterstock.com; Executive Summary: Savani Jayasooriya; Recent Developments: Samitha Sen- adheera; Outlook, Risks and Policy Options: Deshan Tennekoon; Special Focus: Simone D. McCourtie; Last Page: Lakshman Nadaraja. Economic and Poverty Impact of COVID-19 Sri Lanka Development Update 2021 3 Preface he Sri Lanka Development Update (SLDU) has two main aims. First, it reports on key de- velopments over the past 12 months in Sri Lanka’s economy, places these in a longer term Tand global context, and updates the outlook for Sri Lanka’s economy. Second, the SLDU provides a more in-depth examination of selected economic and policy issues. It is intended for a wide audience, including policymakers, business leaders, financial market participants, think tanks, non-governmental organizations and the community of analysts and professionals interested in Sri Lanka’s evolving economy. The SLDU was prepared by a team consisting of Robert Beyer and Kishan Abeygunawardana (Se- nior Economists, Macroeconomics, Trade and Investment (MTI)), Yeon Soo Kim (Senior Econo- mist, Poverty), and Nayantara Sarma (Consultant, SARCE) with inputs from Angela Prigozhina (Senior Financial Sector Specialist, Finance, Competitiveness and Innovation (FCI)), Krishnamurti Damodaran (Lead Financial Sector Specialist, FCI), Amila Dahanayake (Economist, FCI) and Tat- siana Kliatskova (Young Professional, FCI). The team thanks Zoubida Allaoua (Director, Equitable Growth, Finance and Institutions (EFI), South Asia Region), Faris Hadad-Zervos (Country Director for Maldives, Nepal and Sri Lanka), Chiyo Kanda (Country Manager, Maldives and Sri Lanka), Man- uela Francisco (Practice Manager, MTI), Andrew Dabalen (Practice Manager, Poverty), Tae Hyun Lee (Lead Country Economist, EFI) and Aurélien Kruse (Lead Country Economist, MTI) for their guidance and comments on the report. Alejandro Espinosa at Sonideas was responsible for the layout, design, and typesetting. Sudip Mozumder, Dilinika Peiris and Samitha Senadheera led dis- semination efforts. For questions, please contact: [email protected]. The report was prepared based on published data available on or before March 17, 2021. Data sourc- es included the World Bank, Ministry of Finance, Central Bank of Sri Lanka, Department of Census and Statistics, Bloomberg, and press reports. The team thanks the Ministry of Finance and think tank representatives for their comments on the document. This report, additional material and previous reports can be found at: www.worldbank.org/sldu Previous editions: • February 2019: Demographic Change in Sri Lanka https://openknowledge.worldbank.org/handle/10986/31261 • June 2018: More and better jobs for an upper middle-income country, https://openknowledge.worldbank.org/handle/10986/29927 • November 2017: Creating opportunities and managing risks for sustained growth, openknowledge. worldbank.org/handle/10986/28826 • June 2017: Unleashing Sri Lanka’s trade potential, openknowledge.worldbank.org/handle/10986/27519 • October 2016: Structural challenges, openknowledge.worldbank.org/handle/10986/25351 Stay in touch with the World Bank in Sri Lanka and South Asia via m www.worldbank.org/en/country/srilanka L @WorldBank, @WorldBankSAsia, follow hashtag #SLDU2021 F www.facebook.com/worldbanksrilanka Ú https://www.instagram.com/worldbank I www.linkedin.com/company/the-world-bank Economic and Poverty Impact of COVID-19 | 4 Sri Lanka Development Update 2021 Contents Preface ................................................................................. 3 Executive Summary ............................................................. 5 Recent Economic Developments ......................................... 8 Context ................................................................................ 9 Real sector ........................................................................... 10 Monetary and financial sector ...................................................... 11 External sector ....................................................................... 14 Fiscal developments ................................................................ 16 Outlook and Medium-term Prospects ............................... 19 Medium-term outlook .............................................................. 20 Risks and priorities .................................................................. 20 SPECIAL SECTION 2021 The COVID-19 Impact on Employment and Poverty ......... 22 Introduction .......................................................................... 23 Pre-existing vulnerabilities and the impact of COVID-19 on employment ...... 24 The impact of COVID-19 on employment .......................................... 25 The impact of COVID-19 on poverty and inequality .............................. 27 Digital opportunities introduce new divides ....................................... 30 Conclusion ........................................................................... 31 Appendix ............................................................................. 33 | Economic and Poverty Impact of COVID-19 Sri Lanka Development Update 2021 5 Executive Summary Economic and Poverty Impact of COVID-19 6 Sri Lanka Development Update 2021 Recent Economic Developments 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 con- sumption 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 government took proactive measures to mitigate the impact of the pandemic. Despite limited fiscal space, resources were allocated (approximately 0.7 percent of GDP) for health measures, cash transfers, and postponed tax payments. While public expenditures increased, revenues declined, re- sulting in a widening of the fiscal deficit in 2020. Due to the economic contraction and the elevated fiscal deficit amid COVID-19, public and publicly guaranteed debt is estimated to have increased to 109.7 percent of GDP. In line with the government strategy to reduce external debt over the medi- um-term, debt financing relied increasingly on domestic sources. 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. An improved trade balance and strong remittance inflows narrowed the current account deficit. A sharp drop in imports in 2020 more than offset the decline in exports. However, with financial inflows insufficient to meet external liabilities, reserves declined to an 11-year low in February 2021, before a currency swap worth US$ 1.5 billion with the People’s Bank of China was approved in March 2021. Due to a shortage of foreign currency, the exchange rate depreciated by 6.5 percent from January through March 17, 2021. The CBSL took several measures to preserve foreign ex- change reserves and reduce pressures on the exchange rate. Outlook and Medium-term Prospects 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
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