“In Sri Lanka, going forward, there’s objectively a reason for fiscal stimulus but there’s not enough space to actually do it,” Timmer said, speaking at a public lecture organized by the Central Bank of Sri Lanka on the effects of slowing global growth in South Asia.
“Then you have to be very careful to balance that. Because if you over-stimulate when you don’t have the room, instead of stabilizing economy, you could destabilize the economy,” he said.
Sri Lanka’s new cabinet under President Gotabaya Rajapaksa has announced a series of tax cuts, as economic growth fell to 1.6 percent in the second quarter of 2018, in the wake of currency collapse in 2018, triggered by liquidity injections despite tight fiscal policy.
The 2018 currency collapse came on top of a 2015/2016 currency collapse, triggered by liquidity injections by the central bank as the budget deficit deteriorated.
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Timmer said if countries want to solve structural problems which impede growth, it is better to focus on monetary stimulus while such problems are addressed, and if there is only a temporary slowdown, fiscal stimulus is preferred.
With falling revenues and slower than expected growth, Sri Lanka’s 2019 budget deficit is already estimated to have widened to 7 percent of gross domestic product.
With little fiscal space, countries like Sri Lanka will find it difficult to spur growth sustainably with fiscal stimulus, he said.
“You need to build confidence among investors, focus on sources of potential high growth and focus on areas of opportunities for exports, but for some reason, these opportunities have not been taken,” Timmer said.
He said Sri Lanka needed to tap into underutilized resources, such as the informal sector, women, and create the right policies to allow investors to harness these labour pools and increase confidence in the market.
“So, instead of spending as a government to create domestic demand, you create the right policies so that people will come and invest.”
He said countries in South Asia have common structural problems which have to be addressed, such as protectionism, crony capitalism, weak regional integration and low female labour force participation.
Timmer also said South Asian countries have tended to run Keynesian-heavy policies throughout economic cycles, stimulating through both busts and booms.
“It’s true for every country in South Asia. In the past, they ran mostly cyclical policies, they don’t build buffers.”
“I hope countries learned the lesson that it’s good to run counter-cyclical policies in good times too to build up reserves,” he said. (Colombo/Dec04/2019)