Lanka’s fuel price tug of war: Who really pays the price?

By Dhananath Fernando

Originally appeared on the Morning

Fuel prices and fuel price revisions have always been a political football. Statements by various politicians on the taxes imposed on fuel and the scope for reducing fuel prices have come under renewed scrutiny with the 31 October price announcements.

Adding to the confusion, a statement by the Ceylon Petroleum Corporation (CPC) Chairman – that the CPC must compensate for the losses of other players if deviating from the price formula – has sparked fresh controversy. It’s essential to unpack these issues one at a time.

According to Central Bank data, we imported approximately $ 1.5 billion in refined petroleum and $ 0.5 billion in crude oil in the first half of the year. Assuming demand and prices remain steady, total fuel imports this year will be around $ 4 billion.

About 70% of fuel is consumed by the top 30% of high-income earners in Sri Lanka who can actually afford higher fuel prices. Naturally, energy consumption rises with income, as wealthier households use personal vehicles, high-energy appliances, and consume more overall. Only 30% of the total fuel is consumed by the remaining 70% of the population, which includes fishermen, public transport users, and service providers.

Thus, if we artificially lower fuel prices through a subsidy, it effectively subsidises the wealthiest families in Sri Lanka. While a low-tax regime might be ideal, given our fiscal situation and the International Monetary Fund (IMF) programme, Government revenue must increase to about 15% of GDP. Lowering fuel taxes would thus provide tax relief to the wealthiest 30% of households and incentivise excessive fuel consumption.

Imperative to adhere to fuel formula

Instead of being swayed by popular demands to reduce fuel prices, especially with rising tensions in the Middle East, the Government should first review its balance sheet to ensure adequate revenue with minimal market distortions to achieve debt sustainability.

If the Government aims to lower fuel prices for the public transport and fisheries sectors, the best approach would be a direct cash transfer rather than lowering all fuel prices, which would mitigate the impact of high fuel prices on essential goods and services.

It is imperative that we stick with the fuel formula and strengthen it if necessary. Unfortunately, there is limited information regarding the recent controversy over agreements between fuel suppliers on price revisions. If, as the Chairman claims, there is a clause to compensate private players for losses, this would be unreasonable if true.

In the absence of the full report, the only available information is a post on X from the former Minister of Power and Energy, who claims the CPC only pays the difference when the Government provides a subsidy or other mechanism to deviate from the price formula. In fairness to private players, if only the CPC receives a fuel subsidy, it creates an unlevel playing field, as petrol and diesel would be cheaper at CPC stations than at private ones.

Although the subsidy benefits consumers, it primarily benefits the wealthiest 30%, and rising demand could drastically increase the total subsidy cost for the Government. Therefore, a fuel subsidy is not advisable, as it essentially transfers Treasury funds to the wealthiest households in Sri Lanka.

Another issue has arisen: one supplier has reportedly requested about Rs. 82 million as compensation for deviations from the fuel price formula. It is difficult to assess this claim fully, as the original documents are not publicly available, but if true, it raises questions about whether recent price revisions adhered to the formula.

In particular, price adjustments before and after the elections require examination. Data on whether the September and October price revisions complied with the formula has also not been published; making this information available would reduce information asymmetry, essential for a functioning market economy.

Providing consumers with the best price

A further question is whether only a Government-owned CPC can reduce prices, and why prices are not decreasing with private players like Lanka IOC, Sinopec, RM Parks, and United Petroleum in the market.

The answer is not straightforward. The CPC is already heavily in debt, with high financing costs that must be covered. Moreover, prior to the latest revision, Sinopec’s diesel prices were actually lower than others, illustrating how competition can bring prices down.

However, prices depend on global crude and refined oil rates, and sometimes on the efficiency of refineries. When a price formula is in place in a small market, players often charge similar prices, but more competitors could introduce value propositions, including price variations based on global fluctuations.

For example, Lanka IOC offered an environmentally friendly fuel at a higher price, while Sinopec sold diesel at a lower price. To remain competitive, each player must offer something unique, which may not always be a lower price but can include quality or convenience.

The final point is that the new administration has requested a flat dealer margin instead of a percentage tied to global fuel prices, which is a positive move. Dealer costs are mainly influenced by inflation rather than global prices. The purpose of the price formula is to account for both variable and fixed costs to prevent losses and provide consumers with the best price.

In a market system, the consumer is at the centre. To prioritise consumer needs, we must ensure multiple players and transparency in pricing to minimise information asymmetry. Publishing the final fuel price revision calculations for the past two months and the full price revision agreement with private players would be a constructive first step.

Central Bank Defends Liquidity Injections Amid “Money Printing” Controversy

By Dhananath Fernando

Originally appeared on Ada Derana Business

A fresh controversy has erupted following reports that Sri Lanka’s Central Bank (CBSL) injected nearly 100 billion rupees into the banking system by October 25. Given that money printing was the major cause of the country’s financial crisis, this news has sparked considerable attention. CBSL has defended its actions, arguing that these liquidity injections do not equate to money printing.

What is the CBSL’s Argument?

CBSL asserts that these liquidity injections were necessary to address persistent imbalances among banks. Despite an overall surplus of funds in the banking system, this liquidity is unevenly distributed. Foreign banks operating in Sri Lanka hold significant liquidity surpluses but remain cautious about interbank lending due to strict risk management guidelines. As Sri Lanka’s sovereign rating is still ‘Default, this limits their exposure to local financial institutions. As a result, foreign banks deposit excess rupees with the Central Bank rather than in the interbank market.

While this was a serious problem in the midst of the crisis things have improved since: interbank call market (clean or unbacked) trading volumes, once as low as zero 1-2 billion rupees daily, has now returned to Rs10bn to Rs20bn (averaged 10 billion last month). Repo volumes (backed by T-bills) are back around 30 to 70 billion rupees, which is higher than pre-crisis levels.

Notably, auction data shows the central bank offering more than what banks bid for, with some banks bidding close to the deposit rate, indicating a willingness to lose bids—yet CBSL still provided new funds.

Given the much healthier interbank volumes, the CBSL should avoid undermining the working of the interbank market. The CBSL should be the last resort for a bank facing a liquidity crunch, not the first.

The Core Issue: Temporary vs. Longer-Term Impact

The debate centers on whether these injections are temporary or enduring. If CBSL swiftly withdraws the new money by selling Treasury bills or foreign exchange, the money supply remains stable. However, if these short-term purchases are repeatedly rolled over, the increase in money supply could become more long-term. Critics warn that this scenario is no different from lending money to the government, potentially triggering balance of payments problems and inflation, thus jeopardising the ongoing economic recovery.

A Matter of Terminology

CBSL’s reluctance to label this as “money printing” is essentially terminological. Regardless of whether the funds are lent to banks or the government, the impact on the money supply is fundamentally the same. Therefore, interventions must uphold the principle of currency stability, given the grave consequences of unchecked money creation.

Acknowledging CBSL’s Efforts

It is It is important to acknowledge that since September 2022, the CBSL has done an admirable job in restoring monetary stability. The critical task now is to maintain this hard-won stability. These points are presented to promote a healthy academic debate on an issue of great importance, not to cast blame on any specific entity or person.

Potential Alternative Strategies

What alternatives could CBSL have considered?

Purchase Foreign Exchange from Banks: Where balance of payments conditions permit, CBSL could continue the practice of buying foreign exchange, injecting rupees but reducing foreign currency in the If the injected rupees were later used for imports, CBSL could sell foreign exchange back, maintaining balance and avoiding exchange rate issues.

Use the Standing Lending Facility: Lending at the Standing Lending Facility Rate of 9.25% would ensure banks only borrow for urgent liquidity needs. As this penal rate is higher than the interbank rate, it discourages long-term dependency and helps avoid a lasting increase in the reserve money supply.

Reduce the Standing Deposit Facility Rate: If the CBSL wishes to lower rates, it could reduce the rate on deposits held at the Central Bank, which would encourage banks to lend more in the interbank market. However, this would also lower overall interest rates and must be carefully managed. To support reserve accumulation, interest rates need to remain at an appropriate level to curb credit and keep imports in check.

The Balancing Act

CBSL faces the difficult task of supporting the banking sector while safeguarding monetary stability. Any intervention must be carefully weighed to mitigate risks such as inflation and currency destabilisation.

Fuel deal without bidding sparks fears of economic instability

By Dhananath Fernando

Originally appeared on the Morning

On Wednesday (16), a daily newspaper reported that the new Government was planning to strike a fuel supply deal between the Ceylon Petroleum Corporation (CPC) and the Ceylon Electricity Board (CEB) for power generation.

Following this report, there was significant discussion on social media questioning why the Government would deviate from the competitive bidding process (a few Government representatives have personally informed us over the phone that the facts in the news story are incorrect and that the Government plans to clarify details through a press conference).

If the news is true, it would mean that the CEB would no longer engage in competitive bidding when purchasing fuel from the CPC. Fuel purchases, including hydrocarbons like naphtha and heavy fuel oil, are key input costs in electricity generation.

Regardless of the news story’s accuracy, the main concern for businesses is that bypassing the competitive bidding process in fuel procurement could lead to significant risks for CPC and CEB financial stability with corruption vulnerabilities. If the CPC and CEB start incurring losses or attempt to cover up losses by increasing tariffs, it could destabilise the economy.

To put this into perspective, the CPC’s revenue for 2023 was approximately Rs. 1,300 billion and the CEB’s about Rs. 679 billion. In comparison, Sri Lanka’s total tax revenue, including Value-Added Tax (VAT) for 2023, was around Rs. 3,000 billion.

Together, these two institutions manage a cash inflow that amounts to nearly two-thirds of the country’s total tax revenue. Even a minor financial misstep could result in a major crisis for the Government, leading to a complete economic collapse.

Avoiding the competitive bidding process creates a vulnerability to corruption. Competition is a crucial tool for preventing corruption, as it automatically introduces checks and balances through price signals on the supplier side. Without competitive bidding, any corruption within the CPC or CEB would likely manifest as significant financial losses in their balance sheets. Unlike other institutions, losses at the CPC and CEB have massive spillover effects, as has been seen under successive governments.

Typically, the CPC sells naphtha – a byproduct of its refinery – at a price higher than the market rate to the CEB. This is one way the CPC tries to offset its own inefficiencies or cover losses when the Government mandates fuel sales below production cost. However, when the CPC charges more for naphtha, electricity generation becomes more expensive, prompting the CEB to seek tariff increases.

On top of this, the CEB often delays payments to the CPC when it experiences losses, which forces the latter to borrow money from banks at high interest rates. These costs, in turn, are passed on to consumers, affecting industries across the board – from rice mills to poultry farms and even hotel operations, as energy costs are a major expense (CEB tariff hikes impact the water bill and many other industries, including through increasing inflation).

The CPC also sells jet fuel to SriLankan Airlines at inflated prices, similar to how it overcharges the CEB for naphtha. Jet fuel is a significant cost for the aviation industry and the high prices can push airlines into losses. When the CPC, CEB, and SriLankan Airlines all incur losses, they ultimately turn to the Treasury for bailouts.

It is no secret that the Treasury’s budget deficit has remained massive for years, compared to the country’s GDP. Consequently, the Government then turns to State-owned banks like the Bank of Ceylon (BOC) and People’s Bank (PB) to cover the losses. In many cases, the Government provides Treasury guarantees, sometimes even in US Dollars, for fuel purchases.

These banks, in turn, are forced to lend depositors’ money to these institutions, often at a high risk due to the prime lending rates. Ultimately, the financial mismanagement of the CPC and CEB trickles down to depositors’ hard-earned savings.

In the last Budget, the Government allocated Rs. 450 billion, equivalent to three years of Advance Personal Income Tax (APIT, previously the Pay-As-You-Earn [PAYE] tax), to recapitalise the banking sector, mainly with State banks. In addition, the Government absorbed $ 510 million into the Treasury to address losses at SriLankan Airlines, largely caused by the CPC’s inflated prices.

If the CPC indeed moves away from competitive bidding, it is a clear signal of poor governance and a warning of future economic hardship, potentially affecting depositors’ savings. When the CPC and CEB incur losses, the Government typically has to either increase the prices of electricity and fuel beyond what is set by price formulas or continue providing subsidies – both of which lead to higher taxes or interference with key economic indicators, thus creating political pressure.

This cycle has been ongoing for years, which is why the business community and others are deeply concerned about the CPC leaving the competitive bidding process. If the news is false, we can be relieved. But it is essential to understand the grave risks of abandoning competitive bidding, as it extends far beyond corruption; it threatens to bring about complete financial instability.

Scrambled supply: How maize, markets and policy cracked egg prices

By Dhananath Fernando

Originally appeared on the Morning

Just after the election, social media chatter quickly shifted to egg prices, which had dropped by about Rs. 10. Many speculated that a kickback had ended, causing the price drop. However, a few days later, the prices shot up again by Rs. 10 and memes started circulating, joking that now the hens were taking the kickback.

But there is a deeper story behind egg prices and the poultry industry in Sri Lanka. The primary cost in poultry is the cost of feed, with maize being the main ingredient, making up about 60% of the feed by weight. The cost of maize accounts for around 45-60% of the total cost of poultry production.

In Sri Lanka’s poultry market, 40% is through wet markets while 60% is through formal markets, which maintain high standards to supply to hotel chains. At one point, we were even exporting poultry products to the Maldives.

When it comes to eggs, however, the cost factors are front-loaded. Layer chickens must be imported and raised to maturity, which takes longer than broiler chickens. The cost of feeding these layer chickens, especially with maize prices being so high, significantly increases production costs.

After the economic crisis, inflation caused maize prices to soar from Rs. 45 to Rs. 165 per kg, pushing up poultry product prices. Our local maize market, which is the main cost driver for the poultry industry, is tricky.

While Sri Lanka requires about 500,000 MT of maize annually, we only produce 300,000 MT, leaving a shortfall of 200,000 MT, which is imported through a licensing process. This system creates a cartel of importers, driving up maize prices and, consequently, chicken and egg prices.

Maize imports are also heavily taxed, including Ports and Airport Development Levy (PAL), Value-Added Tax (VAT), and Customs duty, further increasing costs. Meanwhile, local maize production is inefficient, yielding only about 1.5 MT per hectare compared to the global average of 2.5 MT per hectare. This low productivity forces farmers to encroach on forests to increase their yield, creating environmental challenges.

In response to the crisis, the Government imposed price controls on eggs. Since farmers had already invested in layer chickens, they were unable to maintain them under the price controls and ended up selling the chickens for meat. This led to a reduction in egg production, driving prices higher.

In the formal market, producers with thin profit margins halted capacity improvements, keeping production stagnant. As a result, we were unable to expand exports, as there was no capital to fund growth. The combination of price controls, maize import licensing, and high tariffs led to low production and high prices.

Eventually, the Government resorted to importing eggs from India. This highlights how distortions in the maize market, coupled with tariffs and inefficient agriculture, have hurt Sri Lanka’s poultry industry.

Despite all the costs, including shipping, insurance, and handling, the cost of an imported egg is still cheaper than locally produced eggs, mainly due to irregularities in the maize market.

Over time, the market began to stabilise. The drop in egg prices right after the election was likely due to lower demand during election week, especially from eateries and bakeries. As eggs are perishable, the surplus likely drove prices down. However, as soon as prices fell, people began buying more than usual, which quickly drove demand back up and prices along with it.

While it’s possible that some farmers and wholesalers may have hoarded eggs, the primary reason for high egg prices lies in Government interference in the maize market and price controls. The well-intentioned move to make protein more affordable through price controls has had the opposite effect – something that happens with many policy decisions.

The new Government must focus on making decisions based on data, facts, and economics, not just good intentions. In economics, good intentions don’t guarantee good outcomes.

The first 200 days: Can the new government lead or will it be overtaken?

By Dhananath Fernando

Originally appeared on the Morning

• Sri Lanka’s new Government faces critical early decisions

The first 100-200 days are critical for any new government. Being prepared to assume power is essential because if a government expects to prepare after getting to power, it risks being overtaken by circumstances.

This is particularly true in a country like Sri Lanka, where uncertainty is the only constant. Governments here face numerous internal and external shocks, and there is little time to prepare or adjust once in power. When a new president or government takes charge, it is akin to boarding a fast-moving train.

Many previous governments have been reactive, merely responding to crises rather than controlling the situation. If a new government fails to take command, the situation will inevitably take control of it.

During his second term, President Mahinda Rajapaksa’s Government was overtaken by corruption and inefficiency before it could address core issues. The ‘Yahapalana’ Government came to power unprepared, only drafting its Vision 2025 plan after a Cabinet reshuffle, including changes to the Ministry of Finance. By then, its primary mandate for rule of law, good governance, and economic transformation had already faded.

President Gotabaya Rajapaksa’s Government faced the unexpected Covid-19 pandemic. While somewhat prepared, its policies were misaligned with sound economic principles. The more policies it implemented, the more unpopular it became, given the delicate balance between economics and politics.

Learning from these past lessons, one hopes the current Government avoids the same mistakes. Its challenge is navigating back-to-back elections. While elections may strengthen the Government’s political power, delaying essential economic reforms could be disastrous for a fragile economy like Sri Lanka’s. Delays in reforms could take years to recover from, and in the meantime, other pressing issues may spiral out of control.

While the plan for economic stability continues, economic growth reforms are equally vital. According to the National People’s Power (NPP) manifesto, simplifying the tariff structure is a good starting point. A simplified tariff would not only boost growth and competition but also reduce corruption, benefiting consumers by lowering prices. The Government should see an increase in revenue as informal money leaks caused by a complex tariff system decline.

However, timing is crucial, and reforms need to be implemented quickly within the first 100-200 days. Simplifying the tariff structure will see resistance from trade unions and stakeholders benefiting from the corrupt system. The best way to minimise resistance is to act early. Some local companies, which profit from targeting only the domestic market, may resist the changes, as will officials who have benefitted from the complexity of the system.

The second key reform the new Government should prioritise is anti-corruption. In fact, it received a strong mandate for this. While addressing corrupt politicians and officials is important, the Government also needs to reduce the potential for future corruption by adjusting or removing certain regulations.

Even if the Government is not entirely prepared to tackle corruption vulnerabilities, the International Monetary Fund (IMF) Governance Diagnostic is ready with specific actions, responsible divisions, and timelines. By committing to this framework, Sri Lanka can also secure financial and technical support from bilateral and multilateral sources. More importantly, it would significantly reduce the country’s corruption vulnerabilities.

The Government must also avoid certain pitfalls. Delaying economic growth reforms in favour of focusing solely on anti-corruption would be a mistake. Both reforms need to move forward simultaneously, and the Government must be proactive rather than reactive.

Another mistake to avoid is the overuse of relief packages and price controls. When governments fail to deliver on promises, they often impose price controls as a last resort, covering everything from eggs and milk powder to hotel rooms. While intended to protect consumers, price controls often lead to unintended consequences. If the controlled price is lower than production costs, sellers lose the incentive to sell, creating black markets.

We hope the Government can maintain stability, grow the economy, and continue its anti-corruption drive in parallel. Failing to do so will only lead to further losses for all.

Why we won’t be able to find the thieves after the election

By Dhananath Fernando

Originally appeared on the Morning

If you ask the average person the reason for our economic crisis, they would probably say one word: ‘corruption’. The idea of corruption was hyped so much that it became the main theme of the people’s movement – the ‘Aragalaya’. 

However, the truth is a little different. This doesn’t mean there hasn’t been corruption; it means corruption is more of a symptom than the root cause. Corruption is like a fever, while the real infection lies elsewhere. The problem is, we don’t fully understand how corruption occurred, and if we don’t know that, it’s unlikely that we can fix it either. 

Even when we look at the election manifestos of political parties, they talk about eliminating corruption, but corruption isn’t the main focus. Instead, they place more emphasis on proposals for exports, business environment reforms, social safety nets, and debt restructuring.

Why don’t we know?

The way many Sri Lankans calculate corruption is simple: they take the total value of loans we have taken over the years, compare it with the asset value of infrastructure projects, and conclude that the difference equals corruption. 

However, most of the money we borrowed was not for infrastructure. In fact, since 2010, about 47% of the loans were taken just to pay interest. Another 26% of the debt increase came from currency depreciation. This means that from 2010 to 2023, about 72% of the total loans was used for interest payments and dealing with currency depreciation. 

Therefore, comparing the value of infrastructure projects to the total debt doesn’t give a clear picture of corruption because we have been borrowing mostly in order to pay interest. As a result, the debt keeps growing and we remain stuck in the same place.

Does that mean there’s no corruption?

This doesn’t mean there has been no corruption. It simply means we don’t fully understand how it took place. As a result, the solutions proposed for corruption only address the symptoms, not the root cause. 

Corruption has taken place during procurement. Most of the projects we conducted have been priced far above their actual value. 

For example, a project that should have cost $ 1 million was priced at $ 3 million. We then borrowed money at high interest rates for that inflated amount. The project is completed, but we’re still paying interest on an inflated value and the interest keeps snowballing. Now, we’re borrowing more just to pay the interest, which only pushes the total debt higher.

How to fix it

This problem needs to be fixed at the beginning, not at the end. Most anti-corruption methods focus on the aftermath – finding thieves and recovering stolen money. Of course, we should recover stolen money and hold people accountable for misuse of public funds. But on a policy level, the real need is for transparency in procurement and competitive bidding. 

Digital procurement systems and a proper procurement law can take us to the next stage. Otherwise, it’s akin to closing the stable door after the horse has bolted. Without competitive bidding, we may never even know the true value of projects or how much was stolen. Recovering stolen money becomes incredibly difficult if we don’t know the amount or the method used to steal it.

The solution is upfront disclosure of the values of large infrastructure projects, as well as clear financing methods and guidelines.

The graph shows the impact of State-Owned Enterprise (SOE) losses on debt. The contributions of Ceylon Petroleum Corporation (CPC) and SriLankan Airlines to the debt are clear; in 2024, we will see more debt from SriLankan Airlines, the National Water Supply and Drainage Board (NWSDB), and other entities.

Simply put, we borrowed too much at high interest rates with short maturities for infrastructure projects that didn’t generate enough revenue to even cover the interest payments. As a result, the interest compounded and we have been continuously borrowing to pay off that growing interest, leaving the debt in place and forcing us to keep borrowing.

Albert Einstein put it wisely when he said: “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”

Price Regulation on Three-Wheelers and School Vans: A Recipe for Transport Troubles

By Gurubaran Ravi & Chanul Singharachchige

Price is fundamental in determining the manner in which market forces influence both patterns of demand and the chains of supply. Price is a manifestation of what economist Adam Smith termed the ‘invisible hand’ which naturally allocates scarce resources in accordance with the laws of supply and demand and requires near zero intervention. The question now lies: what happens when this unneeded intervention is implemented regardless? By manufacturing limitations around prices, the government disrupts the natural balance between supply and demand. With the government planning to introduce a series of price controls on the three wheelers , school and office transportation sector - upon which almost all of us rely - it is worth revisiting what the adverse consequences of such an act can and will look like, how they will most definitely exacerbate already existing problems, and finally, prevent the economy from finding its own equilibrium.

Essentially, price controls entail putting restrictions as to how high or low prices can be set for a certain good or service via ‘price ceilings’ and ‘price floors’ respectively. Conceptually speaking, the implementation of price controls is often for a given purpose, whether it be to control inflation or protect consumers, the government simply tries to artificially balance distortions within the market creating a great deal of uncertainty in the economy itself.

However, not all that is expected to come into fruition in theory can be seen in the outcomes found in objective reality. For example, despite the immediate benefits price controls may provide, they distort the natural dynamics of the market leading to unintended consequences such as supply shortages, the reduction in the quality of goods and services, and the prevalence of underground black markets. This tends to be because producers struggle to cover the costs associated with providing products at pre-established prices. The ultimate harm done to both consumers and producers through the implementation of such regulation - though often well-intentioned - outweighs any temporary benefits that may be reaped. 

Now, let us take a closer look at what the landscape of how the transport market for three wheelers in Sri Lanka looks like and behaves. Nowadays, three-wheelers, school vans, and office vans have become integral parts of the Sri Lankan transportation system - especially with the deterioration of the public transportation system. The three-wheeler segment comprises a significant portion of Sri Lanka’s transport sector with more than 300,000 three-wheelers in operation. These vehicles have made it possible for millions of people to have their means of private transport for daily use, particularly in rural areas and other hard-to-reach places. In the backdrop of an economic crisis, where operating costs become extremely high, the proposed price regulation policy is likely to jeopardize this important service. Such regulation could reduce the number of providers as the financial pressure on operators rises, the availability of transport decreases, and transport fares rise. This impact would be most severely experienced in regions where choices of public transport are already few, possibly leaving many with no affordable means of transport. 

The transport sector for three-wheelers is also mainly composed of individual operators, but recently a few companies like PickMe and Uber have utterly revolutionized Sri Lanka's transport market. They have managed to heighten efficiency, promote route optimization, and enhance service quality, whilst simultaneously providing alternate employment opportunities for a vast and diverse array of people. However, any proposed regulations that stifle the freedom with which price can move will inevitably disrupt the market dynamics fostered by these platforms. Experts warn that such constraints will undermine the flexibility and efficiency of the sector, distort supply and demand, and potentially reverse the benefits of market-based pricing models. This could lead to diminished levels of availability of service, hindrances in the pace of innovation within the industry, and a rollback of the advancements made in respect to meeting needs of consumers - particularly those of low-income earners. 

The free market fosters levels of competition that incentivize providers to one-up one another at every opportunity. In the service-based industries - such as transport - this is best accomplished through the provision of high quality services at as low a price as possible in order to attract consumers. Therefore, if price controls are implemented on the three-wheeler, school,  and office transportation sectors, they stifle the capacity as well as the incentives that providers have to improve levels of flexibility and provide a variety of options to consumers, particularly affecting low-income individuals. These price controls also significantly enlarge an industries’ reaction time - and hence inefficiency- when making adjustments in respect to pricing and supply when faced with fluctuations in economic conditions such as shifts in the levels of inflation or a fuel crisis. Experts in the field have shared similar concerns, emphasizing the fact that while these regulations may be passed in order to provide temporary relief to a select few, they risk the destabilization of the entire market and jeopardize the efficiency of the entire market system.

However, it is impossible to turn a blind eye to the fact that there are certain factors that are crucial to these price controls. The government has to consider how it will be able to oversee and regulate thousands of independent operators across the country, especially in a sector that is as fragmented as the transport sector. The adoption of such regulations would likely require a high administrative cost, which would likely shift attention from other important sectors. Moreover, given the fact that the three-wheeler, school, and office transportation sectors are composed of many small participants, it remains doubtful whether such enforcement can be achieved in the first place. For instance, it may be hard to enforce compliance in rural regions and in urban regions with dissimilar levels of economic development. This may lead to a situation where only some or even a part of the controls are being implemented, thus aggravating and distorting the market more than it is at the moment. The efficiency of these measures is furthermore rather questionable, which leads to questions of whether or not these measures can be implemented without causing more problems than they are solving.

However, the three-wheeler, school, and office transportation sectors are far from the only sectors that have known the weight associated with the adverse consequences of price control implementation. It should be highlighted that LP gas, cement, bread, rice and eggs, have all been subject to similar limitations. These policies have frequently caused significant market distortions. In 2023, in order to combat a sharp rise in the prices of eggs, the Sri Lankan government made the decision to impose price controls on eggs. Despite this intervention aiming to resolve the dilemma, it instead devastated the industry and led to severe shortages in the supply chain with producers failing to sustain costs. The restrictions on LP gas and bread supplies appear to have influenced supply chain disruptions and market fluctuations. Moreover, there is news that cement may be the next to be affected by further price regulations, which will exacerbate the situation in the building and construction industry. Such stopgap regulations impair the normal functioning of free market economics, send misleading signals to actual price factors, and cause more instability in the economy, by providing only short-term relief while exacerbating long-term structural issues.

While the debate around price controls is critical, it raises a more significant question: The public transport system needs to be improved based on the government’s long-term vision of how it plans on fixing the system’s problems. While exercising the price control mechanism may give some relief to commuters and public transporters in the short run, it cannot address the structural issues that are inherent in the public transport system in Sri Lanka. The real solution is to create an integrated plan to upgrade public transport infrastructure and to improve service delivery so that the public transport system becomes the first choice of the transport user. In this regard, it would be possible for the government to ease the burden from the private transport sector, including three-wheelers and school vans, etc., and thereby develop a more balanced transport system. The provision of mass transit systems offers not only the purpose of decreasing reliance on private automobiles but also social justice, optimum resource utilization, and preservation of the earth.

On a more conclusive note, history teaches us a clear lesson: the fundamental importance of allowing prices to reflect supply and demand naturally simply cannot be understated and any intervention in this intricate relationship can have dire direct and indirect consequences.While interventions like price controls may provide temporary relief to a select few, they often just exacerbate already convoluted issues when considering the longer term.  A free market system is pivotal in order to maintain economic equilibrium where efficient resource allocation can be best fostered. In such a system, it is price that serves as the principle signal to guide both consumer and producer behavior. The self-regulating nature of this system not only promotes innovation and competition but helps mitigate market distortions that may arise from intervention or excess regulation.

Sri Lanka’s Productivity Push: Exploring Policy Pathways for the Proposed National Productivity Commission

By Tilani Jayawardhana

Why Does Productivity Matter for Sri Lanka?

Productivity is not just a technical measure of economic efficiency; it is fundamental to improving living standards, sustaining economic growth, and ensuring the long-term prosperity of society. Evaluating and enhancing the productive forces of the economy is crucial for informed policymaking, targeted investments, and achieving sustainable development. For Sri Lanka, focusing on productivity is key to overcoming economic challenges and realizing its potential in the global economy.

Sri Lanka should increase productivity across the economy if it wants to successfully compete in the global value chain. Improvement in productivity will reduce the costs and place the country in a better position to supply to the global markets at competitive prices. 

Productivity growth has to be a top priority of all the successive governments. Without productivity growth, the country’s production system, be it agriculture, industry, or services, will be displaced in the global system.  Therefore, the role of the NPC should be to ensure a data-driven approach to productivity in each sector, promote competition, and encourage international competitiveness. 

Sri Lanka’s productivity has to be built up through investments in physical capital stock, human capital and the diversity and dynamism of our industries. To ignite productivity growth, new business investment and workforce capabilities will need to improve in ways that respond to the changing shape and nature of the economy. Investments in physical capital are expected to continue to drive Sri Lanka’s productivity potential. International evidence shows that about two-thirds of labour productivity growth since the early 1970s has been due to capital deepening. This is because when the amount and quality of capital available to workers increases, they are generally able to produce more per hour worked. As the industrial mix changes, investment in growing industries and effective adoption of new technologies, including digital technologies, will be essential.

The productivity challenges and opportunities that we will face in the future will be different to what we have seen in the past. Improving productivity in the large and growing services sector will be increasingly important, as it will have an outsized impact on Sri Lanka’s overall productivity outcome. Country’s productivity agenda needs to respond to current economic circumstances and identify modern strategies to advance enduring policy goals.

Rationale in establishing the National Productivity Commission (NPC)

An economy’s ability to use labour, capital and other resources efficiently is the essence of productivity and it is when this efficiency increases a country’s economy would expand. In a bid to revive the country’s struggling economy, Sri Lanka has implemented a comprehensive economic reforms agenda. The government has initiated several key recovery strategies, with the establishment of a National Productivity Commission (NPC) being a flagship project under the Economic Transformation Bill. The proposed NPC is expected to help address the productivity enhancement needs of the domestic industrial sector as they are struggling to come out of the economic crisis and exposed to greater international competition. The government of Sri Lanka has taken this correct step forward and acknowledged that higher productivity growth has the advantage of raising average living standards by increasing GDP per capita. 

Productivity growth is an important aspect of economic and social development of a country. Moreover, increasing productivity enhances competitiveness, making it a crucial factor in attracting foreign investments and boosting international trade. Productivity drives economic growth and helps realize improved living standards. 

Though Sri Lanka’s output structure shows a shift to services (with an average share of 59.2% during 2016–2022) and away from agriculture (8.5%), a large share of the employed are still in agriculture (26.4%), where productivity is about 31% of the national average. Furthermore, its manufacturing sector—a sector widely regarded as one that can gainfully employ semiskilled workers—lags in labor productivity. Though Sri Lanka’s manufacturing labor productivity is one of South Asia’s highest, it is roughly half of that in the Philippines and Thailand, and about one-third of that in Malaysia and the People’s Republic of China (ADB Country Partnership Strategy: Sri Lanka, 2024–2028).

Sri Lanka's aging population presents a significant challenge to sustaining high economic growth, while boosting productivity is the key solution to overcoming this hurdle. Sri Lanka is “growing old” before becoming “rich” and thereby there is an urgent need in preparing for an aging society that will require increasing labor force participation and productivity of the workforce. Productivity improvements can offset the economic impacts of a shrinking workforce by enabling the remaining labor force to produce more. This is crucial for sustaining economic growth in the face of demographic challenges. Therefore, establishment of the NPC is a clear step forward in the correct direction. 

Overview of the Proposed NPC

The broad objective of the proposed NPC is to promote economic growth through increased productivity for the improvement of wellbeing of people in a sustainable manner. The NPC will be an independent body which is accountable to Parliament. 

The main duties and functions of the NPC shall be to: 

• Make recommendations to the relevant authorities based on evidence and comprehensive analysis in order to increase productivity and economic performance by; streamlining regulation of productivity, promoting healthy competition and contestable markets, catalysing structural transformation and encouraging international competitiveness

• Make recommendations to the Government on introducing a national competition policy and advise on subsequent revisions as needed from time to time

• Conduct public inquiries and evidence-based research on issues related to productivity, either in-house or contracted out, and disclose the methodologies used for such inquiry or research

• Carry out, performance, monitoring, evaluation and benchmarking on the productivity

• Report annually to Parliament on the productivity trends within the first four months of the following year

• Advocate on the need for productivity improvement 

Although the objectives of the NPC cover a wide range of responsibilities, from streamlining regulation to promoting competition and international competitiveness, this broad scope might dilute the focus and effectiveness of the NPC. It is important to narrow the focus to specific, high-impact areas initially, such as catalyzing structural transformation or enhancing international competitiveness. Clear prioritization of tasks could improve the efficiency and outcomes of the commission’s work. NPC’s work and policy orientation should address the country's on-going productivity issues, it also should carry a longer-term perspective in achieving the development goals of the country.

In addition, conducting inquiries and evidence-based research in-house might lead to biased outcomes, especially if the NPC faces political or administrative pressures. This issue can be resolved through the establishment of an independent research unit within the NPC with a clear mandate. 

NPC should Advocate for the development of standardized productivity metrics and benchmarks, perhaps aligned with international best practices to facilitate performance monitoring, evaluation and benchmarking. 

It is also important to have within the NPC mandate to promote public advocacy and engagement. The mandate to advocate for productivity improvement is broad, and without a clear strategy, these efforts might not reach the right audience or create the desired impact. Development of a targeted communication and advocacy strategy that includes specific campaigns for different sectors, public education initiatives, and collaboration with media and civil society to raise awareness should be taken into consideration.

Concerns on the proposed NPC and some policy recommendations

• The process of appointing the chairman and five members to the NPC is under presidential authority, which raises concerns about potential political interference and the practicality of the level of independence of the commission. Even if the commission operates under an independent entity, the inherent structure would not warrant it to operate at arm’s-length from politicians and other public agencies. 

• The two core features of the NPC has to be its transparency and its economy-wide perspective. The commission’s activities should encompass all levels of government and all sectors of the economy, with the core values of independence, transparency and community-wide perspective, including social and environmental aspects. 

• The NPC should have permanent staff that has the capacity to evaluate all aspects of the public sector operational activities with special emphasis on macroeconomics and competition policy. Their work should be overseen by independent commissioners appointed for a fixed term. 

• The NPC must be geared to contributing by providing quality, independent advice and information to the government, and on the communication of ideas and analysis. - The commission ideally should be an agency of the Government of Sri Lanka, located within the
  Treasury portfolio, covering all levels of government and encompass all sectors of the economy, as well as social and environmental issues 

• National performance monitoring system has to be based on the Total Factor Productivity (TFP). TFP is referred to as the productivity measure involving all factors of production. Most often productivity measurement is based on Partial Factor Productivity, where one or more outputs are measured relative to one particular input (eg. Labour productivity is a ratio of output to labour input). Therefore, unlike labour productivity (or capital productivity), which considers only the labour input (or capital input), TFP is a comprehensive measure of productivity. TFP is usually calculated as the ratio of the total output to the combined inputs of labor and capital. Partial productivity measures are widely used as they are simple to calculate. However, partial factor productivity should be interpreted with caution.  

Regulatory Power of the NPC.The NPC’s mandate to "streamline regulation" and "promote healthy competition" might be limited if the commission does not have sufficient authority to enforce its recommendations. Without enforcement powers, the NPC could become merely an advisory body, with its recommendations being ignored or delayed by the government.

Sri Lanka’s next leader faces a web of crises

By Dhananath Fernando

Originally appeared on the Morning

In two weeks, a newly-elected president and government will take charge of steering the country.

At the beginning of the forex crisis, we warned that an economic crisis often comes as a package of five interconnected crises.

Balance of payments crisis

A balance of payments crisis occurs when excessive borrowing from the central bank (money printing) leads to inflation. In countries like Sri Lanka, where the local currency is not a reserve currency and the economy relies heavily on imports, printing too much money increases the demand for goods and services – many of which are imported.

If exports, remittances, and Foreign Direct Investments (FDI) fail to keep up with this increased demand for imports, we run out of foreign exchange reserves, causing the currency to depreciate.

Debt crisis

When foreign currency reserves are depleted, the country struggles to meet its obligations to creditors. While borrowing from international markets might offer temporary relief, credit rating downgrades make this option limited, triggering a debt crisis. On 12 April 2022, Sri Lanka officially declared it could no longer service its debts, despite having the intention to do so.

Banking crisis

If local banks have provided significant loans to the government and the government defaults, a banking crisis can unfold. Sri Lanka narrowly avoided this scenario.

Humanitarian crisis

With debt defaults and depleted foreign reserves, imports become limited. Inflation makes basic necessities unaffordable for the poorest segments of society. In Sri Lanka, poverty numbers surged from three million to seven million, pushing more than 30% of the population below the poverty line.

Political crisis

When a government faces multiple crises such as these, political instability inevitably follows, as we have seen in Sri Lanka. The President was ousted, the Prime Minister and Finance Minister resigned, and an interim Government was formed.

Although the political crisis continues, it is only one phase in an ongoing cycle of instability, with the Presidential Election being a milestone in this process.

Current political landscape

The incumbent President has introduced significant relief measures, including raising public sector salaries, forgiving agricultural loans, and making other promises. However, if re-elected, he will struggle to deliver on these promises within the limited fiscal space, potentially leading to a deviation from the International Monetary Fund (IMF) programme.

Alternatively, he might be forced to raise taxes or borrow more, which would increase interest rates and add to the economic strain.

If another candidate is elected, they will face the same fiscal limitations and may have to reverse salary increases to maintain fiscal discipline.

In the case of a Samagi Jana Balawegaya (SJB) government, the challenges are compounded. The Economic Council within the SJB sends mixed signals about achieving revenue targets to support proposed expenditures. Additionally, the broad alliance of political factions under the SJB presents internal challenges, especially concerning sensitive reforms like State-Owned Enterprise (SOE) restructuring and maintaining Central Bank independence.

Not all factions have aligned views based on previous voting records and public statements. Managing these internal differences will be critical for an SJB government, especially in the context of carrying forward the relief measures introduced by the current President.

Similarly, in a National People’s Power (NPP) government, the same challenges apply. The NPP, primarily led by the Janatha Vimukthi Peramuna (JVP), advocates for a more State-led development approach, but many professionals in the party’s outer circle lean toward market-driven policies. This could lead to internal conflict, making reforms difficult to implement without alienating part of the party.

This situation resembles the ‘Yahapalana’ Government, where the President and Prime Minister held differing ideologies. As a result, governance became more about managing stakeholders than effective government operation.

If you recall, the Prime Minister made economic decisions through the Cabinet Committee on Economic Management (CCEM), which was later replaced by the National Economic Council appointed by then President Maithripala Sirisena. Stakeholder management within an NPP government could prove just as challenging.

On top of these internal struggles, Parliamentary and Provincial Council Elections are expected to follow, adding even more political promises that will further constrain the fiscal space. Reforms tend to slow down during election periods, making debt restructuring more difficult and putting the IMF programme and long-term debt sustainability at risk.

While we may see temporary relief from one or more of these crises, the interconnected nature of these issues means that one crisis could easily trigger the others. The risk factors remain extremely high, underscoring how difficult and sensitive sovereign debt restructuring and recovery can be. There is always a risk of setbacks before we see real progress.

The path forward

Whoever takes office, the best-case scenario involves continuing with reforms aimed at growing the economy, with all political parties supporting these efforts with transparency and accountability.

Stakeholder management will be crucial, but there is no other way to avoid the complete package of five crises. Economic growth, fiscal discipline, and political unity are essential if Sri Lanka is to emerge from this difficult period.

The thin line between gaining power and triggering crises

By Dhananath Fernando

Originally appeared on the Morning

The game has begun. The familiar auctioning of non-existent resources during election season is in full swing. Candidates are making various promises without considering the repercussions they will face whether they win or lose.

Candidates are likely contemplating two things: first, promise now, gain power, then deal with the aftermath of those promises. Secondly, if they know they’re not going to win, they might promise the impossible, thinking they won’t have to deal with the consequences. Neither of these approaches is without significant risks and either can lead to disastrous consequences.

Elections and governing a country go beyond mere promises and their execution; it’s about managing people’s expectations with available resources.

After the economic crisis, all indicators suggest we are slowly recovering, thanks to stringent measures. Interest rates have soared to record highs to curb inflation. Urban poverty has tripled, rural poverty has doubled, and the already impoverished estate sector has seen a 1.5-fold increase in poverty.

Apart from our parliamentarians, all citizens have compromised their wealth and earnings. The public has reluctantly understood that tough sacrifices are necessary.

Impossible promises

The promises being made now are simply impossible to deliver. One such promise is a 25-50% salary increase for Government employees. Even the last Budget’s cost of living allowance increment is yet to be fully implemented. According to the 2023 Budget, Government salaries and wages total approximately Rs. 939 billion. Therefore, a 25-50% increase would require an additional Rs. 230-460 billion next year.

Our annual revenue from Advance Personal Income Tax (APIT) is at most Rs. 160 billion. This means that the proposed salary hike would require almost 1.5 to three times APIT. Is the private sector ready to shoulder an additional 150-300% in tax or revenue hikes for these Government salary increases?

Just in July, the Government rejected a proposed Rs. 20,000 salary hike for State workers, stating that it would need an additional Rs. 275 billion, which would require increasing the Value-Added Tax (VAT) by 4% to proceed.

Making matters worse, there are suggestions to amend VAT and many other tax rates by different candidates to align with their earlier pitches.

The danger of these promises is that whoever becomes the candidate who comes into power will need to fulfil all these promises, even those made by their competitors, which are unattainable.

The losing candidate, who will then be in the opposition, will always pressure the government to fulfil these unsustainable promises, raising public expectations for things that cannot be delivered. When expectations are unmet, it typically results in a political crisis, or if they try to fulfil what was promised and it is not economically viable, we will end up in an economic crisis.

That is why elections are not just about gaining power but also about managing people’s expectations.

Making promises responsibly

A salary hike for senior Government officials is necessary, but it is only feasible through a complete restructuring of the Government cadre and our military.

Currently, about 48% of our salary expenditure is for the defence sector, with about 32% going to the military. Restructuring the military is complicated and sensitive. A salary hike without restructuring will disincentivise staff who are expecting to leave, adding a massive burden on Government pensions and leading to a pension crisis.

With the new Central Bank of Sri Lanka (CBSL) Act, the Treasury cannot borrow money from the CBSL or print money. Therefore, if the Government borrows more from the market, interest rates will rise and the overall cost of capital will skyrocket.

The proposals to revise VAT are no different. VAT is a reasonable tax system because it only charges for the value added, unlike other indirect taxes like the Social Security Contribution Levy (SSCL), which has a cascading effect. VAT is easier to collect and it creates minimal distortions. Additionally, high-income earners contribute a higher amount of VAT as their consumption is greater.

The discussion about renegotiating the International Monetary Fund (IMF) agreement needs to be approached with caution. In every IMF review, it is clear that adjustments or shifts in timelines are made based on our performance.

However, trying to renegotiate the entire IMF agreement and its structural benchmarks could invite unnecessary complications. Not only Sri Lanka, but our bilateral partners including China, Japan, and India; multilaterals such as the Asian Development Bank (ADB) and Japan International Cooperation Agency (JICA); and our bondholders have all based their calculations on the existing IMF agreement.

It took over a year to negotiate our current terms. Another renegotiation would be time-consuming, and by the time we reach a settlement, the accumulated interest would be unbearable and market confidence would likely falter.

The damage our candidates are collectively doing is by making promises that cannot be delivered during this crucial time, and people’s expectations are a combination of all these. Whoever wins may have to deliver most of these pledges, which is not feasible. If the winner cannot deliver, a political crisis is certain, or if the winner tries to implement what was promised, another economic and social crisis is assured.

While people must vote carefully, candidates must make their promises responsibly; otherwise, they will start losing power from the very first day they receive it.

The State’s business is no business at all

By Dhananath Fernando

Originally appeared on the Morning

We can’t judge a book by its cover, but in the Sri Lankan Presidential Election, we can certainly gauge many people’s futures based on what is said about State-Owned Enterprise (SOE) reforms.

The simple truth is that we can only progress with SOE reforms. These reforms are rare and even mentioning them on a political stage requires courage. However, the fact remains that there is no future without SOE reforms.

Given the resistance by political leaders, this column is another attempt to reiterate why the State should not engage in business and how State involvement in business impacts all citizens.

Why should the State not do business?

The role of the State is not to do business but to ensure the rule of law. As the saying goes, “When you do something, you are not doing something else.” When the State engages in business, it neglects its primary duty – upholding the rule of law, which is its core mandate.

Another reason the State should not do business is that it has a unique way of participating in every business as a mandatory shareholder through the tax system. Every corporation is required to pay 30% of its profit to the State, which is essentially the Government’s share.

Additionally, businesses must pay an 18% tax based on their income. This means that the Government collects more than 50% of the profit value without doing anything. Since the Government is already collecting money from all businesses, there is no need for it to engage in business directly.

Why sell profit-making SOEs?

A common argument against privatisation is, ‘why sell profit-making SOEs?” The answer is that the State has no role in business, and even if these enterprises are making a profit, those profits must be evaluated against the value of the assets.

For instance, the Sri Lanka Cashew Corporation has an asset base of about Rs. 500 million, but its annual profit is only around Rs. 14 million. This translates to roughly Rs. 1 million per month. Does it make sense to run a business that generates just Rs. 1 million in profit after tying up resources worth Rs. 500 million?

If we had Rs. 500 million, even the safest investment, such as a fixed deposit at a 6% interest rate, would yield about Rs. 30 million per year, which is more than double the profit of the Cashew Corporation. Just because an enterprise is making a profit doesn’t justify the State continuing to run it if we can’t maximise the return on those assets.

What about the SOEs of Vietnam and South Korea?

Like Sri Lanka, both South Korea and Vietnam had significant SOEs in the 1960s due to limited private capital. As private capital slowly developed, both countries began reforming their SOEs. These reforms included privatisations and gradual government withdrawal through corporatisation.

In Vietnam, there were about 5,600 SOEs in 2001, which was reduced to 3,200 by 2010 through various reform packages under the Doi Moi reforms. By 2016, the number of SOEs had further decreased to 2,600, thanks to reforms including Public-Private Partnerships (PPPs) and corporatisation.

Vietcombank, which was a 100% State-owned bank, was listed on the Ho Chi Minh Stock Exchange as part of a pilot project in 1990. The State’s ownership was reduced by 75%, with 15% of the shares sold to Japan’s Mizuho Bank. Similarly, Petrolimex, a petroleum company in Vietnam, sold 9% of its shares to JX Nippon Oil & Energy on the Ho Chi Minh Stock Exchange.

In South Korea, Korea Telecom (KT) was fully privatised by listing it on the Korean Stock Exchange, New York Stock Exchange, and London Stock Exchange. The Korea Electric Power Corporation was also opened to private investors by listing on the Korean Stock Exchange in 1989 and the New York Stock Exchange in 1999. Other companies, like Pohang Iron and Steel Company, Korea Exchange Bank, and Korea Tobacco & Ginseng Corporation, also underwent reforms to allow private sector participation.

Vietnam attracted Nokia as a key investor for economic growth, while South Korea grew with Samsung and other electronics companies. If Sri Lanka wants to progress, we need to bring in world-class operators that can run these enterprises efficiently, rather than have the Government manage them.

Benefits of SOE reforms

SOE reforms offer a package of four solutions to our problems.

First, they boost Government revenue, as efficiently-run companies will generate higher profits, allowing the Government to increase its revenue.

Second, SOEs have significantly contributed to our sovereign debt, and reforming them can help reduce the national debt.

Third, Sri Lanka requires Foreign Direct Investment, and SOE reforms can serve as a channel to attract such investments.

Fourth, SOE reforms can help cut down Government expenditure, as these enterprises currently contribute to massive Government losses.

SOE reforms require political will because incorporating them into a manifesto is unlikely to attract votes; in fact, it may deter traditional voters. However, the moment of truth will come, and ultimately, we all have to face it – it’s just a matter of time.

Why public transport should be the real campaign promise

By Dhananath Fernando

Originally appeared on the Morning

All political parties want to make promises during the election to attract their voter base.

Some politicians in the Opposition provide material benefits such as roofing sheets, sarees, and mobile phones. Additionally, the ruling party often announces salary hikes for Government servants, special interest rates for retirees, fuel cost reductions, and fertiliser subsidies, expecting to provide relief for voters and secure their votes in return.

The biggest benefit voters can receive from politicians and their manifestos is the improvement of the public transport system. A solid mechanism to improve public transport is more beneficial compared to all other promises combined.

However, the way most politicians are opting to provide relief for the problem of commuting is by removing the vehicle import ban. Removing the ban is necessary because our vehicle stock has not been renewed for the last 4-5 years. However, vehicle imports will not solve the problem of public transportation. Not many politicians or parties understand that our economy and many of the other struggles related to the cost of living are connected to the problem of commuting.

Given the poor status of our public transport system, every middle-class family living in suburban areas within a 20-30 km radius of Colombo wants to travel in their own vehicle. To own a personal vehicle, a middle-income family pays about 150-200% in tariffs on imported vehicles. Simply put, this means that middle-class people pay twice the value of a car, often with a vehicle loan taken at about 12-14% interest.

The solution many middle-class families choose to solve their commuting problem comes at a significant cost to their living expenses and lifestyle. As a result, they end up spending two to three times the value of a vehicle at high-interest rates, cutting down on other potential expenditure, such as higher education or investing in a business.

When the middle class cuts down on spending, many other industries that could have benefited from middle-class expenditure are negatively impacted.

Moreover, as middle-class citizens purchase personal vehicles to solve their commuting problems, the roads become overcrowded. Our average speed during peak hours is dropping below 20 km/h. By spending a fortune on a car at a very high-interest rate, we spend valuable time on the road.

During peak hours, residents from the stretch of Moratuwa, Wattala, Pelawatta, Battaramulla, Maharagama, Kottawa, and Homagama take at least one hour to enter Colombo and another hour to return home. Spending two hours a day commuting means that if a person works for 22 days per month for 12 months, they spend about 22 full days (24-hour days) on the road. This translates to spending at least one month out of 12 on daily commuting. We are spending a month in the most expensive and uncomfortable way possible.

Politicians need to understand the need for a solid public transport system, which will not only provide relief for people but also improve our productivity manifold and boost economic growth and investments.

How can we fix it?

Many political parties make only broad statements, but none specify how to solve the problem. An often-tried solution is buying extra buses from India for the Sri Lanka Transport Board (SLTB) or purchasing new train engines or compartments from India. Despite trying this approach for over two decades, the situation remains the same.

Recent data reveals that after Covid-19, the number of bus routes has declined. One notable bus route that disappeared in Colombo was route number 155, which operated from Mount Lavinia to Mattakkuliya.

While the problem is complicated, the first step to solving it is to encourage people to commute to the city using public transport rather than personal vehicles. Therefore, we need to prioritise high-passenger capacity vehicles in traffic lanes. The priority lane system for buses was a step in the right direction, but the condition of the buses remains very poor. Bus owners are already complaining that high costs and a lack of labour are causing them to leave the industry.

The framework for the solution is to provide a public transport option that is less expensive than travelling by personal vehicle and allows for faster commuting with the same level of comfort as a personal vehicle. In terms of buses, the option is to allow more air-conditioned buses and permit them to charge a higher price.

However, the route permit system must be abolished or replaced with a new mechanism where supply and demand can be matched. With the current route permit system, even if there are many passengers on a particular route, no new buses can be introduced. With controlled pricing, service providers have no incentive to improve their services. Therefore, allowing players to enter with different price points is the first requirement.

Secondly, we can consider high-level options such as a Light Rail Transit (LRT) system, where we can tap into bilateral and multilateral funds.

In terms of trains, private investment must also be allowed. For instance, railway stations across the island are generally located at points where real estate values are the highest. With amendments to the Railways Authority Act, private investments can be tapped to generate alternative revenue models for these stations. Additionally, railway tracks, compartments, and operations can be unbundled, allowing different players to enter each segment rather than running it as a State-run, loss-making monopoly.

Solutions for public transport do not lie solely in Government investments. They lie in making regulatory changes that can unleash the potential of capital, allowing players to enter the market according to demand, and making regulatory changes that offer the public more choices.

Let’s hope that the manifestos of political parties will address the above issues in the upcoming Presidential and General Elections.

Economics 101: A lesson for presidential candidates

By Dhananath Fernando

Originally appeared on the Morning

The story of how Singapore wanted to emulate Sri Lanka and how Sri Lanka later aspired to be like Singapore is widely known. This narrative has been discussed at many forums and political rallies.

Less known, however, is that Dr. Goh Keng Swee, the architect of Singapore’s financial system, advised the Sri Lankan Government and the then President in the 1980s. He clearly outlined what needed to be done and what should be monitored in our economy. Unfortunately, we did not heed Dr. Goh’s advice. He was then the Deputy Prime Minister of Singapore.

What Dr. Goh recommended remains relevant for whoever is elected as the new president on 22 September. His focus was mainly on the financial architecture of the country because he knew that without stability in the financial system, other achievements would be impossible. As it is famously said, ‘Stability is not everything, but without stability, everything is nothing.’

Dr. Goh’s first advice to the President was to monitor the Central Bank of Sri Lanka’s (CBSL) Government securities holdings, which essentially means the money printed by the CBSL. He noted that should the Government continue to print more money beyond the rate of economic growth, it would be a sign of significant trouble and unsustainability.

Evaluating Sri Lanka’s data since 2020, this issue is evident. The Government’s total securities holdings, which were about Rs. 400 billion in June 2020, rose to about Rs. 1,500 billion in September 2021 and exploded to almost Rs. 3,000 billion by June 2022.

Dr. Goh explained that excessive money printing indicated three things: first, the government is spending more than it can afford. Second, it cannot afford to borrow and spend because borrowing from the market will raise interest rates. Thus, excessive printing means spending beyond our borrowing capacity at market interest rates. Third, it points to leakages in revenue.

Essentially, a government that prints too much money fails in all three areas. Therefore, the new president must avoid money printing at all costs. Although the new CBSL Act imposes limitations, the bank can still add excessive money when buying US Dollar reserves while collecting reserves for upcoming debt repayments.

The second metric Dr. Goh advised monitoring was the CBSL’s reserve levels; how the bank accumulates or depletes reserves signals financial stability.

The third indicator to monitor was the exchange rate, which should be observed alongside reserves and money printing. If reserves are depleting while the exchange rate remains stable, it means the currency is being defended at the expense of reserves. Conversely, if the exchange rate depreciates without reserve depletion, it might indicate influencing forex demand by printing more money.

Dr. Goh’s last two parameters were the consumer price index and the cost of construction materials. Printing too much money leads to inflation, raising consumer prices. If the cost of construction materials is high, it indicates slow development. Economic growth involves building and investing, mainly in the construction sector.

It is unfortunate that the Cabinet recently approved an increase in the cess on cement clinker, which will raise cement prices and open room for corruption. Higher cement prices slow down the economy. When construction costs rise, people cut back on other expenditures, shrinking the overall economic cycle and slowing the economy when growth is most needed.

Dr. Goh’s advice to then President J.R. Jayewardene remains valid for the new president, whoever that may be. The real victory lies not just in electing a president through a massive political campaign, but campaigning for an economic programme that can rescue us from the ongoing crisis.

Revising Sri Lanka’s Competition Law Is Essential for Economic Growth

By Ashanthi Abayasekara and Yasmin Raji

As Sri Lanka’s gears itself toward a path of economic recovery, it is now more important than ever that we rethink Sri Lanka’s existing competition law framework. Why is there a need for such a framework, one might wonder, and what is wrong with the current law? 

The answer to the first, is that competition has profound implications on economic growth. In a dynamic market, competition between businesses becomes the catalyst for technological innovation, improved product quality, and increased productivity. 

For example, Advocata Institute’s newest study on the ‘Impact of Anti-Competitive Practices in the Construction Industry on Affordable Housing in Urban Sri Lanka’, highlights the prevalence of specific anti-competitive practices (such as tied selling, cross-ownerships, prevalence of monopolies, exclusive dealings and misleading advertisements) in the domestic tile, cement, and aluminum industries. These anti-competitive practices have deterred fair competition and stifled innovation among businesses, leading to increased prices of these construction goods in the market. A well-crafted and strictly enforced competition law can help minimise such effects by promoting fair competition  and the efficient allocation of scarce resources within markets. 

However, Sri Lanka’s current competition framework, the Consumer Affairs Authority Act of 2003, is far from comprehensive as it does not effectively address anti-competitive practices in markets. Here’s why.

Although the law has provisions that address abuse of dominance between businesses and anti-competitive trade practices, it fails to address issues pertaining to mergers and acquisitions, which is a fundamental aspect of competition law. Current efforts to privatise Sri Lanka’s state-owned enterprises underscore the urgency of addressing this deficiency in the current competition law to prevent the transition from government monopolies to private sector monopolies.

In addition, despite having the legislative powers, the current competition authority, the Consumer Affairs Authority (CAA), lacks the independence and institutional capacity to practically implement the above law, including successfully investigating and adjudicating anti-competitive practice cases. 

The CAA comes under the purview of a line ministry (presently the Ministry of Trade, Commerce and Food Security), with staff appointments, dismissals and decisions about remuneration being made by the minister in charge, leaving the authority susceptible to undue political influence. The CAA  relies on ministry budget allocations for its daily operations, which constrains the extent to which the authority can strengthen its institutional capacity (by hiring qualified, competent and experienced legal staff) to handle cases related to anti-competitive practices in markets, as and when needed. These financial constraints are also a major reason behind the prevalence of low salary scales for staff members. The fact that the Consumer Affairs Authority has not investigated a single case related to anti-competitive practices in the past ten years, according to findings by Verité Research, is indicative of these issues. 

The CAA also suffers from a lack of transparency, wherein their procedures and scope for carrying out raids and investigations, which are largely limited to consumer protection issues, are discretionary, making it difficult to gain the trust of the public. There is also a lack of awareness amongst the general public of the CAA and its functions. Often, this means that the public are not aware of what anti-competitive practices look like, are unaware of their consumer rights and how the CAA can help them address their concerns, resulting in very few complaints filed with the CAA. Whilst the CAA does carry out some awareness campaigns, they are mostly limited to consumer protection issues.  

To enhance the effectiveness of Sri Lanka's competition law and address anti-competitive practices, the Consumer Affairs Act of 2003 needs to be amended to include provisions on mergers and acquisitions.

Improvements to the transparency of the CAA will also be of importance to enhance legitimacy and build public trust in the organisation. One of the ways in which this can be done is by allowing public access to information on the CAA’s mandate and procedures, including actions taken by the CAA against anti-competitive practices.

In addition, awareness about the nature and consequences of anti-competitive practices should be improved amongst the public, law makers, the business community as well as the judiciary, who will be directly involved in matters related to competition.

Most importantly, establishing an independent competition authority with adequate resources is vital for the successful enforcement of competition law in the country. Some ways to do this would be to transfer the power to appoint and remove staff from the line minister to a parliamentary body. Also, revamping the CAA to serve as an appellate body for specialised regulators, like the Public Utilities Commission of Sri Lanka (PUCSL), funded through regulatory levies rather than government allocations, can contribute to its financial independence and effective enforcement.

While implementing reforms to the current competition legal framework will pose challenges, the long-term benefits of fostering a fair and competitive market far outweigh them. Such reforms are crucial for sustained economic growth and prosperity for businesses and consumers alike. Sri Lanka must pursue recommended changes without delay to secure its economic future.

How Trade Restrictions are Inflating Urban Housing Costs in Sri Lanka

By Ashanthi Abayasekara and Yasmin Raji

A glance at Colombo’s (and suburban) housing prices will quickly establish that buying or renting a house is expensive for a vast majority of Sri Lankans. Advocata Institute in a study found that 70% of Sri Lankans cannot afford to own even a basic 500 square foot house in their lifetime. But what is driving up urban housing prices making house ownership unaffordable?

A recent study by Advocata Institute on the ‘Impact of Anti-Competitive Practices in the Construction Industry on Affordable Housing in Urban Sri Lanka’, reveals that urban housing prices are inflated partly due to restrictive trade policies and anti-competitive practices in the markets for housing construction materials.

The study examined the tiles, cement, and aluminum markets, all essential inputs in urban housing construction. These industries were found to be highly concentrated, with few firms involved. Barriers to entry are high due to substantial capital requirements and the need for economies of scale, which new entrants cannot afford. Additionally, market players benefit from significant trade protection through high import tariffs, cementing the dominance of domestic players.

In the case of domestically produced cement, the raw material used in the production of cement, clinker, has been subjected to a cumulative tariff ranging between 16% and 25% from 2014 to 2022. In comparison, importers of bulk and bag cement—the direct competitors of domestic manufacturers—have faced an additional para tariff of CESS consistently over the same period, ranging between 8% and 14%. This put cumulative tariffs for bulk and bag importers significantly higher than for clinker importers, ranging between 27.5% - 38.5% and 26% - 32.5% for bulk and bag cement importers respectively..

Figure 1: Changes to quantity of cement imported, prices, and tariff structures

A similar situation can be observed in the tile market, where imported tiles have been subjected to a total tariff rate ranging between 79% and 89.5% from 2013 to 2022 while tile raw materials were only subjected to a VAT of 8%. This discrepancy in tariff rates creates an uneven playing field, giving domestic manufacturers an unfair advantage over their importing counterparts. 

In addition to the high border tariffs, quantity restrictions have also been utilized to curtail imports. This was predominantly observed in the sweeping import restrictions imposed in April 2020 owing to the foreign exchange shortage prevailing at the time. This saw the quantity of bag cement imported reducing by 65% and tiles reducing by 87%. While most of these restrictions were placed as an attempt to conserve foreign exchange during the forex crisis, the inconsistent way in which these policies have been implemented has disproportionately benefited the larger domestic players in the markets. 

Apart from its implications on the producers and importers of construction materials, the high border tariffs coupled with import suspensions (protectionist trade policies) have resulted in a limited supply of construction materials available for customers, not only limiting their choices but more importantly, driving up the prices of goods exponentially. For example, high tariffs and import restrictions in the tile market led to customers being subjected to price increases of 93%-123% by August 2022 compared to April 2020. Customers also reported waiting times of over a year to receive the goods. 

So how does all of this impact housing affordability? With rising prices of construction materials due to these protectionist trade policies and the lack of competition in the domestic market, the cost of constructing a house has also seen a significant increase over the years, making it unaffordable to a vast majority of Sri Lankans. 

Given these impacts on necessities like housing, the corrective action would be to abolish tariffs altogether as soon as possible, and boost competition in construction material materials. However, due to Sri Lanka’s constrained fiscal space, reducing tariffs and removing trade restrictions should be done gradually. This approach will steadily increase the import of these goods, boost their supply, gradually drive down prices, and ultimately minimize housing affordability issues.

A new era or more turbulence?

By Dhananath Fernando

Originally appeared on the Morning

• The challenges facing Sri Lanka’s next president

The Presidential Election has been announced. Ideally, by 22 September, there will be a new president with a new mandate from the people.

Sustaining power will be more difficult than winning the election. Generally, from the very first day after assuming office, things start to fall apart. This will be the first election after the ‘Aragalaya,’ and we do not know the ground reality.

The last power transition wasn’t smooth. While there was a democratic element in appointing the eighth President after the resignation of the former, that episode had many dark elements, including a massive economic contraction and impact on human lives.

Focus on economics and corruption

Previous elections had a national element, but this time the focus is completely on economics and corruption. The good news is that the path forward is well defined, including macro targets. The International Monetary Fund (IMF) Governance Diagnostic has provided the main reforms needed to curtail corruption, with timelines and responsible institutions. Most of these are non-controversial.

This time, all candidates will also have to declare their assets electronically. We, as the people, should demand that the Commission to Investigate Allegations of Bribery or Corruption (CIABOC) enforces this.

The new president must deliver on anti-corruption promises because the demands of the ‘Aragalaya’ have not been met yet. However, some promises, like recovering assets overseas, are not easy to execute. Therefore, delivering on the anti-corruption sentiment is challenging.

Delivering on the economic front is equally tough. After debt restructuring, our interest rates will likely remain high. When interest rates are high, the cost of capital is higher, slowing down investment.

For instance, buying a computer to automate manual work becomes difficult when money is hard to source due to high interest rates. As a result, our economy will not grow. If the economy is slow to grow, it invites another crisis. Simply put, if the economy doesn’t grow, our debt will not be sustainable.

In other words, if the economy is slow to grow, it indicates that we are heading towards another debt crisis. The next leader must ensure both growth and stability.

The second piece of good news is that we at least have an idea of what targets we need to achieve on the economic front. Our debt-to-GDP ratio must gradually come down to 95% and our revenue must increase by improving our tax net.

Many promises about increasing Government sector salaries and public sector expenditure are good, but will be difficult to keep.

Limited options

In this context, there are two limited options available to increase money and productivity.

The first is improving productivity in what we already do. Simply working harder and putting in more effort can help. For example, reducing the number of holidays by 10% should increase the economy’s momentum because people will work more. But this race cannot be won solely by working harder. We must also look into channels for improving productivity without capital investments.

One such area is opening up business ventures that change the business format. For example, app-based taxi companies have significantly improved the productivity of both passengers and drivers by connecting potential riders with drivers. Companies like Booking.com connect tourists looking for lodging with small-scale lodging options.

Changing the business model has increased income for many people, reduced expenditure for many, and decreased waiting times, increasing overall productivity. The new leader must leverage this productivity lever.

The second option is to reform State-Owned Enterprises (SOEs) to attract capital. Allowing SOEs to undergo privatisation and Public-Private Partnerships (PPPs) can attract capital through investments. Additionally, rather than incurring losses, private entities can generate revenue for the Government through taxes and improve productivity.

The third option is to release land to improve productivity and circulate capital. Providing land ownership to people allows them to use it as security to unleash capital from the banking system, improving productivity.

Beyond these three options, any president will have limited choices. Relying on geopolitical powers in a highly volatile geopolitical environment may also be unfeasible.

Therefore, the challenge for the new president extends beyond getting elected. The real challenge is navigating the period after the election, which will undoubtedly be tougher than getting elected.

Delaying elections threatens political and economic stability

By Dhananath Fernando

Originally appeared on the Morning

Whenever there is an election, there is always a conversation about delaying it. Already, Provincial Council Elections and Local Government Elections have been delayed. This was the case in 2004/2005 and again in 2019.

One rationale is that, having just achieved stability after a massive economic crisis, we need more time to complete some structural reforms and ensure political stability. On the flip side, how can we execute any reform without the mandate of the people? Operating without the people’s mandate means political stability is the first thing to go out the window.

After the resignation of the former President, the process of appointing a new President followed a democratic process. While it may not have been perfect, there was a democratic element involved. Political parties with a mandate from the people were able to contest, and the candidate who could command a majority of confidence through votes was given the responsibility to lead the country for the remaining term of the previous President.

Despite its flaws, this democratic element brought political stability, which led to economic stability. With the President’s support from Parliament, it was possible to enter into an agreement with the International Monetary Fund (IMF) and continue discussions with external and internal creditors for debt restructuring. The political stability that came through the democratic element in the power transition process made it possible to achieve some level of economic stability.

Uncertainty and economic growth

However, the same democratic process has clear guidelines on the expiry time of the mandate. If we do not follow this process, the system that brought stability will push us towards instability again.

Delaying or attempting to delay elections often prompts political parties and their supporters to demand elections, creating instability as people seek to test the mandate of the public. Delaying an election in the hope of completing unfinished reforms rarely works as planned.

Moreover, postponing elections increases uncertainty. Even holding an election carries some uncertainty, but postponing it intensifies this uncertainty. The biggest enemy of any economic development is uncertainty.

After debt restructuring, the only way out for the country is economic growth. According to agreements with bondholders, we start repaying our interest from September onwards. A year of uncertainty will hinder even the small growth potential we have.

For economic growth, we need investments, and in an uncertain economic environment, attracting investments will be difficult. Falling behind our growth targets due to political uncertainty will challenge our debt repayments and credit rating updates.

International support may not be as easy to secure if the legitimacy of the Government is questioned over a delayed national election. It is true that elections themselves have an element of uncertainty. Especially post-Presidential Elections, if Parliamentary Elections result in fragmented party compositions, we risk returning to a scenario similar to President Chandrika Bandaranaike Kumaratunga’s era, with a Coalition Government barely holding a majority.

Passing bills during a time when growth and structural reforms are needed could face resistance and pushback, leading to maintaining the status quo rather than shifting gears for growth and development.

Having a majority or even two-thirds power does not guarantee that all decisions will be right or fast. As we witnessed, a two-thirds majority Government was short-lived due to misguided economic policies. However, a diluted majority will also bring instability and frequent power changes, causing things to go back and forth.

The solution: A common reform programme

If we think about the country and the people, the only solution is a common minimum reform programme where parties agree on a baseline level of reforms. This ensures that regardless of who comes to power, progress continues. The common minimum programme can start with implementing the IMF Governance Diagnostic, which has recommended significant structural reforms for fiscal, monetary, anti-corruption, and State-Owned Enterprise (SOE) sectors.

If we can at least implement the IMF Governance Diagnostic Report as a common minimum programme, even in case of a drift, it will be slow. Delaying elections, however, will accelerate the drift and slow down existing reforms and growth.

The real challenge will be for whoever comes to power next. If the next government cannot drive economic growth through improving productivity, investment, and efficiency, another collapse is inevitable. A common agreement on reforms is required because the common people care less about who rules the country and more about how their future and standard of living will improve.

Bouquets and brickbats for Economic Transformation Bill

By Dhananath Fernando

Originally appeared on the Morning

We all agree that Sri Lanka’s economy requires transformation. Can we transform an economy solely through an Economic Transformation Bill? No. Can we do it without a bill, without a proper legal framework and institutional structure? Again, the answer is a definite no.

Overall, the bill essentially unbundles the Board of Investment (BOI) into three main parts: establishing a powerful Economic Commission to decide and drive investment strategy at a national level, improving the investment climate for investors, and setting up Invest Sri Lanka to attract investors.

The current zones managed under the BOI have been transferred to a new organisation, with options for establishing industrial zones in collaboration with the private sector. This aims to resolve land issues and improve facilities for investors. The new institution is focused purely on trade agreements and economic integration with global supply chains.

A Productivity Commission, modelled after Australia’s, is proposed to enhance market efficiency and prevent anti-competitive practices. Lastly, a type of Government think tank is proposed to provide research services and analytics on trade and investment.

The bill also appears to compile six ideas into one comprehensive piece of legislation. Incorporating debt-to-GDP ratio targets, export-to-GDP ratio targets, and gross financing needs expectations seems to be another objective, as outlined in the preamble.

Risk of political interference

On the flip side, the appointment of members for the Economic Commission and other institutions falls directly under the president’s purview. In instances where the president is also the minister of finance, significant economic powers are concentrated in the hands of a single individual. Given that the majority of members can be appointed by the president, there is a significant risk of political interference in the business and investment climate.

We can set up numerous institutions, but real reform and transformation occur not when the bill is passed but rather when capable individuals drive real change. If we have flawed provisions for the appointment of members to the Economic Commission and other institutions, allowing for political interference, we risk creating another ineffective BOI.

Ideally, appointments should be nominated or approved by the Constitutional Council (CC). Additionally, representation from professional bodies such as the Institute of Chartered Accountants of Sri Lanka (CA Sri Lanka) could ensure adherence to ethical standards.

Steps in the right direction

The new bill proposes six key institutions:

Economic Commission (EC)

Invest Sri Lanka (Invest SL)

Zones Sri Lanka (Zones SL)

National Productivity Commission (NPC)

Office for International Trade (OIT)

Sri Lanka Institute of Economics and International Trade (SIEIT)

The idea of establishing a separate entity to manage investment zones is a step in the right direction. A 2018 study by the Harvard Center for International Development revealed that 95% of BOI investment zones were occupied and investors had identified land availability as a constraint.

Rather than having the BOI run industrial zones, there are many private sector players who can provide better services to investors. Zones SL should collaborate with the private sector to open new zones, providing infrastructure as landlords rather than managing the zones themselves.

The Productivity Commission is another positive policy step, provided it is implemented correctly. Its role should be to ensure a data-driven approach to productivity in each sector, promote competition, and encourage international competitiveness.

The commission should work with industry experts, as productivity expertise varies by sector. Australia’s experience with its Productivity Commission demonstrates the importance of maintaining focus on competition and avoiding mission drift, as seen with the Consumer Affairs Authority, which has deviated from its original purpose.

The OIT aims to address the lack of capacity in trade negotiations. The bill’s overall concept targets structural issues that hinder exports and Foreign Direct Investments (FDIs). However, it does not guarantee the intentions of politicians or ensure that everything will improve after the passage of the bill. The appointment process and selection of competent individuals for committees are crucial.

Implementation challenges

The key challenge for Sri Lanka will be execution. A large government with poor capacity is likely to result in political appointees populating these commissions, given the current appointment structure and salary scales. There is little incentive for qualified individuals to join at the current salaries offered.

Moreover, the Government lacks the capacity to offer higher salaries, and doing so for one segment could lead to demands for salary increases across the board or protests during a politically sensitive period. Phased reforms to reduce the State’s workforce are necessary to improve State capacity and manage these institutions effectively.

When the BOI was established, it was intended to be a one-stop shop for investors. However, it has become another bureaucratic hurdle. We risk repeating this mistake with all six proposed institutions if the wrong individuals are appointed. Conceptually, the policy is in the right direction, but its success depends on the implementation and the people driving it.

Nearing debt negotiation deal amid economic uncertainty

By Dhananath Fernando

Originally appeared on the Morning

Sri Lanka is hopeful that we can reach a debt negotiation before the first half of the year. Many are focused on the potential for reductions in principal and interest rates or extensions of debt maturities.

According to a recent update from the Ministry of Finance, we are yet to finalise a settlement with our bondholders, although we are close to an agreement. The Internal Rate of Return (IRR) for the Sri Lankan Government’s proposal is about 9.7%, while the bondholders’ proposal is 11.51%. The total cash outflow according to the bondholder proposal for 2024-2028 is approximately $ 16.6 billion, compared to $ 14.7 billion for the Government’s proposal. Ideally, we should reach a settlement close to the Government’s proposal if all goes well.

Both the initial and revised proposals indicate that bondholders are reluctant to reduce the interest accrued during the suspension of debt repayments. In both proposals, there have been no haircuts on $ 1,678 million of accumulated interest. Only a 4% interest rate has been proposed for 2024-2028.

Bondholders have suggested a 28% reduction on existing bonds, reducing the total bond value from $ 12,550 million to $ 9,036 million. Both parties appreciate the depth of the haircut, particularly with respect to economic growth. These adjustments depend heavily on adhering to the International Monetary Fund’s (IMF) baseline projections. If we fail to achieve the necessary growth rates, we will receive a deeper concession, and vice versa.

Achieving the best debt restructuring plan for Sri Lanka is crucial and our future hinges on economic growth. The debt level must be compared with the size and growth of the economy because only growth can ensure our ability to repay our debt. Our debt sustainability can only be secured through high growth rates, not solely through the debt relief offered by bondholders.

Economic and governance reforms are essential for growth. Notably, bondholders have proposed an innovative idea called Governance-Linked Bonds (GLB), where Sri Lanka would receive an additional benefit of 50 basis points on two selected bonds, each worth $ 800 million, if we implement two key governance reforms – one qualitative and one quantitative. The quantitative target is to reach a 14% tax-to-GDP ratio in 2026 and 14.1% in 2027.

A list of qualitative targets primarily focuses on publishing procurement contracts and tax exemptions, both of which are included in the IMF Staff-Level Agreement. However, the governance linked bonds, according to the proposal, would only apply to two bonds maturing in 2034 and 2035, each worth about $ 800 million.

While GLBs are an excellent idea, it is questionable whether the incentive is sufficient to encourage a strong governance programme. The savings from a 50 basis point cut in interest for $ 1,600 million would be about $ 80 million. Given that our accumulated interest is also about $ 1,600 million, there is a risk that governments could easily deviate.

Nevertheless, GLBs would send a strong signal to the market that the Sri Lankan administration is committed to governance reforms, which would enhance confidence in Sri Lanka.

Sri Lanka’s real challenge is avoiding a second debt restructuring. We can only achieve this by taking necessary steps and reforms to grow the economy, not solely relying on debt restructuring agreements.

Even if we secure a 30% haircut, our debt-to-GDP ratio in 2032 would still be approximately 95%. Over 50% of countries that have undergone a first debt restructuring have experienced a second. In Sri Lanka’s case, a second debt restructuring would be extremely painful for the population.

Moreover, our interest rates must remain high to meet the Government’s debt servicing requirements, attracting more funds. However, high interest rates discourage investment as people prefer to deposit their money in banks, leading to a low investment environment that could slow down growth. This slowdown would bring us back to the challenge of managing debt sustainability. This vicious cycle must be avoided.

Growth can only be achieved through improved productivity in a competitive environment, which arises when people are incentivised to perform. When the State dominates business and we try to manage everything independently, people do not become competitive.

Ultimately, growth is the only viable solution. Sadly, it is the only solution. Growth occurs when markets function effectively.

Beyond profit margins and scandals

By Dhananath Fernando

Originally appeared on the Morning

Blaming imports and importers has long been ingrained in Sri Lankan culture, often seen as a root cause of the country’s economic issues. This perspective not only overlooks the fact that many importers are also exporters, but also fails to recognise that imports and exports are fundamentally interconnected components of the global trade system.

Despite this, it is crucial to acknowledge that not all imports are conducted ethically or transparently. Recent scandals, such as the sugar scam, misinvoicing, bribery, and procedural irregularities at Customs, highlight the darker aspects of importation. However, casting imports in a universally negative light and fostering resentment based on ideological reasons could prove to be more harmful than beneficial.

Recent investigative reports have revealed staggering profits made by importers on essential commodities like green gram, B-onions, and potatoes. Some profit margins have been reported as high as 280% when comparing the Cost, Insurance, and Freight (CIF) value to the market prices of these goods.

Before rushing to judgement on these profit margins, it is essential to delve deeper into the circumstances surrounding these imports. For example, the importation of green gram has been severely restricted since the onset of the Covid-19 pandemic, requiring special approval from the Ministry of Agriculture. As a result, the quantity of green gram imported in 2023 has been minimal.

Thus, comparing the CIF value at the port to market prices can be misleading, as it does not accurately reflect the profits made by importers. This situation raises questions about the high market prices for green gram, pointing to inefficiencies in local production rather than exorbitant profits by importers.

The scenario with undu, a staple food item, is similar. With a Rs. 300 import tariff, the market price for 1 kg of undu ranges between Rs. 1,500-1,700. This high cost is partly because importers cannot bring in undu without approval from the Ministry of Agriculture, despite the imposition of tariffs.

Allowing imports could potentially reduce the price of undu to around Rs. 700 per kg, even after tariffs. The restriction on undu imports exacerbates price inflation, making it unaffordable for many, particularly those in estate regions and the northeast, leading to food insecurity among vulnerable populations.

During the recent economic crisis and the consequent shortage of foreign exchange, many imports were facilitated through informal payment channels and ‘open papers’ in undiyal markets. This practice, aimed at evading high tariffs and taxes through under-invoicing, underscores the complexity of Sri Lanka’s tariff structure and the urgent need for its simplification.

The report by the Ways and Means Committee suggests that focusing solely on the cost of goods at the port does not provide a complete picture of the import value, especially considering the prevalence of informal payments. This approach to calculating profits, based solely on declared document values, overlooks additional costs borne by importers, thus distorting the perception of their profit margins.

Moreover, the perishability of essential food items, along with the significant costs associated with storage, wastage, and the impact of rising fuel and electricity prices, further complicates the economic landscape. These factors, combined with high inflation rates, have significantly influenced the cost structure of both the wholesale and retail markets, affecting pricing and profit margins.

The impact of export controls on certain commodities, such as B-onions by India, has also played a role in inflating global prices, illustrating the complex interplay of international trade policies and local market dynamics.

This situation underscores the phenomenon of unintended consequences in economic policy, where well-intentioned policies can lead to outcomes that are diametrically opposed to their original goals. Sri Lanka’s intricate tariff structure and monetary instability have inadvertently encouraged informal payment methods on one hand and escalated costs on the other, placing the poorest members of society in an increasingly precarious position.

While it is undeniable that practices like misinvoicing represent clear violations of the law and must be addressed through appropriate legal channels, attributing the entirety of Sri Lanka’s economic challenges to importers overlooks the broader systemic issues at play. Simplifying the tariff structure, as this column has long advocated, could lead to increased Government revenue and minimise systemic leakages, offering a more sustainable solution to the economic challenges faced by importers and consumers alike.

In conclusion, while illicit practices within the import sector must be rigorously tackled, the solution to Sri Lanka’s economic dilemmas lies not in vilifying importers but in addressing the complex policy and structural issues that underpin the nation’s trade dynamics. A comprehensive approach, focusing on policy reform, tariff simplification, and enhancing local production efficiencies, is essential for creating a more stable and equitable economic environment.