Market-driven solutions for climate resilience

By Dhananath Fernando

Originally appeared on the Morning

It is disheartening to see many areas and lives in Sri Lanka affected by severe weather conditions. The postponement of Advanced Level exams and the broader impact on human lives impose costs that cannot be measured in purely economic terms.

Unfortunately, in Sri Lanka, discussions on climate-related solutions tend to occur only during extreme events like floods or droughts. This article, admittedly, follows a similar trend.

The approach to solving natural disaster challenges in Sri Lanka has often been fragmented, relying heavily on the expertise of individual professions rather than adopting a holistic perspective. For instance, lawyers may frame the issue solely within a legal context, IT professionals may focus on technological solutions, and economists often emphasise financial and economic aspects. This siloed approach overlooks the need for an integrated strategy.

Additionally, many solutions in Sri Lanka depend heavily on Government intervention, creating inefficiencies due to limited governmental capacity and placing a burden on taxpayers. Unfortunately, market-driven solutions for climate and environmental challenges receive inadequate attention in public discourse. There are misconceptions that market-based systems are at odds with climate action, whereas, in reality, markets offer numerous innovative solutions.

Immediate vs. long-term solutions

In the short term, the Government must provide support to those affected by climate-related disasters. Generally, funds are allocated for this purpose in every national budget. However, for long-term solutions, incorporating climate risks into pricing mechanisms is crucial. The market system is not inherently complex; it simply needs to reflect the scarcity value of resources through proper pricing.

Currently, there is no effective way to associate climate risk with specific high-risk areas in Sri Lanka. If we had a digital land registry, we could assign risk values to lands based on factors such as flood, drought, or tsunami risks.

Similar to how platforms like Booking.com rate accommodations for cleanliness, food, and accessibility, land prices could reflect natural disaster risks. This would enable individuals to make informed decisions when selecting locations for agriculture or residence, ultimately reducing property damage and loss of life on a macro scale.

This approach could also encourage financial markets to extend quality credit for low-climate-risk properties within the existing collateral-driven credit system.

Infrastructure and investment prioritisation

The Government could prioritise infrastructure investments in canals and irrigation based on areas with the highest impact, rather than acting on an ad hoc basis. With risk data, disaster relief support could be incentive-based, aligning resources with identified risks.

The concept of property rights and reflective pricing for climate-resistant land can encourage optimal use and sustainable development. Ideally, integrating social safety net information and national identity cards would streamline rescue efforts and improve the efficiency of reaching the most affected people.

Catastrophe bonds

Catastrophe bonds (CAT bonds) represent another market-based solution. These bonds are typically issued through a Special Purpose Vehicle (SPV) by insurance companies to cover large-scale natural disaster risks.

Investors purchase CAT bonds, which provide funds to cover damages in the event of a disaster. If no disaster occurs during the bond’s term, investors receive higher returns. Returns and coupons vary depending on the type of natural disaster covered.

In the event of a catastrophe, investors may lose some or all of their capital. However, the relatively high returns reflect the associated risks. The issuance of CAT bonds also incentivises extensive research and investment in climate event analysis. Early identification of potential disasters not only minimises property damage but also saves lives by enabling timely alerts and evacuations.

With CAT bonds, investors have a financial incentive to invest in areas prone to climate risks, as they see potential returns. For investors, CAT bonds offer diversification opportunities and returns that are less affected by traditional stock market fluctuations or macroeconomic changes. Additionally, CAT bond returns are comparatively higher than those of other types of bonds.

The role of insurance and data

A mature insurance market can significantly mitigate climate risks. One of the main challenges for Sri Lanka’s insurance and capital markets is the lack of comprehensive data.

A digital land registry that integrates weather patterns and risk factors would enable insurance companies and banks to better assess investment risks for businesses and agriculture, in addition to considering the applicant’s credit history.

This would enhance the productivity of the financial sector and improve access to capital. Importantly, it would encourage businesses and agriculture to relocate to low-risk, high-productivity areas, enhancing overall efficiency.

Addressing climate challenges in Sri Lanka requires support from multilateral organisations, particularly for developing markets. However, it is crucial to avoid relying solely on Government interventions or over-regulating productive sectors.

By setting the right incentives and disincentives, and focusing on fundamental, long-term strategies, Sri Lanka can create sustainable solutions beyond ad hoc responses to climate events.

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.

Securing Food Security

Originally appeared on The Morning

By Dhananath Fernando

World Food Day falls on 16 October. In Sri Lanka, food security has been a topic of discussion for a considerable period of time, especially gaining prominence during the Covid-19 pandemic. 

During that period, there was confusion between food security and self-sufficiency. Instead of focusing on ensuring food security, the emphasis was placed on self-sufficiency, with the belief that all food consumed in Sri Lanka should be produced within the country. There were even discussions among Sri Lankans about shifting from using lentils (dhal) to locally-grown maize.

After approximately two years, when we assess the Global Food Security Index report, Sri Lanka is ranked 79th out of 113 countries. Food security isn’t solely about achieving self-sufficiency by producing all the food within the country; it encompasses the affordability, availability, quality and safety, as well as a nation’s exposure and resilience to natural resource risks.

Prior to the inclusion of the natural resources and resilience component, Singapore led the Global Food Security Index. However, after adding this component in 2022, Singapore dropped to the 28th position, with Finland now topping the Index. India is in the 68th position, Nepal in the 74th position, and Bangladesh in the 80th position, just one spot below Sri Lanka.

Due to the economic crisis, characterised by high inflation rates, particularly in food prices, the number of people who were food insecure exceeded six million. This number has now decreased to less than four million, emphasising the significant role economic stability plays in ensuring people’s food security.

Sri Lanka’s food security has always been a challenge due to economic policies that have been against market dynamics. Monetary instability resulting from the unfettered levels of money printing led to food inflation, affecting the affordability of food. 

The Government’s imposition of price controls led to shortages of protein sources such as eggs and chicken, further impacting the availability of food. Additionally, the Government imposed a Special Commodity Levy (SCL) on selected food items as a protectionist measure, maize being a prime example, driving up prices. 

Maize is a key raw material for the aquaculture and poultry industries. Price volatility in maize also affects the prices of poultry products and other locally consumed protein sources, sometimes impacting the competitiveness of our agricultural exports. 

The Government’s approach, whether through higher tariffs or import bans, is equally detrimental. Our food security structure is simply unsustainable, with weak and unpredictable supply chains and inconsistent policies.

Ensuring food security involves addressing both macro and micro issues. A holistic approach, taking into account land rights, is essential. The documentary recently released by the Advocata Institute titled ‘Land, Freedom and Life’ highlights the challenges faced by farmers due to the absence of land rights, hindering their access to capital or technology to enhance productivity.

In addition to land rights, water management is another critical aspect that needs serious consideration. Currently, our water usage in paddy cultivation is unsustainable. We consume approximately 1,400 litres of water to produce 1 kg of rice. Even if we price a litre of water at 50 cents, the cost of the rice we consume would significantly surpass current prices. 

With the challenges posed by climate change, future water availability cannot be guaranteed. Despite the number of people experiencing food insecurity declining, our approach in food production is not sustainable. Another local or global shock could easily set us back.

The Government has attempted various approaches such as providing subsidies for farmers, free meals for school children, and free nutritional packages for women during maternity. However, in order to truly  address Sri Lanka’s food security crisis, a multifaceted approach is required. 

This should begin with macroeconomic stabilisation, providing land titles for farmers and agro-companies to enhance agricultural productivity, reducing labour costs in agriculture, recognising the interconnectedness of markets, and allowing market forces to operate.

Until these issues are resolved, World Food Day will remain a day for discussing problems without implementing solutions.

Contemporary Issues in Agri-Food Supply Chain in Sri Lanka

Originally appeared on the Morning

By Thilini Bandara and Niumi Amarasekara

Introduction

In the current context of food insecurity, building a resilient agri-food supply chain is crucial for Sri Lanka. The agri-food supply chains are a set of activities involved in a “farm to fork'' sequence including farming, processing, testing, packaging, warehousing, transportation, distribution, and marketing. So far, the supply chains have been providing mass quantities of food for the country’s growing population. However, the supply chains are plagued by a number of issues stemming from within and outside the supply chain. Hence this article sheds light on various inefficiencies prevalent in the agri-food supply chain and  the way forward to establish a more resilient supply chain.

Overview of agri-food supply chain in Sri Lanka

Agri-food sector plays a major role in the Sri Lankan economy. It is a key source of food supplies which comprises a complex system of supply chains involving farmers, distributors, processing firms, wholesalers, retailers, and consumers.

Figure 01: Flow of agri-food supply chain

Issues in the agri-food supply chain sector

The country has been experiencing inefficiencies within its agriculture sector due to various issues stemming from within the supply chain.  For instance, Sri Lanka  annually loses 270,000 metric tons of fruits and vegetables along the supply chain, which are estimated to cost around Rs. 20 billion. This accounts for 30-40% of the total agri-food production in the country.One of the key causes of this is the lack of integration between supply and demand . For instance, farmers cultivate their lands without having a scientific understanding of future needs and in the absence of a national-level cultivation strategy to fulfill local demand. This leads to an overproduction of certain crops, which ultimately results in considerable losses for farmers.

Nevertheless, high food miles set along the supply chain also causes a high degree of inefficiency. For instance, when commodities from different parts of the country reach the main economic centers , only to be redistributed, it can cause high cost and further damage to the produce. Also maladaptation of post harvest handling practices at various stages of the supply chain further lead to high wastage and inefficiencies.

Apart from that, a number of additional factors (eg: information asymmetry, limited supply of inputs, lack of infrastructure and support facilities, poor agricultural policies, import restrictions, and price controls, etc.) also hinder the smooth operation of supply chains. Finally, these can lead to significant pricing disparities of the commodities across the island.

Source: Weekly prices, Hector Kobbekaduwa Research & Training Institute

In order to analyze the pricing disparities of Raw Rice (white) across the island, the average of weekly prices were obtained from the Hector Kobbekaduwa Agrarian Research and Training Institute for four weeks from 6th of January 2023 to 2nd of February 2023 of 10 districts across Sri Lanka. Colombo was taken as the base district and the percentage changes were calculated to identify whether there is a significant difference in the prices of each district against Colombo.

Due to lower average retail pricing than Colombo's average retail price, it can be seen from the calculations that in certain paddy production areas like Ampara, Hambantota, and Matara have greater percentage changes of 13.2%, 10.2%, and 9.97% against Colombo respectively. In comparison to Colombo; Anuradhapura, Polonnaruwa, and Kurunegala also have relatively lower average retail prices. The common reason behind this is that food supply to Colombo varies between types of commodities and does not depend on the closest production areas. The variations in distance and transport costs are reflected in the price disparities in Colombo. Apart from that, some other reasons for the price disparities across the island could be possibly due to complex interactions between supply and demand, income variation, uneven population distribution, price controls and the price of close substitutes.

Way forward

In light of the aforementioned issues, continuous development and tailor made policies should be introduced to establish a more resilient agri-food supply chain. Hence below are a few recommendations that can be introduced to the system.

• Establish post harvest handling hubs across main cities of the island to improve the efficiency of the sector

• Farmers/ supply chain actors to be more vigilant on proper post harvest handling techniques to minimize losses

• Utilize railway system as a cost effective source of transportation

• Promote the use of digital marketing platforms to connect different actors across the supply chain

• Integrate these platforms with financial services such as online payments, credit-based transactions, and loan facilities through banks 

• Enhance collaboration among different actors across the supply chain to reduce cost and increase efficiency (eg: promote forward and backward integration via business partnerships)

• Encourage private sector participants to invest in modern technologies along the supply chain to reduce losses

• Encourage innovations/processes that can improve the efficiency and reduce losses along the supply chain
  

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Prof Colombage: Central Bank's V shape recovery projection unrealistic

Originally appeared on The Daily FT

By Prof. Sirimevan Colombage

There is an impending danger that delaying corrective policy decisions might push Sri Lanka towards an L-shaped recovery, prolonging the pandemic-led recession indefinitely

Sri Lanka’s economy contracted by 3.6% in terms of Gross Domestic Product (GDP) in 2020 in the aftermath of the outbreak of COVID-19 pandemic, recording the worst economic performance, as in the case of many countries. Industrial output declined by 6.9%, largely reflecting the adverse performance in apparel, manufacturing and construction. The services sector contracted by 1.5% due to the setback in tourism, transport and personal services. Agricultural production too fell by 2.4% in 2020.

In an effort to revive the economy and to mitigate the adverse impact of the pandemic on individuals and businesses, the Government has implemented a series of measures including health allocations, cash transfers and tax postponements.  These have been supplemented by the monetary easing policy adopted by the Central Bank since last year.

Despite such proactive measures, Sri Lanka is experiencing a prolonged economic recession due to the outbreak of the third wave of the pandemic. The economic recovery has become even more difficult due to the macroeconomic constraints faced by the country even before the pandemic. They include growth slowdown, high fiscal deficit, debt burden and balance of payments difficulties. 

 Alphabet of economic recovery

Questions have been raised across the world regarding the shape of the economic recovery from the COVID-19 pandemic applicable to different countries; whether it is V-shaped, U-shaped, W-shaped or L-shaped.

The best-case scenario is the V-shaped recovery in which the economy rebounds quickly after a sharp decline. In a U-shaped recovery, it takes months or years to revive economic activity. In a W-shaped recovery, the economy recovers quickly but falls into a second recession. Hence, it is known as a double-dip recession. 

The worst-case scenario is the L-shaped recovery in which the economy fails to recover in the foreseeable future.

Central Bank’s V-shaped projection unrealistic

As per the medium-term macroeconomic outlook presented in the Central Bank’s Annual Report-2020, the Sri Lankan economy is expected to rebound strongly in 2021 and sustain the high growth momentum over the medium term, buoyed by growth-oriented policy support. 

Accordingly, the economy is expected to achieve a V-shaped recovery with GDP growth jumping exorbitantly to 6.0% this year from the negative growth experienced last year, as shown in the chart. The growth momentum is projected to remain in the next five years accelerating the growth to 7.0% by 2025.

The Central Bank’s above projection seems to be over-optimistic, given the structural economic imbalances that have been prevailing in the country for a long time, leaving aside the adverse effects of the pandemic. This is clearly reflected by the fact that the economy was already on a downward path even before the pandemic. 

GDP growth averaged only 3.7% during the ‘Yahapalana’ regime of 2015-2019. The average growth rate was down to mere 3.1% in 2017-2019, the period immediately preceding the pandemic. 
Based on our time series projections as shown in the dotted line in the Chart, the annual GDP growth would not have been more than 2% from this year onwards, assuming there is no COVID-19 pandemic. The scenario appears even worse when a non-linear trend projection is applied, which indicates negative growth in the medium-term even without the pandemic. 

Thus, Sri Lanka’s economic downturn is deeply rooted in factors beyond the pandemic which call for immediate policy action.

As the pandemic has exacerbated the economic slowdown, it is highly unrealistic to anticipate a V-shaped economic recovery overtaking the pre-pandemic growth, as projected by the Central Bank.

SL’s poor growth record

Following the cessation of the war in 2009, the economy followed a high growth path supported by the revival of production activities in the north and east together with post-war reconstruction and infrastructure development. However, that construction-based economic recovery was short-lived due to the lack of sustainable growth strategies, fiscal imbalances and export setback. 

The weak economic performance has continued during the ‘Yahapalana’ regime during 2015-2019 in the absence of a coherent economic reform agenda aimed at export-led growth. 

SL lacks technology-driven growth

Economic growth achieved thus far has been driven by using more factors of production – capital and labour. Such growth is identified as ‘factor-driven growth’.  The economic slowdown immediately prior to the COVID-19 pandemic indicated that the economy could not grow any further solely depending on labour and capital inputs. 

In other words, Sri Lanka has reached the ‘Production Possibility Frontier’ (PPF), in economic terminology. Raising the output beyond PPF requires application of technology and innovation thus enabling the economy to materialise ‘technology and innovation-driven growth’. 
In the current global set up, technology and innovations based on human capital are the core growth drivers in many fast-growing countries, which have achieved the knowledge-economy status. Sri Lanka has been lagging behind in terms of knowledge economy indicators: economic and institutional status, education and skills development, Research and Development (R&D) and information and communication technology. 

Unless appropriate policy measures are adopted to fill such gaps targeting technology and innovation-driven growth without further delay, it would be impossible to revive the country’s economic growth hampered by the pandemic in the near future. 

Sri Lanka has lost numerous opportunities to achieve such growth in the post-liberalisation period mainly due to the politically-motivated decisions adopted by successive governments leaving aside economic priorities.

Import-dependent export growth 

A country’s long-run growth rate is constrained by its export capacity and import demand, according to the well-tested theory introduced by Prof. Anthony Thirlwall of University of Kent in 1979. It is known as ‘Thirlwall’s Law of ‘Balance of Payments – constrained economic growth’. The larger the trade surplus (exports minus imports), the faster the economic growth. 

In the long run, therefore, no country can grow faster than that rate consistent with balance of payments equilibrium on current account, unless it can continuously finance ever-growing deficits by foreign borrowing which, in general, is impossible, as evident from Sri Lanka’s experience. 

The country’s envisaged economic recovery largely depends on its ability to raise exports. The pandemic-hit export sector showed some resilience in the first quarter of this year recording a 12.6% increase in total export earnings; industrial exports rose by 7.9%, and agricultural exports by 31.0%. Nevertheless, the trade deficit expanded in the first quarter due to a 12% increase in import outlays. 

The Government has imposed import restrictions on a variety of goods since last year to ease the balance of payments difficulties. Given the high import content of domestic production, such restrictions have downside effects on the export sector as well as on overall economic growth. The recently-announced import ban on chemical fertiliser will adversely affect the agriculture sector, causing food security problems during the pandemic.

Thus, import controls are likely to prolong the pandemic-led recession, as per Thirlwall’s law. 

Selective import relaxation for lawmakers

Whilst import restrictions on some of the essential goods consumed by ordinary people (including turmeric) are in force, the Cabinet is reported to have given its nod to permit importation of luxury vehicles for MPs, reflecting the Government’s absolute insensitivity to the country’s fiscal and foreign exchange crisis amidst the pandemic.  

In contrast, New Zealand’s Prime Minister has said she and the ministers will offer a 20% pay cut lasting six months to show solidarity with those affected by the coronavirus outbreak, as the death toll continues to rise. 

CB’s frequent tinkering with export proceed conversion rules

Last week, the Central Bank once again revised the rules on repatriation of export proceeds, requiring 25% of the proceeds to be converted within 30 days after receiving such proceeds. 

The Monetary Board keeps its discretion to determine the specific export sectors or industries or individual exporters, who or which may be permitted to convert less than 25% of the total of the export proceeds received. This, however, will continue to be subject to not below 10% conversion of the export proceeds and received no later than 180 days from the date of shipment. 

Such discretionary rules introduced in a bid to salvage the country’s foreign exchange situation have severe detrimental effects on the export sector hit by the pandemic, as reiterated in this column earlier. 

Fiscal deficit and debt burden

A crucial macroeconomic imbalance that impinges on Sri Lanka’s growth recovery is the fiscal deficit and the accumulating debt service payments. The budget deficit rose to 11.1% of GDP in 2020 and the available indicators show even a higher increase in the deficit over 13% of GDP this year. 

The continuation of the arbitrary tax cuts and the expenditure hikes already worsened the fiscal situation requiring frequent borrowings from domestic and foreign sources. Annual debt service payments amounting to around 150% of the Government revenue exert enormous pressure on budgetary management. 

While the Central Bank’s low interest rate policy helps to ease the domestic debt service burden, the depreciation of the rupee in recent weeks makes external debt service payments extremely costly. 

Overdependence on foreign loans and swaps

Instead of pursuing the Government to stick to a fiscal consolidation programme targeting a lower fiscal deficit so as to ease the debt burden, the Central Bank continues to rely on short-term foreign borrowings and swap arrangements. This is in addition to its accommodative monetary policy stance with regard to Government’s domestic borrowings.  

Last week, the Bangladesh Bank has agreed to provide a swap facility of $ 200 million. Sri Lanka received renminbi-denominated swap of $ 1.5 billion from China last month. In addition, the Republic of Korea last month agreed to provide concessional loans amounting to $ 500 million to finance the identified projects. 

More swap facilities are in the pipeline, according to the Finance Ministry sources, as reported in the media. 

Fresh debt-funded infrastructure projects 

Meanwhile, the Government is reported to have launched several major debt-funded infrastructure projects including highways a few days ago amidst the pandemic and severe external debt problems. Such borrowings will certainly aggravate the country’s staggering macroeconomic imbalances.

U- or L-shaped recovery for Sri Lanka?

In the backdrop of Sri Lanka’s growth slowdown even prior to the pandemic, the V-shaped recovery projected by the Central Bank is far from reality. 

Assuming a best possible scenario, hopefully the economy would revive after two to three years characterised by U-shaped recovery. The bottom of the U shape represents the extended period of the recession before recovery. 

A longer post-pandemic U-shaped recovery implies that the economy will take a number of years for recovery. First and foremost, the length of the economic recession depends on how long it takes to eradicate the coronavirus at the national and global levels.

Proactive policies are essential to correct the macroeconomic imbalances, specifically the fiscal deficit, bad debt dynamics and the balance of payments deficit so as to revive the Sri Lankan economy at least with U-shape recovery, which is considered to be the second-best option below V-shape recovery. 

There is an impending danger that delaying corrective policy decisions might push Sri Lanka towards an L-shaped recovery, prolonging the pandemic-led recession indefinitely. 

(Prof. Sirimevan Colombage is Emeritus Professor in Economics at the Open University of Sri Lanka and Senior Visiting Fellow of the Advocata Institute. He is a former Director of Statistics of the Central Bank of Sri Lanka, and reachable through sscol@ou.ac.lk)

Fertiliser ban is flawed

Originally appeared on The Daily FT

By Prof. Rohan Samarajiva

The Cabinet Paper banning fertiliser, pesticide, and weedicide imports with immediate effect that was rubber-stamped last week without discussion constitutes a sea change in Sri Lanka’s agriculture policy. Its implications for consumers, for the livelihoods of farmers, and for those who have invested in agriculture and related sectors are vast. 

Despite the 20th Amendment, it is wrong to marginalise Parliament and to ignore State agencies with expertise. Because agriculture is a devolved subject, officials in the Provincial Councils should be consulted even in the absence of elected Council members. Given the expropriatory effects on the private property of those whose investments are affected, the authority of the Courts as the guardians of fundamental rights and as the upholders of equity is likely to be invoked.

No mandate for change

The Cabinet Paper is rather unusual. The entire justification for the proposed actions is anchored on the President’s election manifesto. No references are provided to studies, committee reports, etc.

It is foolhardy to build national policy on the weak foundation of manifesto promises. Each manifesto contains a multiplicity of promises. Was the vote a considered approval for each of those promises? 

The primary purpose of a manifesto is to convince citizens to vote for the candidate or political party presenting it. The secondary purpose is to gain legitimacy for specific actions. Manifesto making is political not scientific or systematic. 

Those who have been involved in manifesto making will testify to the opacity of the process, wherein what is accepted one day can disappear the next and new clauses and conditions can mysteriously appear even after “finalisation”.

Contributions can be sought, and consultations conducted, but in the end, decisions are made by a few in proverbial “smoke-filled rooms.” A manifesto is, at most, broadly indicative of orientation and priority-setting. Given the partisan and opaque procedure used to develop a manifesto, errors and impossible promises are unavoidable.

But because the Cabinet Paper lacks any other justification, one must look. Rather than rely solely on the quoted excerpts, I went to the source. The proposed actions are inconsistent with the language of the manifesto.

In order to guarantee the people’s right to such safe food, the entire Sri Lankan agriculture will be promoted to use organic fertilisers during the next 10 years. For this, production of organic fertiliser will be accelerated.

• To resuscitate the farming community, we need to replace the existing fertiliser subsidy scheme with an alternative system. In the new system, the inorganic and organic fertiliser both will be provided free of charge to farmers. They will be promoted to shift gradually into a complete system using entirely carbonic fertiliser.

• A system of assistance will be introduced to convert traditional farming villages into users of only organic fertiliser.

The language is anchored on food safety. But the ban affects fertilisers and chemicals used for all crops, not just what is consumed by citizens. There is a commitment to provide inorganic fertiliser free. The transition is to take place over a decade. These actions are to be taken in the context of “a new national agricultural policy would be introduced after an in-depth review of the present policies.” This promise is prefaced by a condemnation of “policy that changes from one season to another”.

No national policy based on review of existing policies and experience; no assessment of the experience of other countries; a policy that changes things in one week not a season. And most importantly, the telescoping of a 10-year process into a few months. Sudden, not gradual. Instead of free inorganic fertiliser, a ban. Not limited to traditional villages but across the board. The proposed bans lack a mandate.

Procedurally flawed

A change in a policy with broad impact requires care and caution. 

The change may do much good, as the Cabinet Paper claims. Because of the repeated claims that our food is contaminated with “vasa visa,” most consumers would support a change away from chemical fertiliser and pesticides. But they are unlikely to accept higher prices and unavailability. Hotels are unlikely to accept “ugly fruit”. Growers are unlikely to accept drastically reduced yields and/or inability to market their produce at prices that are above costs of production. The net benefit must be demonstrated, not simply asserted.

Growers large and small will be unhappy about being unable to recover the investments they have made in preparations for growing or in crops in the ground by this sudden reversal in policy. This response will also be shared by other participants in the sector who had entered perfectly legal contracts but are now unable to clear their shipments from the port. It is common sense for the government to give adequate notice of a change in policy or the law so that affected parties can make the necessary adjustments to their business practices minimising losses.

Policy changes that can do good, can also do harm. It is customary in policy formulation and implementation to look at relevant cases in other countries or in this country. Risk assessment, identification of collateral effects, and careful structuring of rules to avoid negative outcomes can be done by government officials or by external consultants with the required expertise. When the government liberalised the market for international telephony in 2003, we studied prior experiences in countries including Hong Kong (the most liberalised market in Asia) and India (to learn what missteps to avoid). 

The President claims that Sri Lanka will be the first to go all-organic. A cursory internet search will show that a fellow SAARC country, Bhutan, announced the intention to go all-organic in 2008; and that its experience has been assessed by independent scholars and published in the peer-reviewed and open scientific publication PLOS ONE in 2018 (DOI =10.1371/journal.pone.0199025). The abstract states: 

Organic agriculture (OA) is considered a strategy to make agriculture more sustainable. Bhutan has embraced the ambitious goal of becoming the world’s first 100% organic nation. By analysing recent on-farm data in Bhutan, we found organic crop yields on average to be 24% lower than conventional yields. Based on these yield gaps, we assess the effects of the 100% organic conversion policy by employing an economy-wide computable general equilibrium (CGE) model with detailed representation of Bhutan’s agricultural sector incorporating agroecological zones, crop nutrients, and field operations. Despite a low dependency on agrochemicals from the onset of this initiative, we find a considerable reduction in Bhutan’s GDP, substantial welfare losses, particularly for non-agricultural households, and adverse impacts on food security.

Does this mean that no other country should go all-organic? No. Is this the only study? No. The purpose of looking at the experience of others is to learn from them. It is irresponsible not make the effort to mitigate the negative impacts will fall upon consumers, growers and others in the sector and to design the policy most suited for local conditions.

Even within the country, prior knowledge existed because the fiasco of the previous Government’s effort to promote organic farming at the behest of Ven. Athuraliye Rathana, MP. That ended with much waste of public funds and the shutting down of the implementing agency, SEMA. It would not have been all wasted if the present Government made the effort to learn from it. 

The Government appears to have learned little from the palm oil ban that had to be walked back and modified. It is normal procedure to circulate a Cabinet Paper to all relevant Ministries for their input to and to win concurrence. Walking back and modifying is what happens when this procedure is not followed.

This blanket ban does not affect only food items consumed within Sri Lanka. It affects subjects under multiple Ministries. It can devastate non-food segments such as foliage exports. It is likely to strangle the fast-growing fruit and vegetable export industry which was subject to rigorous enforcement of standards such as Euro GAP that my organisation worked on with the Department of Agriculture and the exporters association. The Legislature can choose to take actions that result in such collateral effects. But it should at least have considered them. This Cabinet Paper does not.

What should be done

The Government should suspend the implementation of the Cabinet Paper and appoint an inter-Ministry committee of experts with the power to co-opt external experts to report back on a practical method of achieving the objectives of ensuring food safety and environmental conservation. Given the complexity of the changes and the collateral effects, it is best that a pilot be conducted. The larger program design should be based on those learnings. 

If the Government does not act responsibly, the Opposition should demand a select committee, or at least a debate in Parliament. Stakeholders should move the courts. Our food and our livelihoods are too important to be cavalierly toyed with by those learning on the job.

Rohan Samarajiva is founding Chair of LIRNEasia, an ICT policy and regulation think tank active across emerging Asia and the Pacific. He was CEO from 2004 to 2012. He is also an advisor to the Advocata Institute.

Rice crisis: Just give our farmers their lands

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

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By Dhananath Fernando

Rice, the main source of carbohydrates for the majority of Sri Lankans, is a sensitive political topic. I am sure we have all been experiencing this in the recent past. Most often, it is a political football where everyone passes the blame to one another without unpacking the economics behind the rice problem.

Increasing the harvest

If you ask any Sri Lankan the question “what is the problem with the rice market?”, there will be a few common answers. “A rice mafia/monopoly or oligopoly by rice millers” is the most popular. The second most common answer is the fact that the intermediaries are earning more, resulting in farmers being at the losing end.

The third most frequent response is the lack of modern technology in paddy fields which decreases our yield. Many economists and politicians support this argument with a popular statistic which states that agriculture contributes only to 8% of our GDP in comparison to 25% of our labour force involved in farming. In my opinion, the aforementioned concerns are just the tip of the iceberg.

Sri Lankans consume approximately 108 kg of rice per annum per person while the global rice consumption average is 54 kg. The conundrum is that in a country where consumption is twice the global average, farmers continue to be relatively poor.

The main question with rice is: Should farmers increase the harvest or if the harvest drops due to external weather conditions, will they earn the same amount? At times when rice harvest is high, the prices plummet due to ample supply. During this period, we can frequently observe farmers protesting as they urge the government to purchase their seed rice for a guaranteed price or for the government to impose a minimum selling price for farmers as well as a minimum buying price for rice millers. Rice millers have two main solutions to this issue: Either they stop buying seed rice as they cannot sell it at a competitive price because their cost is higher, or they still buy it which results in rice prices in the market skyrocketing to Rs. 110-120.

The high price is not only difficult for consumers to afford but is also a price that political parties pay, which dilutes their political capital. As a result, the Government intervened in the market with limited and poor storage capacity and in some cases, rice was stored in airports. After a few weeks and months, the Government sold these rice seeds to large-scale millers for a lower rate than what they initially paid the farmers, incurring a massive loss of taxpayers’ money. Some of the harvest is wasted due to the lack of storage facilities and logistics failure. As a result, farmers lose out on their income and taxpayers’ money is lost.

The second scenario is the reduction in harvests due to harsh weather conditions which decrease supply and subsequently increase prices of seed rice. Since the total quantity of the harvest is low, the money earned by farmers too continues to be low. Regardless of whether there is a large or smaller harvest, the farmer’s earnings remain consistently low. Hence, farmers are not given an incentive to increase their harvest and overall yield. Playing to their advantage, rice millers have created an oligopoly and so decide on prices in line with their modern and expensive storage capacity.

Land issues

Then comes the question of why technology is out of reach for most farms. The preliminary reason is that most paddy lands are fragmented for small lands, so it is not possible to run a commercial-level operation with superior technology. The more significant reason is that 82% of Sri Lankan land is owned by the government (out of which approximately 30% is covered by forests) and the remaining 18% is available for people’s private usage.

A small proportion of government-owned land has been given to people for cultivation, but their ability to take loans from banks to invest in technologies such as greenhouses is far beyond their reach. Construction on paddy land is illegal, which means there is a lack of space for any transaction or technological investments.

Land issues are a sensitive political issue, but many believe that if farmers are given full ownership of the land, they will sell it to foreigners, which in turn challenges our sovereignty. However, the government ownership of farmlands for nearly a century does not change the destination or quality of life of our farmers. Making things worse, the regulation is such that the paddy lands cannot cultivate anything other than paddy and even if the farmer wants to move for a better high-yield crop, a license needs to be obtained via a cumbersome procedure at government offices.

Given these challenges, how likely is it that anyone would enter paddy farming even if they have a disruptive agricultural idea?

Loopholes in costing structure

Many Sri Lankans believe that we can easily upscale our farming for rice exports. I sincerely wish we could do that too, but unfortunately, this is far from the reality. Sri Lanka cultivates mainly short grain rice in comparison to long grain rice where the world’s demand mainly lies. Even following a good season and excess rice production after domestic consumption, it is not exportable and will further drive the prices down due to excess supply. Furthermore, water is becoming a scarcity due to environmental challenges and currently, we do not calculate costs for water consumed in farming.

Recent research has found that 1 kg of rice requires 2,500 (1) litres of water and more than half of that is consumed by the plant itself. If we consider the cost of water to be Rs. 0.20 per litre, the water consumed by the paddy plant itself adds up to about Rs. 280 which is almost three times the current-controlled price of 1 kg of rice. The cost of utilising land hasn’t been factored. Fertilisers have been provided with a subsidy and that cost needs to be added to our final cost if we are to create a comparable and competitive costing structure.

Solutions

The decade-long series of solutions are well known by most of us. For example, rice millers impose price controls on the selling price following raids by the Consumer Affairs Authority (CAA) at the retail level, and the list goes on. That has been the same response by most governments and it is pointless to further elaborate on what has happened. As a solution, we need to have an easier regulatory system and allow the farmers to own their land. The draconian regulations have trapped farmers in a never-ending cycle of poverty for decades.

From the supply and demand end, the only buyers are rice millers. When there is a single buyer in the industry, they inevitably get higher bargaining power. It is important to diversify our buyer category and the only way to do it is to make rice an industrial product. Today, rice is not only used as a source of carbohydrates; alcohol products, rice bran, rice perfumes, rice-based milk, and rice antioxidants are produced at a commercial level, which offer far higher prices to farmers at the buying stage. This is the solution to increase revenue for farmers and help them escape the vicious cycle of poverty.

The day our farmers have access to their own land will be the day the market is open for many categories of buyers, which will be revolutionary for farmers. Until then, we as the consumers need to patiently experience the price controls, higher prices for rice, and the political blame game.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Coping with latest COPE report

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

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By Nishtha Chadha

On 22 October, the Committee on Public Enterprises (COPE) presented its Third Report to Parliament which examines the performance of 23 state-owned enterprises (SOEs) over the last 19 months. The findings are certainly characteristic of the widescale corruption, wasteful spending, and poor management practices that Sri Lanka’s SOEs are renowned for.

The Chairman’s Note within the report states: “As people are the true shareholders of public enterprises, the right to ascertain that public enterprises invest money so that people get a fair share of its benefits rests with them while it reinforces the democratic foundation of our country.” But unfortunately, as they stand today, Sri Lanka’s SOEs serve exactly the opposite function. Rather than equally distributing the benefits of invested taxpayer money through the Treasury, SOEs place an exorbitant burden on an already debt-ridden economy.

Investigating just 23 of the 450 institutions that the Committee is responsible for overseeing, the report paints a frightening picture of the cumulative extent of damage SOEs have done to Sri Lanka’s economy in recent years. There is no doubt that the current system within which SOEs operate cannot be sustained by the economy. A multitude of reforms have thus been proposed to reduce the toll that SOEs take on the Treasury, ranging from the creation of a public enterprise board to partial and complete privatisation. However, little to no headway has been made in terms of implementation, likely due to the size of these reforms and supplementary lack of political willpower.

How bad is the damage?

According to the Third Report of the COPE, the 18 SOEs with furnished financial statements investigated in the report made a net loss in 2018 amounting to Rs. 61 billion. The report highlights that the Ceylon Petroleum Corporation alone made an enormous loss of Rs. 105 billion in 2018, while the National Water Supply and Drainage Board incurred a loss of Rs. 505 million, and Elkaduwa Plantation Ltd. incurred a loss of Rs. 33 million. Of the 23 institutions being examined, five were found to have annual losses over Rs. 2 million, while another five did not have furnished end-of-year financial statements to present.

The report also outlined several accounts of a wide array of malpractice, including tampering with financial statements, bloating project valuations, conducting unauthorised procurement, failing to collect outstanding debts, and perpetrating political victimisation. Some explicit examples include:

•The Ceylon Petroleum Corporation was found to have wasted over $ 1.5 million on 11 urgent procurements that were undertaken while term agreements were still in place

• Payments for the construction of the Sooriyawewa Stadium by the Sri Lanka Ports Authority amounting to Rs. 3.9 billion, were found to have been removed from the books of the Port Authority in 2017

• An enquiry on the Football Federation of Sri Lanka revealed instances of financial fraud committed by the Manager – Finance, through tampering with the official audit reports of the Auditor General and fraudulently impersonating the President of the Federation on repeated occasions

• A stocktake of the State Pharmaceuticals Corporation found Rs. 20.7 million worth of stocks missing, while Rs. 104.4 million was found to be spent on substandard and expired medicine in 2017 alone

The report thus records over 250 recommendations provided by the Committee to the public enterprises being examined. However, the findings of the Committee also reveal that approximately a third of these recommendations have either not been implemented or not been reported on.

Avenues for SOE reform

Sri Lanka’s total public debt currently amounts to 82.9% of GDP, with domestic debt amounting to 41.6% of GDP, making it one of the most debt-ridden economies in South Asia.

With slowing growth and increasing rollover risks, Sri Lanka’s Treasury cannot sustain annually bailing out loss-making enterprises. There is an urgent need for stronger regulation and tight reforms to stop SOEs from draining public funds.

During the presentation of the latest report to Parliament, COPE Chairman MP Sunil Handunetti requested the Speaker to allow the Attorney General’s Department representatives to observe the proceedings of the COPE, in an effort to expedite accountability procedures. This would certainly present a positive step towards strengthening the legal oversight of malpractice within SOEs and expediting the prosecution of this malpractice. Although the COPE is doing a relatively robust job at identifying incidences of malpractice, this process tends to be slow and lacks sufficient follow through to hold responsible individuals accountable.

The opening up of COPE proceedings to the media has already brought about substantial scrutiny of SOE conduct, however, a lack of enforceable, follow-up accountability mechanisms limits the capacity of this measure. As noted above, several of the SOEs being examined are yet to implement any of the regulatory measures recommended to them by the COPE.

Strengthened accountability mechanisms are thus essential to both holding corruption within SOEs to account, as well as ensuring that the recommendations of the COPE are adhered to. A mechanism needs to be established in order for individuals to be held personally liable for the damages that they are responsible for, beyond just the COPE proceedings. This should extend to all persons who perpetrate, assist, and become aware of malpractice, and do not report it through the appropriate channels.

The surcharge provision of the National Audit Act that allows for the recoupment of any loss caused to the Government by the responsible public servant(s) could prove a useful avenue to achieving this.

There is also an apparent need for industry experts to be further involved in the oversight process. Currently, the COPE reports offer little in the way of strategic enterprise reforms that go beyond merely identifying areas of issue, and look to improve the efficiency and profitability of public enterprises. Technical expertise could therefore prove extremely useful in not only identifying areas for further scrutiny and investigation, but also in creating more effective recommendations for management reforms.

The Commonwealth Association of Public Accounts Committees itself states that the appointment of non-parliamentarians is not without precedent, and given the importance of the Committee, is something that should be considered seriously.

Parliamentary members of the COPE often lack the time and capability to rigorously investigate instances of collusion and malpractice as they happen, and thus support committees of industry experts could prove a valuable resource in addressing this. Appointing non-parliamentarians to the COPE would thereby strengthen the Committee’s independence, increase diversity, and enhance its competency.

Moreover, if the Sri Lankan people are to truly act as the shareholders of public enterprises, they need to be provided with open access to COPE proceedings.

At present, inquiries must be raised by a member of Parliament in order for them to be addressed by the COPE. This distinctly undermines the ability of the public to hold SOE malpractice to account. The limits on non-parliamentarians for attending COPE hearings should be removed, and hearings should be made more accessible to all members of the public. Increased transparency is not something shareholders should have to ask for, especially not from their government.

The Organisation for Economic Co-operation (OECD) proposes a range of guidelines for the corporate governance of SOEs, including the equitable treatment of all shareholders, equal access to corporate information, transparency, and disclosure.

Perhaps a relatively simple way of achieving this would be to list all of Sri Lanka’s SOEs on the Colombo Stock Exchange, thereby making them subjected to the already robust Securities and Exchange Commission (SEC) regulations.

These avenues present achievable interim measures that Sri Lanka should capitalise on. The recent strides made by the COPE are certainly promising in their movement towards stronger regulation and increased public scrutiny, however, Sri Lanka still has a long way to go if it is to seriously mitigate the burden placed on its Treasury by the current state of SOEs. Implementing these reforms could serve as a strong start, but larger reforms will also be essential in achieving sustainable fiscal consolidation.

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Is Sri Lanka keeping its small businesses small?

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

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By Nishtha Chadha

Small and medium enterprises (SMEs) have been a hot topic of this year’s presidential election candidates. Across the spectrum of political parties, SMEs have repeatedly been highlighted as avenues for sustainable economic growth and new innovation. There have been an array of promises to uplift the status and capabilities of SMEs through targeted assistance mechanisms that seek to bolster the role of SMEs in the Sri Lankan economy. However, if the Government truly intends to empower local SMEs, there needs to be a holistic approach to policy reforms and programme implementation.

There is no doubt that SMEs make up a crucial part of the national economy. Accounting for 52% of total GDP and 45% of national employment, these enterprises present a wealth of opportunity for domestic economic growth (1).

Generally, SMEs tend to be labour-intensive and require less establishment capital than larger firms. As such, growth in the SME sector poses significant potential to create new employment opportunities and facilitate wider distribution of wealth across rural and regional areas. They also hold the potential to increase tax bases at a quicker pace than larger enterprises, thereby contributing to government revenue.

However, Sri Lanka still lags behind regional neighbours when it comes to SMEs as a percentage of total enterprises.

In India, Malaysia, and Singapore, SMEs make up between 95-99% of total enterprises, while in Sri Lanka, they barely make up 80% (2018). Moreover, despite their significant contribution to the economy, SMEs in Sri Lanka only account for a marginal proportion of total national exports, suggesting a severe disconnect between the interest of the SME community in expanding their market base beyond the domestic sphere and their practical ability to do so.

The Government itself has acknowledged the need to strengthen the SME sector and increase its export potential.

The National Export Strategy of Sri Lanka (2018-2022) explicitly acknowledges the need to “strengthen Sri Lankan exporters’ market entry capacities” and support “the integration of SMEs from across Sri Lanka into the export value chain”. As a result, the Enterprise Sri Lanka credit programme has been launched by the Government in an attempt to improve awareness and access to finance for small and medium entrepreneurs through a variety of loan schemes. These include interest subsidy loan schemes, donor-funded refinance loan schemes, and financial and non-financial support programmes. Enterprise Sri Lanka seeks to make the Government’s vision of creating 100,000 entrepreneurs in Sri Lanka by 2020 a reality, and has already disbursed Rs. 88 billion through the loan schemes since its launch.

A band-aid approach

While access to finance has certainly been cited as a common barrier to SME growth, there needs to be a more holistic effort to address the various other obstacles that currently deter small and medium entrepreneurs from achieving their export potential. The development of e-commerce has created an era of new opportunity for SMEs to engage in international trade at a fraction of the cost, and Sri Lanka should capitalise on this window of opportunity to reboot its economic growth. The renewed focus of politicians on SMEs does indicate some positive posturing.

However, there is a pressing need to change the narrative on SME growth. Although SMEs are the backbone of the national economy, they need to be supported to grow beyond this classification.

Regulatory burdens and poor access to information continue to remain major impediments to SME expansion.

There are over 20 ministries that serve the business sector in Sri Lanka, with numerous departments, authorities, and councils established under each of them. This has resulted in a major fragmentation of governance mechanisms, critical information gaps, and poor private-public synergy. Thus, in addition to improving access to finance, the Government needs to streamline its SME strategy and make opportunities more accessible to entrepreneurs.

The ultimate goal of SMEs should be to grow into large enterprises that compete at an international scale, and SME-related reforms should reflect these aspirations. Band-aid approaches that target singular obstacles to growth without looking at the bigger picture cannot cultivate the effective ecosystem for entrepreneurship that Sri Lanka needs, if it is to achieve high income status. Present requirements such as the minimum capital contribution of $ 5 million from foreign shareholders in companies that engage in retail trade are not in line with this growth agenda. SMEs should be encouraged to grow faster through partnerships with overseas businesses to access capital and skills. However, restrictions like these hinder the growth of SMEs in the retail sector.

Sri Lanka is already at great risk of falling into the “middle-income trap”, with high debt burdens and slowing national growth. Having recently achieved upper middle-income status, the economy can no longer rely on foreign aid inflows to facilitate economic growth and development. As such, the country must find ways to improve productivity and increase export volumes if it is to remain competitive on the world stage. SMEs present a unique opportunity to facilitate this growth by plugging into global value chains, capitalising on international markets, and driving innovation – but only if they are provided with meaningful resources to do so.

SME success stories from the developed world have demonstrated the importance of public-private co-operation for sustainable growth, and Sri Lanka should look to emulate this if it intends to move beyond its current middle-income status. As noted by the OECD: “Start-ups and SMEs are typically more dependent than large companies on their business ecosystem and, due to their internal constraints, are more vulnerable to market failures, policy inefficiencies, and inconsistencies…a transparent regulatory environment, efficient bankruptcy regulation, and judicial system are essential to support the growth of start-ups and SMEs, especially in innovative, high-risk sectors.” (10)

Thus, to escape the middle-income trap, Sri Lanka needs to make a real commitment to implement all facets of the National Export Strategy and streamline transparent regulatory mechanisms. If Sri Lanka’s next government truly intends to achieve its entrepreneurial vision, it needs to do more than make conflated promises to emerging entrepreneurs and commit to real reforms that will create a fruitful business ecosystem for growth.

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Why SriLankan hasn’t aged well

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

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By Nishtha Chadha

A 2019 poll commissioned by the Advocata Institute found that 81% (Sparkwinn Opinion Poll April 2019. Sample size of 855 participants.) of surveyed Sri Lankans did not believe that the services provided by state-owned enterprises (SOEs) were worth the financial losses incurred by them. Spanning eight provinces and 18 districts, the poll revealed an overwhelming dissatisfaction amongst citizens of all ages and income demographics about the continued use of state funds to bail out loss-making SOEs.

SOEs such as SriLankan Airlines continue to remain some of the largest burdens on Sri Lanka’s already debt-ridden Treasury. While it is a no-brainer that public expenditure should be representative of public interests, there is a severe misalignment between public priorities and government expenditure in Sri Lanka. The above poll results show quite clearly that the public has no interest in bankrolling loss-making SOEs that offer minimal public benefit, but the Government continues to actively support them. Funds wasted on SOEs could easily be redirected to essential public services and institutions, such as healthcare and education, to make real improvements to the everyday lives of Sri Lankans. Instead, exorbitant taxes and low-quality public services have become a staple of Sri Lanka’s public sector, serving the personal interests of corrupt politicians over the legitimate needs of the wider public.

Siphoning taxpayer money

This week, SriLankan Airlines celebrated 40 years since its first flight in 1979. Hailed for its “service to the nation”, the airline has certainly become a hallmark of Sri Lanka’s tourism industry. With an impressive network of 109 cities in 48 countries, SriLankan Airlines Group CEO Vipula Gunatilleka states that the airline’s objective now is “to become the most customer-centric airline in Asia, both in the air and on the ground, building on our four decades of excellence in customer service for which we have won numerous international accolades with our emphasis on safety, punctuality, and service.”

Source: Ministry of Finance Annual Report, 2018

But with the accumulation of Rs. 17.2 billion in net losses for the year 2018, it has become prudent to ask the question: What part of the nation is this airline really serving?

Much like its other state-owned counterparts, the SriLankan Airlines enterprise has become a rampant vehicle for corruption in Sri Lanka’s public sector. A 2018 special report on the airline by the Auditor General’s Department found various accounts of malpractice across the enterprise, including:

• Failure to follow procurement guidelines in the selection of consultative companies

• Failure to introduce formal control systems for the implementation of plans

• Lack of proper cost-benefit analysis in validating expansion of the fleet of aircrafts

• Failure to conduct proper analysis on the method of selection for acquiring aircrafts

• Failure to follow government procurement guidelines in the acquisition of aircraft

Simply put, this suggests a complete lack of accountability within the company. There are few, if any, checks and balances in place to monitor spending, and transparency is scarce. This makes it extremely difficult for the general public to hold managers and public officials to account, despite technically being the owners of the enterprise.

The airline has thus managed to squander a loss of Rs. 58.7 billion of public funds for the past three years. What seems most outrageous about the scale of public expenditure on SriLankan Airlines is the fact that most of the citizens funding these losses will never even get the chance to sit on a SriLankan Airlines flight in their lifetime. As the owners of the enterprise, the public deserves a much larger say in where their money is going.

The airline has thus managed to squander a loss of Rs. 58.7 billion of public funds for the past three years. What seems most outrageous about the scale of public expenditure on SriLankan Airlines is the fact that most of the citizens funding these losses will never even get the chance to sit on a SriLankan Airlines flight in their lifetime

There have been various justifications for the State’s continued commitment to fund these losses, such as the need for capital expenditure to reverse losses and keep the airline internationally competitive. However, evidence suggests that even with the billions of rupees of taxpayer investment, the enterprise is actually becoming increasingly uncompetitive. In 2011, SriLankan Airlines was ranked 52nd globally in the Skytrax World Airline Awards, but today, it does not even rank within the top 100.

What’s the alternative?

Looking at recent years, 2008 stands out among the losses. In this year, SriLankan Airlines enjoyed a net profit of Rs. 4.4 billion. What was different? The airline was running in partnership with Emirates, which had a 40% stake in the company at the time. Emirates was contracted to manage the company for 10 years and completely overhauled the company’s infrastructure and operations to build it into a profit-making enterprise.

However, in 2008, the Government took back sole ownership of the airline after tensions broke out between the Chief Executive and the Sri Lankan Government over the refusal to bump 35 passengers from a full London-Colombo flight to make way for the Sri Lankan President and his entourage (10). From this point onwards, the losses incurred by the airline skyrocketed.

This is an explicit example of why the government should not be running state-owned enterprises. The endemic conflict of interest between players and regulators creates a dangerous breeding ground for malpractice, with taxpayers paying the ultimate price.

SriLankan Airlines’ experience with Emirates has shown the marked benefits of private management, and should serve as a model for future SOE reforms. While partial privatisation can certainly put an end to poor management practices and restore the profit-making capacity of enterprises, the risk of political interference remains pervasive.

Thus, if the Government is to put an end to the enormous burden that loss-making SOEs currently place on the Sri Lankan public sector, it needs to actively pursue avenues for full privatisation while bolstering its role as regulator.

Privatising SOEs will not only allow for better management and increased public expenditure on essential services, but also restore competitive neutrality to the airline business, making air travel more affordable for all Sri Lankans.

Taxpayers should not be spending their hard-earned money on rescuing failing government enterprises with poor management practices. It is high time the Government took a hard look at what the people want and fulfilled its mandate as a representative body. SOEs have become a vehicle for corruption in Sri Lanka’s public sector, and clearly, Sri Lankans are tired of paying for them.

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What to look for in the presidential manifestos

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

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By Nishtha Chadha

The 2019 presidential election campaigns are well and truly in full swing. As rallies pick up across the country, candidates have begun to announce a series of strategies to develop the country, improve living standards, and expand employment opportunities. While a range of promises have been bandied about, this week’s manifesto releases mark a critical juncture for candidates to inform citizens about where their priorities actually lie for the next four years.

Tax cuts, government subsidies, jobs, and social security have all been popular promises on each candidate’s list. The rhetoric is certainly attractive, especially as youth unemployment remains persistent at 21% and the national cost of living is on the rise, with inflation hitting 5% in September. Though there is undoubtedly a need for urgent reforms to improve the average Sri Lankan’s standard of living and access to prosperity, it is prudent to ask the question: How do these promises measure up to Sri Lanka’s current economic situation?

The economic landscape

A number of risk factors currently plague Sri Lanka’s growth trajectory. Although the economy has managed to recover relatively well from the Easter Sunday terrorist attacks, GDP growth is still expected to decelerate to 2.7% in 2019. This is well below the regional average, which is currently forecasted at 5.9% for the year.

The decline of economic growth is in line with global trends, as global GDP growth decelerates and trade and industrial production stagnates. South Asia’s performance is of particular concern, as it concedes its place as the fastest-growing region in the world to East Asia and the Pacific.

Sri Lanka’s economic landscape is reflective of this decline, as the nation’s budget deficit increased above 6% of GDP in the first half of 2019. Sri Lanka’s public debt-to-GDP ratio presently sits at 82.9%, and is expected to increase up to 83.6% in 2020 according to World Bank estimates. This is provided that the current approach to fiscal consolidation continues and no new, uncharacteristic debt is incurred. Even under this conservative estimate, forecasts suggest that Sri Lanka will be the second-most indebted country in South Asia by 2020, with its public debt-to-GDP ratio at more than 20% above the regional average.

Declining export growth and volatile investment across South Asia have further contracted revenues, leading to increased rollover risks. This slowdown in economic activity is likely to constrain job creation and income growth, as well as impede the pace of poverty reduction. Indeed, this is in stark contradiction to the promises currently being relayed by presidential hopefuls and raises serious concerns about what implications the implementation of these measures would have on Sri Lanka’s national economy. Citizens need to be wary of baseless promises that don’t have substantial, long-term priorities at their heart.

What to look for

Sri Lanka needs to consolidate its economic position if it intends to achieve the prosperity it desires, regardless of whose leadership it is under.

This begins with increasing public revenue and tightening government expenditure. Years of ad hoc policies and fragmented government investment into largely unproductive sectors, has resulted in constrained growth and irrational spending across government departments. This has led to large-scale borrowing from international funding partners, and hence, the proliferation of the nation’s current debt crisis. If candidates want to mitigate the risk factors associated with Sri Lanka’s current fiscal position, they need to get Sri Lanka’s spending under control.

Continued fiscal consolidation measures need to be supplemented with long-term expenditure frameworks, which align public expenditure with national growth priorities. Long-term fiscal planning could also serve to increase foreign investment in Sri Lanka, by bolstering investor confidence and reducing the economic impact of political volatility. State-owned enterprises (SOEs) also need to be reformed to reduce their burden on an already debt-ridden Treasury. In 2018, SOE losses amounted to Rs. 156 billion, approximately 9% of total tax revenue, and this figure only seems to be on the increase. Stronger governance and accountability measures are essential to improving SOE performance, and should be a high priority on any candidate’s policy list.

In addition to this, any intended tax reforms must be informed by evidence-based policy and evaluation methods aligned with strategic priorities and fiscal consolidation measures. While there is an obvious need to expand Sri Lanka’s tax base, tax policy amendments must also address the needs of lower income households and ensure sufficient safeguards to limit the burden on Sri Lanka’s most poor and vulnerable. Shifting from indirect to direct taxation methods could be an avenue worthy of pursuit. An active effort must also be made to pre-emptively address the impact of an ageing workforce population. Pension payments currently account for 9% of recurrent expenditure, at Rs. 194.5 billion in 2018. With growth levels already in decline, there is a critical need for the government to encourage longer careers and increase labour force participation across all sectors of society.

Sri Lankans are certainly desperate for change in this election, but this will only happen when politics moves on from being a dinner table conversation to an informed, strategic decision. Citizens need to be informed about more than just the candidates they are electing, but also the policies and priorities they stand for.

Manifestos can present a good gauge of these priorities, but can also be leveraged to hold the incoming president to account. The responsibility here lies with the public, both to vote based on an informed decision, and to demand action on the policies they base their vote upon.

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Are Sri Lanka’s agricultural policies starving our farmers?

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

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By Nishtha Chadha

Farmers have always been a critical voter base in Sri Lankan politics. The 2019 election seems no different. Presidential candidates have thrown around major election promises to improve the living standards of Sri Lanka’s agricultural producers, ranging from the redistribution of state lands to wiping off farmers’ debts. Yet, a stark contradiction exists between the alleged priorities of presidential hopefuls and Sri Lanka’s agriculture policies. 

Agriculture employs 25.5% of Sri Lanka’s population, but only contributes to 7% of the nation’s GDP. While early post-independence agriculture policies focussed on food security and self-sufficiency through rice cultivation, these policies have failed to evolve with the rest of the country, resulting in low standards of living for farmers and high costs for consumers. In 1950, agriculture accounted for 46.3% of GDP and engaged around half the labour force. Clearly the principles that guided agricultural policy then, are unsuited to governing the agricultural sector of today.

A more sustainable approach to improving agriculture

While quick fixes like fertiliser subsidies and debt relief are undoubtedly appealing for struggling farmers, there is an urgent need for more sustainable and holistic policies to support workers in this sector. Farmers need to be provided with real opportunities to earn suitable wages if they are to avoid falling straight back into debilitating debt. This begins with accelerating their production capacity through schemes for diversification and modernisation. 

The Ministry of Agriculture itself has identified the following issues in Sri Lanka’s present agricultural landscape.

• Low productivity of crop and animal products for which demand is rising.

• Poor match between food commodities that are promoted under agriculture development programs and those important for food security.

• Inadequate attention to agricultural diversification in favour of crops that have better income prospects.

• Heavy post-harvest losses, especially in the perishable products.

• Failure to respond to growing concerns of food safety with appropriate
  responses through the full value chain.

• Low priority given to processed food products to cater to demand shaped by changing lifestyles.

• Inadequate attention on producing/developing nutrition-rich food products.

These issues have serious consequences not only on the profitability of Sri Lanka’s agricultural industry, but also on national food security. Malnutrition is already a pervasive issue in Sri Lanka, with the 2016 Demographic and Health Survey revealing that 20.5% of Sri Lankan children are underweight. An explicit misdirection of agriculture policy, in its concentrated focus on low-nutrition cereals rather than diversification, has certainly contributed to this manifestation. Skewed government subsidies towards traditional crops such as paddy, mean that nutrition-rich foods are often imported, and thus fall victim to protectionist taxes that make them unaffordable for many lower-income households. Evidently, Sri Lanka’s current approach of self-sufficiency for food security is not working, and both farmers and consumers are paying the price.

Wasting our export potential

Sri Lanka is uniquely endowed with a high diversity of climatic zones which allows it to grow a range of crops all year-round. This suggests massive potential for the nation to grow and diversify its agricultural exports in fruits, vegetables and floricultural products. The floriculture industry itself has developed rapidly and now earns substantial foreign exchange, while generating direct and indirect employment. In 2018, these exports were valued at US $8.5 million, with 60% travelling to Europe, while Japan, Middle East, USA and Korea make up the other key markets. Sri Lanka is already known globally for its high quality of agricultural exports such as cinnamon and tea, and should capitalise on this to promote other competitive produce. 

However, this must also be supplemented with initiatives to boost productivity and access to export markets for Sri Lankan farmers. In 2018, agricultural exports accounted for 21.7% of total national exports, and were provisionally estimated to be worth USD 2,579 million. But, agricultural productivity measures show very low labour productivity indicators for Sri Lanka when compared to its other South Asian counterparts. Agricultural labour productivity, as measured by gross value added, is also the lowest of all 3 economic sectors - for example, one hour of work in agriculture amounts to Rs. 182.19 gross value added, whereas one hour worked in industry amounts to Rs. 528.27 and one hour worked in services amounts to Rs. 613.91. 

Achieving growth without compromising food security

The Ministry of Agriculture in their Overarching Agricultural Policy 2019 (Draft) states that “Labour productivity is directly linked to farm incomes and therefore, increasing labour productivity will have positive impacts on standards of living.”. This can be achieved through mechanisation and by shifting to production of higher-value commodities. Small-scale farmers who produce most of the country’s agricultural output, though, tend to produce commodities with low economic value. These farmers face a host of barriers in accessing modern technology and plugging into agricultural value chains, which hold massive potential to accelerate production processes. Government assistance programs should therefore be streamlined to encourage the adoption of modern technology at all levels of the production process - from seeding to harvesting, post-harvest processing, value addition, food technology, storage, packaging and marketing. Current strategies of market protection, as well as direct and indirect input subsidies, have meant that governments have distorted incentives towards the production of staple food crops, which have locked subsistence farmers into poor revenues and reinforced their dependence on the state [14]. This has contributed to both a high cost of living for the average Sri Lankan, and low standards of living for small-scale agricultural producers. 

Access to export markets must also be enhanced if farmer incomes are to increase, by removing barriers to trade and increasing intra-industry connectivity. A host of regulatory, procedural, and informational barriers currently plague Sri Lanka’s agricultural sector and obstruct small farmers' ability to access foreign markets. Rigorous stakeholder consultation and long-term planning need to become staples of the regulatory landscape if Sri Lanka is to capitalise on its agricultural export potential. The National Export Strategy of Sri Lanka 2018-2022 has already identified the distinct potential for value addition in the spice and processed food and beverage industries, as a means of increasing agriculture-based export incomes. However, without the right reforms in place to support farmers’ transition into these markets, it is unlikely that this will come to fruition. 

Sri Lanka’s agriculture industry has consistently suffered from a patchwork of ad-hoc policies and fragmented priorities. This has largely been driven by the age-old rationale that self-sufficiency is the answer to food security. However, if the 2019 presidential candidates want to promise meaningful change to their agricultural voter bases, there needs to be a complete overhaul of the current regulatory landscape. Sri Lanka needs to let go of its outdated perceptions of food security and capitalise on its comparative advantage. Singapore boasts the highest food security ranking in the world, yet imports more than 90% of its produce. Global trade is a critical avenue for meeting increasing food demands, as well as changes in consumption and production patterns. Sri Lanka’s agricultural policy should thus focus on increasing cross-border flows and making it more competitive in global markets, not closing itself off from them. Political candidates are constantly touting their visions for Sri Lanka to become a ‘knowledge-based’ and ‘export-oriented economy’, so why doesn’t agriculture form part of this vision?

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