Fuel deal without bidding sparks fears of economic instability

By Dhananath Fernando

Originally appeared on the Morning

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

A facelift for the railway

Originally appeared on The Morning

By Dhananath Fernando

I am a frequent train traveller, whether it’s a short or long distance journey. Often, I book railway tickets from Colombo to Anuradhapura, especially for my mother when she goes to attend religious observances. Many years ago, the process of booking train tickets used to be quite complicated, requiring a visit to the station. However, things have changed over the years. Nowadays, we have the option of booking train tickets online or through our mobile phones.

I usually make the booking by calling my mobile service provider and providing the National Identity Card (NIC) details of the passenger. The fare is then directly charged to my mobile phone. If I am booking for multiple passengers, I need to provide the NIC numbers for all of them. While this method is convenient in some ways, I did have a few concerns.

Despite booking the ticket over the phone, the passenger still needs to physically collect the ticket from a designated counter by presenting their NIC. This seems to defeat the purpose of online/phone booking, as the passenger ultimately has to go and get a physical ticket. The only advantage is that I can ensure that a seat is available before all seats are taken.

Another concern is that online/phone ticket booking opens just two weeks before the departure date. This means that if my mother is travelling on a Sunday and returning on a Tuesday, I need to call on a Saturday two weeks prior for the departure ticket and then again the following Monday for the return ticket. If I wait until Monday to book both tickets, there is a high chance that the Sunday train tickets may be sold out.

Recently, I had the chance to speak with a senior officer from Sri Lanka Railways, who shed light on some of these concerns and suggested ways the railway sector could be transformed. The officer explained that passengers were required to collect tickets in person because the railway ticket inspectors lacked QR-code scanners as well as funding for this investment. Essentially, the requirement to collect the tickets physically stems from the inability to verify the authenticity of online tickets. However, mobile phones could easily scan QR codes, similar to what is done at fuel stations in Sri Lanka.

The limitation of ticket schedules opening only two weeks before departure aims to prevent early bookings that may lead to ticket resales at higher prices, which can disadvantage regular travellers. However, in my view, no business can ask for a better deal than the payment of a service months before even providing it. A ticket shortage also indicates an incapacity to supply services for certain routes on the rail routes that have excess demand.

Another concern I had was why we could not rent out prime railway properties, such as the land owned by Sri Lanka Railways, for development. Regarding this, the officer pointed out that according to the Sri Lanka Railways Authority Act, properties under the railway could only be rented for five years, discouraging larger investments.

This highlights the need for ‘property rights’ to attract investors and promote property development. A key pillar of a market system is ‘property rights’ and most railway stations situated in prime locations are poorly maintained due to a lack of investment. Offering long-term leases to investors could provide funds for essential improvements, including implementing QR code readers for ticket checking.

Developing Sri Lanka’s railway system is not just about receiving train compartments from other countries. Nor is it about having QR codes or simply developing railway stations. We must address pricing incentives for road and train travel while maintaining the benefits for passengers at the core. A customer-centred approach and the right investments are crucial for meeting their expectations. That is why when markets are allowed to develop with space for specialisation, it solves people’s problems.

A master strategy for railway development should aim to fulfil people’s commuting needs. Economics plays a role at both micro and macro levels, emphasising the need to get the economics right for meaningful progress in our railway system.

Fixing policy failures in trade and tariff

Originally appeared on The Morning

By Dhananath Fernando

In Sri Lanka, we have often faced the consequences of two types of failures – ones of those who acted without proper thought and ones of those who had great ideas but never put them into action. This holds true for many of the policies we have implemented, especially when it comes to trade and tariff structures.

Recently, there was a parliamentary discussion on wheat flour prices. While global flour prices have decreased, Sri Lanka’s wheat prices have remained high. Common sense tells us that if prices are not adjusting accordingly, there must be some market intervention or manipulation. We need to return to first principles to better understand this.

The price of any resource represents its scarcity value. Increasing prices indicate a higher scarcity value, while decreasing prices suggest declining scarcity. Wheat flour prices in Sri Lanka have been wielded as a political tool over the years, making them a matter of great significance, particularly for vulnerable communities, such as those in the estate sector. As wheat flour serves as a primary carbohydrate source for many due to income limitations, its price carries immense importance.

In the past, the Government managed wheat flour distribution at heavily subsidised rates, similar to the situation with petroleum products, due to its political value. During the time of President J.R. Jayewardene, wheat flour was imported under the PL 480 agreement and many subsidies were granted under this programme. When Chandrika Bandaranaike Kumaratunga assumed power, she promised to provide a loaf of bread for Rs. 3.50, highlighting the significant political importance attached to the pricing of wheat flour.

Later, a monopoly licence was granted to one company to convert wheat grains into flour. This would have been acceptable if, simultaneously, wheat flour imports were also permitted. However, the Government imposed high tariffs on wheat flour imports while keeping tariffs for wheat grains significantly lower.

This created a lopsided tariff structure that discouraged wheat flour imports, favouring the two companies already engaged in wheat grain to flour conversion. According to the numbers quoted in Parliament, the import tariff for wheat grains is Rs. 3 and the import tariff for wheat flour is about Rs. 35. With this tariff structure, wheat flour importers cannot compete in the market as the tariff rate on flour is about 10 times higher than the tariff on wheat grains.

Additionally, the Government’s practice of issuing licences to selected wheat flour importers has often led to corruption. This combination of higher tariffs, licences, and limited competition has resulted in an advantageous situation for the two domestic companies currently operating in the market, but it has hindered fair market dynamics.

Similar issues exist in the fuel importation process. The tariff on crude oil is lower than that on refined fuel. The crude oil refinery in Sri Lanka, donated by Iran long ago, operates with low efficiency, giving an advantage to inefficient fuel refining processes. This inefficiency in the refining process can impact fuel prices, potentially leading to higher costs for consumers.

In Parliament, the proposed solutions appeared more disastrous than the problem itself. One suggestion involved imposing a special tax on specific companies. However, targeting individual companies with such taxes would be viewed unfavourably by investors. Companies need to be encouraged to make profits through healthy competition and efficiency, rather than through tariff protection and government policies that create problems for all in the long run.

An ideal solution would involve a uniform tariff rate and only a few tariff slabs for all imports, thereby eliminating room for tariff manipulation. Such a system would also minimise corruption at Customs and other government authorities, as importers would find it more economical to pay the standard tariff rates than to resort to corrupt practices.

Let us remember the wisdom of John Charles Salak: “Failures are divided into two classes: those who thought and never did, and those who did and never thought.” We must strive for well-thought-out policies and meaningful actions to foster a fair and prosperous Sri Lanka for all.

Addressing the land problem

Originally appeared on The Morning

By Dhananath Fernando

Decades ago, when tasked with writing an essay about my country, I emphasised its vast potential for production, ranging from agriculture to technology. Since then, Sri Lanka’s need to produce and export goods has been incessantly highlighted in panel discussions, TV debates, and interviews.

However, the real challenge lies not in recognising this need but in understanding why we remain lethargic when it comes to production. While the blame often falls on corrupt politicians and misused public funds, the economic reasons behind our sluggishness go deeper.

In our Grade 9 lessons, we were introduced to the main factors of production: land, labour, capital, and entrepreneurship. Have we ever considered the current status of these factors in Sri Lanka, which are essential for fostering production?

Let’s begin with land. Whether local or foreign, any investor will attest to the difficulty of securing a plot of land for production. Around 95% of the Board of Investment (BOI) zones in the Western Province are already occupied and the BOI has struggled to establish new zones for the past 15 years.

Initiating any production venture typically requires an average of 16 approvals, paving the way for corruption. Investors seek land that is ready for swift set-up and operation, as delays translate to significant costs. They need land equipped with electricity, water, telecom, waste management, and other essential services to minimise the time between investment and production.

Image Credit: JB Securities

Regrettably, the absence of available land turns our aspirations for a production-based economy into mere talk, without any tangible action. Approximately 82% of the land in Sri Lanka is State-owned, encompassing forest reserves and sanctuaries, while only 18% remains in private hands. Resolving land issues is a cumbersome process due to physical documentations that are prone to tearing and misplacement.

Poor utilisation of land by SOEs

State-Owned Enterprises (SOEs) occupy most of our land, and their utilisation has been rather poor. For instance, Sri Lanka Railways monopolises a stretch of land without exploring additional opportunities like real estate development. The Marine Drive land stretch, which offers beautiful sunset views, remains underutilised, discouraging tourists from visiting after 7.30 p.m. due to inadequate street lighting and lack of economic activity.

Private ownership of the railway could have not only transformed that stretch, but also attracted more tourists. SOEs are reluctant to relinquish land, leaving it to the discretion of the respective minister. While occasional rentals or long-term leases may occur, the full potential of the land cannot be unlocked without ownership.

In the present set-up, banks won’t grant loans without land titles and investors won’t risk their entire capital without a proper land base to support their technological advancements. Small-scale, scattered lands are available, but large-scale productions require sizeable plots with appropriate infrastructure. Unfortunately, the Government is losing substantial revenue in taxes and rents due to the underutilisation of land.

Addressing the land problem is imperative for attracting investments and Foreign Direct Investments (FDIs), as highlighted in the Harvard CID team study on Sri Lanka. In the global competition for investors, the land issue remains a key concern for potential stakeholders, as indicated by the World Bank Enterprise Survey.

Image Credit: JB Securities

Solutions

A potential short-term solution involves the Government acquiring land from SOEs that have development potential, converting them into BOI zones, and opening private industrial parks. Private companies can then develop industrial zones and present diverse value propositions to attract investors.

This arrangement would enable the Government to earn revenue through taxes and leasing fees while ensuring efficient land usage. Nonetheless, this is a temporary fix, and we must remain focused on real, long-term solutions.

Looking ahead, the establishment of a digital land registry with accessible and searchable documentation would streamline transactions and promote transparency. Although this vision may appear distant, it should not deter us from pursuing lasting solutions for Sri Lanka’s economic growth.

Rough seas make good sailors: Embracing competition in trade

Originally appeared on The Morning

By Dhananath Fernando

When I first started my career, my boss shared two valuable pieces of advice with me. “There are only two ways to secure a promotion,” he said. “First, you can develop your subordinates to replace you, allowing you to move up the career ladder. Second, you can help your boss get a promotion, positioning yourself to take their place.” 

The essence of his advice was that the key to advancing in one’s career lay in competitiveness. By being competitive, we not only benefit ourselves but also contribute to the entire ecosystem. This principle forms the basis of global trade. Unfortunately, for a long time, Sri Lankans have had a different perspective. We believed that imposing higher tariffs or even banning certain imports would make us competitive. This notion is akin to arguing against hiring smarter individuals to make existing employees more competitive.

For a considerable period, Sri Lankans have embraced this flawed argument at a national level without understanding its fundamental flaw. Many Government policy documents emphasise making local industries competitive through import controls, even using terms like ‘import substitution’.

If this argument were true, why were there no industries developed during the time when most imports remained banned? Even after the recent lifting of some import restrictions, a significant number of imports, including vehicles, still remain on the restricted list. In 2020, imports such as vehicles and turmeric were banned. 

After three years, have we witnessed any local industries becoming globally competitive and gaining market share? By restricting imports of tyres and vehicles, we did not witness the establishment of vehicle or tyre manufacturing for export markets in Sri Lanka. Instead, those who were already competitive in the global market for tyres and rubber continued to thrive, while some competitive players became uncompetitive due to import controls.

There is no formula for becoming competitive by avoiding competition. Just as the saying goes, “rough seas make good sailors”; it is competition that makes any local industry globally competitive.

Another common misconception in Sri Lanka is the belief that we are already an open economy. The truth is that we have become a more closed economy compared to the 1990s and possibly even more closed than in the 1970s. Our imports and exports are constantly declining in relation to our GDP. Instead of becoming a trading hub, we have isolated ourselves over the years, distancing from global economic integration.

Yet another popular argument gaining traction is the need to develop more industries to boost exports. Occasionally, this argument is used to advocate for import restrictions, suggesting that industries can be developed without external competition. In Sri Lanka, the main obstacle to industrial development lies in concerns related to the main factors of production: land, labour, and capital.

Most land slots in the Board of Investment (BOI) zones are already occupied, making it nearly impossible for new investors to secure a plot of land with access to electricity, water, and waste management. Land and property rights are fundamental for unlocking capital. Banks are hesitant to extend credit facilities without land as collateral. Such distortions in factor markets are the reasons behind the poor industrialisation we currently observe.

A commonly cited example for industrialisation is Vietnam, with some falsely claiming that Vietnam became an export hub by avoiding competition. The truth is quite the opposite. If we compare the Free Trade Agreements (FTAs) signed by Vietnam, Sri Lanka, and Thailand, Vietnam has actively embraced Foreign Direct Investment (FDI) and competition, allowing the private sector to drive export development. It was not achieved through a State-led policy of developing industries; rather, industries flourished as a result of market forces.

Competition is the driving force behind trade growth. There is no formula for improving trade by moving away from competition. Just as rough seas make good sailors, it is through competition that our trade can truly thrive.

Economic lessons from ‘The Voice’

Originally appeared on The Morning

By Dhananath Fernando

The global reality TV platform ‘The Voice Sri Lanka’ Season 2 concluded a few weeks ago, with  Rameesh Sashinka, fondly known as ‘Ramiya,’ emerging as the winner. Ramiya comes from a very humble background in Aluthgama and works at the beach, providing services such as surfing for tourists. 

In vernacular terms and according to Ramiya, he is a ‘welle kolla’ or a beach boy, who walked away as the winner of ‘The Voice Sri Lanka’ despite getting eliminated in the knockout rounds. His journey serves as an example of how a functioning market system can lift people out of poverty even in a short period of time.

‘The Voice’ is structured around freedom of choice. In the first round called the ‘blind auditions,’ coaches have the ability to select singers by pressing a button and turning their chair. Generally, talented singers get at least three out of the four chairs to turn, but in Ramiya’s case, only coach Umariya turned around. 

In economic terms, coach Umariya provided Ramiya with market access so that he could test himself in a competitive environment. According to the rules of the competition, if multiple coaches show interest, the singer has a choice of selecting a coach based on their preference. 

A market system works on competition and having diverse choices makes the market more competitive. Market access is very important and licensing schemes that restrict market entry can hinder people such as Ramiya. 

Imagine a situation where Ramiya had to obtain a licence from the Government to prove his talent and a certificate from his Grama Niladhari to prove his skill. Ramiya would have still been in the queue trying to obtain the necessary certificates. As important as minimal regulation and market access is, a competitive regulatory framework with transparency by the organisers is a must.   

In the third round, Ramiya was eliminated. ‘The Voice’ platform has an option for eliminated contestants to make a comeback through a new coach. Coach Supun, who was the fifth coach, picked Ramiya to be a part of his team. 

In economic terms, this is called a safety net. In a competitive market system there cannot be only winners – winning and losing are two sides of the same coin. In order to have a resilient economy, society should have measures in place to support and protect those who experience setbacks. That safety net is the encouragement for them to bounce back and win. That is why our Government should have better focus on building robust social safety nets. 

It is important to recognise Ramiya’s competition strategy as well. He focused on a specific genre of music, but he was very skillful in bringing diversity within his chosen genre. The economic lesson for us is that every nation’s economy is quite different from the next and no one can excel in everything. However, within our competitive environment, we can add diversity and capitalise on our strengths. 

Ramiya, the humble man from the Aluthgama beach, competed on a global platform and brought songs by the likes of Freddie Silva and Upali Kannangara to a global stage by singing in our vernacular. The lesson is that Sri Lankans have the potential to succeed on a global platform and we should not be fearful to compete. Instead, we should embrace the competition as we are capable of winning. There is no point in hiding when we have the capability of winning as Sri Lankans.  

On the other hand, even Ramiya’s most loyal fanbase knows he is not the most talented person in the competition. What he brings is a unique messaging and entertainment to fill the market gap. From an economic and financial perspective, he offers value for money or value for the time people spend on entertainment. He brings a breath of fresh air when he performs. This is a concept that we as Sri Lankans have failed to understand. Our focus has always been on the lowest price, while overlooking value for money.

Let’s take train services as an example. As the Government was able to offer the lowest price, we decided to keep the train service under State control. However, it does not measure up when you compare it in terms of providing value for money. The railway service is plagued by poor quality and delays. It is far better to have a well-functioning train service, even at a higher price, compared to a poorly functioning one.   

In many reality TV programmes, unfortunately, winners fail to succeed in their careers later on. The reason can also be explained through economics. In economics, real wealth is not just money; it is the ability to recreate wealth, the science of making two bucks out of one. 

Songs being sung by the contestants in reality shows are mainly composed by established artists in the field. The original songs have the chemistry or the logic of recreating wealth. If a person who is selected as a winner fails to figure out the science of recreating the same entertainment value, very often they will fail. That is why lottery winners often become poorer than they were, because they do not know how to recreate wealth. 

The reality is that markets exist, whether we like it or not. Markets are not always perfect and they cannot solve all the problems in the world. However, it is the most reasonable solution we have at hand to take our people out of poverty. 

In ‘The Voice’ Season 1, the winner was Harith Wijeratne, a medical doctor. Now, the winner is a beach boy (with all due respect) from Aluthgama. When markets work, it rewards the most competitive person who maximises limited resources. Markets respect diversity (in the quarter-finals of ‘The Voice,’ Ramiya had an intro rap for the song he sang). 

This is another great economic fable from the Sri Lankan community and Ramiya is the one who is presenting it to reality. 

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.

Why it takes so long to recover from an economic crisis

Originally appeared on The Morning

By Dhananath Fernando

I have been reflecting on the last few years of public policy and discussion, which I can broadly divide into three main chapters:

Chapter 1 – Denial

Chapter 2 – Realisation

Chapter 3 - Recovery

Chapter 1 – Denial

There was a time when even respected businessmen thought an economic crisis was a distant scenario. Many politicians, across all party lines, failed to consider a situation of 12-hour power cuts and long fuel lines, and viewed debt restructuring and accessing the International Monetary Fund (IMF) as taboo conversations.

We relied on a $ 3.6 billion bailout from an unknown Omani fund and thought China and the Port City would bail us out as a last resort. Some even thought the discovery of a sapphire cluster might be the breakthrough Sri Lanka needed. Sri Lankans believed we were a special nation with a magical power that would rescue us in some other way.

Despite our strategic location, beautiful weather, and natural beauty being undeniable assets, they do not guarantee a rescue from our own bad policies. Our denial was so strong that an international institution titled their report on the Sri Lankan economy as ‘Denial is Not a Strategy’.

Chapter 2 – Realisation

The moment of truth came, but we were too late to respond. None of our bailout expectations materialised and the international financial architecture found it difficult to save us. Our debt is unsustainable and the IMF requires a commitment from our creditors before providing us financial assistance.

We are struggling due to global geopolitics and our poor diplomatic service and lack of professionalism doesn’t allow us to be taken seriously. We hurt all our friendly nations as well as India, China, Japan, and the US. Islamic countries too were concerned and unhappy with us over different issues.

People only realised the depth of the crisis when medicine was in short supply and their loved ones considered leaving the country. Inflation skyrocketed, prices increased, and poverty affected about 30% of the population.

Chapter 3 – Recovery

The moment people realised the severity of the crisis, they started asking about when we would recover. The simple answer is that it takes a long time and now many of us understand why. Overcoming a crisis of this scale, which in itself is a combination of multiple crises, cannot be done easily.

Simultaneously, we face a balance of payment crisis, a debt crisis, a financial crisis, a humanitarian crisis, and a political crisis. The cost of delaying a response to the crisis and mismanagement has to be shared by us all, with mounting tax increases and high inflation pressure from the grassroots.

As a result, we can see constant protests and interruptions to public life, further worsening the situation. At the same time, this opens a new political space where any political party can make unrealistic promises and auction for votes. This vicious cycle is why recovery from the economic crisis takes a long time.

The specifics of debt restructuring are still a mystery to us. We don’t know how the restructuring will be carried out or the impact it will have on the banking industry. It is also unclear how the markets will respond.

Without domestic debt restructuring, even if we apply a 50% haircut on International Sovereign Bonds (ISBs) and Sri Lanka Development Bonds (SLDBs), our debt to GDP ratio after 10 years will be 136%, according to a Verité Research study published in October 2022. Cost of servicing new debt and the cost of rolling over previous debt at a high yield curve will not bring down our debt to GDP ratio.

Nevertheless, it is still possible for domestic debt to be restructured and banking recapitalisation is necessary. According to the same document, investments in Government securities, primarily Treasury bills and Treasury bonds, account for more than 30% of the interest revenue for the total banking industry.

Hence, changing the interest rates on these securities will affect the stability of banks. On the other hand, 82% of the money in the EPF and ETF has been put into Government securities.

As the required changes take place, no one will be happy, so people and opinion leaders will react in different ways. The changes will go back and forth and recovery will be prolonged. Elections will come and decision-making authorities will change and policy decisions will also go back and forth.

All this is why it takes so long to recover from an economic crisis.

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.

Our only saviour is reforms

Originally appeared on The Morning

By Dhananath Fernando

Whether we will be able to receive International Monetary Fund (IMF) Executive Board approval is now a topic of discussion even amongst the most economically-illiterate person. Let us first set the context.

The Sri Lankan Government and the IMF came to a Staff-Level Agreement in early September 2022. One of the key milestones we have to pass through is to get to some level of negotiation with our creditors. Our credit portfolio is diverse. We have multilateral senior creditors followed by bilateral creditors, including members of the Paris Club, mainly Japan.

On the other hand, there are two main creditors who are non-Paris Club members; India and China.

Paris Club members agree on equal treatment in debt restructuring. In simple words, all member countries of the Paris Club will be treated equally when it comes to restructuring. India has also agreed to assist Sri Lanka in the debt restructuring plan and has provided a letter to the IMF. However, according to the IMF, letters provided by China are not adequate. It has indicated a two-year moratorium, but given the financial needs expected by the IMF, Sri Lanka will not be on a sustainable debt path after a two-year moratorium alone.

Generally, credit assistance provided by multilateral donor agencies such as the World Bank and the Asian Development Bank is not restructured, provided it has been given with very long maturity periods and very low interest rates. Therefore, restructuring those loans has not been the practice. That is how the global financial architecture is designed, given their assistance in eradicating poverty and the IMF being the lender of last resort. 

However, over the last few years, there has been a request by private creditors, bondholders, and some stakeholders that the credit of multilateral donor agencies should also be restructured and China is one party that has made this request. Unfortunately, Sri Lanka is too negligible an economy to make that request or challenge the global financial architecture. .

Given the delays, there is now an emerging conversation on whether we have any other alternative options if the IMF agreement is further delayed. In fact, I asked this question at the meeting convened by the National Council Sub-Committee on identifying short- and medium-term programmes related to economic stabilisation, on whether alternative options were being considered in the likelihood of a delay. According to its Chair MP Patali Champika Ranawaka, the committee has not considered it, but he has an aim of being prepared for the worst-case scenario.  

As we have been saying over the years, we have come to this situation through our own policy errors and with our bad reputation, we do not have many choices in hand. Therefore, finding a solution without the IMF is a major challenge, but we, as a country, cannot avoid the consequences should this agreement get further delayed; social discussion is needed on what we can do to get it soon and on the available alternatives. 

Managing with what we have

One option is to drastically cut down our consumption, including essentials such as food and medicine, and face the situation with what we have. That option can trigger some level of social unrest because ‘a hungry man is an angry man’. 

Even at this level of consumption contraction, our poverty rate has increased above 30% according to a Parliament committee. Out of about five million households, about 1.7 million receive Samurdhi and another 1.1 million are on the waiting list. Of course, Samurdhi is not a good indication, as some people who should receive Samurdhi benefits are not recipients, while others who should not be in the programme are included. However, managing with what we have is one available option that comes with its own consequences. 

Moving ahead with debt restructuring without China?

The next option is to move ahead with debt restructuring without China. This option has a significant limitation because IMF confirmation is required even to restructure the debt of bilateral creditors. Without the IMF, it will be difficult to get Paris Club members and other stakeholders to a debt negotiation table. The more we delay and if China takes a very hard stance, which is likely, we have to request the IMF to move ahead with those who have agreed and hold China’s debt payments until we come to some level of agreement.

We have to understand China’s point of view and geopolitics as well. Our crisis has also become a tug of war between two economic powerhouses. On one hand, China does not want to align or agree with a US-led programme. On the other hand, the relief measures given to Sri Lanka have to be provided to all other countries making similar requests in future.

Pakistan and many African countries and emerging economies are expected to face debt distress in the coming years. China’s growth predictions are low, impacting global economic growth. Hence, the more we delay opening up Sri Lanka to geopolitical sensitivities, the more we will be pushed to align with certain superpowers. If we were to depend on China or India for continuous relief measures, it would be extremely difficult to avoid becoming a geopolitical pawn.

Possible reforms and opportunities 

In this context, it is clear that all available options (with the IMF or without the IMF), will result in extremely difficult times. However, in a crisis, there will be winners as well. Regardless of any of the aforementioned options, there are basic levels of reforms we have to undertake in any scenario. 

State-Owned Enterprise (SOE) reforms must be at the forefront. Without this, we have no future. One good opportunity is to capture the drive within the Indian market. Even if Sri Lanka does nothing, there will be spillover effects from India. The Indian economy, especially the North Indian economy, is growing very fast and we have to connect to their market. If we had played our cards right, we could have become a good connection point for trade between India and China. Instead, we made enemies all over. However, there is still potential. 

The more we delay reforms, it will further exacerbate the problem. As such, reforms are the only saviour in any scenario. It is sad to see how we are distancing ourselves from reforms, with political developments triggering another round of economic and political uncertainty which will lead to social uncertainty. Let us hope reforms move forward fast. 

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.

Sri Lanka’s biggest insecurity: Fear of competition

Originally appeared on The Morning.

By Dhananath Fernando

If we were to take some collective responsibility for the sad state of our country and attribute it to any cause, I believe it is due to our ‘fear of competition’. 

From top to bottom, Sri Lankans have been fearful of competing. Over a period of time, we have become very reluctant to compete and our fear has grown into incompetence. The fear of competition syndrome is spread across all sections of society, from the top executives to people below the poverty line. 

Sadly, as a country, we have not understood the meaning of ‘competition’. In our vocabulary, competition is where winners are selected and losers are ridiculed. However, competition is actually where the winner and the loser both win – when the winner wins, the loser also wins. How can this be?

A winner is defined as an individual who takes the leap to utilise the resources available to their maximum potential. Even in a 100 m race, the winner is the person who covers the distance within the shortest time span.

The recipe for the title of a winner is determined by the effort endured by any individual to go that extra mile and maximise the resources available. Once that formula is found, even the loser can use the formula of the winning person without wasting their resources further. Losers can ask the winners to run on their behalf next time so that the losers can better use their skills elsewhere.

This is how we all use so many consumable goods. Let us take computers as an example: most of us have lost the race of manufacturing computers while many have not even tried. But someone found the computer formula, so now we can all use the winning formula, which helps many of us save our valuable resources. Thus, losers have also benefited. This is why competition makes winners win and losers also win. It is much more than simply picking a winner – it is about the allocation of resources.  

In the Sri Lankan context, the fear of competition is what mainly led to the misallocation of resources. From top to bottom, not only are Sri Lankans fearful, but we also instigate fear in others. 

It was recently reported that a driver who was providing a taxi service using a mobile app had been threatened by some other drivers who were not using the app-based taxi service. The threat had taken place while the service was being provided to foreigners. The underlying reason for this is the fear of competing with mobile app-based technology.  

Fear of competing with private medical schools

While our tuk-tuk drivers have fear of competition regarding app-based solutions, our doctors have a fear of competition regarding private medical schools. They do not want someone capable with a better service in the market because they are fearful that someone else will overtake them. 

Fear of competition in furniture manufacturing 

Our furniture manufacturers are fearful of competing with other furniture manufacturers in the region. Not only are they fearful, they even ask the Government to support some of these industries with taxpayer money.

Fear of competition in the construction industry

Our bathware and tile manufacturers are reluctant to compete with the same category of products overseas. As a result, our cost of construction is about 25-40% higher than the region due to our widespread fear of competition. Most of our construction materials have a tariff of nearly 100% to avoid competition. Even the private sector is suffering from the fear of competition, which is one of the main reasons Sri Lanka lacks big industries and innovation in the system.

University students’ and the labour force’s fear of competition 

Our university students and teachers do not want to compete with international students. As a result, resistance is high against the entrance of any type of private university to the market. Rankings of our universities and colleges have been deteriorating over the years, but we still remain reluctant to compete. Not only do university students want to avoid competition, but they also want to be dependent on the Government.

Our Government servants and entire labour force are fearful that if we open the job market, foreigners with better skills will replace them. Although we are not competitive, we want to maintain our stake.

Across the board, Sri Lankans are deeply fearful of competing with the world. We lack the courage to admit the truth that our competitors can produce high quality products with high efficiency and productivity. If we are so afraid to compete with the world, there is little reason to claim that we have to improve exports. Exporting would mean competing with the world on an uneven playing field with different tariffs imposed in different regions.

Hasn’t our fear of competition not only made the country worse, but also contributed greatly to our economic crisis? Not just politicians, but all Sri Lankans have promoted fear among our fellow citizens. There are no innovations, inventions, or new technologies without competition. That is the sad truth. We have unfortunately become victims of our own actions.

For once, we should admit that we are the problem without absolving ourselves and instead blaming our political elites. While the poor decision-making of politicians is definitely a problem, if we are reluctant to compete, they can easily say that they simply represented our worldview and opinion.

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.

Import controls: Didn’t work in 2020, won’t work in 2022

Originally appeared on The Morning

By Dhananath Fernando

When I was a university student in my final year, I did an internship at one of the leading garment companies in Sri Lanka. My internship stipend was Rs. 5,500 per month, and I worked in Nittambuwa. 

On the weekly payday, it was a tradition that I would bring a small, affordable treat home. Of course, in those days the value of Rs. 5,500 and the purchasing power of the rupee was better than it is today. When my bus reached Pettah station (my interchange for the next bus to my home in Moratuwa), I would walk through the local market. What I could afford to buy from my stipend were fruits like apples, oranges, and grapes that were sold on the market sidewalks, and I would purchase a few of each variety. 

I recalled those days when I heard that the Government would be imposing licensing requirements for the import of 367 products, including apples and oranges. It occurred to me that many of the small traders who used to sell me those fruits would probably go out of business. Furthermore, the consumers who enjoyed affordable sources of fruit may lose access too.

There appears to be a widespread misconception that fruits like apples and oranges are only consumed by the wealthy elite. If they were only consumed by wealthy people, they of course would not be sold on the Pettah pavements and at central bus stands in Colombo and across the country.

The fundamental logic that is important to understand is that we cannot categorise any product as ‘essential’ or ‘non-essential’ in the first place. Different products are essential to different people based on a multitude of factors. 

A particular type of fruit like apples may not be essential to me, as I prefer to eat mangoes instead of apples. But from the perspective of an entrepreneur who was making apple juice or apple vinegar in Sri Lanka, apples cannot be substituted with mangoes. It is very likely that they will go out of business. 

Licensing process

According to the new regulations, the importers of 367 product categories have to obtain a licence for importation. Imposing such a licensing process will undoubtedly lead to corruption.  This move will ultimately only allow people in well-connected elite circles with contacts amongst Customs officers and politicians to obtain the import licences. The small-scale importer will be hit the hardest.

All big industries that require a licence have been taken over by politically-connected individuals. For example, private buses require a licence or a route permit. As the route permit is more expensive than the vehicle itself, buses tend to be poorly maintained, which puts passengers and other road users at risk.

The need for a licence to sell liquor is another example: most of the liquor licences of any given electorate tend to be owned by ruling and Opposition MPs, their family members, or allies.

Similarly, licences for Ceylon Petroleum Corporation-owned filling stations and State-owned LP gas distribution (and many other industries that require licences) have been completely overtaken by politically-connected individuals and most areas have minimal competition as a result.

Even obtaining the licence or approval that is required for basic house construction is a very cumbersome process and is greatly influenced by bribery and corruption.

Furthermore, the prices of many of the newly-affected products will go up. The few people who have the licence will have controlling power over the pricing and will effectively monopolise the industry. 

Imports are not the problem

To think that imports are the cause of the present USD shortage is a completely inaccurate diagnosis of Sri Lanka’s economic situation. 

As the Advocata Institute has explained many times, higher rates of imports have been caused by a reckless monetary policy, including quantitative easing and low-interest rates. Our imports have been declining as a percentage of GDP for the last 30 years, as have our exports. Therefore, thinking that imports are the fundamental problem is a complete misconception.

However, the Government and the Central Bank have recently been taking measures which are steps in the right direction. Increasing interest rates and floating the currency are appropriate in the current context, given the balance of payment crisis the country is undergoing. 

Ideally, interest rates have to be low and the currency has to be strong, but both can happen with time by allowing market forces to work. It is clear that the value of the currency cannot be maintained by forceful intervention. 

However, currency depreciation and higher interest rates will affect citizens in multiple ways. Depreciating the currency will cause inflation rates, which is about 14.2% (CPI, January 2022), and prices of most essentials and non-essentials to spike dramatically. 

Increasing interest rates will encourage people to save more than they spend, so the cost of capital will be high and the economy will be slowed down. Hence, growth will be low. It’s a choice between two equally-difficult options.

Our policymakers should understand that imports are not the problem. The real problem is that we haven’t carried out any reforms to improve the productivity and efficiency of the economy. Until the Government identifies the existence of a problem and takes the necessary actions to rectify it, we will not be able to overcome this crisis.

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.

Fuelling reform

Originally appeared on The Morning

By Dhananath Fernando

Fuel shortages have become abundant. The implications of these shortages need no lengthy explanations. They will affect all of us: from a multinational company to the average man on the street, every action we take in life will be disturbed. The electrical grid is already experiencing multi-hour, island-wide blackouts and the situation could escalate to include water supply and many other utilities, for which the knock-on effect will be very severe. 

There were serious discussions in Parliament about the possibility of revising fuel prices. In fact, the CBSL Governor himself has requested that prices be increased. When fuel prices are increased, it may (to an extent) reduce the demand for fuel. But fuel is such an essential commodity that even when prices are increased, the drop in demand may be low. But when fuel prices are increased, people will have to spend more money on fuel and related products, hence there will be less money being spent on non-fuel imports. As the non-fuel imports come down, the balance of payments will come closer to equilibrium, reducing the extent of that crisis. Ultimately, that’s the fundamental feature of a market system.

Fuel price revisions have never been popular in Sri Lanka, as historically, revisions have always led to price increases. When the former Finance Minister late Mangala Samaraweera announced the price formula along with his team including the present Finance Ministry Secretary Dr. S.R. Attygalle, many people did not see the fuel pricing formula positively. 

In my opinion, the optics and launching the formula were also quite bad in the context of a political economy. The formula was introduced at a time when global crude oil prices were increasing, so many people thought the price formula was just an attempt – or an excuse – to increase the price rather than the proper market mechanism. At launch the officials were laughing and it was launched as V1+V2+V3 = V4 and it was captured in the media and popular rhetoric that policymakers were having fun by increasing the burden on poor people. So while the decision to implement the formula was appropriate, the marketing and getting the public on board with market-based pricing could have been better. Later on, with elections getting closer, adherence to the price formula was not maintained. But market-based pricing of fuel is definitely a need for the ailing Sri Lankan economy. 

It is crystal clear that we are unable to sell fuel at lower prices than the cost of production and distribution without incurring heavy losses and debts. The Ceylon Petroleum Corporation (CPC) makes a loss of Rs. 46.80 per for every litre of diesel even after receiving a duty waiver of Rs. 25. For petrol following a duty waiver of Rs. 45 the CPC makes a loss of about Rs. 18. 37. 

After the fuel shortage became prevalent, the common excuse trotted out by policymakers is that they don’t have dollars to buy fuel. In my view, this is misleading. While it is true that we do not have dollars to buy fuel at the soft-peg rate of approximately Rs. 200 per USD, we may have USD to buy fuel at the market rate of about Rs. 250-260 per dollar. Interestingly, we do not need the assistance of the International Monetary Fund (IMF) to make these little changes with a big impact. Increasing domestic fuel prices may reduce the losses of CPC, but it will not solve the underlying problems causing shortages. Currently our Government makes two main losses on every litre of petrol or diesel: first, it suffers an operational loss on subsidised fuel and secondly, it suffers an exchange rate loss.

While the main reason for the current crisis is shortage of USD, it should be noted that the energy market dynamics are also very weak. It’s a duopoly market with over 80% share for the State-owned CPC, one of the biggest loss-making State-owned enterprises in the nation. As per sales for 2020 of diesel, because of the duty waiver alone, the Government is losing out on about Rs. 30 billion in revenue for petrol and about Rs. 98 billion for diesel. 

It is simply not worth making such losses, making life inconvenient for consumers while also losing political capital at the same time. There is no winner when the State tries to keep fuel prices low. Claiming that our prices are low doesn’t really matter when we have no fuel available at all! So although it is not a popular decision, the right and rational decision is to determine the price based on market forces. Also, the entry barriers have to be reduced or eliminated to allow other players to enter the market. Singapore, a smaller country with a population less than a quarter of Sri Lanka’s, has more fuel and energy suppliers, ensuring price and supply stability.

Rather than merely providing excuses as to why we do not have USD to buy fuel, the Government can identify the price at which it can make the USD available for our fuel imports. Long-term reforms are the only solution for this problem. Emerging from our economic strife is determined by when we start our reforms programme. It’s better for everyone that we start sooner than later. 

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.

Price controls worsen drug shortage

Originally appeared on The Morning

By Dhananath Fernando

Shortages have now become abundant and the new normal. We all know the reason: the foreign exchange shortage that is causing shortages of many essential and non-essential goods. Shortages have even affected our basic essentials, such as fuel and electricity.

We all know the solutions for the problems as well. Unfortunately, we have a shortage of policymakers who have the courage to enact the reforms to rescue our people from the commodity shortages. 

There are many contributing factors to potential shortages: supply chain disruptions, natural disasters, and many other externalities. However, in the Sri Lankan context, it is primarily price controls that are causing shortages. 

When there were price controls on tinned fish, there was a shortage of tinned fish. We had a controlled price for dhal, and dhal disappeared from the market. Cement prices were controlled and we experienced a cement shortage. The same has happened for US Dollars (USD). The Government controlled the price of USD, and the country has a shortage of USD. However, the USD problem is somewhat more complicated as price controls are just one of the reasons for the shortage. Controlling the price of the dollar has the worst effects of all the price controls as it has repercussions on all imports and exports.

As a result of the deteriorating situation, the Government removed price controls on most items which is commendable. It was clearly the right thing to do. Cement, milk powder, and many other commodities removed their price controls. But controls remained in a few very important categories: most significantly, USD and pharmaceuticals. The dollar shortage is worsening the shortages in all other industries and pharmaceutical shortages are creating a nightmare for many patients and their families. Even shortages of basic medicines such as the painkiller paracetamol have been reported. Although it was reported that the demand has increased by more than 200% due to Covid and Dengue, in a market system paracetamol cannot suffer shortages unless there is an economic issue (1).

One of my relatives has a rare type of pneumonia, and only one drug brand is effective in treating it. Since the disease is rare, only a small quantity of that particular drug was imported. Now with dollar shortages and delays in opening Letters of Credit (LCs), that particular drug is of less priority to the drug importer, as the same dollars could have been utilised to import more profitable drugs. 

On the other hand, there are price controls on some drugs and pharmaceuticals. As a result, when the prices have increased, no businesses would have the incentive to import them, as they would be engaging in a business where the cost is higher than the selling price (or where the profit margins are so razor-thin that investment is not justified).

Additionally, pharmaceutical prices and some active pharmaceutical ingredient prices have increased due to the pandemic and resulting supply chain interruptions. Simply maintaining rigid price controls doesn’t make economic sense and it only causes shortages in the market. It even makes the situation worse for local manufacturers, who find it difficult to source raw materials/ingredients. The State Pharmaceutical Corporation (SPC) can survive, because it’s a government institute, and it will receive preferential treatment from the State banks in opening LCs and will receive subsidies from the taxpayer. 

In the case of private companies, the importation of drugs and active pharmaceutical agents are conducted through long-term contracts. If LCs cannot be honoured or opened, both their professional business relationships and the reliability of supply will be affected. Sometimes with changes in credit periods, cost factors will change. This will occur particularly when there are doubts in the market on the exchange rate. In today’s Sri Lanka, where the kerb/black market rate is 20-30% higher than the rate offered by banks, the cost of imports is obviously going to be higher. 

Price controls on pharma are going to create shortages of the drugs that we depend on, as we have already experienced with products including tinned fish, dhal, milk powder, and cement. 

Due to shortages of USD and difficulties in opening LCs, even without price controls it will be difficult to avoid shortages. The main reason is that 2022’s entire global economy is connected through the dollar alone. In such a context, price controls are just going to make the problem worse. 

It is understandable from the Government’s point of view that allowing a sudden price increase of pharma products may not be politically feasible. But it may have a more significant political impact if the products are simply not available on the market. As with oil products, we could have aligned the prices slowly at regular intervals so that the price hikes would be more digestible for the average citizen and therefore less politically damaging. If we had enacted price revisions that aligned with global market prices we may not be where we are today. That is why the market system depends on the price mechanism – it is the thermometer which balances supply and demand. 

For a market system, competition comes before regulation. Imports and exports must work together at full capacity for prices to come down. Therefore, the regulatory framework has to be managed in a way that allows market forces to work. 

When the Board of Investment was positioned as a ‘One Stop Shop,’ there was a joke among the business community that “It’s one more stop” would be more apt. Similarly, the National Medicines Regulatory Authority (NMRA) – supposed to be the regulator of prices and quality of medicines and medical equipment – has simply added a severe burden to the process rather than making it easier. 

References:

• https://ceylontoday.lk/index.php/news/paracetamol-demand-up-275

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.

Government must resign itself to reforms – now

Originally appeared on The Morning

By Dhananath Fernando

My school Advanced Level biology teacher used to tell me how to study for exams. Her main advice was that the first step was to ‘make a decision to study’. I would think to myself, ‘Haven’t we all decided that we need to study?’ 

But she would explain the power of decision making, which applied everytime we make a decision – be it consciously or unconsciously – and mention life every time we had to make a decision: “Not making a decision is a decision. Thinking to ourselves to study later is also a decision. Studying now is a decision. Not studying is also a decision.” 

I realised that it’s all about the thousands of decisions that we make everyday. All of our destinations will be determined by such small decisions. What we are today is based on the decisions that we made in the past; what we will be tomorrow is based on decisions we make today.

The same lesson applies to our economic policy as well. It appears that our policymakers have made a decision to not make any decisions on the public policy front. Since the initial stages of Covid-19, multiple reports have been submitted by experts and the Government has even called for multiple reports on the current economic situation. There was an initial report by the Pathfinder Foundation which focused solely on the pandemic. Then a ‘Road Map for Economic Recovery’ was launched by the Advocata Institute. 

In fact, the President called for a deregulation report, which was chaired by Krishan Balendran and Lalith Weeratunga. Suggestions were handed over by the Delegation of German Industry and Commerce (1) to the Deregulation Committee. There were many other suggestions and ideas by many other stakeholders, including the Chamber of Commerce, on the brewing economic crisis. It was recently reported that the Pathfinder Foundation submitted another report to the Minister of Finance based on the findings of a tripartite discussion between experts from Sri Lanka, Japan, and India. 

After all these suggestions, the decision to delay reforms may have multiple reasons, of which which we can only guess. But keeping assumptions aside, the more we delay, the closer we get pinned to the wall with limited choices to escape from the crisis.

Economic reforms must always be looked at in a political context. Whether the present political power balance supports the reforms is a key question. While many are of the view that with a two-thirds majority reforms can be done, it seems otherwise. Reforms are going to be quite painful so it seems that policymakers are reluctant to push hard reforms, as they are scared that the citizens’ frustration during the reform period may dilute the political capital they enjoy.  Further, this may even cause them to lose the super-majority. 

Even the Minister of Finance has admitted that the State sector and State-Owned Enterprises (SOEs) are a massive burden to Government coffers; yet no State sector reform programme is even on the table. Politics is obviously the concern of the Government and State sector employees and their families are a massive voter bloc. Some of them would lose their jobs or would be pushed into mandatory retirement which would not help politics at the ground level. So reforms are put on the back burner and the Government continues to procrastinate. 

On the other front, the more that we delay reforms, the more the people get frustrated with disturbances to their regular day-to-day activities and businesses, including shortages of essentials such as LP gas, fuel, milk powder, cement, etc. The Government is stuck between a rock and a hard place – whether it carries out reforms or not, its popular support and political capital will be diluted either way. Therefore, my view is that it is better to bite the bullet and carry out reforms, as procrastination is just going to make things worse in the long run.

Another reason that reforms are delayed could be that the energy and focus of policymakers and politicians is spent mainly on fire-fighting day-to-day micro-problems. The situation is such that everyday has become a challenge for the Government to find US Dollars for importing basics and debt repayments.

Weather conditions impacting hydropower generation and global crude oil prices reaching nearly $ 100 a barrel are making our crisis worse. So far our policymakers’ strategy has been to completely depend on swaps. 

Over the last few weeks, India provided us with swaps and credit lines worth $ 1.5 billion and China with another Yuan 10 billion (approximately $ 1.5 b), of which basic information such as interest rates and payment conditionality has yet to be published. Interestingly, the total amount of swaps and credit lines are equivalent to six times the value of the MCC Grant, which created an extensive social discussion on the attached binding conditions which caused the President to appoint a committee to evaluate the grant agreement.

But our economic crisis is such that we are extremely desperate for foreign exchange. We had a presidential commission for a mere $ 480 million grant at a time when people had a deeper sensitivity to the potential conditions, whereas now we have decided to borrow six times more than that without any political party, media, or public figure having voiced their concerns. 

The decisions available at hand for all political parties are limited and difficult. It has come down to simply having the courage to implement reforms. Politics or party lines have become irrelevant as the prescription will not change regardless of the person in the driver’s seat.

Since 1977 and 1990 there has been no effort for any hard economic reforms, so many policymakers think that hard reforms will dilute their popularity. As a result, procrastination on reforms has become the norm. At the same time, the practice and knowhow of driving reforms have not been common. But the truth is that reforms will have less damage on political capital, while not undertaking reforms will have far more serious consequences. Stagnation won’t take us anywhere, but reforms will. 

References

1 https://srilanka.ahk.de/aktuelles/news-details/handover-of-report-on-the-simplification-of-existing-laws-and-regulations-in-sri-lanka

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.

The danger of being anchored in anti-competitive safety

Originally appeared on The Morning

By Dhananath Fernando

The ‘what not to do’ guide for Sri Lanka’s economy from its shipping sector

Once I met a businessman in one of the world’s largest waterproofing corporations, based in the United States. He spoke to me about his humble beginnings. I asked him what his secret for success was. He replied “market system and competition” with confidence. 

He explained that an average person like him was able to create such a large business and social impact which provides employment for thousands of people in just one generation solely because of the market system and competition. “The market system made me an innovative, hard working and a progressive person. I didn’t care about my background. Without competition I could have been the same person as I was 20 years ago,” he said.

In life, hard work and commitment are the basic requirements of prosperity. What we need is a system that rewards hard work and free exchange, so the market system can create progression and prosperity. In any sector when competition is restricted, stagnation is unavoidable. That is one of the main reasons why, in any advanced market system, institutions are built to promote competition and restrict anti-competitive practises such as monopolisation. 

In Sri Lanka our total factor productivity is very low compared to our regional players, due to lack of competition and anti-competitive business practises. Sri Lanka is ranked at 84th in the Global Competitiveness Index (out of 140 economies) while we were ranked 52 in the same index in 2012; clearly, the situation is only becoming more dire.

The shipping industry is just one prominent example of how the lack of competition and anti-competitive trade practises have made Sri Lankan industry stagnant over the decades. While Sri Lanka boasts of its strategic location, our growth has been far below potential for many decades now. We have not only failed at capitalising on our naturally-gifted location but we are mired in debate and friction due to anti-competitive trade practises and attempts to monopolise the shipping industry and supporting services.

Most protected industries and cartels practise  anti-competitive behaviour after a certain period of time, due to stagnation and poor productivity. In a competitive environment, businesses focus more on future opportunities and productivity improvement, than on defending their own interests even if it means resorting to anti-competitive practises. As the American sporting legend Tom Brady famously said: “While the winners are focused on winning, the losers focus on the winners.”

Sri Lanka is quite unfortunate as even shipping, a main sector where we have the opportunity to open up for competition, has fallen victim to protectionist and anti-competitive practises. Minister Vasudeva Nanayakkara filed a public litigation case on the monopolisation of the shipping industry when he was a member of the Joint Opposition during the last regime. However, the lack of regulation to avoid anti-competitive practises will provide very limited space for ordinary citizens to become aware of the extent of the problem. 

Attempts to eliminate minimum investment requirements on shipping industry and freight forwarding with the objective of bringing more competition has failed over the years due to industry resistance. 

The result is shown in the numbers: Sri Lanka has about 750 local shipping, freight forwarding, and clearing agents, whereas Singapore has about 5,000 – despite commencing on its journey to becoming a maritime hub several years after us. Even in the case of the X-Press Pearl environmental disaster, we really did not have the basic ecosystem in place to combat an emergency because of our anti-competitive, inward-looking approach. 

Of course, shipping is not the only industry closed for competition, with anti-competitive behaviour. The acquisition of two of the largest tile manufacturers in Sri Lanka, which operate in an industry that is already highly protected (at one point with 107% total tariff protection), has also been a concern. The result has been the continuous suffering of consumers and the construction industry over the years, with basic housing becoming almost a dream for aspirational Sri Lankans. 

According to the current regulation, the Consumer Affairs Authority (CAA) Act No. 09 of 2003 (which was brought after repealing the Fair Trading Commision [FTC] Act of 1987) is expected to promote competition. Unfortunately, the Act only sets price controls on selected consumer goods instead of truly promoting competition. They raid small mom-and-pop shops for selling goods at rates higher than the set prices, and cast a blind eye on all other anti-competitive behaviour. It should be noted, however, that the CAA is hindered by its limited purview on the Investigation of existence of monopolies, mergers and acquisitions, and anti-competitive practises. 

The previous FTC Act of 1987 had a broader purview to investigate anti-competitive trade practises (compared to current CAA) including agreements to limit production, refusal to prevent  predatory pricing, vertical agreements, and cartels. But the Fair Trade Commision Act lacked implementation guidelines and specific distinction between public and private sectors (1). Anti-competitive practises need to always be analysed with State-Owned Enterprises (SOEs) as most monopolies and anti-competitive practises are SOE driven.

Additionally, the provisions for the appointment and removal of members to the FTC, as well as the way the Act was implemented, raised concerns of the departure from competitive policy at the FTC (2).

A good example of the shortcomings of the FTC is the merger of Glaxo-Wellcome and SmithKline Beecham. FTC considered that it was beyond their purview as it was an international merger. In relation to unfair trade practises, the oft-cited case is that of Ceylon Oxygen Ltd. Ceylon Oxygen had held a dominant market position since 1936 in Sri Lanka. When a new firm named Industrial Gases (Pvt) Ltd. entered the market in 1993, it was alleged that Ceylon Oxygen behaved in predatory manner by reducing the deposit fee on canisters and decreasing maintenance charges, and made discriminatory discounts as well as discriminatory rebates. 

FTC identified  three anti-competitive practices of Ceylon Oxygen, namely, predatory pricing, discriminatory rebates, and excluding dealing. However, when the case went up to the Appeals Court, it was held that the FTC had no jurisdiction to investigate such practises over the case and therefore did not recognise these practises as preventing competition.

Though the FTC had its own shortcomings, the subsequent CAA Act has a far more limited purview. Simply put, Sri Lanka’s business environment and ecosystem are  set on all fronts to avoid competition and promote anti-competitive behaviour, while our prosperity completely depends on the opposite. 

Competition is very important to Micro-, Small- and Medium-Sized Enterprises. They are the first to adapt and grow due to flexibility and agility in a competitive environment. That is the reason the world-class waterproofing businessman whom I had met thanked competition and the market system for his success and the success of his business. 

If Sri Lanka is serious about achieving the status of a high income country, we can only get there by improving our productivity (total factor productivity) and certainly not through debt accumulation. Trade and competition policies play a pivotal role in this journey of reform and our policymakers should focus on implementing high-impact policies to promote competition and avoid anti-competitive behaviours. Unfortunately, the current focus has been on prices and market intervention.

Sri Lanka has a large number of talented young people who could become as successful as the waterproofing businessman I met. If we establish a market system and a competitive environment, then nothing will stand in the way of our youth reaching the top and Sri Lanka will become a far better and more prosperous nation than it is today.

References:

(1)  ​​Trade and Competition Policies: Their implications for productivity Growth in Sri Lanka by Dr.Sarath Rajapathirana

(2)  Thurairtnam (2006), Malathi Knight Jones (2002)

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.

Growth, productivity and competition: Time to shift gears

Originally appeared on Echelon

By Ravi Ratnasabapathy

The Sri Lankan economy has been running, metaphorically speaking, in second gear. It’s time to shift up if we want standards of living to improve.

What determines the ‘standard of living’? Economists measure it in terms of the value of goods and services; when this grows, living standards improve.

Resources – land, labour and capital – and the extent to which they can be harnessed for productive purposes through entrepreneurship are the building blocks of the economy: what people use to produce goods and services. Having a large resource endowment, like oil, is an advantage. Sri Lanka has restarted efforts in oil exploration. In any case, it is better not to pin all our hopes of development on a chance oil strike.

So far, our development has been conventional. Like other poor countries, Sri Lanka has brought previously idle factors of production – land, labour and capital – into productive use.

Post-war, the integration of the North and the East expanded its limited pool of resources. This stage of growth is termed input-led, and is determined by the amount of input that a country can muster.

Once a country reaches middle-income status, especially upper-middle income levels, marginal returns to resources diminish and growth slows. The country also runs out of resources to bring into production: available land gets used, labour is fully employed, the population ages and incremental returns of capital slow down. The growth model is exhausted, so the economy stagnates. The production possibility frontier is reached. Sri Lanka is approaching this stage, as there is not a lot more stuff that can be thrown into our economic ‘pie’.

Sri Lankans today are, on average, much better off than their grandparents were. Some have become very wealthy, but there are still too many people who are relatively poor. The rich will be content, but less so the poor. If the population grows, living standards will fall, unless growth of the economy exceeds that of the population. Now, we face a conundrum. The total value of goods and services must increase, but such idle ‘factors’ are no longer available. The limits of its input have been reached.

From this point, the way to grow is through ‘productivity’. In economic terms, productivity depends on both the value of a nation’s products and services, measured by the prices they can command in open markets, and the efficiency with which they can be produced. It is the overall increase in value that makes high wages possible.

“Once a country reaches middle-income status, especially upper-middle income levels, marginal returns to resources diminish and growth slows”

Productivity matters at all stages of growth, but its importance increases as the production possibility frontier is reached. The New York Times columnist Paul Krugman said, “Productivity isn’t everything, but in the long run, it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.”

The challenge for a middle-income country such as Sri Lanka is how to create the conditions for rapid and sustained productivity growth. Rich economies produce, consume and invest in entirely different goods and services than poor economies. Economies typically move from primary products such as agriculture into manufacturing and services. This structural transformation—the movement of labour from low-productivity to high-productivity sectors—depends on the demand for labour in high-productivity sectors, and the supply of labour from low-productivity sectors. A multitude of factors affect this, but it is broadly driven by investment in more productive sectors and a regulatory regime that facilitates the movement of labour and other resources.

While new investment is important, export-oriented investment is especially important in smaller countries. According to an IMF working paper titled ‘Economic Benefits of Export Diversification in Small States’ (McIntyre et al, April 2018), “Openness to trade provides small states the chance to overcome the limitations of size through access to larger markets and opportunities to achieve economies of scale in production. Moreover, openness to foreign investment generally promotes long run growth through knowledge and technology transfers from foreign to domestic firms.”

However, the productivity of the domestic market cannot be neglected and the spur to this is competition. In ‘Building the Microeconomic Foundations of Prosperity: Findings from the Business Competitiveness Index’, Porter says, “Purely local industries also matter for competitiveness because their productivity has a major influence on the cost of living and the cost of doing business, not to mention their level of wages. The productivity of the entire economy matters for the standard of living, not just the traded goods sector.”

Open and vigorous competition in the local market will see the least efficient firms exiting the market, while market shares are reallocated from less efficient to more efficient firms, which causes overall productivity to rise. Porter also states, “Productivity is the goal, not whether firms operating in the country are domestic or foreign owned. What matters most is not ownership, but the nature and productivity of the companies’ activities in a particular country.”

The government has a two-fold role to play in this structural transformation; it must facilitate the increase in productivity and help manage the costs. Many elements are involved. Investment is needed, especially in new areas, so prudent fiscal and monetary policy is a precondition.

Investors seek low transaction costs and high certainty, and these characteristics are best secured by institutions (judiciary, public administration, the financial system, regulatory agencies). High-quality laws, courts and bureaucracy increase efficiency. Stable, accessible and clear laws; limited discretion (bureaucratic/ministerial); low corruption; and consistent/ impartial court rulings increase predictability. All these influence investments in physical and human capital, technology, and the organisation of production.

The importance of exports has already been stressed, but we cannot rely on garments and tourism; diversification is needed for much faster growth. In 2000, export revenue of both Vietnam and Sri Lanka was around $2 billion. In 2017, Sri Lanka’s exports reached $11.4 billion, but Vietnam achieved $162 billion. Over the period 2000-14, Vietnam added 48 new products to its export basket with a per capita value of $545, while Sri Lanka added seven, with a per capita value of $5. Moving to higher-value sectors will support higher wages in exports.

In the domestic market, the weakest sector is agriculture, which absorbs about 28% of the workforce but contributes only 8% to GDP. Policy to speed up the modernisation of agriculture – helping producers acquire scale, invest in food processing, encourage crop diversification and improve productivity (mechanisation, drip irrigation, greenhouses, quality seeds etc) – is needed. Land policy needs review, and support for R&D must replace subsidies and price guarantees. Reforms to provide tenants and smallholders proper ownership or tenure could inject dynamism to agriculture. It requires careful study and needs to be geared to local circumstances, but the experience of Korea and Taiwan are worthy of study: “Land reforms in the Republic of Korea and Taipei, China, also led to rapid structural transformation in three ways. First, the land reforms led to increased incomes among poor farmers in the two countries, who could then invest some of the income in the schooling of their children. [The increase in agricultural productivity in Taipei, China, was particularly striking, with yields of traditional crops such as rice and sugar increasing by half, and that of fruits and vegetables doubling (Studwell 2013).] This led to the availability of a skilled workforce in the Republic of Korea and Taipei, China, necessary for rapid export-oriented industrialization. Second, increased incomes in rural areas led to an expansion of the domestic market in the manufacturing sector, fostering rapid industrialization. Third, the more egalitarian land distribution provided a stable political environment, which allowed the political leaders of the two countries to concentrate their attention on rapid industrialization.” (Ban, Mun, and Perkins 1980; Putzel 2000; Studwell 2013).

Trade liberalisation is needed to promote competition and improve efficiency in the domestic market. Tariffs or subsidies may be replaced by supporting the adoption of new technology and R&D, and enhancing worker skills.

Improving the quality of the factors will improve productivity: infrastructure to improve physical capital, and education to improve human capital.

“The richer sections of society may not see a need for reforms, but if broad-based growth is not maintained, the destructive ethnic tensions of the past could resurface”

The process of reallocation is disruptive, it involves changes in the size and make-up of an economy, and the distribution of activity and resources among firms and industries. Some sectors will
shrink, or even disappear, and new ones will appear. Firms will close or downsize, while others set up or expand. Some workers may find it difficult to transition, so there is a need for income support for displaced workers and to foster reintegration through training and job search assistance. The focus should be on protecting the worker, not the job.

Sri Lanka’s economy has undergone some structural changes since 1960. According to ‘The Sri Lankan Economy.

Charting A New Course (ADB 2017), “The share of agriculturehas shrunk quite rapidly, from about 30% of GDP to a little over 10%. Industry has expanded from about 20% of GDP in 1960 to over 30% by 2015.” Post-war reconstruction helped boost growth, but this has petered out.

The richer sections of society may not see a need for reforms, but if broad-based growth is not maintained, the destructive ethnic tensions of the past could resurface. Improving living standards is the surest way to avoid a return to our troubled past.