Non-negotiable reforms for election manifestos

By Dhananath Fernando

Originally appeared on the Morning

The year 2024 will be an election year. The general flow of events is that each political party and candidate will launch a manifesto of a grand-scale and present their plans for the people and the country. Most of these promises will not be implemented or will only be half implemented. In certain cases, the opposite of what was promised will be implemented. 

Most manifestos are presented in general terms with a target of 20 years ahead with little data. Many manifestos across all party lines are wish lists with no action plans.

In my view, this time there is a slight difference. 

Regardless of the party formation or whoever the presidential candidate will be, there are few reforms that are non-negotiable. Ideally, across all manifestos, there are five basic ideas which have to be the common denominator.

Strengthening social safety nets 

Following the worst economic crisis in Sri Lanka’s history and high inflation, about four million people have fallen below the poverty line. That puts seven million people under poverty. The recent Household Income and Expenditure Survey carried out by LIRNEasia and the World Bank indicates significant poverty levels and aftereffects of poverty due to the economic crisis. As a conscientious society, we need to take care of our poor people with the social safety net. 

The social safety net is not just an allowance. It is a system and a process of targeting the right people, providing an exit route, and with proper administration. The current Aswesuma programme is making some progress with World Bank assistance, but regardless of the political leader who comes to power, it is a non-negotiable condition that social safety nets have to be strengthened and improved. 

The current process has too many loopholes which have to be addressed and improved. Simplifying the process, providing the exit route, and monitoring and depoliticising has to be a continuous effort from the new leadership of the country.

SOE reforms 

Thus far, mandatory SOE reforms have been painfully slow. Many parties with vested interests are trying to delay it until the election. However, the continuation of SOE reforms is a must. 

Colossal losses, interference in the private sector, intervening in markets, creating an unfair playing field, and inefficiencies are a few reasons why SOEs played a pivotal role in Sri Lanka’s economic crisis. SOEs are vehicles of corruption and have diluted entrepreneurship and Foreign Direct Investments significantly. Without reforming SOEs, the future of Sri Lanka appears to be bleak. 

The principles announced by the SOE Restructuring Unit are in the right direction, but the SOE Act and reforms of the Ceylon Electricity Board, Ceylon Petroleum Corporation, and many other networking industries are a must. 

Anti-corruption and governance reforms

Execution of anti-corruption laws and governance reforms is another area which has no room for negotiation. The International Monetary Fund (IMF) Governance Diagnostic and many other locally-developed reports on governance provide direction on what needs to be done. 

Strengthening our Judiciary system, transparency and accountability in our tax system, removing tax exemptions, and repealing the Special Commodity Levy and the Strategic Development Act too falls under governance and anti-corruption reforms, as those acts provide the legal opportunity for corruption. 

There is a strong sentiment from people on the contribution of corruption to the crisis, so taking long-term measures regarding corruption is a must. Anti-corruption and governance reforms go beyond going after corrupt politicians. Rather, it is a system and framework for minimising government influence. Some reforms are complementary and reforming SOEs is also a key component of anti-corruption and governance reforms, as these SOEs play a vital role in corruption.

Following the IMF programme and debt restructuring 

Given the international financial architecture, we have no option other than sticking to the IMF programme. We can negotiate some of the actions that we have promised, but overall indicative targets and reforms have to be maintained. Otherwise, it will be yet another incomplete IMF programme and the debt restructuring process will be in jeopardy. 

Debt restructuring and the continuation of the IMF programme are very much interconnected. At the moment, external stakeholders are concerned about political instability and in fact, the IMF’s first review identifies the political risks for the continuation of the IMF programme. A commitment from any political leader on sticking to the programme will help Sri Lanka in rebuilding relationships with the world.  

Trade reforms and joining global supply chains 

We have to grow our economy to emerge from this crisis. Tax revisions make it likely that growth will slow down and the only solution to grow small island nations like Sri Lanka is through global trade. Our problems regarding global trade are mainly the problems in our own regulations and systems. 

We have to remove our para-tariffs and simplify the tariff structure for a few tariff lines. Not only will this help trade, but consumers will also have a greater choice of goods and services as well as competitive prices. 

On the other hand, the Government can improve the revenue from Customs since at the moment, the high tariffs are a main reason for revenue leakage in the form of corruption. Trade reforms are about growth, minimising corruption, encouraging exports, and assuring reasonable prices. Even at present, after very high taxes, there are levies such as the Special Commodity Levy, Ports and Airports Development Levy, and a huge array of taxes which hinder the competitive nature of our economy.

These five policies, in my view, are non-negotiable. If any administration deviates from them, it is very likely that we will fall back a few miles behind where we started. 

What happened to our debt?

By Dhananath Fernando

Sri Lanka’s debt situation is still a mystery for some. During a panel discussion, I pointed out that Sri Lanka’s State Owned Enterprises (SOEs) have amassed a staggering 1.8 trillion in debt, all guaranteed by the Treasury and classified as ‘Public Debt’. One question from the audience was, “What did we do with the money we borrowed?” The simple answer is that money was borrowed primarily to service the interest on the initial loans Sri Lanka took out. Therefore,  despite borrowing substantial amounts, there is nothing tangible or visible to show for it, as a majority was essentially sunk into interest. 

To provide context, since 1999, approximately 74% of the increase in debt can be attributed to interest payments and currency depreciation. Interest payments accounted for a substantial 40% of the debt accumulated since the 1990’s, while the exchange rate depreciation contributed to 33%. 

What Sri Lanka faced was a precarious combination in terms of borrowing and our monetary policy. Our expansionary monetary policy played a significant role in the depreciation of the currency over the years, exacerbating the situation further. Compounding this issue was the fact that approximately 50% of our borrowing was in foreign currency. As it is indicated in 2022, with Modern Monetary theory in play, the significant depreciation of the exchange rate since 2020 led to an accumulation of debt beyond our repayment capacity.

Printing more money artificially increases the demand for foreign exchange.  However, after depleting our reserves in an attempt to defend the currency, the only option left was to allow the currency to float, leading to a sharp depreciation. In the case for Sri Lanka, it was not just the currency depreciation; social unrest, debt default, and numerous other crises followed when the government resorted to borrowing from the Central Bank through money printing.

As at the end of June 2023, our total public debt has increased to USD 96.5 billion, with approximately 50% of it in domestic debt. The country’s public debt now stands at about 127.4% of GDP. Even if debt restructuring is successful after negotiations with the Paris Club and separate discussions with China, we only anticipate a reduction to 95% of GDP by 2032. 

Undoubtedly, expediting the debt restructuring process is crucial, especially given the unpredictable twists in geopolitics. While the tentative agreement with China Exim Bank to restructure the debt is a positive development for Sri Lanka, we must fast track negotiations with our other foreign creditors. Complicating matters, as we approach an election year, there is a significant risk of derailing the process as unfortunately, there is a lack of consensus among political parties regarding the economic stabilization program for the next few years. This further exacerbates the challenges Sri Lanka faces.

Solution 

If Sri Lanka is genuinely committed to resolving its debt crisis, a crucial step is to establish a consensus on public finance across the major political parties. At the very least, adherence to a single plan, such as the IMF program, is necessary. However, even the IMF program alone will be insufficient to take Sri Lanka to the next stage of economic stability. Therefore, there must be a fundamental agreement on specific reforms across party lines. For example, there exists a common minimum program in Parliament, shaped with contributions from the business community and organizations like Advocata. It is not too late to revisit and endorse this document. Committing to these agreed-upon reforms before political parties develop their individual manifestos in the coming years could provide a stable foundation for Sri Lanka's economic future.

Investing in Public Transport

Originally appeared on The Morning

By Dhananath Fernando

As a schoolboy, one promise that I remember being consistently made in Budget speeches was the development of the Marine Drive up to Moratuwa. But now, even in 2023, it has only been developed up to Dehiwala.

When the project was announced, I remember Sri Lankans celebrating. When the project was cancelled, we still celebrated. After leaving school, I often took the train to work, so I practically grew up with the Sri Lankan railway system and the Marine Drive. While the Marine Drive has progressed at a snail’s pace, the Sri Lankan Railway remains almost the same.

Later, when the Light Rail Transit (LRT) project was approved, there was renewed hope and celebrations. Consultants were hired and feasibility studies were done. TV commercials were aired on the impact it could create. However, following some back and forth, a new set of consultants were paid, who then cancelled the project. Again, we celebrated the cancellation, and now once again, we are in discussions to resume the project.

One does not need to be an economist to understand the importance of developing a solid public transport system which helps to improve efficiency, minimise pollution levels, and increase convenience for commuters.

As an initial incentive to get more commuters to consider using buses, the Government attempted to implement bus lanes. The provision of a dedicated lane for vehicles shuttling a large number of passengers would have reduced commute time and congestion, and also incentivised commuters to switch from private vehicles to public transport. Unfortunately, the actual adherence to bus lanes was short-lived; if you look at buses today, they move all over the lanes.

Further, there is a route permit system which effectively blocks the entrance of new players. This has created an oligopolistic market system, with a higher chance for cartelisation of the market. Additionally, the Government has imposed a price ceiling which stunts the space for innovation and value-added services.

For example, the 138 Kottawa-Pettah route – considered to be a route utilised by a significant proportion of the middle class – has no air-conditioned bus service. The lack of an efficient market system has led the players to not even be incentivised enough to employ air-conditioned buses.

The market system works when there are no entry and exit barriers and when room is created for innovation through the pricing mechanism to reflect the scarcity value of the product or service. In the current system, nothing is possible. And yet, modifying the public transport system is not a difficult task and will provide significant relief for the people.

One main problem in Sri Lanka for any type of investment is the ownership of land. Unfortunately, this is not an easy puzzle to resolve. There is no digitised land registry and more than 80% of land (including the forest cover) is owned by the Government – this land can be efficiently used for urban development.

Efficient public transportation with greater accessibility and affordability will create urban living hubs around it. One way to solve this puzzle is to start the digitisation of registration of lands in commercial areas within Colombo and Gampaha. Often, these projects tend to progress at a sluggish pace, falling significantly short of the required speed. The delays have not only driven up the cost but have also resulted in a loss of credibility.

Unfortunately, politicians often prioritise projects with short-term timelines, typically ranging from three to five years, as they require something tangible to showcase before the next election. Therefore, with the current governance structures, even these projects that are scheduled to take place would simply be an attempt to build political capital, instead of improving public transport in order to generate value for the people of Sri Lanka.

Debt restructuring: What’s next?

Originally appeared on The Morning

By Dhananath Fernando

Sri Lanka is passing through a crucial week in its history. The details of the final domestic debt restructuring are yet to be known, but we will soon come to know the final details. However, domestic debt restructuring won’t be the be-all and end-all that will confer the expected level of economic growth – we need reforms across the board for a growth trajectory. Progress can only be achieved through a comprehensive reform plan.

Domestic debt restructuring

No debt restructuring plan is easy. Debt restructuring itself is a very painful process. The ideal solution is to have a sound economy in order to avoid any type of debt restructuring, but we are far from such a scenario. The consequences of any type of debt restructuring would be broadly negative. It would only be positive compared to consequences of not undergoing debt restructuring.

When someone borrows money and later says that they cannot pay it back as promised, it is never a pleasant experience. Sri Lanka’s debt restructuring is no exception. The debt restructuring will have consequences at this stage; it is just a matter of who will bear the burden and whether the relief will be enough for Sri Lanka to at least settle the remainder of its debts.

In the proposed plan by the Central Bank of Sri Lanka (CBSL), it has been suggested the Central Bank, superannuation funds, and the holders of Sri Lanka sovereign bonds and other USD bond holders (issued under Sri Lankan Law) bear the burden of local debt. International sovereign bond holders and bilateral creditors are expected to primarily bear the burden of foreign debt.

Although technically it seems as if bond holders and other creditor segments bear the burden, the truth is that most of the burden has already been shared by people of Sri Lanka through inflation.

In the initial plan, the banking sector was excluded from the debt restructuring process. The CBSL has provided four broad reasons to justify this exclusion.

The banking sector pays about 48% taxes (after tax revisions) (30% corporate tax and 18% VAT on financial services) as opposed to previous taxes of 39% (24% corporate tax and 15% VAT on financial services)

The Non-Performing Loan (NPL) ratio of banks is on the rise (8.4% NPLs in 2022 Q2 to 13.3% in May 2023)

Banks are expected to be impacted by International Sovereign Bond (ISB) restructuring as well as Sri Lanka Development Bond (SLDB) restructuring (banks hold 17% in ISBs and SLDBs)

Many concessions and moratoriums were already provided during Covid, Easter attacks, and the economic crisis, where about Rs. 1.6 trillion worth of loans were under concessions, amounting to about 15% of total loans

The main question is whether the provided debt restructuring is adequate for Sri Lanka to reach its target of 13% Gross Financing Needs (GFNs), 2.5% primary surplus, and 95% of debt to GDP ratio by 2032.

If the restructuring is not adequate enough for us to settle our debts, we will likely have to undergo another restructuring. Most countries which have gone through sovereign debt restructuring have to go through two subsequent debt restructurings on average. We are yet to see the analysis by the CBSL on how to ensure that this restructuring plan is adequate for us to achieve targets.

Ideally, we should avoid any further debt restructuring, because further restructuring would be more difficult, economically and socially.

Impact on superannuation funds

With the proposed restructuring, the social conversation is on the impact on superannuation funds. The Government has assured a minimum of 12% until 2025 and a 9% interest until maturity for the EPF. This is projected to amount to an average of 9.1% in rate of returns.

However, we have to keep in mind that any interest rate needs to be compared to inflation. There is no value in getting a 9% interest rate if inflation is 12%. If so, the Central Bank has to ensure that inflation remains around 5% for the real interest to be 4%.

However, the key impact of the proposed debt optimisation plan on superannuation funds would be that as per the Government’s projections, the rate of return would be 9.1%, which is slightly lower (0.3%) than the current returns. This means that if the status quo continues (for instance with no DDO) at 9.4%, the rate of return will be 0.4% higher than if superannuation funds took part in DDO.

The EPF is a nearly Rs. 3 trillion fund where withdrawals per year are less than Rs. 150 billion. Its collection was approximately Rs. 170 billion in 2022 and generally there is a Rs. 30 billion surplus between collections and refunds every year. People can still withdraw the money and their balance will not be affected, instead, it will result in the forgoing of the additional returns the fund could have made.

Domestic debt restructuring to be considered with other reforms

This debt restructuring will only bring partial relief, even if we undertake the necessary reforms. Even if this debt restructuring is successful, our debt to GDP ratio will be 95% in 2032 as per predictions. That is still a very high number. Ideally, an emerging market like Sri Lanka should remain in the range of 60%.

Sri Lanka will only be able to emerge from this crisis if we move forward with State-Owned Enterprises (SOEs) reforms, monetary sector and monetary reforms, and trade reforms. For us to grow our economy, we have to engage in trade. Secondly, we have to avoid growing our debt further through unproductive SOEs. If we fail to fix the rest, we will most likely return to square one, with a much difficult context.

What we, the common people, can do is push our policymakers to allow the market system to operate and limit the size of the Government while pushing for key reforms.