SL slides down to 115 on Global Soft Power Index

Originally appeared on The Morning

By Dhananath Fernando

Global research outfit Brand Finance ranks countries by considering each country as a brand through the Global Soft Power Index. Sri Lanka’s brand results as a nation were released in partnership with the Sri Lanka Institute of Marketing (SLIM) last week and the country was ranked 115th out of 121 countries – a steep drop of 42 positions from ranking at 73 on the index in 2022.

Below us are Iraq, Laos, Trinidad, Uganda, Guatemala, and Zimbabwe. This survey was conducted globally with more than 11,000 samples. SLIM has to be appreciated for taking such an initiative at a very difficult time for Sri Lanka. A country’s perception and brand image are very important, especially when it comes to ‘Country of Origin’ status in global trade. The same matters in tourism and many other income-generating activities.

Brand strength of a country is determined under eight key themes and sub categories for each key pillar:

Business and trade

Governance

International relations

Culture and heritage

Media and communication

Education and science

People and values

Sustainable future

It is said that “perception is reality”. In simple terms, though we may feel that we do not deserve to be ranked 115th, outsiders do not perceive us positively. The reasons for our steep drop are quite obvious. It is more important to understand the drivers of positive perception according to the Brand Finance survey than to dwell on our ranking.

Out of the key drivers of reputation, a strong and stable economy is considered the most important driver for people. In a survey conducted within the index, it ranked very highly, with 8.9 points out of 10. The next driver, with 6.2 points, is having internationally admired leaders. Being politically stable and well-governed is ranked as the third most important attribute, while ease of doing business and sustainable cities for transport are ranked at fourth and fifth place respectively, based on importance.

Developing a nation’s brand

The expectations of people indicate that a dynamic economy and the ability to do business easily are the main drivers of pretty much everything else. If we, as Sri Lankans, are serious about building our brand, attracting FDIs, and bringing in tourists, there is no other choice than to undergo economic reforms.

The expectations indicate that most of the attributes that help develop a nation’s branding are influenced by the market and freedom. When a paternal government steps in, there is no ease of doing business for enterprises. When a government imposes high tariffs on imports, there is no efficient trade. When a government restricts movement of people and adds visa regulations, tourism cannot prosper. Countries which experience a higher degree of economic freedom also have credible country brands and soft power.

In Sri Lanka’s assessment, our worst ranking is for ‘international relations’. We have ranked 120 out of 121 countries. This comes as no surprise after our poor management of foreign relationships with all our key friends including India, China, Japan, the Middle East, and the US.

Our immaturity in managing the Indian Free Trade Agreement (FTA) and the East Container Terminal (India), managing the Port City and the fertiliser shipment (China), cancelling the Light Rail Transit Project (Japan), forced cremations of Muslims (the Middle East), and dealing with the Millennium Challenge Corporation (MCC) (the US) undeniably isolated us, pushing our reputation to a historic low.

Our diplomatic service is basically a meal ticket for unemployable relatives of politicians. It is imperative that a merit-based exam for diplomatic service be required in order to ensure our economic prosperity. Diplomacy is economic; a friendship built on doing business is much better than a business built on a friendship.

We have ranked relatively better on ‘culture and heritage,’ standing at 92 from among 121 nations. On ‘governance,’ we are ranked at 118 and on ‘business and trade’ we come in at 115.

Solutions

There are quick fixes, but building a brand is like raising a child. Values, ethics, and dynamism take time to instil. If we are to improve Sri Lanka’s brand, a comprehensive economic reform package is needed. Countries that recently picked up their ranking did it through reforms and allowing markets to work smoothly.

New Zealand had a reform plan in the 1980s while South Korea transformed through market-based reforms. Dubai was converted into a business hub, Vietnam was converted into an export-oriented economy, and so on. The common denominator is a concrete economic reform plan.

In the short run, what we can consider is implementing a free, six-month business and vacation visa plan for countries with twice the per capita GDP of Sri Lanka. This will allow us to earn much more through their spending in Sri Lanka. At present, we have nothing to lose, as they are not visiting Sri Lanka anyway.

The next step is to allow foreign spouses to work in Sri Lanka. As many people leave the country, at least some may consider staying back in these cases, especially those married to foreigners. They will bring their skill set, which enables better knowledge transfer. In some areas such as Galle, this synergy can already be observed in the tourism industry, despite bad regulations.

Thirdly, all tariffs should be brought under either a four-tier structure (0%, 5%, 10%, and 15%) or a higher tariff structure that is simple and unified so that it can incentivise trade. We need to keep our Central Bank independent and not intervene in the forex market in order to get the maximum benefits out of this. All these can be done with just a stroke of a pen at zero cost to the Government.

The brand ‘Sri Lanka’ can only be built by instilling the right values within the brand. A communications campaign may only dilute the brand when people realise we oversell ourselves by overpromising and under-delivering.

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.

Which reforms should take the spotlight after the IMF?

Originally appeared on The Morning

By Dhananath Fernando

According to news reports and a tweet by International Monetary Fund (IMF) Managing Director Kristalina Georgieva, Sri Lanka is likely to enter its 17th IMF programme since its membership began. We are yet to know the details of the programme, but we have an overview of key areas as per the press conference in September 2022, when we entered the Staff-Level Agreement. Out of the previous 16, we have only completed nine programmes and have given up in the midst of seven programmes without completion.

This time, things are slightly different, because on the previous 16 occasions our debt was sustainable, but this time it is not. Dropping out in the middle of the programme while we are under a debt restructuring plan will erode even the remaining confidence of investors and many other stakeholders.

There seems to be an overestimation that the IMF can fix all our problems. We have been trying to debunk this myth for a long time; the IMF cannot fix our economy. It is merely a lifeboat to make sure we don’t drown in our debt. Only we can fix our economy through economic reforms.

What the IMF can bring us is credibility. Credibility will provide us breathing space on a few fronts. It will provide room to negotiate debt with external creditors and enable us to obtain some relief before we start our debt repayments. This credibility will allow Sri Lanka to tap into more bilateral and multilateral funds to reactivate some of its economic activity.

It is imperative that we reform the economy and move forward with all this funding. Other countries that have gone through debt distress have fallen into a cycle of defaulting. We have to avoid this, which can only be done by creating a competitive economy.

A competitive economy can only be achieved through economic reforms and not in any other way. Most of these reforms are simple to understand but complicated to execute, as many of the beneficiaries of the current inefficiencies will be on the losing end. They will all have to work hard and compete in a market environment.

While there are many reforms to be undertaken, which will also be included in the IMF agreement in different forms, I would like to prioritise three key reforms.

Social safety nets to protect the poor

During an economic crisis, people are angry as well as hungry. Protecting the most vulnerable section of society has to be a priority. Ultimately, the objective of all economic principles we practise is to eradicate poverty.

Poverty eradication cannot be undertaken simply by distributing money to the poor. We can only eradicate poverty by opening up opportunities for the impoverished to engage in economic activity and expand their capacity to add productive value to society. During difficult times, they should have some support so they can worry less about basics and worry more about joining economic activities.

The current expenditure on our main social safety net programme – Samurdhi – is about Rs. 55.4 billion. This is peanuts compared to the losses of the Ceylon Petroleum Corporation (CPC) over eight months in 2022, which amounted to Rs. 632 billion. Most of the losses in petroleum caused by the Government’s fuel subsidy have benefitted 60% of the wealthiest families in the country.

Rather than entertaining the inefficiencies of the CPC and transferring fuel subsidies to those who can obviously afford it, the money should be channelled to the poor. This needs to be done by proper targeting and via cash transfers to their accounts, rather than in a material form.

It was reported that about 3.7 million families have applied for the social safety net system, but unfortunately, the Government authorities have been on strike without having verified the families that have applied. Cash transfer systems should ideally be connected to inflation with a targeted time frame, so that those below the poverty line are incentivised for upskilling and to contribute to economic activity.

State-Owned Enterprises reforms

It is no secret that our State-Owned Enterprises (SOEs) are massive burdens to taxpayers with limited value being added to our economy. Therefore, selected SOEs should be privatised, which will improve the income levels of employees.

It cannot be emphasised enough that the privatisation process has to be transparent and should take place on a competitive basis. Politicians cannot be the facilitators of these transactions. There are some SOEs which can be opened up for Public-Private Partnerships (PPPs). Certain SOEs can be consolidated and others can be brought under a holding company.

Some of these SOEs are managed extremely poorly. Therefore, with the current liabilities, finding a buyer too seems next to impossible. As such, unfortunately, some of the debt may have to be absorbed by the Government, considering the stoppage of longer-term money leakage. We have to realise that the Government has no role in doing business. This has been proven many times globally and in Sri Lanka. Without SOE reforms, Sri Lanka simply has no future.

Trade reforms

In many forums where we converse about solutions for Sri Lanka’s economic crisis, a common refrain is that “Sri Lanka has to come out of this crisis”. A country of 22 million, which is almost the same population as the city of Mumbai, cannot grow by selling goods and services to its own citizens.

Sri Lanka’s market size is very small, so we have to sell to a global market. However, we cannot sell to a global market without being competitive. As such, imports are a big component in being competitive. What we need is a simple unified tariff structure; when things are simple, we can limit the room for corruption.

The complicated para-tariffs such as cess, PAL, and many other tariffs added one on top of the other have to ideally be within three main tiers. For instance, 5%, 10%, and 15% customs duty so that importers are clear on what to pay and can estimate in advance.

Monetary policy has to be fixed with trade reforms so that we will not face a currency crisis. It is true that the US Dollar is required for imports, but import demand is created by the Sri Lankan Rupee when the exchange rate is artificially low and money is added to the monetary system in the form of filling the deficit in Government expenditure and income.

When we fix this monetary policy, the currency will remain solid and exports will automatically start picking up with the stability in the market. The scarce US Dollar resources will be shared only for the prioritised needs through the pricing system.

In conclusion

If we can implement these three reforms within the next 12 months and maintain them for three years, we most likely will not require an IMF bailout for the 18th time.

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.

Feasibility of estimating economic recovery via LKR appreciation, CSE performance

Originally appeared on The Morning

By Dhananath Fernando

Sri Lankans base their assessment of the economy’s performance on two crucial factors. One is on the operations of the Colombo Stock Exchange (CSE) and the other is on the exchange rate – the appreciation or depreciation of the LKR to the USD.

However, neither are the right indicators to measure the performance of the economy. The companies listed on the CSE are insignificant compared to the number of business establishments in Sri Lanka.

Around 99% of the business establishments in Sri Lanka are Micro, Small, and Medium Enterprises (MSMEs) but they are not listed on the CSE. However, the MSME sector accounts for 75% of all employment. Large firms are responsible only for 25% of all employment, but not all large corporations are listed on the CSE.

For instance, MAS Holdings, which is one of Sri Lanka’s leading apparel manufacturers and employers in the sector, is not on the CSE. Moreover, just before the economic downturn in Sri Lanka, there was a bull run at the CSE. A performing economy is measured through the reduction of poverty and when the populace contributes to solving an economic problem.

The second popular measure to assess economic performance is the exchange rate. Recently, with the appreciation of the LKR, there is a sentiment that the economy is recovering. Previously, when the LKR was depreciating, the perception was that the economy was not doing so well.

Appreciation or depreciation of a currency has its own consequences, but connecting the exchange rate to performance of the entire economy is definitely not the right way to look at things.

There were few reasons behind the recent appreciation of the LKR. Nevertheless, the exchange rate is simply the price we pay to buy USD. Like for many other commodities and services, the price of USD is determined through demand and supply. Suppliers of USD are mainly exporters, service exporters, remittances, foreign grants, and tourism. Main buyers are importers, the Central Bank, service importers, etc.

If you are wondering how the Central Bank becomes a buyer of USD, that is one way reserves are built. Until the last week of February, the Central Bank had a direction for all commercial banks to surrender 25% of their USD flows from exporters. That limit has now been reduced to 15%, which means that banks will have an additional 10% of USD than they did before, so the availability of USD in the market is slightly higher. Further, over the last few months, the Central Bank has been the main buyer of USD/forex and as a result our reserve levels have improved slightly.

The International Finance Corporation (IFC) also approved a $ 400 million facility to support Sri Lanka to purchase essential items, so the inflows to the market are likely to increase. As a result of high supply and constant demand, the exchange rate has come down slightly.

Another reason is that the Central Bank increased the middle spot rate for banks to Rs. 5 from Rs. 2.50 last week. In simpler terms, previously, the Central Bank had provided a direction on the price of the USD. It is similar to a price control but slightly more flexible. As a result, banks can now provide better rates so that forex sellers are willing to supply.

As the economy contracted by 7.1% in the first nine months of 2022 and the World Bank projects a further 4.2% contraction for 2023, demand for imports has been low. On top of this, most imports are restricted. Additionally, tourism is slowly picking up and with many Sri Lankans migrating for work, it helps to recover remittances to an extent.

We need to realise that none of the above changes are reforms. They are just dynamics in the market. These little fluctuations are not an indication to measure whether we are moving in the right direction.

Reforms mean establishing a dynamic market and creating a suitable environment as soon as possible given the gravity of our crisis. When reforms are implemented, the exchange rate will become predictable rather than subject to speculation.

Reforms involve systems design and thinking, so that the system works even when a new person takes over. It is important not to mix up market changes and reforms. Markets will always fluctuate based on the availability and scarcity of resources, but reforms are about creating an environment for markets to work. Even the forex market optimises the use of resources.

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.

A flawed independence

Originally appeared on The Morning.

By Dhananath Fernando

Over the years, our definition of ‘freedom’ has become full of flaws. We took freedom for granted and we lost both our freedom and independence. Even though we gained independence in 1948 from Great Britain, we have no understanding of what real freedom is. 

We fail to understand that freedom comes at the cost of hard work, courage, respect, the ability to cooperate, and being competitive with the world. There is an ecosystem we should have built if we really want to be free. We did not build that ecosystem, so over the 75 years of independence, we question ourselves and argue back, asking, “Are we really free?”

Prof. Amal Kumarage in a recent tweet has asked this question very eloquently on independence and freedom.

“I’m confused as to what’s happening on 4 February in #SriLanka. Is it: 

1. A fake celebration of a real independence, 

2. A real celebration of a fake independence, or 

3. A fake celebration of a fake independence?”

Freedom is an alluring subject to many as people in general summarise freedom to being liberated to have an easy life, getting things free of charge. Over time, as the dire need for freedom kept rising, the wrong seeds of freedom grew by encapsulating and manipulating the idea of freedom to a level where people truly believed that we are entitled to many benefits even though we lack the resources. 

The drive down the tunnel of distorted versions of freedom led to many ethnic and religious turns over the years, believing that freedom is restricting someone else’s freedom for the betterment of someone else.

This is similar to a situation where a child learns the wrong values or habits without realising they are wrong and instead thinking they are right. After 75 years of practising the wrong values and ethics, we now have an operating system which we try to sustain with unsustainable resources. That is a brief summary of insights on our 75 years of independence.    

During that journey of 75 years, we have failed to understand the damage done by the existing system to our competitiveness and productivity. We simply became irrelevant in the world over a period of time. By deciding not to compete with the world, we decided to sacrifice our freedom. 

Our decision to not compete with the world mainly came through our economic policy. We simply misread the world and future of the world. In a world of sharing resources and collaborating for each other’s benefit and independence, we thought that real freedom is the ability to produce everything on our own. 

We supported the narrative of ‘self sufficiency’ when the world actually moved away from self sufficiency to interdependence. As per the Fraser Institute’s Economic Freedom of the World Index, Sri Lanka has been ranked at the 138th position out of 165 countries based on our ‘Freedom to Trade Internationally’. Though we claim we are an open economy, the facts say otherwise. In terms of our openness, we are at one of our lowest points.

My father used to say: “If you think you are the smartest person on the street, it is time to change the street.” This is because an uncompetitive environment does not support growth. Without growth, no wealth will be created nor will there be freedom or independence.

When we isolate ourselves from global trade, we avoid competition. Avoiding competition means we are out of touch with the real needs and wants of people. Not only that, we try to become dependent on the world without contributing anything to the world or to its maximum utility of resources. Being open to competition is what keeps us all competitive and relevant.

Real freedom is the freedom to compete and be competitive in a global landscape. Even when we are one of the closed economies in the world, we are open for global competition. Our IT, apparel, tea, and rubber sectors and even unskilled labour that contribute with remittances are competing at a global level. 

When we are really competitive it provides us the tools and freedom to change the direction of our fellow human beings and to support humanity. That comes only through the freedom to trade. That is the real freedom we should all aspire to. We are far from this and we are moving further away, but at least it is important to keep the idea alive so that one day someone can move towards it. 

A fake celebration of a real independence, 

A real celebration of a fake independence, or

A fake celebration of a fake independence? 

According to Prof. Kumarage, it is difficult to judge what we are actually trying to do this year, but we should aspire to have real freedom and this real freedom comes at the cost of hard work, free exchange, and free trade by being relevant and competitive in relation to the world.

Source : Central Bank of 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.

A well-told lie is worth a thousand facts

Originally appeared on The Morning.

By Dhananath Fernando

Sri Lanka has always been consistent about two things. First, finding a villain to blame for incidents that have taken place in the past for Sri Lanka’s performance. Second, waiting for a hero to rescue us all with magical powers without making sure the systems and markets work. 

We always fail to evaluate reasons and economic context and understand the behaviour of people from an economic angle. A recent example is politicians claiming the economic crisis was a result of the Aragalaya and blaming the people who protested against the hardships they were going through, without realising that the economic crisis is what led to the Aragalaya.  

In a new turn, fingers have now been pointed at exporters, claiming that they have not brought money back into the country and accusing them of being part of the problem. In my view, the figures mentioned in relation to claims that exporters have parked funds outside are unrealistic. Some Sri Lankan companies have scaled their operations very successfully around the world, which has been done legally. For instance, there are energy investments in Bangladesh and Senegal and manufacturing plants in Africa and neighbouring India. Even our IT sector is expanding to the Middle East and to different regions around the globe using legally owned foreign exchange. 

This is obviously illegal and remedial action needs to be taken, but what is more important is to understand why it happens. We need to understand the reasons behind this and understand the reality with a solution-oriented framework. In most cases, the enemy is within, though we try to find the enemy outside. 

In my view, there are three main factors that influence such malpractices

Market intervention by the Central Bank

When central banks infuse more money into the system to maintain artificial interest rates, the exchange rate comes under pressure or the currency depreciates. The fear of currency collapse makes people withdraw money or avoid bringing money into the country.

Not only exporters, but even Sri Lankans who were sending remittances stopped sending their money through the banking system. Instead, they sent money through unofficial means at a depreciated exchange rate. When domestic prices are rising due to money printing or import controls, their families back home naturally need more money to buy goods.

However, exporters cannot keep unlimited amounts of money outside the country. Exporters need money to run their local operations, so they have to convert their export proceedings and get Sri Lankan Rupees to run the operation. When interest rates are kept artificially low, there is an incentive to borrow domestically and delay the conversion of dollars into rupees. 

However there is a limit to what exporters can borrow. Even if they borrow domestically, it cannot contribute to a foreign exchange shortage unless the Central Bank printed money to maintain an artificially low policy rate through discount windows or reverse repo operations.

If banks give extra loans to exporters, they have to cut down on other loans (to housebuilders, for example) or they have to pay higher rates and get deposits and reduce the consumption of their customers. Banks do not have to reduce other credit if the interest rate is maintained artificially through the injection of new money.

The policy of the Central Bank has simply created a highly unstable financial situation and it is human behaviour to protect one’s hard-earned money, so they will obviously keep their money outside. Understanding this should not require any financial expertise; even basic logic is enough. This is understood by our unskilled workforce contributing to our economy through remittances. 

To return to the matter of exporters, the margins are low in trading businesses and export quantities have to keep moving; a business cannot run without money. We have to reevaluate the numbers and it is unlikely that more than 10% of the proceedings will be repatriated, which is a figure that leans more towards the higher side. Even that is profits or value created by exporters. 

If the money comes, the exporter will use it and it will trigger demand. If money is not brought back, it will not become imports and instead becomes a private foreign reserve. While it may contribute to higher interest rates, this type of activity will simply reduce imports and not create forex shortages.

There were claims that some exporters sent goods to Singapore or Dubai and re-sold the goods to third countries while keeping some money there. 

We need to understand why people try to keep money outside the country. Who wants to bring money into an unstable country? Dubai and Singapore do not have central banks that print money and people not only import and export freely, they can also freely send capital in and out.

Sri Lanka, on the other hand, has exchange controls. Again, this is due to money printed to keep interest rates artificially low, which is exerting pressure on the exchange rate. Economists call this the impossible trinity of monetary policy objectives. A central bank cannot hold an exchange rate and allow the free flow of capital if it also prints money to control interest rates.

Exchange controls can be seen as a tool used to delay interest rates. It is worthwhile to recall the scale of Central Bank interventions and controls during this crisis. The Central Bank places price controls on Treasury bills and printed money. Exchange controls were also tightened further instead of correcting interest rates and stopping money printing.

The Treasury placed import controls on hundreds of items. The Central Bank increased margins for Letters of Credit (LCs). Moreover, forward markets for foreign exchange were killed, putting importers at risk and also damaging businesses that had hedged their imported input costs. Exporters were forced to convert their dollars early, which created problems for some exporters who had been in the habit of giving credit to customers to win business from competitors.

Additionally, forced conversion rules were imposed on service receipts. Some service workers and those others who used to bring these to the country and save them in foreign exchange accounts then kept their money abroad. Unlike goods exporters, service exporters have larger margins.

By this time, banks were facing a capital outflow and were unable to renew their credit lines and in some cases dollar-rupee swaps. Forced dollar conversions reduced dollar liquidity and brought these closer to default.

There are also concerns as to whether it is a violation of property rights for banks to force account holders to convert dollars without their consent. Foreign exchange controls are in any case a violation of property rights.

This very column previously warned of the potential drying up of forex with such market interventions. In simple terms, in a context where LKR is not hard pegged to the USD with floating interest rates or if there are no floating rates, all additional money supplied to the financial system to keep rates down evaporates in the form of imports, even with under-invoicing.

Trade barriers – High and complicated tariff structure 

Making tariff structures complicated is an incentive for corruption. The level of corruption that takes place at customs is no secret and the more complicated the system becomes, the more room for corruption. Simply, when the cost of corruption is lower than the legal procedure, the incentives are in place for corruption. 

This column has on many occasions recommended a simple tariff structure with three bands so that paying import tariffs becomes easier than taking on the cost of corruption. This was proved by Prof. Premachandra Athukorala in a practical research he undertook, where bringing down the tariffs by half on selected HS codes ensured that the Government income from those particular imported items doubled. Too many restrictions and intervention are the genesis of black markets and corruption. One of the easiest ways to minimise corruption at Sri Lanka Customs is to make our tariff structure simple, low, and consistent. 

Poor business environment 

Overall, Sri Lanka’s business environment is extremely poor. We have to ask ourselves why our own people leave the country and why they are reluctant to bring their money into the country. The answer is not complicated; we may act rationally or emotionally at times, but when it comes to money, we all tend to make rational decisions, especially when there is a tangible cost or benefit associated with it. 

It is obvious that people consider all alternative options to protect their hard-earned money. This is one reason remittances were not sent through official channels. Family members still received the money and imports still took place, but without going through the official channels. Any imports paid for with unofficial funds – such as open account imports – reduce the demand for dollars from exports.

Now that the Central Bank has raised rates and reduced money printing, leading to reduced exchange rates, people are sending their money through official channels. This shows that most people prefer to send their money through official and legal channels if a stable and consistent system is available.

It has been a while since Standard and Poor’s, Fitch Ratings, and many other international agencies warned about Sri Lanka’s worsening economic crisis. As such, our economic environment was extremely poor, which was why people did not feel that it was safe to bring their money into the country. The same happened even in Africa – with the crisis in Zimbabwe, many had bank accounts in Cape Town to protect the value of their money. 

Final thoughts 

One has to be careful about harassing exporters. Exporters, especially subsidiaries of foreign countries, have other countries to operate in. 

Under-invoicing exports is wrong, as it will reduce profits within the country. This is a tax fraud. However, reducing profits cannot contribute to forex shortages since any money that is not spent in the country will also reduce imports.

Sri Lanka wishes to be a hub for South Asia. It wishes to become a place where companies set up regional headquarters. If currency instability and exchange controls exist, these will not be set up in this country. Moreover, there are also rules on transfer pricing. 

If Sri Lanka possessed monetary stability, if there were no exchange controls, and if its tax rates were reasonable – the US has been pushing for a global corporate tax rate of 15% – companies would not try to take profits to safer places.

Exporters and importers have been harassed over the years. Framing exporters as the reason for the crisis instead of solving our own problems will simply make the situation worse. 

Can we really put the entire weight of the economic crisis on our exporters, forgetting the bond scam, Easter attacks, droughts, Covid-19, borrowing money at very high interest in USD, and investing in unproductive projects? The enemy is within, but we are always looking for a culprit outside. In politics, sometimes a well-told lie is worth a thousand facts.    

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.

What next for Sri Lanka?

Originally appeared on The Morning.

By Dhananath Fernando

New predictions are emerging that debt restructuring and International Monetary Fund (IMF) Board-level agreement may take until the end of this year. Another ongoing discussion is about the Local Government Elections and postponement of elections. Electricity tariffs are to be increased and 10 banks have been downgraded by Fitch Ratings as a recalibration of Sri Lanka’s sovereign rating.

Overall, it appears that economic reforms are being sidelined faster than expected, without realising the consequences of each action. It is true these complicated problems have no easy, straightforward solutions. No solution will be perfect and the validity, impact, and effect of any solution will be weighed against time. To put it simply, a solution that appears valid and reasonable today may not sound reasonable in a few weeks or months.

Each action has its consequences and inaction will also have consequences. It will be a battle between the consequences of action and inaction and the continuation of this for the next few years.

Reforms and restructuring

Let’s take the case of reforming State-Owned Enterprises (SOEs). With the election cycle commencing with Local Government Elections, attempts at restructuring SOEs such as the Ceylon Electricity Board (CEB) may be delayed. This delay means that inefficiencies will continue and tariffs will be increased without any competitive basis. This will in turn impact all businesses as well as macroeconomic indicators given the monopoly and the size of the electricity business. It may also extend the duration of power cuts and pave the way for another wave of protests, worsening the business environment.

Reforms too will be painful. Trade unions and some employees will be affected and an electricity monopoly can interrupt the life of the common man in multiple ways, with political and capital implications.

The cost of not implementing reforms will be much higher politically and economically, as it would be a cyclical result. Therefore, the reasonable decision is to restructure loss-making SOEs. Unfortunately, there is no other way out and delaying this further may invite darker years in the future.

The delays in the debt restructuring process will have its own consequences, both economically and geopolitically. The debt restructuring delay is a repercussion of maintaining bad foreign relations.

Poor international relations

How we treated India over the Economic and Technology Cooperation Agreement (ETCA) and in discussions on the East Container Terminal was extremely unprofessional and irresponsible. There is a significant difference between disagreement, negotiation, and unprofessional treatment.

By suspending the Light Rail Transit (LRT) project, we lost the respect and trust of Japan. We even annoyed China with the fertiliser matter and continuous regulatory delays with the Port City project. Our relations with the Middle East deteriorated with the cremation of dead bodies of the Muslim community during Covid.

We are not even in the good books of the US over the way we dealt with the MCC grant. Simply put, we do not have a friend who will extend a helping hand during troubled times. It is said that countries have longer memories than people. As such, we have limited our options due to our own grave mistakes.

A stalemate in a crisis

Economics and politics often go hand in hand. During an economic crisis, instability in politics is unavoidable. Our President does not have a direct mandate and the composition of the Parliament may not really reflect the people’s voice with the dawn of the completely new sociopolitical environment.

This was one reason the discussion of a common minimum programme was floated by concerned individuals and professionals, but it appears that this too has been discarded, with everyone slowly turning their attention to the election cycle. The calibre of our politicians is too inferior for them to understand the dynamics involved and to come up with responsive and novel policies and political options.

We are now in a stalemate, with a lot of short-term distractions. In such situations, we become distracted and waste our time on non-value adding activities without realising the massive deterioration of the quality of life. A deeper analysis shows that while the absence of economic reforms is a major issue, the fragility of our institutions is a bigger concern, with the institutional capability for the functioning of a basic society being almost nonexistent.

Solutions

Appointing capable and credible human resources for debt negotiations with China is essential to avoid delays. Acceleration of debt restructuring will unblock many other barricades, enabling us to move forward. There is a huge vacuum of capable human resources needed to carry out reforms. Therefore, providing space for already appointed committees to recruit more capable people and working out a time-bound solution matrix is important. The solution now lies in setting up institutions that can execute reforms to get us the required results.

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.

Promoting competition over price controls

Originally appeared on The Morning.

By Dhananath Fernando

The decision to import eggs is a classic example of how price controls are backfiring. It proves once again the main argument put forth by Advocata’s research report ‘Price Controls in Sri Lanka – Political Theatre’ published in 2018. It suggests that price controls are merely politically motivated and have never succeeded in bringing prices down. 

The story of price controls imposed on eggs has two sides. Firstly, it is about competitiveness. According to media reports, an imported egg can be sold for Rs. 25-30 while a local egg costs over Rs. 60. When an egg is imported, it involves both a value chain and the distribution of margins. At the production stage, the farmer keeps a margin. 

Secondly, there are taxes and storage charges at customs of the particular country we import eggs from. There are also charges for insurance and shipping. Once the consignment reaches Sri Lanka, there will be tariffs and handling charges imposed by Sri Lanka Customs. There may also be storage expenses in Sri Lanka and the importer and retailer will keep the margins. Even with all these costs, local eggs are almost twice as expensive as imported ones. This indicates the inefficiency of local egg production. 

Restrictions hamstring production  

A primary reason for the uncompetitive and expensive nature of local egg production is the price controls imposed by the Consumer Affairs Authority (CAA). A few months ago, the CAA imposed price controls, expecting a drop in prices. As we all remember, eggs simply disappeared from the market. 

The poultry industry as a whole was also challenged. No poultry farmer could survive at the prices set by the CAA. Some micro- and small-scale poultry farmers had to scale down while some had to close down. They sold their laying hens for meat amid the price controls. Daily production of eggs dropped to about four million per day from seven million. The price cap was later increased but the damage had already been done. Additionally, due to import controls, essential chemicals for the poultry industry were in shortage.

As a result, the poultry supply contracted and led to a price hike. Now we expect to import eggs. Accordingly, the price controls not only increased prices but also damaged the efficiency of the industry. 

We often forget that markets are interconnected. The poultry industry is often interlinked with maize production as it is the main source of food for poultry. Price fluctuations of maize affect the prices of chicken and eggs. Any intervention in the form of price controls, import controls, or regulation has a direct impact on the industry. 

It was not the first time we faced such a situation. Many governments and many trade ministers fell into the same trap over and over again by failing to understand the fundamentals. 

To recall some incidents in the recent past, there was a price cap of Rs. 60 per 1 kg of dhal and Rs. 100 for tin fish during the Covid-19 pandemic. Just compare these prices now. There was also a price cap for rice and at one point, a former military officer was appointed to conduct field raids on rice mills. 

There were times a price ceiling was imposed on hoppers and egg hoppers. Similarly, in 2015, there was a price cap on plain tea and tea. In the same year, price controls were imposed on broiler chicken. Traders started selling chicken parts instead of whole chicken to avoid price controls. Have you ever noticed prices being reduced due to price controls? The simple answer is no. 

Instead, things worsened. After repeating the same mistake over and over again, the poultry industry experienced the same bitter results. Its effect was felt not only by the poultry industry, but by the poorest sections of the population as well. 

Eggs are a necessary protein intake for the poor as they do not have refrigerators for storage. Eggs are also one of the main ingredients in the bakery and restaurants industries, which involve an extended value chain. Everything has been affected and some restaurants have even had to downsize their menus due to unavailability of eggs at one point.       

Solution 

Improved efficiency in local egg production is important to reduce the cost per egg and increase the output, thereby reducing the price of eggs. The farmers in India and Pakistan are doing something right to be able to sell eggs at Rs. 35 after passing through many touchpoints and cost centres. 

We have to make ourselves productive and efficient. Efficiency works when there is competition and when we allow competition to work. We cannot restrict competition for selected markets because one way or the other, all markets are interconnected. We have to redesign the CAA as an agency to promote competition and not as an agency to regulate prices. 

The same is valid for the Public Utilities Commission of Sri Lanka (PUCSL). The solution is setting up institutions to accelerate competition across all industries. The role of the Government is to remove barriers for market operations, not to control prices. Price controls make things worse and it cannot bring down prices, but it will kill the industry and many other connected industries.  

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.

Privatisation! the need of the hour

Originally appeared on The Morning.

By Dhananath Fernando

I travel mainly by a common staff transport from Moratuwa to Colombo to work. I travel by train as well as on normal public transport for other travel purposes. Undoubtedly, my staff transport is the most efficient and affordable, providing the most value for money. It not only provides value for the money I pay, but it also provides a great example of why the Government should not do business and why the private sector should be allowed to. Even in the toughest conditions, private enterprises can bring solutions.   

The operator of my private staff transport is Amal, an executive at an office in Colombo. While a normal bus typically has three main stakeholders, Amal has made it so that there’s just one main stakeholder. That’s efficiency. A normal bus on the road generally has an owner, a driver, and a conductor. Amal just has one. He is the driver who drives us all safely and on time. He does not have a conductor because he has an automated door which the driver can operate easily with just a switch in the dashboard.

He charges about Rs. 12,600 for an air-conditioned bus ride for the entire month. That is approximately Rs. 286 per one-way journey from where I live, which is around 20 km. If I were to calculate my cost per kilometre for a peaceful air-conditioned bus ride where I can sleep comfortably or work on my computer, it costs just Rs. 14. 

Even if I travel by a normal non-air-conditioned bus, the incremental value I pay for Amal is negligible. If I use an air-conditioned bus, my costs are higher than what Amal charges. In the first place, there are no air-conditioned buses where I live and with Amal, my travel time is almost one-third of the total time taken on the normal route. I believe that travelling with Amal not only saves time but also reduces carbon emissions as well. 

A win-win situation 

Amal is just one man in the private sector who adds value to my life while making a profit and a living out of it. He recently bought another bus and now he has two rosters both ways with a time gap of about 30 minutes, meaning I can choose either the first bus or the second according to my convenience. He shares the live location on WhatsApp before every ride, so I can track where the bus is and be prepared. 

Amal is not the only such person. If you observe Colombo between 7-9 a.m. you will notice that there are many buses operating on the same model as Amal’s. There is no regulatory authority on staff transports in Colombo and yet it operates efficiently, with both Amal and I being beneficiaries of the system. It’s a complete win-win. I hope that after reading this article, there won’t be any Government regulations set up regarding staff transport to ruin the market. 

Amal is a one-man private operator who solves a burning issue for me or at least provides me with a reasonable solution which my Government has been unable to provide for more than three decades, even with billions worth of funds.    

Amal can improve efficiency because he has an incentive for improving efficiency. His incentive has a ripple effect leading up to minimising carbon emissions. 

Privatisation to solve problems

Given the discussion on privatisation, there is no better example than Amal of how private enterprises help people. Economics and businesses are all about solving people’s problems. Our life is all about solving each other’s problems and depending on each other. Amal solves my transport problem and by paying him, I may be contributing money for his child’s education. 

Our entire economy is a complicated yet interconnected web. Efficiency and getting the maximum out of our resources are needed, which can only be done when the markets are in operation. Markets are operated by private individuals like you and me who read this article. 

While the process of privatisation is complicated, privatisation is just a normal process for market operations. Sri Lanka’s economic problem is that we don’t solve anybody’s problems. When we do not solve problems, how can we earn money? How can others solve our problems? 

Problem-solving is nothing but improving efficiency. Efficiency can only be improved when people have incentives. It is a universal truth, like the earth revolving around the sun. Even if you look at the Return on Equity (ROE) or Return on Assets (ROA), which are indications of a company’s efficiency, it is very clear that under normal circumstances and on level playing fields, the private sector’s efficiency and impact is much higher than when the Government runs businesses. 

Just take a look at Figure 1, which is a comparison between Sri Lanka Telecom (SLT), which has some private sector engagement and Dialog, which is a private sector player.

Figure 1: ROE analysis of SLT vs. Dialog

Source: Annual Reports of SLT and Dialog (2018-2021)

In some cases, the State sector ROE is simply higher because of the absence of a level playing field. The banking sector is a good example. Most State banks get preferential treatment so their returns are high due to the non-competitive nature of getting businesses. Given the size of the Government, most Government banking is done through the State-owned People’s Bank and Bank of Ceylon. Anyone visiting a State bank and a private bank will experience the difference in service levels. This doesn’t mean the private sector is perfect; markets are always imperfect, but it is obviously many miles ahead of businesses run by the State.

Figure 2: ROE comparison of the banking sector

Source: State of the State-Owned Enterprises, Advocata Institute (2022)

The private sector is not anyone else, it is us. We should be given the opportunity to solve our problems instead of making the Government solve them. When the Government tries to solve the problem, it will not only block the private sector but it will also waste our tax money. Just think of Amal; he is providing me with a reasonable solution to a problem that the Government has been unable to solve for over three decades.  

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.

Defence expenditure: The elephant in the Budget

Originally appeared on the Morning

By Avishka Jayaweera

In his recent Budget speech, President Ranil Wickremesinghe stated: “It has been difficult to allocate resources to health, education, and other important sectors due to the lower level of Government revenue generated from taxes in comparison to other countries.” However, increasing revenue is only one side of the coin. On the flip side, an equally important aspect of a state’s finances is expenditure.

It is only logical that if one tends to spend in excess of what they earn, effectively living beyond their means, their spending is unsustainable in the long run. The same holds true for a state. If a state spends beyond its earnings, it has no alternative but to borrow money to finance its expenditure. However, such borrowing can only be sustained for so long. This is Sri Lanka’s folly.

Except for 2017 and 2018, Sri Lanka has regularly run on a primary deficit [1]. The deficit has largely been financed through debt and money printing. It is the foreign component of this debt, which kept growing incrementally, that is responsible for the crisis Sri Lanka faces today. There is a limit up to which creditors are willing to extend loans to the country. Once Sri Lanka’s credit rating was downgraded and it lost access to the International Sovereign Bond market, the Government could not finance the current account deficit, causing the balance of payments crisis.

Government expenditure and the 2023 Budget

It is clear that the Government must balance its Budget, which is what the International Monetary Fund (IMF) Staff-Level Agreement with the Government aims to achieve by aiming for a primary surplus of 2.3% of the GDP by 2025 [2]. The Government appears to be attempting to do this purely by increasing taxes. This places a high burden on consumers who are already facing diminishing standards of living and an inflation tax, caused by excess money printing among other factors.

What then is the alternative? The answer, although politically unpopular, is relatively straightforward. It lies in cutting down on State expenditure. State expenditure must be scrutinised and prioritised. Instead of reducing expenditure in the 2023 Budget, the Government has increased expenditure by 31% from the 2022 revised Budget to Rs. 5,819 billion.

Expenditure must be rationalised. Calls to cut Government spending do not mean reducing the amount spent on health, education, or social welfare. There are more obvious areas where expenses can be cut, freeing up resources to be used in these aforementioned areas that are of national importance. Defence and security spending is one of the main culprits. The Ministry of Defense has the third highest Budget allocation of all ministries.

Defence and public security spending

Allocations for defence and public security spending have risen in the 2023 Budget to Rs. 539.2 billion, which comprises approximately 1.78% of the GDP for 2023 [3]. The allocations for defence and public security spending have constantly been on the rise, with a 9.1% increase in the 2022 revised Budget and a 10.2% increase in the most recent 2023 Budget.

It has been 10 years since the civil war and Sri Lanka is yet to demilitarise. In fact, since the end of the war in 2009, military expenditure has consistently been on the rise. According to a publication in 2021 by Daniel Alphonsus, not only did military expenditure not return to pre-conflict levels, but even when adjusted for inflation, the military spending post-conflict (from 2009 to 2017) was higher than the spending during the wartime peak [4]. Defence expenditure as a percentage of the GDP was three times higher than in the last period of peace [5].

It must also be noted that 88% of the spending on defence and public security is for recurrent expenditure. Most of this is to sustain an active military force of around 250,000 – incidentally, the 17th highest in the world, exceeding even the military force sustained by the UK [6].

The defence expenditure also includes spending on a Police force of 74,835 officers and a Special Task Force of 8,860 [7]. In 2021, 34.6% of Government salaries and wages were spent on defence [8]. Bearing such a high cost on maintaining an active force during peacetime is not only overspending but is also an inefficient allocation of these resources.

The need for action

Reduction of these active personnel will not only lower Government expenditure but with proper programmes, provide valuable labour that can be utilised in an effective and productive manner in the private sector. While the proposal in the 2023 Budget speech mentions that armed force personnel will be allowed to retire after 18 years, it is unclear if this is optional or mandatory. Further, whether this proposal would even be implemented remains to be seen.

Many Sri Lankan citizens today find it difficult to simply get by due to the crisis brought about by the mismanagement of public finances. While the public is burdened with paying more in taxes, the Government should ensure that the public spendings are efficient, effective, and deliver good social outcomes. It is difficult to justify maintaining a large standing army or a vast defence expenditure in a time of peace.

(The writer is a Research Assistant at the Advocata Institute. He can be contacted at avishka@advocata.org. The Advocata Institute is an independent public policy think tank. Learn more about Advocata’s work at www.advocata.org.)

(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.)

References

• Central Bank, Annual Report 2021.

• IMF, Press Release No. 22/295.

• Based on 2023 Budget Estimates; Public Finance.

• Daniel Alphonsus, Sri Lanka’s Post-War Defence Budget: Overspending and Underprotection, South Asia Scan, Issue No. 15 (Singapore: Institute of South Asian Studies, November 2021).

• Daniel Alphonsus, Sri Lanka’s Post-War Defence Budget: Overspending and Underprotection, South Asia Scan, Issue No. 15 (Singapore: Institute of South Asian Studies, November 2021).

• The International Institute For Strategic Studies, ‘The Military Balance 2021’; Global Fire Power.

• Sri Lanka Police, ‘Performance Report 2019’.

• Calculations based on Central Bank, Annual Report 2021.

Who pays God’s electricity bill?

Originally appeared on The Morning.

By Dhananath Fernando

Over the years, I have volunteered at a humanitarian organisation named CandleAid Lanka to help the poor. The organisation has a programme called ‘Gift a Meal,’ where we provide meals to selected vulnerable households. When these people receive meals or dry rations, they thank the organisation profusely. I have noticed that most families also thank whichever god they believe in, because poor people think it is their god who is giving them a meal through CandleAid. 

I shared this observation later during a dinner table conversation with CandleAid’s Founder, Captain Elmo Jayawardena, who, as usual, cracked a joke regarding my observation. He said: “God takes very good care of people who support CandleAid, because God is rational. God ultimately gets the credit for all the hard work we do, so he must be thinking that he will lose the people’s support on two fronts if he harms such people. Firstly, he will lose the credit he gets through CandleAid’s work, and secondly, people will lose trust in God, because if something happens to people who donate to these charities, others will wonder why generous people are not being taken care of by God. So any rational God would simply do everything to protect us.”

Captain Jayawardena of course did not mean any particular god or religion, but was simply sharing a light moment at a private dinner. 

Lower power tariffs for religious institutions 

There was a time when the high powers of the Ceylon Electricity Board requested the blessings of a rain god for uninterrupted power supply during the Yahapalana regime. Now, religious institutions have requested a lower tariff rate compared to the normal rate.

Let’s face the truth. Even if we provide low tariffs for religious institutions or ask them to pay high tariffs, it is the common people who will pay. If we provide a tariff concession, common people and businesses have to pay it as taxpayers. Someone has to bear the cost of electricity generation, transmission, and distribution. If we cross-subsidise religious institutions, it is ultimately the taxpayers who have to pay. If we ask religious institutions to pay higher tariff rates, these same common people have to pay, as devotees of the god they believe in. 

However, there is a significant difference in behaviour and impact of usage, although the end payer is the same. 

If taxpayers are asked to pay the subsidy for religious institutions, religious institutions have no motivation to reduce their usage, because the buying price is far less than the market price. Therefore, there is no motivation to save electricity. 

At the same time, the difference in treatment of one set of customers will create market distortions. It will also set a bad example and many other customer categories will make the same request. 

Moreover, even those who don’t use electricity at the religious institution have to indirectly pay for it through taxes, instead of spending the money on something productive. This will incentivise the religious institutions to continue using electricity without moving to sustainable energy sources. Even if the particular line ministry pays the electricity bill, it is ultimately the taxpayer who has to foot the bill. 

If the higher electricity tariff is borne by the religious institutions, even then the same taxpayers have to pay the bill, as devotees of the institution. But in this case, devotees who use electricity at the institution will be the ones to bear the cost, so they have a motivation to reduce their consumption. This will also incentivise them to look for alternative energy sources. 

Market reform for better options

Considering the political dynamics surrounding the tariff hike, it appears that once again electricity tariffs are becoming a political weapon as usual. Most likely this will block some electricity sector reforms. 

If there was a market system, there could have been a concessionary rate for religious institutions. For instance, if we had a few companies that undertook electricity generation and distribution, one of these companies may have offered an option for religious institutions to receive electricity at a concessionary rate as charity. 

For example, supermarket chains run various charity projects geared towards sustainability through their outlets. Telco service providers offer different services to donate money on a range of issues at a corporate level. 

Therefore, I believe that religious institutions should request for market reforms rather than tariff concessions, because it is more likely that they will receive a better offer from a market system than from politicians. 

Energy sector reforms should not only be about simple tariff hikes. When we approach an election, these same politicians will simply use the electricity tariff as a political tool, resulting in a bigger mess. The same will happen for fuel as well. 

In Sri Lanka, the culture of entitlement across all sectors is a genuine issue. This culture is not only present in requesting tariff concessions for religious institutions but also in requesting tariff protections for selected industries. On both occasions, the burden is simply passed on to the common man. When the same thing happens repeatedly, there is only one thing left for the common man to say: “God save us.” 

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.

Education is an investment for the future

Originally appeared on The Morning.

By Dhananath Fernando

Last week I was invited for a panel discussion by one of Sri Lanka’s leading stationery manufacturers. This was  for an initiative by them to support 100,000 families with children who are facing hardship due to the current economic crisis. 

According to their data, 50% of Sri Lanka’s families are struggling to support their children’s education. High inflation was mentioned as one main reason for this hardship.  Especially as more than 60% of what people earn have to be spent on basic food so what is left for education is shrinking. Unlike any other crisis, economic crises are the worst because it disrupts society. Inflation is not what the Central Bank says or what Prof.Steve Hanke’s updates as numbers. 

It is people’s pain, sorrow, emotion and helplessness. 80 page exercise books have increased from Rs. 75 to Rs. 100, 120 page books from Rs. 120 to Rs. 225. If you recall Sri Lanka’s World Champion Toastmaster Dhananjaya Hettiarachchi’s winning speech, he says mothers have three types of tears - tears of joy, tears of sorrow and tears of shame. There cannot be any sorrow or shame for a mother other than the inability to educate their loving children. Education is pretty much the most poor parents' insurance policy to overcome poverty at their later stage in life, especially in our context.

In Lebanon the protein intake came down by half and  35% of Lebanon’s 2 million student population have dropped out of school due to the current  economic crisis. As a result of this World Human Capital Index (2020) have projected that children born in Lebanon will only have 52% of productivity. 

So since Sri Lanka is on the same route as Lebanon,  it’s very unlikely that we would deviate far from Lebanon.  The impact of an economic crisis is beyond fuel queues and LP gas lines. Impact can run longer for generations. As Prof.Ricardo Hausmann from the Harvard Kennedy School mentioned, “economic crisis is the same as a civil war.”

So Sri Lanka has to be prepared to overcome this productivity deficit by reskilling and upskilling people. 

Sri Lanka keeps bragging about our skilled labor force and services exports of IT (Information Technology).  This is an industry that is already affected, especially as many such skilled individuals are migrating to greener pastures. Unskilled labour is remaining simply because they can’t afford to leave or they are not skilled enough to leave. Some are unskilled not due to any of their faults but due to economic conditions and flaws in the education system. 

Even though Sri Lanka moves somewhat forward towards economic reforms, after a few years we will experience a skilled labour shortage. When labour is in short supply investors don’t look at us and we become uncompetitive. 

Existing businesses will be further impacted and recovery would be challenging 

What can we do

Reskilling and upskilling our labour force is not just a function of formal education. It is mainly a function of working with co-skilled workers. For example, someone who works in a pizza restaurant has a higher chance of coming up with his or her own pizza recipe than someone just taking a degree in pizza. It's the same like someone who practices and bowls with Lasith Malinga will bowl better yorkers than someone who just watches Malinga bowling or someone just taking a theory course on bowling in cricket. 

So we have to revamp our labour regulations allowing foreign workers to come and work here specially for skilled job categories. That is one way we can attract investors. Not only will it attract investors it would reskill and upskill our own people through on the job training. We have to allow labor markets to work where hiring and firing is easy. 

If the government cannot spend money on education and if the government is too late to contain inflation then at least the government can change the archaic labour laws which have made Sri Lanka uncompetitive. 

While the support and the initiatives by the private sector in uplifting education is welcome, there are quite a lot that can be done with just a stroke of a pen which would have a very high impact at the same time. We need to do charity and reforms both to really survive this education crisis which has been triggered as a result of the 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.

One-size-fits-all reform strategy will not work

Originally appeared on The Morning.

By Dhananath Fernando

It is said that there are three kinds of people: those who watch things happen, those who make things happen, and those who wonder what happened. Sri Lanka’s economic crisis and its story of reforms is undeniably a case of the latter.

Unfortunately, our key institutions and the Government authorities who are currently in the driving seat fall into a new category called ‘those who wonder what happened, but frankly just don’t care’. 

A good example is the recent discussion on the validity of the debt servicing suspension announcement. Since Parliament has the power to approve all public finance decisions, questions have been raised as to how such an important decision, which was made for the first time in the history of Sri Lanka, was not tabled before Parliament for approval.  

Of course, if we had enough money and if our State coffers held a reasonable amount of foreign reserves, we wouldn’t have needed to skip debt servicing or suspend debt repayments, and this would not have been an issue. However, it is no secret that the country did not even have enough funds to clear a shipment of LP Gas worth $ 20-30 million. The phrase ‘scraping the bottom of the barrel’ is not appropriate in this instance, because there is simply nothing at the bottom. 

Warnings fell on deaf ears

There were multiple alerts on Sri Lanka’s debt sustainability issued by local intellectuals as well as by common men and women. Global banks such as Citibank even issued a report titled ‘Denial is not a strategy’. But their warnings fell on deaf ears as our Parliament and Central Bank did next to nothing to remedy the situation. 

Months after suspending debt payments, Parliament is now questioning whether the debt suspension decision had been approved by them. Instead, they should be asking themselves what they were doing for so long when it was obvious that we did not have money to pay our debt. 

When the country was heading straight towards bankruptcy, many policymakers did not bother to question what was happening. This does not justify the failure to follow parliamentary protocol, of course, but two wrongs will not make a right. 

In desperate need of reforms

The current system is a clear indication that our institutions are in desperate need of a complete reform programme, one that includes political reforms. However, expecting reforms to be implemented by a set of policymakers who, up until very recently, did not even bother to question what was happening may be too high an expectation. 

The execution of a solid reform programme requires building upon an understanding of what these reforms should be as well as understanding the importance of laying the foundations for strong, independent institutions. Along with specialist skills, a commitment to seeing these reforms through is required. Political reforms should support economic reforms and vice versa.

SOEs as a starting point

A good starting point is reforming State-Owned Enterprises (SOE). It is quite surprising to me that the International Monetary Fund (IMF) press release on the Staff-Level Agreement (SLA) gives little significance to SOE reforms. 

One of the seven main points highlighted by the IMF and the Government is the need for cost reflective pricing for energy and petroleum products. This is a welcome move, but it will lead to the same problems we have been facing so far. 

Given the state of our institutions, our politicians will adopt the cost reflective pricing strategy for as long as is needed and then simply revert back to their old habits – changing the pricing formula, bringing  prices down, and ignoring the cost factor. For this reason, our reforms have to be of a much more permanent nature this time around and that is why we need a strong combination of specialist skills and a commitment to implementing these reforms. 

The role of the Government

The Government’s role is not to conduct business, and a private sector business leader recently said as much: “The Government’s only business is to not to do business.” Simply looking at which enterprises make profits or incur losses is definitely the wrong way to look at it.  

Government businesses that make profits at present can incur losses in future. The Government has the ability to destroy any notion of a level playing field and can support Government businesses through loans, subsidies, and special permits. The vast majority of profit-making SOEs are not profitable solely due to their own efforts, and in reality, they aren’t competitive businesses.

For instance, it is widely known that the Development Lotteries Board is a profit-making Government institution. What may be a lesser known fact is that there is only one other competitor – the National Lotteries Board, and the directors of both these companies are appointed by the Minister of Finance. Under these circumstances, it can hardly be a surprise that the Development Lotteries Board is profitable. 

Therefore, looking solely at profitability won’t address prevailing issues. We have to first look at what the role of the Government should be. 

It is true that all SOE reforms cannot adopt a one-size-fits-all strategy. Different SOEs have to be treated differently. This treatment has to be based on the principle of the government having no role in business.  

In cricket and football, it is a commonly held view that the umpire or referee has no role in playing the game. It is the umpire’s responsibility to overlook the game and ensure that it is being played fairly. The umpire’s decision is final and if the umpire acts more favourably towards one side, there is another set of regulation mechanisms to manage this. The umpire facilitates the competitive nature of the game. The same holds true for the role of the government. 

Many options have been discussed for reforming SOEs, including privatisation and SOE consolidation that follows models like the Temasek in Singapore and Khazanah in Malaysia. Regardless of which option is chosen and which model is followed, we expect the Government to implement SOE reforms on a case-by-case basis, with special attention being paid to the role of the State.  

If we fail to understand the role of the State and implement solutions for SOEs based on this, Sri Lanka’s reform programme will probably fall into the category of things that make people ‘wonder what happened’. People will certainly question the reform programme and its credibility, while our next generation will wonder how they inherited such a poorly-managed nation that was once so full of potential.  

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.

Reform or perish

Originally appeared on The Morning.

By Dhananath Fernando

A Staff-Level Agreement (SLA) with the International Monetary Fund (IMF) is a positive indicator of things to come. However, we still have a long journey to go and getting an SLA is just the beginning. 

We have negotiated with our creditors and have begun to implement reforms to stabilise the ship. We have to continue this trend and perform hard reforms to ensure our economy grows to a level where we can sustain it without resorting to borrowing.

In the status quo, I foresee a few scenarios that could happen with present political dynamics.

Scenario 1: Forming reform committees but not performing reforms

Sri Lankan policymakers’ solution for all problems is to set up a committee. There is a risk that we will do the same for reforms. Already, committees are being formed to take reforms forward, but reforms generally get sidelined or stuck in limbo. 

I recall many years ago there was a Cabinet Committee on Economic Management (CCEM), which was later replaced by the National Economic Council (NEC). Afterwards, the NEC was also dissolved and no economic reforms were taken forward. 

In the interim Budget, a new committee on SOE reforms and a few other pre-reform steps have been suggested. But the willingness to reform and the ability to execute is the most important aspect. If we leave a committee for reforms to its own devices, it will kill time while this crisis kills many of us.

Scenario 2: Some reforms are as good as no reforms 

There is a probability that a few reforms will be enacted. This is also a dangerous scenario. While in 1977 some reforms were implemented, labour market reforms and many other required reforms were not carried out. As a result, we failed to get the maximum benefit out of opening up the markets. 

Reforms in the 1990s were also not carried out in a holistic manner. Half-baked and half-hearted reforms will not rescue us from this crisis 

Scenario 3: Capitalising on low expectations but no real reforms

Another possible scenario is that policymakers and politicians will try to build their political capital based on a low-expectation environment. 

People’s expectations have fallen so low that a two-hour power cut has become accepted given the circumstances. A few hours staying in a fuel line has also become acceptable and even an achievement, despite us taking the ability to freely pump fuel for granted only a few months ago. The availability of LP gas has also become an achievement. 

Given this environment, politicians may try to just keep the basics supplied and settle for a new normal with very low expectations and build political capital until the election without enacting hard reforms. That will not only take Sri Lanka backwards, but we will move towards stagflation. Our youth will be less aspirational and the dream of a higher income country will fade away 

Scenario 4: Making reforms the entry gate for corruption 

While economic reforms are essential, since we haven’t seen any reforms on the political front, the same corrupt politicians may misuse this opportunity. 

Important reforms such as privatisation and Public-Private Partnerships will be passed with less transparency and no accountability to benefit the inner circle of corrupt politicians and with minimum benefit for poor taxpayers. This will dilute the public’s trust of reforms and create resistance against much-needed change. 

Scenario 5: Reforms that snowball 

This would be the best-case scenario, where we move proactively on a series of reforms to completely transform our economy. These reforms will not just halt after one wave.

Given dynamic economic and global conditions, reforms have to keep moving while keeping up with global changes, since otherwise the reforms that we do today will pose the same barriers for us a few years later. Sri Lanka needs to move towards reform and resetting itself in a holistic manner. 

Our aim has to be to create an economy where the 17th time becomes the last time in which we go to the IMF.  We need in-depth thinking to move fast. Simply making statements or addressing the audience based on current sentiments is not a solution; we need genuine willpower to get reforms done.

We have to capitalise on the IMF SLA and move forward with the rest of the reforms without delaying the process. The research has already been done and what needs to happen is very well known. It is just that we need to get our act together and move forward.

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.

New electricity tariff structure leaves room for considerable improvement

Originally appeared on the Daily Mirror, Timesonline.lk

By the Resident Fellow of Advocata Institute

The recent revision of electricity tariffs is a step towards reducing the fiscal burden caused by the supply of electricity below its cost of production. While the new tariff structure is an improvement on the previous one, anomalies remain.

 In determining tariffs, there are three characteristics of electricity that must be noted:

I. Electricity is a commodity that is interchangeable, both in its generation and use. One megawatt hour (MWh) of electricity produced from coal or hydropower contains the same amount of energy. Different categories of users consume the same product.

II. It must be produced and used simultaneously. Electricity storage is still prohibitively expensive. Supply must meet demand exactly in the power grid.

III. The cost of supplying electricity fluctuates throughout the day, depending on the power generation mix, cost of fuels used, transmission costs and energy losses.

As electricity is a commodity, there should be no difference in the prices charged to different users. The tariff should also reflect the varying cost of supply, depending on the time of day and should as far as possible, balance the generation of electricity with its use. For sustainability, the tariff needs to be on a cost-recovery basis.

The new tariff addresses some of the shortcomings of the existing structure but there is still considerable room for improvement.

1. The proposed structure reduces the discrimination between different types of bulk supply customers.

For users below 42kVA, the different rates that were charged to hotels, government and general-purpose bulk supply, have been amalgamated into a single general-purpose tariff but a lower rate remains applicable to ‘industrial’ customers. However, it is positive that the differential between the general-purpose bulk supply and customers categorised as ‘industrial’ has decreased.

For larger bulk customers, it is welcome that the distinction between categories has been done away with and a single tariff, close to cost recovery and reflecting time of use, has been applied.

The Public Utilities Commission of Sri Lanka (PUCSL) consultation document states that the average cost of generation is Rs.32.87 but the tariff charged to low-use industrial users (Rs.20) and low-use general-purpose customers (Rs.25 for those below 180kWh) is both below cost.

The only justification for a discriminatory tariff is for a lifeline tariff for the poor. While the domestic users below 90kWh do receive a subsidised tariff, the domestic consumers, who exceed this, pay the highest tariff (Rs.50 for usage between 90-180kWh, Rs.75 above 180kWh), which is almost double that of all bulk users. Thus, high-use domestic consumers are subsidising industrial and commercial users.

Moreover, instead of increasing the rate for each block of use, the moment domestic customers exceed 60 units, the tariff increases from an average of Rs.9 to Rs.16. A customer, who consumes 59 units, will pay Rs.9 but one who consumes 61 units will pay Rs.16 per unit. This is unfair and can promote corruption in meter reading. In general, such cross subsidies are undesirable, as they can lead to inefficient resource allocation or have unintended consequences.

For example, the higher domestic tariff may serve as a disincentive for remote work. Remote or flexible work arrangements can reduce transport costs, congestion, energy use and for some, enable a better work/life balance. The government should be facilitating flexible work but the higher rates applicable to some domestic consumers may be a disincentive.

The PUCSL has an unusual definition of industry. It includes, ‘agriculture’, ‘forestry and fishing’, ‘mining and quarrying’, ‘manufacturing’, ‘electricity, gas, steam and air conditioning supply’, ‘water supply, sewerage and waste management. As a matter of principle, the producer should not make judgment on how the product is used or attempt to encourage or discourage particular activities through prices. If the government does wish to encourage particular industries, it is more efficient to do this through a transparent system of grants, rather than distorting prices.

Economic activity is increasingly complex and a value chain can involve many different sectors. For example, the tea industry involves agriculture, processing in factories, transport, warehousing, blending, financing, marketing and exports. Moreover, products are now more knowledge intensive, so a greater part of the value addition arises in non-production-oriented components of the value chain. With differential tariffs, parts of the same value chain may pay different prices for use of the same commodity.

Religious and charitable bodies continue to enjoy preferential treatment under the domestic tariff category but there is a small decrease in the discount offered to these bodies. High-use customers in this category should also be subject to a time of use (TOU)-based tariff. Advocata reiterates that there should be no price discrimination between users; at most there should be two categories, households and businesses.

2. It is welcome to note that the new tariff structure extends the TOU tariff to the agriculture subsector but this should be extended to smaller bulk users and made compulsory for the high-use domestic category. For customers using solar power on a net metering basis, the export and import tariffs should be based on TOU. A TOU-based tariff reflects the changing cost of generation across the day. Generation during peak hours relies more heavily on thermal power, which is more costly. Tariffs charged to customers should reflect this, so that the consumers are incentivised to shift demand to off-peak hours.

3. The new tariff maintains a lower rate for low-use domestic customers and it is welcome that the new structure applies marginal tariffs based on different slabs of usage. The previous system was inherently unfair to the consumer; the new tariff removes this anomaly.

4. The decision to charge for street lighting, which should be paid for by the local authorities, is welcome. Previously, as the Ceylon Electricity Board (CEB) did not charge for street lighting, the local authorities, which have control over when the lights are switched on and off, had no particular incentive to switch off street lights during day time. A lower rate for street lighting is justified because the major part of the use falls into off-peak hours.

5. It is regrettable that the PUCSL permitted the CEB to compel selected clients to pay for electricity in US dollars. This is a step towards forced dollarisation of payments and is precluded under Section 4 of Monetary Law Act No. 58 of 1949. The proposal is meant to address the current shortage of US dollars for importation of fuel for the energy sector. However, this would only divert resources from other alternative users and may not be the most efficient way of allocating the scarce foreign exchange in the country. It would be preferable to allow US dollars to flow into the banking sector (by removing any restrictions and requirements such as forced conversions and surrendering requirements) and for those funds to be allocated based on price (exchange rate).

The increase in the electricity tariff is unavoidable but will impose an additional burden on consumers. Therefore, it is imperative that this must be accompanied by increased transparency and efficiency

within the utility.

Consumers may expect to pay for higher world prices but cannot be expected to pay higher costs, due to inefficiency, waste or corruption. State enterprises need to be open and transparent in their affairs, particularly in procurement and where possible should operate in competitive markets.

As a first step, the CEB should provide a detailed breakdown on the components of its tariff:

• Energy costs: (Own generation costs and that paid to the private generation companies). This must be broken down into the fuel cost and the costs of operating the power stations, such as the manpower and maintenance costs as well as the capital cost of the stations.

• Network costs: This reflects the cost of transporting electricity through the power grid.

• Overhead: This is to recover the costs of central administration, billing and meter reading, data management, retail market systems as well as market development initiatives.

The opinions expressed are the authors’ own views. They may not necessarily reflect the views of the Advocata Institute.

Import controls: Regression when we really need reform

Originally appeared on The Morning.

By Dhananath Fernando

I recall a visit I made to a small eatery back in 2015, just a few weeks after the interim budget speech by the new Yahapalanaya Government. The eatery prepared hoppers, egg hoppers, and short-eats – this was just after the then Finance Minister, in his Budget speech, had announced price controls on hoppers at Rs. 10, egg hoppers at Rs. 25, and, if my memory serves me right, plain tea at Rs. 5 and Rs. 10 for milk tea.

When I asked for an egg hopper, the shopkeeper (‘mudalali’) said: “Sir, we are not selling egg hoppers. If you want, you can buy an egg here for Rs. 17 and give it to the chef and he will put the egg on a normal hopper, which is priced at Rs. 10, and you will get your egg hopper.” I was totally confused and I asked the shopkeeper: “What do you mean? Can’t you give the egg from your counter straight away and give me the final bill?”

He replied: “Sir, because of the price controls we can’t sell egg hoppers at profitable prices. An egg costs about Rs. 17-18. Coconut is also expensive, as are rice flour, wheat flour, and cooking gas, so we can’t sell egg hoppers at Rs. 25. So we sell eggs and hoppers separately.” I then followed his instructions and got the egg hopper prepared.

Generally when buying hoppers, chilli sambol, known as ‘lunu miris,’ comes complementary. I was waiting for ‘lunu miris,’ which did not arrive. I asked the shopkeeper: “Where is my lunu miris?” He replied: “How can we give lunu miris free when we sell hoppers at Rs. 10? You have to buy lunu miris separately by paying an extra Rs. 10.”

Price controls never work

The recently-imposed price controls on eggs will not make any difference to the same set of outcomes I observed about seven years ago. Sadly, Sri Lanka’s policymakers have not learnt their lesson – that price controls have never worked and will never work. Following the implementation of price controls on tea, tea shops will stop serving sugar and ask people to buy their sugar separately. 

If you recall, in the recent past there was a Government-controlled price for chicken. Meat shops at one point stopped selling whole chicken and instead only sold chicken parts. Thereafter, we had many price controls on rice, dhal, tinned fish, sugar, cement, and even on USD. Anyone who has a reasonable memory will remember that none of these price controls worked. 

At one point, there were price controls on pharmaceutical products despite the currency depreciating by 80%. How can a company import the same drugs and keep the same price, with the cost rising by 80% due to poor monetary policy? The only option available for pharma companies was to stop procuring those formulas. 

The same happened with milk powder. The consumer became the ultimate loser by suffering shortages in the market. There is a sentiment that private businesses hoard similar goods, which are stocked at lower prices, and sell only when the prices are increased. There may be some truth in it. As we all are aware, the private sector is also a reflection of our Government sector and policymakers, and the private sector has been given those opportunities when competition is not allowed and financial instability is not managed. But ultimately the common person loses on both ends – both through shortages and higher prices. 

The price control on eggs is going to impact the less-fortunate the most, since eggs are their main source of protein. They don’t require refrigeration and they are more affordable compared to the other protein options. The price of 500 g of fish is now Rs. 1,500-1,800. Chicken and other protein sources are also very expensive. Even dried fish and sprats are more expensive than eggs when calculated on a per meal basis and when accounting for overall convenience, effort, LP gas consumption, etc. 

So when price controls discourage suppliers from supplying eggs at that rate in an environment where chicken feed prices have gone up and prices of medicine for poultry and transportation have increased, price controls simply become meaningless and send a completely wrong signal to markets, while we are in the spotlight for an IMF programme and debt restructuring. 

Import controls a mistake

The Government made a similar, crucial mistake by announcing import controls on 300 selected HS codes as a measure to save our valuable dollars. We need to first remember that we have already cut down quite a lot of imports and we are really scraping the bottom of the barrel by restricting our fuel and some essential medicines. We have completely banned imports such as vehicles for more than two years now. 

Sri Lanka’s imports have been declining since the 1990s; policymakers should ask themselves: if import controls brought us to our darkest hour, how are the same import controls expected to save us from the crisis? Some import bans are on intermediary goods, and, as economic theory has shown around the world, with import restrictions, exports will also decline and Sri Lanka will become a net loser. We have to discourage imports through the pricing of dollars so imports will automatically come down with higher prices.

Import controls will also confuse markets and dilute the credibility of the Central Bank Governor. As he mentioned, we have adequate forex for essentials in the coming months. So the question arises: if we have enough forex, what is the purpose of import controls?

Secondly, both import controls and price controls, in my view, will have an impact on IMF negotiations at home. The Article IV IMF staff report clearly notes that we have to phase out import controls. Announcing import controls at a time when they are visiting Sri Lanka sends a negative signal to the IMF and to our creditors that Sri Lanka is not open to reforms.

Trade is a two-way street

Already the European Union and Japan have on multiple occasions indicated the importance of trade. In fact, the European Union stated: “Trade is a two-way street.” In this context, we are creating more resistance from our neighbouring countries at the brink of a very important debt restructuring and IMF programme. 

Both recent policy actions indicate to the world that we are just following the same old methods and are not open to serious market reforms. We will also not comply with some guidelines of the World Trade Organization with this decision, isolating ourselves globally at a time we need support the most.

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.

Debunking myths about reforms

Originally appeared on The Morning.

By Dhananath Fernando

As this column has highlighted many times, Sri Lanka is presently at a crossroads. Either we will excel and emerge as one of the dynamic tiger economies of Asia, or we will become a failed state, going from one crisis to another. There is simply no middle path between the two outcomes. 

So far in our history, we have missed the bus of economic reforms repeatedly. Our reforms of the late 1970s were half-hearted and necessary labour market reforms; other economic reforms haven’t been completed. Following this, we had a 30-year war and a short period of high growth post war. 

Recently, Prof. Premachandra Athukorala devised an interesting metaphor about Sri Lanka’s economy at Advocata’s #ReformNow conference on ‘Let’s Reset Sri Lanka’. He compared a sumo wrestler to a normal wrestler. 

Sumo wrestlers are big and heavy, whereas the normal wrestler is skinny and small-made in comparison. To the casual observer, it may look like the sumo wrestler is stronger than the normal wrestler, but in reality, the life expectancy of a sumo wrestler is about 20 years less than an average Japanese man. 

Prof. Athukorala compared the Sri Lankan economy’s high growth years to a sumo wrestler. Although the growth numbers were high, our economy has always been vulnerable – just one trigger can cause so many problems. 

As he very correctly mentioned, due to a few triggers such as the Easter attacks and Covid, we are going through a lot and will have to shoulder a great burden in the future. What we need to be, with regard to our economy, is a normal wrestler; one who is flexible, agile, and dynamic, with a high life expectancy and who can adjust easily to global trends and to challenging times. 

As we all know, change is difficult and resistance to reforms is inevitable. In many cases, it is untrue myths about reforms that drive this resistance.

Myth 1 – Privatisation would mean selling the family silver and our sovereignty 

A common myth against State-Owned Enterprise (SOE) reform is the rhetoric that it amounts to selling the family silver or selling off national assets. This is a popular argument in the vernacular.

We have to first identify most of our SOEs as loss-making; they are more of a liability than an asset. Secondly, being owned by the State doesn’t mean that they are owned by the people. If they are owned by the private sector, that is what you might call being owned by the people. 

Let’s take the Ceylon Petroleum Corporation (CPC) or SriLankan Airlines as examples. Both are owned by the Government of Sri Lanka. So where are the benefits for the people? There are none.

We can’t pump all the fuel we want despite being able to pay for it. Most of us can’t apply for a job at the CPC or at SriLankan, since many of these opportunities are given to supporters of political elites. As both institutes are loss-making and taxpayers are paying for something they don’t consume, what is left for the people to own or obtain benefits from? 

But if the same institutes were owned by the private sector, then that company would have to pay taxes, which is a source of revenue for the Government that can be spent on the people and on public goods. People can buy shares, will be entitled to a dividend, and can apply for job opportunities on a competitive basis. 

Sri Lankan businesses and foreigners can invest money and create jobs for our people while improving productivity and efficiency. So in reality, ownership of assets by private companies is a situation where they are in reality owned by the public. 

Consider the main telecom companies and conglomerates as an example. They are the main tax payers to the Government and are often victimised by one-off surcharge taxes when Government revenue drops significantly. This definitely does not mean that all participants in the private sector are clean, but we all know that they are usually better than the Government sector and Government-owned businesses. 

On the argument of sovereignty, it has been said that “the business of business is business”. Businesses enter a market to make profits and they become sustainable when they generate profit. Many Sri Lankans have successfully expanded globally, but have we ever heard the people of those countries complain that Sri Lankans have come to take the sovereignty of their country? 

Myth 2 – The IMF is the solution to all problems

Another common myth is that the International Monetary Fund (IMF) is the solution to all our economic problems. This is simply not the case. The IMF can only give us some money and credibility. Both will bring some stability, but our economy needs to grow organically and continuously like an agile, flexible wrestler for us to overcome the crisis and to become a tiger economy. 

The IMF cannot implement reforms for us – we have to buckle down and implement economic reforms and reset Sri Lanka for our own progress. The IMF is just a stepping stone on a long journey; it cannot solve all our problems. 

We have to welcome a full package of reforms to grow the economy. We have gone to the IMF about 16 times previously and only six programmes have been completed. Out of the Extended Fund Facility (EFF) programmes, which require structural reforms, we have completed only two programmes. Our track record indicates that we are a nation that expects the IMF to solve our problems rather than solving them on our own.   

Myth 3 – IMF is the problem 

On the flip side of the coin are those who think the IMF is the problem. They are of the view that the IMF is some sort of secret agent who will engineer all privatisations in the interest of Western oligarchs and they believe that the IMF operates like a gangster with a gun ready to shoot us if we don’t do what they say. 

This is simply untrue; the IMF in this case is the International Monetary Fund and not the Impossible Missions Force from Tom Cruise’s action film franchise. 

The IMF is like a bank’s credit officer who will evaluate a business proposal and then approve the granting of money. We all know bank officers don’t initiate business proposals, but the customers do. 

Similarly, the Government has to go to the IMF with a plan and the IMF will evaluate whether the plan is adequate to achieve the desired results. If we fail to adhere to what we promise, as we have done 10 times out of 16 in the past, they won’t release the balance money, and nothing will happen except the continued deterioration of our economy. 

Given this context, a side effect will be that no one else will come forward to give us assistance if we don’t move forward with the IMF programme. They are like a gym instructor and they can recommend a good diet and exercise, while our policymakers have to do the work to ensure an outcome. 

Myth 4 – Imports are the problem; imports are bad, exports are good

Since we have a USD/forex shortage, some are of the view that imports are the reason for the crisis. We first need to understand that before we import goods or services, we buy USD by paying in LKR for imports. 

If we really wish to do so, the best way to discourage imports is to increase the price of USD before we ban any imports. This is where the stability of the monetary system becomes of paramount importance in overcoming the crisis. 

If we need to encourage exports, the best way to do it is to pay the market rate for USD to exporters so they can be more competitive. This is why it is said that “stability is not everything and without stability everything is nothing”. 

The truth is that imports and exports are both good because they are two sides of the same coin. We need exports for imports and imports for exports. We need to look at overall trade reforms and facilitate further trade rather than thinking that imports are the problem. The problem is the monetary system which determines the price of USD, not imports or exports. 

The above are just four myths out of many. Those perceptions are like a virus, but we need to implement reforms and reset Sri Lanka if we are interested in forming a dynamic and healthy economy like a natural wrestler who can absorb shocks and perform in good times as well as in bad times.

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 case for privatisation

Originally appeared on The Morning.

By Dhananath Fernando

Privatisation has entered the lingo of the nation once more. A few years ago, the mere mention of it was taboo in many circles and although the fear of using the word hasn’t fully evaporated, an increasing number of people actually understand the concept today. 

The discussion is now drifting towards whether privatisation is good or bad, with those proposing privatisation highlighting examples of success stories while those against it bring up examples of where it has gone wrong. 

In my view, rather than debating the merits of privatisation right away, the starting point of the discussion has to be about what Sri Lanka can do to overcome the crisis and how to transform our little island into a dynamic economy in Asia. 

On our journey to find answers, we can consider many options, of which privatisation is definitely one. However, our starting point has to be getting Sri Lanka out of this mess and our solutions have to be pragmatic and suited to our context. 

It is the same as a doctor prescribing medicine for ailing patients. The doctor first performs a diagnosis and then recommends medication based on the patient’s condition, history, affordability, side effects, and many more; he does not begin debating the merits of a particular treatment without a thorough diagnosis.

Obstacles against reforming the State sector

There is a brewing school of thought in Sri Lanka that given the many public corporations well-operated by honest and honourable professionals in other countries, nothing stands in the way of Sri Lanka having the same. The oft-cited examples include Singapore and New Zealand. 

Firstly, we have to realise that Sri Lanka’s context is very different. We are a country whose political system is rotten to the core. In fact, when President Gotabaya Rajapaksa took over the office of the president, he appointed a committee to appoint directors to State corporations and we are all aware how that ended. 

Simply put, our political system and context doesn’t facilitate getting talented professionals for the management of State-Owned Enterprises (SOEs). 

Secondly, the vast majority of capable professionals in Sri Lanka are very well compensated and taken care of by the private sector, so they have no reason to move to the public sector, which would come with a massive risk of political backlash and less pay to boot. Salary scales in our SOEs simply do not attract the right talent to drive management change. And that’s just one side of the story. 

Thirdly, Sri Lanka is now unfortunately bankrupt and most of the key SOEs carry both massive debts and losses. We cannot realistically expect the right talent to join and transform SOEs, knowing they will be faced with a difficult restructuring and turnaround, particularly without even the incentive of competitive salaries. 

Last but not least, there is a principal-agent problem when the State attempts to conduct business. The State is currently involved in many industries as botha  regulator and a market player. Can you imagine if the umpire in a game of cricket was also a batsman for one of the sides? 

The State is involved in a multitude of sectors including hospitality, aviation, modern trade, banking, energy and many more. Although it has a bigger role in establishing the rule of law and a competitive marketplace, it is instead wasting resources on micromanaging certain industries. 

The State is presently a jack of all trades and master of none, falling far behind expectations both in terms of ensuring the rule of law and managing business. 

Privatisation as a viable option 

It is in this context that Sri Lanka has to consider privatisation – not simply for the sake of privatisation but as a solution for the problems we have. There are six basic reforms that we have to implement if we wish to emerge from this crisis in a timely fashion.

• Increase revenue

Privatisation can increase revenue because private companies pay taxes to the State. At present, rather than receiving taxes, the Government finances a number of heavily loss-making institutions. When undergoing privatisation, the government earns money from the assets it sells, so on both ends it will bring revenue for the Government to overcome the crisis.

• Reduce expenditure

Currently, the Government’s main expenditure is on SOEs. The Ceylon Petroleum Corporation (CPC), for example, has lost Rs. 600 billion in four months. SriLankan Airlines has lost Rs. 200 billion in four months, an amount that is four times the entire Samurdhi budget (Rs. 50 billion), which is used to take care of the most vulnerable people in our society. 

When we privatise, our expenditure will fall and we will stop leaking money, whereupon those savings can be given to the most vulnerable.

• Reduce debt

SOEs not only increase expenditure and burden State coffers – they carry a lot of debt in both LKR and USD. The Central Bank Governor recently stated that the CPC had neither USD nor LKR to run its operations and that the Government had to finance it. Privatisation will reduce our current and future debt burden, which will help restructure our debt and achieve debt sustainability. 

• Increasing growth

Another important aspect of overcoming the crisis is to create growth. The current set-up of retaining State ownership of these loss-making and inefficient enterprises will simply slow down growth. 

Consider the example of the East Container Terminal. Multiple tender proceedings were stopped and cancelled but the Government was still said to be capable of seeing it through. However, it is now obvious that this is not possible given the crisis. 

Moreover, not only are we behind, but we are also losing container transhipment due to capacity constraints while business is moving away from the country, challenging our long-standing transhipment status. 

However, the private sector can drive growth. They have cash, and to an extent, lending capacity. The private sector is more concerned about profits, not so much about the overall economy of the country.  

• Increasing productivity

We all are aware of the productivity figures of State-managed institutes. News reports revealed that even with fuel shortages, the CPC had paid a total overtime pay amounting to billions of rupees. 

The private sector can drive productivity. It can introduce technology, processors, business ecosystems and networks to create synergies, which will create job opportunities and drive productivity across the nation. 

• Attracting FDI

The private sector, locally and internationally, can bring investments to our shores with privatisation (meaning US Dollars) in addition to technology and skills which will spill over to other sectors, driving productivity and efficiency. Foreign Direct Investments (FDIs) will undoubtedly ease the pressure off the Government in relation to USD shortages. 

Case-by-case basis 

Thus, privatisation suits Sri Lanka based on the crisis and context. It is a solution for what we are going through and a medication that fits the condition of the patient. 

However, this doesn’t mean we have to privatise everything. Energy and electricity have to be unbundled first and the market must be made competitive. The pressure on the Ceylon Electricity Board (CEB) and the CPC will ease and consumers will have a better experience. 

Some institutions such as SriLankan Airlines have to go for a fire sale, while some institutions can be consolidated and some can opt for public-private partnerships. There is no single remedy for all, but we have to move forward on a case-by-case basis. The important thing is to move forward and for the State to slowly move away from doing business, instead focusing on the Judiciary and the rule of law. 

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.