Why focusing on trade is paramount

By Dhananath Fernando

Originally appeared on the Morning

If you were to ask the average Sri Lankan what Sri Lanka’s economic problems are, you are most likely to hear three answers. The most common and popular answer would be corruption, a likely second would be high imports, and some may even say there is a lack of exports.

This article will address the second and third answers.

Contrary to popular belief, many Sri Lankans are unaware that our imports are declining compared to the size of our economy. Many make the mistake of checking the total value of imports and claiming that our imports are increasing.

That is correct, but import value can increase for many reasons. It could be due to a significant price fluctuation of certain imported commodities (fuel), a consumption hype due to a growing population over the years, or many other reasons.

Accordingly, imports and exports both have to be evaluated in comparison to the size of the economy – commonly known as the Gross Domestic Product (GDP). It is the same as considering a person’s weight relative to their height and age: weight as an absolute number has no meaning without comparing it with height and age.

Since the 1990s, Sri Lanka’s imports as well as exports have been declining compared to our economy. In recent years, exports have increased because our economy contracted steeply with the economic crisis while our exports remained fairly constant.

This indicates that the claim of our imports being a problem is a complete myth and misleading. Instead, our problem is that our imports are low because our exports are low. We need to export more so we can import more of the things that are being produced competitively and efficiently in other parts of the world.

For instance, let us consider the example of food items. There are many food items with a high range of protein sources and variety that food insecure people can afford, which face a high tariff rate in order to discourage consumption. The final victims of this process are the poorest people in the country who cannot afford a variety of food.

The impoverished spending more on food means they are left with little money to spend on non-food items such as education and health. Therefore, discouragement of imports through tariffs will affect the poor.

Another common myth in Sri Lanka is that Free Trade Agreements (FTAs) increase imports while drying out our USD reserves. Sri Lanka hasn’t signed many FTAs to begin with. Even when we analyse the data, trade primarily takes place outside FTAs.

Let us evaluate the Indo-Sri Lanka Free Trade Agreement (ISFTA). Imports are declining or stagnant from India to Sri Lanka under the ISFTA and we have undertaken more exports than imports under the agreement. However, more trade has taken place outside the ISFTA.

One potential reason for this could be the cost for companies to comply with the ISFTA and the complicated nature of FTAs. However, we have done more exports than imports under the ISFTA, indicating that trade agreements are not necessarily conspiracies by other countries to push their products but that Sri Lanka has done well in exports under FTAs in absolute numbers. As such, the claim that trade agreements push imports and discourage exports is also misleading and the data fails to support the claim.

Even if we check the numbers for the Pakistan-Sri Lanka Free Trade Agreement (PSFTA), we export more under the FTA in absolute numbers than we import. However, compared to our GDP, our trade is very weak, which is one of the main constraints to our economic growth.

Our barriers to trade are beyond trade agreements. Most barriers are internally driven by Sri Lanka Customs, the complicated tariff structure, necessary regulatory barriers, and related to ease of doing business. Blaming FTAs or imports for our economic crisis is meaningless. Instead, our growth potential lies in when we import and export and simplifying the tariff structure unilaterally is the first intervention to minimise corruption and boost trade.

Joining global trade will not only make our country wealthier but position us strongly in Indo-Pacific geopolitics.

As it was famously said: “When goods and services don’t cross borders, soldiers will.”

(Special thank you to Advocata Institute Research Analyst Araliya Weerakoon)

A facelift for the railway

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

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

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

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

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

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

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

Fixing policy failures in trade and tariff

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

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

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

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

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

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

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

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

Addressing the land problem

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

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

Image Credit: JB Securities

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

Poor utilisation of land by SOEs

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

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

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

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

Image Credit: JB Securities

Solutions

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

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

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

Rough seas make good sailors: Embracing competition in trade

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

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

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

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

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

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

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

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

Cattle Slaughter Ban: It’s Not Intentions But Consequences That Matter

Originally appeared on Daily FT, Daily Mirror and The Island

By Sathya Karunarathne and Pravena Yogendra

The Cabinet of Ministers approved the Bill to amend laws to ban cattle slaughter in the third week of October. While this is a contentious policy measure, it did not come as a surprise as the Prime Minister proposed the same policy just over a year ago in September of 2020. 

From the outset, it may seem that the policy is well-intended. Alleviating animal suffering is a noble cause that many Sri Lankans would identify with. Unfortunately, even well-intended policies have unintended consequences. In the case of a cattle slaughter ban, the consequences can be dire for the livelihoods of thousands of people. As stated by the Department of Census and Statistics, 117,033 farmers raised cattle and/or buffalo locally and 56,984 farmers raised improved cattle and/or buffalo in 2020.1 Further, as reported by the Livestock Statistical Bulletin there were 296,111 cattle farms and 26,284 Buffalo farms registered in 2020.

The cattle rearing industry does not exist in isolation, nor is it sustained to nurture the beef industry alone. Cattle are an integral part of the dairy industry, leather tanning industry and footwear and leather goods industry. The dairy industry sells unproductive cattle, where 50% of the animal is salvaged as beef (3) and other parts are sold as raw material to other industries such as the leather tanning industry, etc. Therefore, a cattle slaughter ban would have consequences on all these sectors.

The Government’s intention in banning cattle slaughter is to increase dairy production and local agriculture as reported by the media. According to Central Bank data in 2020, the annual milk production from cattle was 414 m litres and 78 m litres were produced by buffalos. In the same year, Sri Lanka imported 102,355,524 Kgs of milk and milk products, and exported 1,057,079 Kgs of the same.

To keep this dairy industry running, milk producers need to get rid of unproductive cattle. Eranga Nihal Perera, the Chief of the Ceylon Cattle Farmers Association, put this into perspective speaking to the Sunday Times a few weeks ago. He stated that a bull or milch cow requires 10% of its body weight in food daily. For example, an adult stud bull weighs about 400 kgs. That is approximately 40 Kgs of feed per bull, every day. Therefore, a bull would require a monthly cost of around Rs. 26,000 to be maintained. It makes limited economic sense to sustain unproductive cattle incurring such costs as it will increase costs of maintenance with no return on investment. 

A total of 162,000 cattle were legally slaughtered in 2020. Key person interviews with leading industry stakeholders revealed that the cattle population which amounted to 1,628,771 in 2020 can grow up to three times within 10 years with the implementation of a slaughter ban with 75% of them counting to be unproductive.(10) The costs of maintenance will therefore evidently be unbearable. These cost increases, if they can be sustained at all, will be passed on to consumers as price increases in milk. A further stress to an industry already reeling with shortages and high prices. 

Beef is sourced from cattle deemed as unproductive by the dairy industry. Male cattle or bull calves are used to identify female animals in heat and to serve stud purposes, aiding the artificial insemination process. They are slaughtered for beef when they reach about three months of age. Milch cows are slaughtered after completing four calving cycles as they are considered aged, unproductive and unprofitable to maintain at this juncture. Unproductive animals must be culled to maintain the overall productivity of the herd as unproductive stud animals could mate with productive cows, producing low yielding calves. 

The latest available data shows that beef production in 2019 amounted to 29.87 metric tons.

Smallholder dairy farmers contribute to this as smallholders dominate the livestock industry. For example, a 2019 study by the University of Peradeniya revealed that among private dairy farms in the country about 95% are small scale producers. While cattle farming in Sri Lanka is running on narrow margins, a significant contribution of the marginal profits comes from the sale of these animals to the beef industry. 

Dairy farmers make an annual lifetime profit of ~30% from the sale of an animal. Therefore, small farmers who raise cattle individually for an additional income will be severely impacted by the ban. They will not be able to afford the additional maintenance costs of unproductive cattle and will have to halt their small scale business operations.

Banning cattle slaughter with the intention of increasing dairy production therefore is contradictory as it proves to be counterproductive. As illustrated above the milk industry can barely sustain itself without the beef industry. 

A slaughterer purchases an animal for ~LKR 300 per Kg live weight. Live weight ranges from 300-500kg. Thereafter, 50% of the animal is salvaged as beef and the remaining is sold to other industries.(14) The leather tanning industry is one such industry that sources raw material from cattle slaughter. A slaughtered cow yields 15-16 sq ft of rawhide. Rawhide is sourced from the slaughterer by the leather tanning industry at Rs. 45 per Kg. Domestically tanned leather is sold to the footwear and leather goods industry as raw material at Rs. 175 per Kg as opposed to imported tanned leather priced at Rs. 250 per kg ($1- 1.20).(15) 

Moreover, discussions with the industry revealed that about 60% of leather needed to produce affordable footwear is produced domestically and banning cattle slaughter will directly impact the accessibility of affordable footwear by the middle and lower-income earners of the country. Further, more than 60% of the footwear and leather goods industry consists of micro and small businesses.(16) Therefore, this policy measure will indeed hamper their access to affordable raw material and their very sustenance.

Implications of cattle slaughter 

As stated by the Buddhasasana, Religious, and Cultural Affairs Ministry Secretary, Prof. Kapila Gunawardana the Government is discussing the possibility of exporting ageing cows that will not be slaughtered in Sri Lanka with the implementation of the ban. However, exporting aged live cattle is challenging as there is a high probability of international markets being reluctant to purchase cattle exposed to infections in the process of transportation. 

With the increase of idling cattle, the Government will have to invest to build new cattle salvage farms, ensuring adequate veterinary facilities and daily feed. The NLDB has only two salvage farms in Kurunegala and Anuradhapura with a combined capacity of 1,000 animals at a time. About 400 cows are legally slaughtered per day.(19) As aged cattle require high maintenance costs with no return on investment, this will be an added strain on Government expenditure given Sri Lanka’s current limited fiscal space and precarious economic conditions. This will also clash with limited agricultural land available in the country leading to a serious threat to crops. 

Moreover, with the local beef industry coming to a complete halt, the domestic production and importation of alternative sources of protein such as chicken and fish will have to increase, meeting domestic demand and ensuring affordability for the average consumer. It is important to note that the prices of these alternatives have experienced a steep increase. According to the Department of Census and Statistics weekly retail prices, one kg of fresh chicken that cost Rs. 558.93 in November of 2020 costs Rs. 727.27 now. Further, one kg of salaya that cost Rs. 252.67 in November of 2020 is now priced at Rs. 291.67.

Moreover, a flat-out ban on cattle slaughter will breed an underground economy of illegal slaughter and trade. This will foster animal cruelty as the industry will not come under the purview of welfare authorities, creating the environment for low-cost slaughtering techniques defeating the very moral grounds of a cattle slaughter ban.

Further, banning cattle slaughter with no ban on beef consumption allowing for beef imports will only shift the burden of slaughter elsewhere. This is hypocritical as cattle will still have to be slaughtered abroad, for the consumption of Sri Lankan people. It is worthy to note that India is the fifth largest carabeef exporter in the world earning 2.8 billion dollars in exports in 2020 despite the country’s religious veneration of cattle. 

It is evident that even though a slaughter ban may sound ideal in theory, it springs a chain of unintended economic consequences hampering the dairy, beef and other related industries, paving the way for further price increases and posing a threat to business operations. 

Therefore, it is clear that when making economic decisions it is paramount to look at policies in terms of incentives they create rather than blindly pursuing a goal. This simply means that immediate and long term consequences matter more than intentions. Economic policies therefore must strive to go beyond intentions crafted by hopes and inspiration. Failure to do this will certainly lead to disastrous outcomes for the whole nation. 

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.

When ‘national assets’ become ‘national liabilities’

Originally appeared on The Morning

By Dhananath Fernando

• Understanding the Trinco Oil Tank Farm controversy

Robert Kysokai, the author of the book “Rich Dad Poor Dad”, defines the difference between an asset and a liability quite simply. According to Mr. Kysokai, who is a management guru, anything which creates a cash flow is an asset and anything that dries the cash flow is a liability. If someone buys a car to be rented out to a taxi service, then it is an asset, because it can create cash flow and generate income. It can cover the expenses of the car from the income it creates by being used as a taxi. But if someone buys the same car to commute to work, it’s a liability, because it dries the existing cash flow from a different cash inflow, as the buyer has to incur regular cost for fuel, insurance, running costs, etc.

The lack of understanding of this simple concept has cost Sri Lanka a few generations of delayed development, with the recent fiasco surrounding the Trincomalee Oil Tank Farm story being a prime example of this.

The discussion surrounding the Trinco Oil Tank Farm is a good case study to explore the question as to whether the resources we have as a country are actually “national assets” or “national liabilities”. In most cases, holding onto national resources has gone on to create “breeding grounds for corruption and crime”, thereby becoming national liabilities.

The Trincomalee Oil Tanks were developed by the British, using labour from British territories in Africa between 1924 and 1930 – almost a century ago. The project plan was to develop 102 oil tanks. Tank number 100 was not developed and tank number 91 was destroyed due to an aeroplane accident. The tanks were constructed with inch-thick steel and protected with foot-thick concrete rings. The objective of setting up the tanks in Trincomalee was to make the  Trincomalee Port a naval hub in the region. This could be utilised for trade and military usage. The Trincomalee Port was one of the main natural deep-water ports where big vessels can be docked easily. So the vision behind setting up an oil tank farm in Trincomalee was mainly to set up an ecosystem for naval operations and bunkering operations.

In the meantime, in the 1970s, Sri Lanka introduced a policy of nationalisation and self-sufficiency. As a result, the properties of foreign energy companies that were in operation were asked to leave our shores, with the government monopolising the energy market.

Singapore took this as an opportunity and embraced all oil companies that left our shores. They were, in fact, welcomed with open arms. Provisions were made for them to invest and provide the freedom to take their profits off if they wanted. But instead of taking the profits off, investors invested them back into Singapore and made Singapore a dominant trading hub in the region, while also making it a maritime centre. Sri Lanka lost a great opportunity. This loss is signified  by the difference in the GDP per capita of the two countries. In approximate figures, Sri Lanka’s per capita GDP is $ 4,000 while Singapore’s per capita GDP is $ 60,000.

Rather than utilising the resources of oil tanks as an asset by working with foreign investors, the government taking over the energy market converted the asset into a liability. As a result, taxpayers have to keep supporting the colossal loss-making Ceylon Petroleum Corporation (CPC), which was a creation of this monopolising energy markets.

Since the nationalisation and self-sufficiency attempts in the 1970s, only about 15 oil tanks were used by CPC and their subsidiary, Ceylon Petroleum Storage Terminals (CPST) Ltd., till 2002, when Indian Oil Company bought one third of CPST’s shares. Then, the 15 tanks were leased out on a 35-year lease agreement to India for development. The Liberation Tigers of Tamil Eelam (LTTE) war too obstructed the optimum usage of the tanks. Each tank in the  Trincomalee Oil Tank Farm has a storage capacity of about 12,000 MT per tank, which accounts for about 1.2 million MT of storage in the entire facility. The recently built Muthurajawela Oil Tank Facility, built with a $ 72 million loan from China’s Exim Bank (total investment was $ 157 million), can only store upto about 250,000 MT. So the capacity of the Trincomalee Oil Tanks is far more substantial.

However, according to the shipping  industry expert Mr.Rohan Masakorala, the  LTTE problem would never  have taken off if the foriegn oil companies were allowed to operate in Trincomalee. According to him their entire eastern coastal belt would have been developed as much as Colombo, if we had allowed the foreign capital and technology to flow in,  especially in the Energy Market.

In 2018, the then Minister of Petroleum had discussions on a joint development project with India for 15 oil tanks out of the remaining 85 tanks. Again, another political monsoon started and nothing took off. So for nearly a century, we really didn’t use the Trincomalee Oil Tanks, although we still claim it as a “national asset”. Refurbishment of Phase I of the Trincomalee Oil Tanks requires a few billion dollars of capital. It also requires technology beyond our shores, and having an international partner is the only way to operationalise it.

Again in February, the current Minister of Petroleum announced that Sri Lanka is going to take over all oil tanks. Now there is a national interest on these oil tanks as a result of the Indian Foreign Secretary’s visit. The simple reality is that the 100 oil tanks which we failed to do anything with for 100 years, which occupies valuable land stretching 850 acres, are not really assets at present, from an economic perspective. They are simply liabilities, and in our case, they are even more than liabilities.

The only solution we have is to open our resources for foreign investments, if Sri Lanka is really serious about coming out from this economic downturn. Trincomalee has the potential to become a revenue-earning asset. The emerging Bay of Bengal economy is just opposite the Trincomalee Port. Chennai, Bangladesh, Visakhapatnam, and Thailand are countries and cities with large populations, with bigger markets where Trincomalee has the capacity to trade with and become a naval point for much larger economies. Currently, the trade volume we do at the Trincomalee Port is very limited, and the Prima factory and the cement plant are the only players presently using these facilities.

We have to think about Trincomalee as a whole and see the bigger picture than just seeing a fraction of it. The development of Trincomalee can be further extended with tourism up to our southern beach belt.

National assets are the ones that generate cash flows, regardless of ownership, and national liabilities dry up our cash flow. From an economic perspective, what we really celebrate as “national assets” and what we really try to hold for ourselves are “national liabilities”.

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.

When price controls get out of control

Originally appeared on The Morning

By Dhananath Fernando

• Price controls lead to shortages and distort markets

Why has Sri Lanka’s economy remained stagnant? This is not a difficult puzzle to solve. It is simply because Sri Lanka has repeated the same failed policies ignoring “economic fundamentals”. This is evident now more so than ever by the number of “price controls” imposed by the Government. Even an amateur student of economics would know that price controls distort markets creating black markets. Black markets mean reduced quality of goods and services and shortages. The recent conundrum of a few rice millers declaring rice prices and the Government having to withdraw price controls is the best example of the failure of this policy measure. The lack of economic analysis behind such policies have not only diluted the Government’s political capital but also have created shortages of rice in the market. 

It is no secret that the entire economic system has been damaged by the implementation of price controls. The real impact, like in the case of rice, is much more severe than what we see on the surface. 

A retired army officer was appointed to ensure the supply of essential food items. He raided a few rice mills, warehouses, sugar storages, and other essential commodities as per media reports to ensure the supply of essential food items. However, the recent withdrawal of price controls on rice is an indication of the failure of such short-sighted policies. Shortages sprouted, markets reacted and prices have increased further. These miscalculated policies have also led to the dilution of investor confidence by providing all the wrong signals to investors. Heavy Government intervention in businesses and private property, confiscating stocks and storages discourage investors. 

Markets work on the principles of demand and supply. It is a series of coordinated actions and reactions. These happen as a result of people working for the benefit of each other when allocating scarce resources which have alternative uses. Allowing this system to function can achieve the best outcomes for everyone, especially the consumers. Controlling the price by means of force is counterproductive. This will leave a bitter taste for both the consumer and producer as well as the Government. 

The political theatre of price controls is not new to Sri Lanka. It goes back to the 1970’s. Since then Sri Lanka has had a habit of imposing, relaxing and reimposing price controls. We have been in the same vicious cycle for decades. The previous Yahapalana Government imposed price controls on hoppers, tea, and milk tea. The current Government imposed price controls on another long list of goods including lentils and tinned fish. Even today, our USD has a price control of Rs. 203 per dollar. As a result there is a serious shortage of USD in the market. What is evident is that all items which have price controls imposed, experience some level of shortage or market distortions. 

How can the distorted rice market be rectified? 

The distortion of our rice and paddy market ultimately boils down to poor productivity along with excessive political and Governmental interference in the industry. The contribution of the agricultural sector to the country’s GDP is 8% with about 24% of the country’s labour force in agriculture. This is a good indicator to highlight how unproductive the sector is. Additionally, analysis shows that our pricing of one kilogramme of rice is completely irrational. According to research, paddy is a water guzzler that consumes about 2400 litres of water for transpiration. Further, 1200 litres is required to produce one kilogramme of rice. At the moment we do not charge for water needed for paddy cultivation. Most of the water provided is subsidized by taxpayer money. Additionally we provide fertiliser at a subsidised rate (organic or chemical). The subsidy is included in the price of paddy and rice. One of the main factors of production which is land is also not calculated in the cost of production as most of the cultivated land is owned by the Government. 

If we were to calculate the price of water, land and fertiliser, the cost of production of rice in Sri Lanka is extremely high. So if Sri Lanka is serious about rectifying the problem of rice, all these issues must be addressed. Attempting to control the price which is the final indication of resource allocation is not the solution. Failure to address the real bottlenecks at the root of the issue will exacerbate problems faced by the paddy farmer as well as the consumer. 

Importation of rice is not a popular topic in Sri Lanka for many reasons including the current forex crisis. One way to address the market manipulation by rice millers and provide consumers affordable prices is to let the market system work. That includes allowing the importation of rice by private businesses. Unlocking land for our farmers too is important to increase their productivity by using low cost methods of farming. At the moment since the land is owned by the Government, capital infusion and technological development that could be done is limited. Farmers cannot take a loan from the bank or do any technological advancement using the land as collateral. Farmers have very limited options and they are trapped in a vicious debt cycle while continuing to resort to unproductive methods of farming on land they do not own. 

Until Sri Lanka comprehends the problem, our solutions will be mere performative political theatre. Without evidenced-based public policies and a good understanding of economics, price controls will be imposed and reversed overnight, leaving the consumer, producer and the Government with a foul taste.

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.

Losing by focusing on the winners

Originally appeared on The Morning

By Dhananath Fernando

• Winners focus on winning and losers focus on winners.

“Winners focus on winning and losers focus on winners”, I recalled this statement when I saw different headlines on Sri Lanka’s budget for the fiscal year 2022. As per media reports, the Government expects three main policy proposals in the upcoming budget. These include the development of local industries, expansion of infrastructure development, and having an expansionary monetary policy. 

Speculations too have highlighted continued import restrictions as a strategy to develop local industries. This is what reminded me of the saying that losers focus on winners while winners focus on winning. 

In a hundred metre race the most rational thing to do is to focus on one’s timing and speed as opposed to focusing on obstructing fellow athletes. Similarly in economics and business if one wants to develop local industries one must increase productivity and efficiency rather than resorting to import restrictions. 

One reason many justify import controls as a strategy for the development of local industries is the lack of knowledge rather than a strong ideological stance. Sri Lanka has had a trade deficit for a long time, which is “value of imports – value of exports”. Therefore, many Sri Lankans generally believe that by reducing imports the trade deficit can be reduced. 

The same argument applies when people assume that we have to spend foreign exchange earned from exports when importing. People believe that producing locally will save foreign exchange due to the reduced need for imports. As a result, there is growing animosity against imports across all products and services. People believe that this will leave local industries better off. This thought process has led Sri Lanka to become a nation full of people who detest imports. But they forget that local industries depend significantly on raw materials and parts. 

This idea is not endemic to Sri Lanka but can also be found in some other parts of the world. So there is a global belief that having complete import controls can help homegrown local innovation regardless of its severe economic consequences. However the reality is far different. Banning imports would do more harm for local businesses than good. It can significantly impact the production and manufacturing potential of the economy. However, we will only be able to arrive at a reasonable conclusion once the budget is presented. 

One of the main arguments provided by proponents of import controls, is the belief that Micro and Small Enterprises (MSMEs) cannot compete with large-scale global brands. However, the truth is different. In Sri Lanka, the apparel sector especially consists of quite a number of MSMEs. They produce goods at the standards acceptable to international markets. These target markets are far different from the domestic market. Therefore they actually compete internationally and are capable of doing so because they are able to maintain productivity. Therefore the best way to empower small enterprises is by helping them improve productivity and allowing them to compete. 

Another common belief is that some developed countries too have import controls or higher tariffs. Ardent believers of import substitution present these examples to defend their case. A common example provided was the import duty and tariff rates in India and South Korea in comparison to Sri Lanka’s, claiming that our tariff rates are much lower. However the truth is that Sri Lanka has a complicated system of para tariffs. These are additional tariffs on custom duties (CESS and PAL). Para tariffs increase the effective rate of protectionism, which is the overall protection levied at the border on imports. Sri Lanka’s effective rate of protection is much higher than other countries in the region. Once again, this exhibits Sri Lanka’s obsession with winners and the lack of attention given to winning. In addition, many new winners in trade have appreciated the importance of neutral policies that give similar incentives for export production as well as import substitution production.  

Another common argument is that the similar practices by the west at the initial trajectory on their development and the extent to which they protected their industries is often provided by proponents who believe banning imports is a strategy for local industry development. South Korea and Japan have been provided as an example often on how they banned car imports which made the boom of brands like Toyota and Hyundai is a common story. If that argument is true then countries like North Korea have to be most prosperous as they have very serious import restrictions. 

Second, for the country and the market size of Sri Lanka to get economies of scale, we need to produce bigger volumes beyond our shores. So competition is inevitable. Just because one country has succeeded at doing it doesn’t make sense for us to repeat without understanding geography, demography, and geopolitics. Thirdly if we look at the brands that have really done well those are the ones who have been opened for competition. In the case of Japan, the Ministry of Trade and Industry recommended to Toyota Founder Kiichiro Toyoda, not to produce cars in the first place and the rest of the Toyota brand is just history. 

We are all in agreement that the local industries should prosper and have to be productive. But thinking that the import bans as a strategy for local industry development is not in the right direction. It would set a bad example for people to just target winners instead of winning and ultimately the entire country will be a net loser. We have to become a country of thinking about winning rather than a country of focusing on winners and the budget 2022 should lay a broader strategy to achieve this objective. 

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.

Underneath the underwear patriotism

Originally appeared on The Morning

By Dhananath Fernando

• Can Sri Lanka become self-sufficient in undergarments?

My father had a very hard time with me when he accompanied me for haircuts when I was a kid. I’d ask him “Who cuts the hair of the barber?”. He’d say “It has to be another barber!”. Then I’d argue back saying “If the barber can give haircuts to everybody, why can’t he cut his own hair?”. Then my argument continued. Do the doctors go to doctors when they are sick or do they check themselves by their own stethoscope and decide their own medication? The same goes for surgeons. When a surgeon has to go through surgery can they do it on their own or do they have to go for another surgeon? When I look back, though I am not very proud of my arguments as a kid, the recent comments on the economics of undergarments on “Why Sri Lanka cannot produce all undergarments we require locally?” took me back to my childhood. 

A big social media discussion driven by political rhetoric, with little to no understanding of basic economics, was popular last week. Some argued that Sri Lankans will not have enough undergarments with the new direction by the Central Bank of Sri Lanka (CBSL) for licensed commercial banks (LCBs). The direction was to deposit 100% of the invoice value to open a letter of credit and halting credit facilities for LC’s for 623 HS codes including men and women undergarments. 

The opposite argument was there are enough local undergarment brands in Sri Lanka and anyone can buy it from Pamunuwa. There were some arguments going to the extent that “Sathosa” can provide undergarments in case of any shortages. Many argued that if Sri Lanka can export and stitch for world-class brands such as Victoria’s Secret, VS PINK, GAP Body, and Calvin Klein, how come we can’t produce to meet local demand? 

The argument went to the extent of some proponents mentioning that we have to ban everything we can produce in Sri Lanka to solve our foreign exchange crisis. 

First, let’s understand the reason behind the circular direction by the CBSL. A cluster of 623 HS codes are now required to deposit 100% of the value upfront. Additionally LCBs are not permitted to provide credit facilities, to open LC’s for the purposes of importing the mentioned 623 HS code line items. So simply it is not a tariff barrier, but the real objective is to discourage imports, in order to minimise the demand for foreign exchange used for imports, given the forex shortage we have presently. When the supply is suppressed, in this case on undergarments which is an essential product category the prices will automatically go up. That higher prices may impact consumer behaviour. 

Secondly, the question is why can’t we produce undergarments for Sri Lankans if we produce for Victoria’s Secret? Obviously, we can produce but economically or business-wise it doesn’t make any sense for the producer to produce a low-value, low-priced product for a 22 million market. Especially when the existing competency is at producing a world-class high-value, high-priced product for a market of a few billion people. In terms of margin as well as volume, the obvious pick is to produce for a bigger market. If we ask our manufacturers to produce for the local market as well, most likely they will have to shut down most of their factories, and obviously, Sri Lanka’s export numbers will drop drastically. When the capacity is there to produce high-value goods with significant value additions, why should a business consider producing a low-value product for a smaller volume. So pondering whether we can produce undergarments to our own markets by restricting imports, is the same as my childhood argument of asking the surgeon to get his own surgery done. So producing undergarments for the local market just because we produce for Victoria’s Secrets doesn’t have any rationale. On the other hand, if the current garment manufacturing plants are pushed to produce for the local market, the resources such as labour, land and capital have to be taken from the same resource pool. This can make exports expensive and make Sri Lankan exports uncompetitive. 

At the same time, export garments are stitched under branding regulations and contractual standards with strict customer audits where even a rejected garment is not allowed to be released to the local market. The companies have signed intellectual property agreements on individual designs and premium quality raw material is imported from Hong Kong, China and different parts of the world to make the product of superior quality. 

The same argument is there for tea. Often people complain that though Sri Lanka produces Ceylon tea, the tea available at the retail market is not as good as export quality. Obviously, just like the high value branded undergarments, there are high quality teas in Sri Lanka which many can’t afford given our purchasing power. As a result we have to settle for something affordable and the market is offering a product which is affordable for an average Sri Lankan consumer. Obviously a country of nearly a per capita $ 4000 income cannot afford to drink expensive silver tea three times a day. It is same for undergarments that markets offer a range of products where anyone can pick based on their affordability and personal preference. Those who could afford Victoria’s Secret and Tommy Hilfiger can go for it and those who can’t have the freedom to select from a range of undergarment brands and even unbranded categories based on their affordability. What is important is to make sure the choice is available so people can pick what fits them the best. 

Especially in a category like undergarments, it is the last thing that people will check – whether it is imported or locally manufactured. Perfect fit for the body, hygiene factors, sanitation factors, comfortability, affordability and even emotional attachment for the brand are very prominent in the product category at point of purchase. So it is essential that Sri Lankans have the freedom of choice to select what undergarments they feel comfortable with. Some people obviously may have a preference for local brands based on their criterion of selection. 

At the same time it doesn’t mean that local players shouldn’t produce garments for the local market. In a level playing field some businesses can produce for the local market and importing also needs to be allowed for their production as well. 

With the deepening of the US dollar shortage there are economic misperceptions built around imports. Banning imports is deemed to be the only way to develop local industries. Obviously we all know by hating something; we cannot achieve anything and the only way to achieve it is by competing. It is understandable that we face a foreign exchange shortage but obviously trying to produce undergarments for the local market by cutting imports will worsen the situation rather than solving it. 

Thinking that we should produce all undergarments we require locally as we produce for Victoria’s Secret is the same as my childhood thought that the barber should get his own haircut done and the surgeon should do his own surgery.

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.

Work Together or Die Alone

Originally appeared on The Morning

By Dhananath Fernando

How the pandemic highlighted the greatest benefit of globalisation – co-operation

The provision of Covid-19 vaccines has become a serious issue, not only in Sri Lanka, but in all parts of the world, but governments could have faced this issue better if they had understood the economics behind it – especially because it is the science of managing scarce resources by making the right choices in resource allocation.

Understanding this is much more important today because Covid-19 vaccines have become a limited and scarce resource globally. Sri Lankans who got the first jab of the Oxford AstraZeneca vaccine is now in a stage of confusion, as they have lost access to the second jab. This is mostly due to the unfortunate Covid uptick in India, which is globally the main manufacturer of vaccines.

Let’s rewind to about a year ago. This was when Sri Lanka managed the first wave of Covid-19, with a strict lockdown, active contact tracing, and effective quarantine mechanism. The number of infections and fatality cases in the USA, Italy, and some other European countries were very high during the same period. But things have changed. 

Economically, this was the time Sri Lanka embraced self-sufficiency. Many argued that globalisation and global convergence have come to a standstill, and that we have to go for self-sufficiency, and even for a homemade recipe for Covid-19 pandemic management. 

After one year, the entire world – and even the Sri Lankan authorities – has unanimously agreed that the best solution to manage the pandemic is vaccination. At one point, some policymakers even questioned and argued, saying: “Why are we making our people guinea pigs for vaccination testing of the products developed by other countries?” However in just one year, it was proven that global cooperation is needed for us to prosper; and the main vaccines currently in use in Sri Lanka, namely Oxford AstraZeneca, the Russian-developed Sputnik V and Chinese-developed Sinopharm are the result of global cooperation. 

The vaccines Sri Lanka received as a result of Covax are part of a global co-operation programme, where many countries and international donors contributed to developing the vaccines at a rapid pace. The US invested about $ 4 billion in Covax, as did the Bill and Melinda Gates Foundation. The Coax programme is a global mechanism, where countries and donors donate money to the programme, similar to the Paris agreement, for the vaccinations of middle and low-income countries. 

However, it is true that as usual, the countries with deep pockets received an additional advantage of securing more doses than middle-income countries. It is a classic case of “higher the investment, higher the return”. In this case, the higher return is in the number of doses for countries that invested billions of dollars for vaccine development and manufacturing. 

First world countries including Canada, the USA, Japan, and the UK have made multiple bilateral deals with many pharmaceutical companies, and have managed to secure doses more than they require for the entire population. Those countries made the risk of investing in multiple companies in case of the failure of certain vaccines during the development process. As a result, some countries like Canada have now reserved enough vaccines to vaccinate 8.7 times the doses required by their population. The UK and USA have reserved vaccination doses for about 7.7 and 4.0 times the sizes of their population. 

Globally, this has created a debate on the waiver of patent rights for vaccines. Some economists and policymakers have requested a waiving-off of these globally so that  the developing world will be able to produce its own vaccines – thereby increasing the supply of vaccines and bringing the pandemic to an end. 

However, intellectual property (IP) rights is a big component of pharma manufacturing. Companies and scientists embraced taking such a significant risk because of the large returns they could have made. Requesting a waive-off on these IP rights may affect the incentive of developing similar high-demand pharma products in the long run.

In this context, the question is what Sri Lanka can do to accelerate the vaccination programme. 

First, we have to realise we are already late to catch the train. The cost of the delay is a serious economic storm to an already ailing economy. Ordering vaccines and rolling out vaccinations could have started about six to seven months before. However, what we can do now is to open up the vaccine rollout to the private sector. With the global agent agreements, private sector companies may be able to secure some doses, so those individuals who could afford a vaccine may be able to get it by paying a higher price. 

Thereby, the most vulnerable sectors who can’t afford a vaccine could have access to the government programme. Big corporations and exporters in Sri Lanka most likely will pay the vaccinations for their employees. This is the same as PCR testing at the initial stage. The private sector was not allowed to conduct PCR testing. As a result, even someone who could afford a PCR test had to stretch out the resources of the Government, and as usual, it is the most influential people who got a preference in the government system. 

Most healthcare providers currently conduct PCR tests in collaboration with the private sector, which has helped immensely for active contact tracing and quarantining. The same actually happened for the vaccines as well. With the absence of a proper priority list, many who could afford to purchase a vaccine, and who could have survived without a vaccine for some time, got preference over someone who was deeply in need. 

We also have to admit that global co-operation in the modern world is a normal thing, and depending on each other is not a weakness, but a strength.

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.

Budget 2021 : A good or bad kettle?

Originally appeared on The Morning

By Dhananath Fernando

Then school principal of my alma mater, late Rev. Fr. Bonnie Fernandopulle used to mentor students through the use of anecdotes and examples. One of his favourite questions for students he was mentoring was: “Do you know the difference between a ‘good kettle’ and a ‘bad kettle’? They both look the same. They both sound the same. They both serve the same purpose of boiling water. But only time will tell which one is which.” He used to say: “It is not the ‘term-end exams’ nor the ‘semester-end test’ that are the difficult tests of life. The ‘test of time’ is a test that you, as students, should train yourselves to face.” I hold this advice dear and remember it up to date.

One year into a global pandemic calls for a litmus test on the effectiveness of our economic policies and the presented “Budget 2021”. This will help one evaluate where Sri Lanka stands in the “test of time’ metric. 

The Annual Report of the Central Bank of Sri Lanka (CBSL) for 2020 provides some statistical insight for evaluation. Our economy has contracted by about 3.6%. Our debt-to-GDP ratio has increased above 101%. Government revenue has shrunk from about half a trillion rupees. Revenue as a percentage of GDP has shrunk to 9.3% from 12.6% in 2019. The present revenue-to-GDP ratio is among the lowest for countries at our level of development. This would induce us to print more money in the near future, while additionally we have printed about Rs. 650 billion. By contrast, in the year 2019, Sri Lanka printed only about Rs. 4 billion. The two lockdowns and the mounting economic woes that the island has been facing for decades have led us to where we stand now. These figures do not come as a surprise. The end of 2020 left all of us with severe concerns and reasonable estimations of the country’s sorrowful performance of the year.

The 2021 Budget presented Sri Lanka with a good opportunity to take necessary measures to curb the approaching economic downturn. Looking back at the Budget, five months later, it is somewhat evident that we could have done better in certain policy areas.

This column previously highlighted two main loopholes in the 2021 Budget. One was the inadequate allocation of resources and the lack of a solid plan for healthcare services to combat Covid-19. The second was a credible action plan on debt servicing challenges for Sri Lanka. It was evident that without combating Covid-19, mitigating the impact on the economy will be difficult. Some sentiments expressed by members in Parliament questioned the need for the resources for vaccines which were produced by some other countries and highlighted the need for making Sri Lankans guinea pigs for vaccines by multinational pharma corporations. It was personally alarming for me to watch business leaders speaking at budget discussion forums with excessive emphasis on their respective businesses with no regard extended to the larger economic adversity at hand.

As a result of these poor policies and mitigating strategies, we are now in the midst of a raging third wave of the virus. This continues to affect the economy, proposed budget promises, and businesses adversely. Simultaneously, the global demand for vaccines has skyrocketed. Therefore, it is evident that Sri Lanka will have to wait for some time to receive the required amount of vaccines.

The 2021 Budget did not successfully address Sri Lanka’s problem of debt servicing. The only thing concealing the severity of this issue is the burden placed on the country’s healthcare sector at the moment. 

Moreover, Sri Lanka faced international pressure in terms of human rights violations coupled with geopolitical tensions which brings its own economic constraints and impact. As stated by the Central Bank Annual Report 2020, the destinations of more than 60% of our exports are the US, India, Japan, Australia, and the European Union (EU). All these nations have expressed concerns over Sri Lanka’s reconciliation efforts. 

Unlike the first-time shocker of the Covid-19 pandemic, after one year, some countries have made progress even with gigantic challenges. So from the perspective of investor sentiment and businesses, over time, the innovators and early adaptors, who are good to do business in the region and globally, are getting noticed. The attention and priority we received in the initial Covid-19 wave from investors, businesses, local donors, international donor agencies, and the rest of the world may not return during this new wave. Especially if our  policy decisions lack foresight and common sense. The current story published on PublicFinance.lk is that only 6% has been spent from the Yuthukama fund which was set up for Covid management and the availability of Rs. 1.7 billion remaining as the balance is just one example. The fund was supported by many Sri Lankans, and now, local and international companies may doubt the seriousness of our efforts.

We are between two hard choices which will have equally bad negative consequences. Minimising the mobility of people impacts our economic activity but increasing the mobility affects the Covid-19 spread which hits back again on the economy and people’s livelihoods. We need vaccines to control the spread of the virus but we should be able to get the vaccines first, while also balancing our foreign exchange. Economic policy formulation and execution is a team sport. It is not only the right policy but also the execution that matters. Even if we have a good execution team, if we are implementing the wrong policy prescription, the results won’t stand the test of the time. Unfortunately, five months after the Budget 2021 none of our policies nor our policy execution was able to stand the test of time. It is not only the Budget for 2021; the previous budgets and our economic policy over the years have failed to make a positive impact. We should pause for a moment and think about which sort of kettle we are. Are we a good one or a bad one? We should ask ourselves: “Have we been able to stand the ‘test of time’ with the economic policy we have been practicing?”

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.

Policy instability is as bad as political instability

Originally appeared on The Morning

By Dhananath Fernando

The Govt. must start pulling the economy in one direction

We are just over five months away from the 25th anniversary of Sri Lanka’s 1996 Cricket World Cup victory, which is still engraved in every Sri Lankan’s mind. Since then, our players have gone on to break world records and build legendary careers. They have been named in many Greatest XI lists and represented all the major cricket leagues around the world. Therefore, it is clear the quality of our cricketers has improved in leaps and bounds over the past quarter of a century, and we even secured a T20 cricket World Cup in 2014.

However, cricket’s greatest prize has eluded us since 1996 so it is interesting to re-evaluate the contributory factors of the 1996 victory. It is my belief those key takeaways will provide us with some insight on strategies to overcome the current economic storm. There are many elements and ingredients in mapping out the winning formula. However, I see two main contributory factors.

First is the “stability of the team”. Second is a combination of all other factors along with the cricket administration, which I like to call cricket-political stability, or “crickelitical stability” if you will. The 1996 team was not a star-studded team. Most of them became stars after playing the World Cup, including Sanath Jayasuriya, Muttiah Muralitharan, and Chaminda Vaas. It was the above two factors that made them world champions, which have unfortunately remained unattainable to Sri Lanka, even following 25 years of advanced investments and resources.

In an economic context, similar to the cricket team, “policy stability” and “political stability” are both extremely important. Sri Lankans have never had the luck to experience the joy of a World Cup victory in economic terms. This can be mainly attributed to Sri Lanka’s excessive focus on political stability rather than policy stability. The economic equivalent to a World Cup victory in the Sri Lankan context would be achieving lower poverty rates and reaching a GDP per capita of above $ 10,000. This, in my opinion, remains an elusive dream. Over the years, the business community and policy analysts have been highlighting the importance of policy stability and consistency, but we have failed on both fronts.

Lessons from the previous Government

Initially, the last national Government had a two-thirds majority in Parliament. However, policy stability was non-existent. Different parts of the Government functioned with opposing views which resulted in public policy being pushed in two opposing directions. This filtered down to all levels of government.

The then Prime Minister’s policy statement and the Budget Speech by the then Finance Minister prioritised two different policy agendas. Significant salary hikes for the public sector which were not affordable to the state balance sheet, and revising the VAT (value-added tax) rate several times, are a few examples of policy inconsistency. The Vision 2025 policy statement which was the main policy agenda of the Government, was released a considerable time after taking over office. Moreover, in implementation, it was not given equal priority by all sections of the Government. The Cabinet Committee on Economic Management (CCEM) was then replaced by the then President with the National Economic Council (NEC), which was later dismantled by the then President himself. This resulted in a major setback, since important policy decisions took place without sufficient deliberations, thereby leading to further policy inconsistency within the Government. 

Cabinet reshuffles on key portfolios were observed a few times. The constitutional crisis that emerged with the appointing of a new Prime Minister was a key highlight of the island’s policy instability. It goes without saying that this level of instability and inconsistency is beyond the capacity of a small economy in the Indian Ocean. Policy stability and consistency is something that cannot be achieved only at the top level. Consensus between political leaders executing government functions in order to get something done is political stability. The policy implementation team and the execution of those decisions have to fall in line with the policy. It is only then that we can achieve policy stability.

There are so many things that can get held up at the lower level, starting from misplacing documents. This may have a significant effect on policy implementation, especially if we fail to get policy execution in line with the policy agenda. The World Cup victory in 1996 was a team effort where everyone contributed equally at all levels, from the team manager to the water boy. Another important element is political stability in Sri Lanka. This requires policy stability in the economic front, especially to overcome the current crisis.

Evaluation of the current Government: Post one year

In completing one year of being in power, the current Government should be extra cautious and re-evaluate their performance on realistic measures. The accuracy and relevance of their actions, policy consistency, and stability should be the Government’s priority.

Last week’s Economic Summit organised by the Ceylon Chamber of Commerce highlighted a few sentiments that are reflective of some elements of policy inconsistency.

The Governor of the Central Bank highlighted the importance of self-sufficiency with an emphasis on state sector-led development as a key strategy to support local industries to navigate these uncertain times. The Governor expressed his lack of interest in resorting to advice or support of any foreign agencies.

This statement was followed by a session where the Chairman of the Export Development Board (EDB) and Director General of the BOI (Board of Investment) emphasised on the importance of the Government simply playing the role of an enabler. They highlighted the importance of the private sector in driving economic growth and exports. Furthermore, they reiterated the importance of attaining know-how and capital through Foreign Direct Investments (FDIs). This, in their opinion, was the only way forward, if Sri Lanka is to seriously consider development.

For any economy to thrive there are few drivers that come into play. The ability of the people to connect with the economy and link with global production networks has become a fundamental necessity of the modern world. However, the question remains as to how we can achieve the above and if we will ever get implement the reforms to enable this.

From a public policy perspective, “self-sufficiency” stands in contrast to driving global trade, increasing exports, getting connected to global production networks, and FDIs. They are opposing policy outcomes. Having such opposing policy outcomes makes it difficult for a government to have a twin strategy to approach problems which are interconnected and it sends mixed signals to markets.

A common mistake of many governments that is attributed to their failure is their inability to consider the economy in its entirety. FDIs, exports, exchange rates, labour market, debt management, and all other factors of the economy are interconnected. If we fail to look at an overall picture and only target certain sections of the economy, policy instability will be inevitable. This in turn leads to a vicious cycle of political instability. Sadly, this has been Sri Lanka’s excruciating reality for a while.

This vicious cycle is precisely what this administration must strive to avoid.

In my opinion, getting the reforms done, expanding our connectivity to global value chains, and letting the private sector drive the economy is of paramount importance.

Policy stability goes beyond keeping the tax rates consistent or retaining certain sectors as priorities. It requires cohesiveness from all levels. Mainly at the implementation level where there has to be a continuous follow up between the different actors, while simultaneously keeping in mind the overall picture of the economy. It is about creating an ecosystem between sectors where all sectors work at an optimum capacity and level. The only way to do it is to allow the price mechanism to lead the market and let the resource allocation be done based on market prices.

If Sri Lanka is looking for a World Cup-winning era in terms of our economy, we must focus on policy consistency and stability, while maintaining political stability.

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 economy must follow Vietnam

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

Originally appeared on The Morning

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By Dhananath Fernando

With the appointment of the Cabinet of Ministers and state ministers, the real game has started. Now the challenge is transforming an ailing economy to a competitive economy within a short period of time. There are many debates among the public on the division of ministerial portfolios. However in reality, bigger economic challenges and a need to manage foreign affairs will outweigh all micro debates put together.

Problems at hand

The problems in our economy have been discussed extensively. We all know that we are burdened with short and long-term severe economic ailments. We have to literally unlearn, undo, and pay for the sin of economic mismanagement of over 40 years within the next four years. As a matter of fact, $ 4 billion is required each year for debt servicing in the coming four years. Just to put things in context, per year we need four times the value of the Hambantota Port deal to just keep our noses above water. We have to do it for four years provided that there are no major negative shocks in the global and local economy. The poor public finances management combined with deteriorating government income are just additional issues we have to deal with. Sri Lanka managed to contain Covid-19 well compared to our neighbours, but with New Zealand going back to a lockdown and many Sri Lankans working abroad planning to return within the next few months, there is an indication that the risk of a sudden uptick in COVID cases is still high.

Reading the mandate

In this context, people have provided a two-thirds majority for “Saubhagya Dakma”, the manifesto of His Excellency the President. Though it is a reasonable assumption to read this election victory as the citizenry’s overwhelming support of the manifesto, I believe it is also a voice of tiredness and displeasure by all Sri Lankans against the economic and political system that we marinated in for decades. This message can be put simply as a voice calling for a complete revamp of the existing system. In other words, making a competitive, efficient, productive, and sustainable system for a progressive Sri Lanka. The underlying voice is that Sri Lankans are not happy with where we are, although the same Sri Lankans are responsible for electing all governments in the past. It may also be read as a serious betrayal of people’s expectations and under-delivery in performance. A clear mandate was provided in November last year before COVID-19 and it has been re-assured post-COVID with another mandate. Since the world has come to a new equilibrium post-COVID on the economic front, it is important to keep an up-to-date pragmatic approach with the underlying principle of making our economy competitive, efficient, relevant to global markets, and productive.

Role model Vietnam

Through a pragmatic and dynamic approach, one country that has done exceptionally well, not only in the containment of Covid-19 but also in economic management, is Vietnam. Sri Lanka has many lessons to learn from Vietnam if we are serious about transforming our economy! Till 30 July no deaths were reported in Vietnam due to Covid-19 infections, despite Vietnam sharing a border with China and having a population of 95 million. However, over the last few days, according to data, there is a sudden uptick in cases and 16 deaths have been reported. This is also a reminder that Covid-19 management is a continuous battle that must be forged until the world comes up with a vaccine or sustainable solution. By 1986 Vietnam had suffered two wars and their economy and social condition was in shambles. Vietnam won the war with the US but the victory meant very little to overcome economic hardships. Making things worse, they had to fight another battle with Cambodia while it was believed that Cambodia was supported by China. After two crippling wars, Vietnam had lost about 1-3 million young people. Basically, at this point, Vietnam was worse off than Sri Lanka right after the war.

The post-war “Doi Moi” programme transformed Vietnam and put them back on the map in just 10 years. Vietnam managed to pick the right policy mix through the Doi Moi programme and managed to establish a strong economic foundation, stronger than our post-war reforms. This doesn’t mean that Vietnam has solved all their problems, but they have been able to create a strong economy which can withstand a global pandemic. About 97% of their population have health coverage and so far it looks like Vietnam is one of the biggest survivors of the Covid-19 pandemic. They were only able to do this as a result of the business and trade-friendly economic programme they introduced in the early 1990s.

Vietnam started labour-intensive productions similarly to Bangladesh and Sri Lanka, but unlike Sri Lanka, they managed to move on to more technologically advanced product categories. Although Vietnam is somewhat behind us in raw numbers, they are far ahead in the journey of being the next economic miracle in Asia.

How they did it

Simply, they carried out reforms to improve the competitiveness of the Vietnamese economy. Tariffs at the border were lowered to improve the competitiveness of Vietnamese products. The Government limited its role to that of a facilitator and the private sector and foreign direct investment were given the opportunity to lead the economy. Global co-operation was embraced and Vietnam signed 10 very well negotiated free trade agreements. Though I am not a strong proponent of free trade agreements and I believe in unilateral trade facilitation, Vietnam has signalled how serious they are on trade through their consistent collaboration with other markets.

With the Doi Moi programme, they first managed to get one main investor, Nokia, and then built confidence in capital markets. As a result, other investors rallied around the main investment and diversified rapidly. Today, Vietnam has become the China of China. Vietnam has good trade relations with both China and the US and have become the largest beneficiary of trade tensions between these two global economic giants. Due to trade tensions between the US and China, most Chinese-manufactured products were transhipped through Vietnam. On the other hand, most US-allied countries looked at a business-conducive market outside China to diversify their factories and Vietnam had the right ingredients for investments. While most other regional markets, including Sri Lanka, were trapped in labour-intensive industries, Vietnam had already moved to high-tech and advanced product categories through global co-operation.

Samsung shifted its smartphone production to Vietnam, Apple is reported to manufacture its Airpods in Vietnam, and Google plans to shift its smartphone production from China to Vietnam. As a result of co-operation with these global companies, homegrown Vietnamese companies are now emerging, showing competitive potential in global markets. A good lesson for Sri Lanka on understanding the recipe to improve local production is that local production can be improved only if we produce goods and services on a globally competitive scale. Vietnam has proven this.

China Plus One strategy

With Covid-19, ideologies on self-sufficiency are resurfacing, but the reality is that the world has decided to diversify its supply chain. China is the factory of the entire world, but due to rising labour charges even before Covid-19, companies were considering moving out of China. However, given the large infrastructure and business ecosystem and the availability of a range of skills (low-level skills to high-level, specialised skills) in one market, China is still competitive. But now companies are moving to a “China Plus One” strategy – meaning they keep their supply chain in China while investing in another Plus One market as a contingency. Again, Vietnam became the ideal location given the close proximity to China and more than that, its business-conducive environment. Sri Lanka too can get few investments if we play our cards right with big-ticket investors using a China Plus One strategy.

Lessons and solutions

Sri Lanka needs to unlearn from the era of producing everything on our own. That is history. Now the world is in a place where they produce only parts and components and have moved on to assembly. Sri Lanka needs to get onto this boat and begin producing parts and components and that too, competitively. Just producing products for the sake of producing them is not the way to boost local production. Like Vietnam did, first, you get the know-how and play with world-class players on your own soil which will produce results. This will not only improve our share in global markets but also improve local production. I hope the new Government and the respective ministers will understand the dynamics and capitalise on this wave. I wish them all the strength and vision to build a resilient economy and wish Sri Lanka’s economy will stand the test of 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.

New government must ‘unlearn’

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

Originally appeared on The Morning

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By Dhananath Fernando

The election is over and a strong and secure mandate has been provided to President Gotabaya Rajapaksa and the Government. The President has already announced that the new Parliament will be convened on 20 August and I congratulate all the members who will represent our citizenry in this Parliament. It is certainly going to define a new era for Sri Lanka if the newly elected members take it seriously.

Regardless of which party won or the composition of the government, Sri Lanka’s challenges were always going to remain unchanged. A new government cannot create a new Sri Lanka unless the government takes a new approach and starts to unlearn and undo the wrongs we’ve been committing for decades. 

Challenge 1: A severe economic recession 

The official data released by the Census and Statistics Department just the day before the election indicated a 1.6% negative economic growth (economic contraction) in real terms in the first quarter (January-March). Considering the depreciation of the Sri Lankan rupee, in US dollar (USD) terms, it is approximately a 5% contraction of the economy in the first quarter. Sri Lanka took strict social distancing measures towards the end of March, so we have to expect further economic contraction in the second and third quarters. The new government’s biggest challenge would be realigning the economy. 

According to the Export Development Board (EDB), exports have been picking up almost on par with last year’s exports, which is a big relief. A potential reason behind the recovery in exports could be the fact that India and a few competing countries have failed to manage Covid-19. As a result, some degree of production has been parked in Sri Lanka even though our cost factors are high. In the long run, we should be able to keep those orders on our shores by offering competitive prices. Otherwise, once those markets (India, Philippines, etc.) open and bounce back to normal, we will have to fall back to square one.

The EDB has expressed concern about the apparel sector’s ability in securing orders after August. Therefore, the new government has to get prepared early by starting negotiations with the International Monetary Fund (IMF) as soon as the new Parliament is summoned. Our neighbouring countries such as Nepal, the Maldives, Bangladesh, and Pakistan have already managed to secure IMF bailout programmes to overcome the brewing global economic crisis. 

Challenge 2: Trust, cohesiveness, and diversity

Over the last few decades, Sri Lanka has had emotional wounds which haven’t recovered yet. Over the years “suspicion of others’ religious and ethnic identity” has taken root amongst our fellow Sri Lankans and petty politics have ignited these fears in order to polarise Sri Lanka.

All political parties created suspicion between each other for their political advantage. Now, the very same suspicion has become the main bottleneck for us to move forward towards economic development.

In my view, this paranoia of suspecting each other is one reason why Sri Lanka is lagging in economic development when compared to other competitive East Asian countries. For more than 30 years, our Sinhalese and Tamils were suspicious of each other and did not respect our diversity. This led to the creation of the LTTE, who also capitalised on these fears while all of us became victims and losers.

If you remember, thereafter tensions were created between religious groups for converting people to a different religion for financial incentives. The wounds are not yet fully healed between the North and South, and new tensions have erupted between Muslims, Catholics, and Buddhists.

Our suspicions go beyond that. Businessmen have been labelled as a group of people with an “only for profit” motive (“businesskaaraya”), regardless of the service and assistance they provide to our economy. Private enterprises have always been attacked for playing a villain’s role over the years. As a result, all our young graduates keep expecting government jobs.

Now, we are in a situation where our revenue is not adequate to pay the salaries, pensions, and social security expenses of the government. Going a step further, we have created suspicion on foreigners and foreign investors with the famous term “foreign conspiracy”, while completely disregarding diversity. Every white-skinned person has been labelled a threat for an invasion rather than an opportunity to explore opportunities for co-operation globally.

We are where we are now as a collective result of all these domestic perspectives. We all unanimously agree that we have played far below our potential and that we are a deeply divided nation.

We are further divided on political ideology, so much so that we kill each other and damage each other’s property. The new government has the challenge of undoing and unlearning these practices. “Suspicion” is the seed that can crack any relationship, friendship, partnership, or co-operation. Even in Buddhism, “suspicion” is considered an emotion to be treated with extra caution.

Sri Lanka’s strength is its diversity. Starting from our biodiversity, diversity in weather and cultural and architectural diversity have always been our edge. Our exports need to be diversified, our economy has to be diversified, and our Sri Lankan mindset and experiences need to be diversified.

How can we create diversity without respecting diversity between people and all Sri Lankans? One of the main challenges for the new government will be establishing diversity and bringing everyone together in heart and in practice rather than spending years on documenting regulations and strategies. All political parties need to co-operate with the new government, as Sri Lanka is wounded beyond her threshold of tolerance. 

Challenge 3: Establishing competitiveness

Making Sri Lanka an economically advanced nation can only be part of a broader strategy, which is dependent on making our economy competitive. To establish competitiveness we need to increase our productivity and efficiency. The game is like winning the World Cup, where the only way to do it is to play well and play better than all the other teams. The same applies to our economy. There are multiple ways to improve productivity and efficiency. We need to think on a global scale and produce in relation to global markets while joining the Fourth Industrial Revolution. That is the next challenge for the newly elected government. 

The recent reality TV programme performed by teenagers which is getting popular across the world is one good example of the miracles as a result of competition and a competitive environment.

Young Sri Lankan teenagers proved that Sri Lanka can compete. Some of the young artists have not only challenged local original musicians but also western original musicians in their vocals and musical capacity. Some have been compared in foreign media for their performance and this is an indication that the younger generation is ready to compete and they have the fire to compete on the global stage.

Another event that made headlines was Sri Lanka’s national debating team becoming the runner-up in the World Schools Debating Championship by debating in a language which is not their mother tongue – another good example of the benefits of competition and why Sri Lanka can compete on a global level if we pick our strengths right and create a competitive environment.

The new government should push Sri Lankans to work hard for free exchange and create an environment of opportunities for any individual to be successful regardless of religion, ethnicity, caste, or creed. Sri Lanka has been practising to avoid competition and be isolated from the world – the complete opposite.

The new government has the challenge of undoing and unlearning most of what we have been doing over the years. I wish all the courage to His Excellency the President, the new government, and the new Minister of Finance and all the strength to bring in the hard reforms and to put Sri Lanka back on the map.

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.

Economic implications of COVID-19

Originally appeared on The Daily FT

By Dr. Sarath Rajapatirana

There is little doubt that COVID-19 will have a substantial economic impact on the Sri Lankan economy. This impact will include direct reduction in output due to the loss of working days and the necessary social distancing to prevent the spread of the virus, medical expenses to deal with persons who have been infected and expenses to prevent greater infections of those who are both vulnerable and not prepared to follow the instructions with respect to the necessary social distancing.

While there will be an immediate effect on incomes, there will be medium and long term effects following from policies used to prevent the spread of the virus. Where the rate of infections is concerned, so far, we have done well. The issue is whether we can maintain the preventative system that has been put in place with the deployment of large number of police and armed forces personnel. 

This shock to the economy is larger and perhaps deeper than those we have encountered with the Global Financial Crisis (2008-2012). There was a limited effect of that crisis since our main exports markets USA, UK and the European Union experienced reductions in their GDP growth rates. The Easter Sunday bombings had a strong impact on our tourism industry from which we had not fully recovered when COVID-19 19 struck. But effect was relatively small and confined to one sector. 

The initial conditions

When COVID-19 struck we were already in an economically weak position. Our GDP growth rate was 2.6% in the first half of 2019 with the impact of COVID-19, a recovery to our average growth rate (average for three decades of 4%) will be difficult to be achieved in the coming three to five years without substantial reforms and large inflows, particularly FDI.

Earnings from tourism are substantially low after the 2018 Easter Sunday bombings. The immediate future for tourism does not look good. Our exports have not risen enough to help with the current account in the balance of payments. Meanwhile, our foreign exchange reserves have remained low at around $ 7.0 billion including a part of borrowed funds. Finally, we have to meet large debt repayments around $ 16 .0 billion in the coming four years 2020-2023.

The economic impact of COVID-19

We can expect a substantial economic impact of the spread of the virus, both directly and indirectly, the latter being more important than the former. Direct impact given is that to date labour is in virtual quarantine. Measures to prevent the spread of the virus will cost funds that have not been budgeted before. And, the relief measures will cost more. 

There needs to be a special allocation of funds for them. Looking at the experience of other countries these infections will increase but if we follow proper protocols our infections will remain low, particularly through social distancing. We can mitigate their impact by proper procedures to provide access to medical services for prevention and treatment. Greater testing and relying on trained epidemiologists would help. 

The direct cost of the virus on the economy arises from the reduction in output given that production in all the sectors has virtually come to a full stop, only to increase in areas where the curfew has been withdrawn. But most workers are from the highly populous three areas of Colombo, Gampaha and Kalutara and are still in their homes. 

In terms of national income – wages, profits and interest incomes will remain low in the near term. This makes for much-needed policies for recovery. While we deal with the emergency, we have to think beyond the near term for proper policies. Measures taken for this emergency situation will have effects on the medium term and long term.

Government programs to mitigate impact of COVID-19

The Government has proposed a full list of relief measures. These include: 

• Grace periods for the payment of income tax. And VAT, for driving licence renewals, paying water bills, and assessment of taxes less than Rs. 15,000, monthly credit card bills of less than 50,000 given and extension of until 30 April. 

• Suspend leasing loan payments of three-wheelers for six months. 

• No recovery of loan payments from Government and private sector employees until 30 May.

• Suspension of repayments of personal loans less than Rs. 1 million.

• Rs. 20,000 allowance to be paid to graduates chosen to follow training.

• Agrahara insurance benefits for health workers involved in prevention activities and civil security personnel are to be doubled.

• Six-month debt moratorium to be granted to tourism and apparel SMEs.

• Bank of Ceylon, People’s Bank, National Saving Bank, EPF and Employees Trust Fund are to jointly invest in Treasury bills and bonds to stabilise money market at 7% interest rate. 

It is noteworthy that none of these measures are based on the price system. Most are based on directions, orders and quantitative measures.

Additional measures to provide relief include 

• Maximum of 15% interest rate on credit card domestic transactions up to Rs. 50,000 and a 50% reduction in minimum monthly charges.

• All bank branches are to remain open during non-curfew hours.

• Ports, Customs and other regulatory bodies to issue essential food, fertiliser, pharmaceuticals and fuel to relevant individual continuously.

• Samurdhi beneficiaries and Samurdhi cardholders be offered interest-free advances or Rs. 10,000 through Samurdhi Banks. 

• Samurdhi Authority to issue title certificates to low-income families immediately to issue nutritious food items. 

• Exempting Sathosa and Cooperative Store from VAT and other taxes. 

• A special account opened at BOC at the Presidential Fund to provide relief to health and social care. Rs. 100 million allocated. Provide rice, dhal and salt on a weekly basis. Tax and foreign exchange restrictions waived for domestic and foreign donors to contribute to the fund.

Despite all these measures, it is difficult to deliver economic relief to the poor and particularly the unemployed and self-employed. This because Samurdhi is not properly targeted. Some persons who deserve help have no access to these income transfers while others with high income get Samurdhi funds. The issue needs to be addressed in our future programs to help the deserving poor. 

Other countries like Chile have such a system of income transfers based on detailed family and income data. A recent initiative by our Government to provide ration cards to those who are very poor and not recipients of Samurdhi will be helpful. But in the medium to long term, we need to reform the Samurdhi programme and target benefits to the deserving. 

Meanwhile, the CBSL introducing import controls through credit restrictions which will create medium and long term distortions in the economy and lead to higher inflation. With these policies, it signals a greater reliance on quantitative measures rather than use prices to manage the economy including a competitive exchange rate. When the price system is not used the quantities have to be allocated by an authority or a “czar” that breeds irrational allocations and corruption. 

Conclusions

The measures proposed by the President are appropriate to address the short-run situation created by COVID-19, especially on the consumption side. But complete shut-downs such as the closing of the private pharmacies is counterproductive to the maintenance of health standards of those who need daily doses of medicine like those who have diabetes, chronic heart disease and asthma. It was found feasible to relax control such as allowing private pharmacies to open.

However, since we are starting from already weak initial conditions, the task is not easy. And, carries the danger of over-playing the hand of controlling the economy and extending the role of the Government in the economy. And, at times underplaying it, given that implementation of relief measure including income transfers depend heavily on the public service. It is not known to act efficiently and quickly. 

Overplaying the hand of the Government carries with it the danger of bestowing additional and permanent power to the Government. We have seen the results of that experiment in the 1970-1977 period, with income ceilings, near 100% import controls restrictions on the transport of paddy. This overplaying of the hand of the Government led to disastrous results during that period. GDP growth rate fell, as did employment followed by a sharp reduction in living standards.

CBSL would do well to avoid direct quantitative measures to influence the volume of credit. It will reduce the flexibility of the economy to deal with the COVID-19 shock and signal its preference for quantitative measures including the management of reserves specially avoiding flexible and competitive exchange rates. 

Direct measures could lead to a non-competitive economy, especially harmful for our export growth. Banning imports directly will create a bias against exports. We have to depend on incentive reforms to raise our GDP growth rate by raising the productivity of the economy. What has been done in the short run may be necessary. But not it is not sufficient to ensure medium and long term growth. 

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.

Let’s not look too far ahead

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

Originally appeared on The Morning

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By Dhananath Fernando

In cricket, most great batsmen will tell you that they don’t go out to bat thinking “I will score a century today”. They break their innings down to phases; “let’s score 10 runs”, “let’s score 20 runs”, “let’s survive the next four overs”, etc. Basically, “let’s face the next ball”. While this may be misconstrued as a lack of ambition, the underlying principle is that when you look too far ahead you can lose sight of the here and now. In cricket, this could mean getting out for zero while your mind is on the 100. Covid-19, the virus that found its origins in China, not only has Sri Lanka locked in its megalodon jaws but the entire world as well. While this too shall pass, we have to admit that we are well and truly in an unprecedented crisis. We will not be safe until the world is safe and that is the reality. Having faith that things will be back to normal soon is good but our actions should go beyond simply being optimistic and hopeful. Without beating around the bush, let’s be realistic and pragmatic by being scientific. In the past, we have relied on soothsayers who appear on television, devil dancers, turmeric (good luck finding turmeric, now that there’s a price control), and our love of bashing coconuts. The fact is that until we see the production of a vaccine or an acceptable solution, the entire human race is sailing in the eye of the corona storm. Many corporate dons and government officials in Sri Lanka have been pitching in with their business plans and strategies on what can be done “post-COVID”. Sri Lanka has faced the pandemic reasonably well compared to a few of the other countries, but in a crisis of this magnitude, in a closely connected world, the impact of a neighboring nation’s mishandling of the crisis can serve as a cautionary tale for the rest of the world. There is no point in early celebrations for doing well or having anxiety about those who may have mishandled the crisis, as we all are at square one and need to overcome this together. Sentiments on anti-globalisation and going back to the fallacy of “self-sufficiency” is not the solution as we failed that experiment comprehensively almost five decades ago. In a crisis of this scale, all predictions made will fall apart in a matter of not months but days. Take Sri Lanka as an example. We had all planned to open up the Western Province on 22 April but reported cases increased rapidly just two days before. How do we plan in an unpredictable crisis and what should we do is the question that has to be answered sensibly.

Historical examples may have limited relevance

As with managing any crisis, we generally make our decisions based on historic perspectives we have and connect with learnings from peers. First, we have to realise Covid-19 is an unprecedented scenario and how we managed previous crises will hardly help us to overcome the current battle. The strategies that worked for us in overcoming the Boxing Day Tsunami, fighting the brutal civil war against the LTTE, and overcoming the Easter Sunday bombings last year may not work in this battle against Covid-19. We are in a situation where every contract/agreement signed at every level has been challenged. It starts from a simple violation of a rent agreement, by not being able to pay the house rent on time, to a national-level crisis where we lack adequate foreign currency to pay our foreign debt commitments. Having seen the negative side, the reality is there will be a multitude of opportunities which will open up once the storm dies down. The challenge is the inability to predict the opportunities or the shortfalls. So when managing and strategising for the long term, a “one size fits all solutions” plan is very futile at this juncture. However, it doesn’t mean that we need to take a comfortable seat or take a “do nothing and wait” stance. Our game plan has to be pragmatic and dynamic. A game plan can be pragmatic if we have our basic fundamentals right. Predicting opportunities and developing strategies for a crisis without having the “basics” is similar to trying to solve an integration and differentiation mathematical question without having the basic knowledge of addition, subtraction, and multiplication functions. In a recent conversation with Advocata, Export Development Board Chairperson Prabash Subasinghe said it well: “This is a marathon, not a race.” At this point of time, it is of paramount importance that we have a strategy to float for the next 12-18 months and we have to play it dynamically and sail based on the direction of the wind. For the economy to stay afloat, we have to negotiate with the International Monetary Fund (IMF) for a balance of payment (BOP) bailout programme and request them to provide financial assistance to keep us afloat in the coming months. At the same time, we need to use our foreign office and actively seek bilateral loan facilities to manage the crisis. Import controls, liquidity injections, the Government taking over food distribution, and price controls are not at all advisable actions and they won’t help us to keep the rupee afloat, versus the dollar. Rather we will lose our dynamism and pragmatism and crush even the little credibility we have on markets.

The status of our basics

The next question is what can we do and what should we do to get beyond the floating stage. We have to evaluate the status of the basics and spend time on getting our basics right at this dark and stormy hour. Our fundamentals for sound economic policy have never been right in the last three to four decades. We should not lose the benefits of bringing hard reforms and getting the fundamentals right while we fight this crisis. For example, when pay cuts and job losses take place post opening up, people will actively look at part-time opportunities and work more to earn an income. At that point, if our business registration takes three months and if getting an online payment platform takes months for an e-commerce business to take off, the million opportunities created due to Covid-19 will be taken away by our neighbouring competitors. A study done by the Advocata Institute has found that registering a sole proprietorship is far more difficult than incorporating a private limited company. If we fail to fix that level of basic reforms (which can be easily fixed) we will not have any space to capitalise on the opportunities even if we get the support from development agencies over the next few months. Convoluted and complicated customs procedures and red tape have been discussed for years. South Asia Gateway Terminals (Pvt.) Ltd. (SAGT) CEO Romesh David, at a recent online forum on Sri Lanka’s exports economy with Advocata, said that even in the context of Covid-19, goods can cross borders and systems can be automated. If we are not ready to fix these basic regulatory barriers at Sri Lanka Customs, even our revised export target will be just an imaginary number. In summary, our strategy from a national level to that of a small business has to encompass the ability to float pragmatically as we are still in the eye of the storm. At the same time, we have to make sure to utilise our energy on getting our basics in economics right if we are to capitalise on the opportunities that will unfold when the storm is over. In difficult times people will be open to hard reforms and governments can spend political capital on getting hard reforms done. The Government should move back to their role as a facilitator rather than trying to become an active player and throw long-term strategies during one of the most serious crises in the history of mankind.

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.

Sacrificing food security for self-sufficiency

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

Originally appeared on The Morning

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By Dhananath Fernando

The fallacy of a society that thrives on the myth of “self-sufficiency” after the colossal failure during the mid-70s that left nearly the entire population sans the ruling elite’s belly full is making the rounds again. The very definition of the term “self-sufficiency” has different meanings. One school of thought is going back in time to an era where Sri Lanka never existed on the international map with absolutely zero trade. In this instance, one had no choice as you live off of what you grow. Then there are the alternative arguments – the one that argues that one needs self-sufficiency to ensure food security; to be self-sufficient in food but import fuel, coal, medicine, raw materials, and other “essentials” as prescribed by the state. There are others who believe our trade deficit is beyond our means and we need to be self-sufficient to the extent of our export capacity. Out of all the arguments, the one on food security is the most popular. Hence, let›s take a look at data and definitions on food security and evaluate whether Sri Lanka can truly be “self-sufficient”.

What does food security mean?

The popular belief of “food security” is to have enough food for our consumption during a crisis. The present global COVID-19 crisis we are grappling with is a prime example. Another common myth on food security is having sufficient food stocks to last six months and the ability to produce the required calorie intake within the country’s territorial borders. The Food and Agriculture Organisation of the United Nations (FAO) and the World Food Summit have defined food security as follows: “Food security exists when all people, at all times, have physical and economic access to sufficient, safe, and nutritious food that meets their dietary needs and food preferences for an active and healthy life.”

Despite popular belief, to achieve food security, the country in concern need not produce the food it needs within its borders. The key is to produce the required food at scale and desired quality economically. Otherwise, we will waste our precious and limited resources. For example, take Singapore which has a land area of just 725.7 km2, compared with Sri Lanka’s 65,610 km². Singapore has topped the global food security index for the second year running, despite lacking commercial agriculture. This is because Singapore has integrated fully into the global food supply chain and constructed adequate storage to feed its citizens during external shocks. This is truly remarkable as Singaporeans can consume food that is, as defined by the FAO, safe, sufficient, and to the preference of the consumer. In comparison, Sri Lanka is ranked 66th in the same index. How can we ensure fellow Sri Lankans have access to food physically and economically at all times? According to the FAO definition, it is evident through the COVID-19 crisis that although we have food physically, our food security as a country has been hit by not having physical access to this food due to delivery concerns, people losing both economic and physical access to food due to the interruption of their daily wages, and the absence of food preferences. The failed socialism experiment adopted by the Bandaranaike Government failed to achieve any of the above. Food was inadequate, to say the least; choice was a dream and quality was never present. If a citizen was apprehended with anything more than that was rationed, it was deemed a heinous crime and he or she was promptly jailed. Flour was infested with bugs and rice with stones, and apparel was perfumed with the stench of kerosene and the risk of setting on fire those who were careless near the wood-fired kitchen stove. We had the longest queues in the world for the poorest quality of bread, and that too for only one loaf irrespective of the size of your family. In summary, for the urban community (where the majority had cash to buy food), food security was challenged by the absence of physical access and preferences, while the rural and estate communities’ food security was challenged by the absence of income and preferences as they consumed whatever that was available in their gardens or that grew in the wild. So it is obvious that food security is not something we can attain just by trying to be self-sufficient as there are so many other components to it such as access, affordability, safety, preferences, and nutritional value. According to FAO, the average daily per capita energy requirement per person is 1,680 kcal and Sri Lanka on average is at about 500 kcal above the limit, but according to census and statistics data, the energy intake in the poor segment across Sri Lanka is below world standards. So if we are serious about food security in the long run, we need to ensure our people can afford safe and nutritional food, maintain access, and ensure choice rather than living in the fallacy of self-sufficiency. To achieve this, we need to create secure access to the global food supply chains so that our people can afford the diverse range of food required to meet their energy intake (balanced diet). Then the next question one may have is whether this means that we are going to import all our food and whether we have enough foreign exchange to import all that we require.

Low agriculture productivity

To answer both aforementioned questions, we need to check why the productivity in our agriculture (sector) is low. The technology not reaching our paddy fields is the common excuse that has been given over the years. But have we thought about the reason why technology hasn’t reached the paddy fields? Out of 6.5 million hectares of land in Sri Lanka, 5.4 million hectares are owned by the government. As a percentage, private lands are just 18% of Sri Lanka’s total land extent. Farmers are required to take a permit from the government office if they are to cultivate a higher-yielding paddy. Access to a bank loan is very limited for most paddy lands as farmers are not given the title to the land they cultivate. No construction can be done on paddy land as it’s forbidden by law. Under the current regulatory regime, no investor would invest in a greenhouse farm or high-tech farm. In addition to the above, most of the paddy lands are fragmented, so the opportunity to scale up for a big operation is very limited, keeping costs of production high. This means that even if we were to go back to self-sufficiency and cultivate in our backyards, we have just a fifth of our entire land to cultivate, build houses, and do all other industrial work. This also means that we have about 25% of our labour force engaged in farming, but contributing only 7-8% to our GDP, which leaves most of our land unproductive.

Importing food and the trade deficit

Extreme self-sufficiency is not at all an option regardless of how resourceful we are, as it is obvious that we can’t produce all that we need – for example, fuel and machinery. The only way to keep our trade deficit narrow and convert it to a surplus is to develop our exports. Exports and imports are two sides of the same coin. We import products we cannot produce or products for which we do not have a competitive advantage. We export commodities and services where we have a competitive advantage. Following is an extract from FAO which summarises why food security can only be achieved by global collaboration: “Global food trade has to be kept going. One of every five calories people eat has crossed at least one international border, up more than 50% from 40 years ago.” Therefore, our inability and traditionally lethargic approach to developing our exports should not be a trade compromise for the real and meaningful food security of our people.

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.

Attracting foreign exchange: Are we on the right track?

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

Originally appeared on The Morning

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By Dhananath Fernando

What should be our mandate for the coming Sinhala and Tamil New Year? We have to be psychologically prepared to work harder and develop the ability to drive and lead in the best of times as well as the worst of times that are about to dawn on the horizon. Amidst the COVID-19 battle and a quarantined Sinhala and Tamil New Year, the recent figures by the Department of Census and Statistics indicate that our per capita GDP for the year 2019 (which is a reasonable measure to evaluate the standard of living) is at $ 3,852 per annum, a drop from $ 4,079 in 2018 (In USD terms, this is a 5.5% drop compared to 2018 and a 3.9% increase in LKR terms). In 2015, our GDP per capita was $ 3,842. In USD terms, we have pretty much slipped to where we were five years before.

Just to bring our performance into perspective, Japan’s GDP per capita is around $40,000. The standard of living in Japan is 10x as Sri Lanka. Our GDP growth rate is estimated to be at 2.3%, another 0.3% drop from the initial estimation of 2.6%. What this means is Sri Lanka will take 30 years to double our living standard if we are to move at this pace. And even then, we will be falling 5x behind Japan’s present standard of living. We are heading towards a difficult and challenging time period with a bad start. We can overcome this only by working together locally and forging partnerships globally. We have to find opportunities in this crisis and navigate by adding more value to our goods and services which the global market seeks. Our mandate in this New Year should be to be competitive, serve market opportunities, and capitalise on the limited opportunities before us. However, this is easier said than done. In this context, the decisions we make and the messages we push will determine where we are heading towards and the fate that awaits us in the not-so-distant future.

Measures by the Central Bank

It is no secret that Sri Lanka requires foreign exchange to pay back our import bills and the loans that we have taken. We import almost double what we export, hence the balance in the current account – or in common man’s term, imports exceed our exports. This trade deficit has to be narrowed, and this is the challenge. Over the years, instead of implementing the required reforms to make our exports more competitive and to close the gap, our constant strategy has been curbing imports to narrow the trade deficit. Today, we have arrived at the point of no return. With little growth in exports and debt beyond our means, the Sri Lankan taxpayer has racked up debt of about $ 16 billion payable by 2023. The Government took to implementing a futile policy of banning the importation of non-essentials including vehicles. Our rupee has depreciated nearly 70% over the past decade. On 8 April 2020, the Sri Lankan rupee passed 200 against the dollar. Given the ongoing crisis, we are left with few options to save precious foreign reserves as raising money from the market at the present risk premium is almost impossible. However, data indicates that the Central Bank continues with quantitative easing – printing money or adding more money into our financial system – which is the main reason for our currency to depreciate. On 24 February 2020, the Central Bank of Sri Lanka made a Rs. 24 billion profit transfer; on 13 March, the Central Bank injected Rs. 50 billion by buying government securities; and on 17 March, the Statutory Reserve Ratio (SRR) was brought down to 4% from 5%, which injected a further Rs. 50 billion to the Sri Lankan economy. The meaning of the statutory rate cut is that all licensed commercial banks earlier had to maintain a mandatory reserve of 5% of their total deposits with the regulator (deposit liabilities), but now have to maintain only 4%. This money will most likely be utilised towards relief measures provided by the Government. As we continuously highlighted in this column, the Yahapanala Government made the same mistake of imposing import controls and providing cash injections to the system, which resulted in the rapid depreciation of the rupee. The value of the rupee is a market function and trying to distort (it) by intervention is not advisable. In this case, with the devaluation of our rupee, the prices of food and medicine will go up, thereby increasing poverty levels.

Appealing for foreign currency deposits

On 2 April 2020, the Governor of the Central Bank appealed to domestic and international well-wishers on behalf of the Government of the Democratic Socialist Republic of Sri Lanka to deposit foreign exchange into Sri Lankan banks with an assurance that no questions would be asked on the financial trail of the funds. In the appeal, the Governor of the Central Bank mentioned that the money would be accepted without any hindrance from the Central Bank and the banking system and will be exempted from exchange control regulations and taxes for three months from 2 April 2020 onwards. At the point of writing this article, the Central Bank has not published further guidelines; only the statement by the Governor is available. However, it is of paramount importance that these measures do not impact Sri Lanka’s ratings by rating agencies as this would further erode our capacity to work with international donor agencies and financial markets. We have to be cautious not to open space for money laundering while we take decisions at this serious moment to attract more foreign currency. As a result of the serious efforts by the Central Bank of Sri Lanka, we were delisted in the grey list of the Financial Action Task Force (FATF) in October 2019. The FATF is the global policy setter on anti-money laundering and countering the financing of terrorism. A delisting from the FATF grey list is a positive indication to the market to attract quality investments which look for a credible financial system. At the same time, we have to be vigilant not to breach the code of conduct and ethical guidelines of international donor agencies, as there is a high possibility of Sri Lanka knocking on their door as a fallback option. In 2001/2002, a similar tax amnesty scheme was brought by then Minister of Finance K.N. Choksy and the proposal was reversed soon after the new Government was elected in 2004. There are no short-term solutions to mitigating long-term macro issues. Time and time again, it has been proven that curbing imports is not the solution and monetary prudence is the way to stabilise the rupee. The motivation behind these measures is understandable as our foreign exchange income is very tight, but in this new Sinhala and Tamil New Year, we must ensure the cure is not worse than the illness.

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.