Tuk-tuk economy: Where algorithms meet asphalt

By Dhananath Fernando

Originally appeared on the Morning

In mainstream media, clashes between app-based ride-hailing taxis and traditional taxis are frequently reported, especially in tourist hotspots such as Kandy, Sigiriya, and even at the Bandaranaike International Airport. 

However, many Sri Lankans, including tuk-tuk drivers, do not fully understand the economic logic behind this. Often, the debate centres on high commissions taken by app companies or the notion that international ride-hailing platforms repatriate profits overseas.

At the ‘Ignite Growth Conference’ organised by the Advocata Institute, PickMe Founder Jiffry Zulfer shed light on the economic transformation driven by platforms like PickMe and its main competitor, Uber.

The core concept of ride-hailing apps is the ability to match demand and supply within a limited geographic radius in real-time. According to Zulfer, PickMe facilitates around 20 rides every second, striving to ensure that passengers always have a ride available and that drivers remain engaged and productive.

This matching of demand and supply has created significant market efficiency. On average, a driver using the app completes around 17 hires per day, compared to just 7-10 hires for a driver waiting at a tuk-tuk stand or roaming the streets. As a result, app-based drivers utilise their vehicles approximately 81% of the time, compared to just 39% for traditional drivers.

From an economic perspective, this availability of information – knowing who needs a ride and who can provide one – drives greater efficiency, not just for passengers and drivers, but for society at large as well. According to Zulfer, PickMe has covered over one billion passenger kilometres and now transports more people daily than Sri Lanka’s railway system.

Early investors in PickMe saw returns of up to 300 times their original investment, and it is likely the Government benefited as well, collecting around 30% in taxes. App-based drivers now earn on average 40% more than traditional taxi drivers, transforming the lives of 30-50% of tuk-tuk drivers in a population of 1.2 million tuk-tuk owners in Sri Lanka. 

In essence, the biggest beneficiaries of this shift have been ordinary working-class drivers, passengers, investors, and the Government.

PickMe is now listed on the Colombo Stock Exchange, opening the door for broader public investment and shared benefits.

It is crucial to recognise that when demand and supply are allowed to interact freely, it creates a win-win outcome for all stakeholders, unlike Government-run businesses, which often favour one group at the expense of others.

Zulfer also categorised tuk-tuk drivers into three groups based on their engagement: a large segment contributes less than three hours per day, a second tier less than six hours, and only a minority works full-time (over eight hours) through the platform. Interestingly, more women are now joining the platform, unlocking new income opportunities and increasing female participation in the workforce.

The PickMe Founder further explained that when adjusting for inflation, ride prices had decreased, providing passengers with real financial benefits beyond mere convenience. At the time of launch, the app’s per-kilometre rate was Rs. 33, compared to the Rs. 40 charged by traditional meter taxis. This holds true across other ride-hailing platforms as well. 

Unfortunately, many policymakers still struggle to grasp the fundamental economic principles at play – how market forces, when allowed to operate freely, can uplift the average citizen.

Ride-hailing services have since expanded into motorbike transport, courier services, and food delivery. These platforms are now among the largest ‘restaurant’ operators in the country, despite not owning a single restaurant. 

The same model has given rise to the ‘dark kitchen’ phenomenon, enabling home-cooked meals and micro-businesses to reach a wide customer base. This has changed food habits, offered consumers more choice, and encouraged families to spend more time together with the convenience of food delivery.

Zulfer’s economic logic applies beyond transportation. It holds true for other network-based platforms like Booking.com, Airbnb, and others. The average person, especially those with entrepreneurial spirit, stands to benefit the most.

In Sri Lanka, the majority of room inventory is offered by micro and small-scale lodge owners. Online platforms have empowered them to tap into the tourism ecosystem and earn foreign income, something that was previously out of reach.

Understanding the economic logic of network-based industries is crucial for Sri Lanka’s growth. These platforms enhance productivity, generate opportunities, and create wealth. While foreign direct investment and trade policy are important, we must also pay attention to the power of networking demand and supply.

Imagine a world where the same happens to our entire public transport system. Things will not be perfect, but they definitely would be in a much better form than it is at the moment.  

By simply enabling the right environment – often by not interfering – governments can allow these industries to flourish, driving economic efficiency, opportunity, and prosperity for all.

Meeting pricing equilibrium during the fuel crisis

(Source: Slide presented by PickMe Founder Jiffry Zulfer at the ‘Ignite Growth Conference’)

From Sri Lanka to Singapore

By Dhananath Fernando

Originally appeared on the Morning

A 100-year journey or a 40-year leap?

For many Sri Lankans, one of the most common points of comparison is Singapore. We have heard time and again how Singapore once lagged behind Sri Lanka in terms of GDP per capita but eventually surpassed not only Sri Lanka but also many other developing nations worldwide. 

Given that both countries are in Asia and that Singapore once looked to Sri Lanka as an aspirational model, it is natural for Sri Lankans to frequently draw comparisons between the two.

Recently, at the Advocata Institute’s ‘Ignite Growth Conference,’ Central Bank of Sri Lanka Assistant Governor Dr. Chandranath Amarasekara presented a slide illustrating how long it would actually take for Sri Lanka to reach Singapore’s current GDP per capita under different growth scenarios.

Dr. Amarasekara projected the timeframe based on Sri Lanka’s GDP per capita growth at 3%, 5%, 6%, and 8% annually. For context, GDP per capita is a commonly used measure to gauge a country’s economic prosperity. Currently, Sri Lanka’s GDP per capita stands at approximately $ 3,800, while Singapore’s is around $ 84,000.

The calculation estimates the number of years it would take for Sri Lanka’s GDP per capita to grow from $ 3,800 to $ 84,000, assuming compound annual growth at different rates:

• 3% growth rate: 105 years

• 5% growth rate: 64 years

• 6% growth rate: 54 years

• 8% growth rate: 41 years

The challenge of comparing Singapore and SL

In my view, comparing Singapore and Sri Lanka directly is difficult because the two nations offer entirely different value propositions. Singapore is essentially a city state with a population of six million, whereas Sri Lanka is over 3.5 times larger in terms of population. 

The demographics, political landscapes, and economic structures are vastly different. However, from an economic perspective, an average Singaporean is 21 times wealthier than an average Sri Lankan.

To put it in simple terms:

• Singapore, with just six million people, generates an economic output of $ 500 billion

• Sri Lanka, with 21 million people, produces less than $ 90 billion

Learning from Singapore without copying 

While it may not be meaningful to copy Singapore’s model outright due to fundamental differences in culture and circumstances, there are key economic principles Sri Lanka can adopt.

A rock-solid monetary framework

One of Singapore’s greatest strengths is its monetary stability. The country’s financial system remains robust thanks to sound economic policies developed under visionary leaders like Goh Keng Swee.

A stable currency is crucial because wealth is stored in the form of money. For example, if a farmer produces 100 kg of rice and sells it for Rs. 20,000, depositing that money in a bank means converting his labour into a universally accepted currency. If inflation erodes the value of that currency over time, it discourages productivity. A monetary system that fails to preserve value will ultimately undermine economic progress.

Many admire Singapore’s modern infrastructure, but what they often overlook is the country’s strong monetary foundation. Interestingly, the same Dr. Goh who helped shape Singapore’s economy also advised Sri Lanka, but his recommendations were never fully implemented.

The right policy framework

While reaching Singapore’s current economic level may seem like a monumental task, the key lies in laying the right policy framework. If the right economic policies are put in place, progress will follow naturally. It is not about chasing Singapore’s end results but rather about focusing on the right processes to achieve sustainable growth.

Instead of fixating on when Sri Lanka will become like Singapore, we should prioritise fundamental economic reforms in areas like trade, investment, and labour policies. If we get these right, the rest will take care of itself.

(Source: ‘Ignite Growth Conference’ presentation by Dr. Chandranath Amarasekara)

Bracing for Trump’s tariff storm

By Dhananath Fernando

Originally appeared on the Morning

US President Donald Trump’s second term seems to be keeping all people around the world on their toes. The changes and policies, along with their implications, will be complicated, and we have to do our homework to gain an advantage or at least survive in this game.

The new Trump administration has suggested reciprocal tariffs, meaning the same tariff rates applied to each country that they charge for US products. 

Already, a 10% tariff is in effect for non-energy products from Canada and a 25% tariff on energy-related products from Canada. Additionally, a 25% tariff has been imposed on Mexican products, alongside an additional 10% tariff on Chinese products, bringing the total tariff on Chinese products to 21% (from around 11% previously).

SL’s opportunities and challenges

Before Sri Lanka gets affected by any reciprocal tariff, we first need to understand our total exports, including services. 

According to Harvard’s Atlas of Economic Complexity, we export about 21% to the United States. When it comes to apparel, about 40% of our apparel exports are destined for the US. 

Accordingly, the first line of impact for Sri Lanka would be potential consumption contraction in the US. With high tariffs even against Canada, China, and Mexico, as well as increased prices of essential products, the US consumer will likely reduce spending on non-essential items such as seasonal clothing. It is normal consumer behaviour to postpone purchasing decisions if expenditure on essentials like energy and rent increases.

The second line of impact has both positives and negatives. China and Mexico also supply apparel to the US. If relative prices of Sri Lankan apparel become lower following the 25% tariff for Mexico, we might gain an advantage. 

Similarly, we could become more competitive than China, which now faces an overall 21% tariff. Therefore, we must be cautious and prepared, recognising it is not just tariffs on Sri Lanka directly but also tariffs on others that can bring us opportunities or challenges.

The danger lies in the final stage if the US imposes reciprocal tariffs. The US would consider imposing the same tariffs for Harmonised System (HS) codes as the other trading country imposes on US products. 

There is discussion that the US might not only consider customs duties but also other tariff barriers and even non-tariff barriers. In that case, Port and Aviation Levy (PAL), Commodity Export Subsidy Scheme (CESS), Social Security Contribution Levy (SSCL), and Value-Added Tax (VAT) might be considered, according to some reports. 

This decision depends entirely on the Office of the US Trade Representative (USTR) defining ‘unfair trade practices.’ Media reports indicate that the USTR is expected to analyse all data and make a decision on reciprocal tariffs by 1 April.

We must recognise that Sri Lanka’s average tariff rates are significantly higher than those proposed by the US to China, Mexico, and Canada. A 25% tariff in Sri Lanka is considered low, as our effective tariff rates reach nearly 100%, and for vehicles with excise duties, it exceeds 200%. It is joked that even Trump would become confused if he learnt about Sri Lanka’s tariff structures and that he might learn a tough lesson from us.

In the context of reciprocal tariffs, price-sensitive product categories such as food, apparel, and rubber products may face higher prices in US markets. Ultimately, the real impact will depend on how other competing export markets are affected by US tariffs and non-tariff barriers and how these affect US consumption and global economic growth under new trade dynamics.

Meanwhile, Europe and other powerful countries are targeting the US with reciprocal tariffs, which could trigger global supply chains to consider relocation and create new incentive structures. This can present either an opportunity or a disaster for Sri Lanka.

Solutions

To attract new supply chains and assembly components, we must quickly work on basic factor market reforms. Having adequate land ready for industry and a flexible labour force with business consciousness is essential. Secondly, simplifying and lowering our tariff structure is critical, even though it might be somewhat late. 

Additionally, exploring exports towards East Asia and the Indian market is increasingly vital. Whether our US market shrinks or not, we should prepare to explore other markets, primarily India and East Asian countries. Strengthening foreign relationships, activating business chambers, and intensifying diplomatic missions to strengthen ties is necessary. 

Accelerating regional free trade agreements and conducting market sentiment research can help Sri Lankan entrepreneurs expand their exports. Fundamentally, economics never expires – even during trade wars or crises, strong economic fundamentals provide the best way to survive and thrive. We must move from hope to action.

Where did Sri Lanka export all products to in 2022?

Source: Harvard Atlas of Economic Complexity

Where did Sri Lanka export textiles to in 2022?

Source: Harvard Atlas of Economic Complexity

NPP’s maiden Budget

By Dhananath Fernando

Originally appeared on the Morning

The National People’s Power’s (NPP) maiden Budget will be presented to Parliament tomorrow (17). Ideally, a budget should not contain surprises – neither on the income front nor on the expenditure front. Government expenditure is the real tax burden on people; they ultimately bear the cost through taxes, inflation, or both.

Generally, a budget consists of two key components. The first is revenue and expenditure, while the second is the policy direction of the Government. This time, the business community is particularly focused on the latter, as it is evident that income and expenditure must align with the International Monetary Fund (IMF) programme.

Adhering to IMF targets 

The 2025 Budget has no alternative but to adhere to the parameters set by the IMF. While micro-level details and specific projects may change, key indicators such as gross financing needs, Government revenue-to-GDP ratio, primary balance, and debt-to-GDP ratio must be maintained as agreed under the IMF programme.

Additionally, the previous Government introduced new legislation under the economic transformation framework, covering many of the IMF’s targets. Achieving a Government revenue target of 15.1% of GDP will be a major challenge. Value-Added Tax (VAT), corporate tax, and income tax have already reached their upper limits, leaving limited scope for further increases. The Government is likely to bridge part of the revenue gap through vehicle importation.

When governments face revenue shortfalls, ad hoc taxes or sudden tax increases are common, often targeting sin industries such as tobacco and alcohol. However, the Budget must adhere to sound tax principles, ensuring simplicity, transparency, neutrality, and stability. 

The focus should be on simplifying the tax system and improving the efficiency of tax administration, as poor administration is as harmful as a bad tax system. Any unexpected changes in revenue policies could harm businesses, erode investor confidence, and slow down the economy. The best way to achieve the 15.1% revenue target is through efficiency measures and broadening the tax base.

Over 50% of recurrent expenditure towards interest payments

Sri Lanka has little control over its expenditure, with over 50% of spending allocated to interest payments. In 2023, approximately 90% of tax revenue was spent on interest payments. 

Currently, Sri Lanka has one of the highest interest payment-to-revenue ratios in the world, raising concerns about the possibility of a second debt restructuring. Post-debt restructuring, the Government has minimal room for fiscal adjustments.

While Government employees and various sectors may expect relief packages, the reality is that there is no fiscal space to accommodate such demands. It is true that salary structures for senior Government positions need improvement to attract the right talent, but this can only be achieved by restructuring the lower levels of the public service, which absorb the bulk of the salary bill.

Another solution is to drive economic growth and increase labour force participation, reducing the proportion of Government employees relative to the total workforce. Blanket salary increments are difficult to implement without compromising capital expenditure, which is crucial for long-term development. 

Currently, 20% of recurrent expenditure is allocated to salaries and wages, while pensions account for approximately 8%. Given this context, expecting significant relief packages is unrealistic, and any attempt to provide them could lead to long-term economic instability.

Investment should prioritise healthcare, education, social protection

Government spending should prioritise critical sectors such as healthcare, education, and talent development. However, expenditure in these areas – including the ‘Aswesuma’ social safety net – was lower than expected last year. 

The IMF has pointed out that Sri Lanka did not fully allocate the funds intended for ‘Aswesuma,’ which serves as the primary social safety net for the country. Ensuring proper allocation to these essential sectors is crucial.

Focus should be on structural reforms

Rather than solely focusing on balancing income and expenditure, the Government should use the Budget as an opportunity to set a clear policy direction. 

Key areas requiring structural reforms include land policies, labour laws, the export sector, and energy markets. These reforms are fundamental to Sri Lanka’s economic growth, as the country’s challenges are largely structural rather than issue-specific.

We will have to wait until tomorrow to see the extent to which the Government seizes this opportunity. Instead of expecting widespread relief measures, the public should push for meaningful policy reforms – an essential step for securing Sri Lanka’s future

(Sources: CBSL, Advocata Research)

(Sources: CBSL, MOF Annual Report, Advocata Research)

The power of know-how over industry selection

By Dhananath Fernando

Originally appeared on the Morning

In most of our export strategies, the starting point has been the Government deciding which industries should drive exports – some of these decisions are data-driven. 

Accordingly, we examine current export figures and sometimes focus on expanding existing product segments. Secondly, we target additional industries with the expectation that exports can be boosted. While both approaches seem logical at first glance, we need to understand the broader framework of how to grow exports effectively.

Most of the time, we perceive exports as industry-specific, but in reality, exports are about know-how. Know-how becomes a product, and know-how makes a product competitive. However, know-how is not just knowledge – it is sometimes tangible, existing in tools, but more often, it is intangible. 

It is akin to Lasith Malinga’s bowling action and his ability to deliver pinpoint yorkers. We can analyse Malinga’s technique, attempt to replicate his action, and even learn from his strategies through interviews or YouTube videos. Yet, even with all this information, it is extremely difficult to replicate his unique skill set. 

Malinga possesses tangible components such as his slinging action, run-up, and release style, which can be considered tools. He also has knowledge that he shares through various platforms. However, his true know-how – what makes him exceptional – remains elusive, even to himself. 

This difficulty in transferring know-how is likely why the Mumbai Indians recruited Malinga both as a player and later as a coach in the Indian Premier League. If we consider Malinga as a product, he is export-competitive and his value lies in a combination of factors, primarily his unique know-how.

When a country seeks to expand exports, the know-how ecosystem is what determines success or failure. Our apparel manufacturers, for example, possess specialised knowledge that enables them to produce garments at the lowest cost while maintaining high quality. 

Initially, their products were relatively simple, but over time, they evolved in complexity. The industry experimented with various approaches – ethical garment production, lean manufacturing, and women’s empowerment – learning from both successes and failures to refine a sustainable model.

Today, Sri Lanka’s apparel exports are not merely about physical products but also the know-how that allows us to compete globally. Know-how thrives within an ecosystem that supports industries. 

For this to develop, the Government must provide entrepreneurs and businesses with the freedom to access and test resources – what economists refer to as factor markets. Land, labour, and capital must be available with minimal restrictions on a level playing field. 

This is why licensing requirements can be detrimental to exports; they obstruct access to essential resources, thereby stalling know-how development. For instance, if land acquisition is difficult, apparel firms may struggle to operate or innovate. Similarly, excessive labour regulations can increase operational costs, making products uncompetitive and disrupting the know-how ecosystem. Such obstacles discourage exports.

Another common discussion on boosting exports revolves around diversifying the export basket. To understand how diversification occurs, we can refer to Harvard’s Center for International Development, where Prof. Ricardo Hausmann uses the analogy of monkeys and trees in a forest.

In a forest, monkeys do not leap from one end to the other; they move from branch to branch. Similarly, export diversification does not occur in giant leaps but through adjacent product categories. Existing exporters and individuals within the know-how ecosystem expand into related fields. 

For instance, if we excel in gemstone exports, an adjacent category would be jewellery. This is why Government intervention in selecting export industries with large targets is often ineffective – diversification and expansion naturally occur within adjacent categories.

In making more complex products for export, Prof. Hausmann employs an economic theory likening diversification to a Scrabble board. If we have only three letters, our word combinations are limited. However, with four letters, the number of possible words increases exponentially. 

Therefore, minimising restrictions on factor markets – such as land and labour – enables more access to ‘letters,’ allowing for greater diversification.

Additionally, some ‘letters’ contribute significantly to forming words, like the letter ‘A,’ which is more versatile than a letter like ‘Z’. Similarly, removing barriers to factor markets increases the potential for new export combinations.

In Sri Lanka, our export strategy has traditionally relied on the Government selecting industries for growth. While this approach may work to some extent, if we seek rapid export expansion – like Vietnam – we must focus on the framework rather than forcefully pushing selected industries.

In today’s global economy, no country manufactures all its products on its own. Most nations produce parts, components, and assemblies, relying on international trade to complete final products. If we fail to open our economy to trade, our export ambitions will remain unfulfilled. Trade enhances competitiveness and provides access to multiple ‘letters’ at optimal costs.

Foreign Direct Investments (FDIs) are another crucial element in this equation. FDIs bring in individuals with specialised know-how, much like acquiring a player of Malinga’s calibre. They also introduce advanced technology, enabling the creation of more ‘letters’ and exponentially increasing the potential for new products over time.

If Sri Lanka is serious about exports, we need to focus on the process and the journey. We hope that the upcoming Budget will establish key milestones to guide us in the right direction.

Overcoming structural barriers to achieve export growth

By Dhananath Fernando

Originally appeared on the Morning

Sri Lanka has been trying to solve its export puzzle for a long time, with a new export target set at $ 36 billion by 2030. 

As of November 2024, the country had approximately $ 11.6 billion in merchandise exports and $ 3.1 billion in services exports, totalling around $ 16 billion. Over the next five years, exports are expected to double, requiring an annual compounded growth rate of approximately 14%.

Many policymakers define Sri Lanka’s export challenge as a lack of diversity in the export basket, limited access to international markets, or insufficient value addition. While these factors are valid, the core issue is that Sri Lanka is not competitive. 

This lack of competitiveness is not due to an inherent incapability but rather the result of policies and structural inefficiencies that have rendered the country uncompetitive. Often, this fundamental issue is misdiagnosed as a lack of targeting, leading to constant shifts in focus towards different sectors or products every three years without addressing the root causes of uncompetitiveness.

Addressing competitiveness 

Addressing public policy challenges is inherently complex, as solutions impact various stakeholders, making change management difficult. 

One of the primary mistakes governments and policymakers make is attempting to target specific sectors for export growth. Instead, focus should be placed on sectors where Sri Lanka has a competitive advantage. 

The only way to determine competitiveness is through practical application – by actively engaging in export activities rather than relying solely on theoretical projections. In the modern economy, competitive advantage extends beyond specific products to elements such as design, lead times, and supply chain efficiencies – factors that may not be immediately evident to a single decision-maker.

The global trade landscape is shifting from finished products to parts and components within value chains. However, when the Government plans around traditional industry categories, it often overlooks this evolving reality. 

For any product or component to be manufactured competitively, key resources – land, labour, capital, and entrepreneurship – must be accessible and efficient. Sri Lanka’s export underperformance, poor diversification, and lack of market access stem largely from bottlenecks in these factor markets. 

When essential factors of production do not function effectively, innovation stagnates, restricting export diversification and the development of components for various products, including value-added goods. 

If businesses can achieve higher margins through value addition, they would naturally do so. If they choose to export raw materials instead, it suggests the presence of barriers, misaligned incentives, or a competitive disadvantage in value-added production.

To illustrate this, consider the hypothetical case of exporting iron ore. A country rich in iron ore but burdened with high energy costs will find exporting raw ore more advantageous than converting it into steel. Conversely, a country with lower energy costs, proximity to industrial zones, and high steel demand will have a competitive advantage in steel production. 

This principle applies across all industries – cost structures, infrastructure, and resource availability dictate competitiveness.

A complex problem   

Compounding the problem is the interconnected nature of these issues. Solving one aspect alone will not fix the broader export challenge. 

In Sri Lanka’s case, high energy costs place any export industry at a price disadvantage. Subsidising energy is often proposed as a solution, but ultimately, taxpayers bear the cost. 

Similarly, labour costs remain high due to regulatory barriers. For instance, if a major tech company wanted to relocate its regional office to Sri Lanka, the country lacks an adequate pool of IT graduates. Addressing this would require either allowing foreign professionals to work in Sri Lanka or significantly upskilling the local workforce.

Export development also requires capital and entrepreneurship. Capital can be acquired through debt or equity, but debt financing is currently not a viable option for Sri Lanka. Equity investment remains possible, but attracting such investment necessitates improving Sri Lanka’s investment climate. This highlights the urgent need for reforms within the Board of Investment (BOI). 

Additionally, facilitating foreign entrepreneurs’ ability to enter Sri Lanka – through streamlined visa processes and work permits – is essential. The Department of Immigration and Emigration must play a role in this.

For capital to flow, investors require developed lands with ready-to-use infrastructure, minimising lead time and operational delays. Without addressing these factor market inefficiencies, traditional export strategies will continue to fail. The global export market is now highly fragmented, with the future lying in the production of components and participation in global value chains rather than focusing solely on finished products.

Ultimately, the export sector is too complex for any single individual or institution to plan entirely. It is an organic, competitive field where businesses strive to add value through quality and cost efficiency. 

The role of the Government should be to facilitate this process by removing barriers and creating an environment conducive to competition. If the right conditions are in place, export growth will naturally follow and Sri Lanka will achieve its ambitious targets.

Rethinking tax policy in Sri Lanka

By Dhananath Fernando

Originally appeared on the Morning

• The case for adhering to tax principles

Many Sri Lankan budget speeches are essentially discussions on Government expenditure. Revenue proposals are often introduced piecemeal before the budget and frequently fail to align with basic principles of taxation. 

Under the current International Monetary Fund (IMF) programme, Sri Lanka has committed to achieving a revenue target of 15% of Gross Domestic Product (GDP) by 2025, increasing to 15.5% by 2026. Additionally, a primary balance target of 2.3% in 2025 must be met and maintained. 

While we have already exceeded the primary balance target, this achievement has come at the cost of cutting capital expenditure, which will likely impede long-term growth.

Tax revenue has met targets, primarily through record-high import tariffs collected at the border by Sri Lanka Customs, amounting to Rs. 1,500 billion. However, relying on such high border tariffs impacts both the cost of living and the cost of raw materials, adversely affecting exports and local production.

The need for adhering to tax principles

It is crucial that the Government prioritises adherence to fundamental principles of taxation when implementing revenue measures. Over-reliance on border taxes is not a sustainable strategy for achieving a higher tax-to-GDP ratio.

Why border taxes are problematic

Generating revenue through border taxes disproportionately affects importers, as they incur significant costs upfront, even before generating profits. In contrast, profit-based taxes are levied only after profits are realised, making them less burdensome from a cash flow perspective. The time value of money amplifies the impact of upfront border tariffs on profitability.

Sri Lanka’s import basket comprises approximately 80% intermediate and capital goods, with only 20% being consumer goods. Tariffs on these critical imports drive up production costs, ultimately increasing the price of exports and even domestic goods. For example, the Rs. 65 tariff on rice accounts for about 50% of its production cost, leading to a nationwide increase in meal costs by approximately the same margin.

A tax base built on three pillars

Globally, taxes are traditionally levied on three bases:

What you earn (e.g. income tax, corporate tax)

What you buy (e.g. Value-Added Tax, or VAT)

What you own (e.g. property tax)

Principles for an effective tax system

Simplicity: Taxes must be simple for taxpayers to understand and for authorities to collect and enforce. Overly complex tax structures with numerous thresholds lead to lower compliance, reduced revenue, and enforcement challenges. A standard and straightforward tax system is key to maximising efficiency and minimising leakage.

Transparency: Transparency in taxation fosters trust and reduces opportunities for corruption. For instance, Sri Lanka’s import tariff system, based on Harmonised System (HS) codes, lacks transparency due to its cascading structure. Similarly, ambiguities in income tax policies create doubts and complications. Transparency is especially critical for tariffs, which, even when necessary, must be clear and predictable.

Neutrality: Taxes should not create winners and losers by favouring or penalising specific industries, products, or sectors. For example, in 2015, Sri Lanka imposed taxes on profits from the previous year, undermining the fairness of the system. The primary purpose of taxation is revenue generation, not market distortion. Lowering tax rates can expand the tax base, ultimately increasing revenue and minimising evasion.

Stability: Tax rates should remain consistent over time to provide predictability for taxpayers. Frequent changes to tax rates, such as the numerous adjustments to VAT in Sri Lanka, create uncertainty, open avenues for corruption, and undermine economic stability. Temporary taxes and tax holidays should also be avoided to maintain consistency and fairness.

Taxes on property: A case for caution

Among all forms of taxation, taxes on property ownership are particularly burdensome. This is because taxpayers often have to forgo another revenue source to meet their property tax obligations. 

If a property generates income, that income is already taxed under income tax laws. Imposing an additional property tax not only constitutes double taxation but also discourages wealth creation. Such policies can deter investment and economic growth, undermining broader development objectives

Balancing revenue generation and expenditure

Sri Lanka urgently needs to increase tax revenue due to its high expenditure, particularly on interest payments, which account for approximately 50% of total expenditure. This is not repayment of debt but merely the cost of servicing bad debt. While room for expenditure cuts is limited due to the predominance of recurrent spending, hard restructuring is necessary to reduce this burden.

Although the Government has achieved a primary surplus by reducing capital expenditure, this strategy will have adverse long-term effects on growth. Therefore, adhering to fundamental tax principles is critical to improving Government revenue sustainably without jeopardising the country’s economic prospects.

Source: CBSL, Advocata research 

Source: CBSL, Advocata research 

A new era or more turbulence?

By Dhananath Fernando

Originally appeared on the Morning

• The challenges facing Sri Lanka’s next president

The Presidential Election has been announced. Ideally, by 22 September, there will be a new president with a new mandate from the people.

Sustaining power will be more difficult than winning the election. Generally, from the very first day after assuming office, things start to fall apart. This will be the first election after the ‘Aragalaya,’ and we do not know the ground reality.

The last power transition wasn’t smooth. While there was a democratic element in appointing the eighth President after the resignation of the former, that episode had many dark elements, including a massive economic contraction and impact on human lives.

Focus on economics and corruption

Previous elections had a national element, but this time the focus is completely on economics and corruption. The good news is that the path forward is well defined, including macro targets. The International Monetary Fund (IMF) Governance Diagnostic has provided the main reforms needed to curtail corruption, with timelines and responsible institutions. Most of these are non-controversial.

This time, all candidates will also have to declare their assets electronically. We, as the people, should demand that the Commission to Investigate Allegations of Bribery or Corruption (CIABOC) enforces this.

The new president must deliver on anti-corruption promises because the demands of the ‘Aragalaya’ have not been met yet. However, some promises, like recovering assets overseas, are not easy to execute. Therefore, delivering on the anti-corruption sentiment is challenging.

Delivering on the economic front is equally tough. After debt restructuring, our interest rates will likely remain high. When interest rates are high, the cost of capital is higher, slowing down investment.

For instance, buying a computer to automate manual work becomes difficult when money is hard to source due to high interest rates. As a result, our economy will not grow. If the economy is slow to grow, it invites another crisis. Simply put, if the economy doesn’t grow, our debt will not be sustainable.

In other words, if the economy is slow to grow, it indicates that we are heading towards another debt crisis. The next leader must ensure both growth and stability.

The second piece of good news is that we at least have an idea of what targets we need to achieve on the economic front. Our debt-to-GDP ratio must gradually come down to 95% and our revenue must increase by improving our tax net.

Many promises about increasing Government sector salaries and public sector expenditure are good, but will be difficult to keep.

Limited options

In this context, there are two limited options available to increase money and productivity.

The first is improving productivity in what we already do. Simply working harder and putting in more effort can help. For example, reducing the number of holidays by 10% should increase the economy’s momentum because people will work more. But this race cannot be won solely by working harder. We must also look into channels for improving productivity without capital investments.

One such area is opening up business ventures that change the business format. For example, app-based taxi companies have significantly improved the productivity of both passengers and drivers by connecting potential riders with drivers. Companies like Booking.com connect tourists looking for lodging with small-scale lodging options.

Changing the business model has increased income for many people, reduced expenditure for many, and decreased waiting times, increasing overall productivity. The new leader must leverage this productivity lever.

The second option is to reform State-Owned Enterprises (SOEs) to attract capital. Allowing SOEs to undergo privatisation and Public-Private Partnerships (PPPs) can attract capital through investments. Additionally, rather than incurring losses, private entities can generate revenue for the Government through taxes and improve productivity.

The third option is to release land to improve productivity and circulate capital. Providing land ownership to people allows them to use it as security to unleash capital from the banking system, improving productivity.

Beyond these three options, any president will have limited choices. Relying on geopolitical powers in a highly volatile geopolitical environment may also be unfeasible.

Therefore, the challenge for the new president extends beyond getting elected. The real challenge is navigating the period after the election, which will undoubtedly be tougher than getting elected.

Delaying elections threatens political and economic stability

By Dhananath Fernando

Originally appeared on the Morning

Whenever there is an election, there is always a conversation about delaying it. Already, Provincial Council Elections and Local Government Elections have been delayed. This was the case in 2004/2005 and again in 2019.

One rationale is that, having just achieved stability after a massive economic crisis, we need more time to complete some structural reforms and ensure political stability. On the flip side, how can we execute any reform without the mandate of the people? Operating without the people’s mandate means political stability is the first thing to go out the window.

After the resignation of the former President, the process of appointing a new President followed a democratic process. While it may not have been perfect, there was a democratic element involved. Political parties with a mandate from the people were able to contest, and the candidate who could command a majority of confidence through votes was given the responsibility to lead the country for the remaining term of the previous President.

Despite its flaws, this democratic element brought political stability, which led to economic stability. With the President’s support from Parliament, it was possible to enter into an agreement with the International Monetary Fund (IMF) and continue discussions with external and internal creditors for debt restructuring. The political stability that came through the democratic element in the power transition process made it possible to achieve some level of economic stability.

Uncertainty and economic growth

However, the same democratic process has clear guidelines on the expiry time of the mandate. If we do not follow this process, the system that brought stability will push us towards instability again.

Delaying or attempting to delay elections often prompts political parties and their supporters to demand elections, creating instability as people seek to test the mandate of the public. Delaying an election in the hope of completing unfinished reforms rarely works as planned.

Moreover, postponing elections increases uncertainty. Even holding an election carries some uncertainty, but postponing it intensifies this uncertainty. The biggest enemy of any economic development is uncertainty.

After debt restructuring, the only way out for the country is economic growth. According to agreements with bondholders, we start repaying our interest from September onwards. A year of uncertainty will hinder even the small growth potential we have.

For economic growth, we need investments, and in an uncertain economic environment, attracting investments will be difficult. Falling behind our growth targets due to political uncertainty will challenge our debt repayments and credit rating updates.

International support may not be as easy to secure if the legitimacy of the Government is questioned over a delayed national election. It is true that elections themselves have an element of uncertainty. Especially post-Presidential Elections, if Parliamentary Elections result in fragmented party compositions, we risk returning to a scenario similar to President Chandrika Bandaranaike Kumaratunga’s era, with a Coalition Government barely holding a majority.

Passing bills during a time when growth and structural reforms are needed could face resistance and pushback, leading to maintaining the status quo rather than shifting gears for growth and development.

Having a majority or even two-thirds power does not guarantee that all decisions will be right or fast. As we witnessed, a two-thirds majority Government was short-lived due to misguided economic policies. However, a diluted majority will also bring instability and frequent power changes, causing things to go back and forth.

The solution: A common reform programme

If we think about the country and the people, the only solution is a common minimum reform programme where parties agree on a baseline level of reforms. This ensures that regardless of who comes to power, progress continues. The common minimum programme can start with implementing the IMF Governance Diagnostic, which has recommended significant structural reforms for fiscal, monetary, anti-corruption, and State-Owned Enterprise (SOE) sectors.

If we can at least implement the IMF Governance Diagnostic Report as a common minimum programme, even in case of a drift, it will be slow. Delaying elections, however, will accelerate the drift and slow down existing reforms and growth.

The real challenge will be for whoever comes to power next. If the next government cannot drive economic growth through improving productivity, investment, and efficiency, another collapse is inevitable. A common agreement on reforms is required because the common people care less about who rules the country and more about how their future and standard of living will improve.

Bouquets and brickbats for Economic Transformation Bill

By Dhananath Fernando

Originally appeared on the Morning

We all agree that Sri Lanka’s economy requires transformation. Can we transform an economy solely through an Economic Transformation Bill? No. Can we do it without a bill, without a proper legal framework and institutional structure? Again, the answer is a definite no.

Overall, the bill essentially unbundles the Board of Investment (BOI) into three main parts: establishing a powerful Economic Commission to decide and drive investment strategy at a national level, improving the investment climate for investors, and setting up Invest Sri Lanka to attract investors.

The current zones managed under the BOI have been transferred to a new organisation, with options for establishing industrial zones in collaboration with the private sector. This aims to resolve land issues and improve facilities for investors. The new institution is focused purely on trade agreements and economic integration with global supply chains.

A Productivity Commission, modelled after Australia’s, is proposed to enhance market efficiency and prevent anti-competitive practices. Lastly, a type of Government think tank is proposed to provide research services and analytics on trade and investment.

The bill also appears to compile six ideas into one comprehensive piece of legislation. Incorporating debt-to-GDP ratio targets, export-to-GDP ratio targets, and gross financing needs expectations seems to be another objective, as outlined in the preamble.

Risk of political interference

On the flip side, the appointment of members for the Economic Commission and other institutions falls directly under the president’s purview. In instances where the president is also the minister of finance, significant economic powers are concentrated in the hands of a single individual. Given that the majority of members can be appointed by the president, there is a significant risk of political interference in the business and investment climate.

We can set up numerous institutions, but real reform and transformation occur not when the bill is passed but rather when capable individuals drive real change. If we have flawed provisions for the appointment of members to the Economic Commission and other institutions, allowing for political interference, we risk creating another ineffective BOI.

Ideally, appointments should be nominated or approved by the Constitutional Council (CC). Additionally, representation from professional bodies such as the Institute of Chartered Accountants of Sri Lanka (CA Sri Lanka) could ensure adherence to ethical standards.

Steps in the right direction

The new bill proposes six key institutions:

Economic Commission (EC)

Invest Sri Lanka (Invest SL)

Zones Sri Lanka (Zones SL)

National Productivity Commission (NPC)

Office for International Trade (OIT)

Sri Lanka Institute of Economics and International Trade (SIEIT)

The idea of establishing a separate entity to manage investment zones is a step in the right direction. A 2018 study by the Harvard Center for International Development revealed that 95% of BOI investment zones were occupied and investors had identified land availability as a constraint.

Rather than having the BOI run industrial zones, there are many private sector players who can provide better services to investors. Zones SL should collaborate with the private sector to open new zones, providing infrastructure as landlords rather than managing the zones themselves.

The Productivity Commission is another positive policy step, provided it is implemented correctly. Its role should be to ensure a data-driven approach to productivity in each sector, promote competition, and encourage international competitiveness.

The commission should work with industry experts, as productivity expertise varies by sector. Australia’s experience with its Productivity Commission demonstrates the importance of maintaining focus on competition and avoiding mission drift, as seen with the Consumer Affairs Authority, which has deviated from its original purpose.

The OIT aims to address the lack of capacity in trade negotiations. The bill’s overall concept targets structural issues that hinder exports and Foreign Direct Investments (FDIs). However, it does not guarantee the intentions of politicians or ensure that everything will improve after the passage of the bill. The appointment process and selection of competent individuals for committees are crucial.

Implementation challenges

The key challenge for Sri Lanka will be execution. A large government with poor capacity is likely to result in political appointees populating these commissions, given the current appointment structure and salary scales. There is little incentive for qualified individuals to join at the current salaries offered.

Moreover, the Government lacks the capacity to offer higher salaries, and doing so for one segment could lead to demands for salary increases across the board or protests during a politically sensitive period. Phased reforms to reduce the State’s workforce are necessary to improve State capacity and manage these institutions effectively.

When the BOI was established, it was intended to be a one-stop shop for investors. However, it has become another bureaucratic hurdle. We risk repeating this mistake with all six proposed institutions if the wrong individuals are appointed. Conceptually, the policy is in the right direction, but its success depends on the implementation and the people driving it.

Nearing debt negotiation deal amid economic uncertainty

By Dhananath Fernando

Originally appeared on the Morning

Sri Lanka is hopeful that we can reach a debt negotiation before the first half of the year. Many are focused on the potential for reductions in principal and interest rates or extensions of debt maturities.

According to a recent update from the Ministry of Finance, we are yet to finalise a settlement with our bondholders, although we are close to an agreement. The Internal Rate of Return (IRR) for the Sri Lankan Government’s proposal is about 9.7%, while the bondholders’ proposal is 11.51%. The total cash outflow according to the bondholder proposal for 2024-2028 is approximately $ 16.6 billion, compared to $ 14.7 billion for the Government’s proposal. Ideally, we should reach a settlement close to the Government’s proposal if all goes well.

Both the initial and revised proposals indicate that bondholders are reluctant to reduce the interest accrued during the suspension of debt repayments. In both proposals, there have been no haircuts on $ 1,678 million of accumulated interest. Only a 4% interest rate has been proposed for 2024-2028.

Bondholders have suggested a 28% reduction on existing bonds, reducing the total bond value from $ 12,550 million to $ 9,036 million. Both parties appreciate the depth of the haircut, particularly with respect to economic growth. These adjustments depend heavily on adhering to the International Monetary Fund’s (IMF) baseline projections. If we fail to achieve the necessary growth rates, we will receive a deeper concession, and vice versa.

Achieving the best debt restructuring plan for Sri Lanka is crucial and our future hinges on economic growth. The debt level must be compared with the size and growth of the economy because only growth can ensure our ability to repay our debt. Our debt sustainability can only be secured through high growth rates, not solely through the debt relief offered by bondholders.

Economic and governance reforms are essential for growth. Notably, bondholders have proposed an innovative idea called Governance-Linked Bonds (GLB), where Sri Lanka would receive an additional benefit of 50 basis points on two selected bonds, each worth $ 800 million, if we implement two key governance reforms – one qualitative and one quantitative. The quantitative target is to reach a 14% tax-to-GDP ratio in 2026 and 14.1% in 2027.

A list of qualitative targets primarily focuses on publishing procurement contracts and tax exemptions, both of which are included in the IMF Staff-Level Agreement. However, the governance linked bonds, according to the proposal, would only apply to two bonds maturing in 2034 and 2035, each worth about $ 800 million.

While GLBs are an excellent idea, it is questionable whether the incentive is sufficient to encourage a strong governance programme. The savings from a 50 basis point cut in interest for $ 1,600 million would be about $ 80 million. Given that our accumulated interest is also about $ 1,600 million, there is a risk that governments could easily deviate.

Nevertheless, GLBs would send a strong signal to the market that the Sri Lankan administration is committed to governance reforms, which would enhance confidence in Sri Lanka.

Sri Lanka’s real challenge is avoiding a second debt restructuring. We can only achieve this by taking necessary steps and reforms to grow the economy, not solely relying on debt restructuring agreements.

Even if we secure a 30% haircut, our debt-to-GDP ratio in 2032 would still be approximately 95%. Over 50% of countries that have undergone a first debt restructuring have experienced a second. In Sri Lanka’s case, a second debt restructuring would be extremely painful for the population.

Moreover, our interest rates must remain high to meet the Government’s debt servicing requirements, attracting more funds. However, high interest rates discourage investment as people prefer to deposit their money in banks, leading to a low investment environment that could slow down growth. This slowdown would bring us back to the challenge of managing debt sustainability. This vicious cycle must be avoided.

Growth can only be achieved through improved productivity in a competitive environment, which arises when people are incentivised to perform. When the State dominates business and we try to manage everything independently, people do not become competitive.

Ultimately, growth is the only viable solution. Sadly, it is the only solution. Growth occurs when markets function effectively.

Beyond profit margins and scandals

By Dhananath Fernando

Originally appeared on the Morning

Blaming imports and importers has long been ingrained in Sri Lankan culture, often seen as a root cause of the country’s economic issues. This perspective not only overlooks the fact that many importers are also exporters, but also fails to recognise that imports and exports are fundamentally interconnected components of the global trade system.

Despite this, it is crucial to acknowledge that not all imports are conducted ethically or transparently. Recent scandals, such as the sugar scam, misinvoicing, bribery, and procedural irregularities at Customs, highlight the darker aspects of importation. However, casting imports in a universally negative light and fostering resentment based on ideological reasons could prove to be more harmful than beneficial.

Recent investigative reports have revealed staggering profits made by importers on essential commodities like green gram, B-onions, and potatoes. Some profit margins have been reported as high as 280% when comparing the Cost, Insurance, and Freight (CIF) value to the market prices of these goods.

Before rushing to judgement on these profit margins, it is essential to delve deeper into the circumstances surrounding these imports. For example, the importation of green gram has been severely restricted since the onset of the Covid-19 pandemic, requiring special approval from the Ministry of Agriculture. As a result, the quantity of green gram imported in 2023 has been minimal.

Thus, comparing the CIF value at the port to market prices can be misleading, as it does not accurately reflect the profits made by importers. This situation raises questions about the high market prices for green gram, pointing to inefficiencies in local production rather than exorbitant profits by importers.

The scenario with undu, a staple food item, is similar. With a Rs. 300 import tariff, the market price for 1 kg of undu ranges between Rs. 1,500-1,700. This high cost is partly because importers cannot bring in undu without approval from the Ministry of Agriculture, despite the imposition of tariffs.

Allowing imports could potentially reduce the price of undu to around Rs. 700 per kg, even after tariffs. The restriction on undu imports exacerbates price inflation, making it unaffordable for many, particularly those in estate regions and the northeast, leading to food insecurity among vulnerable populations.

During the recent economic crisis and the consequent shortage of foreign exchange, many imports were facilitated through informal payment channels and ‘open papers’ in undiyal markets. This practice, aimed at evading high tariffs and taxes through under-invoicing, underscores the complexity of Sri Lanka’s tariff structure and the urgent need for its simplification.

The report by the Ways and Means Committee suggests that focusing solely on the cost of goods at the port does not provide a complete picture of the import value, especially considering the prevalence of informal payments. This approach to calculating profits, based solely on declared document values, overlooks additional costs borne by importers, thus distorting the perception of their profit margins.

Moreover, the perishability of essential food items, along with the significant costs associated with storage, wastage, and the impact of rising fuel and electricity prices, further complicates the economic landscape. These factors, combined with high inflation rates, have significantly influenced the cost structure of both the wholesale and retail markets, affecting pricing and profit margins.

The impact of export controls on certain commodities, such as B-onions by India, has also played a role in inflating global prices, illustrating the complex interplay of international trade policies and local market dynamics.

This situation underscores the phenomenon of unintended consequences in economic policy, where well-intentioned policies can lead to outcomes that are diametrically opposed to their original goals. Sri Lanka’s intricate tariff structure and monetary instability have inadvertently encouraged informal payment methods on one hand and escalated costs on the other, placing the poorest members of society in an increasingly precarious position.

While it is undeniable that practices like misinvoicing represent clear violations of the law and must be addressed through appropriate legal channels, attributing the entirety of Sri Lanka’s economic challenges to importers overlooks the broader systemic issues at play. Simplifying the tariff structure, as this column has long advocated, could lead to increased Government revenue and minimise systemic leakages, offering a more sustainable solution to the economic challenges faced by importers and consumers alike.

In conclusion, while illicit practices within the import sector must be rigorously tackled, the solution to Sri Lanka’s economic dilemmas lies not in vilifying importers but in addressing the complex policy and structural issues that underpin the nation’s trade dynamics. A comprehensive approach, focusing on policy reform, tariff simplification, and enhancing local production efficiencies, is essential for creating a more stable and equitable economic environment.

Unveiling the true culprit behind economic woes

By Dhananath Fernando

Originally appeared on the Morning

Sri Lankans have a very negative view of imports, which are often portrayed on TV as the problem behind the economic crisis. Not only politicians, but also those who have opinions on our economy subscribe to the idea that imports are the problem.

Our politicians’ favourite pastime is to blame imports and impose various tariffs or ban imports. Banning imports also makes for a very pro-Sri Lankan image, because a common excuse provided is that high imports are damaging to local industries. Accordingly, the banning of imports has been portrayed as a measure to help develop local industries.

A favourite area when it comes to cutting down imports is food imports. Often, media headlines and politicians comment aggressively, even quoting figures on the value of food imported. The middle class, upper middle class, and wealthiest of society often make the argument of needing to save valuable foreign exchange by cutting down food imports.

However, when we consider the data, it indicates the exact opposite. The middle class, upper middle class, and the wealthiest are the ones who consume the most amount of imports in the form of fuel, mainly through personal vehicles and as energy. About 27% of our imports in January was fuel. Fuel is the largest component of our import basket as a single commodity.

What we have imported as food is less than 11% of our total imports. Non-food consumer goods are just 8% of our total imports. Most pharmaceutical products and medicines for patients fall under the non-food consumer goods category, which are primarily consumed by the most vulnerable people in society.

Imported food items are also consumed by the most vulnerable sections of society. Food items such as canned fish, maize, green gram, lentils, black gram, sprats, b-onions, potatoes, and wheat flour are critical food items for the poorest of the poor.

Firstly, these can be stored without a refrigerator, which saves their energy cost. Secondly, they are easily available and affordable compared to many other items of food they consume. Therefore, the request of politicians and academics to cut back on these food items, which comprise less than 11% of our total imports, is nearly impossible to fulfil, and reducing these imports further is tantamount to asking the poor to live in hunger and their children to suffer from malnutrition.

Thirty-seven percent of our import basket comprises intermediate goods, besides food. These are goods required for exports and to produce many things without interrupting the supply chain. For instance while our main export is apparels, our main import is also apparels. Therefore, asking to reduce apparel sector imports amounts to reducing our valuable exports.

In reality, while there persists a belief that imports have to be reduced, it is not the solution it is touted to be. If we have to cut down on food imports, it will lead to increased malnutrition, hunger levels, or food costs for Sri Lankans.

Ways of reducing imports

If we want to bring down our imports, cutting down on fuel is one way to consider. A World Bank study revealed that 70% of the fuel is consumed by the wealthiest 30% of society. Therefore, it only makes sense to maintain fuel prices at market price.

As indicated in the graphs, there is a correlation between high fuel prices and fuel imports. Our fuel imports have decreased when prices are high as people use it sparingly. Compared to January 2023, our fuel imports had declined by about $ 100 million per month by January this year. With the expansion of the economy, this number is expected to slowly grow. Prices can bring imports down without import bans or tariffs.

Another way to reduce fuel imports is by improving public transport. Most of our fuel is wasted in traffic jams as a result of our poor public transportation infrastructure. If we invest in public transport, not only will it reduce fuel imports, but it will also uplift many Sri Lankans and provide significant relief in terms of their purchasing power. Many middle class Sri Lankans pay a 200% tariff to buy a second-hand vehicle at an interest rate of above 12% because they have no other choice but to commute.

Saving foreign exchange

Sri Lanka has been offered many grants, including for the Light Rail Transit (LRT) project, which we turned down on numerous occasions, leading to geopolitical tensions. When people spend less money on commuting and waste less time in traffic congestion, it will not only improve productivity but also their purchasing power, creating many jobs and generating income.

It is an inalienable truth that we need more food imports with different varieties of protein sources for the benefit of the impoverished. Foreign exchange has to be earned through exports, tourism, and remittances.

Saving foreign exchange is a function of the monetary policy or the supply of the Sri Lankan Rupee to the financial system rather than a function of imports and exports. When the rupee becomes expensive, the US Dollar demand decreases automatically because people buy the latter using rupees that they could have used in an alternative manner.

Asking the public to cut down on food imports, which are mainly consumed by the poor, at the expense of allowing the use of more fuel-driven vehicles cannot be justified and borders on cruelty.

Steering clear of divisive politics and economic populism

By Dhananath Fernando

Originally appeared on the Morning

I was recently invited to moderate a session by the European Chamber of Commerce of Sri Lanka (ECCSL) on diversity, equity, and inclusion. Foreign Minister Ali Sabry was one of the Chief Guests and he shared two things we should not do, based on his experience over the past few years in managing a few key portfolios as the Minister of Justice, Finance, and Foreign Affairs.

The event focused on unleashing the power of diversity, equity, and inclusion for businesses in Sri Lanka. Keeping aside the political colours, Sabry’s message on the things Sri Lankans should not do is very apt given the current status of our affairs. These two exhortations were to never play divisive politics and never play with populist economic policies.

The final victim of divisive politics has been none other than our economy and our people. If Sri Lanka is serious about economic development, having a diverse culture is important, as highlighted by Prof. Ricardo Hausmann in his Harvard Growth Diagnostic study on Sri Lanka in 2016-2017. The economic theory behind it is that a diverse culture is capable of creating more combinations of ideas which translate to products, services, and exports.

He provided the example of Silicon Valley – most tech entrepreneurs in Silicon Valley are immigrants to the US, which is one reason a high degree of innovation takes place there. Unfortunately, in Sri Lanka, our politics is used to dilute this strength, which has led to where we are today. At one point, ethnic tensions led to mass migration and we are very slow to include all our ethnicities and religions in our culture.

The divisive politics is now at a level that goes beyond ethnicities. It is now ranged against certain countries, trade agreements, and imports from certain countries. Some good examples are the Suwa Seriya ambulance service and the trade agreement between India and Sri Lanka.

We almost rejected Suwa Seriya on the grounds that it was an Indian invasion and that Indian Intelligence services wanted to collect intelligence data through the ambulance service. This is a service primarily impacting the poorest of the poor and has now been recognised as one of the fastest services in the region by the World Bank.

Divisive politics is now beyond ethnicities and religions. We created the same tensions with trade agreements and claimed that the Free Trade Agreement (FTA) with Singapore would result in foreigners taking over our jobs. Instead, most Sri Lankans left the country for jobs overseas due to the economic crisis and we now beg people to visit us.

We also created similar tensions over the India-Sri Lanka Free Trade Agreement by claiming that the agreement would cause more imports to flow into Sri Lanka, worsening our trade balance. The data shows the exact opposite taking place.

We have a trade surplus with India under the FTA and our trade deficit with India comes from outside the FTA. However, comparing trade balances between countries is completely misleading, since what we need to keep in mind is the budget deficit rather than the trade deficit, because the budget deficit arising from Central Bank lending is what leads to a trade deficit.

At one point, by playing divisive politics, we wanted to boycott our Islamic community. We also wanted to boycott Indian products and chase away Chinese and Japanese investments. To make diversity a strength, we need to look beyond borders and capitalise on the strengths of all communities and all countries.

Minister Sabry’s second directive was to never play with populist economic policies. However, we repeatedly witness political parties engaging in populist politics. We are building resistance against the International Monetary Fund (IMF) programme without any alternative suggestions. Without the IMF programme, even 0.1% of debt relief is not possible. Many funds by many international partners like the Asian Development Bank (ADB), World Bank, and bilateral creditor will evaporate in seconds.

On the other hand, growth reforms are almost non-existent. Not a single State-Owned Enterprise (SOE) reform has been implemented yet and the SOE Bill has been shelved. On the growth front, a complicated tariff structure remains. The establishment of the Central Bank’s independence was the main reform we have undertaken and we can see the results. It is a pity that the Central Bank completely ignored the optics and raised its staff salaries, even at the risk of some policymakers requesting the reversal of the hard-earned reform of the bank’s independence.

While Minister Sabry has correctly understood what exactly should not be done, unfortunately, our politics remains divisive at a new level and populist economic policies have taken a new turn. We still have a long way to go.

The other side of parate execution suspension

By Dhananath Fernando

Originally appeared on the Morning

In India, there was a particular type of cobra that was causing havoc due to snake bites. People were protesting and social pressure was building. The then British Government had a brilliant idea to counter cobra bite-related deaths and bring down the reptiles’ population – it announced an incentive scheme for every dead cobra.

In essence, people in India were encouraged to kill cobras and hand over the animal’s dead body to established Government offices in India and collect cash in return. In the first few weeks, things worked out very well, but later the Government realised that the number of cobras being handed over was increasing exponentially.

Upon investigation, the Government realised that Indians had become somewhat entrepreneurial. They had started cobra breeding houses at homes and killing cobras as a means of revenue generation for the family. At one point, the Government withdrew the cash incentive system given the misuse of the entire scheme.

Since there was no incentive for people to maintain cobra breeding houses, they released the reptiles into the jungle. The cobra population then multiplied several fold more than what it was initially as a result of the same policy being implemented to reduce the cobra population. This is called the Cobra Effect.

The Government decision to suspend parate execution as a relief for Micro, Small, and Medium-sized Enterprises (MSMEs) is no different. It is true that MSMEs are going through a difficult time as a result of higher inflation, high interest rates, and economic contraction. It is necessary to protect the MSMEs as they comprise about 99% of business establishments and about 75% of employment in Sri Lanka.

However, whether the suspension of parate is really for MSMEs is a question; 557 parate executions have been undertaken as of November 2023. The total value of the parate executions was just Rs. 38 billion, which stands at just 0.4% of total loans and a mere 2.7% of total impaired loans. From the numbers, it is clear that most MSMEs have not been impacted by parate executions.

Effect on MSMEs

Parate is an execution power on the part of banks under the Recovery of Loans by Banks (Special Provisions) Act, No.4 of 1990, where lending banks can recover non-repaid debt by borrowers by selling assets without going through the judicial processes. In 1961, this power was only granted to People’s Bank and the Bank of Ceylon, and in 1985, the power was extended to regional rural development banks as well.

If MSMEs are not affected, what could be expected to happen when parate executions are suspended until December by the Government? This is likely to backfire on MSMEs given the nature of the banking industry, akin to the Cobra Effect.

Banks lend depositors money. Parate was a safeguard for depositors’ money in case someone was not repaying loans they had taken, giving banks a final resort to recover that money so they could honour the depositors.

Now with parate suspension, banks have a higher risk of not being able to recover the money from the loans extended, so they have to charge a higher risk premium when borrowing for anybody, including MSMEs. Therefore, if MSMEs want to borrow money now, they have to pay higher interest rates, which means further contraction of the economy at a time when it needs to grow.

Triple whammy

On the flip side, this will encourage borrowers to default as they now know the banks cannot execute parate even if they were to willfully default. Additionally, borrowers who are honouring their loan repayments with the greatest difficulty during this economic crisis will be discouraged, because their hard work in honouring the dues will not be rewarded. This does not mean that even the Rs. 38 billion through parate execution has to be understated, but it has to be addressed separately without changing a law which affects the entire banking sector.

The Government declared a Rs. 450 billion bank recapitalisation in Budget 2024 given the instability of the banking sector as losses and loans of State-Owned Enterprises (SOEs) have to be absorbed. On the other hand, licensed commercial banks including State banks are being exposed to sovereign debt restructuring, which is at its final stage. Accordingly, this is detrimental to the stability of the banking sector.

On the depositors’ end, they may be reluctant to deposit money as their risk is now higher on recovery.

Parate execution generally takes place at the last stage of recovery and must go through a court process. Suspension of parate without even consulting banks may provide wrong signals for the ongoing International Monetary Fund (IMF) review, since the IMF initially advised to conduct an assessment on the stability of the banks, although the context has now changed after a few months.

The Non-Performing Loan (NPL) ratios of banks are also on the rise, so banks basically face a triple whammy with this parate suspension – having to charge risk premiums, high NPL, exposure to sovereign default, and now difficulties in recovering money and incentives for not servicing existing loans.

However, the need to protect MSMEs is paramount, which requires a separate sequence of actions. Setting up a bank specifically to absorb bad loans, setting up bankruptcy laws, or moratoria on some of the bad loans under parate executions are options. Changing the entire parate system will indeed bring consequences similar to the Cobra Effect in India.

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)

Why are we poor?

By Ravi Ratnasabapathy

Originally appeared on the Daily FT

Economists tell us that Sri Lanka’s economy has stabilised but what does this mean if so many are struggling?

To economists stability means that the imbalances in the economy have been resolved. The symptoms of the imbalances appear as rising prices, shortages of foreign exchange and goods. These have indeed disappeared but what does it mean to ordinary people? It only means that the rate at which people were being impoverished has slowed. We were crashing down the mountainside but the fall has been broken, if only temporarily. This is no mean achievement but obviously people expect much better.

People enjoyed a particular standard of living in 2020 but three short years later find themselves pauperised and cannot fathom why. What caused this steep decline in living standards? Corruption, poor governance and weak public finances are blamed but these were prevalent for decades. Why did the effects of these pass unnoticed for so long and how did they suddenly manifest?

The fact is that while these are connected to the problem they are not the immediate causes. To understand the causes of poverty today we must understand what changed between 2020 and 2023.

Two distinct causes of poverty today

There are two distinct causes but for the sake of clarity they must be dealt with separately.

Between December 2019 and August 20221 the Central Bank printed huge volumes of money – net Central Bank credit to Government grew 10-fold; from 363 billion to 3,162 billion. The end result of the increase in the supply of money is the fall in its value. This is reflected in rising prices and depreciation of the rupee in the foreign exchange market.

The Government at the time tried to mask the symptoms of the problem by imposing price controls; the exchange rate for the rupee was fixed at Rs. 200 along with the prices of many other goods. The result was scarcities – of foreign exchange and of goods which were visible in the long queues and in power cuts. As the printing continued, the Government imposed ever tighter import and price controls until eventually economic activity ground to a near halt. People were either standing in queues or sitting in the dark. Work in factories and offices stopped because of the unavailability of materials, the inability to transport staff or products and the lack of power.

To resolve this problem the only option was to allow interest rates to rise to slow the credit growth that was fuelling excess demand. A partial devaluation was initially attempted without a significant rate increase but this failed and forex shortages persisted. The corner was turned only when rates were hiked significantly and a peg re-established at 360.

As the rupee fell all prices rose. Price controls had to be removed, most importantly on energy – fuel, electricity and cooking gas to reflect the diminished value of the currency. This explains the sudden increase in prices of both goods and services.

Unfortunately while prices rose people’s incomes and savings did not. People’s living standards are measured not by their income but by what that income can procure. When the value of money falls living standards fall.

Effects of currency debasement are permanent

How is this to be reversed? The tragedy is that the effects of currency debasement are permanent. Complete reversal requires that stock money to shrink back to the level it was in 2019 – this would lead to a massive increase in interest rates; much higher than present. The consequences of this would be widespread business collapse and an economic contraction that would impose even more suffering.

What should be done? The debasement of the currency can only happen through the Central Bank. It must be prevented by rules from ever doing so again.

People mistakenly think that the Central Bank should try to keep interest rates low but the only way in which this can be done is (a) if the Government reduces its volume of borrowing, the sheer size of which puts significant upward pressure on rates or (b) if the Central Bank keeps increasing the supply money (money printing) which lowers rates. It is difficult to reduce Government spending in the short term, therefore the borrowing will have to continue. This means the only avenue to lower interest rates is money printing which ultimately impoverishes all.

The Central Bank should not engage in activist monetary policy to stimulate the economy. It must not finance the Government’s budget deficit and in its role as provider of liquidity to the banking sector it must not become a banking intermediary. Liquidity to the interbank market needs to be purely temporary, based on market rates with an added premium to prevent moral hazard. Central Bank intermediation is in some way a substitute for interbank markets and therefore the relative level of costs between the two is crucial.

If the value of the rupee holds it will allow people to try and restore what has been lost. People need to start all over again and through their own efforts try to rebuild their lives.

Second reason for increase in poverty – increase in taxes

The second reason for the increase in poverty is the increase in taxes. People who have already suffered terribly because of currency debasement now face another blow when the Government appropriates even more of their income and raises the prices of goods through sales based taxes. The Government is fixing the problems in its own finances but doing so by passing the buck on to the people.

In the short-term some increases in taxes were unavoidable because of the rigidity in Government spending – the bulk of which is salaries, pensions and interest. These must be reduced but this takes time. However there is no excuse for making no attempt to cut costs. For example, the high prices of electricity and fuel include the extra costs caused by corruption in fuel purchases, inflated power purchase costs, excess payroll and inefficiency.

Corruption and waste become relevant to the problem of impoverishment when their costs are transferred to citizens through increased taxes, higher prices and poorer quality of services provided by the Government. The use of debt and more moderate levels of money printing allowed the Government to conceal the real burden of its spending from people for decades.

The public blames the general increases in prices that result from money printing on “profiteering” by traders. Increases in debt have no immediate impact, it is only when it has to be repaid are the consequences felt at which point the lenders are blamed.

Citizens who voted repeatedly for corrupt populists have awoken from slumber as the costs of past profligacy have finally become apparent.

Ability of the Government to disguise the real burden of its activities

Because of the ability of the Government to disguise the real burden of its activities, in the context of corruption citizens need to have a singular focus on all economic activities of the Government. It is Government spending rather than taxation that ultimately determines the total burden of Government activity on the private sector. The critical question citizens must ask is how far does Government activity and spending actually improve the lives of citizens?

The IMF program is trying to reduce the Government’s deficit and debt – but the approach they have taken is to simply increase taxes rather than doing so concurrently with cutting expenditure. There seems to be unquestioned acceptance of the level of public spending, regardless of its quality or nature.

Tax morale – citizens’ willingness to pay taxes – depends on the trust they have in the Government and the quality of services they receive. In the modern world a state must earn the right to collect tax. To do so it must treat its citizens fairly. It must be responsive and seen to be addressing needs and improving services. The lack of this was evident in the protests of 2022.

The Sri Lankan State fails in the provision of the most fundamental of public goods – those that cannot be provided by private markets: the rule of law and a functioning system of justice. While some useful services are provided in health and education, quality is poor. The spending on private tuition, private schools and private healthcare is a testament to this. Corruption is rampant. For example, COPE reports show the State Pharmaceuticals Corporation has repeatedly procured substandard drugs2, dud software3 and failed to follow strictures imposed by COPE4.

Promises of jobs are a vote-winner. Elections have been won, jobs have been created but only now have the public been presented with the bill. A large proportion of taxes are in effect sustaining the patronage system that enables the election of corrupt politicians.

Voters must realise that there are no easy or painless solutions. After a crisis such as this, countries may experience ‘a lost decade’ before output reaches its pre-crisis level. Populists who promise quick solutions without proper diagnosis or are unable to locate the sources of the problem could easily tip the country back into crisis

Identify the villains in this tragedy

People need to identify clearly the villains in this tragedy; the Central Bank and mis-spending by the Government. Public outrage is justified but unless the sources of the problem; the Central Bank and Government spending are correctly identified, they may well be duped again.

That the rate of impoverishment has slowed will not satisfy the public but do they realise the fragility of this meagre achievement? Politicians are eager to promise quick and painless solutions. The electorate can expect to be subjected to “death by slogan” over the election cycle. A fairer society. End corruption. A brighter future.

Desperate people may clutch at any alternative assuming that things cannot get any worse but they are gravely mistaken. Politicians who do not grasp the problem may trigger another spiral. Criticism of the current approach is needed but people should look for politicians who offer realistic alternatives. How should voters evaluate alternatives?

To avoid another crisis it is vital to maintain monetary stability and fiscal prudence. Serious politicians must commit to both. Ambitious manifestos must be seen to translate into pragmatic programs within the fiscal constraint. The British tradition of access talks: pre-election talks between opposition politicians and civil servants helps prepare the opposition for Government. They need to decide on policy priorities and the mechanics of delivery. Those who have done their homework will demonstrate familiarity with the public finances5.

Some talk of billions in stolen assets and imply that all it takes is to recover this and all will be well. Have they examined the complexity of the legal proceedings in the recovery of stolen assets? The international record of successful of stolen asset recovery is poor. The Stolen Asset Recovery (StAR) Initiative – a partnership between the World Bank and the United Nations Office on Drugs and Crime (UNODC) has over 15 years recovered a total of around $ 1.9 billion6. The most successful has been the Philippines which recovered more than $ 1 billion over 21 years. This is a tidy sum but do those who tout this as a solution understand the gargantuan size of the Government expenditure?

Public salaries and wages cost Rs. 956.2 billion in 20227. For year of 365 days that works out to Rs. 2.62 billion per day. Subsidies cost another 1,020 billion or Rs. 2.23 billion per day. Including interest total recurrent expenditure runs at Rs. 9.64 billion a day.

The sum total recovered under the StAR over 15 years would only cover the public sector salaries for a little over seven months; total recurrent expenditure for only two. In any case can a realistic budget be built on such an uncertain stream of revenues? Can the rich pay for this all? How many billionaires and millionaires does the Government need to find to sustain spending at a rate of Rs. 9.6 billion per day?

Government spending

Government spending can create the opportunities for corruption; affecting not just the level of public expenditure, but also its composition, favouring projects that allow the collection bribes.

If the misspending in the public sector were reduced greatly then the tax burden could be reduced. Salaries and pensions for the 1.5 million employees of public sector and the 672,0008 pensioners made up 36% of recurrent spending in 2022 (interest took up 44%). This is an ongoing expense that needs to be paid. Are the citizens receiving valuable public services in return?

In 2016 there were 230,525 teachers and around 62,000 in the health service. The problem is with the million others in employment. The number in public employment stood at 812,472 in 19949 but is now estimated at 1.5 m10. Was there a proportionate increase in the quality of services that people received?

Voters must realise that there are no easy or painless solutions. After a crisis such as this, countries may experience ‘a lost decade’ before output reaches its pre-crisis level. Populists who promise quick solutions without proper diagnosis or are unable to locate the sources of the problem could easily tip the country back into crisis.

Footnotes:

1 Sri Lanka: Macroeconomic Developments in Charts, First Quarter 2023, p34 https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/statistics/mecpac/Chart_Pack_Q1_2023_e1.pdf

2 See reports: https://www.advocata.org/commentary-archives/2019/11/5/coping-with-latest-cope-report; https://www.dailymirror.lk/breaking-news/Fraud-corruption-rampant-at-SPC-GMOF/108-276243;

3 https://readme.lk/spc-has-paid-lkr-644-million-for-software-that-doesnt-work/

4 https://www.news.lk/news/political-current-affairs/item/26077-govt-agencies-failure-to-act-on-cope-recommendations

5 The Institute for Government, a think tank offers a useful guide: https://www.instituteforgovernment.org.uk/sites/default/files/2024-01/preparing-for-government.pdf

6 https://star.worldbank.org/blog/fifteen-years-star

7 Ministry of Finance Annual Report 2022, p109, https://www.treasury.gov.lk/api/file/39a16e61-7659-476b-8f18-d969c7a69733

8 https://www.parliament.lk/uploads/documents/paperspresented/1662013778004147.pdf

9 “Census Of The Public And Semi-Government Sector Employment 1994”. 1994. Statistics.Gov.Lk. http://www.

statistics.gov.lk/PublicEmployment/StaticalInformation/census_reports/CensusOfPublicAndSemiGovernmentSectorEmployment-1994FinalReport.

10 https://economynext.com/crisis-hit-sri-lanka-finally-starts-to-deal-with-bloated-public-sector-96277/

(The views expressed in this article are those of the writer and do not reflect the views of organisations he is affiliated to.)

High tariffs on basic food items: A blow to the struggling masses

By Dhananath Fernando

Originally appeared on the Morning

Last week it was reported that the Government has again imposed high tariffs (Special Commodity Levy) on some food items such as cowpea, finger millet, undu, maize, and a few others. At a time when seven million people are below the poverty line, tariffs on food items are a crime. Imposing tariffs on such food items is not done just to increase Government revenue.

The tariff on undu has increased to Rs. 300 from Rs. 200 per kg. For finger millet and other items, it has increased from Rs. 70 to Rs. 300. How much can a Government earn from a population of 22 million by imposing a Rs. 300 tariff on finger millet and cowpea?

According to the Ministry of Agriculture, the per annum demand for cowpea in Sri Lanka is 15,000 MT, while the demand for finger millet stands at 10,000 MT. Even if we import the entire demand for finger millet and cowpea, the amount the Government can earn as tariff is about Rs. 7.5 billion for the entire year.

This is a negligible amount compared to our expenditure. The expenditure for the President is about Rs. 5.8 billion as per the Budget estimate for 2024. It is clear that the increase of the Special Commodity Levy (SCL) for food items will have an impact beyond taxes, because at this tariff rate no one will import finger millet or cowpea.

However, it means that the consumer will lose the opportunity to purchase cowpea, undu, and finger millet for Rs. 300 less than what is available in the market. How can we justify people paying an additional Rs. 300 when seven million people – one-third of our country – live in poverty?

This general justification is that this tariff is imposed to protect local manufacturing of finger millet, cowpea, and maize. Even if this is true, what is the justification in terms of consumers when they no longer have access to affordable food items?

Given existing lifestyle changes, products such as undu, cowpea, and finger millet are mainly consumed not by the wealthiest section of the society but the poorest. Diabetes patients, pregnant mothers, estate workers, people in the north and east are the primary consumers of these food items.

It doesn’t stop there. High prices on maize will impact the entire food supply chain as maize is one of the main expenditures of the poultry industry. About 40% of the cost of poultry is on food, primarily driven by maize. This indicates that the cost of main protein sources such as chicken and eggs will increase.

The cost of chicken and eggs in turn impacts the costs of the bakery industry and all food items at restaurants and eateries.

Accordingly, the net impact on the entire food supply chain due to this ad hoc Special Commodity Levy is much greater than what we see at the surface level. Although it is not ideal, if the Government really wishes to protect finger millet, cowpea, and maize farmers, it can give a direct subsidy of Rs. 7.5 billion, based on the productivity and efficiency of farms.

This would mean that at least those who push for better cultivation methods receive an incentive to ensure a better harvest, rather than asking consumers to shoulder a flat price hike for all food items at a time when they are struggling to put three meals on the table per day. People are facing excessive burdens due to inflation and the high tax rate in order to pay for the mistakes of our policymakers.

The second argument against the high SCL on imported food items concerns saving foreign exchange. Firstly, we cannot save foreign exchange through higher tariffs because the demand for imports is determined by the money supply within the economy. People buy forex to import by spending the rupees they earn. When they buy forex in rupees, they have to reduce their consumption by some other means.

If we can save forex simply through higher tariffs and import controls, we have to question how we ran out of forex when import controls, in place since Covid, existed until very recently.

We even controlled some of our pharmaceutical imports but we were still unable to save forex. Foreign exchange cannot be saved by import controls or high tariffs.

Secondly, 40% of our imports is fuel. If we really want to cut down on our imports, we must reduce fuel imports, which this column has recommended multiple times, suggesting a market system for public transport. By imposing a Special Commodity Levy on food, we are simply asking the poorest of the poor to face starvation while providing the opportunity for rent-seeking behaviour of a few crony elites.

Whether in socialism or in capitalism or with the argument of saving foreign exchange, how can we justify a Special Commodity Levy of Rs. 300 on basic food items when one out of every three fellow Sri Lankans are forced to skip a meal due to poverty?

Prioritising SOE bill over OSA: A shift in economic direction

By Dhananath Fernando

Originally appeared on the Morning

While the Government has prioritised the Online Safety Act (OSA), which is extremely negative for our economy, there are other bills in the line-up which are expected to get through. One such bill is on the State-Owned Enterprise (SOE) holding company.

The SOE Restructuring Unit (SOERU) has outlined the principles of SOE reforms, which are in the right direction, but the Government’s prioritisation of bringing the OSA is definitely in the wrong direction.

Key principles

While the bill on the SOE holding company is yet to be released, the SOERU has outlined nine key principles on which they expect to base the SOE reforms. In the first principle it admits the Government has no role in commercial activities except for three instances.

(1) If there is a concern on national security, the Government can engage in business.

(2) If there will be no private participation in certain industries given the size of our market, the Government can engage in business. For instance, if we open the rural bus routes for the private sector, there may be a possibility that, given the nature of the low population density, no private bus operator will be interested in entering the market. While it can be to an extent addressed through allowing to charge a higher price and the Government providing a direct cash subsidy to the citizens in the rural area, there can be practical challenges. In that case the SOERU principals have left the space for the Government to enter business.

(3) If the service from the Government is essential in nature but if the regulatory mechanisms are weak for competition, where there is opportunity for market exploitation by the private sector, the Government can be in the business.

While the three areas are logically right, we have to wait for the final bill to see how exactly this has been worded. The danger is that governments are so powerful that even in the above three areas, it can leave a lot of room to keep a lot of existing SOEs under the government of the day if the political ideology is to keep SOEs, claiming it is under national security.

In the Right to Information (RTI) Act, there is provision that the authority can decline to disclose the requested information if it threatens national security. For most RTI requests, many Government institutions have been responding that the information cannot be disclosed due to national security reasons. Therefore, defining national security or the process of deciding how an organisation or industry comes under national security is important.

Unless the Government can always build a logical stand, even institutions like the Cashew Corporation will have to be under the Government as it can impact national security.

On the second condition, that in the absence of a private player due to limitation of the market size or another criterion for a service that is essential in nature, the guidelines have to be developed in the case of what could be a new player wanting to join the industry later.

For example, it could be an industry with high capital investment and low market penetration, making Sri Lanka unattractive at the beginning due to the market size. As a result the Government can be in that business as the service is in the nature of being essential.

But over the years as technology and other parameters develop, at one point there may be new players interested in joining the industry. At that point, a natural resistance may occur from the SOEs over a new entrant being in the market as they will lose their monopoly status. The same happened when Lanka IOC entered the market and still there is some resistance to the entrance of Sinopec and other players in the energy market.

Deciding what an essential service is also requires a framework. Otherwise, when a government wants to be in a business, it can easily announce that industry as an essential service and enter the business, bringing forth various reasons.

All of the above are beyond the scope of the SOE law, but we need to keep in mind that these are the loopholes governments always have when ideological stances are different. Even if the new bill passes, we should not underestimate the skills of policymakers in finding the loopholes.

Other principles

The fourth principle of the SOE holding company is to bring all SOEs under one registration format. At the moment, different SOEs have different structures with a very high degree of complexity. For instance, the railway is a commercial activity and runs as the ‘Railway Department,’ while the Ceylon Electric Board runs as a board under an act. Meanwhile, Lanka Hospitals is a hospital but operates as a private limited company. Therefore bringing them all under one registration is vital when we set up the SOE holding company.

The fifth principle mainly focuses on the governance of SOEs as the SOE reform process is a longhaul game. The SOE holding company and the subsidiaries are required to adhere to Colombo Stock Exchange guidelines. This includes releasing quarterly financial statements and the board of directors being required to conform to the Code of Best Practice on Corporate Governance.

The other principles in the list are on unbundling the regulator and the operator in certain industries. There are industries run by the Government where the Government is a player as well as a regulator at the same time.

Overall the SOERU’s principles to base the SOE holding company is in the right direction, although there is always room for politicians to exploit the principles.

It is sad to see the pushing back of such important SOE holding company legislation over the draconian Online Safety Act.

Housing affordability in Sri Lanka: The looming crisis and need for multifaceted approach

By Advocata Institute

Originally appeared on the Daily FT

Sri Lanka is at a crossroads, confronting with a mounting crisis in housing affordability that demands immediate and comprehensive attention. The complexity of this challenge is underscored by the stark disparities between the escalating housing demand and the sluggish pace of housing supply growth. Data derived from the 2012 Census of Population and Housing Survey paints a stark reality: housing demand has surged by 11.9%, reaching 5,875,009 units from 2012 to 2022. In contrast, housing supply has lagged, with an increase of only 9.5% to 5,685,151 units. This glaring gap which is approximately 3.23% of housing units (189,858) raises a red flag, necessitating urgent and effective policy interventions.

Delving deeper into the district-wise dynamics exposes the severity of the issue. Colombo, as a critical urban hub, experienced a 10% surge in housing demand, reaching 635,385 units in 2022. However, the corresponding supply increase was a mere 7.4%, resulting in a substantial shortfall of approximately 26,978 units. This scarcity not only exerts upward pressure on house prices but fundamentally challenges the broader affordability of housing, impacting citizens across various socioeconomic strata.

Challenges

At the heart of this crisis lies a multifaceted challenge. Urbanisation, population growth, and evolving societal needs have outpaced the pace at which housing supply is expanding. A legacy of historical housing policies, coupled with limited private sector participation, has left the Government shouldering the bulk of responsibility. The absence of a robust regulatory framework and streamlined approval processes further impedes the swift execution of housing projects. This perfect storm of factors has led to a housing deficit that reverberates across the nation.

To this, in the housing landscape in Sri Lanka, a disconcerting reality emerges from the statistics. Out of the 6,094,115 families, a fraction grapples with precarious living conditions, with 0.73% residing in cadjan/palmyrah houses, 4.56% in temporary structures, and 6.35% inhabiting partly constructed houses. The prevalence of households not yet plastered stands at 13.79%, while 7.25% have roofs consisting of galvanised sheets. Alarmingly, 3.55% represent homeless-landless families, and 0.49% temporarily dwell in quarters for job requirements. Another 2.74% of families are categorised as homeless yet possess a block of land, and 1.31% are temporarily living on rent while maintaining a permanent residence elsewhere. Additionally, 8.39% face challenges with proper water supply, 2.97% lack adequate access to roads, 3.19% lack proper sanitation facilities, and 2.74% are without electricity. These realities underscore the multifaceted challenges faced by a significant portion of the population in securing decent and dignified housing.

Housing demand, a pivotal component, is linked to demographic trends, housing finance accessibility and cost, and Government policies encompassing taxation and subsidies. The precarious nature of property rights, particularly insecure tenure, has the potential to hinder investments in housing. Conversely, housing supply is contingent upon factors such as land availability, robust infrastructure, construction material costs, and market efficiency. The interplay of consumer, producer, and Government behaviour further shapes the delicate equilibrium of demand and supply in the housing sector. Government policies, notably those governing land use and building regulations, wield significant influence over housing construction, subsequently impacting the supply of affordable housing.

Multifaceted approach

To navigate this housing affordability crisis, a multifaceted approach is imperative. Reforming housing policies is imperative for the Government, necessitating an alignment with contemporary needs and fostering adaptability to evolving trends. Priority should be given to strategic reforms that emphasise affordable housing development in both urban and rural areas. Facilitating collaboration between the public and private sectors emerges as a key solution to bridge the housing gap. Incentivising private developers to partake in affordable housing projects, coupled with supportive measures like infrastructure and regulatory facilitation, can yield significant positive outcomes. A pivotal aspect involves strengthening the role and capacity of the National Housing Development Authority (NHDA). This entails regular leadership by the NHDA in conducting comprehensive housing needs assessments that encompass qualitative dimensions. Securing adequate funding, autonomy, and an unwavering commitment to improving living standards within NHDA are indispensable components of this multifaceted strategy.

Housing affordability is not just an economic metric; it's a barometer of societal well-being. A secure, affordable home is the bedrock upon which individuals build their lives. It impacts education, healthcare, and overall community prosperity. Failure to address this crisis risks leaving a lasting scar on the nation's social fabric.

The absence of a cohesive, long-term housing policy focused on low-income housing has significantly contributed to the limited construction of affordable houses. Historically, the Government's housing initiatives, especially in the past two decades, primarily aimed at clearing slums for land development rather than addressing affordable housing concerns directly (The World Bank 2012). Resolving housing policy issues is crucial, and it's equally vital to address market failures in land, building materials, and the construction industry to enhance housing affordability (World Bank 1993).

To enhance the business environment, the Government should transition from being the sole provider of housing to creating a legislative, administrative, and policy framework that fosters a competitive market. Direct Government involvement in construction, coupled with regulatory roles, may lead to conflicts of interest. Instead, policies should incentivise private entities to engage in affordable housing construction. This involves eliminating protectionist measures like import tariffs, para-tariffs, and addressing concentration issues in building materials industries.

Addressing institutional failures is paramount. Multiple agencies with overlapping functions create bottlenecks, hindering policy development and project execution for adequate and affordable housing. Streamlining these agencies, ensuring coordination, and establishing a robust regulatory framework are necessary. Regulatory issues, such as land availability and titling problems, are major barriers. Unlocking Government-owned land for housing projects, improving titling processes, and digitizing land registries can facilitate development and clear ownership, enabling better access to finance.

Provision of infrastructure and support services is crucial. Government investment in public services like water, sanitation, and public transportation can unlock regions for housing development. Improving the efficiency and productivity of the construction industry, potentially through standardised housing units and prefabrication, would significantly reduce construction costs.

Reducing the cost of borrowing and enhancing financing options for low-income households is a challenge. Mortgage guarantees, encouragement for banks to access low-cost wholesale funding, and addressing issues related to land titling and borrower risk can enhance access to affordable financing. Additionally, focusing on the underdeveloped incremental housing finance market can cater to the unique needs of low-income households.

Improving data availability is essential for effective planning. Establishing a centralized mechanism to collect, analyse, and disseminate recent housing data is crucial for long-term planning and achieving sector and economic objectives. Conducting regular surveys and censuses will provide up-to-date insights into the state of the housing sector in Sri Lanka.

In conclusion, addressing these multifaceted challenges requires a holistic and well-coordinated approach involving comprehensive policy reforms, market enhancements, and improvements in data collection and analysis mechanisms.