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.

Repeal para-tariffs on period products

Originally appeared on The Morning

By Thathsarini Siriwardana

On 2 October, the President’s Media Division announced that the Government had decided to remove all import duties on imported raw materials for domestically-produced sanitary napkins while providing zero VAT benefits for imported finished sanitary napkins. This is yet to be implemented; no gazette has been issued at the time of writing. 

The move to reduce tariffs is positive and doubtless well-intentioned and should be welcomed. These tax revisions will help to reduce the prices of domestically-produced sanitary napkins considerably. Nevertheless, we would have liked to see the tariff cuts on sanitary napkins as part of a broader overall reform of the tariff structure rather than an ad hoc adjustment.

Women constitute just over half of Sri Lanka’s population of 21 million. Of the female population, 5.3 million menstruate. Menstrual products had high tariffs prior to 2018. The total tariff imposed on sanitary napkins was over 101.2% [1] in 2018, but these were gradually reduced. 

The current total tariff on sanitary napkins is 46.9% [2]. Although the current tariffs are much lower, they are still quite high, so access to affordable and safe menstrual products remains a luxury for some women. 

The collapse of the currency and soaring inflation have brought a lot of pressure on household budgets. The Government should try to reduce inflationary pressure through supply-side reforms. Simplifying and standardising the tariff structure will facilitate trade and can reduce costs.

Sanitary napkins are vital for girls and women. High protective tariffs imposed on these products benefit producers, but this is at the expense of consumers. The inability to afford sanitary napkins in Sri Lanka is pervasive, especially among the low-income segment of society.  

Tariffs on menstrual hygiene products

It is clear that in terms of tariffs on menstrual hygiene products, such policy decisions benefit producers. The current total tariff of 46.9% consists of 15% (VAT) + 10% (PAL) + 15% (CESS) [3] and while this is an improvement, prices are still high.

When a protectionist tariff is placed on a good, it will achieve two main things. First, it will act as a barrier for new products entering the domestic market. This lowers competition and reduces the choice available to women when purchasing sanitary napkins. Secondly, high tariffs trickle down to final product prices, resulting in higher prices for both domestically-produced and imported products. 

Sri Lankan women and girls face challenges in choosing a menstrual hygiene product that best suits them. The ability to choose comes with the affordability and the availability of the product. The current high tariff rates hinder the choice of women and girls.

By reducing tariffs, the cost of importing products will decrease while simultaneously creating competition, which will help to reduce the prices. This will encourage new local producers to innovate better quality products while ensuring their prices remain low and competitive in the market. 

Cost analysis of sanitary napkins

A market price analysis of sanitary napkins shows that the average imported price per pad remained more expensive than the most expensive locally-produced price per pad as of September 2022. The currently available cheapest price per pad is Rs. 33. When comparing per-pad price changes within a year, it shows that both prices of local and imported brands have increased by more than 70%. 

Economic factors such as the depreciating exchange rate and high rates of inflation are the main contributors to this vast price increase. The increasing prices are also influenced by the high para-tariffs. Removing the imposed protectionist tariffs on sanitary napkins and menstrual hygiene products will provide some degree of relief for low-income-earning women.

Advocata Institute reported that in 2016 Sri Lanka’s absolute household period poverty rate was approximately 50%. This means that around half of the households with menstruating women do not report buying sanitary napkins as part of their household expenditure. In 2019, Sri Lanka’s absolute household period poverty rate was approximately 40%. Even though this is an improvement compared to 2016, the situation is expected to worsen due to the economic crisis.

To provide relief, the Government should also focus on removing the PAL (10%) and the CESS (15%) imposed on imported sanitary napkins. This will allow competition to enter domestic markets while providing cheaper and healthier options for women. 

Necessary tariff structure reforms

The Sri Lankan tariff structure is complex, disorganised, and comprises a combination of multiple para-tariffs and duties. The current protectionist import tax structure has significant negative effects on exports as well as the domestic economy. 

The International Monetary Fund (IMF) in its Article IV consultation in 2021 stated that high para-tariffs hindered competitiveness and growth [4]. This clearly shows that immediate reforms should be carried out on the Sri Lankan tariff system. 

To begin with, the existing Customs duty and excess para-tariffs such as PAL, VAT, CESS, surcharge, etc. should be unified into a single Customs duty. For a simpler tariff system, a single rate should apply across all categories where possible, within each HS code. A uniform tariff rate should apply for raw materials and components of the industry [5].

Sri Lanka has been a member of multiple international organisations such as the World Trade Organization (WTO) since 1955, the General Agreement on Tariffs and Trade since 1948, and the IMF since 1950, due to which we have to reaffirm commitments to the multilateral trading system. As members of these organisations, we have to adhere to their protocols and commitments to reducing barriers to international trade by eliminating or reducing tariffs and quotas. 

Thathsarini Siriwardana is a Research Assistant at the Advocata Institute. She can be contacted at thathsarini.advocata@gmail.com. The Advocata Institute is an Independent Public Policy Think Tank. The opinions expressed are the authors’ own views. They may not necessarily reflect the views of the Advocata Institute.

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

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

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

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

Licensing process

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

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

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

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

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

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

Imports are not the problem

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

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

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

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

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

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

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

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Crisis is here, reforms must be too

Originally appeared on The Morning

By Dhananath Fernando

Providing a definition for an economic crisis is a difficult task. Especially for a country like ours, which has had an ever present economic crisis, since independence. Realising the depth of the crisis is too difficult when we don’t know the real potential outside. This is because we have normalised our economic difficulties. As a result a transition from one phase of the crisis to another phase is celebrated as a victory. In certain instances due to lack of understanding, deepening the economic crisis too has been celebrated as a move towards economic prosperity without realisation of the reality. 

Our comparison has always been “how we did in the past” or “how the previous governments had done it”. As a result we have become accustomed to having very low levels of expectations. This is also a result of  a lack of exposure to where we really want to be and without realising our potential. 

The current economic crisis is just a good reflection of where we all stand including our policy-makers. Many of us consider that having adequate USD (foreign currency) to settle our foreign debts is the point of getting over the line from our economic hardships. Basically, the ability to pay debts is perceived as prosperity.  As a result we have added enormous pressure on all our businesses to celebrate a fake victory. At this backdrop we keep implementing the wrong policies, such as import restrictions without realising that we are deepening our economic crisis by adding extra burden on their raw material importation. We have reached a stage where we look for credit lines to secure our fuel imports mainly from Oman, India, and the Middle East. 

At the rate crude oil prices are increasing, without a significant reduction in consumption, credit lines will increase the amount of bi-lateral debt. It is also most likely that our bi-lateral partners would ask for a condition to join an IMF programme, if they are to lend to us in the future. This is because the individual countries who we borrow money from, need an assurance of our solvency. On the flip side, our bilateral partners too need to take precautionary measures to minimise the risk of lending to us, or else it would cause political unrest in their respective countries. There will be questions raised as to why a bi-lateral loan was provided to a country with a low credit rating. Some of Sri Lanka’s potential borrowers are beneficiaries of different forms of IMF assistance. The recent Bangladesh swap facility is a good example. Bangladesh received a $ 732 million disbursement from the IMF to address the Covid-19 pandemic, following which they have agreed to provide us with a $ 250 million swap facility in tranches. 

Adding fuel to fire is the lack of reforms. The failure to do so is like not using the tools in our tool box. So, existing hardships will prevail or worsen, and complaints on delays on clearing shipments haven’t been addressed as yet and the USD shortages still continue at banks. Further, the lack of decisive action being taken is risking the stability of our banking sector. As a result we have downscaled our capacity and expectations to a greater extent and everyone has gone to a survival mode and comparing an era of survival with another era of survival while the human race and societies have taken great strides on developing the entire society as a whole. 

The current control of the USD has now started to affect our remittances. Our remittances are declining significantly even with the nature of the pandemic we had earlier. Increasing remittances was a key goal of our policy-makers. In fact remittances were encouraged by agreeing to offer a slightly higher exchange rate for remittances to cover up the loss of revenue from tourism. It is not rocket science to figure out why our remittances are in decline, when the kerb market offers a rate about 20-30% higher than the rate fixed by the Central Bank of Sri Lanka. At the same time, when imports are restricted people are motivated to get goods directly, at a reasonable price from overseas travellers, instead of transferring foreign currency to Sri Lanka and bearing the exchange rate loss. 

The most recent statement by the Central Bank, the six-month road map, places a bigger weight on the generation of foreign exchange through investments in national assets such as the West Container Terminal, power plants and development projects. That is a positive sign that our underutilised assets are now being looked at for revenue generation. But in terms of the tools that we have used, are they sufficient? Most likely not. However we will have to wait for a few weeks to make an estimation on the effectiveness of these tools and measures. 

On the other hand, investments such as the WCT and other infrastructure development carry a larger import component. Even in tourism about 80% of the revenue consists of imported content. Unfortunately there are no shortcuts for a deepening economic crisis brewing for decades. We are already in a crisis for too long and we are cornering ourselves. The impact for common people would be to sacrifice their quality of life. That is to let go of what they consumed before and give way even to the little convenience we had. 

Solution 

The solution to overcome the problem are economic reforms. We reiterate often on reforms because there is no other solution. They are the only solution. Budget 2022 is a golden opportunity to direct the country towards economic reforms. Merely reading numbers that allocate money on expenditure that we cannot afford, will take us nowhere. 

The policy direction has to be on allowing the markets to operate based on prices instead of excessive regulation or promoting a culture of banning. The price signalling system will optimise the resources allocation. Markets and investments will receive a positive signalling that Sri Lanka is open for change. Only an optimisation of resource allocation and getting our economic fundamentals right can take us out from this crisis. Otherwise, Sri Lanka will remain where it has been in the past into the foreseeable future. Reforms provide the only road out of this crisis! 

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Will India’s cobra bite Sri Lanka’s cattle?

Originally appeared on The Morning

By Dhananath Fernando

• A ban on cattle slaughter could create a herd of new problems

Not long ago, India had a serious issue with snakes. Many people died, as a result of being bitten by a specific species of cobras. As a remedy to this problem the government of the day, proposed a cash reward system. A bounty was made available for every dead cobra. It appeared to be a good solution at the initial stage but later on the government realised the cobra numbers are increasing though people redeem cobras. Later on the government realised that entrepreneurial Indians were now breeding cobras as an income stream and they maintain breeding houses of the same type of cobras. As a result the government suddenly stopped the cash incentive system. Then the breeders did not have any financial incentive to keep them at their breeding houses. As a result they just released the cobras to an open environment which rapidly increased the cobra population and the problem became worse than ever before. This is called the “cobra effect”, where you bring a solution with good intentions but the outcome is a series of negative consequences far worse than the original problem. This is a story all Sri Lankan policy-makers should keep in mind, especially the ones who keep proposing the banning of cattle slaughter. Every ban so far has backfired economically as well as politically. The only bans which haven’t backfired are the ones which haven’t been implemented.

The former president proposed a ban of carpentry sheds and chainsaws in a move to protect the environment which didn’t get implemented. Then a ban on glyphosate was proposed. Recently, in addition to many import bans, a ban on sachets and a ban on chemical fertiliser have been proposed. The impact of these bans have been like a boomerang, making colossal losses to our economy, the livelihoods of the people and the political capital of the government which could have been invested to implement much needed macroeconomic reforms.

The cattle slaughter ban is most likely going to bring similar consequences. The biggest impact being farmers having the burden to maintain animals past their productive prime. This will significantly impact the productivity of the dairy industry. In the very likes of the cobra effect in India. Undoubtedly the policy is implemented with good intentions but merely having good intentions isn’t sufficient to the harms and consequences of these actions. Our politicians cannot just run away from these bad consequences without taking responsibility, just because their intentions are good. Governing Sri Lanka is not like the high school prefects checking for the uncombed hair or the bags of fellow students. We are a democratic country where the actions of policies determine the well being of people’s lives. Just to mention “we did it with good intentions without realising the bad consequences” is not an acceptable excuse at all.

With the ban on cattle slaughter, and the topic gaining national attention, it is sufficient for milk farmers to accelerate the selling process of cattle for slaughter. This will be fueled by the fear that they will lose out by holding on to cows in future. In the meantime our dairy industry which is finding it difficult to manage even with very high tariff protection will find it further difficult to sustain. This will greatly affect national milk production and the livelihoods of dairy farmers.

In the liquid milk industry, the output of the cow depends on the feed, temperature and protection from infections. Better the feed and lower the temperature (which avoids sweating of the cow) increases the output. Sri Lankan dairy farmers are already finding it very difficult to provide better feed for cows. According to data, in 2019 Sri Lanka had about 323,490 milking cows but the average output is about four to five litres a day where the global average is about 28 litres per day. In countries like Israel the output per day is as high as 40 litres.

It is a clear indication of how difficult it is for our farmers to provide adequate water and food for milking cows. So after a certain period most farmers recover money by selling it for meat. Otherwise economically it doesn’t make sense to keep them at home just feeding. Another aspect that must be explored is the impact on natural forests. Most of Sri Lanka’s forest reserves are facing dangers by cattle farms, especially in villages bordering sanctuaries. Cattle farmers let the cows enter protected sanctuaries for feed which then affects the natural vegetation of herbivorous animals such as elephants. This too is one contributory factor for human-elephant conflict where elephants come out of forest areas looking for food as a result of depleting vegetation.

On the other hand the male cattle or bulls will have a very short life span as maintaining a bull without the ability to sell doesn’t make economic sense. So illegal cattle slaughtering will increase. Already Sri Lanka’s domestic liquid milk supply is about 373 million litres and the local demand is almost twice that, which is 700 million litres. So the milk powder imports will most likely go up and employment will be affected. According to the EDB (Export Development Board) data, there are about five large companies, 10 medium-scale companies, and more than 1,000 small enterprises and seven tanneries that produce 25 tonnes of leather daily which brings in about $ 550 million worth of foreign exchange annually. This decision to stop the slaughter of cattle will have a significant impact on these livelihoods and Sri Lanka’s foreign exchange revenue will take a hit, especially at a time where we are desperately in need of foreign exchange.

Keeping money matters aside, from an animal cruelty perspective, this regulation will discourage farmers to take care of their cattle and keep them well-fed. This decision will further distort the incentives to provide proper protection and shelter for cows due to a lack of financial incentives. This is best illustrated by the situation in India. A similar policy decision by the Indian government on banning the slaughter of cattle has been one factor leading to vehicle traffic, in some areas due to the overpopulation of cows and cows inhabiting roads. In some cases the government has had to spend extra resources, building cow care centres as many cows were being mistreated.

In policy decisions “good intentions” is not the litmus test to decide which policy should get the priority. It is the cost benefit analysis, causes consequences analysis and factual and evidence-based research that should decide the implementation of a policy. Intentions are important but bad consequences such as the “cobra effect” can only be avoided by sensible well thought economic thinking.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Avoiding IMF won’t help us avoid austerity

Originally appeared on The Daily FT, Daily Mirror, Lanka Business Online, The Island, ColomboTelegraph

By Naqiya Shiraz and Rehana Thowfeek

Sri Lanka’s debt problems are  a topic of national conversation. Foreign reserves, already low at USD 4bn in May 2021 fell to USD 2.8bn after the most recent bond repayment of USD 1bn in July 2021 . The Government claims that the timely repayment of the bond is proof that doomsayers were wrong and that it indicates a robust economy. Is this correct?

While it is true that a default has been avoided thus far it does not necessarily mean that the economy is sound. The recent bond repayment comes at a cost: a foreign exchange squeeze. Bond holders are being repaid, but this means that foreign exchange that could otherwise have been used for imports are now being used to pay bond holders instead.

The government seems to be adamant in avoiding the bogeyman, the IMF, perhaps to avoid the tough medication an IMF program will bring. Yet avoiding the IMF does not mean we can escape the inevitable austerity that will follow. Austerity is in fact already upon us, in the form of restricted imports. The restrictions are denying essential inputs to the local economy and medicines and food to citizens. These restrictions work   in two ways:

1. The outright restrictions on imports

2. The shortages of foreign exchange in the market

The government has banned or restricted imports of what is termed “non-essential” items although the list includes goods like some clothing items, refrigerators and food items ( live fish, tomatoes for example). 

In addition, Central Bank’s attempts to control the rate of exchange have resulted in shortages of foreign exchange. The Central Bank has decreed an official rate of around 200/- but only limited amounts are being converted at these rates resulting in a shortage of hard currency.

 Banks are now rationing foreign exchange with the result that even items that are not banned are becoming unavailable.

“We cannot accommodate the requests for LCs so we have to ration them,” a banker said. “There is no regulation to say to ration them, but we are forced to do it.”

https://economynext.com/sri-lanka-rupee-forex-markets-in-pickle-as-lc-rationing-froths-83224/

The import restrictions were supposed to be restricted to luxury items but the currency shortage means that even medicine and some food items seem to be running short

While foreign bondholders will undoubtedly be pleased to have been repaid, local consumers and businesses must now suffer, making do without everyday products. The shortages in supply mean that prices rise: of whatever available imported products as well as local products. 

This affects not only consumers but also businesses. With banks being unable to open a Letter of Credit (LC’s), imports of intermediate goods, even exports by SME’s which have no access to BOI facilities are at risk. 

Unable to trade or operate due to lack of stocks or input material, import-dependent businesses are losing out. The net result is an overall decline in economic activity and welfare of all Sri Lankans. 

A person interviewed for this report explained the difficulty in obtaining asthma medication for his mother. He had to try 4 different pharmacies to get the required drugs.  He said that he believes larger stores have fewer stocks available as the volume of people going to them is much higher. 

Another respondent said chemotherapy drugs brought in from Europe were no longer available with only cheaper products from India, Bangladesh or Argentina being available. As he had no other choice he used the substitutes for part of his wife’s chemotherapy treatment but was worried about the quality and safety. 

The knock on effects of these are palpable. Prices of basic goods are increasing. Inflation in January 2019 according to the NCPI was 127 index points which increased to 146 in June 2021. That means prices have increased by 15% in little over two years as a whole. But prices of essential food prices have increased by a lot more. Food inflation particularly has dramatically increased by 25% (NCPI). According to the Advocata Institute’s Buth Curry Indicator, prices of food that would be consumed in a buth curry meal have increased by 45% from July 2020 to July 2021.

The effects don’t end there. Importers of seeds were complaining that their sales have dropped by 50% because of uncertainty over fertiliser imports. These importers bring in seeds that are not produced in Sri Lanka, for vegetables like beetroot and carrots. Sales have fallen as they are not being purchased by domestic farmers. Farmers are holding back from cultivating due to the uncertainty caused by the shortages of fertilizers needed for production. A consequence of this would be shortages and rising prices of fruits, vegetables and other produce in the coming months. This will not only affect farmers' incomes but also result in higher consumer prices. The government may have to resort to importing more food, thereby negating the impact of the fertilizer ban to begin with. Only recently, the cabinet approved the importation of 6000 metric tonnes of rice from Pakistan to manage the shortage in the market.

This fertiliser fiasco has affected the poor disproportionately. Larger businesses are able to stock up on fertilizer, but not everyone can afford to do that. It’s the small farmers that lose out on income. The incomes of these small farmers are in jeopardy. Coupled with the milk powder and gas shortage, prices of these essential commodities are forced to increase at an already difficult time. 

Economic policy affects the ordinary person in a society. These may be individual stories but they are certainly not one off situations. 

The fact of the matter is that the country is undergoing a self-imposed austerity program in the form of import restrictions and more recently a foreign currency shortage that has resulted in the rationing of even items that are not subject to control.  

The basic principles of economics cannot be ignored in policymaking. By avoiding the IMF for fear of austerity measures, has resulted in more damaging self-imposed austerity. We need to ask ourselves how sustainable this really is in the long term. The longer we wait, more stringent austerity measures will be needed. 

Rehana Thowfeek is an economics researcher by profession. She has a MSc in Economics from the University of Warwick and a BSc in Mathematics and Economics from the University of London. She has worked previously for Sri Lanka-based think tanks; Verité Research and the Institute for Health Policy. At present she works for a US-based food technology company as a researcher. Naqiya Shiraz is the Research Analyst at the Advocata Institute and can be contacted at naqiya@advocata.org.

Enough rent seeking, bring on competition

Originally appeared on The Morning

By Dhananath Fernando

I studied at a semi-government school. Students studying in these schools pay a school fee every month. Due to financial constraints, some students found it rather difficult to pay this fee. As a solution, we decided to organise a food fair to raise funds as opposed to collecting money, which we thought would be a direct burden on most parents. The fair required students to bring food that was tradable. I remember referring to this as a “salpila” in Sinhala. Most parents contributed by sending in homemade food items such as hot dogs, sherbet, short eats, faluda, and sweetmeats.

However, the food fair faced a significant challenge. We were only permitted to have the fair within the 20-minute lunch break and were strictly advised not to disturb the academic timetable for the day. I was not too pleased with this and proudly suggested a “brilliant” idea to increase the demand and sales of our little “salpila”. My “brilliant” idea was to close down the school canteen during the lunch break on that particular day, so students will be left with no choice but to purchase from the “salpila”. However, to my dismay, the then principal explicitly turned down my request. He then explained to me how short-sighted my proposal was.

It was then that I was introduced to the concept of “rent-seeking. Rent-seeking is the manipulation or alteration of the market for financial gains. This exactly was what we had proposed. The principal went on to question us on how we could match the demand of 3,000 students and the plight of the canteen owner who was on a rent agreement with the school.

I argued back, questioning “what is the big loss the canteen owner is going to make just for closing down the canteen for 20 minutes” and “why can’t the principal support us in such a noble effort of assisting our classmates to continue their education”. Our principal explained to us that bending the rules to make profit is not the way to do business or to help our classmates. However, he said that we can compete with the canteen focusing on goods that are not available there.

Now, as an adult, every time I see an overnight gazette notification or stories of import taxes on sugar, CESS on tiles, import duties on menstrual hygiene products, I revisit my school days and my short-sighted thought process which I believed to be “brilliant” at the time. The most recent story on the matter is the sugar importation conundrum which took the limelight with the COPA report. There is one school of thought that it is just a revenue loss for the government and there is another school of thought that this is a fraud. However, it is clear that the consumer has become the net loser. It is unfortunate that the discussion is not on the economics of it but rather pointing fingers at each other and comparing which losses are greater: Bond fiasco or sugar tax reduction.

Overnight gazettes: Open window for fraud and corruption

Having low duties on imports is always better for imported commodities as ultimately the tax has to be paid by the consumer. While the taxes have to be low, it is equally important for the taxes to be consistent and predictable so the room for market manipulation is limited. On the other hand, using quantitative restrictions to limit imports would encourage rent-seeking, a concept proposed by Prof. Anne Krueger.

It has become the habit of all consecutive governments to impose various import duties and taxes on various import items which affect the prices drastically. When the taxes are changed overnight in significant amounts inconsistently across and selected commodities, it will act as a barrier for small players to enter into business as they do not have the capacity to absorb tax losses or match massive quantities as it is difficult to decide on prices.

As a result, the importation of commodities such as sugar only has a handful of importers who act as an oligopoly and can manipulate market prices. Especially when taxes are brought down from large amounts such as from Rs. 50 to 25 cents, there is a higher chance of getting insider information and manipulating the market. As a result, few traders have the opportunity to get to know information early and bring in stocks early and store in bonded warehouses where only the taxes are applicable on rates where the consignment is released. This allows them to take the tax advantage by keeping prices unchanged. Or in worst cases, taxes can be brought down overnight and it can be increased again overnight, favouring a few individuals just after the goods are cleared at the port, and this is how the overnight gazette notification opens the window for rent-seeking. This can be seen every time when a budget is presented and many speculations float around on the vehicle market and many other commodity markets.

Consecutive governments are of the belief that overnight gazette notifications have become a tool to raise revenue for the government as well as to regulate markets, and this sugar tax has proved that it is not only a completely ineffective tool, but also a window for corruption.

Government’s policy inconsistency with tax policy

One of the main reasons provided by the Government to keep the corporate tax and income tax unchanged is to provide policy consistency so the business can predict future trends and support growth. The same thinking process needs to be applicable for indirect taxes as well. Both direct taxes as well as indirect taxes have similar consequences when it comes to inconsistency. Finance Ministry officials have agreed that high tariffs on sugar add a burden on the cost of living and that is one reason to bring down taxes, which is the right way to think about it.

At the same time, we should not forget the tariff on other commodities such as tiles, bathware, menstrual hygiene products, construction steel, other food items, cement; all product categories and commodities too add to the cost of living of people. When we have double and multiple standards on tariffs, that too distort markets and open opportunities for rent-seeking.

The policy of self-sufficiency has been challenged

On the other front, with the reduction of sugar tariffs, acknowledging that the tariffs have caused to increase the prices and shrink the supply has proved that self-sufficiency in sugar is an impractical concept to achieve. In a recent interview, Trade Minister Bandula Gunawardana has mentioned that import controls caused small-scale exporters who export coconut-related products and food items to be badly affected. The same argument has been highlighted by this column since the day the self-sufficiency policy was pronounced, highlighting the consequences on both losing our export markets, volumes, as well as our export competitiveness. 

Imports restrictions by themselves cannot cause pressure on the LKR, as it does not reduce the demand for sugar. What can cause pressure on the rupee is the ill-managed Monetary Policy that causes the pressure on the LKR and the balance of payment crisis. After serious import controls and trade restrictions, that is one reason why the rupee has achieved a historic low last week.

Though how good may be our intention, not knowing the right concepts not only distorts markets, but also brings united consequences for people and their quality of life. Like my principal advised me many years ago, the way to combat issues is not by rent-seeking but by competition.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.