Imports

A facelift for the railway

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

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

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

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

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

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

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

Fixing policy failures in trade and tariff

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

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

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

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

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

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

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

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

Addressing the land problem

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

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

Image Credit: JB Securities

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

Poor utilisation of land by SOEs

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

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

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

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

Image Credit: JB Securities

Solutions

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

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

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

Rough seas make good sailors: Embracing competition in trade

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

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

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

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

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

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

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

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




Timescale confusions in solutions for the crisis

Originally appeared on the Daily FT

By Prof. Rohan Samarajiva

A few days after the tsunami, I was called to an expert meeting at Temple Trees by the then Prime Minister, Mahinda Rajapaksa. I was seated next to Arisen Ahubudu, the famous giver of names. He stated that we had lost too much territory, including Madagascar, and that we could not afford to lose more. He proposed building a wall around the country, using the traditional techniques used in protecting tank bunds, the ralepanawa. I was stunned that such a nice and well-meaning person could come out with such arrant nonsense. He had confused geological time with human time. 

Timescale confusions of a smaller magnitude are evident among many proposing solutions to our current multi-faceted crisis. 

Solutions to power cuts

We all experience the problem. Some of us understand the cause: no dollars to pay for fuel for the generators that make up for the shortfall from lower production from the hydro generators and Norochcholai. Even if we had the dollars, such fuel is priced in dollars and subject to price fluctuations that we cannot control. It is common sense that we should shift to electricity produced by renewable sources such as solar and wind. 

The problem is that under current market and technology conditions, both the distribution network (low voltage) and the transmission network (high voltage) are limited in how much solar- and wind-generated electricity they can accept. We can, and should, increase the use of electricity from renewable sources, but we need to upgrade the transmission network to be able to do so. Solar panels yield electricity when the sun is out (not at night and not when clouds pass over the panels); the wind will produce electricity even in evenings when our use is highest, but it is still intermittent. Batteries are not cost-effective yet.

Given the need to balance supply and demand of electricity in real-time caused by lack of cost-effective storage technologies, we need a large and modernised system in order to absorb more energy from these intermittent sources. We need to invest in upgrading the national grid and possibly connect to the large Indian grid. Feasibility studies must be done, and investment mobilised. It will take several years for the desired outcomes to be achieved. Increasing solar- and wind-based energy is not a viable solution for our immediate problems, though it is a solution in the long term. Within the applicable timescale, what we need are dollars for coal and diesel.

Promotion of manufacturing

Twin deficits, exacerbated by recent economic mismanagement, caused the crisis. More exports would have addressed the current-account deficit and may have helped with the fiscal deficit if the right tax policy was in place. Roughly $ 11 billion was earned from the export of goods such as apparel, tea, and value-added rubber products before the pandemic. Around $ 7 billion was claimed from service exports such as tourism, software and business process outsourcing. 

It is true that the East Asian Tigers and China took their people out of poverty through the production of goods for export. One has to ask why Sri Lanka (and to a significant extent, the rest of South Asia) failed to ramp up the production of goods for export, relying more heavily on service exports. One could even argue that the apparel industry is a service industry. A tailor who makes a suit out of material given to him is undoubtably a provider of services. The Sri Lankan apparel industry, which is the largest importer as well as the largest exporter, is doing what a tailor does, at scale. If it is manufacturing, it is manufacturing lite.

Until the market opening in 1978, the answer to the question of why we had no industries was that our private sector was weak and lacked capital. Therefore, the State went into manufacturing: steel, plywood, tyres, sugar, paper, shoes, cooking implements, etc. were all produced by fully State-owned enterprises under protection. They produced shoddy goods at high prices for the local market and lost enormous amounts of money. The plywood factory resulted in the clear-cutting of half of Sinharaja. After the market was opened to imports, they went out of business.

Since 1978, we have relied on private investors, with or without foreign partners, to manufacture for export (and for domestic use). They have tended to invest in sectors that did not rely too heavily on cheap energy (because our electricity prices were high, especially for industrial users). Except in the case of a few sectors such as apparel and rubber-based products, our producers failed to secure access to markets. Restrictive laws and para tariffs hindered local producers from getting integrated into global production networks, with very few exceptions. 

So, the industrialisation prescription as a solution to the crisis will take time and effort to implement. We would have to ensure reliable and low-cost energy (and other infrastructure services such as waste disposal), eliminate para-tariffs, and create the conditions for market access. The latter is the most challenging. 

Investors such as Michelin ensured market access for the solid tyres produced in Sri Lanka. The apparel industry also benefited in the early stages from foreign investors who facilitated market access. Attracting such investors and entering into trade agreements are needed for market access. But both take time. 

Industrialisation may be a good solution, but it is not for the Government to decide on manufacturing priorities. Because China has established itself as the factory to the world, countries such as ours must identify and exploit niches. Those best positioned for this are those with intimate knowledge of the markets, with skin in the game, namely private investors. The State must create the conditions and leave the actual investment decisions to such players. All this will occur on a timescale different from what is relevant to emerging from the present crisis.

Constitutional reforms

It has become evident that the hyper-presidential system created by the 1978 Constitution has failed to yield the promised benefits and has caused serious damage after the enactment of the 20th Amendment, which removed all the checks that were placed on the President by the 19th Amendment. For example, the Minister of Finance has stated that specific officials were responsible for the tax cuts that triggered the present crisis and the delay in debt restructuring. In the current system, the sole authority for those appointments was the President who must therefore be held accountable for the current crisis.

To address the demands of the protestors, the President must go. He must resign or be impeached. The former can take place immediately would allow the country to return to normal (if such a condition exists after the devastation wreaked by the President and his appointees). The time taken to impeach will be too long. 

The next best solution is to reduce the powers of the President. This would require a Constitutional amendment. An amendment that is approved by Cabinet can be completed within around six weeks. If it is moved as a private member’s motion, it could take more than six months, outside the timeframe needed to calm the country and get the debt restructuring done. The announcement that the Government is proposing the restoration of the 19th Amendment suggests a solution within the required timescale. Of course, it would be necessary to scrutinise the proposed amendment and ensure the President’s powers are meaningfully reduced immediately.

In innumerable discussions I have participated in, I hear proposals for Constitutional reform that pay no heed to the time factor. Some talk of a Constitution authored by the people, modelled on what is going on in Chile. The process began with an amendment to the Constitution and a referendum in 2020. This was followed by an election for a Constituent Assembly in April 2021. Its deliberations are ongoing. How realistic is this kind of process for the kinds of issues that have brought our people to the streets?

In these days of limited attention (and paper supplies), it would be useful if greater weight is given to the appropriateness of the proposed solutions for the time needed to solve the problems that beset us.

Rohan Samarajiva is founding Chair of LIRNEasia, an ICT policy and regulation think tank active across emerging Asia and the Pacific. He was CEO from 2004 to 2012. He is also an advisor to 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.

How can affordable electricity be assured 24x7?

Originally appeared on the Daily FT

By Prof. Rohan Samarajiva

The best way to understand the value of something is to experience life without it. These days, the Government is giving us a crash course on the value of reliable electricity supply. An unpleasant lesson, but nonetheless a learning opportunity.

If we probe the causes of load shedding, the learning can be deeper. Load shedding can be eliminated but at a cost. When hydropower declines due to periodic drought, the difference can be made up with generators running on imported fuel, the dollar price of which is determined by world market conditions. We can have 24x7 electricity, but not at an affordable price.

The Government created the immediate conditions for unreliable electricity supply through mismanagement of the country’s external debt. Today’s problems are not caused by delays in building additional generating capacity; they are caused by the lack of dollars to provide fuel for the existing generating plants. But there were deeper weaknesses in the organically developed system that must be understood.

With benchmark crude oil prices going over $ 100 per barrel, we must rethink our dependence on imported fossil fuels.

Reducing dependence on fossil fuels

Examination of the composition of our imports (Figure 1) shows that refined petroleum and crude oil taken together is the largest or second largest category of what is imported. It follows then that reducing the import of petroleum products would be an action that would satisfy many: those concerned about global warming will be made happy; those who want self-sufficiency would also be pleased. 

Petroleum imports are not used solely for electricity generation. But the way to reduce the consumption of petroleum products for transportation also involves electricity generated by renewables: buses and trains that are powered by electricity; lorries, cars, three-wheelers, and two-wheelers that are powered by electricity. Promoting electric vehicles makes no sense unless electricity comes from renewable sources. 

The significant increase in expenditure for fossil fuels starting in 2011 (Figure 2) appears correlated with the massive increase in the vehicle stock after the end of the conflict, leading to a doubling by 2014. Luckily, the biggest increase was in two wheelers, which do not take up a lot of road space and consume less fuel. 

Generating electricity from renewables does require some imported elements such as low-cost, efficient turbines and photo-voltaic panels but the costs and dependence is nowhere near that which exists with imported oil and natural gas. In fact, it may be possible even to export electricity at certain times of the day or even for months on end. But this will require substantial investment in the transmission grid.

Preconditions for increasing use of renewables

An economics commentator whose work I follow had expressed puzzlement at “demand for electricity is higher than supply” being given as a reason for load shedding. Others had expressed outrage at some Facebook posts that I had shared, which stated that solar and wind could not provide a complete solution to our energy woes. These responses by well-meaning and intelligent commentators made me realise the need for a better understanding of how the electricity is generated, transmitted, and distributed.

For all practical purposes using currently affordable technology, electricity must be treated as something that cannot be stored (but see discussion of pumped storage below). That means that it must be generated at the same time as people consume electricity by activating lights or appliances. Peak consumption in Sri Lanka (in the evening hours starting from around 6:30 p.m.) is around 2 or 2.5 times that of lowest use which is around 1000 MW. 

That necessitates a cheap source of baseload electricity that can be drawn upon throughout the day. In addition, we must have other sources that can be mobilised as demand increases. One would think that the major hydroelectric plants that have been built on the main rivers which generate cheap electricity that is unaffected by world market prices and the value of the rupee could serve as the source of baseload power. But there are constraints, such as competing demands from agriculture. The weather affects hydropower, as we are experiencing now. 

Therefore, planners in the past argued for coal as the ideal baseload for Sri Lanka. If Norochcholai does not keep breaking down and operates optimally, it can give 900 MW continuously whether or not the rains come. But it does break down, and it appears there have been irregularities in coal purchases. Coal, even if procured on long-term contracts at the lowest possible price, still must be paid for in dollars.

There are those who argue that Sri Lanka has plenty of wind and sun, and we can solve all problems by shifting to wind and sun. But the simple fact is that these are intermittent sources. Solar does not produce electricity when the sun does not shine and produces less when clouds cover the sun. Wind can produce throughout the day and night, but there are times when the wind dies down. It requires complex system controls to blend these intermittent sources into a centralised system designed for large, stable and controllable generators. 

Countries have incorporated massive amounts of intermittent renewable sources. In 2019, 47% of Denmark’s electricity came from wind. But they have a very sophisticated grid that is capable of handling intermittent power sources, and they use interconnections with other national systems to help balance the system. So, for example, when excess power is generated by the Danish wind turbines, it is used to pump water back up into reservoirs in Norway and Sweden (a method of storing electricity in the form of water known as pumped storage), which can then be run through turbines again to produce more electricity when needed. Yet with all that, Danish consumers pay more for electricity than their neighbours.

Similarly, if Sri Lanka is to increase the use of intermittent power sources, we will have to upgrade the grid and the system control centre’s software. Given the difficulties of synchronising the frequencies to one big plant such as Victoria, it may even be necessary to gradually convert the grid to direct current. If the Sri Lankan grid is connected via a high voltage direct current cable to the Southern Indian grid, the much larger combined system can absorb a greater amount of wind and solar power. 

Interconnecting does not mean that a country gives up on generating its own electricity. It simply means that marginal amounts of electricity will flow in either direction when it is advantageous to two (or more) systems. The fact that the peaks are different in the two systems can also be used to reduce the high costs incurred at peak.

It may be necessary to directly link revenues derived from regulated prices to those who make the substantial investments needed for the grid. This will almost necessarily require a restructuring of the current ungainly, unresponsive, and money-losing CEB in a manner that allows the transmission unit to be run efficiently. 

All these options require careful study in terms of costs, benefits and energy security. The relations between Denmark and its neighbours are such that all the parties can be confident about the contracts being respected and any disputes that arise being settled in a fair manner. We must ensure that the interconnection agreements with India have all these safeguards. The precedent of India’s interconnections with Bhutan shows that mutual interdependence is achievable in South Asia. The experience in Europe where interconnection, including over long distances across water, is growing rapidly even after Brexit, will have to be studied. 

Rohan Samarajiva is founding Chair of LIRNEasia, an ICT policy and regulation think tank active across emerging Asia and the Pacific. He was CEO from 2004 to 2012. He is also an advisor to the Advocata Institute.

Government relief packages: Pros, cons, and criteria for perfecting

Originally appeared on The Morning

By Dhananath Fernando

Last Monday (3), Finance Minister Basil Rajapaksa announced a relief package worth Rs. 229 billion. This package consists of a Rs. 5,000 allowance for government workers, 500 g wheat flour for estate communities per day, an increase in the purchasing price of paddy by Rs. 25 to Rs. 75 a kilogramme to assist farmers, a Rs. 1,000 increase for Samurdhi beneficiaries and an incentive scheme for home gardening. When evaluating relief packages, a long list of factors should be considered. One such factor is inflation. It is no secret that there is creeping inflation affecting the livelihoods of all cross sections of society. This is openly being expressed to politicians. Food inflation is at 22% and headline inflation is at 12%. 

This column has always highlighted the grave dangers of high inflation. We have been closely following these developments and our prediction has now been admitted by the Government. The sources for financing the Rs. 229 billion was not specified. The Finance Minister only mentioned that it would be utilised from the 2022 Budget while also mentioning that no tax will be increased. Both the budget numbers and their justification in the text were problematic. Inflation is the worst tax which hurts the poor more than middle income families. 

Given these circumstances, the available options are to cut down some of the already allocated capital expenditure or to borrow money from the Central Bank to finance this new expense. The former is happening already, as when the Government made reductions in capital expenditure as per the budget speech. Some were manifested through policy decisions such as halting construction activities for the next two years. Therefore, if there is a reduction in capital expenditure, it will have to come through cutting down budget lines allocated to areas such as highways, road development, education, and health care. 

Alternatively, we may have to finance this by borrowing more money from the Central Bank, continuing the dangerous policy of believing in Modern Monetary Theory. It will have a very high risk of starting a wage spiral and contributing further to inflation and the depreciation of our currency faster than we expect. Most of this (extra) money will be spent on imported goods. This increase of demand on imports will continue to dry up our limited foriegn reserves. 

In my view, the announcement will confuse investors and businesses, putting the credibility of the Finance Minister at risk. Presenting the Appropriation Bill, the Finance Minister used an anecdote to express how our economy is trapped between three competing challenges. The proposals of the budget such as to cut down expenditure by cutting down the fuel quota and extending the pension entitlement for 10 years for parliamentarians, was a positive signal. However, announcing a relief package completely opposing this may cause further business uncertainty. 

An ideal relief package 

While a relief package has its own pros and cons in politics and economics, it is worthwhile to explore how the relief package should be structured. As this column expressed multiple times, the only solution to overcome this crisis is through structural reforms. Structural reforms will be initially painful across the board, specially for low income earners. Pressure is already upon them with high inflation, and this demographic is being forced to make sacrifices to their food basket. 

The long-term solution for this problem is establishing a digital cash transfer system based on market prices. For example, a fisherman may consume a fair share of fuel to generate income and to contribute to the economy. But the consumption of fuel of a daily wage earning labourer is limited. So the fuel subsidy has to be targeted more towards the fisherman and less towards the labourer. A digital cash transfer to the bank account based on market prices of fuel is the most efficient way of undertaking this. If we try to keep the entire fuel price low through a non-targeted system, consumers who consume more and can afford market prices will automatically benefit as well. At the same time it may be an incentive for low fuel economic machines to be used when fuel prices are low across the board. A cash transfer will not only provide dignity for a person to consume based on their needs, but also provides freedom of choice to shift to alternatives.

Making it a cash transfer avoids political interference where beneficiaries need not worry about their political opinion in order to be entitled for the scheme. Governments can also save resources and be more efficient by adhering to the market forces of demand and supply.

The Samurdhi programme which is the main safety net in Sri Lanka is very poorly targeted and about half our households have become entitled to it. Additionally, about 25% of the Samurdhi fund is spent on administration costs. Therefore, a direct cash transfer can be more efficient than Samurdhi by saving administration costs. 

India administers a system called Adhar with a colour-coded system, where the value of the cash transfer is determined based on the level of poverty. In addition to being based on the poverty level, the option of managing the cash transfer in subsidies often varies with global prices of fuel and liquid petroleum gas. 

Unfortunately, the relief package which was announced did not have the depth necessary, and the targeting could have been better. If we look at the public service, it is usually overstaffed and worker category cardres who are entitled for overtime are maintained by the Sri Lankan Government. As a result, in addition to the basic pay, people simply sign up for overtime work without really having the need to commit for overtime. On multiple occasions many board chairpersons and senior officers have mentioned that they sign off on overtime for their staff assistants and chauffeurs, where in most cases, the total take-home pay is higher than that of the chairman or the senior officer. As such, providing a Rs. 5,000 allowance with non-existing resources would not really help to overcome the crisis. 

Sri Lanka should move towards a digital cash transfer system to strengthen our safety net. But simply strengthening the safety net won’t help the poor. Making imports competitive, bringing down tariffs on essentials and connecting with global value chains is of paramount importance in order to help the poor out of poverty. 

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.

It’s not about reserves – it’s about reforms

Originally appeared on The Morning

By Dhananath Fernando

We spent another year just debating so many economic issues without really getting anything substantial done. 

During the last few days, the debate has been around the official reserves position of the Central Bank of Sri Lanka (CBSL). So many questions have been raised on whether it can be used to service our debt or whether this is just a double account entry of the Chinese Yuan worth of $ 1.5 billion, which we secured many months ago. The reasonable answer is “we don’t know” until the CBSL makes the data available. The CBSL now says that our reserves are currently at $ 3.1 billion, but refuses to reveal the breakdown of how the country doubled its reserves. So much for transparency!

However, we all have to admit that the economic solutions implemented to overcome the crisis haven’t really worked. Rather, they have thrown the lower and middle-class Sri Lankans from the frying pans to the fire. 

A self-sufficient economic model was proposed at the initial stages. Many economic experts including this column highlighted why a self-sufficient economic model is an expired concept in the 21st Century. Therefore, we must reiterate that the pursuit of self-sufficiency can completely isolate Sri Lanka from global supply chains. As a result, our trade balance will be adversely affected and will continue to be so, due to our lack of understanding of the simple balance of payments and the dependency of exports on imports. Further, there is the absence of incentive reforms.  

A policy of strict import controls and price controls was imposed with the objective of boosting local production, sidelining the market forces. The result was shortages and long lines even for essentials such as liquid petroleum gas and milk powder. Another argument was brought in that the import controls can create a trade surplus. The past two years have proven fair and square that the direction of our policies is completely wrong. In the period of January-October 2021 imports rose by 26.5% and the overall trade balance grew by 34% to $ 6,498 million. This is while the strong performance of exports increased by 22%. All this happened against the backdrop of attempting to keep the interest rates artificially low and keeping the US dollar artificially fixed at around Rs. 200. This is one main reason for our US dollar shortage. Simply, the excess demand created by a loose monetary policy is the reason for there being excess demand for imports. 

Afterwards, Modern Monetary Theory (MMT) was introduced as a panacea for all forex problems, claiming there is no connection between inflation and money supply. Today, inflation has risen to 11.5% fueling the balance of payment crisis to a boiling point. Instead of resolving the problem at its root, shortsighted measures were proposed such as tax amnesties and incentives for some US dollar savings without realising the basics – which is that investments are driven by the perception of trust, credibility, and policy consistency instead of ad hoc factors. People who believe in the efficacy of MMT for a small country with a non-international currency could be believing in the tooth fairy. 

Meanwhile, some considerable effort was also made by the Government in the right direction, but it was not adequate. Someone may call it a half-hearted attempt to overcome the scale of the crisis we are facing. The Deregulation Commission, appointed by His Excellency the President, proposed to do some land reforms and improve ease of doing business. Further price controls have been removed, except the price control on the US dollar and interest rates. 

With our inability to provide a clear direction, rating agencies questioned Sri Lanka’s debt sustainability multiple times and requested a credible plan which failed on many occasions. 

The new Governor presented a six-month roadmap, but in my view, the damage of the MMT, the self-sufficient economic model, and industrial policy logic had already been done by then. 

A discussion has always been up in the air regarding whether we should go to the International Monetary Fund (IMF). At the same time, the discussion was underway on whether we should re-profile and restructure our debt. 

In simple terms, that was the summary of economic policy in 2021. We were optimistic that tourism numbers will pick up and it’s a relief that the numbers indicate a positive trend. However, higher tourism increases our import components as well. Expansions, maintenance, and consumption by tourists result in a fair share of imports, so expecting the tourism revival as a panacea for our forex shortages is just another shortsighted dream similar to the MMT. 

In 2022, the outlook will remain the same or it will worsen unless we undertake economic reforms. Expecting a different result without reforms is mere wishful thinking. 

Whether we go to the IMF or not, the economic reforms have to be the starting point. The Government should initiate the reform agenda without waiting for anyone else. However, an IMF programme (always with the agreement of the Government), would be more credible to our lenders and potential FDI partners. Our present situation is not credible to both foreign and domestic investors. 

Below are a few suggestions we have to think through:

  1. Establish independence of the CBSL and make sure that the exchange rate is competitive

  2. Privatise loss-making state-owned enterprises and consolidate and privatise non-strategic SOE’s

  3. A cash transfer system for poor people based on market prices to face the high cost of living during the reform period

  4. A grand-scale deregulation of business regulations as per the report submitted to the President (by the Lalith Weerathunga and Krishan Balendra committee)

  5. Lower tariff rates with Sri Lanka customs reforms to increase global trade and increase competitiveness

  6. Freeze government sector recruitment and offer voluntary retirement schemes and minimise the government cadre

We have to provide a rapid response for this economic crisis without waiting until the last minute to come up with solutions. 

The reality is we are already too late – not by months but by a few decades. 

Rather than focusing on the official reserves position, we have to shift our gears towards reforms. No country ever overcame an economic crisis without any economic reforms.  

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.

Did we miss the opportunity to formulate ‘a non-traditional budget’?

Originally appeared on The Morning

By K.D.D.B Vimanga

A non-traditional budget was what the country needed. In general, budgets in Sri Lanka have mostly been giveaways to maintain political status quo or simply an outline of the Government’s plan for the economy, without taking into consideration current economic realities. As a result of numerous governments prioritising political gains over economic realities, the nation is currently experiencing severe economic consequences. These are manifested to the public in the form of steep price increases, shortages of essential goods, import restrictions, and much more. The macroeconomic consequences of this are fiscal and monetary instability, coupled with serious questions on Sri Lanka’s debt sustainability. A non-traditional budget would have indicated the broad policy direction and priorities of the Government with an understanding of where the economy is right now. The Budget would have prioritised macroeconomic stabilisation, taking into consideration the seriousness of the present economic crisis. Whether the budget proposals for 2022 achieve this remains a question.

Analysing the Budget Speech makes it clear that the intention of the Budget was to be conscious of government expenditure. Is this consciousness sufficient? Especially at a time where the foreign debt service forecast for 2022 is an estimated $ 4,483.80 million? (1), when the state of the country’s foreign reserves stood at about $ 2.6 billion in September 2021 (1.7 months of imports [2]), and following which the net foreign assets have been negative in the months after. This very question of debt sustainability remains the elephant in the room. Yet, the Budget Speech failed to elaborate on specific measures that the Government hopes to utilise to meet this target. A budget that understands the present challenges would have presented a roadmap of actions to meet these outflows. The failure to do so highlights the failure to streamline the Budget to meet the seriousness of the present economic crisis.

A certain amount of credit must be given to the Government for refraining from making excessive government expenditure proposals. There is a slight increase in government total expenditure from the revised estimate of Rs. 3,387 billion for 2021 to Rs. 3,912 billion for 2022. This remains prudent in comparison to the Government’s total revenue from the revised estimate of Rs. 1,556 billion in 2021 to Rs. 2,284 billion (3). According to the figures provided by the Ministry of Finance, the budget deficit would see a reduction from Rs. 1,826 billion in 2021 to Rs. 1,628 billion in 2022. However, it should be noted that while the Budget Speech of 2021 promised a deficit of 9%, the revised estimate of the deficit has increased to 11.1% as per the Fiscal Management Report of 2022.

The budget deficit still remains unsustainably large for a country with a gross domestic product (GDP) of $ 80.7 billion in 2020 (4). The Budget tries to reduce government expenditure by proposing policies to reduce recurrent expenditure. These include reducing the fuel allowance provided to ministers and government officials by five litres per month, a 25% reduction in telephone expenses, and increasing the eligibility of MPs to receive a pension from five to 10 years. The magnitude of these cuts in government expenditure remains insignificant in contrast to the real need of the hour; especially when the Budget has made provisions to further expand the public sector, by offering permanent appointments to over 53,000 graduates which would drain a further Rs. 27,600 million from the exchequer. Such is counterintuitive to policies aimed at countering recurrent expenditure, and maintaining a bloated public sector is simply unaffordable with the current state of our public finances. Bold cuts to government expenditure would have reassured Sri Lanka’s creditors, donors, and lenders that we are serious about reforms while also making more resources and talent available to the private sector. Maintaining inflated departments with little or no productive output is a luxury we cannot afford anymore.

The continuation of financing this budget deficit through the domestic market borrowings will have a crowding out effect, especially as it will stunt credit available for the private sector and in return slow the country’s medium to long-term growth potential. Therefore, an ideal budget or a non-traditional budget would have prioritised fiscal consolidation. This includes setting a clear path to reduce the fiscal deficit to 5% by 2024. More efficient tax policy alternatives would have been reintroducing PAYE and withholding taxes and widening the tax base and spreading the tax burden to include a significant number of organisations that were given long tax breaks.

The Budget Speech highlighted three policies that, if implemented right, could direct the economy towards growth. The first being the acknowledgement that price controls have failed, and that market intervention creates uncertainties that affect consumers. This must be looked at with pragmatism, as the complete elimination of price controls including in the energy sector, can achieve better outcomes for the economy. The second being a policy focus to ensure a fair and competitive market. Recognising the role of the market economy and competition is a move in the right direction. This remains the only tried and tested solution to lower prices in the economy. The third policy that should be highlighted is the Finance Minister’s acknowledgement of a re-examination of the Samurdhi scheme. The scheme currently excludes some of the most vulnerable households and therefore, there is a need for tighter administration to ensure benefits accrue to those who need it most. The focus to streamline this initiative towards building entrepreneurship, fostering SMEs, and skill development is the right decision. However, for this to materialise, the Government needs to implement comprehensive reforms to improve ease of doing business and a comprehensive programme of digitalisation.

Addressing macroeconomic imbalances should have been a policy priority of the Budget. This includes addressing the fiscal deficit and the external current account deficit which have effects on the rest of the economy through interest rates and exchange rates. The Budget tries to address this issue by focusing on empowering local production. Prioritising self-sufficiency without opening the domestic market for competition is untenable. The Finance Minister’s speech outlined proposals to boost productivity, which are indeed pragmatic. Yet, one cannot increase productivity without improving competition. Focusing on improving national output has no economic impact without boosting domestic competition.

In the background, there was hope that the Government would start stabilising public finances, which would restore confidence. However, analysing the policy priorities of the Budget makes it clear that there has been little attempt to address the deficit and debt sustainability. Therefore, markets are unlikely to respond positively. At this juncture, Sri Lanka cannot afford to be complacent about our credit ratings. The Budget provided an ideal opportunity to provide a credible plan of action to get our credit ratings up. However, we seem to have missed this opportunity.

Measures to control public finances: spending, budget deficits, and debt 

Year after year, the budget proposals have highlighted large-scale policies that remain limited to budget speeches. However, the present economic storm makes no space for such complacency. Hard structural reforms will need to be implemented inevitably. The Budget could have been the starting point. However, it seems that this window has passed. Therefore, there is a conscious need to build consensus for the implementation of key structural reforms that achieve macroeconomic stabilisation and long-term economic growth. Without macroeconomic stability, there will be no growth. Furthermore, these reforms need to be institutionalised. One way of doing this is the adoption of a medium-term fiscal and monetary framework that gives confidence to donors, lenders, investors, and citizens. Having such a framework will act as a clear sign that the State is committed to fiscal prudence and monetary stability. A medium-term expenditure framework is a tool for establishing public expenditure programmes within a coherent multi-year economic and fiscal framework. 

Other key structural reforms for macroeconomic stabilisation, as outlined in Advocata’s Framework for Economic Recovery, include public finance management and public sector reforms, state-owned enterprise reforms, enhancing monetary policy effectiveness and maintaining exchange rate flexibility, supporting trade and investment to strengthen external trade, land reform, improving ease of doing business, and bridging infrastructure gaps. The only salvation to Sri Lanka’s present economic crisis is such a comprehensive reform package that goes beyond a traditional budget.

References:

  1. MOF annual report 2020

  2. CBSL Recent Economic Developments: Highlights of 2021 and prospects for 2022

  3. https://www.treasury.gov.lk/api/file/0c3639d9-cb0a-4f9d-b4f9-5571c2d16a8b

  4. https://data.worldbank.org/indicator/NY.GDP.MKTP.CD?locations=LK

K.D.D.B. Vimanga is a Policy Analyst at the Advocata Institute. He can be contacted at kdvimanga@advocata.org.

The Advocata Institute is an Independent Public Policy Think Tank. Learn more about Advocata’s work at www.advocata.org. The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute


Losing by focusing on the winners

Originally appeared on The Morning

By Dhananath Fernando

  • Winners focus on winning and losers focus on winners.

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

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

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

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

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

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

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

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

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

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

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

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

Underneath the underwear patriotism

Originally appeared on The Morning

By Dhananath Fernando

  • Can Sri Lanka become self-sufficient in undergarments?

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

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

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

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

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

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

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

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

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

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

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

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

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

Reform or Perish. It’s not too late

Originally appeared on The Island, ColomboTelegraph and Groundviews

By K.D.D.B Vimanga and Naqiya Shiraz

The Sri Lankan economy faces a historical crisis.  The root causes are the twin deficits. First, the persistent fiscal deficit - the gap between government expenditure and income. Second, the external current account deficit - the gap between total exports and imports.  The problems have been festering for too long. Without urgent reforms, the crisis could easily morph into a full-blown debt crisis. 

Sovereign debt workouts are extremely painful for citizens. A mangled debt restructuring can perpetuate the sense of crisis for years or even decades. A return to normal economic activity may be delayed, credit market access frozen, trade finance unavailable.

With the global pandemic, these are unusual and difficult times. The next five years are going to be crucial for the country.  The problems can no longer be avoided and should be faced squarely. The journey ahead is going to be painful but the longer these are delayed the worse the problem becomes and the magnitude of the damage compounds. 

The State of the Economy 

The new government inherited a fragile economy, battered by the Easter attacks of 2019, the constitutional crisis of October 2018 and the worst drought in 40 years in 2017. With the pandemic in 2020 Sri Lanka’s economy shrank by 3.6% with all sectors of the economy contracting. 

Yet, the pandemic is not the sole cause - it only accelerated the decline of Sri Lanka’s economy that was weak to begin with.  The country has long been plagued by structural weaknesses, with growth rates in the last few years even below the average growth rate during the war. Mismanaged government expenditure coupled with a long term decline in revenue have characterised Sri Lanka’s fiscal policy. As of 2020 total tax as a percentage of GDP fell to just 8%, while recurrent expenditure increased. 

Borrowing to finance the persistent budget deficits is proving to be unsustainable. Total government debt rose to 101% of GDP in 2020 and has grown since. Sovereign downgrades have shut the country from international debt markets. The foreign reserves declined from US$ 7.6 bn in 2019 to US$ 5.7bn at the end of 2020 and to US$ 2.8 bn by July 2021. This level of reserves is equivalent to less than two months of imports. With future debt obligations also in need of financing, the situation is dire. 

Reserves and months.png

The import restrictions placed to combat this foreign exchange crisis have failed to achieve their purpose and are doing more harm than good. imports rose 30% in the first half of  2021 compared to 2020 despite stringent restrictions.

The problem lies not in the trade policy but in loose fiscal and monetary policy that has increased demand pressures within the economy, drawing in imports and leading to the balance of payments crisis and consequently the depreciation of the currency.  

Measures by the Central Bank to address this by exchange rate controls and moral suasion have caused a shortage of foreign currency leading to a logjam in imports.

Money growth.png

Fundamental and long-running macroeconomic problems were  intensified by the pandemic.Import restrictions, price and exchange controls do not address the real causes.

Treating symptoms instead of the underlying causes is a recipe for disaster.

The continuation of such policies will lead to the deterioration of the economy,  elevate scarcities, disadvantage the poor who are more vulnerable and in the long run lead to even higher prices and lower output due to lack of investment. 

Sri Lanka’s GDP growth over the last decade has been alternating between short periods of high growth and prolonged periods of low growth. This is a result of the state-led, inward-looking policies of the last decade.

A comprehensive reform agenda must be built around  five fundamental pillars:

i) fiscal consolidation - The need to manage government spending within available resources and to reduce debt are paramount. Revenue mobilization must improve but the control of expenditure cannot be ignored. Budgetary institutions must be strengthened and there must be reviews not only of the scale of spending but also the scope of Government.

 ii) Much of government expenditure is rigid - the bulk comprises salaries, pensions and interest so reducing these is a long term process. Reforming State Enterprises, especially in the energy sector and Sri Lankan Airlines is less difficult and could yield substantial savings. Continued operation of  inefficient and loss-making SOE’s is untenable under such tight fiscal conditions. Financing SOE’s from state bank borrowings and transfers from government reduces the funds available for vital and underfunded sectors such as healthcare and education. Excessive SOE debt also  weakens the financial sector and increases the contingent liabilities of the state. Therefore SOE reforms commencing with improving governance, transparency, establishing cost reflective pricing and privatisation are necessary. This can take a significant weight off the public finances and by fostering competition contribute to improvements in overall economic  productivity. 

iii) Tighten monetary policy and maintain exchange rate flexibility.  Immediate structural reforms include, Inflation targeting, ensuring the independence of the central bank by way of legislation and enabling the functioning of a flexible exchange rate regime. Further significant  attention has to be placed on the  financial sector stability with a cohesive financial sector consolidation plan, with special emphasis on restructuring of SOE debt. 

 iv) Supporting trade and investment. Sri Lanka cannot achieve economic growth without international trade which means linking to  global production sharing networks. Special focus has to be given to reducing Sri Lanka’s high rates of protection which creates a domestic market bias in the economy along with measures to improve trade facilitation and attract new export oriented FDI. 

Attempts to build local champions supported by high levels of protection have 

(a) diverted resources away from competitive businesses, 

(b) created a hostile environment for foreign investment, 

(c) been detrimental to consumer welfare,

(d) dragged down growth

v) Structural reforms to increase productivity and attract FDI - Productivity levels in Sri Lanka have not matched pace with the rest of the growing economies. The reforms mentioned above are extensively discussed in Advocata’s  latest publication “Framework for Economic Recovery”.

Sri Lanka  stumbled into the coronavirus crisis in bad shape,with weak finances; high debt and widening fiscal deficits. It no longer has the luxury to delay painful reforms. Failure to do so will not only jeopardize the economy; it could even spawn social and humanitarian crises.

Naqiya Shiraz is the Research Analyst at the Advocata Institute and can be contacted at naqiya@advocata.org.K.D.D.B. Vimanga is a Policy Analyst at the Advocata Institute. He can be contacted at kdvimanga@advocata.org.

The Advocata Institute is an Independent Public Policy Think Tank. Learn more about Advocata’s work at www.advocata.org. The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute


The myth: Self-sufficiency guarantees food security

Covered in the Daily Mirror, Ada derana and Colombo Telegraph

By Sathya Karunarathne

The novel coronavirus which drove cities and countries into lockdown has now sparked anxiety over a possible food crisis given the increase in export and import bans and disruption of global food supply chains. 

This uncertainty has left the Sri Lankan government to question whether these disruptions would affect food security in the near future and if ensuring self-sufficiency is the absolute and undisputed solution to this conundrum. In this attempt to achieve self-sufficiency in food the government has resorted to import substitution to strengthen domestic production.

Keeping in line with these protectionist policies the government has indefinitely extended import controls that were initially introduced on the 22nd of May for three months “to be in effect till further notice”. Import controls in this degree and nature have not been seen since the 1970s and this has led policymakers and public debate to be heavily inclined towards the possibility of revisiting and reconsidering the socialist policies adopted by the Bandaranaike government.

How credible is the popular narrative?

The renewed vigor attached to closed economic policies and food protectionism through public discourse is perhaps understandable. Amidst a foreign exchange crisis in April, the government imposed import restrictions on 156 categories of products including essential food items such as rice, flour, and sugar. 

Although import restrictions on most of the essential food items have been removed, temporary restrictions have been extended indefinitely on grains, stainless steel tankers and bowsers needed for the distribution of milk and blast freezers needed for preserving poultry meat. While these restrictions have been put in place with the motive of protecting the depreciating rupee it carries a massive potential to further harm the domestic distribution and storage of food which is already in a fragile state.  

Moreover, the latest Climate and Food Security Monitoring bulletin of WFP (United Nations World Food Programme) raises concerns of food security among vulnerable parts in Sri Lanka as a result of the impact and control response of the COVID-19 outbreak. The report further elaborated that weather-related shocks combined with poor hygienic and sanitation conditions could result in an increase of acute malnutrition in the island.  

In response to these growing anxieties in the wake of the COVID 19 pandemic, the government put in place programs and policies to ensure self-sufficiency in food within the island. On the 28th of May, the government approved the importation of 2,500 dairy cows from Australia. The motive behind this decision as stated by the cabinet spokesman is to ensure Sri Lanka’s self-sufficiency in milk by 2025, even though this measure failed just over a year ago with the death of 500 imported heifers that were ill-suited to Sri Lanka’s climate.

Furthermore, restrictions on maize imports that were imposed with the intention of strengthening domestic production has resulted in a lack of maize as feed for chicken. Available alternative feed is not as nutritious for poultry and has affected the quality and production of eggs. Egg production has fallen from 200-300 eggs per year from chicken to 200-240 eggs per year.  With the fall of production, prices have picked up.

On the 3rd of July, Senaka Samarasinghe, Managing Director of Harischandra Mills PLC stated to Ada Derana that import restrictions imposed on agricultural products such as ulundu, black-eyed pea, big onion, red onion, green gram, peanut, corn, and dried chili have affected manufacturers adversely resulting in a massive drop of production. 

These import restrictions have severely affected manufacturers who rely on ulundu as a raw material to produce products such as papadam, flour, thosai, wadai and dhal. Given the lack of raw materials, Harischandra Mills PLC has had to reduce their production by a staggering 90 per cent. Sri Lanka’s domestic ulundu requirement per year is about 12,000 metric tonnes (mt). The production of ulundu domestically has reduced to 5000 mt due to the drought. External factors that affect the domestic supply of food such as these calls for imports to fill the output gap. 

These import restrictions have adversely affected Sri Lanka’s already fragile export sector as well, as manufacturers have failed to meet the demand of international markets for products such as thosai mix. Harischandra PLC exports 15 per cent of its thosai mix to markets in Europe, North America, Asia, and Australia. These protectionist policies that aim to protect the domestic producer and to strengthen their production, have resulted in achieving the very opposite of its intentions as small scale producers of ulundu have opted to close down resulting in reduced shop sales. Moreover, the ban has affected the production of kurakkan flour with producers resorting to completely stopping or reducing production. This fibre-rich alternative to wheat flour is widely consumed by diabetic patients and is an important part of their medically recommended diet. 

It is no doubt that the pandemic has brought to light the extreme vulnerability of Sri Lanka’s domestic food supply to external shocks. These policies have a demonstrated history of achieving quite the opposite of their intentions. The ’70s “produce or perish” economy is an excruciating reminder of this fact as bug-infested flour, hardly edible bread, and stone infiltrated rice was every Sri Lankan’s staple. Therefore the popular narrative that promotes restrictive policies has zero credibility as it will only tighten the already constrained food supply by repeating the mistakes of the past. Long term policy solutions to the crisis, therefore,  should focus on the sustainability and practicality of isolating the island from global trade and food supply chains and producing the bulk of our dietary needs domestically.

Sustainable approach to attaining food security: Lessons from Singapore

The Global Food Security Index (GFSI)  ranks countries’ food security based on food affordability, availability,  quality as well as an adjustment for natural resources and resilience.  Singapore was able to secure the title as the most food-secure nation for two consecutive years, with a high rank in all three core pillars. 

Singapore’s success is attributed to the government’s continued commitment to stay connected to global food supply chains and to strengthen local production. Singapore diversified its food import sources from 140 countries in 2004 to more than 170 countries and regions in 2019  making the country’s food supply chain more resilient and has set a “30 by 30” goal to produce 30 per cent of the country’s nutritional needs by 2030. Diversifying food imports and making the country’s food supply chain more resilient are two sustainable policy solutions through which Sri Lanka can ensure long term food security. 

The Food and Agriculture Association of the United Nations (FAO) states that the crisis we are facing is a global problem that requires a global response.  This calls for governments to collaborate to avoid further disruptions to food supply chains. Import diversification in the context of food security refers to increasing the number of countries from which we import food. 
This ensures an undisrupted inflow of food supply into the country ensuring both physical availability and choice of food in crisis situations. Import diversification is effective even in ordinary situations as loss in the harvest of one exporting country will not threaten the availability or supply of that particular product/produce for the importing country. Singapore imports over 90 per cent of their consumption needs with only 13 per cent of vegetables and 9 per cent of fish being produced locally.  

Moreover, in order to avoid disruptions to the supply chain that may occur by depending on a single major import supplier Singapore has resorted to promoting frozen and powdered product alternatives. Sri Lanka cannot resort to these options by restricting the importation of freezers, tankers, and bowsers that are necessary for such alternatives.

The world is highly globalized and so are food supply chains. Isolating from this interconnected food supply chain will only exacerbate Sri Lanka’s food insecurity. This was evident in the 2007-2008 global food price crisis when export restrictions put in place by exporting countries to increase food security domestically led to serious disturbance in the world food market resulting in price spikes and increased price volatility. In a more local context, this was evident when the government banned the importation of turmeric along with other non-essential goods which led to a scarcity and the available being sold for an exorbitant price ranging from Rs 300-350/- per 100 g despite a maximum retail price of Rs.75 per 100 g. 

Eradicating weaknesses and inefficiencies in the domestic food supply chain is essential to ensuring food security within a country. This is referred to as building a resilient food system domestically. The Food and Agriculture Organisation of the United Nations (FAO) defines food security as follows: “Food security exists when all people, at all times, have physical and economic access to sufficient, safe, and nutritious food that meets their dietary needs and food preferences ”.  The abrupt lockdown and curfew COVID-19 brought revealed that our domestic food supply chain does not offer economic or physical access to nutritious food. This was painfully apparent when people desperate to eat set off a stampede during a cash handout held in celebration of Eid, leaving eight injured and three killed. 

This is an obvious cautionary alarm to the government to fix the inefficiencies of the domestic food system and to enhance emergency food assistance to the vulnerable communities, who most often end up bearing the brunt of such inefficiencies. Every crisis presents an opportunity to focus on rebuilding through a novel lens. This presents an opportunity for Sri Lanka to rethink its approach to food security and to branch out our policy solutions to more sustainable and timely options.

Solution 

This crisis has proved that import restrictions and heavy gravitation towards self-sufficiency cannot solve the myriad of issues plaguing the country’s food supply system. Closed economic policies to achieve self-sufficiency, do not guarantee all citizen’s economic and physical access to nutritious food nor do they guarantee a resilient domestic food supply chain. 

Investing in cold storages and strengthened logistics networks, shifting towards climate-smart agriculture, ensuring the supply of raw materials and agricultural equipment by making the eligibility verification process for tax exemptions less complicated and improving ease of doing business, removing import restrictions on veterinary medicine, chemical fertilizer, and other inputs,  relaxing restrictions on the cultivation of crops, strengthening emergency food assistance to vulnerable communities with linkages to local and provincial governments can be stated as policy priorities that can address the inefficiencies of the domestic food supply chain.

The way forward to ensuring the island’s food security is in improving internal inefficiencies while recognizing the extreme and timely importance of staying connected to global food supply chains through relaxing import restrictions and multiplying our food and raw material import sources. 

Sathya Karunarathne is a Research Executive at the Advocata Institute and can be contacted at sathya@advocata.org or @SathyaKarunara1 on twitter. Learn more about Advocata’s work at www.advocata.org. The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute

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.

Import controls - out of control?

Covered in the Colombo Telegraph

By Erandi de Silva

As the COVID-19 virus forced much of the world into lockdown, the scale of interdependence and reliance on trade across nations was apparent by the global urgency to re-open economies as soon as possible. The shortage of goods and loss of income experienced due to the disruption of supply chains helped some nations realize that a country typically stands to lose more than it may gain by being shut out from the global market. Sri Lanka continually increasing import controls and locking itself out of trading networks then begs the question, why are we punishing ourselves? 

A common justification in people’s minds may be that difficult times call for difficult measures; curbing imports may seem inevitable amidst the current health crisis caused by a contagious virus and the financial threat of a depreciating currency. However, as elections are approaching, it appears these decisions are primarily driven by political and not economic motives. Given that Sri Lanka’s exchange rate became a key campaign topic in the last election, the current rise in import controls seems to be an attempt at artificially maintaining a “strong” currency prior to elections after the excessive money-printing in March this year. 

Furthermore, such decisions should also be recognised as far more than precautionary policies due to the pandemic, and rather, a projection of the national tendency to revert to protectionism. The ban placed on maize imports in mid-January (prior to when the first case of coronavirus was reported in Sri Lanka) indicates this predisposition. Sri Lanka exhibits a recurrent desire - often fueled by nationalistic rhetoric - to boost domestic production or even become self-sufficient across various sectors and industries, sometimes in complete ignorance of comparative advantage and practicalities. This is evidenced in the aftermath of importing 5,000 milk cows in order to boost local dairy production in 2017 which led to many farmers accruing debt whilst over 400 cows died due to poor living conditions. Not only did it result in Sri Lanka still importing; this method was more expensive because now money had to be spent to feed and care for the cows in the absence of their natural habitat. Despite this result, the new Government again approved a proposal to import 2,500 cattle from Australia on the 1st of June this year in the hope of curbing milk product imports to Sri Lanka.

In the case of import controls and such protectionist actions, problems tend to manifest regardless of the intentions behind the implementation of such policies. For example, the maize embargo which was imposed with the intent of accelerating domestic production and protecting local farmers has led to several adversities - now including a shortage of supply. It is important to note that the brunt of the outcome was faced by a vulnerable stakeholder that the Government aims to protect: small-scale poultry farmers. As the main consumers of maize (because it is needed for chicken feed), poultry farmers were initially forced to pay higher prices to obtain maize and were at the mercy of Sri Lanka’s oligopoly of grain collectors. The problem was exacerbated as domestic stocks of maize withered away and suppliers could not import to fill the deficit. According to the Export Development Board, Sri Lanka imported 102,461.175 metric tonnes of maize in 2019 despite domestic production for the year being at 245,647 metric tonnes. This clearly reflects that the local demand for maize is far greater than the domestic capacity for maize production. Another example of unintended consequences can be extracted from the confectionery industry which recently expressed concern regarding the inability to access imported raw materials that are necessary for cost-effective local production. The 340% special commodity levy on block fat and margarine imports which was introduced this month has led to significant strain and job-insecurity within the industry

The new administration recently reiterated their pledge made under the ‘Saubhagya Dekma’ policy statement of turning Sri Lanka into a “people-centric production economy”. Despite his claim that limiting imports has “paved the way” for a production economy, it is necessary to understand that even most local businesses require imported materials in order to produce. The latest statistics from the World Bank indicate that 38.19% of our total merchandise imports are intermediate goods that are used locally as inputs for production. Regardless of our ambitions, Sri Lanka’s economy requires imports for growth. Many of our consumables are imported and local businesses, including key exporters such as the textile industry, use imported raw materials. Curbing imports will impede the ability of local businesses to cost-effectively grow.

If the Government fails to readjust its policy on import controls and continues down the path of increasing protectionism post-COVID-19, Sri Lanka may continue to face economic instability and revenue loss within the sectors that are affected by these constraints. Ultimately, despite the rhetoric and propaganda of “saving local businesses” and creating a brand of “made in Sri Lanka” that enamours the public during political campaigns, it is often the most vulnerable within local businesses that stand to lose the most from the enactment of protectionist policies. As poultry farmers struggle to maintain their income and employees within the confectionery industry remain anxious about the status of their jobs, the question remains: why are we punishing ourselves?

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.

Production economy: Think small, Sri Lanka!

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

Originally appeared on The Morning


By Dhananath Fernando

Why can’t we produce the goods we need? Why do we have to depend on all these other countries?  Why can’t we produce world-class brands? Over the years, these have been million-dollar, or to be politically correct, million-rupee questions. 

From agri-based economic planning to state-owned industries that left a stench not only on the economy but also on the shirts and the sarees of the public, policymakers have ignored or botched time and again economic reforms which could have made Sri Lanka a production-based economy.

Let’s get back to fundamentals – “producing an economic good” and “producing it competitively” are two completely different concepts. I can drive a car, but I’m no Ayrton Senna or Michael Schumacher. In cricket terms, many Sri Lankans can play cricket but only a handful can make it to the National XI. In today’s age, producing an economic good is like playing to win at a World Cup. Observe how the Australians go about their business at World Cups. They play to win. If we are not focused and fail to adapt, we will fail as a nation. As Charles Darwin said: “It’s not the strongest but the most adaptable that will survive.” 

Many centuries ago we produced goods and services for our consumption and all parts and components of that economic good or service had an ecosystem in the same country. With the invention of penicillin, arguably the most important life-saving drug ever discovered, by Scottish scientist Alexander Fleming, the world saw a burst in population and Sri Lanka was no exception. Keeping a growing population fed, housed, and employed paved the way for integrated supply chains to form the world over. 

This is because every country has a competitive edge in a particular good or service. For example, Germany and Japan have it in cars, Korea in electronics, New Zealand in dairy products, etc. Factors such as human capital, education, technical skills, natural resources, the climate, and trade agreements have a direct impact on what we produce. Since independence, Sri Lanka has relied heavily on the big three for foreign exchange, namely tea, coconut, and rubber, but failed to make it as an integrated member of the world supply chain mechanism due to poor branding and value addition. Other countries have successfully done it. There are French champagne, Swiss chocolates, California oranges, etc. 

However, the apparel sector which took off during the post-liberalisation period has eclipsed the rest as a major player in the world apparel sector and an integrated part of the world supply chain. The apparel sector competes on price, quality, service, and delivery with the rest of the world and has won due to specialising in high-value apparel such as lingerie and swimwear. With the exception of the aforesaid example, as a result of not understanding the need for producing goods competitively, we failed to catch up with the fast-growing East Asian tiger economies. 

Joining a global production network

Rather than producing all parts and components of a complicated final product, countries began producing a small component of a big product in a complex procedure. As an example, rather than producing a total computer, companies started producing microchips, transistors, and hundreds of other small components in large scale. Producing small components of large complex products in a gigantic scale brought the cost significantly down and as a result, the price of products became reasonable. This process became a common factor in the range of high-end expensive products like aeroplanes and even to lower-end products like sporting shoes. 

Source: Aeronews TV.com

Going back to my cricket example, winning a World Cup means not only having more talented players but a host of other elements and individuals which are already operating at a world-class level. This includes compatible cricket turfs, safety and cricketing gear (headgear, pads, gloves, cricket bats, boots, cricket bats), training techniques, professional administrators, supplements, and the list goes on. In simple words, now the production of even a simple component or a product is shared across the globe (which is called Global Production Sharing [GPS]). Everyone is contributing to a small component of a complex product and everyone is part of a big value chain (which is called a Global Production Network [GPN]). 

Sri Lanka’s strategy should be to join more and more GPNs if we are serious about converting our economy to a production-based economy. The good thing about joining GPN is that it only requires a basic-skilled workforce to join the network. This will lead to earning better income for unskilled and semi-skilled workers, so the poverty levels will be elevated, because for most vulnerable sections of the society the only tradable good they have is their “labour”, and by joining a GPN we provide the opportunity for them to sell their labour. Countries like China have the unique advantage of being able to produce parts and small components of a complex product as well as assemble it and make the final product due to their large population and availability of labour at all levels (starting from unskilled to supervisory and super skilled). 

How do we do it? 

Some Sri Lankans tend to believe that joining a part of a big production network is an underestimation of utilising full Sri Lankan potential of manufacturing all components under one roof.  Some believe it may hinder Sri Lanka’s ability to create world-class brands and labels. Certainly not; Sri Lanka can create a Sri Lankan label brand for a component rather than a final product. It is already done in Sri Lanka. Certain safety and rubber components that are vital for the automobile sector are manufactured in Sri Lanka. The entire world is aware that Apple computers are not made in the US and even the product itself mentions that it is made in China and designed in the US. The same is valid for Boeing aeroplanes. 

Sri Lanka makes high-end apparel. We manufacture for giant brands such as Victoria Secrets, Nike, and Adidas. But this doesn’t mean that if we launch it under a brand name of ours that there will be the same demand. An apparel manufacturer tried to launch its own brand in India but was not successful. Sri Lanka can move towards assembling and creating more Sri Lankan brands when we evolve from our basics, but as we would all agree, our basics are not right yet. This is where foreign direct investments (FDIs) become critically important. We need to attract one big company to set up here and Sri Lanka should actively capitalise on post-COVID-19 dynamics of companies that are forced to move out from China. If we attract one good investment for a GPN, the rest will follow. That is exactly what Vietnam did, attracting just one company as they knew then the tide would turn. 

Rethink import substitution

A popular strategy to convert Sri Lanka to a production-based economy is considering import substitution. As we have highlighted in this column previously, most of our imports are capital goods and intermediate goods used for many other products (57% of imports are intermediate goods and 23.1% of imports are capital goods). If we are to join GPNs, the inputs have to be competitive. Otherwise, the output will be expensive and uncompetitive.

If we are to carry out import substitution, then ideally it has to be based on the competitiveness of the local substitutes but not substitution through a complete ban or through exorbitant tariff rates for imports. If we are to substitute imports through bans and tariffs it would further impact other local industries due to higher costs and regulatory barriers creating difficulties in managing their input supply chains. That’s why the word “competition” has significant meaning in economic vocabulary. 

The best example for this is the construction industry. Importation of most of the construction raw materials are subjected to a 60%-plus tariff and as a result, our hotel room rates are higher compared to our competitive destinations such as Thailand, given the time taken to capital recover is high (there are more reasons contributing to high room rates but construction cost is one major determinant). So the tourism sector as a whole is impacted just because of one single attempt of import substitution in the construction industry. 

COVID-19 provides us the opportunity to convert Sri Lanka into a production-based economy again, but we need to take the correct path instead of being shortsighted as in the past. We should focus on making our inputs and outputs competitive and look at the broader picture rather than restricting ourselves to micromanagement.  

 

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

The import ban will kill the aspirational Sri Lankan

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

Originally appeared on The Morning


By Dhananath Fernando

A friend of mine in his mid-40s had a heart attack. I mean a real one. He was a dynamic rugby player and a national-level athlete in school. Everyone was dumbfounded at how a person with such a high level of physical fitness could possibly have a heart attack. I asked him: “When did you last hit the gym or go for a walk to burn calories?” He replied: “After I left school, I did not do any exercises.” He has also been constantly eating greasy and unhealthy food. That being said, are we still surprised at why a dynamic school athlete, who probably was the envy of some of his classmates at that time, suffered from a heart attack?

Past glories

We always reminisce at what a blissful nation we were during King Parakramabahu’s reign and how our state coffers were full when our colonial masters – the British – left us. It’s a distant memory, even surreal now; how strong the exchange rate was and how we were only second to Japan, which is now the third-largest economy in the world, just a shade over seven decades ago in 1948.

While all that is undoubtedly true, the world has evolved. And alas, we have been under the shade of a coconut tree with a kurumba (local king coconut) in hand dreaming of our past glory, while Japan, despite getting nuked no less than two times, forged ahead as an economic superpower.

It all comes down to choice. Japan as a nation could have withered away dreaming about their past glory, being the first nation to launch a purpose-built aircraft carrier, the IJN (Imperial Japanese Navy) Hosho, and later, to rule the seas (at least for short while) with – to date – the largest battleship ever built, the IJN Yamato.

Japan lost the Pacific theatre and ultimately the war, comprehensively. They arrived at a crossroads and decided not to simply fade away. As I said earlier, it simply comes down to choice, the choice Japan made. We all know what that was and so can comprehend why the West calls Japan the Land of the Rising Sun.

Japan is just like us, in that it doesn’t have much in natural resources, despite churning out cars and electronics to be exported by the shipload.

Returning to the Pearl of the Indian Ocean, the quagmire we face raises the question: Have we been engaging in our daily 20-minute exercise to be in the game or at least in the park, to keep pace with the world?

Definitely not. And as a result, we have blocked our arteries and are staring down the barrel of an impending economic heart attack as a result.

No more new cars

At the time of writing, the Government announced a complete halt on the import of vehicles and luxury goods for the next five years.

I want to get this off my chest – the Government’s or Finance Minister Dr. Bandula Gunawardana’s definition of a luxury good differs from mine. Maybe even your – the reader’s – definition of a luxury good greatly differs from mine.

A pertinent question is: How can a luxury good be defined? And can imports be stopped in this day and age without actually doing the opposite of what was intended; hurting the economy? A high-end Mercedes, Lexus, Range Rover, or BMW, even with the present exorbitant taxes, might be needed for the tourism industry. Luxury goods send the right signals to investors and tourists, of a vibrant economy. The economy also becomes a lot less scary. No one wants to go for a holiday to Kim Jong-un’s land. It’s just too boring…and scary.

Similar to imposing price controls, the Government may have drifted towards this move with the good intention to manage our limited foreign currency reserves. Put simply, we have about Rs. 16 billion in debt payments that need to be fulfilled in the next two to four years. To put things in perspective, this is a colossal amount, equivalent to 16 times the debt-to-equity swap we transacted for the Hambantota Port. Regardless of good intentions, this will follow a deadly sequence of unintended consequences. Leaving aside the revenue losses to the Government and the impact on the retail sector and bank credit, the biggest impact would be for “Aspirational Sri Lankans”.

In any country, aspirations and aspirational people drive the economy. They need a dangling carrot to entice and motivate them to reach higher.

Let me give you a few examples. In the midst of the Covid-19 battle, the GMOA (Government Medical Officers’ Association) requested tax relief on duty-free vehicle permits from the Government; this received significant criticism online and offline.

Though I have my own opinion, keeping that aside, a question we should ask ourselves is: Why, in the heat of a pandemic, is a leading trade union requesting duty-free concessions on vehicles, out of all the consumable goods?

Although I see their request as unfair, the reality is doctors are aspirational Sri Lankans, and vehicles are an element of an aspirational Sri Lankan; I would even dare to stay, a status symbol. If you look at the life cycle of a doctor, you observe that they study very hard to get into medical college, study even harder for about five to six years at that medical college, and undergo training at an obscure hospital thereafter. After burning so much midnight oil, is it unfair for them to buy a vehicle from the market? (I refer to the general right for a doctor to buy a vehicle, not a duty-free vehicle; whether to utilise one’s aspirations at a cost of a pandemic, is a different discussion altogether).

This fate seems to be shared by not only doctors but by everyone who dreams big and is really committed to contributing back to the world. Young, middle-class professionals work very hard to accomplish the aspirations that drive them. While writing this article, I recalled a TV advert by a finance company or bank, of a young couple on a motorcycle stuck on the roadside, seeking shade during a thunderstorm. They want to move up in life to be able to afford a vehicle. It’s the same situation; everyone wants to live a good life because they have all made enough sacrifices. What is wrong with that and why should they have to pay for the cock-ups since 1948?

Money isn’t everything, but…

Aspirational people drive the entire economy. They are business people who take on the risk of starting a business, pay salaries to employees, and invest their money on research development and technology.

If you ask students at a university or any young graduate during their job interview, what they hope to achieve in five years, their most likely response would be: “Build a house, buy a vehicle, and travel the world.” These are the three things that top the list. Why are banking jobs and even jobs at the Central Bank very high in demand? Simply because of the so-called 4% interest rate for housing and vehicles extended to staff.

Many alternative arguments have come into the limelight; that we have to measure happiness instead of our living standards; some say the material world is not the entire world. That may be true, but for a country which has continuously missed opportunities over and over again, and which is at the edge of another brewing economic crisis, this is not a time to conduct any social experiments and kill the aspirations and hopes of young Sri Lankans.

Of course, I am a true believer that money’s not everything, but there is a cycle that you come to realise and your aspirational motives are what brings you there.

Most of our tariff lines on housing materials are above 60% and the fate is the same for many consumables for middle-class people. How can we justify asking the middle class to sacrifice their living standards by downgrading them at the cost of import controls for someone else’s sins? They have paid their taxes, they have worked hard, and they have done their job. The private sector hasn’t been given any vehicle permits nor have they used any government relief packages. Instead, every corporation has been taxed heavily, even on profits earned over the prior years when the previous Government was in power.

From a different perspective, Sri Lankans who work abroad and send foreign remittances from the Middle East, Europe, and Asia, do so to upgrade the living standards of their families, who consume goods like vehicles and electronics. You can observe how fellow Sri Lankans buy TVs and washing machines from duty-free shops at the airport. Do you think it is fair to ask them to cut their usage of electronics to cover up the failures of our incompetent politicians who ruled the country for the last seven decades?

Solution

We hope the import controls imposed are a temporary move and the Government will reconsider this decision. In this column, we have highlighted multiple times, backed by facts, that import control is not the way to defend our currency nor is it the path to economic prosperity.

In 1972, this experiment failed comprehensively. At the same time, too many controls mean too many regulations, and this may contradict His Excellency, the President’s inaugural Independence Day speech where he hit the nail on the head on why Sri Lanka failed to succeed, speaking of how badly its people were treated with over-regulation. In unprecedented times, it is understood that we need to take hard calls, but the cure cannot be worse than the disease.

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

Let’s not look too far ahead

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

Originally appeared on The Morning


By Dhananath Fernando

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

Historical examples may have limited relevance

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

The status of our basics

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

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

Sacrificing food security for self-sufficiency

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

Originally appeared on The Morning


By Dhananath Fernando

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

What does food security mean?

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

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

Low agriculture productivity

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

Importing food and the trade deficit

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

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

Attracting foreign exchange: Are we on the right track?

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

Originally appeared on The Morning


By Dhananath Fernando

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

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

Measures by the Central Bank

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

Appealing for foreign currency deposits

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

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