Sri Lanka needs a bottom-up approach

Originally appeared on The Morning

By Dhananath Fernando

Regrettably, over the years, Sri Lanka's approach to development has primarily relied on aid and subsidies for its impoverished population. Many politicians have spoken about poverty, but they have often neglected to address its root causes. If our policies were centered on eradicating poverty rather than simply targeting the poor, our development framework could have evolved significantly.

As the adage goes, "there are no poor people, only poor places or countries." A recent report by LirneAsia revealed a startling increase in poverty numbers, rising from 3 million to 7 million people, pushing over 4 million individuals below the poverty line. If our long-standing strategies, such as fertilizer subsidies, Samurdhi, and fuel subsidies were on the right track, how did an economic crisis suddenly plunge 4 million Sri Lankans into poverty?

The ability to maintain strong international relationships and secure more aid has been considered a crucial qualification for candidates, during election cycles. Within the voting community, politicians offering the most substantial subsidy handouts are often perceived as popular leaders. While it is true that we need comprehensive international relationships in modern politics and must take care of our citizens, we must do so while keeping a development-oriented mindset at the core. Regrettably, development cannot rely solely on foreign aid, nor can we lift people out of poverty by offering aid exclusively to the poor.

This situation is not unique to Sri Lanka; it's a global phenomenon. No country has achieved development solely through aid programs. Instead, countries that have reached the development stage share strong institutions and reasonably functioning market systems as common denominators.

The primary focus of any government or political leader should revolve around two key conceptual frameworks:

1. Are we establishing institutions that promote a level playing field?

2. Are we encouraging a functioning market system?

Development is generally a bottom-up approach. People often know what's best for themselves better than politicians or leaders do. We simply need to provide them with opportunities in a competitive environment. Recently, I had the privilege of meeting a few small and medium-sized exporters. The entire system and processes seemed designed to hinder their export activities. Many exporters emphasized the difficulties they face when exporting in Sri Lanka, including challenges and harassment from government regulatory authorities, such as Sri Lanka Customs.

A prime example of our low export numbers is not only market access problems but the barriers within our own system that obstruct exports. One exporter from Kandy, specializing in vanilla exports, highlighted how customs consistently questioned HS codes and demanded repetitive documentation, causing him to spend more time on export processes than on developing his product and capacity. These challenges are consistent across the board for exporters, explaining why Sri Lanka's exports remain stagnant despite numerous committees, task forces, and chairpersons at the Export Development Boards.

Real change should start from the bottom by removing barriers for businesses and offering people the freedom to pursue their desired endeavors. Such reforms may not bring personal glory, as they empower individuals to make their own choices. In contrast, an aid-driven approach often results in leaders or countries seeking personal recognition through associated aid packages.

In Sri Lanka's case, we must remind ourselves that only we can make a difference and pull ourselves out of this crisis. While we need the support of international institutions like the International Monetary Fund and bilateral and multilateral creditors, they alone cannot rescue us from our predicament. It is only through economic reforms and the development of inclusive institutions that we can compete on a level playing field and extricate ourselves from this mess. Both small and large reforms are essential, and we must implement them swiftly and effectively.

Economic lessons from ‘The Voice’

Originally appeared on The Morning

By Dhananath Fernando

The global reality TV platform ‘The Voice Sri Lanka’ Season 2 concluded a few weeks ago, with  Rameesh Sashinka, fondly known as ‘Ramiya,’ emerging as the winner. Ramiya comes from a very humble background in Aluthgama and works at the beach, providing services such as surfing for tourists. 

In vernacular terms and according to Ramiya, he is a ‘welle kolla’ or a beach boy, who walked away as the winner of ‘The Voice Sri Lanka’ despite getting eliminated in the knockout rounds. His journey serves as an example of how a functioning market system can lift people out of poverty even in a short period of time.

‘The Voice’ is structured around freedom of choice. In the first round called the ‘blind auditions,’ coaches have the ability to select singers by pressing a button and turning their chair. Generally, talented singers get at least three out of the four chairs to turn, but in Ramiya’s case, only coach Umariya turned around. 

In economic terms, coach Umariya provided Ramiya with market access so that he could test himself in a competitive environment. According to the rules of the competition, if multiple coaches show interest, the singer has a choice of selecting a coach based on their preference. 

A market system works on competition and having diverse choices makes the market more competitive. Market access is very important and licensing schemes that restrict market entry can hinder people such as Ramiya. 

Imagine a situation where Ramiya had to obtain a licence from the Government to prove his talent and a certificate from his Grama Niladhari to prove his skill. Ramiya would have still been in the queue trying to obtain the necessary certificates. As important as minimal regulation and market access is, a competitive regulatory framework with transparency by the organisers is a must.   

In the third round, Ramiya was eliminated. ‘The Voice’ platform has an option for eliminated contestants to make a comeback through a new coach. Coach Supun, who was the fifth coach, picked Ramiya to be a part of his team. 

In economic terms, this is called a safety net. In a competitive market system there cannot be only winners – winning and losing are two sides of the same coin. In order to have a resilient economy, society should have measures in place to support and protect those who experience setbacks. That safety net is the encouragement for them to bounce back and win. That is why our Government should have better focus on building robust social safety nets. 

It is important to recognise Ramiya’s competition strategy as well. He focused on a specific genre of music, but he was very skillful in bringing diversity within his chosen genre. The economic lesson for us is that every nation’s economy is quite different from the next and no one can excel in everything. However, within our competitive environment, we can add diversity and capitalise on our strengths. 

Ramiya, the humble man from the Aluthgama beach, competed on a global platform and brought songs by the likes of Freddie Silva and Upali Kannangara to a global stage by singing in our vernacular. The lesson is that Sri Lankans have the potential to succeed on a global platform and we should not be fearful to compete. Instead, we should embrace the competition as we are capable of winning. There is no point in hiding when we have the capability of winning as Sri Lankans.  

On the other hand, even Ramiya’s most loyal fanbase knows he is not the most talented person in the competition. What he brings is a unique messaging and entertainment to fill the market gap. From an economic and financial perspective, he offers value for money or value for the time people spend on entertainment. He brings a breath of fresh air when he performs. This is a concept that we as Sri Lankans have failed to understand. Our focus has always been on the lowest price, while overlooking value for money.

Let’s take train services as an example. As the Government was able to offer the lowest price, we decided to keep the train service under State control. However, it does not measure up when you compare it in terms of providing value for money. The railway service is plagued by poor quality and delays. It is far better to have a well-functioning train service, even at a higher price, compared to a poorly functioning one.   

In many reality TV programmes, unfortunately, winners fail to succeed in their careers later on. The reason can also be explained through economics. In economics, real wealth is not just money; it is the ability to recreate wealth, the science of making two bucks out of one. 

Songs being sung by the contestants in reality shows are mainly composed by established artists in the field. The original songs have the chemistry or the logic of recreating wealth. If a person who is selected as a winner fails to figure out the science of recreating the same entertainment value, very often they will fail. That is why lottery winners often become poorer than they were, because they do not know how to recreate wealth. 

The reality is that markets exist, whether we like it or not. Markets are not always perfect and they cannot solve all the problems in the world. However, it is the most reasonable solution we have at hand to take our people out of poverty. 

In ‘The Voice’ Season 1, the winner was Harith Wijeratne, a medical doctor. Now, the winner is a beach boy (with all due respect) from Aluthgama. When markets work, it rewards the most competitive person who maximises limited resources. Markets respect diversity (in the quarter-finals of ‘The Voice,’ Ramiya had an intro rap for the song he sang). 

This is another great economic fable from the Sri Lankan community and Ramiya is the one who is presenting it to reality. 

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.

On the 75th Independence, time to re-plug to the world economy

Originally appeared on the Daily FT

By Anuka Rathnayake & Thilini Banadara

As Sri Lanka is inaugurating its political independence of 75 years on 4 February, the burning issue the public is struggling to grapple with, in the recent past, is the worst economic slump. Many factors have contributed to the current economic crisis but protectionism and trade barriers are main elements that have further depleted the economy, shaping it as uncompetitive and inward-looking.

Even though Sri Lanka was known as a fairly open economy, the dynamics of trade has changed since 2004. The planned reduction of tariffs into a single band had been abandoned by the end of 1990s.  Since about 2005, Sri Lankan trade policy has been characterised by a protectionist approach. 

The Government was involved in economic decision making and policies related to import substitution were much more prominent. As highlighted in the Trade Policy Review of Sri Lanka by the World Trade Organisation in 2010, the average tariff protection increased . In fact, it can be noted as frequent and ad hoc changes in tariff structure. The trend in protectionist policies resulted in a fall of exports as depicted by the ratio of exports to GDP . 

In 2009, by the time peace was restored, Sri Lanka had nine para tariffs applicable for imports  in addition to the standard customs duties, of which , five were ‘para-tariffs’: taxes which are only applied to imports and there is no domestic equivalent. Adding  to whatever protection is provided to domestic production by customs duties, with such para tariffs being in place, the protectionism became even more complicated. 

A systematic comparison of Sri Lanka’s tariff structure at November 2002, January 2004, 2009 and January 2011 suggests that the total protection rate notably increased between 2004 and 2009 . 

The ensuing years were followed by many ad hoc and duty exceptions and case-by-case adjustment of duties on many imports which directly compete with domestic production. By 2015, the average effective rate of protection for manufacturing production had increased by 16%.

This trend is well depicted through the Trade Openness indicator as given in Figure 1. The degree of openness is measured by the actual size of registered imports and exports of an economy. In other words, it suggests how free or restricted a country is in its relations with the rest of the world. 

Since 2004 onwards there has been a decline in the trade openness of Sri Lanka and this trend continued up until 2010. By 2015 with an increased rate of protection, the trade openness deteriorated to 36.6%. 

Since 2019, Sri Lanka has been pushing many import controls creating disruptions in the market. This tendency resulted in further decline of trade openness 32.2% in 2020. It is similar to the trade openness during 1970 - 1976 when the liberalisation policies were reversed and the economy had high regulations. The trade policy was more aligned towards import substitution.

Trade restrictions 

Sri Lankan businesses face a variety of trade restrictions exacerbated by the economic crisis. Accordingly, such conditions that impact the price, quality, quantity, or timeliness of product delivery but are outside the direct control of the exporter or importer. 

Both the importing country’s border and the border of the exporting country have been parallelly imposed with restrictions. Even though a number of Free Trade Agreements have reduced external trade barriers and expanded access to markets, Sri Lanka has kept its borders closed by enacting internal trade restrictions.

Internal trade restrictions can be identified in terms of broader categories such as; 

1. Monetary and regulatory barriers, 

2. Procedural barriers, 

3. Service barriers,

4. Technical barriers and 

5. Market barriers 

Currently a number of monetary and regulatory barriers exert pressure on Sri Lankan businesses, while lowering the country’s competitiveness on international trade. Such barriers include complex tariff structures, quotas, import restrictions, excessive duties or levies and export and import licenses. 

Both exporters and importers encounter ineffective, unpredictable, and less transparent procedures throughout the entire trade process. This is mostly the result of poor coordination between agencies and excessive bureaucracy (red tape) among Government employees.

Additionally, the distribution and financial services channels are two areas where existing enterprises face significant service obstacles, which slows down the final stage of clearance.  Shedding further light on the obstacles placed, the technological obstacles  have a negative impact on the export competitiveness of local enterprises because of their limited technical and financial resources. Besides the market constraints like price controls are a significant obstacle because they are unrealistic in a setting of shifting global markets and fluctuating currencies.

Impact of trade restrictions

Over the years, the country has experienced a number of adverse effects due to trade restrictions. Net economic losses in the wider economy have increased as this restricts competition. Shrinking volumes of exports and imports have negatively affected domestic production. Consumers are left with limited choice of products while they experience increased prices. 

Trade restrictions impact the macroeconomy with a fall in employment opportunities mainly due to the deterrents on domestic and foreign investment. Limitations on land, labour and capital have disincentivised investors from competitive export industries to protected industries and inefficient import substitution. Reduction in economic activity has increased the economic woes among people.  

Restrictions on trade have put a significant number of businesses in a precarious position.  Starting with street vendors, small and medium scale enterprises who depended on imported raw materials to the larger apparel and construction industries; all the businesses are finding it a challenge to continue their business. 

Way towards trade freedom

The way to greater freedom of trade is to reformulate the existing monetary policies and laws in order to enhance trade freedom and provide more opportunities for local enterprises to engage in trade. Also in the current context, easing import restrictions and reducing taxes or levies on imports and exports would be crucial.  Additionally, it is important to remove unnecessary Government red tape or bureaucracy wherever possible to make customs processes more simple, effective, clear, predictable and timely. This will help to cut down on processing times at the border and make the movement of goods cheaper, faster and more efficient.

Paving way to greater freedom to Trade - the ability to exchange goods and services openly, creates greater opportunities for Sri Lankans to achieve greater economic prosperity. It opens many avenues towards competition, innovation and economies of scale. The beneficiaries of open trade are the Sri Lankan citizens and businesses who will benefit from lower prices and greater choice.  

Freedom to trade will ensure the economic freedom by which the fundamental rights of an individual to make their economic decisions will enhance. The true meaning of independence will only be assured through greater economic freedom. 

Source : Central Bank of Sri Lanka 

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

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.

The Government’s dangerous honey

Originally appeared on The Morning

By Dhananath Fernando

Minister of Finance Basil Rajapaksa, moving two important bills in Parliament, recited a poem in Sinhala literature, which is also a proverb, to explain the sorry state of our economy. He compared Sri Lanka’s economy to a man in the jungle trying to rescue himself from three life-threatening challenges.

Firstly, a furious wild elephant, similar to our mounting debt obligations. Secondly, to avoid the elephant, the man attempts to hide in a pit, but before he jumps into the pit, he realises that there is a cobra in it. So instead of jumping, the man then decides to hang onto the roots of a tree that lies above the pit as an alternative. The cobra in the bottom of the pit is similar to our Balance of Payment (BOP) crisis. Our importers and exporters are in big trouble, having difficulties opening Letters of Credit (LCs) due to forex shortages, and currency is depreciating rapidly with attempts to keep interest rates artificially low by policymakers.

Then the man realises that one root he is holding onto is the tail of a venomous reptile. He now cannot release his grip on the tail as the reptile will bite back. So, the adventure of running away from the elephant waiting at the edge of the pit now has two more severe life-threatening risks. The Finance Minister’s analogy reflects that trying to avoid one problem without a proper estimation and analysis has now opened us to more vulnerabilities while the previous challenges remain as they are.

As the story goes, one tree root the man is holding in his other hand is attached to a bee honey nest. So when he tightens his grip, bee honey keeps dripping, and so he decides to indulge in some bee honey. While the man has three life threats from the elephant, the cobra, and the other reptile, he decides to enjoy the dripping bee honey for a moment.

The Sri Lankan economic crisis is exactly the same. At a moment in history where urgent, hard, and serious economic reforms are required to overcome the crisis in the midst of the global pandemic, some alternative policies such as self-sufficiency, Modern Monetary Theory (MMT), and import substitution have become sweet bee honey for some policymakers who really do not understand the gravity of the crisis.

Unfortunately, just as the man who attempted to jump to a pitfall without properly analysing the situation, some economic measures with little analysis are cornering us for a brewing crisis.

Fixing USD at Rs. 203

Attempting to fix our exchange rate at Rs. 203 against the USD to avoid currency depreciation is one such activity. Simply, it is a price control on US dollars. Every good or service with an economic value is naturally obliged to a demand and supply matrix. In other terms, there is no alternative to fix the price of a currency without someone intervening in the excess or shortage.

In the forex market, the Central Bank does not have adequate forex to intervene in markets any longer, with the mounting debt obligations. So it is natural that $ 1 for Rs. 203 is a complete misguidance where there is no USD in the market at that price. The downside of trying to fix the USD at an artificially lower price is the encouragement it would provide on more importers to open LCs, adding more pressure on banks as well as the USD.

“Imports” are incentivised at a lower rate than the market rate for the USD. Exporters, on the other hand, are discouraged to bring forex as they get a far less market rate if they bring USD to the market. As a result, exporters hold the USD as long as possible and many exporters maximise their offshore accounts, as it is very cost-effective and hassle-free. As such, banks’ forex market has now further dried up, with both importers and exporters falling into trouble. It is the same predicament faced by the man who tried to avoid an elephant and came across two more additional troubles.

Additionally, another restriction has been imposed on more than 600 HS codes where the full amount has to be paid upfront to open the LC. This move will directly impact micro, small, and medium-sized businesses that depend on imports in those categories. Consumers will have to experience higher prices and black markets in most of these product categories, and the quality of life will be affected drastically.

Concerns expressed by investors on property rights over seizing rice stocks

Recent raids carried out on rice mills in Polonnaruwa will worsen Sri Lanka’s image as a destination for investors. As previously written in this column, it is the lack of competition, along with political support, that leads to the creation of cartels in the rice milling industry. However, seizing private property of an individual undermines investor confidence – no investor will consider Sri Lanka if there is a fear that the government will take over their property rights.

This was the same point made by the President when he was questioned by Indian media in his very first international media interview about the Hambantota Port. Though his supporters claimed that the Hambantota Port will be taken back by China, the President mentioned that if we were to do it, it would completely provide a wrong message for the investor community. According to media reports, the Government is initiating a very important Selendiva project for investors (Hilton Colombo, Grand Hyatt, etc). However, property rights concerns will seriously erode attracting quality investors for the Selendiva project.

At the same time, exactly like the proverb in the speech by the Finance Minister, while we are in serious trouble on multiple fronts, ideological groups seem to be defending their ideology rather than finding solutions with pragmatism. Ideological groups are the same as the man who is focusing on bee honey dripping, by forgetting that we are already in a very serious situation. The narration created on self-sufficiency and import substitution are just an example.

The Finance Minister has to be objective and pragmatic instead of falling into ideological traps. Otherwise, he will be a victim of his own analogy and the proverb of the man who multiplied the problem by irrational decision-making.

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.

Closing the gate once the horse has bolted

Originally appeared on The Morning

By Dhananath Fernando

Can price controls rein in uncontrolled depreciation?

People are infuriated over the recent drastic price hikes on essential food items, and analysts and policymakers are attempting to make sense of what triggered this.

Some argue that the increasing global commodity prices are indeed the root cause of these local price hikes. In my opinion, however, global price hikes cannot be the sole reason. This conclusion is misleading as the domestic prices of these food items are higher than the percentage increase of global commodity prices adjusted for the depreciation of the Sri Lankan rupee (SLR).

Steep depreciation of the currency

It is no secret that the Government sought refuge in Modern Monetary Theory (MMT) in recent times. This has had a considerable impact on commodity prices due to the depreciation of the rupee. A depreciating rupee coupled with increasing commodity prices is certainly an ill-fated combination. Even though many economists alerted the Government of the risks MMT could pose, they fell on deaf ears.

When global market prices rise, it is inevitable that domestic markets adjust accordingly due to price signals. This means that people shift their consumption behaviours and patterns with price volatility. However, Sri Lanka’s essential commodity price hikes came suddenly and have given people no time to adjust their purchasing patterns.

As per Central Bank data, Sri Lanka’s food inflation is increasing. Advocata Institute’s Bath Curry Indicator, which tracks the weekly expenditure of a four-member household on rice and curry, found that prices increased by 45% on a YoY (Year-on-Year) basis in July and by 30% in August.

I’d like to conclude my argument by quoting Nobel Laureate Prof. Milton Friedman: “Inflation is always and everywhere a monetary phenomenon.”

Acute foreign exchange crisis exacerbated by MMT

The acute foreign exchange crisis we are in, too, is a major contributor to recent price hikes. Oversupply of money has drained our reserves and added additional pressure on the currency. For example, when the government provides Rs. 20,000 (which is beyond the government’s capacity) for low-income families, money will flow out of the system due to the purchase of imported goods. People will be inclined towards buying imported LP gas, lentils, sprats, and tin fish.

Further, maintaining a negative real interest rate, which is to keep interest rates artificially low by increasing money supply below the inflation rate, will motivate people to spend more money than to save. More spending equals more expenditure on imports, which will then exacerbate the country’s Balance of Payment (BOP) crisis.

Currently, banks have different exchange rates for different customers. The kerb market’s exchange rate for the US dollar is between Rs. 250 and Rs. 260.

If this trend continues, the country’s fuel prices, LP gas, milk powder, and many other commodity prices will continue to rise.

Price controls

The Government has announced strict price controls and has appointed a designated officer to curb hoarding by traders with the objective of decreasing essential commodity prices. Recent news reports claim that hoarded essential food items such as sugar have been confiscated from stores by the authorities.

However, price controls are proven to be ineffective and will lead to goods disappearing from markets, as a result creating black markets. Further, it is likely that price controls will result in importers stopping the importation of goods. The first lockdown saw an initial price control of Rs. 65 on lentils and a controlled price of Rs. 100 on tin fish. Later, the Government had to withdraw the price controls as it resulted in severe shortages, with traders halting imports and the sellers hesitating to trade at a loss. Price controls simply don’t work because the price structure is unique for each trader.

Competition is the only factor that drives prices down. For example, the cost structure of a trader who sells lentils in an air-conditioned shop and a trader who sells at the Sunday market is different. The price they mark is based on the cost, and consumers buy it based on the value they get. Price controls hamper the signalling mechanism, resulting in severe repercussions.

Why do traders hoard?

Even with increased raids by the Consumer Affairs Authority (CAA), traders continue to hoard. This behaviour is intricately linked with the foreign exchange crisis the country is in. The Central Bank introduced regulations stating that traders cannot buy US dollars for a future day (forward market) at the current exchange rate. Further, importers were requested to open Letters of Credit (LCs) for a 180-day credit period. As a result, importers brought essential commodities in agreement to pay the exchange rate to be in effect after 180 days. They brought the goods they already sold at a calculated exchange rate.

However, now the exchange rates are depreciating further. For example, when traders imported the consignments, our exchange rate was about Rs. 190. But with the currency depreciation, now they have to pay the current exchange rate as there is no forward market or interbank market in operation. This is pushing importers to hoard to secure stocks for the future. Importers will also be inclined to increase prices to cover their losses incurred due to exchange rate volatility.

All of these trickle down to the average consumer as higher prices on essential commodities. Higher prices, long queues for essential goods, and empty shelves are symptoms of wrong macroeconomic policies.

This column and many economists alerted the Government that it would come to this, and I am disappointed that the Government did not heed our advice.

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.

Reforms required, IMF or no IMF

Originally appeared on The Morning

By Dhananath Fernando

At Advocata’s first deep-dive session on Sri Lanka’s debt sustainability, Harvard Prof. Ricardo Hausmann emphasised on the importance of avoiding an economic crisis at all costs. As he is of Venezuelan origin, it is safe to assume Prof. Hausmann has first-hand experience of having to live through the realities of such a crisis. He warned that “an economic crisis comes slowly and then suddenly”.

Every week, the Central Bank attempts with various tools to subjugate the situation, but unfortunately the intensity of the wind seems difficult to change. The Energy Minister initiating discussions with the UAE to purchase fuel on a long-term credit period while restricting the country’s USD payments with a 5% ceiling on USD deposits indicates how hazardous things can be in future.

The Central Bank’s recent inflation numbers have indicated high food inflation. Now the last resort in sight is to approach the International Monetary Fund (IMF). Opinions on this are many.

In my view, emphasis should not be on the IMF. A credible plan to drive economic growth must take precedence. However, I don’t see such a plan in place as of now.

So let’s discuss solutions we can incorporate into a credible plan as the problem is clear.

Immediate policies

Cash transfer system for safety nets

Given the nature of the pandemic, it looks like we have to expect more lockdowns or limited travel in the immediate future. This will affect Sri Lanka’s MSME (micro, small, and medium-sized enterprise) sector and informal employment. At the moment, 99% of our establishments are MSMEs and more than 60% of our labour force is in the informal sector. MSMEs contribute more than 50% of our GDP. So any policy to stop spreading the virus through travel restrictions will undoubtedly affect our informal sector. We do not have a mechanism to protect them.

Samurdhi targeting and distribution through grama niladharis is extremely poor. Therefore, what governments often do is bring down prices of all food items, fuel, and other essentials across the board. This is direct intervention in the market in the form of subsidies. These subsidies end up in rich households due to their high consumption of commodities.

The solution is to introduce a cash transfer system to the vulnerable households. This will give them the freedom to choose what they want to spend on. The cash transfers can have multiple tiers based on the poverty levels. For example, when the global fuel prices are increasing, the cash transfer on fuel can be increased, but when prices decrease, the cash transfer can decrease proportionately. Simply, we have to introduce an agile digital safety net system in the future because market reforms are painful, especially for the poor.

Cutting down govt. expenditure and voluntary retirement scheme for govt. servants

A reason the Central Bank has to continue to follow Modern Monetary Theory (MMT) is the ballooning government expenditure. It is true our expenditure is somewhat on par with our regional peers, but our labour market is completely distorted by about 1.5 million people, and most of them are unproductive and dissatisfied with their work conditions. Undoubtedly, this is beyond our government’s afforbality, especially with pension payments and other expenses incurred utilising prime property across the island wasting most of our resources. Our state-owned enterprises (SOE) absorb a greater portion of our government revenue, their debt in state banks adding a serious risk to the stability of the banking system. So a freeze in the government sector is a must and we do not have any alternatives left.

Debt restructuring and debt conversion

We have to leave our current strategy of trying to manage debt with short-term swap agreements. The more we wait, the more the pain we have to go through. Debt conversion is a strategy that can be explored. We can consider a few debts to equity swaps similar to what we did with the Hambantota Port on identified unproductive assets. Debt restructuring or reprofiling is another option, which, however, requires serious effort. It will be an extremely costly process, where we will have to work with foreign legal firms and our creditors. This will have both positive and negative consequences.

Unlocking our land supply

Land is one of the main factors of production. It is unimaginable that 80% of land is owned by the government and only 3% of the land have clear titles, as per a World Bank study. Without having land ownership for its people, there is no opportunity for capital flow that can expand the entire business ecosystem. The Government has to prioritise creating a digital land registry instead of other unproductive alternatives.

Above are just a few recommendations for a credible recovery plan, whether we go to the IMF or not. The real problem is not whether we are going to the IMF or not. It is looking at what reforms we have to make on our own and how we are going to make these changes, which are required to drive economic growth.

Prof. Hausmann said that the big bad wolf comes slowly and suddenly. I hope we move much faster and get the reforms done before “the big bad wolf that comes slowly and suddenly” comes for us.

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

We too might lose everything

Originally appeared on The Morning

By Dhananath Fernando

I have a friend in Afghanistan. I met him about five years ago. He has been telling me how beautiful and resourceful Afghanistan is. After seeing the tragic stories in the media, I quickly reached out to him over email and checked his family’s wellbeing. He responded in just three words: “I lost everything.” His three-word response powerfully described the magnitude of what a crisis could look like.

Not only Afghanistan, Sri Lanka is also in a crisis. I have highlighted the enormity of our crisis through this column on many occasions. Many prominent economists have also alerted the subsequent governments on the same issue. Unfortunately, nothing has been done other than implementing short-term solutions. Our crisis can also lead us to Afghanistan’s predicament. “We will lose everything”, if we continue to go down this path.

It is not only terrorist activities or natural disasters that could lead to the loss of everything. An economic crisis can also pave the way to losing all our hard-earned money and dreams. Recovering from a crisis is not easy for a country like Sri Lanka, especially in the middle of a global pandemic. That is one reason why many experts have voiced the need to avoid such a crisis. Recovery is a difficult, long and painful process.

What we experience currently are signs of a potential economic crisis. People are already feeling the difficulties and it has been just overshadowed by the Delta variant. In simple words, like my friend in Afghanistan said, we are all at the risk of losing a significant amount of our wealth. Undoubtedly, the poor will be the most affected. Unlike during the 1970-1977 period, there is much to lose for people in a modern-day society with more complicated needs and wants. As well as huge debts of the private sector with multi-storey buildings, which may not be easily rented to pay off debts incurred for construction.

Shortages of some essential drugs have been reported. Minister of Energy Udaya Gammanpila urged the public to use the fossil fuel economy to save the foreign exchange for the importation of medicine and vaccines. Fuel imports are estimated to be about 25% of our import bill, according to the Minister’s statement. If this trend continues, it is likely that the Government will have to ration diesel and petrol. This will create a series of repercussions on people’s day-to-day living at unimaginable levels.

The existing USD crisis has already rationed the opening of Letters of Credit (LCs) and supply chains are already shrinking. The impact of this is that businesses will downsize or wind up and many people will lose their jobs. Our exports will drop and local suppliers of export business will face significant knock on effects.

Lower income and higher unemployment are breeding grounds for many illegal activities and extremist ideas to take root. Sri Lanka already has tension between different ethnic and religious groups. The eruption of one of these activities is the path for all of us to “lose everything we have”.

There are few notable events that took place over the last week which would provide an indication of the gravity of the crisis we are in.

At the time this article was written, a big conversation making rounds on social media was about the difficulties in proceeding with online payments in foreign currency, even for small amounts such as online subscriptions for digital platforms. Some banks have already announced an additional interest rate for USD payments. It is natural for banks to stop online payment as they have to prioritise their long-standing customers who need foreign exchange for their import and export businesses. At the same time, such actions will have a serious negative impact on all our online businesses and the digital economy.

In the meantime, the Central Bank increased the Standard Statutory Ratio (SRR) to 4% from 2%. This simply means that licensed commercial banks have to deposit Rs. 4 at the Central Bank for every Rs. 100 of savings they get, instead of the Rs. 2 rupees earlier. The impact would be that the banking system will have less money to lend for their customers, as they now have to deposit more money at the Central Bank. Also, the interest rates – both the Standing Lending Facility Rate (SLFR) and Standing Deposit Facility Rate – have increased by 50 basis points each to 5% and 6%, respectively. The outcome would be that this will incentivise people to deposit more money, spend less, and borrow less money with interest rates going upwards. However, this is taking place in a backdrop where low interest rates were leading to high demand for credit, which spills on to balance of payments.

We also received the first tranche of $ 50 million tranche of the Bangladesh swap facility of $ 250 million and our reserves are at a record low after settling nearly a $ 1 billion bullet payment last month. Avoiding going to traditional sources of credit like India, Malaysia, or Singapore shows the desperation of Sri Lanka.

The Sri Lankan rupee depreciated to 22-228 in kerb markets; prices have already been increased in some bakery products and the cost of living will go up, making people more poor.

In situations of this nature, it is natural for people to consider leaving the country, and what we saw in Afghanistan was one dimension of how humans react to such situations. The inability to do business, consume what we want, restrictions on the economy, or in simple words economic freedom, matter most to the people. When people realise their freedom, mainly in the economy, is shrinking in any form, they feel they are losing what they have and that the wealth they earned through years of hard work is starting to diminish.

So the obvious choice is to look for better places with freedom, respect, and dignity to start life over. Our dreams of a high-quality life are shrinking everyday and Covid-19 is just accelerating it. So like Afghanistan, Sri Lanka too is drifting towards an unprecedented economic crisis.

Solutions

There is no other solution than market-oriented reforms. Markets must be allowed to work and prices should indicate the scarcity of our resources. Before all that, we first need to have a credible plan on what we intend to do. With a credible plan, we can move towards action and raise money to keep our nose just above the water. When we have a plan, we can decide whether we want the IMF (International Monetary Fund) or someone else. But even without a plan, no one else can help or assist us to overcome the situation. However, the times are getting difficult and the clock is ticking faster. Before we lose all that we have, we need to fight back together in these difficult times which are about to come.

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.

Markets: We can’t see them, but they exist

Originally appeared on The Morning

By Dhananath Fernando

When I was a kid, my father used to share stories about heroes, science, literature, and many more. I still remember the day he shared the story of Sir Issac Newton’s famous story of an apple falling from a tree, which made him think more and discovered the theory of gravitational forces. I wasn’t very impressed with the story. I questioned back as a kid: “If there is a force, why can’t we see it. Can’t we avoid gravity during the night? How can gravity act on a water surface and how can water flow if there is gravity?”

Later I realised, just because we can’t see it, that does not mean it doesn’t exist. It was because as a kid I simply did not understand the concept of gravity. The concept of “markets” is the same. It’s there and we all are part of it. When markets work well, we do not feel the existence of it. We only feel the existence of markets when we try to intervene in markets.

The current milk powder shortage and long lines to buy LP gas is a classic case of market interventions. While we have long lines for LP gas and milk powder, there are no lines to buy shampoo or soap or similar household products. In both cases, the market exists, but we just don’t see it.

Milk powder shortage

In the case of milk powder, supermarkets have rationed the quantity that can be purchased and most of the milk powder shelves are empty. There are many sides to the story. One side is that milk powder is not good for health, so we should move to liquid milk. There is further argument that Sri Lanka has to be self-sufficient in milk and produce all the milk it requires. As a result, Sri Lanka has always imposed high tariffs on powdered milk as well as imported milk, as high as 33.1%, as per the previous tariff calculations. This has been carried out with the objective of promoting local milk farmers and industry.

In Sri Lanka, there is a conspiracy theory for anything. The conspiracy theory is that milk powder companies create artificial shortages to cause inconvenience for the government and promote milk powder.

When we look at data and numbers, however, the story is different and it is multidimensional. First, global milk powder prices have been increasing significantly over the past few years. Since most of the milk powder is imported, when the global prices are increasing and when our currency is depreciating, there is no alternative to keeping prices constant. However, the Government and it’s main price regulating body, the Consumer Affairs Authority (CAA), are not allowing price increases by milk powder companies. They have at present imposed a price control – if you visit their website, the price controls can be seen.

Different brands and different pack sizes have specified prices. However, when global prices continue to increase constantly at one point, milk powder companies will reach a point where the losses of selling one pack of milk powder exceeds the loss of not selling a packet of milk powder at all.

At that point, obviously, the supply will be curtailed by the companies as no company can survive by making losses. So in a market system, the shortages start taking place. The long lines or shortages of any product category is the outcome of the market intervention in the form of price controls. (Source: https://www.globaldairytrade.info/en/product-results/)

This is basic economics which this column has explained many times.

The second argument is on the health concerns of milk powder. Many people are confused about why people do not consume liquid milk regardless of much propaganda by certain trade union groups and ideological groups.

The answer again lies in economics. In Sri Lanka, the domestic liquid milk demand is at about 700 million litres per annum, whereas our production is only 374 million litres per annum. Obviously, the balance has to be matched if we cannot produce it. On the flip side, our milk production is extremely unproductive. The average production by a milking cow is about 4.3 litres per day, whereas the world average is about 28 litres per day. In some countries like Israel, the productivity is about 40 litres per milking cow per day. Obviously, our productivity is very low to match the demand and we have been protecting the inefficiencies in the milk industry by imposing high tariff rates as high as 33.1%, as per the previous tariff calculations on milk-related products in importation.

When the global prices move up and when our currency is depreciating, when banks are going through a hard time to provide foreign exchange for importations, there is no way we can keep our prices constant in the milk powder market.

Only if we allow the prices to move up will the people who value milk powder at those prices will buy it, and there will be an incentive for other alternatives for milk powder to enter the market. So people can decide what they want and shift to alternatives. Even the promoters of liquid milk should now support a move to raise the prices of powdered milk, so that there is an incentive for increasing the supply of liquid milk in the market.

The case of LP gas

The liquefied petroleum (LP) gas market follows similar dimensions. Global gas prices have increased rapidly along with crude oil prices, and Sri Lanka has only two players. One is the government-owned operator and the other is the private sector operator. Private sector local businessmen cannot increase prices and they cannot import due to the US dollar shortage in the country. When we only have two players in the market and when one player is going out of the market due to price controls and US dollar shortages, the markets react naturally. It reacts in ways such as shortages, hoarding, or people who are storing more than what they want for future usage/panic-buying. So naturally, products will start disappearing at an accelerated rate. (Source: Saudi Aramco LPG prices per metric tonne)

The prices should move up and there is no doubt it would burden people with an increasing cost of living. But having long lines and making people inconvenienced during a global pandemic would cause more harm than a rise in the cost of living. As a result, the Government has finally decided to let the prices go up by Rs. 386 for the private sector player, but the actual value will be determined by the market.

Markets work whether we like it or not. Thinking that we can oversmart markets by price controls and regulations is no different to a man who tries to avoid gravity without realising the entire concept in the first place.

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.

Hanky-panky under the blanket

Originally appeared on The Morning

By Dhananath Fernando

Who benefits from the licensing systems that come about with our blanket bans?

Recently I was thinking about why people do certain things and why they don’t. I realised there are things that have been banned but still, people do. Consumption of certain types of drugs is just an example. At the same time, there are things that are not banned,  but still, some people don’t use them. Smoking is a good example. It’s not banned but data shows that people are now less likely to smoke due to health reasons. Analysing human behaviour shows us that there are reasons to engage in some activities while reasons to avoid them. Undoubtedly knowledge, information, and many other factors influence and incentivise certain actions over others. However, there are certain activities, where the Government decides on behalf of the people, that such are either good or bad for the broader population and try to control the choices of people. Our ban on chemical fertiliser is one such instance out of many. 

Another round of discussions has erupted over whether the fertiliser ban is relaxed or not. In a recent statement, the Government reiterated that there are no changes in their policy announced earlier. This trend of banning product categories on the grounds that it is not good for society has been common over the past few years. Then-President Maithripala Sirisena proposed a ban on chainsaws and carpentry sheds as an attempt to protect forests. Another proposal was to ban glyphosate to maintain our soil structure and avoid unknown kidney diseases. Then recently another development was the banning of sachet packets, banning the importation of palm oil, numerous discussions to ban cattle slaughter, and now the blanket ban on the use and importation of chemical fertiliser. 

Whether these decisions were made based on grounds of scientific analysis or analysing data and economic principles, remains a serious question. These recent decisions will have serious consequences on economic activity, especially in the import sector. A key point to note is that these outright blanket bans have led to the proposition of issuing a license for the importation of the particular product category. 

Many policymakers as well as common Sri Lankans lack an understanding of the negative consequences of licensing. Having a licensing process, for example, to import chemical fertiliser will lead to an increase in prices, open avenues for corruption and bribery, activate informal black market activity, and allow inferior quality products to enter the market. This cost of maintaining a licensing regime will have to be borne by the general public. 

Any Sri Lankan who has attempted the construction of a house or shop or wall has to go through a process of getting the plan approved by the technical officer at the Local Government. It is a license or an approval that allows any individual to build any construction. Those who have gone through the system know how painful the process is. In the first place, meeting the technical officer is not easy. Secondly, regardless of how compliant the draft was, he/ she always has suggestions and changes. As a result many common people hand over the drafting process of the building to the technical officer himself so he can approve it. 

The economics behind this is that when anyone has an authoritative power to decide the “go” or “no-go” of a project the person who has the decision making power is naturally motivated to capitalise an incentive over the approval. On the other hand the person who wants approval is getting naturally motivated to incentivise the decision maker to provide the approval even compromising the quality and standard. The same dynamics work in every licensing process, including the licensing of imports. Examples of the licensing processes include the exercise department for alcohol shops, Sri Lanka Customs, passport office, driving license and Registry of Motor Vehicles (RMV). 

When we first impose a ban and secondly issue a licensing system it is a double whammy to the economy. By creating a blanket ban we are creating a scarcity of resources which is in demand. Then by issuing a licence we are making the utilisation of that scarce resource unproductive. Simply, the more we keep the discretionary authority the more we leave room for corruption and inefficiency. Secondly, the immediate  implementation of a licensing process can lead to increased scarcity, where fewer goods are available relative to the population. Therefore there can be market shortages putting thousands of people into hardship and inconvenience. Unfortunately in Sri Lanka’s case these interventions and restrictions have come into place when the market system was working perfectly well, especially for the benefit of the general consumer. This therefore needs much thought and reflection. 

If the intentions behind imposing a ban on a certain product category are correct, then logically, there cannot be a justifiable reason to allow a few people to import the particular product, especially if the product is harmful for human consumption in the first place. 

As an example, if palm oil is carcinogenic, the cancer-causing ability doesn’t disappear just because few people are importing it. Instead it could be higher as now the market system is completely broken down as a result of the ban and as a result of the license only a few players are able to import any substandard products due to the limited competition. Secondly, when a licensing system is in place it allows close associates and people connected with authority to be issued with licenses, reaping benefits at the cost of the general public. The flip side is that  these licenses are issued not on a competitive basis. So the room for the political authority to share profits with a person who is getting a licence is higher than operating in a competitive environment. 

In a market where different players compete to supply a product, the general consumer will benefit from lower prices. Now as a result of a license raj the majority will be made worse off as a few players connected to the political authority can keep prices higher.  

Allowing a few people to import essential compounds and organic fertiliser is not different in my view. This will end up in few people controlling the entire market causing very high prices for the farmers which will end up in very high prices on food for common people. 

Additionally, the politicians who would back the licensing process will defend the same importers of suppliers in any case of any malpractice or importation of any substandard products.  

Just like I thought about why some people do certain things while others don’t, there are reasons why politicians prefer licensing. Simply the licensing process incentivises them and that is why they push for it regardless of the colour of the political flags they host. The current trend of setting up a licence raj which India had until the 1991 reforms and which were experimented in Sri Lanka in the 1970s is the surest way of making our entire country unproductive. 

However the ultimate loser of this game is the consumer and the farmer. Overall, Sri Lanka will lose while few politicians get some short term gains and the entire ecosystem feels the effects of instability. 

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.

To get rich, reward the hardworking

Originally appeared on The Morning

By Dhananath Fernando

Market-oriented policy reforms needed

Bill Gates famously said: “If you are born poor it’s not your mistake, but if you die poor it’s your mistake.” I believe this statement is quite apt if applied to Sri Lanka’s economy. Our recent economic trajectory shows a deep struggle to maintain economic growth and reduce poverty. We also don’t have a strong record of building prosperity for Sri Lanka since Independence.

The reasons and solutions have been discussed consistently by many experts, most often analysed and even over-analysed. Some policymakers understand the problem but fail to implement solutions, while some neither comprehend nor implement known programmes. In worst cases, some fail to comprehend but instead implement policies that worsen the situation. Sri Lanka’s post-Independence failure is a result of a combination of the above scenarios. It is a sequence of half-hearted attempts for much-needed reforms.

Sri Lanka is reaching a crucial juncture in its history; of having to pay for the country’s past mistakes and struggling to keep up with global developments yet again. On a more optimistic note, this presents Sri Lanka with the opportunity to understand the pressing need and importance of implementing much-needed economic reforms. However, to much of our dismay, the current political discussion is solely concentrated on evaluating the symptoms of the problem and not on accelerating the process of implementing the solutions we desperately need.

There has always been a debate on the rankings provided by different rating agencies on our dwindling foreign reserves. Some argue that our little island nation can survive the current foreign debt crisis, given our cash inflow and outflow numbers. Others present the case on Sri Lanka’s poor debt management.

The policy discussion needs to move beyond this and expand its scope to discuss solutions. The most practical short-term solution available to Sri Lanka right now is to seek the International Monetary Fund’s (IMF’s) assistance. However, this is not to be confused with a “be-all and end-all” solution, as it is only a painkiller to provide temporary relief from the agony the country’s economy is in at the moment. Working with the IMF will give us the credibility needed to convince the rating agencies that we are serious about addressing our macroeconomic problems, slow growth, high debt, and twin deficits in the fiscal accounts and the Balance of Payments.

However, it is time Sri Lanka addresses the million-dollar question we’ve been avoiding for decades – the need to implement hard economic reforms. Today’s column discusses the desperate need for reforms from a market-oriented perspective.

Sri Lankan society can be broadly divided into four main subsections on a matrix of “working hard” and “getting wealthy/successful”. Getting wealthy or successful can be loosely defined as earning in proportion to the effort put in/risk they take.

Below are the four subsections that Sri Lankan society can be divided into:

1. Individuals who work hard and become prosperous

2. Individuals who work hard but don’t become prosperous

3. Individuals who do not work hard but become prosperous

4. Individuals who do not work hard and and do not become prosperous

If Sri Lanka wants to avoid the mistake of dying poor, Sri Lankans must work harder. Hard work takes place when the incentive structure works and people get rewarded for their hard work and the risks they take. That can only be done through the market. The market system allows prices to work. It’s not only a profit-making system but a profit and loss signalling system. This encourages people to utilise resources optimally.

It is vital that we allow the market to function independently if we are to fix the economic crisis at hand. Its proper function will ensure the prosperity of all Sri Lankans.

The more we delay reforms and preoccupy ourselves debating and evaluating the symptoms of the problem, the further away we get from the opportunity of setting the price mechanism right. This allows the sustenance of a system that rewards the non-hardworking over the hardworking. This will only encourage the latter to seek opportunities and prosperity outside of Sri Lanka.

While cartels and market manipulators thrive, the average Sri Lankan suffers from excessive regulations and red tape. Most micro, small, and medium enterprises (MSMEs) struggle to keep their heads above water. Their productivity is hampered with no return or reward for their hard work. The more we strengthen the cartels and market manipulators, the more we discourage the hard-working Sri Lankan. 

The quadrant of not becoming prosperous and not working hard could be a personal choice, but most often, when the incentive structures are not in place, people have no impetus to do the hard work. That is why our reforms have to be focused on improving competition and price mechanisms, as it would encourage people to work harder. 

Sadly, the policy discussion is not one of the myriad solutions we can adopt. It is solely concentrated on our short-term ability to pay our creditors.

If Sri Lanka intends on getting rich, the solution lies in market-based 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.