Why Sri Lanka is poor, according to Bill Gates

Originally appeared on The Morning

By Dhananath Fernando

Bill Gates famously said: “My daughter won’t marry a poor man.” His definition of poor here is interesting. He explains that a person who wins $ 100 million is not wealthy: “He is simply a poor man with a lot of money. 90% of lottery winners eventually return to where they were before as they do not know how to recreate wealth.” “Wealth” is primarily the ability to create “wealth”, explained Bill Gates.

He further explained this with an example: “One day, a bank vigilante found a bag full of money, and delivered it to the bank manager. People called him an idiot, but in reality, this gentleman was just a rich man who had no money. A year later, the bank offered him a receptionist position, three years later he was in charge of clients and a decade later, he managed the regional branch of the bank. The bonuses of hundreds of employees he managed here were beyond the value he could have stolen.” Bill Gates concluded: “Wealth is a state of mind, my friend. That’s what I meant by ‘my daughter won’t marry a poor man’.”

Sri Lanka can learn from this story. A majority of Sri Lankans believe that the country is wealthy, given our resources. We have a sea of marine resources strategically located in the silk maritime route, natural harbours such as Trincomalee, a phosphate mine, and many more. However, as per Bill Gates’ definition, none of these resources create wealth. In economics, resources that cannot create and recreate wealth are no different to having no resources.

This is not endemic to Sri Lanka. Venezuela, which was the world’s fifth largest crude oil producer, is a poor and unstable country now. Afghanistan, which is also a very resourceful country in minerals and land, does not seem to have a very promising future. Nepal, which has the tallest mountains in the world with the potential to generate hydropower, often experiences blackouts. On the other hand, countries which do not have a rich history nor any resources – such as Singapore – found prosperity and wealth in a few generations. They simply knew the art of recreating wealth.

Sri Lanka has always prioritised sovereignty. However, we fail to comprehend that erosion of wealth is indeed erosion of sovereignty. Most of our scarce resources do not create any wealth, instead it consistently erodes existing wealth.

Many Sri Lankans and large scale businesses believe that the Government needs to provide them protection. This ideology has hindered our potential to keep up with global developments and has severely discouraged budding businesses and entrepreneurs. The businesses owned by the Government are managed by political appointees and government officials. They haven’t risked their money, nor do they know anything about business. As a result, they know very little about recreating wealth. There are no consequences to them if they were to lose large amounts of money.

The common denominator of the loss-making state owned enterprises is that they are allowed to manage a business without risking any money. Most trade union action also takes place in these very loss-making enterprises such as the Ceylon Electricity Board, the Ceylon Petroleum Corporation, and the Ceylon Transportation Board.

The state institutes that make profits also do not create any wealth. Like a man who steals money, they are just poor institutions with little to no profits. Most state institutes make profits either due to hampering competition or by monopolising the sector. For example, the two lottery boards are owned by the Government with no other lottery players in the market. Institutions like the Civil Aviation Authority are monopolies. The government milk supplier makes profits by hampering competition with higher effective tariff rates.

The role of the state should be to maintain safety nets for the poor. However, the state can’t even manage its core functions due to erosion of wealth. State owned airlines lose more money in eight months than the country’s annual budget for Samurdhi.

As per Bill Gates’ example, we are not creating wealth, but over the years we have made a habit of losing the wealth we have. As a result, we have now reached the bottom of poor economic management. The recent credit rating downgrade by Moody’s and Central Bank’s directive on exporters confirms the crisis we are in. As per the news reports, we have submitted documentation to secure $ 3.5 billion from Oman to sustain our fuel supply. This means the country’s future fuel supply is at a potential risk. This will discourage investors and foreign direct investments (FDIs). We already have LP gas and sugar shortages. Even if the price controls have been removed, there are no dollars to open and clear letters of credits for banks to operate. Our misperceptions in thinking that resources are indeed wealth, have made Sri Lanka what it is today.

Wealth is the ability to create wealth. Poverty is the state of thinking about money or resources as wealth without realising how to recreate wealth. Bill Gates was absolutely right.

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

Economic reforms before constitutional reforms, please

Originally appeared on The Morning

By Dhananath Fernando

Kumar Sangakkara in his famous Colin Cowdrey Lecture at London’s hallowed Marylebone Cricket Club (MCC) in 2011 said: “In cricket, timing is everything.” Not only in cricket but in economics and politics too, timing is everything.

Unfortunately, Sri Lanka’s track record on “economic reforms” has been very poor and completely devoid of timing. We have been completely ignorant of the need for economic reform and things are now at a dire stage. Across the board, even the Government has conceded that things are not easy!

Sri Lanka is experiencing a second wave of Covid-19 and the continued imposition of curfew in parts of an important district such Gampaha, which is a key economic centre, is a cause for concern. The recent lockdowns also cover a free trade zone, the country’s main international airport, and many export-oriented factories. Hence, one cannot simply ignore the economic impact of this health crisis.

Our economy contracted by 1.6% in the first quarter of 2019 and the second quarter data is yet to be released. On the positive side, our exports have exceeded the $ 1 billion mark in September and our remittances have increased by 28% YoY (year-on-year). While this increase in remittances is a good sign, this sudden increase may be due to workers sending home their final savings due to job losses. Another positive sign is that our stock market is performing well with about Rs. 5 billion turnover with more than 41,000 transactions, the highest since 2011. However, on the other hand, following Moody’s credit rating downgrade and even prior to that, the departure of foreign investors from the stock market can be observed, and our treasury bills have been undersubscribed as of late.

Unfortunately, with Covid-19 infections picking up again, it is unlikely that people will see further relief measures from the Government, as the Government’s finances are in a complicated situation; in fact, they are probably worse off than our household finances. Reopening the country for tourism will most likely be postponed, at least until the end of the first quarter of next year, and further moratoriums or government handouts may be unlikely, given that the budget deficit for 2021 is expected to be around 9% of GDP.

In this context, we have to admit that our economy cannot be fixed just by incremental reforms. Superficial changes or stopgap solutions will not help us reach where we aspire to be.

Unfortunately what we are seeing at the moment are attempts to micromanage what is essentially a macroeconomic problem, while serious core economic concerns are reaching a boiling point. Measures such as the reduction of tariff lines on a few consumable goods and allowing the importation of some ingredients for the production of incense sticks are just a couple of examples of ad hoc micromanagement of the macroeconomy. When a senior minister has to engage himself in a micro-task such as creating a tiny tariff reduction on just one HS (Harmonised System) code, it prevents them from prioritising the broader issues to navigate the economy at a time where the country is facing the unprecedented crisis of Covid-19.

A similar situation was reported to have occurred during the 1970s where the Minister of Finance had to go through a file every morning to evaluate the licence requests for the importation of motor vehicles. When a Finance Minister has to sit and supervise such a micro issue, it is obvious that many other policy priorities will be either ignored or mismanaged.

The World Bank predicted an economic contraction of about 6.7% for 2020 even before the emergence of the new wave of Covid infections, but mainstream conversation has been focused on constitutional reforms, particularly the 20th Amendment. It is true that people have provided a clear mandate for a new constitution, but our policymakers have to think of the timing of the new constitution and other constitutional reforms. The country and people’s needs and expectations have shifted, especially as the entire world is grappling with a pandemic. New needs and lifestyles have been created. Consumer and citizen behaviour and priorities have undergone a massive transformation. This doesn’t mean that the mandate for a new constitution is no longer valid, but the timing and focus being given to a new constitution has to be reconsidered. This matter could just as easily be taken up whenever the current crisis has been dealt with.

There is no doubt that our constitution is far from our expectations, but the brewing economic crisis (not just in Sri Lanka but across the world) requires 100 times greater focus for the economy to be put back on the right track.

The previous Government too was spending its energy on a new constitution without focusing on much-needed economic reforms. After spending significant time and resources during its tenure on a proposed constitution, it was ultimately not even presented to Parliament. Much-needed economic reforms were postponed and we ended up with 2.3% economic growth with stagnation in exports and foreign direct investments.

It is a political reality that there is a trade-off between constitutional reform and economic reform. Ultimately, for both constitutional reforms and economic reforms, one needs to sacrifice some political capital as, naturally, there is opposition to any type of reform. It all comes down to prioritising what reforms are urgent considering the internal and external environments.

Serious legal reforms can be carried out to positively affect businesses and the business climate before these planned constitutional reforms. As I have highlighted before in this column, Sri Lanka’s land regulations, regulations on micro and small enterprises, and employment regulations can be easily reformed to bring faster results. Age-old laws, regulations, and bureaucratic practices continue to hamper investment. Therefore, instead of a heavily energy-consuming constitutional reform process, we can focus on getting our economic fundamentals right. Creating competition and competitiveness is the way to go.

Over the years, while we have been discussing constitutional reforms, our regional peers have moved ahead of us, especially on the economic front. For example, Vietnam increased its exports from $ 50 billion to $ 250 billion from 2008 to 2018, while Sri Lanka’s performance improved only from $ 7.5 billion to $ 10 billion in the same period.

National Budget 2021

Now the Government has a golden opportunity to bring in a series of economic reforms through the upcoming national budget. A clear direction through serious reforms will bring back credibility to the Government and the economy, and send a positive signal to investors locally and globally. Sri Lanka’s economic problems have gone far beyond ad hoc fixing. Now it can only be fixed through macro reforms.

Then comes the question of what sort of reforms. In the world of business and economics, it is incentives that drive growth and innovation. It is by expanding markets and access to markets that growth can be achieved. It is through competition and by creating a level playing field that growing economies, including our regional peers, have achieved growth. So, for a market of 21 million people, our reforms have to be based on setting up proper incentives, connecting with other markets, and improving productivity for those who work hard and value-free exchange of goods and services.

Bringing in these macro changes before micromanagement has to be at the forefront of government policy. Unfortunately, we have no other alternative if we are serious about creating a prosperous country. Let’s hope that Sri Lanka will get its timing right at least this time and establish the right fundamentals for a competitive economy.

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.

Is Sri Lanka unlucky or unprepared?

Originally appeared on The Morning

By Dhananath Fernando

Some time back, a friend of mine died in a motorcycle accident. I consoled myself thinking it was pure misfortune. However, upon visiting the location of the accident, I discovered my friend had ridden his bike without a safety helmet. Needless to say, if he hadn’t met with the accident, regardless of whether he was wearing a helmet or not, he would’ve still been amongst us. However, if he had worn a helmet, it is likely that he would’ve survived the accident.

Most incidents in life, or even in the economy, can be seen through two lenses – of misfortune and mismanagement (in its positive variation, these can be interpreted as good fortune or as the results of hard work and smart decisions). It is embedded in Sri Lankan culture to interpret most unfavourable events in life through the lens of misfortune. However, a deeper dive into the root causes of unfortunate incidents often emphasises lapses of management.

A sudden uptick in Covid-19 cases can also be viewed by society through these two lenses. As individuals, isn’t it the appropriate time to question if we followed the simple steps of wearing a face mask, washing our hands, maintaining social distance, and taking precautionary measures to avoid greater misfortune?

On the broader picture of public policy; have we increased our testing capacity, have we followed the right testing strategy, and have we been conducting random testing? These are questions we should ask ourselves before jumping to any conclusions.

However, a combination of mismanagement and misfortune is deadly, and these two often complement each other. Whether it’s misfortune or mismanagement, the consequences for citizens would be very serious both from a public health perspective and from an economic angle.

One main lesson COVID-19 has taught us is that only self-control and self-discipline can contain the virus, not state control. The state can only play a facilitatory role, and the impact on public health and our economy worsens with each blanket policy decision.

When we look at the events over the last five to six years, an unaccounted cost of mismanagement is throwing away resources and opportunities that could have been utilised during hard times of misfortune.

For example, think of a cricket team which is chasing a total, and loses half their wickets due to the frontline batsmen playing careless shots. However, the team ends up losing only by two runs due to a brave fightback by the lower order batsmen, which took the team to the brink of an unlikely victory. Should we say the team was unlucky because it got agonisingly close and lost by only two runs, or should we blame the carelessness of the batsmen at the top, without whom the team would have presumably ended up winning the match?

When we look back at our recent history, in 2015-2016, the Central Bank bond fiasco affected our financial markets to an extent; in 2016, the drought greatly affected Sri Lanka’s economic prospects; in 2018, we had a constitutional crisis; this was followed by the 2019 Easter Sunday attacks which further shattered hopes of any economic recovery; we had the Digana riots and social media blockages in between; in 2020, we are still in the middle of a global pandemic. Some of these negative shocks are due to mismanagement, and some events are due to misfortune. But it is undeniable that we are hindered by the mismanagement of our misfortunes.

However, all the misfortune and mismanagement over the last few decades now appear to be funnelling down to a serious economic shock. The uncertainty of COVID-19 and its impact at the global scale have made it the right ingredient to stir up a storm for Sri Lanka.

Mismanagement and misfortune of exports

Covid-19 hit our exports badly on all fronts. As our export markets were affected by falling consumption, our supply chains for exports were interrupted during the first wave of COVID. Since then, however, our exports have been on the rise to reach pre-COVID levels. However, our apparel sector is one major industry that was badly hit by COVID-19 just at the start of this year – a time we need exports the most.

There is talk in society that the recent COVID-19 cluster is viewed as a result of both misfortune and mismanagement. However, we as a country cannot be forgiven for the mismanagement of our export sector over the years. Our mismanagement of exports backed by a system of unnecessary and excessive regulations on exports continues to handicap our export potential. According to a study conducted by Verite Research in 2018, registering as an exporter is an extensive process. The example they provided is of the coconut industry, where the process adds three to four weeks in the time taken to register, in addition to the time taken penetrating regulatory barriers that stand in the way of easy registration, only to prolong the process even further, continuing all the way to the point of customs.

The added unnecessary import restrictions further hurt Sri Lanka’s export potential with higher tariffs on imported raw materials for export processing making matters worse and Sri Lanka’s exports uncompetitive on the global stage.

The intention of protecting local industries by imposing tariffs has made our own local industries uncompetitive and has forced consumers to bear the cost of inefficiencies. As a result, local industries are neither productive for export nor competitive, and we are back at square one.

Our mismanagement has caused us to restrict our exports only to a few sectors and we have placed too many export eggs in the apparel basket.

Mismanagement and misfortune of our debt sustainability

COVID-19 has had a direct impact on our debt sustainability. As we have highlighted multiple times, servicing debt of nearly $ 4 billion till 2025 is a mammoth task. Our debt servicing cost has exploded to a whopping 107% of our annual revenue, and our annual revenue is declining as a percentage of GDP over the years.

The Government’s generous tax cut offered at the end of last year is expected to significantly reduce tax revenue for 2020. The Government assured us that we are in a position to service all our debts. However, that can be only done by borrowing money from other lenders and servicing the existing debt. Even if it is possible, it won’t provide a permanent solution due to the unsustainability of our debt.

If Sri Lanka had built the right economic foundations with proper social security safety nets and policies to boost competition and productivity with a firm understanding of economic fundamentals, we would never have reached this dangerous juncture.

By and large, we could also have navigated or totally avoided most of the misfortunes we are facing at the moment. Our mismanagement is what has made us believe that we are unfortunate. Unfortunately, the degree of mismanagement through which we have survived so far is more than we can afford. Therefore, we have now reached such a precarious position that we simply cannot afford to face any further misfortune!

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 bad parenting leads to bad credit

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

Originally appeared on The Morning

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By Dhananath Fernando

Parenting a child is a difficult task. It is no doubt that educating and teaching a child takes a significant amount of time and effort for all parents. The bigger the pile of homework, the more it becomes an affair of the household, requiring the attention and time from either parents or caregivers.

Some parents take an easy route; instead of encouraging their child to get the work done, they do it themselves and bestow the child with all the credit. This may be owed to the fact that the assigned task is above and beyond the grasp of a child, or simply because parents can’t afford to allocate the time and effort required to assist their child. Undoubtedly, both reasons are not in the best interest of the child and will certainly hamper his or her learning curve and growth.

Given the above phenomenon, I can’t help but notice similarities between common parenting mistakes and the Sri Lankan economy. Our economy has adopted a habit of conveniently ignoring hard reforms for political motives and instant gratification. This has resulted in long-term damage to the country’s economy.

Moody’s Analytics downgraded Sri Lanka’s credit rating from B2 to Caa1 last week with a “Stable” outlook. While the Government has made a statement expressing their disagreement with Moody’s credit rating downgrade. It is important to understand Moody’s rationale in depth. Long-term measures to correct these problems are vital, and hard reforms may be the only way out.

The effective containment of COVID-19 and the recent performance of the stock market has been reiterated by the Government as part of their success story. Additionally, the rebound of exports and foreign worker remittances are highlighted as positives. The Government has further provided a commitment to reduce the debt-to-GDP ratio, serve all external creditors without delays, and uphold a clean record of debt servicing.

However, Moody’s evaluation, which was in the works since April, highlighted concerns over-servicing debt of about $ 4 billion (between 2021 and 2025) with a reserve level of $ 7.4 billion, along with low growth predictions. Moody’s estimation of raising the debt-to-GDP ratio of 100% exceeding the median of 86% in the Caa1 category has been highlighted as a fundamental reason for the downgrade.

Moody’s downgrade forecasts the possibility of Sri Lanka’s credit rating being further downgraded by other rating agencies such as Fitch and S&P in the coming months. This will thrust Sri Lanka into the “Speculative Grade: Very High Risks” category, raising serious concerns over the possibility of acquiring money in international capital markets. The risk attached to this doubles as the coming years are burdened with heavy debt repayments.

How can this be managed?

Prevalent data highlights that consecutive governments have resorted to borrowing in international sovereign bonds at high-interest rates of about 6.6%, with an average repayment period of nine years. It is no doubt that our economic woes are deep-rooted in these poor policy solutions.

It is vital that we acknowledge the damage caused by these measures and formulate a strategy to overcome it.

The diagnosis is clear – our interest payments take 47% of our revenue and 30% of our expenditure.

The first step to manage this downgrade is to build credibility in financial markets. This is both painful and time-consuming. However, this is not an excuse to postpone much-needed reforms. Doing too little too late would lead to severe consequences, further hampering our debt sustainability.

To build credibility, the Government enjoys the benefit of two main strengths, a key strength being the successful management of the COVID-19 pandemic, which has also been praised by the World Health Organisation (WHO). At the international stage, this can be our ticket for a possible debt restructuring, giving the Government leverage to convince the International Monetary Fund (IMF) of a credible debt restructuring plan.

As per the below graphs, a greater portion of our foreign debt is in international sovereign bonds (ISBs). The IMF programme, of course, will come with conditions which are painful, but it will also bring credibility to Sri Lanka within international financial markets. This will require a commitment from the Government to maintain fiscal discipline. Sri Lanka has spent 42% of the last 70 years under an IMF facility. We have approached the IMF 16 times for bailout programmes. This isn’t a point of pride but indicates how irresponsibly our economy has been managed over the years.

An IMF restructuring programme will not uplift Sri Lanka’s credibility to the point where a credit rating downgrade can be reversed. However, it provides additional confidence for creditors and investors who are looking to invest in high-risk markets even at a premium rate.

The second strength is the Government’s opportunity to present a convincing budget with serious reforms in November. The budget needs to have a comprehensive strategy on improving government revenue and achieving a positive primary balance. (Primary balance is the difference between government revenue and government’s non-interest expenditure.)

Both measures are painful, but the Government has the political capital and political strength to pass through key essential reforms. Unfortunately, although we measure ourselves with what we intend to do, the markets and outsiders assess us with what we have done and continue to do.

Similar to parenting a child and encouraging the child to complete their assigned homework, the path to hard reforms is difficult and time-consuming. But we all need to support and help the Government to carry out these hard reforms, as it is ultimately being carried out for the betterment of our beloved motherland and 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.