Lessons from Singapore

Originally appeared on The Morning

By Dhananath Fernando

Where Sri Lanka went wrong and pathways to recovery

Too many comparisons have been made between Sri Lanka and Singapore. Once upon a time, becoming Sri Lanka was Singapore’s dream. Today, Singapore has been Sri Lanka’s dream for quite some time. Many credit the success of Singapore to the charismatic leadership given by Lee Kuan Yew. However, little is known about the work done by Dr. Goh Keng Swee on setting up the right architecture for a series of market-oriented policies in Singapore.

Relatively, Sri Lanka’s economy must grow at about 6% per annum for the next 40 years without failure in order to reach where Singapore is today, by 2061. In order to reach the kind of growth Malaysia has reached, Sri Lanka needs to grow at a steady rate of 6% until 2031.

Visionary Singaporean leaders realised that a country the size of Singapore cannot be self-reliant. With a minimum stock of resources, the country has to depend on imports to maintain the overall wellbeing of the people.

Policy consistency as well as establishing the right economic fundamentals set the country in the right direction. Consequently, the currency and monetary system became stable. Having a monetary system which focused on open market policies brought certainty and increased investor confidence. Special emphasis was placed by Singaporean policy makers to ensure that the wealth of the people was not eroded by unnecessary inflationary pressure.

Embracing open market policies attracted global multinationals and regional players to move their headquarters to Singapore, making Singapore a global hub for strategic industries in the region. Many multinational oil companies which left Sri Lankan shores due to nationalisation were welcomed with open arms to operate in Singapore. Even today, without a drop of oil, Singapore is a key player in the fossil fuel trade. They became competitive, efficient, and productive as they embraced the global market with an open mind and attitude geared towards development and prosperity.

Singapore also realised the role of the government. In fact, the world class Singapore AirLines and public housing is still state owned. Many Sri Lankans take these two examples to showcase why a state sector should engage in business like Singapore does with their airline. Many who put forth this argument conveniently forget that the management of some of the state entities are done on a Temasek Model on a competitive basis, where the government has no intervention in business. The professionals running the business earn the same as in a private company and the work culture is set right from the beginning to be competitive.

Unfortunately, Sri Lanka did not make any effort to create an open system. Instead, we closed ourselves from the world of trade and from connecting with global supply chains. In fact, many Sri Lankans once thought that Singaporeans would take over the jobs of Sri Lankans through the Singapore-Sri Lanka Free Trade Agreement. We missed an opportunity of a grand scale due to the pressure from trade unions and some professional groups to showcase to the world that we are trading with countries such as Singapore, and are ready for business and investment. As a result of shortsighted, irrational policies, our financial system became very fragile.

Another issue that holds back our potential is central bank intervention. Our Central Bank continues to intervene in market activity. “Price” can be looked at as being the same as body temperature. There has to be constant diagnosis by a physician. This monitoring without intervening is the role of a central bank in achieving efficient resource allocation. Therefore, intervening in the price signaling function has caused Sri Lanka damage beyond recovery.

Recently released data by the Central Bank indicated about 9.9% Year-on-Year (YoY) inflation compared to November 2020. YoY food inflation is 17.5%. There are many contributory factors behind the price rises such as global commodity price hikes, fertiliser ban, and continuous rains. However, one key reason which cannot be ignored is that over the last few weeks, a money supply of about Rs. 1.48 trillion has been injected from July 2019 to September 2021. This is a primary reason for the uptick in inflation .

Poor people will be the most affected, and as per the Advocata Bath Curry Indicator, the cost of rice and curry for a family of four members has gone up by 35% compared to last year. The poorest sections of society, who spend a greater amount of their money on food, now have to either receive a pay hike or cut down on their regular food intake.

This could also add pressure on private sector businesses, with employees requesting more wages and driving an increase in the cost of production. The high cost of production would impact existing investments, and with inflation Sri Lanka would not be an attractive investor destination.

On the Government front, the 1.5 million state workers will add more pressure by requesting further pay hikes with the new election circle. Making this more complicated, we have now accelerated a dual exchange rate offering, with an additional Rs. 10 for remittances as a measure to incentivise the usage of legal channels.

Singapore avoided most of the above problems we face by setting up a framework on a market based system, understanding the role of the government. As a result, they have developed a strong monetary system. This is a testament to getting macroeconomic policies right.

We can’t simply copy Singaporean policies blindly. Often policies have to be evaluated based on culture and dynamics, from a socio-economic context. However, the principles behind the policies remain the same. It has to be based on price signals and driven by the private sector, with the government only taking the role related to essential public goods such as the judiciary system.

An easy point to begin with is making our Central Bank an independent institution and moving away from ad hoc interventions. Moreover, we should let the markets work rather than having central bank intervention in foreign exchange through different strategies from time to time. Simply, our Central Bank has to work similarly to a currency board and the structure has to be made to facilitate this requirement.

At the same time, the structure has to be revised to ensure the independence of the Central Bank as the monetary policy can erode the hard earned money of poor citizens.

If Sri Lanka is serious about economic growth, it is of paramount importance to have a stable financial system which is an outcome of an implementation of a market based economic policy package. As Karl Schiller famously said: “Stability is not everything, but without stability, everything is nothing”.

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.

Mother land or other land?

Originally appeared on The Morning

By Dhananath Fernando

Economic crisis fueling migratory instability

Long queues to sort out passports and visas led many people to believe that Sri Lanka’s economic conditions were driving citizens away.

A survey by the Institute for Health Policy (IHP) conducted on 746 adults revealed that 27% of Sri Lankans are indeed willing to migrate if presented with the opportunity. According to the survey, 48% of those aged between 18-29 are considering migration, and 16% have started preparations to leave. The findings also revealed that 21% of those aged between 18-29 too have started preparations to leave. Further, 22% of women in the sample are considering migration, with 12% already having started preparations. There is no doubt that this survey is an indication of the critical situation Sri Lanka’s economy is faced with.

Sri Lankans have experienced the economic impact of various environmental hazards such as the tsunami, floods, landslides, and droughts. The economic impact of the ethnic conflict that lasted for 30 years and the impact of the Easter Sunday attacks on tourism were two other shocks that Sri Lanka has had to endure. However, the impact of an economic crisis is not felt overnight. The crisis we are in now has brewed at a slower pace and has hit us much faster than we expected. People often fail to understand the gravity of an economic crisis, and that in itself is rather dangerous.

The country is at a risk of losing more lives due to medicine shortages. Therefore, it is evident that measuring the impact of the crisis is quite difficult. However, this will indeed be felt in the form of increasingly poor quality of life and loss of hard-earned wealth across the board.

Economic crises physically manifest in the form of price hikes on essential items, shortages, and lower income levels. Shortages of LP gas, cement, and sugar is indeed an indication of the magnitude of the crisis we are in. Therefore, it is quite self-explanatory that people have increasingly felt the need to seek a better quality of life and opportunities outside Sri Lanka. Sri Lanka has experienced this before, during the ethnic conflict. Many people from the North and East fled to the West. These people didn’t leave Sri Lanka because they loved the country any less, they left because it was becoming increasingly hard to live here.

According to the aforementioned IHP survey, about 43% from the Northern Province desire to migrate, while 38% from Eastern Province desire to migrate. However, only about 2% have started preparations for migration in the Northern Province, indicating the gap between the desired action and resources.

The pressure is mounting up for the Government, and recently even his Excellency the President and the Prime Minister both admitted and highlighted the concern of youth migration. So, it is clear that the pressure felt at grassroot level is being noticed by the decision makers of the country. However, this is happening while the rising cost of living and worsening economic conditions are taking a hit at people’s consumption patterns.

The pressure is such that the Government is now considering IMF support, which they have been avoiding thus far.

All main indicators in our economy so far are not pointing towards any stronger recovery to overcome the crisis we are in.

In my view we are already too late. The only silver lining I see is the opportunity to restructure the economy. However, reforms in an environment which is unprepared for an economic overturn will be painful. It will take a longer time to recover, and it may have unintended consequences sociologically.

The Budget has pronounced some reform measures such as restructuring the public sector and reforming State Owned Enterprises. However, these reforms were contradicted by short sighted proposals to further recruit more than 50,000 government workers, etc.

One out of every two people expecting to emigrate and one out of four adults expecting to emigrate should not be taken lightly by the Government. It is a symptom of a bigger problem. Sri Lanka needs a credible plan to face the economic crisis we are in. Otherwise, those who have the capability and capacity to navigate through the storm will abandon the sinking ship or consider sailing to the land of Kangaroos through illegal means.

References

• http://ihp.lk/publications/docs/SLOTSReport20210ENG.pdf

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.

Ending the annual budget auction

Originally appeared on The Morning

By Dhananath Fernando

Budget 2022 must be the first step to getting the fundamentals right

As Lee Kuan Yew famously said: “Sri Lankan elections are an auction of non existing resources”. Over the years, our annual budget speech and promises have not been different. A long wish list of proposals skewed towards expenditure is read by the Minister of Finance. In between, some policy decisions and revenue proposals are pronounced 

A few weeks after a massive media focus, the budget is forgotten and everyone goes into deep slumber. This again gets the attention of next year’s budget. The same cycle follows, as some senior ministers fall asleep during the budget speech and wake up again for the traditional tea party generously sponsored by taxpayers. 

According to the analysis by Verite Research on PublicFinance.lk, of 34 proposals from 2020 (Verite has analyzed 34 selected proposals in the absence of a budget speech in 2020), only 4% were fully completed. On 50% of the proposals, information is not disclosed even to track whether the projects are progressing. Even in the 2019 Budget, only about 32% of the budget proposals were fulfilled. 

Most  financial analysts and financial sector professionals provide comprehensive coverages on the budget speech along with insights. Generally, it’s a time when vehicle owners and potential buyers get stressed. It is also commonly known that liquor and cigarette prices increase, and some relief packages in the form of subsidies for people get announced during the budget speech. So far, the budget speech is kind of a festival where people and businesses look for relief. That shows the level of government intervention that exists in Sri Lanka. In an ideal system where the market economy works, decisions cannot be surprises nor ad hoc, enabling people to have time to adjust and the price determining the allocation of resources. 

Traditionally, parliamentarians who support the government say that: “It’s the best budget post independence,” and the opposition says: “It’s the worst budget post independence,” as the microphones get directed by the media for comments on the budget.  

The budget this time is crucial for Sri Lanka. As per the numbers reported by authorities and independent analysts, it is clear we are short of money for detailed expenditure proposals and for daily operations.

86% of our tax revenue goes for salaries and pensions of state workers, and more than 100% of our revenue goes for our debt servicing. 

So as Lee Kuan Yew commented on our elections, most of the budget promises are just mere statements. It’s just a feel good statement or the auction of non-existent resources.  

This time it’s different because we are already inside the eye of the storm. This storm is the worst economic crisis post independence. 

Credit rating agencies have downgraded us, limiting our access to international finances, and we have about $ 22 billion of debt servicing for the next five years to be paid with just less than $ 2.5 billion in our reserves, as of 5 November 2021.

As we highlighted in this column post Budget 2021, it missed the elephant in the room, ignoring the debt crisis and the Covid-19 healthcare crisis. Even most of the business tycoons in most industries did not have the courage to point out that the last budget lacked the policy mechanisms of addressing the brewing economic crisis. Instead, they only looked inwards and failed to look beyond their interest without realising that we are on the same ship. There is very little meaning in demarcating our own territory when the entire ship is sinking.  

So we have arrived at a new cycle with a more serious situation, along with a further credit rating downgrade and more disincentives for exporters. The recent new rules on converting export proceedings will impact exports negatively. First, the exporters are paid a rate of Rs. 203 for each US dollar (USD) they bring, while the market rate is about Rs. 235 per USD. On the other hand, for importers, a USD was sold at Rs. 203 when the market rate is Rs. 235. So, we have fueled more imports and discouraged exports on exchange rate. Secondly, imposing controls on converting export proceedings will make life difficult for exporters to do business. Already exporters suffer from USD shortages and supply chain issues. Current policies just double the weight on their shoulders. 

There were heavy social media criticisms on the response by the Finance Minister on a budget related question. A journalist asked: “What benefits do you expect to announce for the people?”, to which he responded: “We may have to take from the people”. The reality is that the poor people who spend a higher percentage of their income on food have been greatly impacted by the increasing food prices caused due to the global commodity bubble. This has been made worse by the implementation of the Modern Monetary Theory implemented by our policy makers. So, taking from the poor will be difficult. At present they are mainly taxed through indirect taxes. 

Accordingly, this year’s budget has to be the first step to getting the fundamentals right. If we start auctioning non existent resources, this budget would lead us towards the direction of a looming crisis, making the situation even worse. 

Since the budget is now out, we can do an evaluation and make a judgement on the direction of the economy. 

(This article was written before the budget speech) 

Sources:

• CBSL, Annual Reports

• https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/statistics/wei/WEI_20211105_e.pdf

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.

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.

Crisis is here, reforms must be too

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

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

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

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

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

Solution 

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

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

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

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

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

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

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

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

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

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

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

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

Living according to a government’s will

Originally appeared on The Morning

By Dhananath Fernando

• Cost of living and the freedom of choice

Jeewan Thondaman, the political leader representing the estate electorate in Sri Lanka, was questioned recently on what development means for the estate sector. He said: “One politician visits the estates and says he built five houses and another one says he built 10. Merely building houses is not development.”

Then the TV anchor probed him on what development really is. “Giving the opportunity for people to build their own house in a land they own, as per their preference and aspirations, is development,” he replied. He went on to say that “if politicians build houses for the estate sector, regardless of the number of houses built, estates would never be developed”.

Politics aside, the young politician’s views on choice are highly commendable. Most often, people do not realise the importance of the ability to choose from a wide range of options. Especially in countries like Sri Lanka, we expect all things to be provided by the government. We like to eat what the government tells us to eat, we want to get educated on what the government says is good for us, we strive to get a job from the government as they see fit, etc.

The ability to choose is often tested in terms of marriage and relationships. Imagine if the government decided to select partners for us. We can all picture what chaos it would be. Similarly, when the government decides which food we should eat, which fertiliser we should use, and which job we should do, the results are not that different.

Availability of a range of options and increasing choices as much as possible is one key parameter on consumer convenience. The same concept works for essential commodities as well at a time when the national conversation is on rising food prices.

Let’s first understand the reason for rising food prices.

The recent food price hikes are caused by multiple reasons. One is rising global food prices and commodity prices with economies opening up after lockdowns. As a result, a barrel of Brent Crude oil, which was priced at about $ 42, is now at $ 83. So, a fuel price hike can be expected, which will, in turn, have a knock-on effect on many consumer goods.

Sri Lankans will be affected more significantly due to the Sri Lankan rupee depreciating in comparison to the US dollar. Excessive printing of money under Modern Monetary Theory (MMT) has further contributed to the depreciation of the currency. As this column highlighted many times, excessive printing of money, which increases the money supply, will also increase the demand for imports. A lot of the money printed will be used to purchase imported goods, which will worsen the balance of payment (BOP) crisis. A worsening BOP crisis will also increase the shortage of USD, thus increasing the price for a US dollar in LKR terms, or the exchange rate.

An increasing exchange rate will cause the prices of all imported goods to increase as the market adjusts, and keeping the exchange rate fixed without really having sufficient US dollars doesn’t make any sense. Simply, we have imposed a price control on the USD, which has created shortages just as with milk powder and liquified petroleum (LP) gas. Price controls also led to shortages.

If the Central Bank has unlimited USD supply, we can keep the exchange rate without fluctuations, but as per official data, our reserves are at a historically low level. So the Government and also our people are in a very unfortunate situation without having adequate tools to arrest the rising prices.

In a situation like this, some recommendations have been floated, such as increasing wages or Lanka Sathosa distributing essential goods.

On the question of increasing wages, the private sector has to have increased profits and revenue if they were to consider a salary hike. The government sector, which is about 18% of our labour force, cannot have a salary hike without further borrowing from the Central Bank. If the Central Bank further borrows on behalf of the Government, the prices will further increase. So, the only way to overcome this is to fasten our seatbelts and make sacrifices on our real consumption.

Sathosa has no other magic formula to reduce the prices unless a subsidy or budgetary support is provided, and obviously someone has to bear that cost of such a subsidy. Removing price controls is indeed a move in the right direction, but ensuring the market has enough competition across sections is also important in bringing down prices.

One good example is the wheat flour market, where there are only two players in the market. There is a very high tariff on imported milled wheat instead of raw wheat. So this acts as an entry barrier for other industry players to enter the market. As a result of such a lack of competition, the two existing players set the market price and the barriers to entry allow ample space for rent-seeking activities.

It’s the same for cement and industries like LP gas. In most cases, these industries are protected from competition. Protection from competition is directly undermining consumer choice. If Sri Lanka is serious about bringing down prices, our only solution is competition and expanding consumer choice.

At present, though, it seems that sacrificing consumption will be the only option we have and it will not be easy, specifically for the poor, where a higher percentage of income goes for purchasing food. This is going to be a truly difficult time period for such families. So the only option available is increasing the range of options available by increasing competition. Then, people can adjust their choices so that they have room to explore alternatives without experiencing the effect of higher prices. The only way to do it is to remove all barriers to market entry in order to pick the supply side up and iron out market distortions.

Different households will adjust in different ways to price hikes. For example, some households will reduce the quantity of milk powder used per cup. Some households may decide that only kids should be fed with milk powder and adults give up milk powder and shift to plain tea. Some families may adjust with frequency. Instead of having milk tea seven days a week, some will skip two to three days based on their affordability. Some families or businesses who have a higher degree of dependence on milk powder will use the same quantity, but they will reduce their entertainment expenses or other expenditure categories to keep the milk powder consumption going.

In simple terms, each household and individual, based on their circumstances, can decide what is the best choice for them. So even when making “sacrifices in consumption”, the freedom to choose is vital. With people making choices, there will be new market opportunities where suppliers will consider more options to supply alternatives to the  market and capture a different market segment.

Freedom of choice matters both in hard times and good. It is a fundamental pillar in a market system where people have the option of adjusting for higher prices by managing the cost of living to a certain extent. Competition in the market is what fuels the choice for consumers. Sri Lanka has to set the fundamentals right. For example, we cannot develop the estate sector by just building houses. We need to provide them the opportunity and choice to build a house as per their preference. This can only be done by allowing the market forces to work and establishing freedom of choice for people. While the importance of having the freedom to make individual choices is fundamental, the Central Bank can ensure that the rate of money supply increase is limited by using monetary policy. Finally, MMT does not work as it is claimed by those innocent of simple monetary economics. As our currency is not an internationally accepted currency, money printing by the Central Bank leads to inflation.

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.

When ‘national assets’ become ‘national liabilities’

Originally appeared on The Morning

By Dhananath Fernando

• Understanding the Trinco Oil Tank Farm controversy

Robert Kysokai, the author of the book “Rich Dad Poor Dad”, defines the difference between an asset and a liability quite simply. According to Mr. Kysokai, who is a management guru, anything which creates a cash flow is an asset and anything that dries the cash flow is a liability. If someone buys a car to be rented out to a taxi service, then it is an asset, because it can create cash flow and generate income. It can cover the expenses of the car from the income it creates by being used as a taxi. But if someone buys the same car to commute to work, it’s a liability, because it dries the existing cash flow from a different cash inflow, as the buyer has to incur regular cost for fuel, insurance, running costs, etc.

The lack of understanding of this simple concept has cost Sri Lanka a few generations of delayed development, with the recent fiasco surrounding the Trincomalee Oil Tank Farm story being a prime example of this.

The discussion surrounding the Trinco Oil Tank Farm is a good case study to explore the question as to whether the resources we have as a country are actually “national assets” or “national liabilities”. In most cases, holding onto national resources has gone on to create “breeding grounds for corruption and crime”, thereby becoming national liabilities.

The Trincomalee Oil Tanks were developed by the British, using labour from British territories in Africa between 1924 and 1930 – almost a century ago. The project plan was to develop 102 oil tanks. Tank number 100 was not developed and tank number 91 was destroyed due to an aeroplane accident. The tanks were constructed with inch-thick steel and protected with foot-thick concrete rings. The objective of setting up the tanks in Trincomalee was to make the  Trincomalee Port a naval hub in the region. This could be utilised for trade and military usage. The Trincomalee Port was one of the main natural deep-water ports where big vessels can be docked easily. So the vision behind setting up an oil tank farm in Trincomalee was mainly to set up an ecosystem for naval operations and bunkering operations.

In the meantime, in the 1970s, Sri Lanka introduced a policy of nationalisation and self-sufficiency. As a result, the properties of foreign energy companies that were in operation were asked to leave our shores, with the government monopolising the energy market.

Singapore took this as an opportunity and embraced all oil companies that left our shores. They were, in fact, welcomed with open arms. Provisions were made for them to invest and provide the freedom to take their profits off if they wanted. But instead of taking the profits off, investors invested them back into Singapore and made Singapore a dominant trading hub in the region, while also making it a maritime centre. Sri Lanka lost a great opportunity. This loss is signified  by the difference in the GDP per capita of the two countries. In approximate figures, Sri Lanka’s per capita GDP is $ 4,000 while Singapore’s per capita GDP is $ 60,000.

Rather than utilising the resources of oil tanks as an asset by working with foreign investors, the government taking over the energy market converted the asset into a liability. As a result, taxpayers have to keep supporting the colossal loss-making Ceylon Petroleum Corporation (CPC), which was a creation of this monopolising energy markets.

Since the nationalisation and self-sufficiency attempts in the 1970s, only about 15 oil tanks were used by CPC and their subsidiary, Ceylon Petroleum Storage Terminals (CPST) Ltd., till 2002, when Indian Oil Company bought one third of CPST’s shares. Then, the 15 tanks were leased out on a 35-year lease agreement to India for development. The Liberation Tigers of Tamil Eelam (LTTE) war too obstructed the optimum usage of the tanks. Each tank in the  Trincomalee Oil Tank Farm has a storage capacity of about 12,000 MT per tank, which accounts for about 1.2 million MT of storage in the entire facility. The recently built Muthurajawela Oil Tank Facility, built with a $ 72 million loan from China’s Exim Bank (total investment was $ 157 million), can only store upto about 250,000 MT. So the capacity of the Trincomalee Oil Tanks is far more substantial.

However, according to the shipping  industry expert Mr.Rohan Masakorala, the  LTTE problem would never  have taken off if the foriegn oil companies were allowed to operate in Trincomalee. According to him their entire eastern coastal belt would have been developed as much as Colombo, if we had allowed the foreign capital and technology to flow in,  especially in the Energy Market.

In 2018, the then Minister of Petroleum had discussions on a joint development project with India for 15 oil tanks out of the remaining 85 tanks. Again, another political monsoon started and nothing took off. So for nearly a century, we really didn’t use the Trincomalee Oil Tanks, although we still claim it as a “national asset”. Refurbishment of Phase I of the Trincomalee Oil Tanks requires a few billion dollars of capital. It also requires technology beyond our shores, and having an international partner is the only way to operationalise it.

Again in February, the current Minister of Petroleum announced that Sri Lanka is going to take over all oil tanks. Now there is a national interest on these oil tanks as a result of the Indian Foreign Secretary’s visit. The simple reality is that the 100 oil tanks which we failed to do anything with for 100 years, which occupies valuable land stretching 850 acres, are not really assets at present, from an economic perspective. They are simply liabilities, and in our case, they are even more than liabilities.

The only solution we have is to open our resources for foreign investments, if Sri Lanka is really serious about coming out from this economic downturn. Trincomalee has the potential to become a revenue-earning asset. The emerging Bay of Bengal economy is just opposite the Trincomalee Port. Chennai, Bangladesh, Visakhapatnam, and Thailand are countries and cities with large populations, with bigger markets where Trincomalee has the capacity to trade with and become a naval point for much larger economies. Currently, the trade volume we do at the Trincomalee Port is very limited, and the Prima factory and the cement plant are the only players presently using these facilities.

We have to think about Trincomalee as a whole and see the bigger picture than just seeing a fraction of it. The development of Trincomalee can be further extended with tourism up to our southern beach belt.

National assets are the ones that generate cash flows, regardless of ownership, and national liabilities dry up our cash flow. From an economic perspective, what we really celebrate as “national assets” and what we really try to hold for ourselves are “national liabilities”.

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.

When price controls get out of control

Originally appeared on The Morning

By Dhananath Fernando

• Price controls lead to shortages and distort markets

Why has Sri Lanka’s economy remained stagnant? This is not a difficult puzzle to solve. It is simply because Sri Lanka has repeated the same failed policies ignoring “economic fundamentals”. This is evident now more so than ever by the number of “price controls” imposed by the Government. Even an amateur student of economics would know that price controls distort markets creating black markets. Black markets mean reduced quality of goods and services and shortages. The recent conundrum of a few rice millers declaring rice prices and the Government having to withdraw price controls is the best example of the failure of this policy measure. The lack of economic analysis behind such policies have not only diluted the Government’s political capital but also have created shortages of rice in the market. 

It is no secret that the entire economic system has been damaged by the implementation of price controls. The real impact, like in the case of rice, is much more severe than what we see on the surface. 

A retired army officer was appointed to ensure the supply of essential food items. He raided a few rice mills, warehouses, sugar storages, and other essential commodities as per media reports to ensure the supply of essential food items. However, the recent withdrawal of price controls on rice is an indication of the failure of such short-sighted policies. Shortages sprouted, markets reacted and prices have increased further. These miscalculated policies have also led to the dilution of investor confidence by providing all the wrong signals to investors. Heavy Government intervention in businesses and private property, confiscating stocks and storages discourage investors. 

Markets work on the principles of demand and supply. It is a series of coordinated actions and reactions. These happen as a result of people working for the benefit of each other when allocating scarce resources which have alternative uses. Allowing this system to function can achieve the best outcomes for everyone, especially the consumers. Controlling the price by means of force is counterproductive. This will leave a bitter taste for both the consumer and producer as well as the Government. 

The political theatre of price controls is not new to Sri Lanka. It goes back to the 1970’s. Since then Sri Lanka has had a habit of imposing, relaxing and reimposing price controls. We have been in the same vicious cycle for decades. The previous Yahapalana Government imposed price controls on hoppers, tea, and milk tea. The current Government imposed price controls on another long list of goods including lentils and tinned fish. Even today, our USD has a price control of Rs. 203 per dollar. As a result there is a serious shortage of USD in the market. What is evident is that all items which have price controls imposed, experience some level of shortage or market distortions. 

How can the distorted rice market be rectified? 

The distortion of our rice and paddy market ultimately boils down to poor productivity along with excessive political and Governmental interference in the industry. The contribution of the agricultural sector to the country’s GDP is 8% with about 24% of the country’s labour force in agriculture. This is a good indicator to highlight how unproductive the sector is. Additionally, analysis shows that our pricing of one kilogramme of rice is completely irrational. According to research, paddy is a water guzzler that consumes about 2400 litres of water for transpiration. Further, 1200 litres is required to produce one kilogramme of rice. At the moment we do not charge for water needed for paddy cultivation. Most of the water provided is subsidized by taxpayer money. Additionally we provide fertiliser at a subsidised rate (organic or chemical). The subsidy is included in the price of paddy and rice. One of the main factors of production which is land is also not calculated in the cost of production as most of the cultivated land is owned by the Government. 

If we were to calculate the price of water, land and fertiliser, the cost of production of rice in Sri Lanka is extremely high. So if Sri Lanka is serious about rectifying the problem of rice, all these issues must be addressed. Attempting to control the price which is the final indication of resource allocation is not the solution. Failure to address the real bottlenecks at the root of the issue will exacerbate problems faced by the paddy farmer as well as the consumer. 

Importation of rice is not a popular topic in Sri Lanka for many reasons including the current forex crisis. One way to address the market manipulation by rice millers and provide consumers affordable prices is to let the market system work. That includes allowing the importation of rice by private businesses. Unlocking land for our farmers too is important to increase their productivity by using low cost methods of farming. At the moment since the land is owned by the Government, capital infusion and technological development that could be done is limited. Farmers cannot take a loan from the bank or do any technological advancement using the land as collateral. Farmers have very limited options and they are trapped in a vicious debt cycle while continuing to resort to unproductive methods of farming on land they do not own. 

Until Sri Lanka comprehends the problem, our solutions will be mere performative political theatre. Without evidenced-based public policies and a good understanding of economics, price controls will be imposed and reversed overnight, leaving the consumer, producer and the Government with a foul taste.

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.

Long-awaited economic revival: Will we ‘make it happen’ this year?

Originally appeared on The Morning

By Dhananath Fernando

Every year, as a kid, I used to write down my new year’s resolutions on a piece of paper and place it in a sealed envelope and revisit it on the last day of the year. Some of these resolutions were plans like scoring 85 marks for mathematics, learning to ride a bicycle, and scoring 12 half-centuries when playing cricket with my friends. The idea of revisiting them was to evaluate how far I have realised my goals for the year.

A quote by basketball legend Michael Jordan, which goes as “some people want it to happen, some wish it would happen, others make it happen”, made me realise that my dreams were merely wishful thinking without my conscious effort and action to pursue them.

In my opinion, this same scenario could be applied to realising the dream of a dynamic Sri Lankan economy. Choices spelt out by Michael Jordan are relevant to policymakers and the Sri Lankan people. Are we wanting to make it happen? Are we wishing it would happen? Or are we really making it happen? Only at the end of 2021 will tell what choices we have made as a collective.

In this light, this week’s column will explore possibilities for Sri Lanka’s economic revival for the year 2021, drawing on Michael Jordan’s wisdom, my experience as a common citizen, and the ways in which economic matters have been handled post Independence.

Scenario 1: Want it to happen

A possible scenario that could play out in 2021 is the political and economic leadership wanting to revive the economy but with the wrong tools. This is a classic scenario. Despite a genuine need and effort, things fail to work out in the expected manner due to multiple unintended consequences. Many academics and economic experts over the years have diagnosed Sri Lanka’s economic problem. However, we have spent way too much time on our diagnosis alone.

Even economists with conflicting ideologies would agree that the Sri Lankan economy has a severe productivity problem. This means that we waste large amounts of Sri Lanka’s valuable resources only to receive a very low output in comparison to the substantial input. The island’s structural situation has been deficient, creating sizable distortions in the economy. Sporadically, macroeconomic instability also occurs, arising from fiscal deficits leading to the creation of money and unsustainable current account deficits in the balance of payments. These have been the norm for decades.

The multitude of economic issues springing up in public discourse from time to time is a byproduct of these fundamental problems. Challenges on debt sustainability, poor performance of our exports, and lack of competitiveness are all just symptoms of a severe illness in our economy. If we deal with the symptoms of the problem rather than fix the root cause, 2021 will be yet another year where we “want it to happen but something else happened”.

There is a tendency to sell the same expired policy recipes wrapped in a new glittery package back to policymakers as an effective policy measure for economic revival. This may happen due to misunderstanding the diagnosis or lack of comprehension of the gravity of the problems at hand. If Sri Lanka picks the choice of “wanting it to happen”, our economic destination would be more likely the same or worse, coupled with many other unexpected challenges.

Scenario 2: Wish it would happen

The second possible scenario would be policymakers prioritising other political motives over economic reforms and simply wish the “economy would be revived”. Over the years, all parties have compromised the Sri Lankan economy for political power. Starting from the 1953 Hartal, 1981 riots, 1983 Black July riots, and the formation of the LTTE (Liberation Tigers of Tamil Eelam) up to the recent 2018 constitutional coup and the 2019 Easter Sunday attacks, the political agenda has always been prioritised over the island’s economy.

This sparks a two-way reaction which is a never-ending vicious cycle: When economic conditions are bad, it converts to political instability, and political instability fuels economic downturns. In all cases, we have had the wishful thinking that our economy would do better without the necessary steps to prioritise what needs to be done.

In 2021, all stakeholders and policymakers should leave wishful thinking aside and become more action-oriented to face the mounting debt sustainability challenges. With available foreign reserves and securing few swaps from neighbouring countries, we will be able to float through this year. However, failing to adapt necessary policies will mount up the pressure in the last quarter and in the beginning of 2022, if the environment for growth is not created.

In the back of our heads, we have a positive sentiment and wishful feeling that we can soldier through the debt challenge. The reality is that we should provide serious attention on the matter without taking it lightly. There is a higher possibility that a bilateral relationship with China will come for the island’s rescue; however, if China provides special treatment for Sri Lanka, they will have a long list of countries lined up expecting the same treatment. A recent article on Financial Times has revealed that the funding by China Development Bank and Export-Import Bank of China, which are the main two funding engines for the Belt and Road Initiative (BRI), has cut down the funding for BRI to $ 4 billion in 2019 from $ 75 billion in 2016.

There is a counter-argument that China will provide funds through Chinese SOEs (state-owned enterprises) as a novel strategy of financing the BRI. However, wishful thinking and placing all our eggs in one Chinese basket will not help Sri Lanka to overcome challenges at home. Sri Lanka requires action. It is unfair to have higher expectations from China as they have bigger interests over the entire BRI project, and at the same time, there will be geopolitical tensions. Incorrect prioritisation of reforms is a sure way for deepening the crisis.

So far, the tragedy of our economy is that we didn’t do anything. In a dynamic world, not doing anything is sometimes worse than even attempting to do the wrong thing. Settling in stagnation without moving in any direction and postponing the problem by kicking the can down the road of wishful prosperity is a distant recipe for actual prosperity.

Scenario 3: Make it happen

The third and most favourable scenario would be the policymakers making it happen. It’s easier said than done, but I still believe there is a good opportunity to make it happen if the correct tools are available and correct prioritisation is done. Every crisis brings opportunities and opens up windows for reforms. We have to just get the right reforms done. Very importantly, when the right tools are used, investor confidence will be restored and the market signaling system will work.

To “make it happen”, policymakers have to realise that there are no shortcuts, nor can there be any alternative method to be adapted. It has to be hard economic reforms to improve productivity by allowing markets to operate based on price signals and improve fiscal management and monetary stability. “Making it happen” requires commitment and comprehension of the problem diagnosis.

We need to understand that the solution mix we have at hand is not the most convenient, given our bad economic management over the years. There is a cost for every action, reaction, and choice we make. Since the Government has kept the solution with the International Monetary Fund (IMF) aside, now we have to evaluate the other available solutions. Financing through FDI (foreign direct investment) and bilateral swaps is one way to look at it. How far we can accelerate our growth realistically is another way to estimate where our possible landing would be.

As the Government is unwilling to amend the tax concessions, then we have to evaluate where we can cut the expenditure and if we are willing to let go of at least a few of our loss-making SOEs for private investors to run it. Or else, we can utilise some untapped resources and open it up for investment and take our economy back on track. We have to evaluate the pros and cons of going with the IMF vs. going without the IMF with a cost-benefit analysis and see where we really want to mix and match our solutions.

There are suites of solutions even in the darkest hour, but to make it happen, we have to move to the driving seat and get things done. Using wrong tools, not doing anything, and wishful thinking of an economic revival will surely not help Sri Lanka to move forward. Only time will tell us whether we just wanted things to happen, whether we were a bunch of wishful thinkers waiting for things to just happen, or whether we were a courageous nation which made things happen.

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.

Preserving foreign exchange or earning foreign exchange?

Originally appeared on The Morning

By Dhananath Fernando

A cricket game I played as a kid is still fresh in my memory. I did not know the rules of the game at the time. It was just me and my friend. We played against each other taking turns to bat and bowl. My friend batted first and I got him out when he had scored 25 runs after three overs in a five-over match. Then he started bowling. I was defending most of his deliveries and I scored 20 runs not-out after the end of five overs. I claimed the victory because I defended my wicket. My friend too claimed the victory as I couldn’t exceed the runs he scored. After a few arguments, my friend explained that in cricket, the victory of a game is decided not on the number of wickets defended, but by the runs scored. 

This childhood memory makes me question as to whether Sri Lankans and local policymakers, throughout history and to date, have ever fully comprehended the basics of an economy.

The recent commentaries and people’s reactions to the national GDP data for the second and third quarters by the Department of Census and Statistics and the external sector performance report by the Central Bank, make me question whether we in Sri Lanka understand our economic problem. Or are we continuing to drive further in the wrong direction?

The main objective of a well-performing economy is to raise national income, which will also help to reduce poverty and to allow more people to consume a wide range of goods and services in order to improve their quality of life. Simultaneously, sustainable consumption too is important to ensure long-term prosperity. To achieve these objectives, our strategy has to have a concentrated focus on providing equal access for all people across the country to enter into the economy. Special attention should be given to vulnerable sectors of the economy whose only tradable good is their labour. Efforts must be actively taken to integrate these vulnerable sectors to global production networks, as it will not only provide them with new opportunities to trade their labour but will also eventually help to eradicate their conditions of extreme poverty.

The Central Bank’s recent report on the external sector for October 2020 reveals that in the first 10 months, Sri Lanka’s exports have dropped from about 16% and our imports have reduced by about 19%. As a result, our trade deficit has shrunk to $ 4.8 billion from a corresponding $ 6.4 billion in 2019. 

It is imperative that we understand that the trade deficit/surplus (balance in the trade account)  is not necessarily the main indication of the direction of our economy. In reality, the most important indicators are the level of income and poverty, quality of life, and purchasing power of income. These indicators provide a better signal of the state of our economy and the wellbeing of Sri Lankans than mere trade balances and fiscal deficits and surpluses.

Our imports have shrunk, mostly as a result of the import restrictions, and our exports have dropped as a result of Covid-19 and the bias against export in our trade regime. The impact of Covid-19 was the very same reason why import controls were placed in the first place. Most of the imports are inputs for the manufacturing of goods to be exported. The scarcity or the lack of these imports result in exports being uncompetitive in the global market. Following an ideology that calls for defending the foreign exchange rate and targeting only the trade deficit as a strategy, may bring some long-term adverse consequences to our economy. Solely targeting a trade account deficit or surplus is similar to how I tried to defend the wicket without understanding the need to surpass the runs the opposing team has already accumulated. 

We need to realize the problem of trade is mainly due to the larger macroeconomic problems that have been ignored for the last few decades. Of aggregate demand running ahead of aggregate supply

We need to realise the problem of trade is mainly due to the larger macroeconomic problems that have been ignored for the last few decades; of aggregate demand running ahead of aggregate supply. Imports and exports are mainly a function of the private sector. What a government imports and exports compared to the private sector is negligible. In other words, the Government doesn’t import or export (except for direct government imports such as vehicles, food items for Sathosa, etc.), yet their intervention, through the imposition of restrictions through tariffs and non-tariffs, is very sensitive for the functioning of both import and export markets. So improvement of trade is a market function, and the Government should not intervene, except in the case of public goods. The role of the Government should largely be to set up a level playing field for our exports and assist and boost competitiveness. The current state of the trade account is just an outcome of poor macroeconomic policies implemented by consecutive governments.

On the fiscal management side, money printing (quantitative easing) to finance our budget deficit every year, while maintaining a long list of loss-making and unproductive SOEs (state-owned enterprises) is like adding fuel to fire. When we do quantitative easing to bridge the budget deficit, it may automatically distort markets as demand for available imports may increase, causing further market distortion, leading to further pressure on our currency.

It is a positive indication that our economy has achieved a growth of 1.5% compared to the corresponding period in 2019 as per the recent numbers by the Department of Census and Statistics. However, without addressing macroeconomic reforms and solely targeting the trade deficit alone, Sri Lanka will have a feeble chance in achieving the main objective of a well-performing economy. 

Rather than focusing on defending our foreign exchange rate, we have to shift our gears to a better strategy where we focus on a competitive exchange rate. To do this, we must acknowledge the problem and find a suitable strategy to meet this objective. 

The fundamental understanding has to be that the Sri Lankan economy is plagued by macroeconomic imbalances, and governments cannot fix the outcome of a problem without fixing the problem in itself. The island’s low growth, from the recent low exports to GDP, quality of life, pressure on external debt, pressure on the currency, poor productivity, and a stagnant economy are a result of poor understanding on the way the system operates. As we did not comprehend the magnitude of our problems, we failed to address macroeconomic reforms or we postponed it every year.

If we continue to defend our foreign exchange like defending wickets in cricket and continue to fail at earning foreign exchange by fixing our macroeconomic fundamentals, the situation is prone to worsen. Sri Lanka must strive at scoring runs that exceed our opponents’ instead of defending wickets.

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.