Unveiling the true culprit behind economic woes

By Dhananath Fernando

Originally appeared on the Morning

Sri Lankans have a very negative view of imports, which are often portrayed on TV as the problem behind the economic crisis. Not only politicians, but also those who have opinions on our economy subscribe to the idea that imports are the problem.

Our politicians’ favourite pastime is to blame imports and impose various tariffs or ban imports. Banning imports also makes for a very pro-Sri Lankan image, because a common excuse provided is that high imports are damaging to local industries. Accordingly, the banning of imports has been portrayed as a measure to help develop local industries.

A favourite area when it comes to cutting down imports is food imports. Often, media headlines and politicians comment aggressively, even quoting figures on the value of food imported. The middle class, upper middle class, and wealthiest of society often make the argument of needing to save valuable foreign exchange by cutting down food imports.

However, when we consider the data, it indicates the exact opposite. The middle class, upper middle class, and the wealthiest are the ones who consume the most amount of imports in the form of fuel, mainly through personal vehicles and as energy. About 27% of our imports in January was fuel. Fuel is the largest component of our import basket as a single commodity.

What we have imported as food is less than 11% of our total imports. Non-food consumer goods are just 8% of our total imports. Most pharmaceutical products and medicines for patients fall under the non-food consumer goods category, which are primarily consumed by the most vulnerable people in society.

Imported food items are also consumed by the most vulnerable sections of society. Food items such as canned fish, maize, green gram, lentils, black gram, sprats, b-onions, potatoes, and wheat flour are critical food items for the poorest of the poor.

Firstly, these can be stored without a refrigerator, which saves their energy cost. Secondly, they are easily available and affordable compared to many other items of food they consume. Therefore, the request of politicians and academics to cut back on these food items, which comprise less than 11% of our total imports, is nearly impossible to fulfil, and reducing these imports further is tantamount to asking the poor to live in hunger and their children to suffer from malnutrition.

Thirty-seven percent of our import basket comprises intermediate goods, besides food. These are goods required for exports and to produce many things without interrupting the supply chain. For instance while our main export is apparels, our main import is also apparels. Therefore, asking to reduce apparel sector imports amounts to reducing our valuable exports.

In reality, while there persists a belief that imports have to be reduced, it is not the solution it is touted to be. If we have to cut down on food imports, it will lead to increased malnutrition, hunger levels, or food costs for Sri Lankans.

Ways of reducing imports

If we want to bring down our imports, cutting down on fuel is one way to consider. A World Bank study revealed that 70% of the fuel is consumed by the wealthiest 30% of society. Therefore, it only makes sense to maintain fuel prices at market price.

As indicated in the graphs, there is a correlation between high fuel prices and fuel imports. Our fuel imports have decreased when prices are high as people use it sparingly. Compared to January 2023, our fuel imports had declined by about $ 100 million per month by January this year. With the expansion of the economy, this number is expected to slowly grow. Prices can bring imports down without import bans or tariffs.

Another way to reduce fuel imports is by improving public transport. Most of our fuel is wasted in traffic jams as a result of our poor public transportation infrastructure. If we invest in public transport, not only will it reduce fuel imports, but it will also uplift many Sri Lankans and provide significant relief in terms of their purchasing power. Many middle class Sri Lankans pay a 200% tariff to buy a second-hand vehicle at an interest rate of above 12% because they have no other choice but to commute.

Saving foreign exchange

Sri Lanka has been offered many grants, including for the Light Rail Transit (LRT) project, which we turned down on numerous occasions, leading to geopolitical tensions. When people spend less money on commuting and waste less time in traffic congestion, it will not only improve productivity but also their purchasing power, creating many jobs and generating income.

It is an inalienable truth that we need more food imports with different varieties of protein sources for the benefit of the impoverished. Foreign exchange has to be earned through exports, tourism, and remittances.

Saving foreign exchange is a function of the monetary policy or the supply of the Sri Lankan Rupee to the financial system rather than a function of imports and exports. When the rupee becomes expensive, the US Dollar demand decreases automatically because people buy the latter using rupees that they could have used in an alternative manner.

Asking the public to cut down on food imports, which are mainly consumed by the poor, at the expense of allowing the use of more fuel-driven vehicles cannot be justified and borders on cruelty.

Poverty reduction needs to be prioritised with cohesive export-led growth policy framework

Originally appeared on The Daily FT

By Prof. Sirimevan Colombage

In Sri Lanka, around 40% of the population lives below the poverty line, according to expert opinion based on the survey data for 2016, in contrast to the official poverty ratio of only 4%. In the backdrop of the COVID-19 pandemic, the poverty ratio is likely to have reached nearly 50% of the population by now.

Adequate attention has not been given to poverty reduction in policy formulation agendas in recent times. 

An outward-looking trade policy aiming at export-led economic growth is imperative for poverty reduction, as evident from the fast-grown East Asian countries and emerging Asian economies such as Vietnam and Bangladesh. 

SL’s actual poverty 10 times bigger than official estimate

According to the Department of Census and Statistics (DCS), Sri Lanka’s headcount poverty index dramatically declined from 22.7% in 2002 to 4.1% in 2016, as per consumption approach. In computing this poverty index, DCS has used the National Poverty Line (NPL). 

The limitations of using the NPL for poverty estimation have been articulated in his incisive article by Wimal Nanayakkara, Senior Visiting Fellow at the Institute of Policy Studies (IPS) and former Director General of the Department of Census and Statistics. 

He suggests that the World Bank’s Global Poverty Line (GPL) is more appropriate for estimating the headcount index in keeping with international standards. The current NPL is based on the market values of an outdated basket of goods and services drawn from the Household Income and Expenditure Survey conducted by DCS way back in 2002. 

The World Bank’s poverty thresholds vary with the member country’s per capita Gross National Income (GNI). With her per capita GNI of $ 4,060, Sri Lanka reached the Upper-Middle Income Country (UMIC) status ($ 3,996 – $ 12,375) in July 2019, and hence, people who live below $ 5.5 daily income per person are poor based on GPL relevant to UMIC, according to Nanayakkara. 

Sri Lanka’s per capita GNI declined to $ 4,010 in 2019. As it was lower than the revised July 2020 UMIC classification ($ 4,046 - $ 12,535), Sri Lanka quickly slipped back to the Lower Middle-Income Country (LMIC) status ($ 1,036 - $ 4,045) along with Algeria and Sudan, as rightly predicted by Nanayakkara.  The applicable GPL for LMIC is $ 3.20. 

In terms of the GPL of $ 5.5, which is applicable for UMIC, Sri Lanka’s headcount poverty index for 2019 is as much as 40.4%, according to Nanayakkara. This can still be considered as the current poverty position of Sri Lanka, as her per capita GNI is still very close to the lower end of per capita GNI of UMIC, though she is now in LMIC category. 

Thus, the actual number of people living below the poverty line in Sri Lanka is about 10 times bigger than the mere 4.1% of population, as reflected in official statistics. 

Export-led growth for poverty reduction

It is essential to accelerate the rate of growth of Gross Domestic Product (GDP) to overcome poverty. The main ingredient for growth acceleration is foreign trade expansion which enables developing countries to gain market access, economies of scale, capital inflows, technology infusion, productivity improvements and efficiency. 

Open trade has been increasingly recognised as the key driver of employment creation and poverty reduction across the world in recent decades. Exports are critically important for economic growth, particularly for developing countries where domestic markets are small. Exports allow domestic producers to access international markets, and thereby to benefit from economies of scale. 

The world-wide evidence proves that those countries that achieved high export growth are the ones that enjoy high GDP growth and extensive poverty reduction. 

Sri Lanka’s backward technology and innovation

The formidable challenge currently faced by Sri Lanka is to raise her export growth at a rapid pace to achieve high GDP growth so as to reduce poverty. 

The country’s export sector, which is limited to a few low-tech products particularly apparels, has failed to graduate to high-tech and high value-added exports such as electronics and bio-technology products, unlike East Asian countries. This was due to the country’s backwardness in technology and innovation. 

In this regard, Foreign Direct Investment (FDI) can play a major role in fostering export growth by way of facilitating foreign capital inflows, technology infusion and foreign market access.

Trade opening and FDI inflows are found to be the major driving force behind the success stories of East Asian economies. More recent examples are India, China, Vietnam and Bangladesh. Outward-oriented economic strategies adopted in these countries, much later than Sri Lanka, led to foster export-led growth enabling millions of people to come out of poverty. 

Bangladesh: from a “basket case” to an economic powerhouse

Bangladesh is a good example to illustrate how prudent economic policies can turn a poor country, which was once branded as a “basket case”, into fastest growing economy in the Asian-Pacific region. It has become the new economic leader in South Asia with annual GDP growth rate over 6% in recent years, which was driven by the three star-performers – agriculture, garment exports and worker remittances. 

The key factor that fosters export-led growth in Bangladesh has been the liberal foreign investment regime by means of legal protection for foreign investment, generous fiscal incentives, concessions on machinery imports, unrestricted exit policy and full repatriation of dividends. 

Prudent fiscal management too was achieved in Bangladesh containing budget deficit to 3.5 - 4.0% of GDP. It helped to lessen inflationary pressures and to maintain exchange rate stability so as to facilitate the export drive. 

Export-led growth has enabled Bangladesh to reduce poverty from 40% of the population to 14%. In parallel, there have been substantial improvements in social indicators – infant mortality, maternal mortality, undernourishment, school education and adult literacy

Phases of foreign trade regimes

Sri Lanka has oscillated between inward-looking and outward-looking trade policies from time to time since Independence, and therefore, failed to sustain steady export-led growth path so as to bring down poverty levels. 

Perhaps, such policy changes can be conceptualised by using the theoretical framework developed by the US National Bureau of Economic Research (NBER) in its series of studies on trade liberalisation under the direction of Anne Krueger and Jagdish Bhagwati in 1978. They divided a country’s liberalisation process into five phases from trade controls to liberalisation, as shown in the Table.

The NBER studies, drawn from the experiences from different trade regimes in a number of countries including India, Ghana, the Philippines, South Korea and Chile provided ample evidence on the benefits of trade liberalisation.

Sri Lanka’s trade liberalisation under stress

In 1977, Sri Lanka moved from Phase II (NBER classification) of stringent trade and exchange control controls to Phase III marking the initial stages of trade and exchange liberalisation. The liberalisation process had been intensified since then.

In 1994, the Sri Lankan Government accepted the obligations under Article VIII of the Articles of Agreement of the International Monetary Fund (IMF). Accordingly, all restrictions on current account transactions of the balance of payments (BOP) were removed and the Sri Lankan Rupee was allowed to be freely convertible for such transactions. This shift to Phase V (NBER classification) was a major step towards trade liberalisation. 

However, the momentum of liberalisation was short-lived as various types of controls had to be imposed frequently due to the ethnic conflict, balance of payments difficulties, macroeconomic instability and external trade shocks. Thus, the country reverts back to Phases I and II from time to time.

Recent import controls

The country’s BOP situation has worsened since last year due to the COVID-19 pandemic which has adversely affected the export and tourism sectors. The external payments problems have been compounded by foreign debt commitments which amount to $ 6 billion this year. The rise in global market prices of crude oil and other commodities has further pressurised the BOP situation. The likely decline in worker remittances will further enhance the BOP deficit. 

In the backdrop of BOP difficulties, the Government has imposed import controls on a number of “non-essential” goods since last year. These include motor vehicles and various other consumer durables.

These import controls have adverse implications for economic activity, GDP growth and poverty reduction. 

Debt sustainability risks ignored through swaps  

The Government was able to secure $ 1.5 billion swap from the People’s Bank of China last week to meet immediate BOP needs. It is reported that the Government is negotiating with India to obtain another $1.1 billion under swap facility, debt freezing arrangement and development aid.

These swap facilities are temporary solutions to overcome BOP difficulties, and hence, deeper policy adjustments are essential to address the disarrays in macroeconomic fundamentals, particularly debt sustainability risks.   

Keeping IMF at distance

Overwhelmed by the Chinese swap, State Minister Ajith Nivard Cabraal claims that the Government can manage without IMF assistance. In fact, the challenge is to resolve the macroeconomic imbalances, rather than stubbornly refusing to go to IMF. 

Malaysia, which had strong macroeconomic fundamentals during the Asian financial crisis, could afford to refuse bailout from IMF. 

Sri Lanka’s case is totally different with her high budget deficit, unsustainable debt commitments, balance of payments difficulties, slow economic growth and more than anything else, acute poverty. 

It is ideal that if these deep-rooted problems can be resolved by ourselves without seeking anybody’s assistance, leaving aside the IMF.

IMF’s conditionality requires correction of macroeconomic fundamentals with stipulated deadlines. We ourselves can make these corrections without obliging to IMF. It is not happening that way, and therefore, swaps which do not impose any corrective measures, are the easy way out for the authorities to evade the much-needed policy reforms. 

So, the macroeconomic disarrays will remain unresolved forever exerting disastrous effects on the country’s economic growth. As a result, the poor who represent about one half of the population will continue to suffer without having basic human needs met. 

Outward-looking strategy imperative for poverty reduction

The current restrictive trade policy measures, which are based on the inward-looking approach, have been imposed to tackle the BOP difficulties. However, they are detrimental to export-led growth and poverty reduction.  

Hence, a cohesive export-led growth policy framework is essential to address the socioeconomic problems faced by nearly 50% of the population living below the poverty line. Poverty reduction, which is almost ignored in the current economic policy formulation, should be an explicit target of any future growth strategy. 

(Prof. Sirimevan Colombage is Emeritus Professor in Economics at the Open University of Sri Lanka and Senior Visiting Fellow of the Advocata Institute. He is a former Director of Statistics of the Central Bank of Sri Lanka, and reachable through sscol@ou.ac.lk)

Assessing Colombo’s urban redevelopment projects

By Ravi Ratnasabapathy

There has been some controversy about the urban redevelopment that took place at break-neck speed in Colombo under previous regime. Visitors and casual observers were struck by the changes to the city; Colombo was looking a lot cleaner and smarter.

The criticism has focused on the human aspects: the plight of evicted residents, the loss of a certain way of life or the change in the character of the city. Little attempt seems to have been made to assess the financial costs and benefits, chiefly because the full costs remain unknown.

The World Bank funded a part of the project and has borne the brunt of the criticism, but many of the projects were carried out independently by the UDA, the military and other state agencies.

The World Bank provided a loan of US$213m of which US$148m was allocated to finance flood and drainage management, US$ 51m for infrastructure rehabilitation (mainly streets and drainage) and US$10m for implementation support.

According to the project brief, the World Bank funding is in two components; the first addresses the problem of urban flooding, which regularly affects economic activities of Colombo. The second aims to support local authorities to rehabilitate and manage their drainage infrastructure and improve the systematic collection of solid waste. 

What the World Bank has been funding is basic infrastructure, something that was sorely lacking. Some observers have conflated this with the high profile redevelopments such as The Dutch Hospital, Colombo Racecourse, Floating Market, and Independence Arcade which seem to have been done independently by various state agencies. The confusion is understandable, given the lack of information.

The most controversial projects involving the rehousing of the urban poor seem to have been carried out mainly by state agencies, with the World Bank involvement being limited to one project at St Sebastian's Canal.

For a proper assessment citizens should know all the facts but the costs of the projects were deliberately shrouded in secrecy. In the interests of transparency the Government should collate and publish the total cost of the regeneration projects and the means by which they were financed. Since some of the projects are largely commercial in nature it is also necessary to know the income earned and the costs of operation.

Pending the availability of hard financial data, we can look at some of the broad philosophical arguments for urban regeneration.

There are many positive things that can come from urban renewal, depending on what drives the programme. The earliest projects were carried out in Victorian London to provide social housing to the poor, replacing the terrible slums that they lived in. A similar justification was used in the case of some of Colombo's new projects but one must note two critical points: the terrible conditions in London at the time, and the underlying purpose of the exercise : to improve the lives of the poor by providing cheap housing for the poor.

In Colombo the impetus seems to be more modern, one of stimulating economic growth through urban regeneration. This is something that has also worked (with varying degrees of success) in many different places but success is dependent on the right policy and governance framework.

If the economy booms, consistently over a few years people will have money to spend and there will be demand for land: for shops, for business premises, for entertainment.

When the demand materialises it makes sense to redevelop older or decaying parts of the city, to improve land usage or ease congestion. If the economy were booming then the Town and Urban Councils would be flush with cash (from trade based taxes) and there would be less need to borrow money to redevelop. It would also be possible to get the private sector involved in the redevelopment process, minimising the need for debt funding.

Urban regeneration needs to go hand in hand with the right policy and good governance because this is what ultimately drives growth. Ideally these should precede the regeneration effort and will help overall growth and the building of confidence. Getting this right policy costs little money but requires enlightened leadership. Once in place, growth will take place overall and attention may be turned towards the more neglected or decaying parts of the city.

Unfortunately what appears to have happened is debt funded beautification for which there is scant demand. According to news reports the floating market in Pettah is deserted. The Racecourse and Independence Arcade fare somewhat better, but store owners have complained that traffic is limited. It is a nice place to wander around in but few people actually seem to buy anything, as indicated by a recent news report that the Ceylon Tea Board shop at the Racecourse is running at a monthly loss of Rs.1m.

The problem seems partly to be in the mix of the shops in the malls. The shops were not allocated on general commercial principles or through a transparent process. Most crucially the malls seem to lack a proper ‘anchor’ tenant. Typical shopping malls incorporate one or more anchor stores and a variety of smaller stores, an anchor tenant being the largest retail outlet in the mall, chosen on the basis of its potential to attract customers to the shopping centre in general.

Naturally, these are commercial decisions and are best taken by businesses, not the Government.

What the Government should have done with these prime locations is to have tendered for proposals for redevelopment and handed over the entire project to a commercial developer. The property would have been developed, the treasury would have earned some revenue, the Government would be less burdened with debt and citizens need not be concerned with the commercial risks and rewards of the restaurant and retail trade.

What was the final cost to the taxpayer and could the money could have been better spent elsewhere? These are fundamentals question which must be answered and it is imperative that all the relevant information be made public as soon as possible.

The townsmen and visitors may be delighted by the external appearance of the city, but let us just hope that we are not walking on streets paved with gold, as in the folk tale of Dick Whittington.