Cycling to work in Colombo is easier said than done

Originally appeared on The Morning

By Dhananath Fernando

A new proposal is under discussion to encourage travelling to work by bicycle. No doubt any policymaker who pays a trip to Europe may observe many people commuting to work by bicycle and on foot. So it is normal for anyone to think “if Europeans can do it, why can’t we?”

Some may even believe that countries in Europe have become developed nations because of behaviour involving “a healthier way of life”; commuting to work by bicycles and using electronic vehicles to reduce pollution.

That line of thought is no different to thinking that the work of Usain Bolt, the Olympic Gold Medallist is easy – running 100 metres in about 10 seconds while accumulating millions of dollars in wealth. All this while many other people cannot come close to accumulating the same amount of wealth even by working throughout their lifetime. 

But what many fail to realise is that Bolt had to put about 20 years or more of training to run that 100 metre in 10 seconds under Olympic game conditions. Similarly, most of the outcomes are a result of a series of policies which go hand in hand with culture, geography, and many other economic factors. 

There is no doubt that cycling is good for health and it will help reduce emissions as well. But if policymakers are deeply interested in encouraging people to cycle to work, it has a lot to do with Sri Lanka’s land, housing, and tariffs on construction materials policy rather than being purely based on cycling. 

You may ask how ‘cycling to work’ is connected to housing, construction tariffs, and land policy? 

It goes without saying that people can cycle to work when they reside at a reasonable distance from their workplaces. When many of the members of the workforce live far away from their workplace, they have to have a convenient mode of transportation not only for reporting to work but also for other personal needs. Given the poor public transportation and lack of interest in developing public transportation, the reasonable option available for the middle class is to have their own vehicle. 

As Sri Lanka became a middle-income country, many could afford a vehicle even at very high border taxes, which are as high as above 100%. So for the average middle class, the available reasonable choice is to reside far from the city limits (main cities such as Colombo, Gampaha, Kandy, and Galle) and commute in their personal vehicles.

The question is why people reside so far away from city limits. It is mainly because housing is not affordable within city limits. Unaffordability of housing is due to two main reasons. First, about 82% of the land in Sri Lanka is owned by the Government, including prime properties within city limits. So land prices are very high due to the Government holding land for completely unproductive enterprises. 

A simple walk around Colombo would bring to view a number of  single-storeyed State buildings where the space is utilised in a very unproductive manner due to poor city planning and excessive regulation. 

Secondly, our cost of construction is very high due to tariffs and paratariffs. Hence, the cost of productive land usage housing schemes such as apartments have become only affordable to the elite and not the middle class. Our floor tiles, wall tiles, cement, steel, construction, aluminium, electrical material and a long list of other materials are more expensive than the global market prices. This is due to very high tariff rates that do not generate much revenue for the Government but only benefit a few protectionist industries, which is called ‘rent’ in economic terms. On housing projects there is a regulation which stipulates that every apartment should have a parking space.

A young professional who uses mobile app-based taxi services or lives at a walking distance to their office does not necessarily need to pay for the land, bearing the construction cost for a 300 Sq.Ft. parking slot in an 800 Sq.Ft. apartment. It is such regulations that drive the housing prices within city limits and minimise choice for the consumer.

As a result we have very few vertical housing schemes that are affordable to the working middle class located within city limits. Young professionals who could easily settle in a two-bedroom apartment within walking or cycling distance to their workplace now have to buy unproductively utilised and expensive land far away from the city, along with a vehicle to commute to work.

If the middle class has housing options within city limits, they would be the happiest to settle in Colombo. They can save their hard-earned money on an apartment property which is a transferable asset rather than purchasing five-year-old low quality reconditioned vehicles which are subject to a tariff of more than 100% to commute to the workplace, burning fuel in the congested and traffic-riddled city streets. 

When middle-class aspirational Sri Lankans can afford to reside in the city where they will be able to use a bike instead of a reconditioned vehicle to commute to work, it is then that we will achieve the objective of saving fuel and minimising emissions and valuable foreign exchange, thus increasing productivity across the board. 

A few years ago the Colombo Mayor and Dutch Ambassador also promoted cycling on weekends. It just became a typical Colombo event and now we hardly see people cycling in Colombo. Often cyclists in Colombo are lottery sellers selling a dream of a fortune to the working middle class and aspirational Sri Lankans, where they can buy a house if they have the luck on a State-issued lottery ticket.

Additionally, we have to remember that there are regions in Europe where it’s less humid than Sri Lanka, so cycling to work is easier than in a tropical country.

If our policymakers really want to see a city of cyclists, they have to start working on our land policy, housing, and tariffs on construction. If we set those policies right, many more developments will be achieved rather than just producing cycling professionals within city limits. 

The Government will need to consider enforcing traffic laws and providing cycling space to enable safe and easy cycling to and from work. 

Reference:

• https://www.newswire.lk/2022/01/26/proposal-to-travel-by-bicycles-to-work/

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.

Special Goods and Services Tax: Issues and Concerns

Originally appeared on Ceylon Today, Daily FT, The Island

By Dr Roshan Perera & Naqiya Shiraz

I. Background

The new bill titled ‘Special Goods and Services Tax’ was published by gazette dated 07 January 2022. (1) The Special Goods and Services Tax (SGST) was originally proposed in Budget speech 2021 but was not implemented. It has once again been presented in Budget 2022. The SGST aims to consolidate taxes on manufacturing and importing cigarettes, liquor, vehicles and assembly parts, while also consolidating taxes on telecommunication and betting and gaming (see table 1 for existing taxes on these products and table 2 for taxes consolidated into the SGST as per the schedule in the gazette). The rationale for this new tax as per the bill is “...to promote self-compliance in the payment of taxes in order to ensure greater efficiency in relation to the collection and administration on such taxes by avoiding the complexities associated with the application and administration of a multiple tax regime on specified goods and services.”

Given the multiplicity of taxes and the complexity of the current tax system as a whole, rationalising taxes is necessary to improve collection. However, whether the proposed SGST simplifies the tax system while ensuring revenue neutrality or even improving revenue collection, needs to be carefully examined.

The SGST Bill is silent on the treatment of the existing VAT on these goods and services. However, according to the Value Added Tax (Amendment) Bill also gazetted on 07 January 2022,(2) liquor, cigarettes and motor vehicles will be exempted from VAT while telecommunications and betting and gaming services will still be subject to VAT. 

While the gazetted Bill sets out some of the features of the proposed SGST there are many important areas not covered in the Bill.  These are expected to be gazetted as and when required by the Minister in charge. 

II. Issues & Concerns

The motivation behind SGST is the simplification of the tax system. Although the objective of introducing the SGST is to improve efficiency by reducing the complexity of the tax system there are many issues and concerns with this proposed tax.

1. Revenue

Tax revenue which was 13% of GDP in 2010, declined to 8% in 2020.  Ad hoc policy changes and weak administration contributed to the decline in tax revenue collection.  This continuous decline in tax revenue has led to widening fiscal deficits and increasing debt. One of the main reasons for the current macroeconomic crisis is low tax revenue collection. Hence, any change to the existing tax system should be with the primary objective of raising more revenue.  

According to the budget speech the SGST is estimated to bring in an additional Rs. 50 billion in revenue in 2022. (3) Revenue from taxes proposed to be consolidated under the SGST has significantly declined over the past 3 years. Given the already difficult macroeconomic environment, along with ad hoc tax policy changes raising the additional revenue estimated at Rs. 50 billion seems a difficult task. 

2. Tax Base and Rate

For the SGST to raise taxes in excess of what is already being collected through the existing taxes, the rate and the base for the SGST needs to be carefully and methodically calculated. Further, the existing taxes have different bases of taxation. For instance the basis of taxation of motor vehicles is both on an ad valorem (4) basis and a quantity basis while the basis of taxation of cigarettes and liquor is quantity. (5) In light of this, the basis of taxation on which SGST is applied becomes an issue. Having different bases and different rates for various goods and services would complicate the implementation of the tax These issues need to be carefully considered to ensure the new tax is revenue neutral or be able to enhance revenue collection.

3. Efficiency

One possible revenue benefit of this proposal is the inability to claim input tax credits on the sectors exempted from VAT. However, the issue is the cascading effect that would result where there would be a tax on tax with the end consumer paying taxes on already paid taxes. If the idea was to raise additional revenue by limiting tax credits, it would have been simpler to raise the tax rates on the existing taxes rather than introduce a new tax. 

4. Administration

According to the bill, SGST  will now be collected through a new unit set up under the General Treasury where a Designated Officer (DO) will be in charge of the administration, collection and accountability of the tax. The existing revenue collection agencies, such as the Inland Revenue Department (IRD) or the Excise Department will not be primarily responsible for the collection of this tax. By removing the  IRD and Excise Department, a parallel bureaucracy will be created, at a time when public spending needs to be carefully managed. The General Treasury also has no previous experience and expertise in direct revenue collection. Weak administration is one of the key reasons for the low tax collection and success of this tax would depend on the strength of its administration. 

In addition to the above-mentioned concerns, as per the Bill the minister in charge of the SGST has been vested with the power to set the rates, the base and grant exemptions. Accordingly, Parliamentary oversight over fiscal matters is weakened under this proposed Bill. 

It could also lead to a time lag between the gazetting and implementing of changes to the SGST (such as the rate, base etc) and obtaining Parliamentary approval for those changes.

5. Dispute resolution 

The SGST Bill also focuses on the dispute resolution mechanism. Under the present tax system,  with the enactment of the Tax Appeals Commission Act, No. 23 in 2011 the Tax Appeals Commission has the “responsibility of hearing all appeals in respect of matters relating to imposition of any tax, levy or duty”.(6) The most recent amendment to the Tax Appeal Commissions act (2013) (7)  seeks to address the large number (495) of cases pending before the Tax Appeals Commission (8) by increasing the number of panels to hear the appeals. 

Under the proposed SGST disputes will be handled through the court of appeal. However, the time period by which specific actions need to be taken is not provided in the bill. In addition, disputes have to be taken to the court of appeal.  Hence, the entire process will be more time consuming. This could result in revenue lags and difficulties in revenue estimation until disputes are resolved.

Additionally, in the case that no valid appeal has been lodged within 14 days, any remaining payments would be considered to be in default. Thereafter, the responsibility is shifted to the Commissioner-General of the IRD to recover the dues. Given the IRD is completely removed from the normal collection process, the rationale for bringing defaults under the IRD is not clear.

III. Policy Recommendations

As discussed, the SGST Bill has several limitations and much of this is due to the ambiguities in the Bill.  

• If the tax is implemented, the rate and basis of taxation need to be revenue-neutral to ensure tax collection is maximised and administrative costs minimised.

• The rates, basis of taxation, exemptions etc should be specified in the Bill, as done in most other Acts. This would avoid the power for discretionary changes to the tax being placed in the hands of the minister in charge. 

• Given the already weak tax administration, it would be more sensible to strengthen the existing revenue collecting agencies and address the weaknesses in the existing system without creating a parallel bureaucracy.

• In the case where VAT is consolidated into the proposed GST, the issue of cascading effect of input tax credits needs to be addressed. This is relevant particularly in the case of capital expenditure. 

Given the critical state of revenue collection in the country, the question to ask is whether this is the best time to introduce a new tax. Focus should be on fixing issues in the existing tax system to ensure revenue is maximised.  The VAT is the least distortionary tax and it is the easiest to administer. Given these features, it can be a very efficient revenue generator for a country. Therefore instead of introducing a new tax, capitalising on systems that are already in place and amending the VAT rate, threshold and exemptions may be a more practical solution to the revenue problem that the country is currently facing. 

Dr. Roshan Perera, Senior Research Fellow, Advocata Institute and former Director, Central Bank of Sri Lanka.

Naqiya Shiraz is a Research Analyst at the Advocata Institute.

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

References:

1. http://documents.gov.lk/files/bill/2022/1/162-2022_E.pdf

2. http://documents.gov.lk/files/bill/2022/1/163-2022_E.pdf

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

4. A value based tax base of ad-valorem refers to a rate of tax, where revenue will increase if the value of tax base increases. 
   A quantity based tax base is a tax imposed on a per unit quantity of the product.

5. https://www.treasury.gov.lk/api/file/304e2f2f-f215-40ad-b613-4d7cc3427178

6. https://www.treasury.gov.lk/api/file/4028b5a0-f166-4f1d-a076-299e32200212
   http://www.cabinetoffice.gov.lk/cab/index.php?option=com_content&view=article&id=16&Itemid=49&lang=en&dID=10210

Borrowing from Peter to pay Paul

Originally appeared on The Morning

By Dhananath Fernando

There’s a childhood memory engraved in my mind, of an incident with a fellow schoolmate concerning an act of borrowing. Back then, we borrowed money from each other constantly to eat sweets and junk food and buy video game gadgets. A particular friend of mine had the habit of borrowing a little money every week and settling the same again after a week’s time right on schedule. After a few weeks, I realised he borrowed the same amount of money from another friend as well. 

Like a well-planned roster, he proceeds to settle his debt with the other friend in a week’s time. One day my frequently borrowing friend did not settle my money as he promised. When I confronted him on the matter, he plainly stated that he settled the amount owed to me with the money he borrowed from my other friend and vice versa. At this one instance, the other friend had refused to lend money to my frequently borrowing friend so he was unable to settle with me. 

But what was particularly amusing was what he said after. “What I have been borrowing and settling for the past few weeks is money from the two of you to each other. So to resolve the matter, the two of you must settle with each other because it’s your money. Not mine.” 

Sri Lanka’s debt servicing is a much more complex version of what my classmate did; we settle our creditors by borrowing from someone else. Most sovereign countries do the same. However, this can only be done when someone agrees to give us money. Similar to the incident with my friend, the moment people refuse to lend us money, the cycle starts collapsing. That is exactly what happened to Sri Lanka. As a result, the country has lost its credit rating by international rating agencies and has thereby lost market access. 

The current strategy we follow is requesting lifelines from our bi-lateral partners as a form of assistance. As a result, in just five days, India threw in about $ 1.4 billion worth of credit lines and swaps to secure our fuel, medicine, essential supplies, and debt repayments. 

Initially, China provided us with a swap of 10 billion Yuan as a back-up, which the Central Bank absorbed as reserves according to their data. 

At the same time with some of the bi-lateral partners, our relationship has not been professional. We cancelled the LRT project with Japan, which is our main bilateral creditor as well as the main funder for one of our main multilateral partners, the Asian Development Bank (ADB). To make matters worse, we keep the trade channels such as vehicles and spare parts closed, which is precisely where the bilateral relationships can be strengthened. 

Our mismanagement of bilateral relations is reflected, even with China. Recent events, such as our shortsighted handling of diplomatic relations over the fertiliser issue, with China blacklisting a state bank for not honouring payments, illustrates this issue. 

Economically and geopolitically, we have lost market access for borrowing on one hand, and on the other, we have somewhat tarnished the relationship with our friends at a time when we need their assistance the most. So far, we have been very lucky to still have their continuous support regardless of the setbacks even though the fault is on our end entirely. As a recommendation, the Government should not take the silence of some bilateral partners lightly, but work double-time to restore trust and understanding in business and trade. 

The current strategy of paying our International Sovereign Bonds through bilateral swaps and depending on credit lines for essentials will eventually come at a geopolitical expense. We become more vulnerable with our past track record of working with our bilateral partners. 

In this context, the Central Bank increased policy rates by 50 basis points, a policy move in the right direction. However, this comes – unfortunately – too late to stop the inflationary pressure constantly building, probably due to the faulty use of Modern Monetary Theory, which we have been following for some time now. The policy rate revisions will encourage people to save more money instead of spending more. This will somewhat ease the pressure, but at the same time slow the economy down. But we can’t afford to accelerate the economy with a historic balance of payment crisis which was already exacerbated by a price control on US Dollars (USD) in an attempt to encourage imports and discourage exports. 

Surprisingly, policymakers have not taken any reforms to overcome the situation, believing that debt servicing through borrowed money will solve the problem. Very high hopes have been kept on tourism but the same thing that happened to remittances will happen to tourism when we try to keep the exchange rate very low. We encourage people to keep the USD in grey markets so people will become further reluctant to sell their hard-earned USD to the Central Bank. 

At the same time, we need to understand tourism also increases the consumption of the economy where, with USD inflows, there will be a fair share of USD outflows concurrently. Thus, keeping all our eggs in the basket of tourism would not be advisable at all. If policymakers recall, at the beginning of the pandemic, remittances were at a record high. With mounting debt, our policymakers replied that our solutions remained in our remittances, which today are in decline due to our own policy failures. In this context, there are certain areas for restructuring that policymakers have to consider if they were to come out of the crisis: 

1. Restructuring of our social security net. A market pricing-based digital cash transfer system with better targeting than Samurdhi is recommended to provide poor people the opportunity to keep their noses above the water to navigate through the economic reform period

2. Restructuring and Reforms on the State sector and State-owned enterprises are a must. Listing the debt of State-owned enterprises, privatisations, consolidations and outright sale of some of the assets owned by State-owned enterprises is required for the private sector, including land. Government care has to be limited through a reasonable voluntary retirement scheme

3. Restructuring and Reforming in our Central Bank .The current tools of excessive interventions by the Central Bank on interest rates, exchange rates and every part of monetary policy has to be refined

4. Restructuring and reforming our tax system and tariff system is a must. Currently, our income and corporate tax systems are too complicated and it has to be simplified if policy makers are interested in increasing revenue. The complicated tariff structure has to be simplified with three tariff bands. Bringing down tariffs will also help the Government increase the revenue and boost trade

5. Restructuring and reforming our production structures for it to be aligned with global production and supply chains is vital to increase export revenue. At the same time, a deregulation drive has to be initiated to ensure conducive business environment for locals and foreigners

6. If our debt is unsustainable, we have to consider a restructuring of debt, but with the above-mentioned reforms. Attempting to do a debt restructuring without a solid commitment to reform will worsen the problem and debt restructuring could become a frequent event causing us to lose our credibility and market access if we fail to do the necessary reforms

All these ideas are not new and not a first mention in this column. These have been repeatedly spoken of by countless economic experts. It is simply that the call to action rate is very low. Policymakers whose job is to change policies and get things done. Not to behave like my classmate – paying debts with borrowed money, wiping their hands clean, and shifting the responsibility elsewhere at the last minute.

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.

Sri Lanka Railway railed with strikes and losses; Time to reform?

Originally appeared on The Morning.

By Anuka Ratnayake and Aaditha Edirisinghe

On 13 January 2022, the Station Masters’ Union launched a 24-hour token strike cancelling over 200 scheduled trips. As a result, commuters heading back home from Colombo, long distance travellers, tourists (both local and foreign) were all inconvenienced and left stranded in stations partway through their journey. Angry commuters attacked the train bound to Batticaloa when it passed the Kekirawa Station. This public outrage at the services provided by Sri Lanka Railway (SLR) is nothing new. However, little has been done to reform or restructure amidst public disappointment and escalating losses.

Why should the Railway be reformed? 

Operating as a Government institution under the Ministry of Transport, SLR is the country’s primary alternative mode of public transport to the often congested road network. Underpricing of railway fares along with systemic issues including mismanagement and poor governance have led to recurring annual losses. Despite budgetary support, the railway has recorded an accumulated loss of Rs. 46.7 billion in the years 2015-20. 

As with many transportation networks globally, the impact of Covid-19 has made SLR’s financial position increasingly precarious; with revenues down, losses amounted to over Rs.10 billion in 2020 alone. The widening chasm between the revenue raised and expenditure incurred, stood at a staggering Rs. 22 billion in 2018, as per official records. This has led to the dependence on Government bailouts. The Treasury spent a grand total of Rs. 48.7 billion in 2020, of which around Rs. 14 billion was for recurrent expenditure such as salaries, subsidies and grants. 

Sri Lanka Railway has an exceedingly large workforce with very active trade unions and an extensive bureaucracy. According to the official statistics of 2019, SLR has 14,207 employees. The total personal emoluments incurred for the same year was Rs. 9.8 billion, which was up by Rs. 809 million compared to 2018.

Due to the overstaffing issue, work duplication is often seen at SLR and is a serious issue affecting efficiency. Union actions are a burden on the operations of SLR, as observed during the last week of December 2021 and on 13 January 2022. 

In an interview conducted in January 2022, the Station Masters’ Association Chairman Sumedha Someratne claimed that as a result of the strikes in December, SLR incurred a loss as high as Rs. 20 million per day although the Railway General Manager quoted a much lower figure. 

A major reason for SLR’s budgetary reliance is the lack of cost reflective pricing. As of now, for a trip between 51-100 km, the fare per kilometre is around Rs. 3.30 for first class seats and Rs. 1 for third class seats. This underpricing has led to a reduction in the availability of funds to cover operational costs, resulting in the lack of finance for maintenance and repairs; by 2017, 65% of SLR’s locomotives were over 30 years old. 

The Urban Transport Master Plan 2014 identified several irregularities of the condition of the railway. A few noteworthy issues were the malfunctionings in the signalling system along with the deformation of rails and irregularities in alignment, which caused delays and sudden cancellation of trains. This poses a threat to passenger safety and is increasingly dangerous during inclement weather conditions. 

Reform recommendations 

Given that Sri Lanka is facing an economic crisis, the treasury cannot afford to shield SLR from the adverse repercussions of its inefficient operations. Immediate reforms are needed to get SLR back on track. 

Since most of SLR’s issues stem from its inability to raise sufficient revenues, the implementation of a cost-reflective fare structure should be prioritised. However, standing in the way of such price reform are the cheap fares of public bus service, the primary substitute to rail transport.

Therefore, for the price revision to be viable SLR should look into improving the quality of service to justify higher prices while reducing costs to be more competitive. 

Furthermore, to offset some costs SLR can focus on the profitable use of its vast asset base, such as its 13,000 acres of land which can be capitalised for this purpose. In 2017, it was reported that nearly 15% of land owned by SLR was leased to 6,400 users. Yet it has been unable to collect Rs. 1.46 billion in lease revenue from the users of the land owned by the department. Better management of real estate would bring in massive revenues to the Railway Department, which can be used to finance repairs and maintenance. 

Moreover, the Railway Department can focus on improving freight transportation, a lucrative and profitable source of revenue generation. According to the Asian Development Bank, by 2017, the freight transportation service market share of Sri Lanka Railway had eroded to less than 1%. The lack of necessary transportation and containerisation equipment limits the freight business to goods such as cement and petroleum. In the interest of expanding the freight service with the available resources; tracks which are reserved for passenger transportation during the daytime can be utilised under a night schedule. 

Furthermore, portions of SLR’s underutilised land can be used profitably for freight-related logistics services which will also bring in much-needed revenue to the loss-making institution.  

To bridge the prevailing investment gap at SLR, public private partnerships (PPPs) should be encouraged for operations and maintenance. A major bottleneck in SLR’s ability to deliver a consistent service is the outdated and malfunctioning infrastructure it owns, such as signalling and tracks. Investments in this respect will allow SLR to provide the public a consistent service while accumulating a sustained influx of cash. 

Colossal losses of state-owned institutions such as the Sri Lanka Railway is a burden on the state coffers, and ultimately the taxpayer. The Government’s increasing reliance on debt to keep such institutions afloat is compromising the economic future of Sri Lanka. Thus it is the need of the hour to begin reforming and restructuring potential cash cows such as Sri Lanka Railway. If reformed, Sri Lanka Railway would undoubtedly be a pillar of Sri Lanka’s transport infrastructure, contributing to the overall productivity of the economy.

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

Debt restructuring: Between a rock and a hard place?

Originally appeared on The Morning

By Dhananath Fernando

According to news sources, the President has requested the Chinese Foreign Minister to assist Sri Lanka in restructuring our debt. The Finance Minister too has indicated to Japan and India, our long-standing bilateral partners, the need for more assistance to overcome the economic crisis Sri Lanka is going through. 

In a recent press conference, the Central Bank of Sri Lanka (CBSL) Governor also mentioned that discussions for a new loan from China to restructure our debt is underway. 

However, it seems that the President and the CBSL Governor have given the term ‘restructuring’ two different meanings. One as run by the Global Times, the Chinese Communist Party-run newspaper, which said: “After President Rajapaksa’s request to restructure debt, Song Wei, a research fellow at the Chinese Academy of International Trade and Economic Cooperation stated that interest-free loans offered by the Chinese Government are applicable for debt relief while the concessional loans raised through the market cannot be written off.” 

However, as measures for debt restructuring, the CBSL Governor suggested taking more swap agreements, paying International Sovereign Bonds (ISBs) and bilaterally skewing our debt profile from market borrowing. Considering all this, we are yet to know what would be the final decision.

In Sri Lanka’s external debt profile as at the end of 2020, about 57% was borrowed from financial markets (34% from ISBs and 8% from China Exim Bank). 

In my view, we cannot evaluate debt restructuring without really understanding the problem. The issue at hand is that Sri Lanka borrowed money in US Dollar terms with a short maturity at high-interest rates and invested in assets on non-revenue generating non-tradable assets. As a result, we had to borrow money at even higher interest rates to service the interest of previous debts which has snowballed to a point where Sri Lanka has lost access to capital markets.

So the choices are not between ‘good’ vs. ‘bad’. The choices are between ‘worse’ vs. still ‘worse’. That is why it is called an economic crisis. Either measure will result in a catastrophic impact on the people of Sri Lanka. So in this context let us evaluate debt restructuring. 

The objective of any debt restructuring is to avoid a similar situation in the future and ensure sovereign debt sustainability. So a debt restructuring plan without an economic reform plan to improve competition, trade, and efficiency of the economy will not bring us any sustainable solution. Rather, it will worsen the situation. 

Secondly, debt restructuring is also a very difficult process for a country like Sri Lanka with a limited resource base. Countries such as Argentina and Ecuador defaulted but they have large reserve bases including oil to get back on a path of recovery. But Sri Lanka is a small $ 82 billion economy with no experience on debt restructuring.

Debt restructuring is not an easy process given Sri Lanka’s debt profile. Usually, senior creditors such as the International Monetary Fund (IMF), the World Bank, and the Asian Development Bank (ADB) are unlikely to restructure debt as it is provided at a concessional rate and with a longer maturity period. In restructuring multilateral debt, generally, a new programme would be introduced to recover the previous debt. 

Restructuring bilateral debt is complicated. The debt of Paris Club members has to be negotiated at the Paris Club. Australia, Austria, Belgium, Brazil, Canada, Denmark, Finland, France, Germany, Ireland, Israel, Italy, Japan, South Korea, the Netherlands, Norway, Russia, Spain, Sweden, Switzerland, the UK, and the US are the members of Paris Club. So any bilateral debt restructuring from the above nations have to be at the Paris Club. According to data, 10% of our creditors are members of the Paris Club, with Japan being the main bilateral creditor for Sri Lanka.

Our debts with China and India, who are not Paris Club partners, have to be negotiated outside the Paris Club. Generally, any bilateral creditor would not agree to single-handedly bear the entire restructuring loss of one particular country. They will request other partners to assist. Even in the case of China, according to NewsIn Asia, Long Xingchun, a senior research fellow at the Academy of Regional and Global Governance of the Beijing Foreign Studies University, stated that restructuring loans with China alone is insufficient to help the island nation tide over its difficulty, which needs a package plan with other involved parties.

The geopolitical situation in Sri Lanka will give way to more geopolitical externalities in debt restructuring with bilateral partners. But it seems we have to move towards that direction as we have very limited alternatives at hand. 

Additionally, bilateral partners will also request to share the debt burden with commercial creditors including ISB holders. This is because in debt restructuring, the main objective is to distribute the loss as much as possible. 

Restructuring commercial debt has to be dealt with by international law and it is somewhat an expensive and time-consuming process to reach a consensus with all creditors. According to global debt restructuring expert Prof. Lee Buchheit, it can take about nine months to a few years based on the profile of the debt. 

In debt restructuring, there are four parameters generally considered. 

1. Reducing debt stock or principal amount commonly known as haircuts

2. Adjusting the interest rates to be paid or coupon rates commonly known as coupon adjustment

3. Extending the repayment or maturity period

4. Mix and match of all above

The general practice is creditors ask to conduct a debt sustainability study of the country before deciding the adjustment or deciding which parameters of restructuring are to be used. The only credible organisation to conduct an independent study is the IMF, and that is why in most of the debt restructuring processes, the countries are under the IMF programme. In Sri Lanka’s case, in the event of a restructuring as our President requested, we have to disclose all debt including the debt owed by the State-Owned Enterprises because the restructuring burden will be calculated across the board. 

Creditors are generally very reluctant to restructure debt especially when it is due to financial mismanagement. In case of a natural disaster or a negative externality, the negotiation would be easier compared to a situation concerning economic mismanagement. 

So the available choices for Sri Lanka are very limited and every choice may have its own set of consequences. Reserves are declining and people often complain about shortages of essentials and interruption of utilities. Businesses are complaining about the inconvenience of working with banks due to difficulties in opening Letters of Credit (LCs). Creditors and investors are embroiled in suspicion and confusion with constant credit rating downgrades. Debt restructuring will be complicated and an open Sri Lanka for geopolitical sensitivities will affect political stability. 

The choices at hand are difficult. This column has continuously highlighted the need for reforms since the beginning of the pandemic with full knowledge that delays will limit the alternatives. We need to shift gears and move forward with hard reforms before people become hard on reforms. 

References:

• https://newsin.asia/china-to-revise-lankan-loans-repayment-schedules/

• https://newsin.asia/china-to-revise-lankan-loans-repayment-schedules/

• https://www.youtube.com/watch?v=I1hezyj2YxA&list=WL&index=1&t=7182s

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.

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

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

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

An ideal relief package 

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

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

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

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

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

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

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

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

Repay Foreign Debt or Finance Essential Imports

Originally appeared on Daily FT, Lanka Business Online and Groundviews

By Dr Roshan Perera and Dr. Sarath Rajapatirana

The available foreign reserves of the country can be used to either repay foreign creditors or to finance imports of essential goods and services required by its citizens. This is the dilemma facing Sri Lanka today. Repaying the full value of the bond using the limited foreign reserves available would provide a windfall gain to those currently holding these bonds. But it will be at great cost to the citizens of the country who will face shortages of essentials like food, medicine, and fuel. 

In these circumstances, it is in the best interest of all its citizens, for the government to defer payment of the US dollar 500 million International Sovereign Bond (ISB) coming due on 18 January 2022, until the economy can fully recover and rebuild. 

Just as an individual with co-morbidities is more vulnerable to develop severe illness if infected with COVID-19 and more to likely require hospitalisation and even treatment in an ICU, Sri Lanka was vulnerable to economic shocks long before COVID-19 struck. The country was already facing several macroeconomic challenges. Muted economic growth. An untenable fiscal position. Although a tough consolidation programme was put in place to bring government finances to a more sustainable path, sweeping tax changes implemented at the end of 2019 reversed this process, with adverse consequences to government revenue collection. Weak external sector due to high foreign debt repayments and inadequate foreign reserves to service these debts. COVID-19 only exacerbated these macroeconomic challenges. And like a patient who gets over the worst of COVID-19 has a long road to recovery; the economy of Sri Lanka faces many challenges to get back on track. 

The onset of COVID-19 in early 2020, only worsened an already grim macroeconomic situation. The country lost the confidence of international markets, and the ability of the sovereign to rollover its external debt became difficult if not impossible. In these circumstances, there was a solid argument for a sovereign debt restructuring. But the response from the government and the Central Bank of Sri Lanka (CBSL) was a firm “No”. The argument was that Sri Lanka never defaulted on its debt and it was not going to do so now. The official position was also that the government had a ‘plan’ to repay its debt and hence there was no reason to engage in a debt restructuring exercise. However, Sri Lanka faced high debt sustainability risks: the debt to GDP ratio at 110% was one of the highest historically and interest payments to government revenue at over 70% was one of the highest in the world. 

Table 1: Summary of External Sector Performance Q1 – 2017 to 2021 ($mn)

Therefore, it is in the best interest of the country and its citizens for the government to defer payment on its debt and use its limited foreign reserves to ensure uninterrupted supply of essential imports. But this requires a plan. To minimise the cost to the economy, the government must immediately engage its creditors in a debt restructuring exercise. This will require a debt sustainability analysis (DSA) by a credible agency to identify the resources required for debt relief and the economic adjustment needed to put the country back on a sustainable path. This will be critical to bring creditors to the negotiating table and provide them comfort that the country is able and willing to repay its debt obligations in the future. 

The cost of not restructuring is much higher. A non-negotiated default (if and when the country runs out of options to service its debt) would lead to a greater loss of output, loss of access to financing or high cost of future borrowing for the sovereign. It could even spill over to the domestic banking sector, triggering a banking or financial crisis. 

The consequences are clear. What will we choose?

Dr. Roshan Perera, Senior Research Fellow, Advocata Institute and former Director, Central Bank of Sri Lanka.

Dr. Sarath Rajapatirana, Chair, Academic Programme, Advocata Institute and former Economic Adviser at the World Bank. He was the Director and the main author of the 1987 World Development Report on Trade and Industrialisation.

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.

National Single Window: Paving the way for paperless trade

Originally appeared on Daily FT, The Morning, the Island, and Lanka Business Online

By Mithara Fonseka and Kavishka Indraratna

In 2016, Sri Lanka ratified its Trade Facilitation Agreement (TFA) with the WTO and in 2017 a Secretariat was established for the National Trade Facilitation Committee to drive much needed trade reforms in the country. Currently, the rate of Sri Lanka’s implementation commitments under TFA stands at 34.9% with a timeframe ranging from 2017-2030. Reforms include the Trade Information Portal, streamlining customs processes and revamping the systems for post-clearance audit. However, progress of one of the key reforms, the National Single Window (NSW), has been stalled. Deviating from the initial time frame of completing the Single Window in December 2022, the target date has been delayed to 2030. The NSW, a globally recognised trading portal, acts as a one-stop shop for exporters and importers where customs documents, permits, registrations and other information can be submitted online at once. The definition of a Single Window, as provided by the UN/CEFACT Recommendation No. 33, is as follows: “A Single Window is defined as a facility that allows parties involved in trade and transport to lodge standardized information and documents with a single entry point to fulfil all import, export, and transit-related regulatory requirements. If information is electronic, then individual data elements should only be submitted once”. Putting such a reform on the back-burner will only delay Sri Lanka’s transition to a system of streamlined, paperless trade processes and therefore acts as an impediment to local and foreign investment.

Why should Sri Lanka implement a NSW?
Sri Lanka has been underperforming in global trade rankings, where we sometimes rank in the bottom 50 countries. According to the Ease of Doing Business in 2020, in the trading across borders pillar, Sri Lanka ranks 96 out of 190 economies. While several of Sri Lanka’s indicators perform better than the South Asian average, there is significant room for improvement. When comparing with OECD standards, Sri Lanka takes 72 hours for border compliance regarding imports and 48 hours for export documentary compliance whereas the OECD average stands at 8.5 and 2.3 hours respectively. Lengthy customs procedures and multiple inspections impede efficiency. Meanwhile, we ranked 94 out of 160 countries under World’s Bank 2018 Logistics Performance index and 103 out of 136 for the World Economic Forum’s 2016 Enabling Trade index. Notably, one of the indicators from the Enabling Trade Index, the customs services index, which considers factors such as clearance of shipments via electronic data interchange and the separation of physical release of goods from fiscal control, we rank 116 out of 117 countries. A lack of transparency, inter-agency coordination and lengthy cumbersome processes contribute to Sri Lanka’s poor trade environment. An average trade transaction can involve over 30 different agencies and upto 200 data elements, a lot of which have to be repeated. There is thus an evident need to streamline trade processes through digitisation, creating a business friendly environment that supports small businesses as well as foreign investors.

A Background into the National Single Window

In 1989, the Government of Singapore introduced the world’s first NSW, known as Tradenet. It took two years for the model to become operational and has now become one of the most advanced models in the world. Since then, many countries have adopted similar models and a NSW has become a critical tool in facilitating efficient and paperless trade. The annual survey conducted by The United Nations on trade facilitation identified that almost 74% of countries surveyed in the Asia Pacific region have to some extent engaged in creating a NSW (this includes countries which are only in the pilot stage). While a NSW is universally known for promoting the transition from paper-based to electronic customs processing, each window developed by a country is unique and varies according to the context of the country. For example, in Chile and Malaysia, the NSW enables traders to submit their export and import declarations, manifests and their trade-related documents to customs authorities electronically. In Korea and Hong Kong, private sector participants including banks, customs brokers, insurance companies and freight forwarders are also connected through the portal.

Single entry, single submission, standardized documents and data, sharing of information (information dissemination), centralised risk management, coordination of agencies and stakeholders, analytical capability and electronic payment facilities are some of the key functions included in a Single Window. In Sri Lanka, the World Bank did several studies on the NSW, identifying different operational models, best practices and a final blueprint document was given to the government and Sri Lanka Customs (SLC) in July 2019. However, since then, there has been no news of progress. While many countries including Sri Lanka are keen to emulate Singapore’s pioneering model, a lack of clear targets and timelines deteriorate the chances of implementing such a system.

The Mutual Benefits of a NSW

Businesses in countries without an integrated trade system find it difficult to compete in the international arena given the time and money spent to simply get clearance. Streamlining the entire process from start to finish in a manner that’s comprehensive and transparent, sans bureaucracy has a number of positive effects for traders. It was estimated that Singapore’s TradeNet saved its traders around US$1 billion per year. Korea’s uTradeHub allowed its business community to save approximately US$ 818.9 million. These were savings from the use of e-documents, automated administrative work and information storage and retrieval with the use of ICT. A Single Window automatically simplifies the compliance requirements traders face. In Mozambique traders benefited from faster clearance times, where through the NSW, the time was reduced from 3 days to a few hours. Meanwhile, Thailand’s NSW transformed the customs clearance turnaround time (measured as per declaration) to 95% in 5 minutes. Using a single portal has enabled traders to avoid visiting multiple agencies and simply submit an application at their convenience from any location. NSW has supported businesses through the removal of unnecessary costs, time and red tape, factors which tend to act as key deterrents to small businesses as well as foreign enterprises. 

The NSW system has similarly provided noteworthy cost-savings for government entities involved in trade. Singapore Customs, has claimed that for every US$1 earned in customs revenue, it only spends 1 cent, implying a profit margin of 9,900%.  In Hong Kong, trade facilitation measures have provided them with HK$1.3 billion in annual savings. The NSW has also reduced revenue leakages which may arise through transit. For example, Mozambique is a transit country to Swaziland, South Africa, Zimbabwe, Zambia and Malawi. By expanding their NSW to include value added services such as GPS tracking of consignments in transit, automatic detection of breaches in consignment and deviation from assigned transit corridors the NSW prevents revenue leakages and the opportunity for corruption, maximising revenue collection. The NSW has further led to productivity and efficiency improvements. A Single Window has enabled authorities to handle a larger volume of applications with much more ease. Mozambique, which used to face infrastructural weaknesses, through the implementation of its single window, is able to handle roughly 1,500 custom declarations per day.  Shifting to paperless customs processes would reduce costs for inventory and assist in improved resource allocation as personnel would not be required for trivial and mundane tasks such as preparation and cross checking of numerous documents. In totality, a fully digitised system provides government agencies with the means to do away with inefficiencies that hold back the speed of document processing, approval, communication and inspection stages. Further contributing to efficency, a NSW has also facilitated the dissemination of data through multiple agencies ranging from border control authorities, freight forwarders, customs brokers, shipping agents, banks and so on. As a result, there is improved inter-agency coordination and increased transparency.

Apart from a substantial increase in government revenue, the NSW will contribute to an improved business environment in Sri Lanka. The domino effects include an upward movement in the country’s global rankings, incentives for FDI and local business as well as a global recognition. 

Driving forces for implementation

While the NSW on the surface seems like an IT-based innovation, it is rather a platform for inter-agency and private sector collaboration. As the NSW is a system which requires involvement from government, the private sector and the transport community, it is crucial to ensure inter-agency collaboration. Ensuring public-private sector participation, introducing mandates and a steering committee to oversee implementation is crucial in developing such a system. The system as a whole is one that constantly evolves with no end stage. It requires continuous maintenance, support, and enhancement. This should be supplemented by the appropriate legislation, disclosure and publishing, backed by training and airtight data security policies. Thus governance of the NSW needs to be executed appropriately so that new technologies, techniques and new modes of trade can be leveraged. In best performing nations, a Single Window is not considered a single system but rather “a combination of trade-related platforms that serve various trade communities and modalities”. This has enabled leading countries such as Singapore and Hong Kong to facilitate seamless trade by building an environment of interoperable trade systems.

1. WTO, Trade facilitation Agreement Database, https://tfadatabase.org/members/sri-lanka , Accessed January 6, 2022.

2. WTO, Trade facilitation Agreement Database,10.4-Single Window, https://tfadatabase.org/members/sri-lanka/technical-assistance-projects/article-10-4

3. United Nations, UN/CEFACT, ‘Recommendation and Guidelines on establishing a Single Window: to enhance the efficient exchange of information between trade and government, Recommendation No.33, (2005), https://unece.org/fileadmin/DAM/cefact/recommendations/rec33/rec33_trd352e.pdf Accessed January 6, 2022.

4. World Bank Group, ‘Doing Business 2020’, Economy Profile Sri Lanka, Comparing Business Regulation in 190 Economies,(2020), https://www.doingbusiness.org/content/dam/doingBusiness/country/s/sri-lanka/LKA.pdf Accessed January 6, 2022.

5. World Bank Group, ‘Doing Business 2020’, Economy Profile Sri Lanka, Comparing Business Regulation in 190 Economies,(2020), https://www.doingbusiness.org/content/dam/doingBusiness/country/s/sri-lanka/LKA.pdf Accessed January 6, 2022.

6. World Bank Group, ‘Logistics Performance Index 2018’, (2018), https://lpi.worldbank.org/international/scorecard/radar/254/C/LKA/2018#chartarea Accessed January 6, 2022.

7. World Economic Forum,’The Global Enabling Trade Report 2016, Enabling Trade Rankings’, (2016) https://reports.weforum.org/global-enabling-trade-report-2016/enabling-trade-rankings/#series=CUSTSERVIND

8. World Economic Forum, ‘Enabling Trade Index 2016’, (2016) https://www3.weforum.org/docs/WEF_GETR_2016_report.pdf Accessed January 6, 2022.

9. World Economic Forum, ‘The Global Enabling Trade Report 2016, Enabling Trade Rankings’, https://reports.weforum.org/global-enabling-trade-report-2016/enabling-trade-rankings/#series=CUSTSERVIND Accessed January 6, 2022.

10. Johns, M. “Trade facilitation reform in Sri Lanka can drive a change in culture”, World Bank Blogs, 2017

    https://blogs.worldbank.org/endpovertyinsouthasia/trade-facilitation-reform-sri-lanka-can-drive-change-culture Accessed January 6, 2022.

11. UN ESCAP,’Digital and Sustainable Trade Facilitation in Asia and the Pacific 2021’, (2021)
      https://www.unescap.org/sites/default/d8files/knowledge-products/UNTF%20Report.pdf Accessed January 6, 2022.

12. UN ESCAP,’Single Window Planning and Implementation Guide’,

    https://www.unescap.org/sites/default/d8files/5%20-%201.%20Introduction_0.pdf Accessed January 6, 2022.

13. UN ESCAP, ’Single Window Planning and Implementation Guide’

     https://www.unescap.org/sites/default/d8files/5%20-%201.%20Introduction_0.pdf Accessed January 6, 2022.

14. UN ESCAP, ‘Single Window for Trade Facilitation: Regional Best Practices and Future Development’ https://www.unescap.org/sites/default/files/Regional%20Best%20Practices%20of%20Single%20Windows_updated.pdf, Accessed January 6, 2022.

15.  UNECE, ‘Trade Facilitation Implementation Guide, Singapore case study’, https://unece.org/fileadmin/DAM/cefact/single_window/sw_cases/Download/Singapore.pdf Accessed January 6, 2022.

16. United Nations ESCAP, ‘Single Window Implementation: Benefits and Key Success Factors’, (2012), https://unnext.unescap.org/sites/default/files/switajik-sangwon.pdf Accessed January 6, 2022.

17. UNECE, ‘Trade Facilitation Guide, Single Window Implementation in Mozambique’,
    https://tfig.unece.org/cases/Mozambique.pdf Accessed January 6, 2022.

18. UNECE,Trade Facilitation Implementation Guide, Interagency Collaboration for Single Window    Implementation:Thailand’s Experience, https://tfig.unece.org/cases/Thailand.pdf Accessed January 6, 2022.

19. United Nations, Single Window Planning and Implementation Guide, (2012) https://www.unescap.org/sites/default/files/0%20-%20Full%20Report_5.pdf Accessed January 6, 2022.

20. United Nations, ESCAP, Single Window Implementation: Benefits and Key Success Factors

     https://unnext.unescap.org/sites/default/files/switajik-sangwon.pdf Accessed January 6, 2022.

21. UNECE, ‘Trade Facilitation Guide, Single Window Implementation in Mozambique’,   
        https://tfig.unece.org/cases/Mozambique.pdf Accessed January 6, 2022.

22. United Nations, ESCAP, Single Window for Trade Facilitation:Regional Best Practices and Future  
    Development, (2018),  https://www.unescap.org/sites/default/files/Regional%20Best%20Practices%20of%20Single%20Windows_updated.pdf Accessed January 6, 2022.
    

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.

State-owned enterprises: A major crisis in the making

Originally appeared on Daily FT, The Island, Ada Derana Biz, Ground Views and The Morning

By Migara Rodrigo

Sri Lankan State-Owned Enterprises: A Major Crisis in the Making

Sri Lanka has a whopping 527 state-owned enterprises (1) (SOEs). The 55 SOEs classified as “strategically important” alone employ 10% of the public sector workforce (2) or about 1.9% of all workers. Such a large number of SOEs are not the norm globally(3); many other countries (such as India) have been reducing their stakes in SOEs and, in some cases (e.g. Air India), have been privatizing them entirely. SOEs - particularly many in Sri Lanka - tend to be grossly inefficient, loss-making, and a burden on the taxpayer. The time is ripe for major SOE reforms. 

What is an SOE?

An SOE is traditionally defined as a commercial entity that has majority ownership/control by a nation’s government – in Sri Lanka, this can include statutory bodies, regulatory agencies, promotional institutions, educational institutions, public and limited companies. While Sri Lankan SOEs have traditionally been incorporated by an Act of Parliament, in recent years these entities have also been incorporated under the Companies Act instead. 

Sri Lankan SOEs can be divided into three categories: 55 Strategic SOEs, 287 SOEs with commercial interests, and 185 SOEs with non-commercial interests. Unlike nations such as India which mandate internal audits of their SOE’s business activities and publish an annual overview with a balance sheet of each individual business, the majority of Sri Lankan SOEs do not reveal this pertinent information to the public; financial information is available for just 10.4% of SOEs. 

Fundamental problems with Sri Lankan SOEs

Contrary to what some believe, low quality of talent is not the most significant issue with SOEs; many employees are eminently qualified and capable. Unfortunately, these organisations fall victim to government mismanagement and corruption. In addition to excessive employment to fulfil their political ambitions, there have been allegations that some SOEs have been formed purely to facilitate corruption – for example, the Lanka Coal Company engaged in fraudulent deals to purchase coal causing a loss of over Rs. 4 billion (allegedly with the knowledge of the minister in charge)(4). 

SOE financials are late and few obtain ‘clean’ audit reports. Investigations have revealed repeated instances of fraud, mismanagement, corruption and negligence. Furthermore, the internal control, monitoring and governance frameworks seem inadequate to deal with these problems – of over 500 SOEs, regular information is only available for 55. Even obtaining a complete list of entities proved to be a challenge. Public access to information is limited – the Department of Public Enterprises has not released an annual report since 2018, and right-to-information requests often go unanswered.

Figure 1 Source: Ginting, Edimon et al, 2020, Reforms, Opportunities, and Challenges for State-Owned Enterprises, Asian Development Bank

Moreover, SOEs have few budget constraints and shareholder (public) accountability and therefore have limited incentive to control costs. Unlike with private sector enterprises, which have a need to make a profit, many SOEs (particularly in Sri Lanka) can simply borrow from other state organisations/banks or the government when they require additional funds, which undermines the threat of bankruptcy as a source of discipline(5). Some recently established SOEs have found a new way of bypassing budgets and oversight: by incorporating as companies rather than through an act of Parliament, they are excluded from Parliamentary accountability and allowed to rack up unsustainable debts and surpass budgets more easily. This has led to SOEs burning through taxpayer rupees: the cumulative losses of the 55 strategic SOEs from 2006-20 amounts to Rs. 1.2 trillion.

Finally, while some SOEs do manage to make a profit this is, more often than not, due to the advantage that these companies have in an uneven playing field. In addition to lax budgetary requirements and the ability to rack up unsustainable debts, these companies are supported by the government through direct subsidies and state-backed guarantees; by regulators through exemptions from antitrust policies and preferential treatment; and by the justice system through an ability to sidestep parliament. This has led to private sector organisations being crowded out of the industries that SOEs operate in. Instead of having private firms in the marketplace with efficient and high-quality services, the Sri Lankan taxpayer is beset with SOEs with total liabilities of 4-5% of GDP(6).

Potential reforms 

Given that the nation has reached an economic tipping point, with serious questions about debt sustainability and government solvency, it is clear that immediate action must be taken. Advocata proposes a short-term policy solution consisting of privatisation, restructuring and disinvestment, and listing on the Colombo Stock Exchange. None of these solutions are particularly radical in the global or local context. According to Lankan Angel Network Director Anarkali Moonesinghe, the two main policies of both Western and Eastern governments when reforming SOEs are to reduce subsidies and increase efficiency, forcing SOEs to compete more equitably with private enterprises.

Alternatively, full or partial privatisation is a possible solution: SLT-Mobitel’s service has markedly improved following its 1997 privatisation and the entrance of competitors such as Dialog Axiata, all held accountable by the broadly competent Telecommunications Regulatory Commission. Listing on the CSE would allow these firms to have broad-based direct ownership, while also improving the growth of the CSE and capital markets. Importantly, these firms would have to be ‘corporatised’ before listing, an opportunity to improve productivity and eliminate bloat. 

There are, unfortunately, firms that will essentially have to be given away due to their huge debts and poor reputations. A prime example of this is SriLankan Airlines, which has racked up Rs. 316 billion in losses (7) since control was taken from Emirates in 2008. While some will regard this as a blow to our national pride, Sri Lanka would not be alone in taking such a pragmatic step to improve government finances and customer experience; Air India, the Indian national carrier, is currently in the process of being sold to the Tata Group for the relatively small sum of INR 18,000 crore. This would also inspire confidence in Sri Lanka amongst foreign investors as it would show the country’s commitment to meeting its upcoming debt servicing obligations.

Furthermore, long-term solutions include strengthening governance/limiting corruption and influence, improving efficiency, enacting cost-reflective pricing, and finally unbundling key sectors. This applies particularly to firms like the Ceylon Electricity Board which, as a natural monopoly, cannot be broken up and privatised without losing efficiency. A 2006 study by the Japan International Cooperation Agency recommended breaking up CEB into three parts: “making the generation, transmission, and distribution divisions…independent” (8). Despite the 15 years and multiple nationwide blackouts that have occurred since, GoSL continues to drag their feet on the issue, as it is politically unpopular. 

Cost-reflective pricing (also prevented due to political unpopularity) is another essential reform. The existing system of having electricity tariffs priced below cost is a public subsidy whose cost will be borne by future generations. It is also inequitable, as the Government could provide low-cost services to those who need it by giving them direct cash transfers, instead of subsidising the wealthy who can afford to pay. A similar situation is evident with the Ceylon Petroleum Corporation, which currently makes a loss of Rs. 23-38 per litre of fuel (9); again, a public subsidy to those who can often afford to pay the market price. Finally, greater accountability, by means of annual internal audits and the availability of SOEs’ financial information to the public, is also important to ensure these firms stick to the targets they are given.

A successful and thriving market, in most industries, will only occur with the presence of three crucial factors: competition, a good framework, and competent regulation. By reforming Sri Lanka’s SOEs to meet these criteria, we will ensure a good customer experience, a reduction in the government deficit, and general prosperity for all key stakeholders. 

References:

1 Ratnsabapathy, Ravi et al, 2019, The State of State Enterprises in Sri Lanka, Advocata Institute

2 Dissanayake, Imesha, 2021, SOE Reforms; the Impetus for Post Pandemic Economic Revival, Ceylon Chamber of Commerce

3 Büge, Max et al, State-owned enterprises in the global economy: Reason for concern? Last modified: May 2nd, 2013 

4 ColomboPage.com, President to take action against removal of head of Lanka Coal Company, Last modified: January 21st, 2017, http://www.colombopage.com/archive_17A/Jan21_1484983651CH.php

5 Ratnsabapathy, et al, The State of State Enterprises in Sri Lanka

6 WorldBank.org, South Asia Must Reform Debt-Accumulating State-Owned Banks and Enterprises to Avert Next Financial Crisis, Last modified: June 29th, 2021, https://www.worldbank.org/en/news/press-release/2021/06/24/south-asia-must-reform-debt-accumulating-state-owned-banks-and-enterprises

7 PublicFinance.lk, Sri Lankan Airlines: Annual and Accumulated Loss to the Public, Last modified: 24th August 2021, https://publicfinance.lk/en/topics/Sri-Lankan-Airlines:-Annual-and-Accumulated-Loss-to-the-Public-1629789830

8 Saito, Yoshitaka et al, 2006, Master Plan Study on the Development of Power Generation and Transmission System in Sri Lanka, Japan International Cooperation Agency Economic Development Department

9 EconomyNext.com, Sri Lanka’s CPC says petrol, diesel losses rise as LIOC hikes prices, Last modified: 25th October 2021, https://economynext.com/sri-lankas-cpc-says-petrol-diesel-losses-rise-as-lioc-hikes-prices-87276/#modal-one

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

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

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

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

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

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

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

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

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

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

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

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

Below are a few suggestions we have to think through:

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

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

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

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

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

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

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

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

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

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