Our depressing debt diagnosis

Originally appeared on The Morning

By Dhananath Fernando

Sri Lanka must understand how it got here before getting out of here

Last week, the Central Bank announced all export proceeds should be brought into the country within 180 days of shipment. Additionally, they stated that all exporters should convert 25% of their foreign currency earnings to LKR from the invoice value upon entry into the country. This was brought in just a few weeks after they restricted forward purchasing for importers. With these two moves, Sri Lanka’s debt sustainability has come under the spotlight once again. Recent reports from Standard Chartered Bank and Barclays Bank have also contributed to the discussion.

It is clear that the Government and the Central Bank are looking at the problem differently to how investors, financial markets, and other stakeholders perceive the problem. Indeed both sides share their opinion with good intentions of overcoming the current turbulent time. 

As per recent media reports and a press release by the Central Bank, their objective is to build non-borrowed foreign reserves in order to meet our debt commitments. The Government is looking at the problem as a cash inflow-outflow problem. Accordingly, the Government expects about $ 32-35 billion inflows, about $ 15 billion from exports, about another $ 7 billion from remittances, and about $ 1.5 billion from tourism, with foreign direct investments (FDIs) and other transfers, etc. filling the balance.

On the outflow side, the Government expects about $ 19 billion for imports and sovereign bond payments are about $ 2 billion every year, so the debt can easily be served without any problem according to the reports. It further states that total sovereign bonds are about $ 15 billion which is about 17% of total debt, and none of the other creditors have made any concern over our debt sustainability. Recently, the Governor made remarks that the Central Bank buys about $ 10 million per day to build up reserves so we can cover all debt commitments. According to his view, the outlook on exports, FDIs, tourism, and remittances looks positive with the vaccination drive. 

On the other hand, investors and other agencies are of the view that reprofiling debt with International Monetary Fund (IMF) support is the best solution at hand as our foreign reserves are eroding faster than expected. They see the problem as a solvency problem rather than a cash flow problem; that we need to buy time to bounce back with a lesser impact on the entire economy. It’s not that all reserves are liquid as some reserves are in gold and some IMF commitments and swap commitments are already included in the available reserves of about $ 5 billion. The question from the investors is: “If the cash flow is smooth, why does it continue to erode the reserves which are now at a historic low?” In this context we have to evaluate what we should do and what is possible to do.

Let’s get into the basics. In the debt discussion, we have all been debating on how we can settle the debt and how we can keep our noses above the water. But we should not forget the reasons that brought us to where we are today. We borrowed beyond our capacity at high interest rates and invested in projects which generate returns far less than our payment capacity. In other words, we borrowed at market rate and invested in non-tradable goods which did not generate any tradable return necessary to repay a part of the debt. Since we have failed to avoid the causes of the problem, now we have to pick the best possible escape route from the problem.

Secondly, in my view, we have to estimate the extent to which we can build up reserves by buying USD from the market given the current policy stance. The Government has committed to a policy to keep the interest rates unchanged and keep the exchange rate to USD in the Rs. 185 range. We need to understand that the USD inflow estimate of about $ 15 billion is not owned by the Government but by the exporters, and so are our remittances. The same applies for the imports where importers have to have money from the market to import the basics such as fuel, pharmaceuticals, etc. In this context, to build up the reserves, the Government has to buy USD from the market and that is how the Government can capture the USD available in the market from exporters. To do that, the incentive structures have to be there for exporters to sell more USD rather than save USD. Currently, the interest rates for USD are higher than interest rates for LKR accounts, so expecting a currency depreciation, the market perception is more skewed towards keeping their money in USD form. To overcome that incentive discrepancy, when the Government imposes a regulation to procure the USD earnings by exporters within 180 days and to convert 25% upon shipment, it is likely that the exporters under invoice consider options to park their money in offshore accounts, which will further erode our inflows. 

At the same time the regulation will impact some exporters who run on thin margins who have a portion of imports in their exports. On the other hand, the companies who have USD commitments and agreements with other companies now have to face extra pressure and loss on conversions due to this regulation. 

In my view, the sovereign debt problem has a broader dimension beyond just calculating cash flow. Because the Government owns the debt and because the USD cash flow is owned by private businesses and individuals, the Government requires a mechanism to capture it either by taxation or mopping up the liquidy from the market by tightening the systems by allowing the interest rates to move upwards. That will slow down the economy. The Government’s current strategy of buying their own Treasury bills and bonds, in other words printing money, will add constant and excessive pressure on imports through channels where the imports are open, though we have a import control policy. At the same time, it is highly likely that the excess liquidity will convert to credit with the economic recovery from Covid-19 and add pressure on inflation and cost of living. We have to keep in mind that while we build reserves by buying USD from the market, we might have to sell some of it again to keep the exchange rate stable. Changes in the exchange rate will affect our debt-to-GDP ratio.

It is true the sovereign nations have the legitimate power to print money, but ultimately what consecutive governments consumed by taking debt has to be paid in real terms by earning it real value, and there is no shortcut for it. Very importantly, while the debate is on as to what route we need to take, we should not forget the reason that brought us here.

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

Why is the President being ‘landed’ with this request?

Originally appeared on The Morning

By Dhananath Fernando

A digital land registry could help our rural masses 

The “Gama Samaga Pilisadarak” is the President’s most recent engagement programme. Positives and negatives of the programme have both been openly discussed on mainstream and social media. As per media reports, the programme is structured in such a way that officials of key ministries, such as Land, Education, and Road Development, visit villages with the President. 

People are then requested to put forward their problems before this entourage of officials. They try to solve the problems at the location itself, directing the state officials to act faster. The President mentioned that following such a course of action has helped build local infrastructure and helps him understand people’s problems better. 

On the contrary, on social media, views have been expressed on forest destruction concerning areas where the President has been visiting, and describing this as an attempt to prioritise development at the expense of our green cover. 

The objective of today’s column is not to provide a commentary on “Gama Samaga Pilisadarak”, but an effort to put things into perspective regarding the most common concerns people have been putting before Sri Lanka’s First Citizen. Secondly, we aim to explore why the very same issues are being repeated in most of the villages. In my understanding, the problems presented to the President are just symptoms of a bigger problem, and it looks like the solutions instantly provided by the officials are just temporary solutions without understanding the problem at its root. 

Most frequent requests made to the President, as have been telecast in the news, are requests for land to conduct agricultural activities. The fundamental question is why solving issues surrounding land has become a common-priority request, as we saw on television, with people screaming and pleading the President to get their land matters solved.

As indicated multiple times in this column, about 80% of Sri Lanka’s land is owned by the Government. Out of that, about 30% is our forest cover. As a tiny island, land is obviously a limited resource in economic terms. Therefore, if we fail to optimise the utilisation of land, all the natural beauty and biodiversity we brag about is most likely to fade away from us. 

Creating land, like what we did with the Port City, is extremely expensive and environmentally costly. The problem lies in the fact that most of the land our farmers cutivate is only under a licence, and they do not have a title. As a result, the farmer has to visit the Divisional Secretariat to obtain a license, renew the license, or even to obtain approval to change the crop they cultivate. 

Smaller and smaller portions

Most of these lands our farmers cultivate are provided under different land and agricultural projects. Over generations when the original land is divided among family members, the land plot becomes smaller and smaller.

For example, look at what happens when the original land of five acres is provided to a farmer, which in turn is divided among his four children. This will get subdivided after the next generation. Now, instead of five acres, only about 25 perches of land will now be available, and this has limited scope for agriculture. As a result of these smaller land plots over generations, industrialisation or commercialisation of cultivating lands is unfeasible.

Employing technology and machinery to increase productivity on a 25-perch land plot is not feasible. As a result, people ask for more lands from the Government, or encroach on forest cover to do their farming.

On the other hand, these lands do not have titles. So farmers are unable to optimise the maximum usage of the land using technology, because they have no source for capital. They don’t have other assets to use as collateral to access finance, nor are the banks willing to provide them loans without any valid collateral.

As a result, the land problem has become a vicious cycle. These circumstances have led to a scenario where a combination of factors continue to make our farmers poorer and our agriculture unproductive, while trapping our farmers in informal loans and creating severe social concerns such as suicide. There is the additional issue of contributing to the loss of our forest cover and destroying our biodiversity. 

If we look at countries that are in deep poverty, one of the common denominators is that the people of those countries do not have their land and property rights. There is no magical formula for an economy to take off without establishing property rights for their citizens. 

The President expressed his displeasure at rumours circulating on social media on the destruction of forest cover, but until we provide a permanent solution to this problem, we will lose out on every front. The President will have to hear the same complaint at every location he visits.

On top of that, the Government has decided to stop all agricultural imports for the next four years, as per reports by The Morning. This will most likely worsen the situation. Food prices will go up, and more farmers will attempt to do agriculture by practicing their unproductive farming methods. 

The rising prices will punish all our poor consumers already suffering from the high cost of living. At the same time, our tourism will suffer, as it needs some imported agricultural products to prepare the cuisine. However, it is understandable that balancing such a dilemma when foreign reserves are depleting is going to be a serious challenge.  

What is the solution?

The President has a greater opportunity to capitalise on this matter economically as well as politically. We have to have a digital system and a digital land registry. As soon as the “digital land registry” is spelled out, many associate it to the three-letter “MCC” agreement. That is now gone, and there is very little value in debating it now. 

But over the next four years, the President can prioritise the digital land registry, which will mark forest cover on the cadastral survey system with GPS coordinates. It will increase Government efficiency drastically, release the dead capital of land among farmers, and investments will start kicking off. Most of the back-end work has been done, and cases for the need for a digital land registry have been developed. 

The question is: how are we going to find money to implement the survey and purchase the technology? We have to seek out multilateral donor agencies, or a potential bilateral loan, to secure the funding, as this will create massive economic potential. Setting up a digital land registry will be significantly impactful, rather than just developing a road or incurring another massive capital expenditure. 

This is an action which will move us upwards in the Ease of Doing Business Index, and build investor confidence. At the same time this will fall perfectly in line with the President’s manifesto of “Vistas of Prosperity and Splendor” under a digitised economy. 

The ripple effect will trickle down to smaller cases at courthouses, as well as to micro and small business enterprises when the project unfolds. 

Since there have already been many land deed programmes such as “Jayabhoomi” and “Swarnabhoomi”, this will not be a simple and easy project. Having the simple digital infrastructure ready is the first step to address these issues, both at present and in the long term. 

The main opposition comes from lawyers, as they are the main beneficiaries of delayed court proceedings. If the President focuses on this single reform, it will not only be the best-ever environmental conservation reform to protect our green cover, but also a historic economic reform to unlock our dead capital, and reactivate capital markets and agriculture. Most importantly, it will be a big relief for our farmers and fellow Sri Lankans.

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

When floor tiles go sky high

Originally appeared on The Morning

By Dhananath Fernando

Sri Lanka can’t win by obstructing its competitors

I still remember some silly things I did when I was in school. It was an inter-house pre-selection race for 400 metres for the school sports meet. As you all may know, to match the equal distance for each athlete, the most outer track athlete is placed slightly ahead at the start of the race and the most inner track athlete is placed at the very behind at the start. So during this race, I got lane eight, the most outer track. Without realising that the starting point placement was done to provide a level-playing field I thought I have some added advantage to start the race well ahead.

The race started and we were all accelerating to the finish line. After a few metres, from the corner of my eye I saw the athlete next to my lane running faster and he was getting closer to overtake me. So I changed my track to lane seven and obstructed him. Just after a few seconds, I realised that the lane six athlete was about to overtake me. I changed my track to lane six. Then the athlete on lane seven overtook me. Throughout the race I was trying to obstruct the other athletes without running my race in my own track.

I was disqualified from the race. I was not only disqualified from the race because of my silly way of obstructing all athletes, but also because they had to redo the race. I still remember what my house master in charge told me after disqualifying me from the race. “Son, you can’t win a race by obstructing your fellow competitors. You have to work hard and practice to run faster than them. That is the only way you can become competitive and win a race.”

When I saw headline news stories on the Sri Lankan floor tiles, wall tiles, and bathware cess tax revisions and Customs import duties, and collective voices against obstructing imports of these product categories as per the new tax revisions, for a moment I wondered whether we as a country are trying to make the same mistake I did as a schoolboy athlete by trying to win a competition by obstructing our competitors without trying to be competitive by ourselves.

The bathware story took the limelight with a gazette notification allowing the importation of bathware with a 180-day credit period when the forward purchasing of foreign currency was not facilitated by banks. In simple terms, this is a condition where the importer has to negotiate with the supplier to give goods for a credit period of half a year and the importer has to bear the cost of exchange depreciation. So it was not at all very favourable for importers. Even in that context, the Imports and Exports Commissioner General instructed banks not to facilitate any imports of tile and bathware products on the next day itself. 

It was reported after a few days on some news stories (gazette notification is not yet up on the Government website) that the industry associations agreed to increase the Customs import duty to 30% from 15% and increase cess to a flat rate of Rs. 125. Currently for certain sanitary products cess is 0% and some other product categories are charged at 15% or Rs. 40 per kg.  

Essentially, if the media report is true, our Customs duty has increased by twofold and our cess has increased by threefold. According to the same media report, even before 2015, cess was 25% or Rs. 75 per kg. So even after a good seven years, we still want to obstruct our competitors at a higher degree with the higher cess. Let’s try to understand the overall impact 

First, many people do not know how the tax calculation is done. The import tax formula is not as simple as saying that it is the addition of one tax to another tax. There are taxes on taxes (Value-Added Tax [VAT], Port and Airport Development Levy [PAL], etc.). So if the Customs duty doubles from 15% to 30%, the impact on the final tax on the consumer can be larger than just adding 15% to the final tax rate. According to the current calculation revealed by Sri Lanka Customs, the effective rate can go up as high as 89.80% of the actual imported value. 

What does this mean for the local consumer? This means the local consumer has to pay twice the price to buy a bathware set, floor tile, or wall tile. In other words, our fellow Sri Lankans have to pay the cost of two bathrooms to build one bathroom. Needless to highlight, the bathrooms constructed by Sri Lankans are not royal-class gold-plated commodes and silver flushing systems; a basic commode and even a squatting pan have been taxed at a high rate as 52%. This will not only impact the local consumers but also other local micro, small and medium enterprises (MSMEs) as well. 

When most of the MSMEs do their small constructions, they have to spend twice as much for the bathware and tiles, which increases the capital they require to start business. Most of them take loans to start businesses. Ultimately, this high cost of tiles affects their competitiveness in the business as well. Think of a small clothing shop in your town. Most of the time the floor is tiled and the shop requires a bathroom, so can we justify asking that entrepreneur to pay twice as much for some of his construction items which is a main part of the building when he is starting the business?

It does not affect only the small entrepreneurs, but rather creates a ripple effect across the economy. In the tourism industry, construction materials such as wall tiles, floor tiles, and bathware are used for most constructions. So as a result, their capital investment goes up and they have to cover capital through the room rate. As such, in the same room category, Sri Lanka’s hotel room rates are higher than the competing destinations in the region.

It is the same for luxury hotels as well as medium and small leisure sector entrepreneurs. It is not just the leisure sector, but even the Government has a big problem with the cost of construction. If you list down requests from rural students to the President in the programme “Gama Samaga Pilisadarak”, they are all about a building to do their studies, toilet facilities, a laboratory, or a playground. The cost of construction is as high as the sky so even the Government has a problem in allocating money for construction capital expenditure.

Further, think about the young professionals and all Sri Lankans who want to build a basic house but consider it a dream house. They take a bank loan with the greatest difficulty and pay twice the price for wall tiles and floor tiles from the money they borrowed.

Protecting local manufacturers and industries?

The main argument that has been put forward on increasing the tariff on bathware and tiles is that it is a move to protect local manufacturers. As Sri Lankans, we unanimously agree that local industries should be protected, but we have to evaluate how we are going to protect them without punishing our consumers. The only solution to protect them is to become competitive and that is a win-win for local manufacturers as well as the local consumers. 

Many policy-makers and, to an extent, Sri Lankans are of the opinion that when we allow imports, it will affect the local manufacturers’ sales volumes. Some consumers are of the opinion that the higher import duties don’t affect them because only the prices of imported items are increasing and the prices of local manufactured products will remain the same. I too wish that the market acts the way we think. What happens in the market is actually the same thing I tried to do in the 400-metre race.

When we obstruct the competitor’s imported products, we narrow the window of competitiveness in the market and limit the entry of similar products to the market. In other words, we limit the opportunity for the consumer to buy a reasonably priced product from the market by imposing a higher tariff and making them uncompetitive. By doing that, like I obstructed the entire race which created an absolute disaster, all other connected industries will be affected. It will affect the pricing of apartments, roads, government infrastructure, wages, and the aspirations of young professionals. The tariff rates are extraordinarily high, not only with regard to tiles but in terms of most construction items. This obstruction of competition is not a recent phenomenon but it’s been there for decades in the tile and bathware industry. However, even after a near tariff imposition of over 80% on cost in some instances, we have managed to fulfil only about 50%-60% of the local market demand. As a result, Sri Lanka is stagnated in the same place without being competitive in industries, but rather complaining that our export portfolio is not diversified. 

How can we protect the local industries?

Local industries can only be protected by being competitive and the definition of protecting local industries should not be punishing the fellow voiceless Sri Lankans. The only sustainable way of winning a game is hard work and being competitive. Instead of being competitive, if we lose our focus and try to obstruct the competition, we will not be able to achieve anything more than what we have been experiencing so far. This was the same policy we adhered to for decades and we have to question ourselves as to why we haven’t succeeded. We have to remind ourselves what my house master in charge said many years ago and redefine the way we think as Sri Lankans.

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.

Celebrating all the wrong things

Originally appeared on The Morning

By Dhananath Fernando

There can be no independence without economic freedom

The lockdowns amidst the pandemic left all of us with ample time to explore new avenues in life. A friend of mine, excited to learn, enrolled himself in a bunch of online lessons with the motive of productively utilising this time. However, as time progressed, he got too lazy to keep up with the lessons and succumbed to the comforts of his home. He watched television, read novels, and baked way too many cupcakes. He did everything except follow through with his lessons, all the while feeling immensely guilty for failing to do so.

Every independence day, I can’t help but draw parallels between my friend and my motherland. We, Sri Lankans, are quick to celebrate independence with much excitement, just like my friend was to learn, but we fail to actually do the hard work to follow through with the initial commitment. We are quick to identify that learning is vital and even advocate for education. However, we lack initiative. Similarly, we proudly celebrate the British leaving us but have failed to do the work to achieve freedom in real terms.

As a result, over the years, Sri Lanka has only achieved certain elements of independence and democracy. Economic freedom remains an enigma up to date. Whether our fellow Sri Lankans have the ability to engage in business and trade with each other voluntarily has become a serious question. 80% of our land is owned by the Government. People have to wait in long lines and oil the palms of bureaucrats with discretionary powers to obtain a licence to cultivate a crop they think is best to earn a living.

Whether our fellow Sri Lankans can make economic decisions for the betterment of themselves and their children is a question which still remains unanswered. Yet, we opt to proudly celebrate “independence” with minimal comprehension of the true essence of freedom. I fail to see a big difference between my friend and this popular uninformed “patriotism”. 

Over the years, we have been excessively reactive rather than being proactive. Similar to my friend who celebrated the opportunity he had to learn but failed to follow through with it, we too continue to celebrate independence in its literal terms. To put things into perspective, let’s take a look at Sri Lanka’s economic incidents in the recent past.

We signed a Free Trade Agreement (FTA) with Singapore and went against our own terms and celebrated the “victory”. Since then, we have done very little to enhance Sri Lanka’s involvement in global trade. Instead, we continue to hamper the island’s economic growth and development through consistent import and export restrictions as highlighted by this column on numerous occasions.

We spent way too much time debating the Millennium Challenge Corporation (MCC) Compact for more than two years and eventually celebrated not signing the agreement. The agreement could have helped Sri Lanka enhance her land use and improve transport and traffic. It is clear the issue was politicised. However, we could have informed the donors as to why we opted not to sign the agreement before they directed the funds elsewhere. Even without the MCC Compact, we have done very little to reform the island’s myriad transport, traffic, and land use issues.

Recently, we celebrated withdrawing from signing a Memorandum of Understanding  (MoU), foregoing much-needed Foreign Direct Investment (FDI) for the development of the East Container Terminal (ECT). The development here had already been delayed by more than five years. Do we have a plan for the ECT’s development? Have we thought of competitive bidding? Do we have a better cost structure to implement investments on strategic assets? Sadly, the answer is “no”, yet again. It is clear that we Sri Lankans celebrate poor policy measures as victories and fail to embark on proactive actions that cause real change.

What causes real change?

Instead of celebrating policy measures that stunt Sri Lanka’s growth, we have to work towards establishing economic freedom and initiate important but hard reforms. What we should celebrate, however, is the implementation and impact of progressive policies.

The Economic Freedom of the World Index by the Fraser Institute states that countries with high economic freedom are more likely to prosper. The quality of life in these countries is evidently much better than countries with low economic freedom. If we wish to be free and independent, we have to prioritise economic freedom.

Sri Lanka has to implement reforms that ensure people’s ability to do business with ease, voluntarily without any barriers. We have to strive towards attaining a small government. The legal system and property rights have to be strong. People should be able to resolve their court cases faster and with improved efficiency. Sri Lankans should be given the right of ownership to their land and property especially on what they wish to do and grow on these lands.

Sri Lanka’s monetary system has to be stronger. We should have sound money where people do not lose the value of money in hand, due to the use of a bad monetary policy. When the value of money depreciates (from inflation), it is the poor who lose their freedom to buy what they want. Vulnerable sections of Sri Lanka are definitely the most affected.  Inflation is the unkindest tax of all as the poor have no defence against it.

Our businesses should have the freedom to trade internationally and barriers to trade have to be removed. Sri Lankans should not pay about 80% on their tiny bathroom tiles or 300% for the vehicles they use as taxes. They should be given access to trade internationally without any barriers. A minimum and appropriate regulatory environment is fundamental if we Sri Lankans wish to enjoy real freedom. Currently, to register a sole proprietorship or a partnership, a library of documents have to be submitted to authorities. It takes weeks for these documents to process when it should be a matter of a few minutes. The Government should not hinder the growth and development of our own people and their businesses.

On last year’s Independence Day, President Gotabaya Rajapaksa stated that he wants to remove regulatory barriers at all levels. A few weeks ago, he appointed a committee to evaluate unnecessary regulation for businesses.

The Economic Freedom of the World Index compiled by the Fraser Institute is a good indication of whether a country is moving in the right direction in terms of economic freedom. I wish and pray that we celebrate actions and reforms taken to improve economic freedom instead of celebrating the wrong forms of independence. If we fail to initiate hard reform and establish economic freedom, we will continue to celebrate independence for the wrong reasons. Then Sri Lanka’s prospects would be the same as my friend who makes no progress.

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.

Bribes and ‘service charges’

Originally appeared on The Morning

By Dhananath Fernando

Deregulation commission good only if it actually deregulates

While having a conversation with a businessman, I brought up the topic of bribery in Sri Lanka. I put him on the spot by asking: “Have you ever paid a bribe to sort out your business matters?” He responded: “The answer depends on your definition of a ‘bribe’.” He added: “If your definition of a bribe is dishonestly persuading someone to act in an illegitimate manner by a gift of money or another inducement, my answer is ‘no’. But I have paid and continue to pay ‘service charges’ (which I believe is the new term for bribery). This is ‘paid’ to get legitimate things done faster. Without oiling the palm, I cannot get any legalities processed,” he stated. “Following that definition, my answer is ‘yes’,” he went on to say. He further explained: “Paying money to get things done as per procedure is termed a ‘service charge’, and paying to get anything illegal done is a bribe.”

Unfortunately in Sri Lanka, following normal procedure to get things done requires the paying of bribes. If you don’t pay, you can’t get anything done, even if you have followed protocol and procedure to the dot. This is a common practice, from the security guard up to the director generals of many institutions; from getting a passport to getting approval for a million-dollar investment. 

This issue has been discussed over the years and it is not only a problem in Sri Lanka but across the world. But we all agree that in this part of the world, bribery is painfully common. Fear surrounding the act too has started to erode. That is the reason my friend, who is a businessman, prefers the term “service charge” instead of bribe. The main reason for high levels of bribery is excessive regulation and discretionary power assigned to certain officers. When we have too many gatekeepers with discretionary powers, bribery or service charges, as we term it, becomes unavoidable.

With this context in mind, President Gotabaya Rajapaksa has appointed a deregulation commission. The committee is assigned with the objective of easing business processes with a 90-day time frame. Identifying deregulation as an urgent need to ease the process of doing business is a step in the right direction. Many a time this column emphasised the importance of deregulation and its impact on easing the process of doing business. It is a low-hanging fruit that can be plucked easily with minimal financial resources. The President’s initiative and the Government’s efforts on deregulation have to be appreciated without a doubt. This will be a big game-changer if we utilise this opportunity with good intentions. 

Understanding the gravity of this assignment is of vital importance. Developing a feasible framework to achieve its objectives, too, is of high importance. There are two sides to deregulation. One is deregulating the factor markets. There are regulations at a higher level on main factors that contribute to productivity. That is land regulations, labour regulations, capital regulations, and entrepreneur regulations. Deregulation in each sector is an assignment on its own. 

Just take land regulation as an example. Eighty percent of the land is owned by the Government, and our farmers do not have the property rights to cultivate what they want and develop their lands. Different types of land registrations are in place by the name of Swarnabhoomi, Jaya Bhoomi, etc., but nothing can be used as collateral at a bank to obtain much-needed capital. As a result, for decades, our farmers have been using the same technology and very inefficient methods of farming. This is evident in how 25% of our labour force contributed about 8% in terms of GDP. 

The situation is not very different in other sectors in terms of capital market regulations and labour market regulations. Our hiring and firing guidelines are rigid, so doing business is a complete nightmare. Under the existing regulatory framework, it is therefore unlikely that investors will come to Sri Lanka more often. One reason why investors are actively looking at the Port City is that businesses at the Port City will have a separate regulatory framework. Faster and convenient systems and processes, and minimum yet strong regulation are what all investors are looking for. They want to invest easily without excessively spending their energy and money on unnecessary regulatory work which increases their transaction costs or by paying “service charges”, as per my friend’s definition. 

The business registration process is a nightmare for budding entrepreneurs. Small businesses registering proprietorships require a grama sewa certificate, rent agreement, nameboards, and have to provide so much more unnecessary documentation and go through unnecessary processes, that it kills the aspiration of the entrepreneur even before they commence the business. The company registration process can be done via an online system to get the business registered. However, getting copies certified by directors and other documents that are required, has become a long and tiring process.

Many exporters have said their main challenges are not issues such as finding opportunities in outside markets. Their biggest concerns are in Sri Lanka where their activities and scope of innovation are restricted by a regulatory framework.

The other side of regulation is product regulation, which calls for unnecessary documentation at every office. This is common for all product sectors of the economy. The National Medicines Regulatory Authority (NMRA) has so many various processes and procedures on getting medical equipment and issuing licences; so does the Telecommunication Regulatory Commission, which has another set of regulations on products. These are all fine examples of excessive regulation restricting product markets.  

When considering all these products and licence requirements as the general regulatory framework, then the scope of the newly appointed commission will be very broad. So, most likely, they may have to identify a few big-ticket items where deregulation can be done faster, with a higher impact on business and investment. Sri Lanka’s Customs’ regulation, land regulation, and capital market regulation are definitely a few areas where the problems are known yet nothing has been done over the years. The problem for many businessmen is not that they want to bend the law or do anything illegitimate, but rather that the authorities do not provide any answer for the applications and delay the process. For an investor, a very delayed date is an expense, as he/she has to repay the capital and interest on capital, and he/she is losing an opportunity to make a profit.

It would be a gigantic task for the committee to cover the scope of all regulations just in 90 days, and all the members are already on different fulltime assignments. Since this committee comes under the purview of the President, the business community will keep a close eye on the outcome of this initiative. 

We need to learn lessons from the past committees where nothing happened apart from the spending of public money and kicking of the can down the road. This Government, unfortunately, fell into the same trap with the committee appointed to appoint heads for SOEs (state-owned organisations), which did not achieve the expected outcome. There were media reports of political appointees, and some members even submitted fraudulent documents as qualifications to sit in high-level director boards at state institutions.

The deregulation commission is undoubtedly an initiative in the right direction, but the real victory for business and investment would be the day actual deregulation takes place – where the businessmen do not have to pay any “service charge” to speed up the process or bribe to get anything illegitimate done.

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.

Vaccine policy : is it time for the paid option ?

Originally appeared on Daily FT

By Prof. Rohan Samarajiva

When there is a population of 22 million and vaccines sufficient for 300,000, it is logical to give priority to frontline workers (health and other) who are most exposed to risks of infection. They are exposed by the nature of what they do for all of us. If they get sick, everyone suffers, not just them. There won’t be trained people who can care for the sick and bring the pandemic under control.

Comments on the efficacy, risks, etc. of vaccines should be made by those with specialised knowledge on the subject. But those of us working at the intersection of economics, law and technology can make useful contributions as well.

What kind of good is vaccination?

There is a limited stock of vaccines available in a country at a given time. A vial of vaccine is not a public good that cannot be sold for a price. One person getting a jab means there is one less for another. It can easily be given or denied. It is a private good that can be supplied through the market.

But vaccinations have strong positive externalities. The true benefits come to individuals (and countries) only when a significant majority of the population (or countries with which the country is interacting) are vaccinated. Benefits flow not only to the person getting the vaccination, but to others in her environment. 

Vaccinations can be sold through the market, but it is better if at least some quantity is given away free to those who are hesitant to pay. In fact, if there is resistance to vaccination for whatever reason, additional inducements or penalties can be justified.

How should limited stocks be allocated?

When there is a population of 22 million and vaccines sufficient for 300,000, it is logical to give priority to frontline workers (health and other) who are most exposed to risks of infection. They are exposed by the nature of what they do for all of us. If they get sick, everyone suffers, not just them. There won’t be trained people who can care for the sick and bring the pandemic under control.  

Who is next in priority? Most societies would privilege those most at risk, in the case of COVID-19 those who are elderly with other illnesses. The expected short duration of vaccine effectiveness makes this a relatively easy choice.

Those engaged in processing food perform essential functions. Infections in other countries show that such workers are facing high risks. Should they be next in priority after frontline health workers? What about those who work in close proximity in factories to keep the exports going? Without them, we may not have the resources to fight the pandemic.

What about persons such as politicians and religious functionaries whose functions require extensive human interactions and thus place them at some risk? They may be distinguished from frontline health workers who are compelled to expose themselves to risk. 

Should it be possible to pay?  

The various vaccines that are being made available are priced from around $ 3 (AstraZeneca-Oxford/Covishield) to $ 33 (Moderna). Bulk purchases by governments and programs such as Covax will make some vaccinations free of charge to citizens. Should those willing to pay be allowed to obtain vaccines on a parallel track?

For example, an export firm may be willing to spend its own funds to protect its workforce. As long as it does not disturb the priority list for free vaccines, is there any harm?

If vaccination for payment is acceptable for companies, why not for individuals? Those who wish to travel may require vaccines even if they do not fall within priority categories. It may be cleaner to allow them access to a payment-based option, than make case-by-case determinations on jumping the queue. Should the pay option be limited for those with cause as above, or simply open to anyone who is willing to pay?

This is how the Sri Lankan healthcare system works anyway. Those willing to pay can reach the specialists of their choice, technically with shorter waiting times, than those who go through the free channels in State hospitals. 

The same with hospital care. Those wanting the conveniences of attached bathrooms and TVs, can use private hospitals. Not perfect, but works. And in conditions of resource constraint, it may be the sensible option if the free channel can be protected from harm by the pay option. 

Vaccination and trust

Injecting one’s body with foreign substances requires trust in science and scientists. It is because vaccinations are risky that extensive trials are conducted, and rigorous approval procedures have been put in place. Government officials are instructed on how to communicate about vaccinations, specifically about the associated and unavoidable risks and unknowns. 

There is some percentage of the populace that is fearful of injections and untrusting of science. There are also those in the media who seek to profit by creating distrust, for example by peddling patent falsehoods about microchips being injected along with the vaccines. Stories about genes being altered are also in this category.

It is hypocritical for a political coalition that demonised the then Government and minorities by vigorously promoting the principle of ‘one country, one law’, to then propose to carve out the Port City development as a geographical area exempt from many of the laws and practices prevalent in the country. Those who sow the wind, reap the whirlwind. Because of this hypocrisy, the Government has great difficulty doing what it knows is the right thing for the country.

It is hypocritical for members of the dominant party in the previous Government (now split) to protest vociferously against the special treatment proposed for investors by the Colombo Port City Economic Commission Bill. They full well know the dysfunctions of the investment environment in Sri Lanka. The then Government was working on a bill on the same lines. There was discussion on placing the financial city within the jurisdiction of the English courts then.

It is not hypocritical for the Bar Association and other interveners to object to the proposal to establish an International Commercial Dispute Resolution Centre and to the associated legal workarounds. But it is wrong and self-serving. Members of the legal profession, more than anyone else, should know how dysfunctional the country’s legal system has become.

At the 47th Annual Convocation of the Bar Association, the Minister of Justice said that the average time to enforce a commercial contract in this country is 1,318 days (3.5 years). It is said to take one year to get a date for an appeal to be fixed for hearing on a criminal matter.

All of us who worked on improving Sri Lanka’s rank in the Ease of Doing Business Indicator know that the legal-system-related factors are a major factor in Sri Lanka being relegated to the back of the class. Poor performance in resolving insolvency and enforcing contracts are major contributors to Sri Lanka being ranked 99th out of 190 countries. On enforcing contracts, we are ranked 164th.

So, the previous Government was right when they considered placing contracts of investors in the Port City under English commercial courts. The experts who crafted the present bill were right in making arbitration by the International Commercial Dispute Resolution Centre mandatory and allowing for a fast-track engagement with the Sri Lankan courts as needed. Commercial arbitration is nothing new in Sri Lanka. To argue that it violates our Constitution is a little farfetched.

But of course, professional associations rarely allow logic and the national interest to come in the way of the financial and related interests of the members. The Sri Lankan legal system is one of the worst in the world, partly because the powerful private interests of the legal professionals are given priority over the interests of litigants and the country. It is not in their interest to admit how broken the system, they profit off, is. The Colombo Port City Economic Commission Bill is an indictment of that system. Lawyers, individually (as a prominent politician/President’s Counsel so vividly demonstrated) and collectively, are likely to oppose it.

The Port City bill is a workaround. It is needed because our systems are broken. President J.R. Jayewardene established the Greater Colombo Economic Commission (predecessor to the Board of Investment) as a workaround solution, by Act No. 4 of 1978 because our systems were a barrier to the attraction of needed foreign investment. We have the Katunayake and Biyagama zones and the various value-added manufacturing industries that are keeping our economy afloat, thanks to that workaround.

The tragedy is that 43 years later we are still doing workarounds. We need these stopgap measures, but we need to give the highest importance to fix all the systems that affect all our citizens, not just the foreign investors. Despite the specific mention of the doing business indicator in the Port City Commission Bill, the indicator is not done for enclaves but for the country as a whole. Improving the key systems across the country is what others are doing. India is now more than 30 places ahead of Sri Lanka, thanks to dedicated task forces. China is ranked 31st, more than 30 positions ahead of India and more than 60 ahead of Sri Lanka. I invite the readers to look at how well our competitor, Viet Nam, is doing.

If we do not improve the ease of doing business for all, we will be overtaken by Pakistan soon. They are taking concerted action to improve performance on the components and are now just nine places behind. Do the work around, but for God’s sake, focus on system improvements throughout. Define threshold levels in the Port City Bill itself when the workarounds can be discontinued, and we can celebrate living in a country where the legal system does not require bypass.

Rohan Samarajiva is founding Chair of LIRNEasia, an ICT policy and regulation think tank active across emerging Asia and the Pacific. He was CEO from 2004 to 2012. He is also an advisor to the Advocata Institute.

The East Container Terminal incentive

Originally appeared on The Morning

By Dhananath Fernando

I generally buy my toothbrush from a neighbouring grocery store. I usually gravitate towards one particular brand, but the shopkeeper convinced me to buy a different brand. The way in which he convinced me was so appealing, and to date I can recall the brand of toothbrush he recommended.

“Sir, there is a new brand in the market, which is the best. The thickness of the bristols are better and the handle has a special shape which can easily reach the teeth in your lower jaw.” He further explained the impact on my gums, how this model helps with oral hygiene and fights tooth cavities, etc. For a second, I thought to myself, this storekeeper must be a part-time dentist.

Later on, when I worked at a market research agency, I did a study on toothbrushes and I analysed the margins provided for retailers. Here I realised the particular brand my neighbouring storekeeper promoted provides a significantly higher margin than the rest of the brands for the retailer. So the business model is designed to influence the buyer by providing a better incentive. For any business, understanding and setting up the right business model will determine the success of that business in a competitive industry.

Sri Lanka’s debate on the East Container Terminal (ECT) has come into play in this context.

Sri Lanka doesn’t have a bright history of creating sustainable business models. The shipping business is a networking business. There are many stakeholders and decision-makers who could bring the businesses into the port at many levels based on the incentive structure. Our strategic location of the port is one advantage, but in modern days, a strategic location will not be sufficient to bring in the expected benefits in a broader economic context.

The Colombo Port is mainly a hub for transhipment business. According to Shippers Academy Colombo CEO Mr. Rohan Masakorala, transhipment is a very sensitive business as the business can move from one port to the other based on developments, if we fail to attract the right business partners. He has further provided an example of how Singapore learnt a lesson by removing a major shipping alliance from a partnership and the transhipment business moved to Malaysia. As a result, Singapore had to reverse the decision.

According to Mr. Masakorala, the lack of knowledge and willingness to take an outward-oriented approach on economics has resulted in Sri Lanka not reaching the benefits from ports as we should have. About 80% of ports and terminals in the world are managed by private-public partnerships (PPPs) and only 20% is managed by governments. In the case of the Colombo Port, through the Sri Lanka Ports Authority (SLPA), the government has a stake in all terminals whilst also playing the role of the regulator. It is the same as becoming the umpire of the game while contesting in the same game.

Usually, it is the ship owners who decide which port or terminal that has to be used. That decision is taken after considering the efficiency of the port/terminal and their business interest and the terminals in their network, in addition to the location. Shipping is a very cost-competitive industry and profits are based on volumes.

At the same time, the investment is front-loaded, which means you have to do a significant investment even before you start the operation. The higher the investment, the higher the risk and liability. In a dynamic business environment, a minor disruption in operations can cause significant losses and result in the loss of competitive advantage in this industry. This is the nature of this business.

The Port of Singapore is a classic example of the importance of entering into joint ventures.

Identifying the correct business model when managing ports and their terminals is of paramount importance. The business works in such a way that you opt for joint ventures and network with other stakeholders with the objective of attracting as many volumes as possible, while keeping  productivity and efficiency at a maximum. In a joint venture, it is not only the investment, but also the knowledge, knowhow, and the use of better management that are going to reap the real benefits.

If such a joint venture that reaps such benefits is implemented, then the country gets economic benefits across other sectors. As a country, we have to look at the broader economy and not a single industry, because at a broader level, all industries are connected with main factors of production – land, labour, capital, and entrepreneurship.

On the other hand, over the years, consecutive governments made the ECT project very complicated by signing Memorandums of Corporation (MoCs) and calling bids for operators and cancelling it multiple times. As a result, we have delayed this process for years. Our reputation  has been irreparably damaged by such prolonged delays, especially when taking into account the losses due to delays and the impact on investor confidence.

As this writer highlighted in this column before the general election, it could have been an opportunity for the then interim government and president to reflect not only the transparency, but also the importance of having a competitive business model. Following such a competitive focused model with partners across main shipping alliances and getting the ECT networked for more businesses would have reaped significant benefits by now.

Similar to the business model created by the toothbrush manufacturer with the retailer, we had the opportunity to arrive at a win-win business model, creating synergies and respecting local businesses as well as other stakeholders. From a geopolitics angle, if a transparent bidding process was followed with clear guidelines, then such external influences could have been completely avoided, as transparency and competitive bidding are the standard global good practice principle.

If the SLPA was to invest in the ECT in full, then the question arises as to why we wasted so many years without investing in the first place. It raises questions as to why we wasted time and who is responsible for the opportunity we missed for making profits. Therefore, the fundamental  business principle of ownership of risk must be considered with foresight. When private investors are brought into the business and when they risk their money, they are responsible to make matters efficient and productive. That doesn’t happen when governments invest taxpayer money. Many Sri Lankans fail to understand the basic role of incentives in economics and tend to only look at the ownership angle without realising the synergies of business models.

The second question is that the Sri Lankan rupee is under pressure. The recent Sri Lanka development bonds issuance has been undersubscribed by 25%, so the foreign exchange needed to invest in the ECT remains an enigma. All equipment and machinery has to be imported to keep it at a world-class level. We cannot afford to spend our valuable foreign reserves on this matter at this juncture. So are we going to delay the ETC further?

As always, only time will tell us whether Sri Lanka created the correct business model similar to the incentives given by the shopkeeper, or whether we opt to keep postponing this for a few more years and forget the opportunity to make profits from the port for business and the people of Sri Lanka.

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

Can we print our way out of this economic hole?

Originally appeared on The Morning

By Dhananath Fernando

I had a friend in school whose aspiration was to be the president of Sri Lanka. One day, our school teacher asked him: “So what are you going to do when you become the President?”

He had a simple answer. “I am going to end poverty in Sri Lanka and make all citizens wealthy by ensuring they all have enough money.” In response, the teacher further questioned: “How are you going to do it?” To which my friend answered: “It’s not difficult. I will print money and distribute one million per citizen among all citizens so they have money to buy all the goods and services they want.”

This sounded like a great idea to schoolboys who did not know anything about economics. “Why can’t governments print money and increase the income of people and allow them to buy goods and services as they wish?” were our initial thoughts.

The teacher then questioned: “What if the market doesn’t have enough goods and services to buy with the money you expect to give away. Do you think that having money in hand but no goods and services in the market will help people consume what they need?”

Through my teacher’s counter-questioning I realised that “money” or fiat currency is just a piece of paper. The amount of goods and services we can buy from that money is what matters instead of the quantitative or numerical amount of money in hand.

Take a Rs. 100 note and a $ 100 note for example. Both of them might represent a 100 but we can buy more goods and services from $ 100 than Rs. 100. Therefore, managing “money” or the currency must be done very carefully. 

The economy is a broader concept where the supply of money is just one tool within this system. This economic system performs the function of optimising limited and scarce resources to meet unlimited wants. Prices determine what could be bought or sold by the quantity of money.

If there is strong demand for one good over another, its price will go up and the supply of that good will go up, as producers try to make more money to get more profits.

Excessive creation of money without regard to the number of goods and services produced in a country leads to price inflation, which distorts relative prices. Sri Lanka’s economic problems are multifaceted. Therefore, we have to evaluate whether we can overcome our economic challenges by printing money as suggested by my school friend. This dilemma brings Modern Monetary Theory (MMT) into context.

Some advocates of MMT say money can be printed by governments without a problem. Other advocates say governments can borrow large amounts of money without a problem. At the end of the day, printing money is also a form of borrowing from the Central Bank. Still, other proponents say taxation can be used to stop the inflationary effect. 

While different proponents of MMT have proposed slightly different views, some of the key ideas are that governments can increase deficit spending without a problem and that they can also print money. Still, others argue that money can be printed to repay bonds, and therefore there will be no default on debt.

However, it is important to remember that the comparison of a government to a household only goes so far. This is because sovereign nations can print money which a household cannot. Some believers of MMT claim that in an environment where a country hasn’t reached full employment, printing money or quantitative easing doesn’t cause inflation. Some others argue that if inflation picks up, taxation can be used to take spending power and reduce inflation.  

When a country like Sri Lanka prints more money it can cause two problems. One is that it will

create a balance of payment problem when economic activities and credit picks up. Sri Lanka or any other country cannot live in complete isolation. We have to import some basics such as fossil fuel, pharmaceuticals, and inputs for our exports. Statistics by the Central Bank show that about 80% of our imports are capital and intermediate goods, required for consumption and for our exports. When we print excessive money, that will increase imports and create a balance of payment crisis. In addition, the fall in reserves and the fall in exchange rate will lead to a loss of confidence. Then, foreigners who had loaned money and other investors will take their money back. This is called capital flight. That is one reason the yields of sovereign bonds have increased to very high levels and we cannot issue more sovereign bonds.

But what about rupee debt, you may ask.

One question commonly asked is why Sri Lanka cannot print money if the US and Japan can print money in trillions. This is possible for the US and Japan to some extent because both the US dollar and the Japanese yen are pure floating exchange rates. The US dollar in particular is also used abroad. However, that did not prevent the collapse of the US dollar in 1971 when it was pegged to gold and money was printed in excess.

When the US dollar was a floating currency also it was not immune. After very low rates from 2001, a massive credit bubble was fired in the US and the dollar weakened. Inflation and oil and house prices went up and then collapsed.

Sri Lanka does not have a pure floating currency. Sri Lanka collects reserves through the purchase of dollars and then the sale of dollars to defend the value of the rupee against the US dollar at different rates. 

Such countries are much more at risk from printing money than those with a pure floating exchange rate. Consecutive governments of the past resorted to the practice of financing our budget deficit by money printing. One reason Sri Lanka has had to go to the International Monetary Fund many times over the last 70 years is mainly due to such balance of payment crises caused by the excessive printing of money.

Restricting imports reduces the amount of goods and services available in a country and leads to higher prices. When countries without floating exchange rates print money, not just inflation but hyperinflation also can happen.

Zimbabwe created excessive amounts of fiat money that led to inflation rates of more than 1,000% per year. As the currency crashed, notes of million-dollar Zimbabwe banknotes were printed. Eventually people shifted to US dollars. Inflation then stopped. But many were left destitute. Large numbers left as refugees. Creating money without regard to the availability of goods and services can ruin an economy. And worse. It devastates the poor.  

It is true that the economy of a country cannot be compared to the economy of a household because people trade in different currencies and trade between countries is a global phenomenon bringing in competitive synergies.

But when money is printed, the main objective of economic policy becomes “saving foreign exchange”.

The MMT advocates of the West did not say to control imports. Some people hold up Japan as an example due to its high debt levels and attempts at trying to ignite inflation there through money printing. But there is no import control in Japan.

So we should not forget that the main objective of an economy and economic policy is not to just have money in every citizen’s hand or saving US dollars to pay our debt. The prime objective of a well-functioning economy is to improve the quality of life of the people and reduce poverty. We can only achieve these objectives by utilising our scarce resources optimally. Hence my teacher’s question, “what if we all have money but not enough goods and services for our consumption?” must be analysed in depth.

Therefore, improving the quality of life, eradication of poverty, and using our resources optimally have to be the broader objectives of the economic policies we implement. This does not mean that we divert from our focus of facing the ever-growing economic challenges before us. However, our solutions to meet short-term economic challenges should not dilute our aspirations or our long-term economic goals of improving quality of life and eradicating poverty.

Monetary history has shown over and over again that the oversupply of money causes inflation and currency depreciation and balance of payments problems. When money printing is continued, it will end in hyperinflation like in Zimbabwe. The poorest sections of the society will be most affected by hyperinflation.

Countries like Venezuela and Zimbabwe are prime examples of the various consequences that can occur as a result of governments running their money printing machines overtime. It results in a situation where they have money, but not the adequate amount to afford their necessities.

What is the solution?

It is understandable that in a global pandemic and a credit collapse some countries printed money, especially when there was no economic activity to make use of the money. But expecting to use it as a permanent solution may cause long-term damage to our economy. 

To optimise the use of our resources, we have to remove the structural impediments that stop the people from doing growth-creating economic activity. 

We must restructure our state-owned enterprises (SOEs) and open public sector resources to the private sector, in order to attract money, for example, rather than print money. Ultimately, it is the production of goods and services and getting all Sri Lankans to contribute to economic growth that will help meet our long and short-term economic objectives. Expecting that production will kickstart when excess money is supplied through money printing is surely a not solution. Instead, we should examine the barriers that have to be removed in order to ramp up production. These barriers keep dragging our economy behind.

We should not forget the scenario where everyone was given money through money printing but there were insufficient goods and services to purchase. This lesson taught by my school teacher to my aspirational friend who wanted to lead the country, is a lesson for the whole country. A lesson as to why such thinking is fundamentally flawed.

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

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

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

Scenario 1: Want it to happen

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

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

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

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

Scenario 2: Wish it would happen

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

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

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

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

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

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

Scenario 3: Make it happen

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

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

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

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

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

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

Preserving foreign exchange or earning foreign exchange?

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Unlocking the Potential of Micro, Small and Medium Enterprises Essential to Sri Lanka’s Post Covid Economic Recovery (Part 2)

Originally appeared on Colombo Telegraph, Daily News and Daily FT

By Ayesha Zainudeen

Small and medium-sized businesses (SMEs) represent over half of the businesses in Sri Lanka. They also provide an important source of employment for a large part of the labour force. They have been dubbed the ‘backbone’ of the economy in national policy frameworks. Supporting this sector and helping small businesses to grow should be an important part of the national strategy for post-COVID economic recovery. 

This article is the second in a multi-part series by the Advocata Institute and LIRNEasia on what needs to be done to empower Sri Lanka’s micro, small-medium businesses for post-COVID economic recovery. In Part 1, the Advocata Institute examined the barriers faced by small businesses to formalization and what needs to be done to lower them. In this part, LIRNEasia looks at what is holding SMEs back, through the lens of digital exclusion.

Connectivity is related to better business performance

 A 2019 LIRNEasia survey of SMEs across Sri Lanka showed that businesses classified as ‘high’ ICT users performed considerably better on a number of indicators such as revenues, profits, number of customers, etc. (Figure 1).  Perhaps most interestingly, they were also connected to a global value chain in some way. 

Figure 1: How SMEs classified as high ICT users are different to those classified as low ICT users (Source: LIRNEasia AfterAccess SME survey, 2019)

Dear sir, optimism is not a strategy

Originally appeared on The Morning

By Dhananath Fernando

The Govt. must start pulling the economy in one direction

The former Chief Pilot of Air Lanka and former Boeing 747 instructor Captain Elmo Jayawardena is someone I know well. He has had a long career as a pilot at Singapore Airlines. Out of curiosity I often question him on how flight operations work. He describes vividly the level of detail with which pilots go through pre-flight checklists before they sit in the cockpit; fuel levels, weather patterns, emergency landing at each phase of the journey, and so many technical details get evaluated by them.

He always talks about a “plan B”. As pilots always operate on the basis of something going wrong and having a back-up plan for it, I feel they are very pessimistic – my judgemental thoughts on their level of planning and carefulness. However, one day I asked Captain Elmo: “Can’t you become an optimistic pilot, thinking that everything will be fine? There are so many aircrafts taking off and landing safely and very rarely do we hear about plane crashes. So, do you have to really go into that level of planning?” He answered: “Optimism is not being ignorant or denying the possibility of a potential risk scenario. Optimism must be grounded in reality that all events and decisions have a risk factor.” I then realised that one can be genuinely more optimistic if you have a plan to face the worst-case scenario.

Looking back at Sri Lanka’s economy provides some important lessons on how we have dealt with optimism. We as a people have always lived in an optimistic state. After Independence, we thought it was all over. Then following the end of the youth insurrections and  30-year long civil war, we looked forward with optimism. This period was followed by a window of economic reforms, with the end of the war adding to our economy.

However, we missed that grand opportunity of reform as we only focused on short-term development.  We failed to put our economic fundamentals right! As this column has highlighted previously, since 2015 up to date we have faced five major shocks to our economy – the Central Bank bond fiasco, drought in 2017-2018, a constitutional coup in 2018, Easter attacks in 2019, and Covid-19 in 2020. These events have decided the fate of our current economy and pushed it to where it is today. However, some of these events are due to misfortune and the others are examples of mismanagement. 

In this context, the Government still looks very optimistic about the growth numbers for next year and provides messages of absolute confidence that Sri Lanka can overcome the current situation through medium and long-term growth. In order to walk the talk, the Government did not reverse any tax concessions announced in December 2019, even with two rating downgrades by Moody’s and Fitch. Likewise, the Government has provided an optimistic message to all our creditors, assuring them that we will pay all our debts, taking into account our track record of servicing the debt without any default (with rescue efforts from the IMF [International Monetary Fund], World Bank, and the ADB [Asian Development Bank]).

All the positivity and clear, focused messaging by the Government is commendable. However, the Government should not divert from the real situation on the ground in this Covid-19 world, where external support may not be easily available as in the past. The Government must understand the impact of this on our short, medium, and long-term credibility.  A recent Citi Bank report for their investors highlighted the same concerns again. What is missing in this puzzle for many investors is a credible action plan. Having a credible action plan is similar to the planning that a responsible pilot carries out. It illustrates accountability for creating a safe and pleasant flying experience. This helps build trust and confidence about the pilot among passengers and also provides them the peace of mind that they will reach the destination safely.

This is done by having a plan on how to achieve the goal and what needs to be done in case of an emergency.  When we provide a positive message without a strategy or action plan to back these arguments, then this affects our credibility and our partners may not take us seriously. Even if we have a strategy and if we fail to disclose it with objectivity, then this raises concerns about our sincerity and commitment to overcoming the looming economic crisis.

The Government’s growth is expected through Foreign Direct Investments (FDIs) and exports according to the Budget 2021. Both these inflow sources are very sentiment-driven and an optimistic psychology without an action plan may not build the image we want to project – an image that attracts top investors, companies, and gives the edge to reach export markets. Tourism, which we expect to open in the first quarter of 2021, is even more sentiment-driven than the above two. Over the years, none of the necessary and serious reforms have taken place to signal the markets to attract more investments or encourage exports to take off.  We should explain our logic of how Sri Lanka is going to pay on average $ 4 billion every year for the next five years. It must be noted that we have $ 5 billion in reserves at hand and with two credit rating downgrades, interest rates will increase on further borrowing. If we can explain the logic of how we are going to manage the numbers with a credible plan, then the key stakeholders can work towards materialising the plan and achieving results.

On the other hand, we should not forget that our strategies are comparative to the strategies of the rest of the world. The rest of the world competes with us for the same export markets, for the same investors, with their own advantages and disadvantages. So reaching new export markets and attracting new investment is a competitive process which we can’t ignore. It is credibility and reasoning that matters when attracting these inflows.  Looking at the past, we cannot ignore the possibility of new shocks that might occur during our recovery period. So we have to be prepared!  

As his Excellency the President mentioned in his meeting with the Central Bank a few months ago, we can’t let the health crisis lead to an economic crisis. Likewise, we cannot let the economic crisis lead to a social crisis. Our optimism cannot lead to denial or a blindness to the ground reality – that there is a significant challenge right at our doorstep. I am all for optimism and positive thinking, but as my mentor, Captain Jayawardena said: “We can be genuinely optimistic only if we have a plan to manage the worst-case scenario.”

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.

Taxes on Essential Products: Bringing The Debate Back to Where It Matters

Originally appeared on Colombo Telegraph, Citizen.lk, The Morning, Lanka Business Online and Daily Mirror

By Aneetha Warusavitarana

Sri Lanka’s exorbitant taxes on sanitary napkins had the media spotlight over the last few weeks - this is not a new issue. In 2018 the total tariffs on sanitary napkins was over 101.2%.  Since then we have seen some progress, with the tax being reduced from 101.2% to its current rate of 52%; a result of several tax revisions.

The 2020 budget revised down general duties for sanitary napkins to 15% and introduced a CESS tax of 15%, causing an uproar in social media and in parliament leading to fresh calls for the abolition of these taxes.  

Menstrual hygiene products are essential for girls and women, and this issue has put the interests of these consumers who want more variety and cheaper products against the interests of the local producers who want larger margins. Since the initial uproar last week, there have been claims that the local brands account for 95% of the local market and therefore import taxes do not have a bearing on the market price.  

Bringing the debate back to where it matters: impact on women

It is clear that for this issue, policy decisions have to be taken with the best interests of the consumer at heart - in this case, the millions of menstruating women. 

At the most basic level of analysis, when protectionist tariffs are placed on a good, it is the consumer who loses out. The tariffs will achieve two things: they will limit the range of products that enter the domestic market, and they will raise the prices of both imported products and locally manufactured products. How so? The inputs into the local production process are also taxed, which raises production costs, and therefore raises the final price of the locally manufactured product. Additionally, the tariff raises the price of the imported product, which allows local producers to raise their prices and keep substantial margins. In other words - tariffs cause both the locally produced goods and the imported goods to be sold at a higher price. 

These tariffs are also keeping more affordable options out of the market. At the time of writing, locally manufactured products can range in price (per pad) from LKR 11 to LKR 19. However, cheap imported alternatives are not available. For example, Indian supermarkets have products at the equivalent of LKR 5. The tariffs may not be deterring higher-priced imports from entering the market, but it could be possible that this is happening with more affordable imported options - it makes little sense to bring in a cheaper product if the tariff raises your costs to the point where you have to price the final good at the same price point as your more expensive product.

Will removing the tax only affect high-income earners?

An argument leveled against the removal of the tax has been that imported products are often out of reach of the average Sri Lankan woman, and as such has little relevance as a policy decision. This argument has also been coupled with the statement that as locally manufactured products exist, and women do purchase them - why should we care about bringing in imports? 

The example provided above makes it clear that removing the tax would actually bring more affordable products into the market. This is also where the importance of choice comes to play. Each woman will have different requirements at different points in their life. This is compounded by the fact that menstruation is often accompanied by pain and discomfort, which can range from mildly annoying to debilitating. In short, one size does not fit all when it comes to menstrual hygiene products. In response to this fact, the global industry has innovated - period cups, period underwear, reusable pads and more. These tariffs should be removed, and Sri Lankan women should also be given access to these choices. 

Economic Rents

By now it should be clear that there is only one winner, and it is not the millions of menstruating women. The basic explanation of the impact protectionist tariffs have is that they serve to benefit local producers, that are few in number. They shield them from the competition and allow them to price well above marginal costs. A classic case of ‘rent-seeking’ behaviour, where a company lobbies to secure itself protection in order to charge a higher price. The result is that the local consumer loses out. 

There is one area where the producer's complaints do have merits - that is the tariffs placed on their inputs.  Much of the input that goes into the production of sanitary napkins are also taxed.  The government should look into reducing these costs to help the local manufacturers stay price competitive.  

Given this, there is a clear call to reform - prioritise the requirements of women, and remove the taxes imposed on the final good and on the inputs into the production of these goods.

Aneetha Warusavitarana is the Research Manager at the Advocata Institute and can be contacted at aneetha@advocata.org or @AneethaW on Twitter. Learn more about Advocata’s work at www.advocata.org. 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.

Unlocking Potential of Micro and Small businesses Essential for Post-COVID Economic Recover

Originally appeared on Ceylon Today, Economy Next, Colombo Telegraph, The Island and Daily FT

By K.D.D.B. Vimanga

Sole proprietorships account for 63.1% of businesses in the country and account for 27.1% of national employment (Annual Survey of Industries, Department of Census and Statistics). Their contribution to the local economy is significant and lockdowns due to the COVID-19 pandemic have had an adverse impact on these small businesses.

At present, it is difficult to estimate how many small businesses would be out of business, but given that the department of labour has estimated (from a survey of 2,764 establishments) that 52.15% or 764 of firms, employing under 1 to 15 employees have closed down, it is likely that small businesses have also been hit hard.  

However successive Sri Lankan governments have failed to strategise on the potential of these enterprises to Sri Lanka’s economic development. Emerging markets such as Vietnam on the other hand have been able to capitalise on the potential of these businesses to accelerate economic growth.  

Any hope of inclusive economic growth for Sri Lanka’s post-COVID recovery can only then be achieved if we utilise this sector, unlock their potential and empower them to grow, compete and thrive. While there is a lot of work to be done in terms of policy reform in this area, there are a few low hanging fruits, namely re-hauling the business registration process, and bridging the digital divide. 

In the form of a multi-part series, the Advocata Institute in partnership with LIRNEasia will provide an in-depth analysis of these two vital policy tools to empower Sri Lanka’s small businesses. 

Sri Lanka’s business ecosystem:

According to the listing operation of Economic Census conducted in 2013/ 2014 the number of SMEs in Sri Lanka, most of which are categorized as sole ownerships, account for 1,019,681 of which 71,126 are small enterprises and 10,405 are medium scale enterprises.  This number only represents enterprises that have registered under the above criteria. However, according to the same survey, there are 3 million people who engage in a similar SME related industry, trade or services. 45% of the micro-enterprises and 10% of small enterprises remain unregistered. Overall, 42% of business establishments remain unregistered while 25% of these establishments are run by women entrepreneurs. In other words, informality is still high. 

According to a survey done by LIRNEasia, 40% of SMEs reported using the internet or social media for business; much of this use was limited to information seeking, rather than transactional use. Those who used the internet for business thought that access to the internet is either important or very important, while those who did not use the internet remained unconvinced of its benefits: most said there was ‘no need’ to use the internet. Few SMEs were capable of taking any form of card payment at the time of the survey, and the majority of SMEs did not use mobile money services. This research points to a serious digital divide restricting the potential of Sri Lanka’s small businesses. This would be tackled comprehensively during next week’s Op-Ed outlining the serious implications of the digital divide.  

So what is the problem?

Let’s look at it through the experience of a micro-entrepreneur. Chitra. She runs a string hopper stall opposite her village fish market and her story is similar to that of three million people who engage in an SME related industry, trade or service. Her business remains unregistered. She does not use any digital technology. Because she is unregistered, she cannot go to a bank and get a low-interest SME loan or even apply for the recently introduced Saubagya COVID-19 renaissance facility.

Reforming the Business Registration Process

So what must be done urgently is to simplify our business registration process. At present, the business registration process is implemented by the Divisional Secretariats. In contrast, the Business Registration process for companies under the Companies Act No. 7 of 2007 are streamlined through an online registration system called the e-ROC. However, this does not benefit small businesses who classify as sole proprietors and partnerships and is therefore regulated at the Divisional Secretariat.  At best we have about nine different regulatory processors for the registration of sole enterprises and partnerships. Typically, an entrepreneur like Chitra would have to visit the Divisional Secretariat, collect and fill forms, provide documentation such as proof of premises ownership such as deeds, or rent agreements, tax assessments etc. Then she would have to visit the Grama Niladhari and get the documents validated. She might need other approvals as per the request of the Grama Niladhari before she hands over the final forms to the Divisional Secretariat. A more effective method would be to have an online system. As implemented by New Zealand and Hong Kong, the applicant must be able to submit the form (available in all three languages) online on the Divisional Secretariat website, pay the business registration fee online or at a bank and receive the business registration the next day without the requirement for numerous signatures or documentation of ownership (the company registration process does not call for the original deed or proof of ownership, so why should a small business?). Then an entrepreneur such as Chitra can easily go to the nearest communication fill the forms, upload the deposit slip and get her business registration done with ease. 

Therefore, in practice, what has to be done is establishing an e-registration system which can be availed of by small businesses. The Ministry of Industries must play an active role in setting up the online platform in partnership with Provincial Councils. Secondly, the requirement for unnecessary documentation (proof of ownership, grama niladhari approval, etc.) has to be amended at the provincial council level.  Implementation of these two policy recommendations would significantly empower small businesses to get registered. 

Conclusion

Sri Lanka needs to urgently capitalise on the potential of MSMEs. Creating growth and productivity in the small business sector is an investment on our wider economy. This is not an easy task; however, mobilising synergies and bringing in much needed regulatory reforms such as making the business registration process simpler and secondly bridging the digital divide.

K.D.D.B. Vimanga is a Policy Analyst at the Advocata Institute. He can be contacted at kdvimanga@advocata.org. The Advocata Institute is an Independent Public Policy Think Tank. Learn more about Advocata’s work at www.advocata.org. LIRNEasia is a regional digital policy and regulation think tank active across Asia. The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or LIRNEasia.

Policy instability is as bad as political instability

Originally appeared on The Morning

By Dhananath Fernando

The Govt. must start pulling the economy in one direction

We are just over five months away from the 25th anniversary of Sri Lanka’s 1996 Cricket World Cup victory, which is still engraved in every Sri Lankan’s mind. Since then, our players have gone on to break world records and build legendary careers. They have been named in many Greatest XI lists and represented all the major cricket leagues around the world. Therefore, it is clear the quality of our cricketers has improved in leaps and bounds over the past quarter of a century, and we even secured a T20 cricket World Cup in 2014.

However, cricket’s greatest prize has eluded us since 1996 so it is interesting to re-evaluate the contributory factors of the 1996 victory. It is my belief those key takeaways will provide us with some insight on strategies to overcome the current economic storm. There are many elements and ingredients in mapping out the winning formula. However, I see two main contributory factors.

First is the “stability of the team”. Second is a combination of all other factors along with the cricket administration, which I like to call cricket-political stability, or “crickelitical stability” if you will. The 1996 team was not a star-studded team. Most of them became stars after playing the World Cup, including Sanath Jayasuriya, Muttiah Muralitharan, and Chaminda Vaas. It was the above two factors that made them world champions, which have unfortunately remained unattainable to Sri Lanka, even following 25 years of advanced investments and resources.

In an economic context, similar to the cricket team, “policy stability” and “political stability” are both extremely important. Sri Lankans have never had the luck to experience the joy of a World Cup victory in economic terms. This can be mainly attributed to Sri Lanka’s excessive focus on political stability rather than policy stability. The economic equivalent to a World Cup victory in the Sri Lankan context would be achieving lower poverty rates and reaching a GDP per capita of above $ 10,000. This, in my opinion, remains an elusive dream. Over the years, the business community and policy analysts have been highlighting the importance of policy stability and consistency, but we have failed on both fronts.

Lessons from the previous Government

Initially, the last national Government had a two-thirds majority in Parliament. However, policy stability was non-existent. Different parts of the Government functioned with opposing views which resulted in public policy being pushed in two opposing directions. This filtered down to all levels of government.

The then Prime Minister’s policy statement and the Budget Speech by the then Finance Minister prioritised two different policy agendas. Significant salary hikes for the public sector which were not affordable to the state balance sheet, and revising the VAT (value-added tax) rate several times, are a few examples of policy inconsistency. The Vision 2025 policy statement which was the main policy agenda of the Government, was released a considerable time after taking over office. Moreover, in implementation, it was not given equal priority by all sections of the Government. The Cabinet Committee on Economic Management (CCEM) was then replaced by the then President with the National Economic Council (NEC), which was later dismantled by the then President himself. This resulted in a major setback, since important policy decisions took place without sufficient deliberations, thereby leading to further policy inconsistency within the Government. 

Cabinet reshuffles on key portfolios were observed a few times. The constitutional crisis that emerged with the appointing of a new Prime Minister was a key highlight of the island’s policy instability. It goes without saying that this level of instability and inconsistency is beyond the capacity of a small economy in the Indian Ocean. Policy stability and consistency is something that cannot be achieved only at the top level. Consensus between political leaders executing government functions in order to get something done is political stability. The policy implementation team and the execution of those decisions have to fall in line with the policy. It is only then that we can achieve policy stability.

There are so many things that can get held up at the lower level, starting from misplacing documents. This may have a significant effect on policy implementation, especially if we fail to get policy execution in line with the policy agenda. The World Cup victory in 1996 was a team effort where everyone contributed equally at all levels, from the team manager to the water boy. Another important element is political stability in Sri Lanka. This requires policy stability in the economic front, especially to overcome the current crisis.

Evaluation of the current Government: Post one year

In completing one year of being in power, the current Government should be extra cautious and re-evaluate their performance on realistic measures. The accuracy and relevance of their actions, policy consistency, and stability should be the Government’s priority.

Last week’s Economic Summit organised by the Ceylon Chamber of Commerce highlighted a few sentiments that are reflective of some elements of policy inconsistency.

The Governor of the Central Bank highlighted the importance of self-sufficiency with an emphasis on state sector-led development as a key strategy to support local industries to navigate these uncertain times. The Governor expressed his lack of interest in resorting to advice or support of any foreign agencies.

This statement was followed by a session where the Chairman of the Export Development Board (EDB) and Director General of the BOI (Board of Investment) emphasised on the importance of the Government simply playing the role of an enabler. They highlighted the importance of the private sector in driving economic growth and exports. Furthermore, they reiterated the importance of attaining know-how and capital through Foreign Direct Investments (FDIs). This, in their opinion, was the only way forward, if Sri Lanka is to seriously consider development.

For any economy to thrive there are few drivers that come into play. The ability of the people to connect with the economy and link with global production networks has become a fundamental necessity of the modern world. However, the question remains as to how we can achieve the above and if we will ever get implement the reforms to enable this.

From a public policy perspective, “self-sufficiency” stands in contrast to driving global trade, increasing exports, getting connected to global production networks, and FDIs. They are opposing policy outcomes. Having such opposing policy outcomes makes it difficult for a government to have a twin strategy to approach problems which are interconnected and it sends mixed signals to markets.

A common mistake of many governments that is attributed to their failure is their inability to consider the economy in its entirety. FDIs, exports, exchange rates, labour market, debt management, and all other factors of the economy are interconnected. If we fail to look at an overall picture and only target certain sections of the economy, policy instability will be inevitable. This in turn leads to a vicious cycle of political instability. Sadly, this has been Sri Lanka’s excruciating reality for a while.

This vicious cycle is precisely what this administration must strive to avoid.

In my opinion, getting the reforms done, expanding our connectivity to global value chains, and letting the private sector drive the economy is of paramount importance.

Policy stability goes beyond keeping the tax rates consistent or retaining certain sectors as priorities. It requires cohesiveness from all levels. Mainly at the implementation level where there has to be a continuous follow up between the different actors, while simultaneously keeping in mind the overall picture of the economy. It is about creating an ecosystem between sectors where all sectors work at an optimum capacity and level. The only way to do it is to allow the price mechanism to lead the market and let the resource allocation be done based on market prices.

If Sri Lanka is looking for a World Cup-winning era in terms of our economy, we must focus on policy consistency and stability, while maintaining political stability.

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.

Not cost of living but quality of life

Originally appeared on The Morning

By Dhananath Fernando

The gentleman who cleans and repairs my roof every month is the breadwinner of a family of four, and a father to two children who are still schooling. He earns a living working for a company for an end-of-the-month salary, but it is paid based only on his working days. I often ask him: “How is life?” He always grins and provides me with the same answer: “On payday Rs. 5,000 is worth just Rs. 50. One week before payday, Rs.50 is worth Rs. 5,000.” 

I recalled what he said when recently, a Minister stated in Parliament that “the Rs. 5,000 was given for a month, not to be spent within a week”. Things took an emotional turn following this statement and social media castigated him for being tone-deaf and being detached from ground realities. 

This makes complete sense from the receiver’s point of view. Rs. 5,000 is not adequate for a family of four! A simple calculation breaks it down as follows: Rs. 1,250 per person per month, which means about Rs. 42 per person a day, and about Rs. 14 per meal, even if the calculation is based on the rather broader and irrational assumption that the money is only spent on food.

According to the Household Income and Expenditure Survey by the Department of Census and Statistics, Sri Lanka’s mean household expenditure per month is Rs. 54,000.  In the estate sector, which is in the lowest part of the income pyramid, it is about Rs. 34,000. On average in Sri Lanka, food expenditure is Rs. 19,140 per month and even in the estate sector, it is at Rs. 16,890. This is according to data for the year 2016. Bearing this in mind, if we add 5% inflation every year, the expenditure must be significantly higher today.    

It is painfully obvious that an allowance of Rs. 5,000 is not at all adequate for a month’s expenditure. However, in defence of the Government, it was communicated that the Rs. 5,000 was not a stipend and is adequate for a month as a supplement for people whose livelihoods are affected. The Government reiterated that this was a form of financial assistance to help them keep their nose afloat in these trying times. It is no secret that the Government is running a massive budget deficit to the extent of 8.9% of GDP in 2021. Therefore, providing Rs.5,000 is also a challenging task, given the strained and limited financial resources. 

This points to just one conclusion; that nobody but poverty is to be blamed for the current circumstances. Sadly, as a country, we are in denial of this fact.   

Let’s look one step further. Our inability to tackle poverty is our own doing. We have failed over and over again, from one successive government to another, to set our fundamentals in the right direction. Unfortunately, we still continue to drift ignorantly in the same wrong direction.  

Sri Lanka’s workforce is highly state-dependent and the island’s massive inclination towards a welfare state is far beyond our affordability or financial capacity. Politicians promise long lists of free supplies from fertiliser to sanitary napkins and to even jobs in the government sector. It is a vicious cycle of politicians cheating people and people cheating themselves, owing to their enormous reliance on the State. This unsustainable codependency has today shoved the island to one of its worst economic calamities since independence.

Starvation-driven crowds protest in the streets of Colombo requesting for more money. The Government is struggling to make repayments to our external creditors; $ 4 billion on average over the next four years. Our reserves stand at $ 5 billion in total with the Government still running a significant trade deficit.

Why is the cost of living high?

Our cost of living has always been a much-discussed topic over the decades. The real reason why it’s high is because we are very unproductive as a country. Despite low labour costs, our production tends to be expensive and unproductive. We spend about 20-50% more than the average price on some essential goods. In certain product categories, it goes beyond 100%, which is almost double. Our products are not competitive on a global scale. Consecutive governments have failed at making reforms that are required to make them competitive. Our tax structure is 80% indirect tax and 20% direct tax, where most of the basics, including food items, are subjected to a tariff. That is one reason why most of the gazette notifications which are released are on tariff revisions. When this happens, every government becomes the victim of their own policies when the cost of living starts rising.  

 We often look at increasing local production but fail to consider improving local manufacturing and competitiveness. Global benchmarks are forgotten. We continue to ignore the consumer. As a result, higher incomes become meaningless in Sri Lanka as our quality of life continues to deteriorate. For example, even if you have a vehicle, it is difficult to commute and if you are in business, there are way too many interventions and bureaucracy. If you use the courts as a means of conflict resolution, the matter takes decades to be resolved. Thus, we don’t really meet the basic requirements for a satisfying quality of life or ease of doing business. 

Solution

There is only one solution – hard reforms to make Sri Lanka’s products competitive. We can make products competitive through competition. We can compete and be competitive only if we increase productivity. Darwin’s theory of evolution that only the fittest survive is still very much valid. The problem is that we have failed to grasp the reality that we must evolve with the changing times.

If we continue to disregard the need to evolve our fate, it will be catastrophic and a payday where we feel that Rs. 5,000 is actually worth Rs. 5,000 will be a distant dream. If the hard reforms are not prioritised and pushed through, all Sri Lankans will live forever in that week before payday, just like that nice gentleman who cleans and repairs my roof. 

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.

Budget 2021 : Ignoring the elephant in Parliament

Originally appeared on The Morning

By Dhananath Fernando

Doesn’t the ‘pandemic budget’ have to be about the pandemic?

When I was an undergraduate, I used to borrow lecture notes from my senior batchmates to study for exams. As I was engaged in many other extracurricular activities, including in the students’ council, I often missed lectures and used to self-study with the assistance of my friends. In local universities, there is a collaborative learning session called “kuppiya” and this was my main source of learning. For one course unit, I borrowed lecture notes from a senior batchmate and got his assistance, and sat for the exam.

During the exam, I realised that most of the questions asked in the paper had not been in my notes and I hardly knew any answers, especially for the main sections of the question paper.  At first, I thought I had been given the wrong exam paper by mistake. Then I thought it was a mistake by the examiner and that it must be the same for all my batchmates. After the exam, when I inquired from my friends as to why the questions in the exam paper were not covered in the lecture notes, I realised that the notes that I had been referring to from my senior batchmate was prior to a syllabus revision. The exam paper that I wrote had been set for the new syllabus. Sometimes we miss the obvious facts.

I was reminded of this incident from years ago when I was evaluating the Budget 2021, which was presented to Parliament last week. Have we ignored the big elephant in the room: The fact that we are navigating our way through a Covid-19 world? That we are passing through an unprecedented time locally and globally? To what extent does our budget address and cater to the new normal is a matter for discussion.

Presenting a budget when a global pandemic ravages our economies and societies is undoubtedly a challenging task. I would like to congratulate the Government and the Minister of Finance for all the hard work put into the proposed budget. However, as with any policy proposal or annual budget, there will be praise and criticism.

Relating the budget to the new normal COVID-19

A big component the Budget 2021 lacked was its compatibility with the Covid-19 pandemic at hand. The obvious expectation was to know how we are to sustain operations in the country at its full capacity until we get access to the much-anticipated vaccine. The second expectation was on the financial allocation for PCR testing, contact tracing, and preparation to purchase the vaccine, as well as the distribution of it to our Sri Lankans citizens. According to global news stories on vaccines, it looks like the pandemic is going to continue till at least early 2021.

Furthermore, the main vaccine manufacturing pharma companies have revealed that the current vaccines have to be stored at low temperatures. Therefore, it is vital that we have resources such as refrigerators and necessary equipment when the vaccine is ready. Otherwise, it is likely that the process gets delayed. Sri Lanka already has refrigerators and cold storage bottlenecks. This is one main reason why we can’t store perishable food items from farmers to the consumer.

This is evident in the recent stories we heard of how farmers had to throw away unsold harvest and how consumers complain about higher prices at the same time. In addition, we need a strategy to prioritise testing, vaccine distribution, and meet our ever-growing healthcare needs at hand.

Fiscal consolidation and market-based solutions

One positive in the Budget 2021 is there are no grand-scale expenditure schemes such as salary hikes or special allowances. However, it is obvious that even if our budget deficit is expected to be at 8.9% of GDP in 2021, the Government does not have the spending space or borrowing power. In such a situation, the ideal option is to go for market-based solutions and allow the market to come up with solutions organically, rather than the Government trying to intervene, which in turn would make things more inefficient and complicated. That is one reason this column highlighted the Budget 2021 as a golden opportunity for reforms. 

These reforms are essential to make markets operate and make them competitive so that productivity will be higher and the waste will be lower. Cutting regulatory barriers and market entry barriers have to be the main focus when we don’t have deep pockets to spend money. That was a key promise made by His Excellency the President during his Independence Day speech on 4 February 2020.

Priority should have been given to how the country is going to settle its external debt. A clear methodology and plan to ensure debt sustainability too should have been pronounced. This would have provided markets with positive signals. Whether we have received any assistance from our neighbouring countries or how our strategy is expected to produce the expected results should ideally have been made. A clear statement on this would have cleared many doubts from markets.

The overall macroeconomic numbers the Government expects to achieve – such as price stability of 5%, a debt-to-GDP ratio of 70%, and reducing the budget deficit to 4% from the expected 9% – are in the right direction. How the Government is to achieve this in the midst of a global pandemic with its same old strategies, however, remains a mystery.

According to budget promises tracking by Verite Research (www.budgetpromises.org), only 29% of the promises in the Budget 2019 have been fulfilled, while most of it remains unsolicited and 8% have been broken. This is not different from previous budgets, as most have been wish lists without a detailed strategy and in-depth thought, making implementation difficult.

Whether we have done the right contextualisation of the Budget 2021 with Covid-19 in mind is my main concern. Effective implementation of budget proposals will depend on how they are streamlined to meet the demands of the new normal. My wish is that when the budget proposals meet the unavoidable challenges of these extraordinary times, the Government won’t be rudely surprised as I was in learning the syllabus I revised was outdated.

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 needs systems, not people

Originally appeared on The Morning

By Dhananath Fernando

Time to stop looking for heroes or magicians, and start looking for systems

The first time I saw a vending machine as a little boy I was awestruck. I insert coins and pick the product I want to consume and the machine automatically serves it! I had a thousand questions as to how it operated. First I thought there must be a man inside the machine who sees what I order and counts the money and serves me from behind the machine. I was confused as to how the machine identifies the value of the coin and notes; as a kid, I myself got the values of the coins mixed up. Since both the products and coins are together, what if someone steals the entire machine at night? How do they refill the bottles and how do they collect the cash? All sorts of questions were crossing my mind.

Later on, I realised there is a proper system established to run the vending machine with precision, like clockwork. In other words, there is a system in place to run a system. Today, when I see a vending machine I am not surprised. I am only surprised as to why it is not commonly available in Sri Lanka.

If I compare Sri Lanka to a vending machine, most often we place a human behind the machine instead of “setting a system” to run the “system”. Then, we fail miserably and wonder where we got things messed up. As a result, we fall back to square one and point fingers at each other and pass the responsibility to former politicians who have been in office and sometimes the blame game ends with the common citizen being the culprit when things go really wrong. Often we tell ourselves at crowded places: “Why can’t people just stay in the line?” without understanding that people don’t stay in the line not because they don’t like staying in line, but because of the absence of a token queue system.  

Many political scientists interpreted the mandate received by His Excellency the President as a mandate for a “system change”; to set up processes and procedures to ensure things operate smoothly and conveniently without any interruptions and delays. One common mistake we often make is just trying to establish a “system” without setting up a “system to set up the system”. It is the same as placing a man behind a vending machine instead of automating it.

Over the years, we have tried to set up the “system” just by using muscle power and brute force or relying on the negotiation skills and the influence of those with close political connections, rather than setting up institutions to ensure checks and balances. As a result, unsurprisingly, none of the systems have proven sustainable nor have they delivered the expected results. It has only given us hit-or-miss results, sometimes positive but mostly negative.

A good case study for the above would be the containment of the Covid-19 pandemic. Sri Lanka outperformed the rest of the world in its first phase. However, we have drastically lost our grip and the momentum we previously had in this second wave of the virus which is much larger in scale. When the cases were limited and numbers were small, it was at a scale where people’s skills were able to manage it with somewhat strict mobility controls.

However, we did not have the systems in place to face a pandemic on a larger scale and to study it scientifically and increase testing capacity. We diverted our focus and could not reduce the lead time for testing and increase accessibility. We did not have the institutions and mechanisms to collectively enforce guidelines to overcome a health crisis and as a result, we have to depend on our muscle power by transferring most of the responsibilities to our respected tri-forces and the Sri Lanka Police. Even after the first round experience of a Covid-19 cluster at the Sri Lanka Navy, we couldn’t avoid a second cluster in the Sri Lanka Police which was at the forefront of the Covid-19 battle according to the structure of containment.

Simply, we did not have “systems” to “set up systems” and throughout, the attempt was to “set up systems” by appointing people we believe are trustworthy and competent. Of course, appointing trustworthy skilful humans is a main element of a system transformation, but the mandate of the trustworthy people has to be to “set up a system” to “run the system” instead of just setting up the system to react based on the incidents taking place.

When it comes to business and investment, things are no different. One main challenge faced by most Sri Lankan entrepreneurs when they enter joint ventures with overseas companies is that the foreign company requests 51% of the shares. The reason is, if there is a legal dispute, being a minority shareholder, the investment would not be worthwhile due to the time and money they have to spend to resolve the case in Sri Lanka’s notoriously slow legal system. The first step to fixing the judiciary system is to have a system to set up systems and fix systems. It has to start from the top to the bottom, covering all aspects of the system.

Another common mistake in attempting to set up systems is trying to fix one system at a time. Though it looks practical, a governance system even in a small country like Sri Lanka is very complicated. Taking one problem at a time works in some cases but in this case when you take one case at a time the other systems mount an opposition to this and bring down the system that we try to fix. That is why we need rapid reform across all sectors of the governance system, setting up high-level institutions to “set the system” right.

Setting up systems starts from institutions. Those institutions should function independently, transparently, and democratically while ensuring equal opportunity to everybody. Institutions should be open and accessible to all sorts of ideas on a selected issue before they reach the decision-making level. Checks and balances have to be ensured. That is how we understand all sides of the problem and reduce the margin of error in our decision-making process in public policy.

People who establish systems should be able to see the broader picture and matters from a holistic approach. For example, from the perspective of prioritising healthcare, extending the lockdown for a few more weeks makes sense as it would help contain the virus to an extent. However, this would be at the expense of the growth of our already hampered economy. In a complex world, everything is interconnected and system changes need to take a look at an overall view, with a sound 360-degree understanding of the story.

As this author has been saying even before the Covid-19 pandemic, a system change is not going to make leaders popular. In fact, it will make them unpopular in the short run. However, over time, gradual successes will pave the path for them to become legends.

Setting up systems is an art like many other subjects. It is a rare art which requires knowledge in diverse fields and management skills to implement it. Sri Lanka is at a crossroads with an opportunity to revamp the “systems” and “set up a system” to “set up systems”. Only time will tell whether we capitalised on it, or in simpler terms, whether we placed a man behind the vending machine or whether we automated it.

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.

Daniel Alphonsus : A Crises Manifesto: Exorcising Hunger, Unemployment and Debt

Originally appeared on Echelon

By Daniel Alphonsus

An unprecedented crisis can only be met with comprehensive and deep reform. Bandages and tinctures will not do.

There are crises and there are crises. But the truly momentous calamities, those that set the stage for the decades that follow are few and far between. Surveying 20th century Sri Lankan history, two such events stand out – the Great Depression and the rice-queues of the 1970s. Those traumatic experiences dictated economy policy for the decades that followed. In the case of the Great Depression, rapid reductions in commodity prices, combined with a global credit crunch, ravaged Sri Lanka’s undiversified plantation economy. A consensus emerged for reducing Sri Lanka’s dependence on international markets.

The Ceylon Banking Commission report of 1934, in many ways the premier pre-independence analysis of Sri Lanka’s economy, observed, “Never before was the vulnerability of the economic structure of Ceylon more forcibly revealed than during this period. The three major products, namely, tea, rubber, and coconut, which between them account for over 90% of the wealth of the country, suffered seriously during the depression. The creed of economic self-sufficiency which became an article of faith in the economic policies of other countries spread to Ceylon as well.” Inspired by war-time planning and the Soviet command economy’s success in industrializing Russia, there was also widespread agreement that in the newly independent third world, governments, not firms, would be the motor of this historic transformation from global dependence to national independence.

Exhilaration soon gave way to enervation. The failure of import-substitution and appalling government record of running enterprises – including the critical plantation sector – paved the way for the open market reforms of 1977. The desperation was palpable. On election platforms, Sirima Bandaranaike accused J.R. Jayawardene of being in bed with the Americans, thinking that would dissuade voters from supporting him. But the ploy boomeranged. Voters, who just two or three decades ago were Asia’s second richest but now had to wait in queues for rice, voted with their stomachs. Their reasoning was simple, if J.R. is in bed with the Americans, then he will be able to secure relief from them.

Despite a quarter-century of the open market model coming to a sudden and unexpected halt in 2004, economically speaking, we are still the children of the 1977 revolution. This year may mark the twilight of that epoch, or at the very least a new chapter.

For Sri Lanka is facing an unprecedented economic crisis. It is a crisis of four tempests, whose sum is a raging storm that threatens to engulf the entire island in its dark thunderous deluge. They are:

1. Coronavirus: the global and domestic combined supply and demand shocks caused by the Coronavirus.

2. Original Sin: borrowing liberally from international capital markets in foreign currency, at high-interest rates and with low maturities for low-productivity construction and import consumption.

3. Negative Growth Shocks: the economic slowdown caused by floods, droughts, the constitutional coup and Easter Bombings.

4. Stalled Reform: with the exception of the new Inland Revenue Act, the failure to carry through any serious structural reform since 2004 has seen real growth fall.

As a result, we may be on the verge of Sri Lanka’s first sovereign default since Independence. Prior to the pandemic, though the trajectory was grim, there was still hope of avoiding that catastrophe. That hope is now waning fast. The origins of this crisis lie in the early years of this millennium. In 2004, the quarter-century long bipartisan consensus for reform stalled. In many cases – such as tariffs and privatizations – reform reversed. Due to time-lags the reforms of the late 90s and early 2000s continued to bear fruit for some years. But by the turn of the millennium, high-interest dollar debt increasingly became growth’s chief hand-maiden.

Post-2007 commercial borrowings from international capital markets rose rapidly from almost zero. This fueled a construction and consumption boom soon after the war’s end in 2009. Project loans were spent on empty airports and useless towers. Sovereign Bonds were issued to bridge the government’s ballooning budget deficit; caused by an unprecedently massive and swift expansion of the public sector.

Over the last few years, supported by an IMF programme, the government worked hard to reduce Sri Lanka’s debt-burden and dependence on international capital markets. Sri Lanka ran a non-trivial primary surplus for the first time in 2017, repeating that success in 2018 and upto November 2019 despite the coup and the Easter Bombing. But this alone was not enough.

In reality, the value of public debt rarely declines. What matters is reducing public debt relative to the size of public repayment capacity. In its simplest form, it’s about reducing the value of this equation:

This can be done in two ways. Reducing the value of the numerator, “Public Debt”. Or by increasing the value of the denominator, “Annual GDP”. In the last few years, Sri Lanka adopted a ‘fiscal consolidation’ approach which rightly attacked the numerator. But coalition dynamics and time-lags thwarted progress on the denominator, growth, which is more important. The new government reversed course significantly loosening fiscal policy. It implemented a sweeping range of tax cuts which drastically reduced government revenue. In the language of our equation, these tax-cuts increased the numerator. The wager – to describe the strategy charitably – was that rising public debt would be off-set by an even faster surge in GDP growth, thus reducing the relative value of public debt. That plan has clearly failed. Today, public debt is touching 95% of GDP. The true value, when one calculates all liabilities such as Treasury guarantees for invoices, is likely much higher.

As a result, markets seem to think Sri Lanka is at risk of defaulting for the first time in its history. Bond yields are in the double digits. Among emerging markets, only Argentina, Zambia and Lebanon have higher risk premiums on their debt. A default will be a further blow to an economy that has been ravaged by floods, coups, the Easter Bombings and COVID. The country will be shut off from international capital markets. It will not be able to finance the budget deficit. Inflation unless government spending is cut. Taken together, they could well lead us into an Argentine, Lebanese or Greek-style vicious cycle of default and political instability. An unprecedented crisis can only be met with comprehensive and deep reform. Bandages and tinctures will not do. As Italy has shown neither will attacking the numerator alone: decades of focusing on primary surpluses without structural reforms have only resulted in stagnation. Rather we need the second-round of 1977 type reforms that served Sri Lanka so well. There are many ways of thinking about such a reform programme. However, as the catalyst this time is likely to be a sovereign default, it is easier to label reforms as either an “attack on the numerator” or an “attack on the denominator”.

Attacking the Numerator: Reducing Debt

Reducing public debt – ‘attacking the numerator’ – can be done in three ways. First, increasing taxes. Second, reducing expenditure. Third, selling assets. Sri Lanka will probably have to do all three.

Increasing Taxes: Property Taxes and Tax Loopholes

 It is well known that Sri Lanka has one of the lowest tax-to-GDP ratios in the world and has a regressive tax system. This year Sri Lanka’s tax-to-GDP ratio could rank among the lowest 15 countries in the world. However, in the midst of economic contraction raising taxes that reduce consumption and investment could catalyze growth shocks. One solution would be to tax savings, especially those savings that are not productive. The biggest example of such savings is land ownership. A Western Province property tax could raise substantial revenue and encourage efficient use of idle property. In the last decade property prices in Colombo rose by 300%, much of this windfall is the direct result of public infrastructure spending. Our tax system also has many loopholes. Consider the case of excise taxes on cigarettes. Estimates suggest the government could prevent over two hundred billion rupees of revenue leakage over the next decade by introducing a formula for cigarette prices. Similarly, the duty on beedi clearly points to political rather than economic considerations in excise taxation.

Reducing Expenditure: Too Many Men

Sri Lanka has a bloated public sector. From a revenue, productivity and ultimately security viewpoint the large size of the military is a challenge. Around 40% of government salary expenditure is spent on the military. The military, nearing 280 thousand men (compared to the British Army’s approximately 100,000), is holding back our most able men from productive employment. Transferring most of these men to reserves and offering subsidized labour to the export industry through an apprenticeship scheme would substantially improve public finance and propel growth. A similar story of job growth can be found in the public sector.

Selling Assets: Sell Enterprises

The government is poor at managing businesses. State-owned enterprises are renowned for their mismanagement, waste and corruption. The direct cost is colossal. But the indirect costs are even greater. Despite competition from Ports Authority run terminals, SAGT and China Merchant Holdings have played a key role in making Colombo one of the world’s great ports. Imagine if airports and air-services had been similarly open to competition and private enterprise; Sri Lanka could have become an aviation and air-sea hub, as well as a shipping-hub. There are countless other examples throughout our economy.

At this stage of economic development, there is little reason for the state to run enterprises. In fact, the state can increase the value of the assets it owns by selling enterprises without selling land per se. For example, state-owned hotels, container terminals and air terminals could be privatized without selling the land on which they operate. In other words, privatize the enterprises, not their land-holdings. The tax-payer would be significantly better off as the privatization proceeds can be used to settle debt. In addition lease values, for the land, will rise and the land-value will appreciate faster too.

From a productivity point of view, key targets for privatization could be Sri Lankan Airlines, Ratmalana Airport, Jaya Container Terminal and Unity Container Terminal. One simple method of doing this would be to place all SOEs operating in competitive industries in a holding company that has an explicit mandate to sell them within a set time-frame, failing which they are automatically listed on the Colombo Stock Exchange.

Attacking the Denominator: Productivity Growth

There is only one tried and tested way of going from third world to first in the space of a few decades: manufacturing exports. Sri Lanka successfully completed the first step of this process by the 1980s when it established apparel exports industry, which remains Sri Lanka’s only manufacturing export. In 1983, Sri Lanka was about to move up the value chain to semi-conductors, which would have led to South-East Asian and East Asian style growth. But Black July was engineered, and the semiconductor plants being built in Katunayake by Motorola and Harris Corporation were shipped-off to Penang. Similarly, we missed the wave of Japanese investment that was about to begin at that time.

Since then Sri Lanka hasn’t developed a major manufactured export. The challenge for Sri Lanka is to create new higher-productivity export industries. This is a complex task requiring government effort. But Sri Lanka has done it before. The tested strategy of the 1977 revolution is as follows. First, create investment zones where the usual constraints affecting investment can be managed. That is the genius of the Free Trade Zones. Second, make Sri Lanka’s exports competitive: reduce tariffs (a tax on imports is a tax on exports) and sign Free-Trade Agreements. Third, enable efficient factor allocation: remove regulatory constraints on agricultural production and update labour laws. Fourth, unleash the power of the developmental state by fast-tracking the MCC grant, designing clever export subsidies and most importantly completing land reform.

Investment Oases

The engines of Sri Lanka’s manufacturing exports are the Free Trade Zones. It is here that the apparel industry started. It is also the zones that were the cradle for the island’s solid-tyre export industry and they remain the primary site of all other manufactured exports. The reason for this is that zones make it much easier for an investor to open a factory. Land, electricity and water are available; regulatory permissions are already secured; customs officers and other government agencies are on hand. Over time an eco-system of trained labour and ancillary suppliers also develops. Despite being near capacity, Sri Lanka failed to build any new free trade zones between 2002 and 2017. So its no surprise to hear investors complain that access to land is the primary constraint for investment.

Almost all of Sri Lanka’s Free Trade Zones are managed by the BOI. One exception is the DFCC Bank run Linden Industrial Zone. The BOI run model worked well and was competitive in the 1980s. Today the world has moved on. In order to attract new investors in sectors outside apparel, Sri Lanka needs to allow international zone operators. For example, Sri Lanka should court a Chinese free trade zone operator, a Japanese free trade zone operator and a Singaporean one to establish facilities in Sri Lanka. These zone operators will then leverage the relationships they have with manufacturers in their countries and regions, doing the job successive governments have failed to do since the late 1980s.

The energies of Sri Lanka’s own private sector could also be unleashed in zone-management. MAS and Brandix run successful textile parks in Sri Lanka and India. There is no reason they couldn’t successfully run a zone in Sri Lanka. The failure is not the central government’s alone. As far as I know, no other province has done what the Wayamba Provincial Council did within a couple of years of the formation of a provincial government: establish not one but two province run industrial zones, at Heraliyawala and Dangaspitiya respectively. The Northern Province with its devolutionary fervour, combined with access to the KKS Port and Palaly Airport, should be particularly ashamed.

A pilot project could deploy under-utilized state land around Ratmalana to create an electronics free-trade zone. There is no better place in Sri Lanka due to proximity to a port, railway and airport, universities and technical schools and trained labour.

Export Competitiveness

But no one will build factories in Sri Lanka if input costs are high. In this era of global supply chains, one country rarely adds more than 20% to 30% of a product’s final value. Therefore, being able to import components and raw materials at the same prices as in competitor countries is vital. However, Sri Lanka has some of the highest effective tariff rates in the world. To make matters worse they are highly complex, creating ample room for discretion and thus delays and corruption. If Sri Lanka is to become the trading and manufacturing hub of the Indian Ocean, it will have to benchmark its tariffs against Dubai and Singapore. This is not new to Sri Lanka. In 1994 it has a simple three-band tariff structure. It is only after 2004 that Sri Lanka’s effective tariff rate sky-rocketed, primarily due to the cascading effects of CESS and PAL. Their abolition would be a very good start.

Similarly, during the 1977-2004 Sri Lanka’s real effective exchange rate was kept more or less constant. A weaker currency makes foreign goods dearer domestically and makes Sri Lankan goods cheaper on global markets. This helped ensure the competitiveness of exports and acted as an automatic, non-discretionary import substitution incentive. However, from 2004 onward the real effective exchange rate started creeping upwards, discouraging exports and encouraging imports. By 2017 Sri Lanka’s real effective exchange rate was 31% higher than in 2004.

Finally, Sri Lanka’s competitiveness is eroding because all its competitors are signing free trade agreements (FTAs). Sri Lanka must fast-track deeper goods and service trade integration with India, China and ASEAN. Most importantly, we need to become part of the two-major trade agreements the CPP11 and the RCEP. The constraints of space and time, robbed of the opportunity to discuss the importance of a new Customs Act, the implementation of the National Export Strategy or other reforms to facilitate cross-border trade. Suffice to say they too are essential.

Efficient Factor Allocation

Land, labour, capital; it is the development and allocation of these factors that determines the wealth of nations. Sri Lanka’s capital allocation is relatively efficient. Our challenge today is to ensure the efficient allocation of land and labour.

Land

Many cite East Asia’s successful land reform as the key to their economic prosperity. Studwell’s How Asia Works is perhaps the most persuasive and readable account. There is much to commend in this analysis. Granting freehold land to families already farming it will increase agricultural productivity. This is true of Sri Lanka too. One critical land reform, that can be implemented quickly, will be to make small-holders of the existing tea-estate workers. This will improve productivity, as the principal-agent problem will be solved. In addition, with freehold rights, they will have every incentive to replant and improve the land. Access to credit will not be an issue; the land itself will act as collateral.

As for the RPCs, the factories and land equal to the value of their remaining leaseterm can be transferred to them freehold. They can then offer extension services and an out-grower model to the new small-holders. In a similar vein, there is absolutely no good reason for the continuation of the Paddy Lands Act, especially in the wet-zone. In fact, some of the land in the wet-zone restricted by the Paddy Lands Act was never paddy land in the first place. This law is a major barrier to more productive use of land for high-value export crops, such as spices.

Having got land out of the way, we can move on to labour. Sri Lanka’s labour laws have created a de facto caste system of a few highly protected insiders and a sea of completely unprotected informal workers. In fact, the failure to make labour law more flexible is an important reason why over a million Sri Lankans work in the hazardous conditions of the Gulf. It is better to have some protection for many, than a great deal of protection for a few. Especially as labour law is a major constraint to growth. The downsides of more flexible labour laws can be effectively managed through a targeted social security net, such as in the Danish Flexisecurity model, which combines high levels of labour market flexibility with generous social safety nets, such as solid unemployment insurance.

The Developmental State

Finally, Sri Lanka needs to restructure its state to facilitate rather than hamper development. The first is a question of a simply accepting reality. What credibility does a country have when it refuses the largest grant in its history (MCC), while going-cap in hand asking for debt moratoria from its creditors?

Second, the state-owned enterprises in natural monopoly sectors, such as railways and power-lines need to be depoliticized and forced to be efficient. Depoliticization can be significantly achieved by simply passing a new law. The law can require that the appointment of directors of all State-Owned Enterprises be subject to the approval of a Constitutional Council appointed nominating board, with clear ‘fit-and-proper’ criteria. A similar mechanism is already in place for banks.

Furthermore, efficiency can be improved by introducing competition, resolving conflicts-of-interest and raising transparency. Sri Lanka’s competition law does not cover state-owned-enterprises: this allows public sector monopolies to enjoy rents at the expense of citizens. That needs to go. It is also absurd, for example, that the Sri Lanka Ports Authority is owner, operator and regulator of port terminals. The public sector is rife with such conflicts-of-interest which appear designed to breed corruption and mismanagement.

These are the key changes, but information matters too. As they are owned by the tax-payer, SOEs should have greater disclosure requirements than firms listed on the Colombo Stock Exchange. But a start would be to simply require SOEs to follow all CSE disclosure requirements, this can be done by law or by requiring SOEs to list their debt on the CSE. Or both.

There are also government departments that need to be made into SOEs. The railways are the most important example. If the railways were able to borrow money, which they could if they were an SOE, they could then finance the electrification and double-tracking through the development of land the CGR owns around railway stations.

Way Forward

The real economic policy statements in Sri Lanka are not budgets but IMF programmes. Budgets are often nothing more than promises of bread and the certainty of circuses. They bear little reality to actual revenue and expenditure, much the less actual economic management. As such the crescendo of this crisis, and thus opportunity, will be the inevitable IMF programme. It is almost certain that Sri Lanka will enter into its 17th IMF programme later this year or early in 2021. Sri Lanka has been in IMF devil-dances for much of its post-independence history. We have failed to undertake the reforms needed to grow and to protect our sovereignty. The IMF kapuralas have also failed to require front-loading reforms: allowing Sri Lanka to get away with cosmetic compliance rather than really restructuring the economy.

With COVID, the IMF is also overextended; perversely this improves its bargaining position. As a result, this programme can be a water-shed that combines both fiscal consolidation and export-driven productivity growth. It must be a landmark programme with a single objective: to be the last programme the IMF has with Sri Lanka. Then, as in 1977, Sri Lanka may just pull-off a Phoenix-like rise from the ashes. If not, then the demons of hunger, unemployment and debt-collectors will follow.

(Daniel Alphonsus was an advisor at Sri Lanka’s Finance Ministry. He also worked at Sri Lanka’s Foreign Ministry and at Verite Research. Daniel read philosophy, politics and economics at Balliol College, Oxford and public policy at the Harvard Kennedy School where he was a Fulbright Scholar.)

Forget the White House, get our house in order

Originally appeared on The Morning

By Dhananath Fernando

Pointless discussing ‘Biden effect’ on SL without fixing our economy’s structural issues

It was shortly after my graduation. I was shortlisted for an interview and was close to being late for it. I reached the office and got into the elevator when I saw a gentleman running to catch the same elevator. As I was running late, I pretended not to have seen him and allowed the doors to close. I made it to the interview just on time but as I entered the Board Room I was told that one interviewer hadn’t arrived yet. After a few minutes, the gentleman whom I had left behind downstairs filled the main interviewer’s chair. As he introduced himself, he jokingly said: “I couldn’t catch the elevator with you – if I did, we could have had a real elevator pitch. So, what’s your pitch for us?”
With that question, I realised that punctuality is important but punctuality is important not for the sake of being punctual! Punctuality is a sign of respect and value for other people, and it is these human connections that matter. Courtesy and manners are pretty much a reflection of who you really are. Transactions are not just transactions. It is an exchange between people who connect, respect each other, and do business. This incident comes to mind when I think of the many opinions that have been expressed on the impact of the US presidential elections on Sri Lanka. This is because the image of respect and courtesy still matters, especially in terms of relationships between countries.

Many people see diplomatic relations almost as something imagined, intangible, theoretical, and conceptual. But in the real world, diplomatic relations are all about human connections. It’s people who trade with each other and not countries. It’s people who draft policies and make decisions and not countries. The impact of the US presidential elections has to be viewed in this context backed by a sound understanding of the country’s economic affairs.

Sri Lanka has made headlines across international media for our strategic location and the resultant geopolitical value to both the US and China. Recent visits by high-level delegations from both these nations have further highlighted this importance. This has led to various opinions being floated around about the impact of a Republican or Democratic win on Sri Lanka.

US elections are pivotal not only for Sri Lanka but for the entire world. This impact can be seen in how global financial markets fluctuate based on US political developments and how countries make strategic plans, long or short term, based on the policies of the US administration. For Sri Lanka, this time, the results of the US elections are much more significant, especially due to the current geopolitical arm wrestling in the Indian Ocean region.

Economics and geopolitics are strongly interconnected, and Sri Lanka is no exception to this rule. However, before we analyse the effects of the US election on Sri Lanka we need to understand the interests that all nations have in the Indian Ocean region and observe their current geopolitical alignments.

Currently Japan, India, the US, and Australia – referred to as The Quad – have established strong economic and military ties with each other. Sri Lanka’s significance comes into the picture as our geographic location is at a peripheral level where it can directly affect India’s trade and defence activities and their presence in the Indian Ocean. The US for that matter also has a long-term strategy for the entire Indo-Pacific region.  So regardless of which US President is at the helm, it is most likely that the Indo-Pacific strategy will continue. Their main interest seems to be ensuring supply chain security and protecting the freedom of navigation within the Indian Ocean.

From Sri Lanka’s point of view, one main factor that we should focus on is our ability to trade and gain access to international markets. The US is the destination of about 25% of our exports, of which a significant proportion is in apparel products. We also export tea to the Middle East where the US has significant diplomatic clout and where US policy decisions tend to directly affect global oil prices, affecting countries such ours. Another 15% of our exports are purchased by the European Union (EU) which also represents the western bloc. For Sri Lanka, the continuation of the EU’s Generalised Scheme of Preferences Plus (GSP+) tariff concession is of paramount importance.

The second factor is the relationship the US has with China which will affect Sri Lanka on trade and investment. Already, the Port City and the Hambantota Port and economic zone are major Chinese investments and the policy direction taken by the office of the US president on these matters can have a significant impact on the island.

Donald Trump’s protectionist policies, “America First” to be precise, and the US-China trade war has affected global trade to a great extent. When it came to the region, his relationship with India was his priority. A second Donald Trump term would mean that much stricter policies against China will be implemented. This is because he would no longer be shackled by the impact on his voters or the economy from the retaliatory trade measures by China. Simultaneously, under a Joe Biden presidency, there is greater room for China to be held accountable for alleged human rights violations.

A Biden presidency would not really shift away from a hard policy stance on China, especially because Trump’s overall stance on China enjoyed bipartisan support in the US, even if some of his methods and measures came in for criticism. There may be relaxations in the trade war, but it would be hard to expect a significant policy shift, especially considering the nature of global geopolitics. This must be considered when looking at our foreign relationships because managing this complicated relationship has a direct impact on  Sri Lanka retaining concessions such as GSP+. We must be able to diplomatically negotiate our way through opposing geopolitical partners. Diplomacy must be used to secure our trade-related activities regardless of who becomes the President of the US.

Once again, it is important to remember that the US foreign policy has a long-term strategy for the Indo-Pacific region. Therefore, a change at the Oval Office can have an impact on the foreign policy direction taken by the US. However, it is very unlikely that the US will take a complete “U” turn in most policy matters.  

It is about time Sri Lanka took an interest in diversifying its export markets to Asia and increasing its exports. At the moment, we have placed too many eggs in one basket. We are almost wholly dependent on the western bloc for our export revenue. We need to maintain a good relationship with China as the ability to import at reasonable prices from China is what helps us export to western markets at competitive prices.

Challenges faced by Sri Lanka, such as our extremely poor economic competitiveness, cannot be ignored and have little to do with external factors such as who takes the presidency of the US. Our policymakers have to make our economy better by having an export-oriented, free exchange culture. Like what happened at my interview, it is human connections and how good and open for trade we are that matters. Other factors matter, but the impact of outside matters are based on how good or bad we are in our economic and trade policy.

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.