Reform or perish

Originally appeared on The Morning.

By Dhananath Fernando

A Staff-Level Agreement (SLA) with the International Monetary Fund (IMF) is a positive indicator of things to come. However, we still have a long journey to go and getting an SLA is just the beginning. 

We have negotiated with our creditors and have begun to implement reforms to stabilise the ship. We have to continue this trend and perform hard reforms to ensure our economy grows to a level where we can sustain it without resorting to borrowing.

In the status quo, I foresee a few scenarios that could happen with present political dynamics.

Scenario 1: Forming reform committees but not performing reforms

Sri Lankan policymakers’ solution for all problems is to set up a committee. There is a risk that we will do the same for reforms. Already, committees are being formed to take reforms forward, but reforms generally get sidelined or stuck in limbo. 

I recall many years ago there was a Cabinet Committee on Economic Management (CCEM), which was later replaced by the National Economic Council (NEC). Afterwards, the NEC was also dissolved and no economic reforms were taken forward. 

In the interim Budget, a new committee on SOE reforms and a few other pre-reform steps have been suggested. But the willingness to reform and the ability to execute is the most important aspect. If we leave a committee for reforms to its own devices, it will kill time while this crisis kills many of us.

Scenario 2: Some reforms are as good as no reforms 

There is a probability that a few reforms will be enacted. This is also a dangerous scenario. While in 1977 some reforms were implemented, labour market reforms and many other required reforms were not carried out. As a result, we failed to get the maximum benefit out of opening up the markets. 

Reforms in the 1990s were also not carried out in a holistic manner. Half-baked and half-hearted reforms will not rescue us from this crisis 

Scenario 3: Capitalising on low expectations but no real reforms

Another possible scenario is that policymakers and politicians will try to build their political capital based on a low-expectation environment. 

People’s expectations have fallen so low that a two-hour power cut has become accepted given the circumstances. A few hours staying in a fuel line has also become acceptable and even an achievement, despite us taking the ability to freely pump fuel for granted only a few months ago. The availability of LP gas has also become an achievement. 

Given this environment, politicians may try to just keep the basics supplied and settle for a new normal with very low expectations and build political capital until the election without enacting hard reforms. That will not only take Sri Lanka backwards, but we will move towards stagflation. Our youth will be less aspirational and the dream of a higher income country will fade away 

Scenario 4: Making reforms the entry gate for corruption 

While economic reforms are essential, since we haven’t seen any reforms on the political front, the same corrupt politicians may misuse this opportunity. 

Important reforms such as privatisation and Public-Private Partnerships will be passed with less transparency and no accountability to benefit the inner circle of corrupt politicians and with minimum benefit for poor taxpayers. This will dilute the public’s trust of reforms and create resistance against much-needed change. 

Scenario 5: Reforms that snowball 

This would be the best-case scenario, where we move proactively on a series of reforms to completely transform our economy. These reforms will not just halt after one wave.

Given dynamic economic and global conditions, reforms have to keep moving while keeping up with global changes, since otherwise the reforms that we do today will pose the same barriers for us a few years later. Sri Lanka needs to move towards reform and resetting itself in a holistic manner. 

Our aim has to be to create an economy where the 17th time becomes the last time in which we go to the IMF.  We need in-depth thinking to move fast. Simply making statements or addressing the audience based on current sentiments is not a solution; we need genuine willpower to get reforms done.

We have to capitalise on the IMF SLA and move forward with the rest of the reforms without delaying the process. The research has already been done and what needs to happen is very well known. It is just that we need to get our act together and move forward.

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.

Import controls: Regression when we really need reform

Originally appeared on The Morning.

By Dhananath Fernando

I recall a visit I made to a small eatery back in 2015, just a few weeks after the interim budget speech by the new Yahapalanaya Government. The eatery prepared hoppers, egg hoppers, and short-eats – this was just after the then Finance Minister, in his Budget speech, had announced price controls on hoppers at Rs. 10, egg hoppers at Rs. 25, and, if my memory serves me right, plain tea at Rs. 5 and Rs. 10 for milk tea.

When I asked for an egg hopper, the shopkeeper (‘mudalali’) said: “Sir, we are not selling egg hoppers. If you want, you can buy an egg here for Rs. 17 and give it to the chef and he will put the egg on a normal hopper, which is priced at Rs. 10, and you will get your egg hopper.” I was totally confused and I asked the shopkeeper: “What do you mean? Can’t you give the egg from your counter straight away and give me the final bill?”

He replied: “Sir, because of the price controls we can’t sell egg hoppers at profitable prices. An egg costs about Rs. 17-18. Coconut is also expensive, as are rice flour, wheat flour, and cooking gas, so we can’t sell egg hoppers at Rs. 25. So we sell eggs and hoppers separately.” I then followed his instructions and got the egg hopper prepared.

Generally when buying hoppers, chilli sambol, known as ‘lunu miris,’ comes complementary. I was waiting for ‘lunu miris,’ which did not arrive. I asked the shopkeeper: “Where is my lunu miris?” He replied: “How can we give lunu miris free when we sell hoppers at Rs. 10? You have to buy lunu miris separately by paying an extra Rs. 10.”

Price controls never work

The recently-imposed price controls on eggs will not make any difference to the same set of outcomes I observed about seven years ago. Sadly, Sri Lanka’s policymakers have not learnt their lesson – that price controls have never worked and will never work. Following the implementation of price controls on tea, tea shops will stop serving sugar and ask people to buy their sugar separately. 

If you recall, in the recent past there was a Government-controlled price for chicken. Meat shops at one point stopped selling whole chicken and instead only sold chicken parts. Thereafter, we had many price controls on rice, dhal, tinned fish, sugar, cement, and even on USD. Anyone who has a reasonable memory will remember that none of these price controls worked. 

At one point, there were price controls on pharmaceutical products despite the currency depreciating by 80%. How can a company import the same drugs and keep the same price, with the cost rising by 80% due to poor monetary policy? The only option available for pharma companies was to stop procuring those formulas. 

The same happened with milk powder. The consumer became the ultimate loser by suffering shortages in the market. There is a sentiment that private businesses hoard similar goods, which are stocked at lower prices, and sell only when the prices are increased. There may be some truth in it. As we all are aware, the private sector is also a reflection of our Government sector and policymakers, and the private sector has been given those opportunities when competition is not allowed and financial instability is not managed. But ultimately the common person loses on both ends – both through shortages and higher prices. 

The price control on eggs is going to impact the less-fortunate the most, since eggs are their main source of protein. They don’t require refrigeration and they are more affordable compared to the other protein options. The price of 500 g of fish is now Rs. 1,500-1,800. Chicken and other protein sources are also very expensive. Even dried fish and sprats are more expensive than eggs when calculated on a per meal basis and when accounting for overall convenience, effort, LP gas consumption, etc. 

So when price controls discourage suppliers from supplying eggs at that rate in an environment where chicken feed prices have gone up and prices of medicine for poultry and transportation have increased, price controls simply become meaningless and send a completely wrong signal to markets, while we are in the spotlight for an IMF programme and debt restructuring. 

Import controls a mistake

The Government made a similar, crucial mistake by announcing import controls on 300 selected HS codes as a measure to save our valuable dollars. We need to first remember that we have already cut down quite a lot of imports and we are really scraping the bottom of the barrel by restricting our fuel and some essential medicines. We have completely banned imports such as vehicles for more than two years now. 

Sri Lanka’s imports have been declining since the 1990s; policymakers should ask themselves: if import controls brought us to our darkest hour, how are the same import controls expected to save us from the crisis? Some import bans are on intermediary goods, and, as economic theory has shown around the world, with import restrictions, exports will also decline and Sri Lanka will become a net loser. We have to discourage imports through the pricing of dollars so imports will automatically come down with higher prices.

Import controls will also confuse markets and dilute the credibility of the Central Bank Governor. As he mentioned, we have adequate forex for essentials in the coming months. So the question arises: if we have enough forex, what is the purpose of import controls?

Secondly, both import controls and price controls, in my view, will have an impact on IMF negotiations at home. The Article IV IMF staff report clearly notes that we have to phase out import controls. Announcing import controls at a time when they are visiting Sri Lanka sends a negative signal to the IMF and to our creditors that Sri Lanka is not open to reforms.

Trade is a two-way street

Already the European Union and Japan have on multiple occasions indicated the importance of trade. In fact, the European Union stated: “Trade is a two-way street.” In this context, we are creating more resistance from our neighbouring countries at the brink of a very important debt restructuring and IMF programme. 

Both recent policy actions indicate to the world that we are just following the same old methods and are not open to serious market reforms. We will also not comply with some guidelines of the World Trade Organization with this decision, isolating ourselves globally at a time we need support the most.

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.

Debunking myths about reforms

Originally appeared on The Morning.

By Dhananath Fernando

As this column has highlighted many times, Sri Lanka is presently at a crossroads. Either we will excel and emerge as one of the dynamic tiger economies of Asia, or we will become a failed state, going from one crisis to another. There is simply no middle path between the two outcomes. 

So far in our history, we have missed the bus of economic reforms repeatedly. Our reforms of the late 1970s were half-hearted and necessary labour market reforms; other economic reforms haven’t been completed. Following this, we had a 30-year war and a short period of high growth post war. 

Recently, Prof. Premachandra Athukorala devised an interesting metaphor about Sri Lanka’s economy at Advocata’s #ReformNow conference on ‘Let’s Reset Sri Lanka’. He compared a sumo wrestler to a normal wrestler. 

Sumo wrestlers are big and heavy, whereas the normal wrestler is skinny and small-made in comparison. To the casual observer, it may look like the sumo wrestler is stronger than the normal wrestler, but in reality, the life expectancy of a sumo wrestler is about 20 years less than an average Japanese man. 

Prof. Athukorala compared the Sri Lankan economy’s high growth years to a sumo wrestler. Although the growth numbers were high, our economy has always been vulnerable – just one trigger can cause so many problems. 

As he very correctly mentioned, due to a few triggers such as the Easter attacks and Covid, we are going through a lot and will have to shoulder a great burden in the future. What we need to be, with regard to our economy, is a normal wrestler; one who is flexible, agile, and dynamic, with a high life expectancy and who can adjust easily to global trends and to challenging times. 

As we all know, change is difficult and resistance to reforms is inevitable. In many cases, it is untrue myths about reforms that drive this resistance.

Myth 1 – Privatisation would mean selling the family silver and our sovereignty 

A common myth against State-Owned Enterprise (SOE) reform is the rhetoric that it amounts to selling the family silver or selling off national assets. This is a popular argument in the vernacular.

We have to first identify most of our SOEs as loss-making; they are more of a liability than an asset. Secondly, being owned by the State doesn’t mean that they are owned by the people. If they are owned by the private sector, that is what you might call being owned by the people. 

Let’s take the Ceylon Petroleum Corporation (CPC) or SriLankan Airlines as examples. Both are owned by the Government of Sri Lanka. So where are the benefits for the people? There are none.

We can’t pump all the fuel we want despite being able to pay for it. Most of us can’t apply for a job at the CPC or at SriLankan, since many of these opportunities are given to supporters of political elites. As both institutes are loss-making and taxpayers are paying for something they don’t consume, what is left for the people to own or obtain benefits from? 

But if the same institutes were owned by the private sector, then that company would have to pay taxes, which is a source of revenue for the Government that can be spent on the people and on public goods. People can buy shares, will be entitled to a dividend, and can apply for job opportunities on a competitive basis. 

Sri Lankan businesses and foreigners can invest money and create jobs for our people while improving productivity and efficiency. So in reality, ownership of assets by private companies is a situation where they are in reality owned by the public. 

Consider the main telecom companies and conglomerates as an example. They are the main tax payers to the Government and are often victimised by one-off surcharge taxes when Government revenue drops significantly. This definitely does not mean that all participants in the private sector are clean, but we all know that they are usually better than the Government sector and Government-owned businesses. 

On the argument of sovereignty, it has been said that “the business of business is business”. Businesses enter a market to make profits and they become sustainable when they generate profit. Many Sri Lankans have successfully expanded globally, but have we ever heard the people of those countries complain that Sri Lankans have come to take the sovereignty of their country? 

Myth 2 – The IMF is the solution to all problems

Another common myth is that the International Monetary Fund (IMF) is the solution to all our economic problems. This is simply not the case. The IMF can only give us some money and credibility. Both will bring some stability, but our economy needs to grow organically and continuously like an agile, flexible wrestler for us to overcome the crisis and to become a tiger economy. 

The IMF cannot implement reforms for us – we have to buckle down and implement economic reforms and reset Sri Lanka for our own progress. The IMF is just a stepping stone on a long journey; it cannot solve all our problems. 

We have to welcome a full package of reforms to grow the economy. We have gone to the IMF about 16 times previously and only six programmes have been completed. Out of the Extended Fund Facility (EFF) programmes, which require structural reforms, we have completed only two programmes. Our track record indicates that we are a nation that expects the IMF to solve our problems rather than solving them on our own.   

Myth 3 – IMF is the problem 

On the flip side of the coin are those who think the IMF is the problem. They are of the view that the IMF is some sort of secret agent who will engineer all privatisations in the interest of Western oligarchs and they believe that the IMF operates like a gangster with a gun ready to shoot us if we don’t do what they say. 

This is simply untrue; the IMF in this case is the International Monetary Fund and not the Impossible Missions Force from Tom Cruise’s action film franchise. 

The IMF is like a bank’s credit officer who will evaluate a business proposal and then approve the granting of money. We all know bank officers don’t initiate business proposals, but the customers do. 

Similarly, the Government has to go to the IMF with a plan and the IMF will evaluate whether the plan is adequate to achieve the desired results. If we fail to adhere to what we promise, as we have done 10 times out of 16 in the past, they won’t release the balance money, and nothing will happen except the continued deterioration of our economy. 

Given this context, a side effect will be that no one else will come forward to give us assistance if we don’t move forward with the IMF programme. They are like a gym instructor and they can recommend a good diet and exercise, while our policymakers have to do the work to ensure an outcome. 

Myth 4 – Imports are the problem; imports are bad, exports are good

Since we have a USD/forex shortage, some are of the view that imports are the reason for the crisis. We first need to understand that before we import goods or services, we buy USD by paying in LKR for imports. 

If we really wish to do so, the best way to discourage imports is to increase the price of USD before we ban any imports. This is where the stability of the monetary system becomes of paramount importance in overcoming the crisis. 

If we need to encourage exports, the best way to do it is to pay the market rate for USD to exporters so they can be more competitive. This is why it is said that “stability is not everything and without stability everything is nothing”. 

The truth is that imports and exports are both good because they are two sides of the same coin. We need exports for imports and imports for exports. We need to look at overall trade reforms and facilitate further trade rather than thinking that imports are the problem. The problem is the monetary system which determines the price of USD, not imports or exports. 

The above are just four myths out of many. Those perceptions are like a virus, but we need to implement reforms and reset Sri Lanka if we are interested in forming a dynamic and healthy economy like a natural wrestler who can absorb shocks and perform in good times as well as in bad times.

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

The case for privatisation

Originally appeared on The Morning.

By Dhananath Fernando

Privatisation has entered the lingo of the nation once more. A few years ago, the mere mention of it was taboo in many circles and although the fear of using the word hasn’t fully evaporated, an increasing number of people actually understand the concept today. 

The discussion is now drifting towards whether privatisation is good or bad, with those proposing privatisation highlighting examples of success stories while those against it bring up examples of where it has gone wrong. 

In my view, rather than debating the merits of privatisation right away, the starting point of the discussion has to be about what Sri Lanka can do to overcome the crisis and how to transform our little island into a dynamic economy in Asia. 

On our journey to find answers, we can consider many options, of which privatisation is definitely one. However, our starting point has to be getting Sri Lanka out of this mess and our solutions have to be pragmatic and suited to our context. 

It is the same as a doctor prescribing medicine for ailing patients. The doctor first performs a diagnosis and then recommends medication based on the patient’s condition, history, affordability, side effects, and many more; he does not begin debating the merits of a particular treatment without a thorough diagnosis.

Obstacles against reforming the State sector

There is a brewing school of thought in Sri Lanka that given the many public corporations well-operated by honest and honourable professionals in other countries, nothing stands in the way of Sri Lanka having the same. The oft-cited examples include Singapore and New Zealand. 

Firstly, we have to realise that Sri Lanka’s context is very different. We are a country whose political system is rotten to the core. In fact, when President Gotabaya Rajapaksa took over the office of the president, he appointed a committee to appoint directors to State corporations and we are all aware how that ended. 

Simply put, our political system and context doesn’t facilitate getting talented professionals for the management of State-Owned Enterprises (SOEs). 

Secondly, the vast majority of capable professionals in Sri Lanka are very well compensated and taken care of by the private sector, so they have no reason to move to the public sector, which would come with a massive risk of political backlash and less pay to boot. Salary scales in our SOEs simply do not attract the right talent to drive management change. And that’s just one side of the story. 

Thirdly, Sri Lanka is now unfortunately bankrupt and most of the key SOEs carry both massive debts and losses. We cannot realistically expect the right talent to join and transform SOEs, knowing they will be faced with a difficult restructuring and turnaround, particularly without even the incentive of competitive salaries. 

Last but not least, there is a principal-agent problem when the State attempts to conduct business. The State is currently involved in many industries as botha  regulator and a market player. Can you imagine if the umpire in a game of cricket was also a batsman for one of the sides? 

The State is involved in a multitude of sectors including hospitality, aviation, modern trade, banking, energy and many more. Although it has a bigger role in establishing the rule of law and a competitive marketplace, it is instead wasting resources on micromanaging certain industries. 

The State is presently a jack of all trades and master of none, falling far behind expectations both in terms of ensuring the rule of law and managing business. 

Privatisation as a viable option 

It is in this context that Sri Lanka has to consider privatisation – not simply for the sake of privatisation but as a solution for the problems we have. There are six basic reforms that we have to implement if we wish to emerge from this crisis in a timely fashion.

• Increase revenue

Privatisation can increase revenue because private companies pay taxes to the State. At present, rather than receiving taxes, the Government finances a number of heavily loss-making institutions. When undergoing privatisation, the government earns money from the assets it sells, so on both ends it will bring revenue for the Government to overcome the crisis.

• Reduce expenditure

Currently, the Government’s main expenditure is on SOEs. The Ceylon Petroleum Corporation (CPC), for example, has lost Rs. 600 billion in four months. SriLankan Airlines has lost Rs. 200 billion in four months, an amount that is four times the entire Samurdhi budget (Rs. 50 billion), which is used to take care of the most vulnerable people in our society. 

When we privatise, our expenditure will fall and we will stop leaking money, whereupon those savings can be given to the most vulnerable.

• Reduce debt

SOEs not only increase expenditure and burden State coffers – they carry a lot of debt in both LKR and USD. The Central Bank Governor recently stated that the CPC had neither USD nor LKR to run its operations and that the Government had to finance it. Privatisation will reduce our current and future debt burden, which will help restructure our debt and achieve debt sustainability. 

• Increasing growth

Another important aspect of overcoming the crisis is to create growth. The current set-up of retaining State ownership of these loss-making and inefficient enterprises will simply slow down growth. 

Consider the example of the East Container Terminal. Multiple tender proceedings were stopped and cancelled but the Government was still said to be capable of seeing it through. However, it is now obvious that this is not possible given the crisis. 

Moreover, not only are we behind, but we are also losing container transhipment due to capacity constraints while business is moving away from the country, challenging our long-standing transhipment status. 

However, the private sector can drive growth. They have cash, and to an extent, lending capacity. The private sector is more concerned about profits, not so much about the overall economy of the country.  

• Increasing productivity

We all are aware of the productivity figures of State-managed institutes. News reports revealed that even with fuel shortages, the CPC had paid a total overtime pay amounting to billions of rupees. 

The private sector can drive productivity. It can introduce technology, processors, business ecosystems and networks to create synergies, which will create job opportunities and drive productivity across the nation. 

• Attracting FDI

The private sector, locally and internationally, can bring investments to our shores with privatisation (meaning US Dollars) in addition to technology and skills which will spill over to other sectors, driving productivity and efficiency. Foreign Direct Investments (FDIs) will undoubtedly ease the pressure off the Government in relation to USD shortages. 

Case-by-case basis 

Thus, privatisation suits Sri Lanka based on the crisis and context. It is a solution for what we are going through and a medication that fits the condition of the patient. 

However, this doesn’t mean we have to privatise everything. Energy and electricity have to be unbundled first and the market must be made competitive. The pressure on the Ceylon Electricity Board (CEB) and the CPC will ease and consumers will have a better experience. 

Some institutions such as SriLankan Airlines have to go for a fire sale, while some institutions can be consolidated and some can opt for public-private partnerships. There is no single remedy for all, but we have to move forward on a case-by-case basis. The important thing is to move forward and for the State to slowly move away from doing business, instead focusing on the Judiciary and the rule of law. 

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.

A reformist mindset is crucial

Originally appeared on The Morning.

By Dhananath Fernando

On one side of the aisle, hopes have been raised with the election of a new President. Hopes abound that necessary and sorely needed economic reforms will now move forward. On the other side, yet another round of suspicion has arisen about whether politicians are yet again deceiving the common people. 

There is suspicion that the unaddressed sufferings of the people will be swept under the rug with another political plot. As I was trying to understand which side made the more compelling argument, I recollected my memories of a story related by my school Principal, the late Rev. Father Bonnie Fernandopulle. 

He asked his students: “Do you know the difference between a good kettle and a bad kettle? Both kettles serve the same purpose – boiling water. They both give the same whistle when water is boiling.” He paused before continuing: “Then what is the difference between a good kettle and a bad kettle?” 

After letting the students mull over it for a moment, he said: “Only time will tell which one is good and which one is bad. The good kettle will be durable and can be used for a longer time, while the bad kettle cannot be used for that long. Only time will tell which is which.” 

Rev. Fr. Fernandopulle repeatedly advised students to be good kettles and make decisions that could stand the test of time. His message can also be applied to the spheres of politics and reforms. Within these spheres, too, the test of the time is the best test to administer before arriving at hasty conclusions.

Political instability 

Since 2018, back-to-back political instability has too often been present in the key decision-making positions. The 2018 constitutional coup and 2019 Easter attacks kick-started a sequence of events fraught with political instability. Then the country was sent into lockdown as Covid numbers surged. 

Since then, after the country was reopened, we have so far had five finance ministers, three prime ministers, and two presidents in the very short period of time of two-and-a-half years. Since 2019, even the Central Bank has had three governors.

To make any headway in reforms, a government should be allowed to remain in place for at least two or three years to ensure that some progress is made. The first 100 days are the main reform window. Any government can capitalise on the first 100 days if it has done its homework and if it has a competent team and reforms ready to execute at short notice. 

To stay in power for two to three years, the initial reforms have to have some impact and people should have some level of hope that things are improving. The common people should also have some level of confidence that the people in charge are moving the country in the right direction. To achieve this, we need a written action plan to give confidence to all stakeholders, including the International Monetary Fund (IMF), and even for all political parties to reach a consensus and work together. 

So it is of paramount importance that we obtain some level of consensus on a programme of reforms. Otherwise, we will just waste time going back and forth appointing more ministers and cabinets every fortnight while reforms come to a complete standstill. 

A reform programme 

Putting forth a reform programme in a document is the very first step on the path to achieving consensus. 

Surprisingly, no political party has taken the initiative or led discussions on a commonly-agreeable work plan. What political parties have put forward are long manifesto type documents which lack an actionable plan. Those documents often have drawn-out explanations of the problem and broader solutions with executions that are vague.

The National Movement for Social Justice (NMSJ) has compiled a common minimum programme evaluating reform ideas from multiple parties and organisations (the author was a part of the process). 

In a recent tweet, Samagi Jana Balawegaya (SJB) MP Dr. Harsha de Silva mentioned that they have created a reform plan based on NMSJ proposals. According to his tweet, the team, which was supported by Dullas Alahapperuma and included Dr. Nalaka Godahewa and Prof. Charitha Herath, had agreed on the proposals. All that happened before the parliamentary presidential race, but nonetheless the reform plan remains valid. 

NMSJ documents have been endorsed by economists and business leaders, so a sensible starting point could be to move ahead with the plan and get the consensus of all parties, forging ahead with the reform pathway. Let me remind you that we are already very late to start reforms at all.  

Unfortunately, we do not have many options other than performing economic reforms if we are serious about overcoming this crisis. If we want to settle for not executing any reforms, we will have to settle for becoming a failed state in the coming years. 

Reform communications 

The second step of any successful reform package is the communication of reforms. 

Reform communication is less about running an expensive media campaign and airing catchy commercials, and is instead more about explaining clearly and simply the change that will be wrought on the system and ensuring transparency. Transparency and actually executing actions are the biggest tool of communication. It provides signals to both markets and individuals. 

For example, if we start the process of privatising SriLankan Airlines, the tender process has to be competitive so that it communicates to investors, the local community, and international financial institutions that the urge for change has come from within. Then when we actually go about enacting privatisation, it will clearly communicate the message that we are open for private investments, which assures private property and competitiveness. 

In the world of reforms, actions are the strongest tool of communication. The second most important tool is ensuring transparency and explaining reforms in simple language for people to understand their impacts and how they will help us emerge from the crisis.

Institutions for executing reforms

Another key piece of the puzzle is having necessary institutions and capacity to carry forward reforms. 

For instance, there is a process and an engagement strategy we need to follow to privatise a State enterprise. The strategy and the execution requires skilled manpower, networking capabilities, negotiation power, and transaction management. Only a strong institutional structure will bring transparency and seriousness to our reform programme. 

The new Government or any governments expected to be formed in future should realise that reforms are the only way out. Economic reforms are both a science and an art. A key challenge for the new Government is that it is running out of time. 

As my Principal mentioned, the sooner people realise which kettle is which, the better for the nation. If people realise the kettle is bad, it is natural that people will take to the streets and protest will gain momentum, where forceful control will have little effect than to push things completely out of control. 

Only time will tell us whether the new Government is serious about reforms. That will decide whether Sri Lanka will become a tiger economy or a failed state.

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.

Any government’s biggest enemy is INFLATION

Originally appeared on The Morning.

By Dhananath Fernando

Friedrich Hayek famously said, “I do not think it is an exaggeration to say history is largely a history of inflation, usually inflation is engineered by governments for the gain of governments.” While there are many reasons for the ‘Aragalaya’ to advance and develop as a movement, the economic context for movements such as the ‘Aragalaya’ taking off should not be underestimated. 

Those who remember our recent history will recall a similar ‘Aragalaya’ in 2001-2002 called ‘#JanabalaAragalaya’. During that time as well, Sri Lanka’s currency depreciated significantly and cost of living was on the rise. In fact, every time Sri Lanka’s currency depreciated and inflation started soaring, we would see similar kinds of people’s protests rising to prominence. 

Inflation leads to crisis

Today we are going through one of the largest crises in our history and the people’s resistance has been reflective of what we are going through. That is why it is said that the biggest enemy of any government is not the opposition, but inflation. 

Unfortunately, many governments and central banks around the world have not realised this truth and have created inflation by lending their respective governments money without any control; they followed reckless monetary policies without understanding the gravity of their actions.

Another currency crisis hit in 2011-2012, which led to the build-up of pressure on then President Mahinda Rajapaksa. Later, in 2016-2017, yet another currency crisis took place, with pressure mounting against the Yahapalana Government in connection with the Bond scam. Since 2019, Modern Monetary Theory (MMT)-led money printing has undoubtedly been one of the main reasons for the crisis we are experiencing today. 

When countries that do not possess a global reserve currency as the national currency add money to their economy, that money will generally chase behind imports, which require foreign exchange. If the country allows the currency to fluctuate automatically, the prices of imports will increase and demand will drop without any forex shortages. But if a country is trying to control the exchange rate using its reserves, unless it has a mechanism to continuously build reserves, at some point it will encounter forex shortages followed by steep currency depreciation. 

Perfect storm 

Sri Lanka has often faced this same problem, which is also the reason we always face currency crises. The present crisis is of historic proportions, as it is accompanied by a perfect storm of so many other policy errors, along with deteriorating global conditions. 

Since 2008, we have had the option of borrowing from markets. We complicated our problem by borrowing money at high interest rates to build our reserves as well as to keep the exchange rate controlled and artificially high. 

Ultimately, we have lost control of everything, and now we have a USD shortage which has led to many shortages of essentials. Since we have borrowed money from international markets, we are now experiencing a debt crisis. Further, due to our own banks investing in sovereign bonds, the stability of our financial system is in question. 

The graph shows the currency depreciation since 1970. We can observe what has happened in recent years to understand and validate Freidrich Hayek’s statement that history is a history of inflation. 

Solutions 

The first part of the solution is for all future and potential leaders and governments to understand that one of the main potential enemies of the country is the inflation they themselves have the power to create. On the other hand, central banks should understand that their excessive lending to governments can lead the country to absolute chaos and instability.

Therefore, regulation has to come forward for inflation targeting and to have a limitation on lending capacity of central banks to governments to ensure stability in our financial system. 

The already-drafted Monetary Law Act is a good starting point for the new government and finance minister and getting it approved with necessary amendments and inflation targeting is an easy win that will establish and indicate the direction of monetary stability. When inflation starts moving upwards, bringing it down is not an easy task, so we should make sure to keep it in check before it takes control and sends every other aspect out of control. 

Sri Lanka is at a crossroads, where we undoubtedly need a sequence of reforms. If we implement the reforms that are required, we have the potential to become a tiger economy, but if we continue to behave with old habits and allow inflation to take us over with our bad monetary policy, we will become a failed state. 

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

Economic ‘Aragalaya’ crucial for reform

Originally appeared on The Morning.

By Dhananath Fernando

SL economy has reached point of collapse; needs a total reset to recover

Every day on my way to work I walk past 5th Lane, the current Prime Minister’s residence. Last week, one of his security officers stopped me. He smiled and said, “Sir, we watch videos of Advocata Plus.” After a moment, he continued: “What is actually happening? How long will it take to recover?” I didn’t have a concrete answer. I couldn’t adequately answer him because our path to recovery depends on our course of action. 

The only certainty is the fact that it’s going to take time. Yet, to refrain from discouraging a hopeful individual, I smiled back, and said: “It’s a difficult time and recovery will be slow, but we will recover if people like the Prime Minister make the right decisions and policies.” His response was heavy with emotion, as his eyes brimmed with tears: “Our time is over. I thought we could make our children’s lives better, but now I can’t even provide my kids with what my parents provided me. It hurts, sir.”

The story of many Sri Lankans is no different. This is why we need a complete reset of our economy. The existing system, which we have inherited, cannot move forward any further – a point of collapse has been reached. The collapse has been painful and recovery takes time, but in order to ensure that we successfully overcome this collapsed system, an ‘Aragalaya’ for economic reform is absolutely crucial.

A question remains. What can we do to overcome and speed up our recovery? One common mistake many policymakers make is that they only see a fraction of the bigger picture. Reviving tourism, or getting remittances, or bridge financing is seen as a solution. However, these are just smaller concerns in a much larger problem. 

The core issue is that our economy is not competitive. Having existed as a closed economy for an extended period of time and losing our competitive edge has caused the Sri Lankan economy to lose its overall competitiveness. Many believe in the myth that our economy has been open since 1977, when in reality it has been closing down since the 1990s. One of the best indicators to measure this is through the comparison of our imports and exports to the size of our economy – both of which have been declining at a record pace since the 1990s. Exports are the indicator to measure our relevance in the global market and the declining trend in our exports means that we have become less relevant to global markets. 

Why is Sri Lanka losing competitive advantage? Firstly, the nation’s factor and product markets have not experienced any major reforms for decades – and in some cases for centuries. As Charles Darwin said in his Theory of Evolution, only those who adapt will remain. Sri Lanka did not adapt and thus became irrelevant. The country’s land market is virtually a closed market, with approximately 82% of the land owned by the Government, which causes one of the main factors of production to be hindered. 

Secondly, labour market reforms have not been implemented. Even in 1977 there were no labour market reforms. Hiring and firing employees is a very difficult process and stringent regulations on part-time work and flexible work hours are preventing Sri Lanka’s growth. On the supply side, productive labour remains glued to the Government sector, with very low salary scales despite having the potential of contributing to the economy in a far bigger capacity.  

Sri Lanka’s public sector employment, which was at 812,472 in 1994 (1), increased to 909,564 by 2002. By 2020, public sector employment was at 1,423,116 (2). The latest figures report 1.58 million public sector employees, making Sri Lanka home to one of the highest ratios of public sector employees in Asia (3).

The current economic crisis has brought the country’s public sector finances and savings to shame. With 54% inflation and more than 100% currency depreciation, EPF/ETF savings and the pensions of the public sector have been reduced to an amount that means little in comparison to skyrocketing living expenses. 

While the situation is unfortunate, it can be capitalised upon to enact public sector reforms. The first step would be to first freeze all recruitment and offer a retirement scheme to bring the employee numbers down. We can cut down the number of working days for public servants and consider different types of voluntary retirement schemes to hedge costs. There needs to be a prioritisation of public servants and the salaries of capable staff should be increased, with adequate training opportunities provided to enable further refinement of skills.

The current structure of public workers is not only negatively impacting their own lives, but also making the lives of the general public quite difficult. As a result, similar to the Prime Minister’s security personnel, most of us are unable to provide our children with what our parents provided for us. As such, public sector reforms have to occupy a core spot in the ‘Aragalaya’ to ensure economic reform. 

When suitable policies that can bring macroeconomic stability are implemented, the micro pieces will adjust accordingly. Thus far, the strategy has been micromanagement rather than macro stabilisation. However, when necessary Government policies attend to macromanagement, micromanagement will naturally be provided for by the private sector.

In the investment sector, labour and land have once again been key constraints, as the country lacks adequate land to provide investors. Zones managed by the Board of Investment (BOI) have run out of plots of land and getting new land for development has become a nightmare. Until the newly-appointed Minister of Investment Promotion offered a five-year visa for foreign investors, we did not even have a programme to attract talent and investment through our immigration system. 

If the macro policy is sound and a level playing field is created for all, then future generations will be better equipped to take care of themselves. One very important component of the ‘Aragalaya’ for economic reforms is our monetary policy, since without fixing our currency and the value of the notes we exchange, macro stabilisation will be a futile effort. 

References:

• Census of the Public and Semi-Government Sector Employment 1994, Department of Census and Statistics. http://www.statistics.gov.lk/PublicEmployment/StaticalInformation/census_reports/CensusOfPublicAndSemiGovernmentSectorEmployment-1994FinalReport

• Ministry of Finance Sri Lanka Annual Report 2020, treasury.gov.lk. https://www.treasury.gov.lk/api/file/0b7d1935-6235-4156-97b6-752d6a8039d0

• Employment in Public Sector and by Gender, OECD iLibrary. https://www.oecd-ilibrary.org/sites/2558c185-en/index.html?itemId=/content/component/2558c185-en

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.

Golden opportunity for energy market reform

Originally appeared on The Morning.

By Dhananath Fernando

Let markets work and adjust expectations

As children, most of you might have tried the trick of obscuring the vision of a bigger object by closing one eye. I used to try this with a lamp post, by moving the finger closer to the eye while closing the other eye, thereby making the lamp post disappear. As a child, there was a thrill in making the lamp post disappear with a minute object such as my finger. 

However, in reality, we know that a lamp post or a bigger object cannot be covered with a finger, due to factors such as volume and mass. Similarly, until we ran out of petrol, Sri Lanka also pretty much thought the finger could actually cover the lamp post – the finger in this case was import controls, which we all thought was the solution for a brewing Balance of Payments crisis. 

This column has been a consistent opponent of import controls since the beginning. It has been two years since we stopped importing vehicles. Some non-essential imports (as per the definition of policymakers) such as apples and other food items have also been halted. At one point in this debacle, the Government issued licences for imports, which threatened to create a new Licence Raj. 

We went as far as to kill the forward market and once even issued a regulation mandating a 100% cash requirement to open Letters of Credit (LCs), which were then required to be opened with a 90-180-day credit period. We did so much to reduce imports for so long, so why didn’t any of these policies bring their promised results and how did we run out of money even to import fuel and life-saving medicines? After all those remedies, why have we fallen to a state where the country is in a de facto lockdown – not because of Covid but due to a fuel shortage? 

Many still haven’t understood that imports were not the problem. By contrast, having no fuel imports has become a significant problem. Of course, at a time when we as a nation have hit rock bottom, imports will come to an automatic halt due to the unavailability of foreign exchange. But import controls have certainly not helped matters and have in fact worsened the problem. If we had a solid monetary policy, if we hadn’t maintained the exchange rate at artificial levels and if we maintained stability, this problem would not have arisen. 

It is in this context that the Cabinet has granted the opportunity for any oil producing country that can bring fuel to Sri Lanka to run the fuel distribution while the Government keeps control of the operations of the Sapugaskanda Refinery. 

Surprisingly, even the strong Ceylon Petroleum Corporation (CPC) unions remain silent. Previously, CPC unions were the first to mobilise on the streets when any policymaker dared to even broach the topic of opening up investment activity to the private sector for energy and fuel. Now, private investment has entered their territory and the signals of privatisation are all there, but silence still remains. It is obvious now to these unions and to the nation at large that the State cannot operate in such competitive sectors and that attempting to do so guarantees disaster. Unfortunately, we are presently living through such a disaster. 

While allowing the private sector to operate in the energy market is a good move, expecting the fuel problem to go away simply by allowing private companies to enter the Sri Lankan market is very short-sighted. For context, the reality of the fuel market is that fuel supply can only be secured by paying in US Dollars, but sales in Sri Lanka are transacted in LKR. Even if an investor enters the market with a USD investment, if they can’t convert their LKR into USD, there will be no strong business case unless they have some other business lines which have LKR and USD interests. Whoever invests in USD should be able to convert their sales to USD; otherwise this is not a sustainable long-term solution. 

One segment that has both USD and LKR interests is exporters. They earn USD from their exports and they need LKR for their local operations. If they can get a higher profit margin through fuel sales than through a USD conversion in the banking sector and if they have adequate volumes to run a fuel business, then there is a business case for these exporters to manage a fuel distribution operation. 

Alternatively, there has to be a separate financing arm for fuel, whereby anyone who has an interest in both USD and LKR can invest with an expectation of dividends. To do that, however, fuel pricing requires flexibility. Our present environment of price controls won’t work as fuel has far too many variable cost components and competitive margins. Therefore, one solution is to open the fuel business to anyone – including local exporters – to enter distribution and not necessarily to provide the opportunity only to oil producing nations.  

Allowing anyone to import fuel is the right decision at this moment, particularly as the big companies that can afford to purchase fuel at a premium either individually or through business collaborations will do so, thereby minimising the burden on the Government. The private sector, of course, will increase efficiency as well. 

Another group that has both USD and LKR interests is our overseas workforce that provides foreign remittances. If they can get higher margins than the conversion rate offered by Sri Lankan banks, they might be willing to channel their money into the business of importing essentials. That was the logic expounded by Daniel Alphonsus in his recent article on allowing anybody to undertake fuel imports, even through open accounts. 

The expectation is that the undiyal money presently parked offshore will be channelled to essential imports as the importers can now obtain LKR by selling fuel and other goods. But again, prices have to be flexible and competition will bring the market to a stable position. Currently, the black market price of a litre of petrol is over Rs. 1,500, whereas the official price is Rs. 400. This is no secret. Alphonsus argues that the same system existed during the war in the north and east – although there was no official supply, fuel was available even in small mom-and-pop stores at a price premium, often in small glass bottles. 

Markets are strong and they will always work. Of course, they may not work as per our expectations, but the reality is that our expectations should adjust according to the markets. Since we have completely run out of options, we have a golden opportunity for reform. It is possible that we may fail, but we have little to lose and are presently not doing anything other than going around the world with a begging bowl. That too will have to be continued for now, but expecting other countries to donate their taxpayer money to Sri Lanka after so much mismanagement and loss of credibility is idealistic thinking. It is the same as our thinking when we were children – that an object would disappear if we simply didn’t see it anymore.

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.

Cricket while the country burns?

Originally appeared on The Morning.

By Dhananath Fernando

In the mid 1990s, when Sri Lanka’s Cricket was performing extraordinarily well, there was an accusation that then President Chandrika Bandaranayake Kumarathunga was announcing unpopular policy decisions while public attention was on cricket. After Sri Lanka won a match, and while people are celebrating the next morning, the prices of items such as bread and LP gas are increased. There were even rumors that LTTE leaders had said “Sri Lankans remember any event only for two weeks”. Today, while public & media attention is focused on our historic cricket win against Australia, our policymakers seem to think that the attention diversion from cricket would save them from a historic Economic crisis. They are definitely wrong.

While IMF representatives are in Sri Lanka to explore the details of the programme, the drive for reforms among policy makers is extremely slow. Even more than 2 months after announcing the suspension of external debt, we have not yet provided any policy direction for stakeholders on reforms that we intend to follow to overcome the crisis.

So far, it seems like another round of political musical chairs without any genuine effort from policymakers to enact economic reforms. The school of thought that favored bringing political reforms hand in hand with Economic reforms is also now in question due to the situation with the 21st amendment. According to the Prime Minister, as per his recent speech in Parliament, we have to show our willingness for reforms to get the support of other countries. So what willingness has been indicated by our policy makers on any reforms? We have only been going to other countries and organizations with a begging bowl to find money for essentials on a weekly basis, and sadly that has become the new normal. We are at a very high risk of some level of social unrest with no reforms on the table and the poor leadership on display from our representatives. A short video clip uploaded by a journalist of a man in a fuel queue alerted me to the degree of risk we are in. The journalist asked about the impact of the economic crisis from this particular person in the queue. He said, with a very calm tone and patient body language, “I am a chauffeur and a father of 3 kids. I kindly request our leaders to not test the patience of fathers like me. The current protests & ‘Galle Face Green protests’ are broadly by youth. Not by fathers like me. Fathers like me do everything for our kids. We can’t see them suffering. When a father crosses the border of patience we don’t know where it will stop,” he said, with a measured tone and with a lot of depth.

While this column highlighted many preliminary reforms over the last two years, there are new reforms that we have to expedite given the severity of the crisis. As recent news stories have indicated, the debt restructuring in Sri Lanka seems likely to be very complicated and time consuming. In particular, the news that Hamilton Reserve Bank is suing Sri Lanka in American Federal courts indicates how complicated the situation could become. As per the report, they possess more than 25% of the July 2022 bond series and are requesting the full amount to be paid; they possess a share of the bond large enough to make them a ‘blocking minority’ which can block and delay the entire debt negotiating programme. The IMF, for their part, has indicated that they want to see a clear direction on debt restructuring if they were to support Sri Lanka. Bilateral partners such as China and Japan will also play a vital role in the entire process.

Given this situation and our slow approach to Economic reforms even after announcing debt restructuring, we will be left with a lot more debt to be paid. If we move at this pace, there is no doubt that we will have subsequent defaults even after restructuring, if we fail to boost economic growth. Therefore, the establishment of an independent debt office is extremely important. Our debt portfolio is diverse and expensive so highly skilled financial analysts should manage our debt in line with global trends. Following the dilution of our Civil Service, that level of skill is unfortunately not available in our public sector. Given the salary scale of the public sector we can’t expect talent with the calibre of skills of a fund manager to stay in the public sector. Simply put, a salary scale of LKR80,000 will not attract a fund manager who has to manage a few billion rupees worth of debts. Therefore, the independent public debt office should have a different salary scale (based on key performance indicators) and independent regulation if we are to have a sustainable problem for our debt crisis. We are where we are today due to our poor debt management. The “Common Minimum Programme” by the National Movement for Social Justice has indicated the same.

Furthermore, this crisis will inevitably impact many private enterprises and a record number of businesses will go bankrupt. In a market system it is unavoidable that while some companies succeed, others will fail. Our legal framework should allow the failed firms a faster exit so entrepreneurs can bounce back with a new business or otherwise utilise their time productively. Investing their energy and money on something productive instead of on an already failed business will inevitably affect the overall productivity and efficiency of the economy. Unfortunately, Sri Lanka does not have unified bankruptcy laws. So when a company fails, exit is not easy. More money, time & energy has to be invested to manage a bankruptcy as a result. There are some exceptions laid out as provisions in the Companies Act, but for most micro, small and medium enterprises - which are sole properties and partnerships - the absence of a bankruptcy law will cause severe repercussions. Sri Lanka should proactively think of these issues before the situation gets out of control.

Our policymakers should realise that the hunger and anger of the common man has created a volatile and flammable situation. There is no way for cricket or any other diversion to stop the righteous fury of a hungry man, so it is imperative that we bring about Economic reforms before a spark ignites the entire situation and pushes us deeper into crisis.

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

The economics behind the fuel crisis

Originally appeared on The Morning.

By Dhananath Fernando

I recently overheard a conversation while taking public transport. The bus I was commuting in was moving at a snail’s pace across Dehiwala as people had blocked the road to show their displeasure over fuel shortages. The fuel queue was long, spanning over a few kilometres, consisting of mostly three-wheelers. The conversation started when a lady seated at the back lost her patience as some three-wheeler drivers tried to block the road. 

“Three-wheelers are a curse on our country,” she said. “Look how long the queue is and how undisciplined these tuk drivers are. They consume a lot of fuel and they just sit and waste their time browsing the internet on their phones while they are in the queue. All these drivers are a part of our labour force and they are part of the problem behind this fuel crisis. We should ban three-wheelers and develop public transport. The Sri Lanka Transport Board should field as many buses as possible. Why can’t they employ more trains at this time?” She had initiated the conversation with a gentleman seated next to her, who was also highlighting some solutions. 

Her opinion would be mirrored by many Sri Lankans if they were asked about the reasons behind the fuel crisis and economic crisis. While we all understand that it is the foreign exchange or USD shortage which led to this fuel crisis, the productive use of our limited fuel stocks has been in discussion for many months. People are now worried that once the latest fuel shipment is exhausted, Sri Lanka will completely run out of fuel as we are scraping the bottom of the barrel of the Indian credit line. 

We all have to admit that fuel has become an extremely scarce resource given the shortage of USD. Another side to the problem is that fuel importation and distribution is mainly done by the Ceylon Petroleum Corporation (CPC) and Lanka IOC (LIOC). Both these companies do not generate USD revenue. 

If we allow anyone to import fuel, then the exporters who have US Dollars will import fuel mainly for their usage for export output. The garment and rubber industries will import fuel on their own with their own US Dollars to run their generators and plants and pay the tax. 

It is far more convenient, efficient, and productive for them to depend on their own supply chains than depend on the inefficient CPC. When there are industries that can afford fuel imports at their own cost, there will be more fuel for common people through CPC and LIOC with the little forex and credit lines they secure. 

Daniel Alponsus has explained this in his recent blog in detail (1), where he further suggested removing price controls on fuel and allowing an open market account for fuel imports so the informal forex will automatically move towards essentials such as fuel while remittances will start flowing.

Before we come to the conclusion that three-wheelers are the problem (as per the conversation I overheard on my journey), we have to first ask why there are so many three-wheelers on the roads. The simple fact of the matter is that they are very efficient – they are lightweight, their fuel economy is about 30 km/litre, and they can transport one to three passengers per trip. By comparison, the fuel efficiency of a personal vehicle – depending on the weight and engine displacement – would on average be approximately one-third of the fuel efficiency of a three-wheeler. 

Secondly, three-wheelers are the main form of last-mile transport. They provide flexibility in labour markets, contributing to their popularity. The final and most significant reason for the large number of three-wheelers is the lack of sufficient public transport – both in terms of quantity and quality. If there was an option for anyone to become a service provider of public transport, most three-wheeler drivers would have become public transport drivers. 

At present, just because you have a bus doesn’t mean that you can field it on the road due to the route permit system. In many cases, the selling price of a route permit is a few times higher than the value of the bus even after a massive excise duty, sometimes above 100%, being imposed on the vehicle. 

Our policies have therefore discouraged many entrepreneurs from entering the market for public transport. In addition, we have strict price controls on bus fares, which limit the ability of service providers to differentiate their services at different price levels. 

For example, a young executive may be willing to leave his vehicle at home and shift to public transport if there is a transport service that provides internet service and a breakfast package. The executive can work while commuting and he can save on his breakfast preparation time at home. However, with the current controlled prices and route permit system, such niches with higher quality of service (and higher prices) cannot be fulfilled. 

So the main reason for the higher number of three-wheelers and more fuel combinations is the absence of market forces in the public transportation sector. The fuel crisis has been exacerbated by bad public policy in relation to public transport. This has compelled us to use 60% of our fuel imports, which is the highest single commodity type import in our import basket. 

The only encouragement provided for public transport was the bus lane priority system – now even that has unfortunately been abandoned. If we want to incentivise the buses for their fuel, another option is to subsidise their fuel based on mileage. This means the bus operators would buy fuel at the same price as a normal customer at the pump but they will obtain a subsidy based on mileage to avoid any leakages (i.e. resale of fuel on the secondary market at a premium) and provide incentive for drivers and consumers. 

Poor data availability and the lack of information systems acts as a bottleneck for such initiatives. However, if private mobile based services like PickMe or Uber can track mileage and location, there cannot be a reason why the same mechanism cannot be implemented for public transport.  

In the midst of rising fuel prices, Germany reduced public transport fares to encourage more people to commute through public transport. This is so that the fuel consumption of using individual vehicles would be lower. Unfortunately, Sri Lanka did otherwise. Our policymakers did not understand the economics and optics of the problem. Until we understand the dynamics of the situation, we will all simply listen to and believe conversations about three-wheelers being the issue without really understanding the fundamental problem.  

References:

1. https://danielalphonsus.substack.com/p/solving-sri-lankas-fuel-crisis?s=w

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.

Don’t throw the baby out with the bathwater

Originally appeared on The Morning.

By Dhananath Fernando

While Sri Lankans have learned to accommodate daily blackouts by now, Sri Lanka’s power generation, or rather the lack thereof, has made headlines again. Minister of Power and Energy Kanchana Wijesekera’s amendments to the Electricity Act and trade union actions have created quite the chaos.

Sri Lanka’s power generation has always been political capital for politicians. During the Yahapalana Government, then President Maithripala Sirisena said he wouldn’t join the Cabinet until the Public Utilities Commission of Sri Lanka (PUCSL) and Ceylon Electricity Board (CEB) came to some resolution (1). The same administration saw CEB officials vehemently organising ‘bodhi poojas’ for the rain gods to avoid the horrors of extended power cuts. Recently, the CEB Chairman followed suit, stating: “When God gives rain and the Ceylon Petroleum Corporation (CPC) gives fuel, the CEB can provide electricity”(2).

In this context, the new Power and Energy Minister plans to amend the Electricity Act. The CEB Engineers’ Union has declared public resistance. The CEB enjoys a monopoly in transmission and maintenance of the grid and a greater control on power generation development and distribution. Therefore, as a trade union it has very high influence. This makes energy sector reforms very complicated. Achieving consensus between stakeholders is next to impossible. Given this monopoly and profit-making ability, reforms have taken a backseat. In this climate, the willingness of the Power and Energy Minister to prioritise reforms is commendable.

The Minister made a speech in Parliament highlighting the delays of renewable energy. In response, the Government suggested moving away from competitive bidding for renewable energy projects. While there is some degree of truth to delays occurring during the process of competitive bidding, the sustainable solution is not to completely do away with it. Under competitive bidding, the cost per unit of solar energy can drop drastically. Getting rid of competitive bidding would mean welcoming unsolicited renewable energy projects with much higher cost per unit. This cost will ultimately have to be borne by industries and consumers. In any trade, complete absence of competition means more rent seeking, inefficiencies, and corruption. 

A major reason for the delay of solar energy projects is the unavailability of land; 82% of Sri Lanka’s land is owned by the Government. Therefore, finding land for projects has become very difficult. The Government must prioritise clearing land for private investments. This applies to businesses across the board.

Secondly, making the policy and regulatory environment conducive to unsolicited proposals may not benefit the Government. This is because the current economic conditions are such that we do not have dollars to import material needed for renewable energy projects. Further, the cost of finance is also significantly high as our interest rates have skyrocketed. Without foreign exchange and high capital cost for any investor, development of renewable energy projects will take a backseat. Ultimately we will end up abolishing a competitive system with further delays and corruption.

The controversial wind power plants in Mannar should also be under the competitive bidding process. Failing this, Sri Lanka will not be able to reach market rates and will probably have to sell our energy generation for less than the market rate.

The solution is the unbundling of power generation, development, and distribution. Presently, whoever generates power has to contribute to the CEB grid. They have a monopoly in generation and development. Unbundling will divide these three segments and open some of it to the private sector. This will give people the choice to switch between any service provider based on the quality and reliability of the supply. Completely removing the competitive bidding process, without unbundling, will bring a double whammy on the cost. The prices of renewable energy will increase, while the CEB will continue to control the system through the grid. Thereby the Power and Energy Minister’s good intention to reform the energy sector may end up leading to a more negative condition with unintended consequences.

The Minister’s suggestion to connect the grid with India through a HVDC (High Voltage DC) cable is a sensible decision. One of the main challenges and restrictions for the expansion of renewable energy are demand and supply. Lack of management and access to a larger grid to sell and buy surplus or deficit of power too is an impediment. Connecting the Sri Lankan grid with India creates opportunities to overcome this issue. However, energy security precautions will have to be taken.

The suggestion of connecting the power grids of India and Sri Lanka was also made by Prof. Rohan Samarajiva in a report compiled under the chairmanship of former Governor of the Central Bank Dr. Indrajit Coomaraswamy, which was handed over to the President.

If Sri Lanka is to overcome the current energy crisis, reforms in the sector through unbundling and competitive bidding are necessary. Let’s be hopeful that our young Minister can make this crisis an opportunity to implement necessary reforms. 

References

(1) https://www.timesonline.lk/news/president-wont-attend-cabinet-meetings-until-ceb-pucsl-dispute-is-resolved/18-1082024

(2) https://www.newsfirst.lk/2022/03/31/when-god-gives-rain-and-cpc-gives-fuel-ceb-can-give-power-ceb-chairman/

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.

Low-hanging fruit from a disastrous harvest

Originally appeared on The Morning.

By Dhananath Fernando

We all want quick fixes to reset the economy. Difficult times like these make quick fixes a vital necessity as patience amongst the public runs thin. However, when an economy grows to a level of high dysfunctionality – as ours unfortunately has – the availability of quick fixes is extremely limited. 

The first step towards economic recovery is for individuals to understand that given the nature of the current crisis, quick fixes simply do not exist. The process of economic recovery can be likened to the growth of a plant. A mere need for a quick harvest does not mean that what is sown can be reaped in just a few days – it takes its own time. All that we can do is to sow the right policy strategy. We will eventually reap what we sow; if we sow the wrong ideas and wrong policies we will have to reap painful outcomes in future, similarly to how we are currently reaping the pain of what we sowed many years ago. 

However, a few quick fixes can still be attempted. One such attempt can be made in the tourism sector. We all know that there is a shortage of fuel for transportation and hotels don’t have reliable electricity. It’s true that tourists consider the situation of the country before they visit, and we are far from presenting an ideal situation. That said, in economic terms what we can do is to provide incentives on the regulatory side for people to visit Sri Lanka. 

One possible measure is to provide an on-arrival short stay visa for selected countries, which will encourage and increase tourist arrivals. Merely maintaining existing regulations will not help in economic recovery as it does not attract tourism. At the same time, Sri Lanka’s aviation authorities charge very high prices for landing and other aviation related services. For example, an economy class flight from Singapore to Colombo costs Rs. 155,000, of which Rs. 35,000 (23%) is incurred in airport and Government taxes. If we reduce those charges, prices of air tickets to Colombo will come down. 

One business leader recently informed me that the price of a flight from Chennai to Colombo was significantly higher than a flight of the same distance and duration from Chennai to other airports in India. Despite the same travel class on the flight, the same quality of staff, and the same distance, the price is mainly driven up by levies and taxes charged when the border is crossed. Given this, bringing down our rates may mean that some audiences may consider visiting Sri Lanka. 

In my humble opinion, when foreign media questioned the Prime Minister on tourism, his answer should have been: “It is a difficult time for all of us, but even with all those difficulties we have the best beaches and the most amazing sunsets and Sri Lanka is still ranked very high on all travel magazines.” 

Nonetheless, we have to keep in mind that tourism alone will not be sufficient to turn our economy around. We made this mistake earlier and attempted to settle our sovereign debt through tourism receipts. Generally, about 80% of tourism income will go back as a USD outflow due to the consumption of imported items required to sustain tourism. At the moment, we have little going for us and this is just a suggestion that is scraping the bottom of the barrel. 

Moreover, we have to establish a unified bankruptcy law. It will take time, but it is needed urgently, and it’s important to start now. With the economic downturn, many organisations have had to downsize or wrap up their operations. This is the same sequence of events that has taken place in other countries that were facing similar crisis situations. 

In Sri Lanka, private limited companies have some cover on bankruptcy, but about 80% of the business establishments in Sri Lanka are Micro, Small, and Medium Enterprises (MSMEs). Most of these businesses are registered as proprietorships or as partnerships. When these enterprises are impacted, closing down the company is often the easiest and least painful option, as it helps the entrepreneurs move forward and get to the next phase of their lives quickly. If they have to spend a lot of time wrapping up their existing businesses that are not sustainable, it will slow down the economic recovery process, as a lot of valuable time, energy, money, and effort of capable people will be wasted on shutting down a company which is no longer viable. Therefore, an easy exit for businesses is as important as easy entry. Unfortunately, Sri Lanka’s labour laws do not support such an exit process and therefore, the process of exit is slowed. 

Finally, while accepting that there are no quick fixes to overcome the current crisis, we have to steel ourselves to go through the tough process of bridging reforms for markets to work. Markets work with credibility, a sound legal framework, and the rule of law. Given that the current situation has more to do with a question of credibility, legal reforms often go hand in hand with political reforms. Therefore, policymakers have to look at the reforms from a holistic point of view rather than just seeking out a quick fix. We are at the stage of sowing seeds for future reaping – if we don’t manage this situation well, we will reap a bad harvest once again.

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.

Tackling poverty with competent policies

Originally appeared on The Morning.

By Dhananath Fernando

I learnt poverty through two sources. Firstly, I myself have experienced poverty. 

At university, a basic lunch was served for Rs. 20. It was just three curries, and often the only source of protein was a watery fish curry or half an egg. A watery chicken curry with saffron rice was only served on Fridays. It was a very basic meal. There was an option to get a re-serving for Rs. 5.

The re-serving provided only the curries (not the protein source) on the condition that you went with the unfinished plate. Students who couldn’t afford Rs. 20 for the full meal would wait until a friend finished their first round, borrow their unwashed plate, and join the line for just the Rs. 5 re-serving. At one point in my life I was one of those students. 

That’s why this column has alerted the reader many times to the possibility of rising inflation due to Modern Monetary Theory (MMT). Money matters, and when inflation starts skyrocketing, basic essentials will be in short supply and the poor will suffer. 

Secondly, I learnt about poverty through my volunteer experience at CandleAid Lanka (1). CandleAid is a Government-approved humanitarian organisation founded by Captain Elmo Jayawardena. I have seen and heard so many stories of poverty and overcoming poverty from around the country during my interactions with CandleAid and Capt. Jayawardena. Out of all the stories, the story of Pahalagedara Jayathilaka is simply inspiring and reshaped my understanding of what poverty means for the poor.

Pahalagedara Jayathilaka was a crippled child who started his education in a borrowed wheelchair. His father had passed away from cancer when he was 10. Once, when narrating Jayathilaka’s story, Capt. Jayawardena said: “Jayathilaka’s best meals at university had been a cream bun or a fish bun.”

To cut a long story short, from the bottom of the poverty barrel, with the sheer determination and pure courage of his mother, Jayathilaka successfully entered the University of Moratuwa. He had come to Moratuwa with just his crutches and Rs. 1,000 in hand. Then CandleAid had provided him with an education sponsorship, through which he obtained superb results and a first class in Mechanical Engineering, and subsequently received a scholarship to the National University of Singapore (NUS). Today he is a Postdoctoral Researcher at the Department of Oncology of the University of Oxford (2).

In the terminology of economic research, there are many definitions of poverty, such as urban poverty and rural poverty, but the jargon of researchers is not sufficiently descriptive of the circumstances people find themselves in. When you are actually facing poverty, your decision-making processes, consequences, and outcomes in life are very different. 

For people in poverty, what matters the most is a fair opportunity to have a chance to succeed in life. It is an evolving process and it will never be an overnight miracle. 

They can overcome their circumstances if we establish the proper macroeconomic environment. That is what most of us forget; we forget the basics and try to target poverty without realising that macroeconomic instability causes poverty. 

I believe Pahalagedara Jayathilaka was unstoppable because he got a fair chance to compete as well as  support from a private charitable organisation. He was upskilled, an opportunity was created, and his fate was changed. 

The question during these unprecedented times is: how can we save our poor, and how can we support more people like Jayathilaka to create outstanding success stories? Of course, most people may not have stories as outstanding as Jayathilaka did, but they will at least gradually move above the poverty line and acquire a higher standard of living.

Before any suggestions are made, we need to understand that bringing down the inflation rate is the best way to help the poor. We created this problem of high inflation through bad monetary and fiscal policy, so bringing down inflation and creating stability through competent policy has to be the first priority. 

Furthermore, this column has often suggested the establishment of an efficient cash transfer system through the Government mechanism. While that is still an option, we all know how inefficient our Government apparatus is. 

The other option is to encourage private charitable organisations to help the poor. These organisations have good targeting systems and they have the capacity to reach people like Pahalagedara Jayathilaka and identify those who are truly in need. They are already doing a commendable service at a grassroots level, managing highly agile and impactful charitable projects to look after the poor. 

It would of course be the best case scenario if the Government can manage this, but our experience is that the Government’s management of all affairs is far below even our most basic expectations. 

Most charitable organisations have a far better reputation than the Government, and it is likely that expatriates will be more open to the idea of donating to these organisations than to the State to manage relief for the poor. This will bring in foreign exchange inflows, which will add further relief to our State coffers to manage essential imports.  

The best way to eradicate poverty is by creating wealth. To create wealth we need to first create opportunities, because the easiest tradeable good that the poor have is labour and human capital. We need to set up competitive processes to upskill our labour; poor people will gradually emerge from the poverty trap through the dignity of labour, and not by just becoming henchmen for a political party or by waiting in long queues to get a small cash subsidy or a handout.

A cash transfer system is a must. We should move as fast as possible on this matter. However, looking at how slowly things move with Government bureaucracy, it’s reasonable to assume that this will take time. 

Regardless, poor people cannot stay hungry for long. That is why we have to tackle inflation as public enemy number one and stop adding further inflationary pressures to our economy. Until we get the cash transfer system up and running, private charitable organisations should at least be approached or requested to come forward to utilise their network. They will be able to work faster than the Government and find and support many other Pahalagedara Jayathilakas who can excel. 

I still remember how Captain Jayawardena concluded his long story with a lot of emotion all those years ago. 

Every word I wrote about Jayathilaka is the absolute truth. Jayathilaka does not need colouring.

References:

• https://www.ft.lk/News/some-call-it-courage-e28093-the-definition-is-inadequate/56-39233

• https://www.oncology.ox.ac.uk/team/jayathilake-pahala-gedara

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.

Salvaging the debt-ridden National Carrier

Originally appeared on The Morning.

By Dhananath Fernando

Privatising SriLankan Airlines is a hot topic once more, although this discussion is decades old now. Founded as Air Lanka in 1979, the airline was described by Singapore’s Lee Kuan Yew as “a glamour project, not of great value for developing Sri Lanka”. 

In 1998 Air Lanka signed a 10-year management contract with Dubai-based Emirates Airline for 40% of shares and provided the Emirates management the ability to make most of the management decisions. Air Lanka was rebranded as SriLankan Airlines. However, after 10 years, Emirates realised that the Sri Lankan Government was not going to renew the contract. 

According to SriLankan Airlines Annual Reports from 2008, the final year in which Emirates operated the airline, it made a profit of Rs. 4.4 billion. It was mentioned in some reports that this profit included insurance claims after the terrorist attacks on the Bandaranaike International Airport. 

Fig 1: Losses and Profits of Sri Lankan Airlines

However, since then, SriLankan Airlines has not made a single cent of profit. Cumulatively it has lost Rs. 372 billion since 2008. The airline made a loss of Rs. 44 billion in 2019, Rs. 47 billion in 2020, and Rs. 45 billion in 2021. Losses in 2019 were equivalent to 93% of the Samurdhi scheme’s budget – Samurdhi being the main social safety net in place to protect the poor. The losses were also equivalent to 84% and 90% of the Samurdhi budget in 2020 and 2021, respectively. These losses are equivalent to 17% of 2019’s health sector allocation in the National Budget. 

The problem is both clear and dire. We maintain a national airline at a substantial loss and ask the common people, many of whom don’t even possess a passport or haven’t even stepped on an aeroplane, to foot the bill. In other words, we are maintaining a failing  airline at the expense of the education and healthcare of our people. 

There are multiple reasons why SriLankan Airlines incurs losses. It is too politicised and many politicians and their relatives are not charged for extra baggage when they travel. Board appointments and recruitments have all been politically driven. Simply put, it is bad management. The general remedy for bad management is to replace it with good management so we can make the enterprise profitable. This has been the popular suggestion each time that the privatisation of SriLankan Airlines has been proposed. That is the exact thing we have been trying to do since we ended the management contract with Emirates. 

We have to ask ourselves why the outcome hasn’t changed even after the same remedy has been proposed and implemented repeatedly. Simply put, when you don’t invest sufficient money, time, or reputation into a business, no one has the ability to make it profitable. All the business leaders who have been appointed to lead the firm already have their own businesses, so it is obvious that SriLankan Airlines will become a secondary priority. 

Airlines are a very competitive business. Even privately-owned airlines are finding it difficult to compete and maximise profits, so how can we expect a State-owned and managed airline to do the same? There is a difference between a private company making a loss versus a State-owned company making a loss. A private company’s losses are borne by the private investors, who knowingly and consensually made the choice to invest their money in a potentially risky endeavour. But when public companies make losses, taxpayers have to pay and their money will be spent without their consent. How can this be justified, especially in a country like Sri Lanka where people suffer from a lack of basic needs, and when our healthcare, education, and social safety nets need significant improvement?

So what can be done about SriLankan Airlines? SriLankan Airlines’ business has few strategic units: The airline operation, catering, and the ground handling operation. Each section has some assets as well as liabilities. Overall, the airline has a lot of liabilities and debt. Most of the debt is guaranteed by the Treasury (part of it dollar denominated), which is part of the debt that is to be restructured as per the announcement on 12 April 2022.

Table: Debt guaranteed by Sri Lanka treasury for Sri Lankan Airlines

Accordingly, one option is that we ask strategic investors to pitch in to buy SriLankan outright. The bidding process has to be made transparent and competitive. The airline as a group is making colossal losses, so it is unlikely that we will be able to realise significant proceeds from the sale. As has been said, beggars can’t be choosers. 

Another option is for divisions like catering to be sold at concessionary rates to a potential buyer, again through a competitive bidding process, so that we don’t have to shoulder the burden of managing an operation while also closing any future window for corruption.

There is also the option to explore the feasibility of a similar kind of management contract or a Public-Private Partnership (PPP) similar to that which existed with Emirates. However, our airline is now in such a poor shape financially that the feasibility of a management contract is questionable. 

There are suggestions to list the airline on the Colombo Stock Exchange and allow investors to buy shares. Generally listings are successful when the company is doing well. At the moment, given the present economic conditions of the country and the historical performance of the entity, this may be challenging.   

Finding a strategic investor through a competitive bidding process is still a possibility given our connectivity with the main South Indian airports. Some Indian and international airlines may have an interest in expanding their network and will see a potential win-win situation. 

We have to begin the process of privatisation as it is obvious that we can’t run a business on taxpayer money at a time when the people are struggling for their basic survival. The citizens of Sri Lanka gave the management experts of all political parties and their close associates multiple opportunities over 14 years to turn the airline around and bore significant losses in return. Let us hope that policymakers will understand the gravity of the situation and that they will not allow such a huge drain on our coffers to continue unimpeded. 

For explanation of SLA losses for 4 years.

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.

Becoming the victim of one’s own policies

Originally appeared on The Morning.

By Dhananath Fernando

At a recent press conference, the Central Bank of Sri Lanka (CBSL) announced that importing goods through open accounts was going to be banned as a move to curb the money transfer through undiyal and hawala. In my view, this will have a negative impact on the supply of essential food items, drugs, and some raw materials. 

When a merchant imports goods, they can pay their supplier through a letter of credit. A letter of credit is simply a letter of guarantee by a bank or a financial institution to the supplier/seller that the correct amount will be paid in full on time. To open a letter of credit, the Sri Lankan importers should be able to buy foreign exchange or simply purchase US Dollars. But as we are all aware, all Sri Lankan banks have a drastic shortage of foreign exchange. The shortage is of such severity that we can’t import essentials, and in some cases even life saving drugs. 

In the case of imports, if the buyer and the seller have mutual trust, a letter of credit is not mandatory. They can settle on a credit basis later on. The goods will be cleared on Documents against Payments (DP) or Documents against Acceptance (DA). Most importers and their buyers/suppliers have long-standing business relationships. They pay later either through different modes including hawala and undiyal. This is no secret. They pay an additional charge for hawala and undiyal to buy USD for a reason, which is simply that our banks don’t have sufficient dollars to facilitate imports even if the importer requests the opening of a letter of credit. Otherwise, no businessman would want to pay a higher price for forex if there were cheaper options available. Especially in the areas of food, medicine, essentials, and raw materials, these open account transactions are common. According to a recent news report, approximately $ 1.6-1.8 billion worth of transactions are done on open accounts every month. 

So what could happen when the Central Bank forces these importers to conduct transactions only through letters of credit? Simply put, they may not have any option other than to stop importing. Because banks don’t have USD, they can’t even import on open accounts to settle later. The Central Bank expects more USD to flow into formal channels since the demand for USD through undiyal and hawala is set to decline with the new regulation banning open accounts. Even if the Central Bank’s assumption is right, it won’t happen overnight. Given the uncertainty, importers will either hold or slow down the imports to observe the situation. It will take a few months to settle even if all USD inflows started flowing through official channels. What would happen to our essential food items, certain raw materials for businesses, and drugs during those long months? 

However, so far the Gazette notification has not been issued by the Central Bank, and we have to wait and observe the situation in the next few months.

It is not the first time the Central Bank has burnt its fingers by unnecessary attempts to control the market. 

First, the Central Bank imposed a 100% cash margin requirement on vehicle imports in 2018 and later vehicle importation was banned completely (1).

Later, the Central Bank’s 100% cash margin requirement on selected imports categorised as non-essentials was extended from vehicles to many other imports (2). This column questioned how an officer decides what is essential and what is not essential. A digital camera may not be considered an essential by a writer or a banker, but a camera is an essential to a wedding photographer whose livelihood depends on it. 

Then, the Central Bank stopped the forward purchasing market and only provided space to open letters of credit with a 180-day limit. 

It was then decided to artificially keep the currency at Rs. 200 per USD, and the undiyal and hawala market expanded dramatically.

All the main Key Performance Indicators (KPI) of the Central Bank have been eroded drastically during the same period in which these controls were imposed. Our inflation has increased to 29.8% and our food inflation has increased to almost 50%. Our currency has depreciated by more than 75% in a matter of a few months. Simply put, our Central Bank has fallen far short on all its key indicators regardless of back-to-back controls and interventions. Many new theories employed by CBSL economists, including Modern Monetary Theory, have backfired spectacularly and unfortunately it is the poor people who have to pay the ultimate price in hunger and inconvenience for the grave mistakes of the Central Bank and the Monetary Board.  

As a remedial action to these mistakes, our Central Bank has now made an attempt to ban open accounts and cripple the undiyal and hawala systems. 

In my humble opinion, this may potentially create shortages of essentials and inconvenience the traders and importers who have been supplying the essentials at a higher price. These merchants have been bearing the higher cost of the informal markets boosted by the Central Bank due to mistakes beyond their control made by policymakers. 

We have to first ask ourselves why an importer should bear a higher price on USD to import. Without fixing our monetary policy, there is no point passing the blame to the hawala and undiyal markets. They have existed for centuries in Sri Lanka and around the world because of their competitive and evolving nature. The buck stops with policymakers, and not with merchants or foriegn currency middlemen.

Quite frankly, it will accomplish very little to close the stable door after the horse has already bolted.  

References:

• https://www.cbsl.gov.lk/en/node/4093

• https://www.cbsl.gov.lk/en/news/margin-deposit-requirement-of-importation-under-letter-of-credit
  

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.

Walking the talk on reforms: First step to Lankan recovery

Originally appeared on The Morning.

By Dhananath Fernando

Often we all see the world the way we want to see it, and not as it is. Sri Lanka’s economic crisis is also seen by many people through their own perception of reality. 

In previous years, we believed that self-sufficiency, State-led industrialisation, State-centred economic planning, and more recently, Modern Monetary Theory, were the way forward for our economy. The current crisis has shown that none of that has really helped us; by contrast, it has exacerbated a poor situation to where we are today.  

Next comes the question of overcoming the crisis. This has to be analysed with context; the most significant piece of context is that we are facing the worst situation we’ve been in since independence in 1948 – and it is only getting worse. 

There are some suggestions to increase industrialisation, improve exports and the trade balance, and incentivise Foriegn Direct Investments (FDIs). However, it is of no use to have lofty goals of industrialisation when we can hardly provide an uninterrupted electricity supply. 

Foreign investors are planning to leave. Investors are by no means considering entering the country. Thus, potential solutions have to be evaluated based on this context. Simply having a wishlist of suggestions with minimal viability will add very little value at this juncture. We need rational solutions to solve the crisis immediately, rather than policies that can only be enacted in times of relative normalcy. 

The Government needs to bring its finances into a sustainable state. Revenue must increase and expenditure should be reduced. Reducing the losses of State enterprises is a way to reduce the deficit without touching social expenditure.

With that in mind, here are a few suggestions for reform:

1. Privatise SriLankan Airlines

At a time when people are struggling to feed their families and when our official usable reserves are less than $ 200 million, there are very few upsides to running a fully State-owned airline making losses equivalent to the value of our entire Samurdhi scheme, which, despite its flaws, is the main social safety net in Sri Lanka. Privatisation will provide strong signals that we are serious about reforms. 

For the last 15 years, we have not made any profits on SriLankan Airlines. We can disclose all finances and ask for interested companies to buy it outright with assets and liabilities. Having a higher liability than assets is the main problem in this instance. With the suspension of debt repayment of State enterprises, Treasury guarantees for the State are on hold at the moment. 

Even if we need to pay a certain amount to the buyer to take it off our hands and sell it off with staff, it is much better than keeping the enterprise in-house and incurring colossal losses repeatedly. The new buyer can be given the responsibility of staff restructuring. We can follow the playbook through which Air India was sold outright by the Modi Government. Our airline is unfortunately no longer an asset but a liability to our national coffers. 

However, it is not only the National Airline that makes losses. There are many institutes that add little value to the public, make massive losses, and are a very high burden on the Treasury. Some of these public enterprises are classified as ‘strategic’ and others as ‘non-strategic,’ but two things they have in common is that, more often than not, they make substantial losses and have very limited transparency. 

There were some discussions to revive Sri Lankan Airlines by appointing business leaders with a profit motive, converting it to a budget airline, and appointing committees to reform and restructure. We have run out of time to even attempt these options. Unfortunately, hard times require hard decisions and we do not have the time, money, or options to avoid them. 

With interest rates and Treasury bill interest rates reaching above 20%, running loss-making enterprises on borrowed money will make our local debt increasingly unstable the more we delay reforms. Most importantly, we don’t need to wait for pressure from creditors or the International Monetary Fund (IMF) to kickstart reforms; we can begin them now.

2. Better utilisation of idle assets

Improving service efficiency and increasing revenue of railways through Public-Private Partnerships (PPP) have to be the way forward for better utilisation of idle assets. 

Sri Lanka Railways is categorised as a department of the Government, even though it is actually a State-Owned Enterprise. Sri Lanka Railways holds a considerable amount of State land which is used very unproductively. 

Fort Railway Station, Maradana Railway Station, and the surrounding land along the track between these two stations are prime examples. Major railway stations such as Kollupitiya, Wellawatte, and Bambalapitiya are all prime beachfront properties which are very poorly maintained and completely underutilised. Land prices in Colombo are extremely high. There are plenty of such examples under the Railways Department with zero or negative value addition to our economy. Sri Lanka Railways first has to be made a State-Owned Enterprise, and then the sector needs to be opened for private sector investment. 

In the past, some train compartments were operated by private players and it was a very successful and lucrative business model. If we eliminate the State railway monopoly and open up the time table, tracks, and properties to the private sector, we can cut down on our fuel consumption significantly, provide a convenient service to passengers, and even turn a loss-making liability into a revenue-generating asset.

Given the very high energy prices at present – which are only set to increase – many people need the option of efficient and robust public transit infrastructure. In any case, the majority of people in Sri Lanka cannot afford to purchase and operate personal vehicles, and trains have been the main source of transportation in areas where they are available.

It is also of paramount importance that the most vulnerable segments of the population benefit from a rehauled cash transfer system, which should cover the energy price component in public transport. Everyone, regardless of their socio-economic stratification, should be given a fair chance to compete in life. 

However, it should be emphasised that these two steps alone will not help overcome the crisis. However, it is a good start to get the wheels rolling on reforms. These reforms will provide an unambiguous signal to investors and the world that we are no longer a NATO (No Action, Talk Only) nation, but a nation that walks the talk.

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

How protectionism killed Sri Lankan industry

Originally appeared on The Morning.

By Dhananath Fernando

Sri Lanka’s economic crisis was probably a crisis which was analysed (indeed over-analysed) and predicted from an early stage, but we failed to avoid it. We all knew that it was coming and therefore remedies were presented much earlier, but our policymakers simply turned a blind eye. They didn’t have the courage to face reality. Instead, they thought that wishful thinking would save Sri Lanka from the current crisis, and today, we have hit rock bottom. Unfortunately, we are just at the beginning of the crisis and have not even reached the recovery phase.  

It is important to reiterate that self-sufficiency, Modern Monetary Theory, industrial policy, protectionism, and import substitution failed yet again, and this time brought our people down on their knees. While we look towards solutions, we must also understand that it is not easy to rebuild an economy once it collapses. Recovery takes time, and recovery can only happen with the right set of policies.

There is one school of thought that argues that the lack of industrialisation is the reason for Sri Lanka’s balance of payments crisis. The main argument is that if we produced more to export, we would have had more USD revenue and this crisis would not have taken place. So the argument again comes back to import substitution, which involves banning imports or imposing higher tariffs on imports in order to produce locally. The argument is that this can save import expenditure while local manufacturing can scale up in order to focus on exports and bring export revenue. In the same theory, it is recommended that the government picks up which industries should be supported and which industries should not. This is simply going back to the same theory of the central planning model where a few officers decide which industries are good and which are bad. Often quoted examples for this are Japan, South Korea, and Vietnam. So today, let’s evaluate the strategy of industrialisation based on market principles. 

In simple terms, you become a good sailor by facing rough waters. Similarly the government selecting which industries to support and which industries to avoid will have consequences for all industries. Industrialisation should take place in a market system that optimally allocates all the available resources. If the government intervenes to assist one industry, it will have a knock-on effect on all other industries. Japan is indeed a classic example. The high-powered Japanese Ministry of Trade and Industry (MITI) recommended that Toyoda not produce cars. But he ignored their advice and today no explanations are required on Toyota’s success and competitiveness. In fact, in our apparel industry, big companies follow Toyoda’s example in the lean manufacturing techniques they pioneered. Rather than providing government support, price controls imposed by the Japanese Government impacted the automobile industry. So government intervention in the markets and industries is a sure recipe for failure. 

In Sri Lanka’s case, industries such as wall tiles, floor tiles, steel, aluminium, bathware, shoes, confectionery, and many others have been protected for decades. Have they become globally competitive due to protectionism and import substitution? In fact, import substitution is the worst we can do to develop exports because it creates an incentive to only produce for the local markets and discourages producers from producing for the global market given the tariff and non-tariff protection. Do our rubber, seafood, apparel, and electronic chips industries require any protection for them to be globally competitive? The simple answer is: no.  

In cricket terms, we can’t create a world class batsman by asking the bowlers to bowl loose deliveries. We can’t create a good bowler by asking the batsman to go soft on bowlers. Only in a competitive environment are heroes created. The protection is a sure way of killing the heroes and robbing poor consumers and exporters simultaneously. That is exactly what we have been doing for the last few decades. 

No export promotion can be done through import substitution; in fact, import substitution is killing our export potential. When the exporters have to pay more than 40% higher for construction materials, it is impossible for even our best performing exports to be competitive in global markets. 

If we observe the trade data, it is clear that our imports and exports are both declining as a percentage of GDP. In 2009, Sri Lanka had nine import taxes in addition to standard customs duties, and five of them are ‘para-tariffs’. Between 2004-2009, our total nominal protection doubled from 13.4% to 27.9%. Higher protectionism also indicates our continuous drop in both imports and exports.

Things got worse over time. The average effective rate of protection for manufacturing production increased from 47% to 63% from 2000 to 2015, and production for the domestic market was over 70% more profitable compared to production for exporting (World Bank, 2005; DCS, 2018). 

Accordingly, industrial policy and import substitution are contributory factors to where we are today with low exports and low productivity in the economy. 

In the history of industrialisation there are certain instances where some countries protected local industries, but in the success stories, protection had been given for a specified, strict time period or output and had a price-based structure.

Countries such as South Korea and Vietnam too became competitive not through import substitution but by allowing the markets to work. In a paper authored by Advocata Advisor Prof. Premachandra Athukorala, he quotes General Park Chung-Hee, who is considered the father of the Korean economic miracle: 

“The economic planning or long-range development programme must not be allowed to stifle creativity or spontaneity of private enterprises. We should utilise to the maximum extent the merit usually introduced by the price mechanism of free competition, thus avoiding the possible damages accompanying a monopoly system. There can be and will be no economic planning for the sake of planning itself.”

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’s economy is entering a dangerous tailspin

Originally appeared on Daily Mirror

By Ravi Rathnasabapathy and Rehana Thowfeek

Sri Lanka has just entered the deepest economic crisis in its history. Shortages and rising prices that people face today are only the first inkling of what lies ahead. Unless decisive action is taken, it can go into a destructive tailspin. 

Downgrades and forex shortages mean foreign banks will only accept upfront payments for imports until credibility is restored. This means the country is now in a hand-to-mouth existence: imports are restricted to the quantum of foreign exchange inflows. These inflows are shrinking. 

Production of goods and services, for both exports and domestic consumption is contracting due to shortages of fuel, power and other inputs. Exporters are losing orders as overseas buyers, concerned about the inability to supply and missed deadlines are switching orders to other countries. Tourist numbers dwindle due to long power cuts, lack of fuel for transport and the closure of restaurants due to lack of gas. 

Lower exports lead to even lower foreign exchange receipts, which in turn limits production even further. With each cycle, the noose tightens further, until eventually most activity ceases. 

The shrinking supply of goods and services within the economy leads to increases in prices, as spending outpaces production. Businesses become unviable due to their inability to function at normal capacity and people lose their livelihoods. As activity shrinks, individuals and businesses alike find it difficult to repay their bank loans and the pressure shifts to the banking sector. This cycle continues until most economic activity grinds to a halt. As the country is pushed into a subsistence existence malnutrition and hunger become widespread.

The crippling effects of the inability to import are similar to that of being under international sanctions except that these have been self-inflicted. Now that the downward cycle has started, it is very difficult to stop as the forces of destruction gather momentum and speed. Until the appointment of the new governor last week, Sri Lanka was in free-fall. The best hope now is to arrest the descent and stabilise it at some point. The governor has taken only the first step on the path to stabilisation but much more needs to be done.

It is clear from the people’s protests that the public have lost confidence in the government. What people don’t realise is that multilateral agencies, international banks and rating agencies have also lost confidence. The government budgets the last two years were replete with errors: overestimated revenues, irreconcilable differences and unrealistic assumptions. Abrupt changes in polices and asinine statements by officials underlined these concerns; one international bank entitled its update “Denial is not a Strategy”. Even before the default many foreign banks refuse to accept letters of credit from Sri Lankan banks unless guaranteed by an international bank.    
A key benefit of an International Monetary Fund (IMF) programme is that it will restore confidence. The mere fact that the government budgets and forecasts are being reviewed by the IMF signals that they are based on realistic assumptions and reasonable estimates. Together with concrete steps towards repairing public finances it will restore some confidence among lenders and pave the way for bridge finance – to relieve some of the crippling shortages that are choking production and livelihoods.

Returning to growth is not impossible but this means addressing the structural issues within the economy, a matter that is all but impossible due to the thicket of vested interests that have grown during the past two decades.

Stabilisation – averting complete meltdown
The major cause of the disequilibrium in the economy was the excessive money printing carried out by the Central Bank since 2019. Money has been printed to finance government expenditure at an alarming rate. The huge increase in government spending results in strong demand for goods and services within the economy. High levels of demand feed into local products and services as well as for imports. Historically, whenever the government has run a large budget deficit financed by the Central Bank credit, it has always resulted in a current account deficit.
The first step to addressing the problem of money printing is to borrow from the domestic market, instead of the Central Bank. Given the enormous sums being borrowed, the government needs to offer a sufficiently high interest rate to attract the required quantum of funds. This is why rates have been raised sharply. Higher rates will reduce consumption by the private sector (which also reduces imports) but may also affect investment, so such high rates, while unavoidable to stabilise the present situation, cannot be maintained in the long term.

For rates to reduce, the levels of government borrowing must reduce. This means cutting the budget deficit. This will have to be approached in two ways: an increase in taxes and a reduction in expenditure.

Increases in personal taxes will reduce the government deficit and therefore the government borrowing requirement reducing the pressure on interest rates. Higher taxes can help curtail private consumption (including import consumption) but may also impact savings and therefore investment. Increases in corporate taxes could curtail investment.

To minimise the negative effect on investment, the government should not rely on taxes alone, expenditure must be cut but the recurrent expenditure is very rigid (mainly salaries, interest and pensions), so reducing capital expenditure is more feasible both politically and practically. Resistance will however be encountered due the corruption involved, especially in highway projects. Reducing the drain from state enterprises and the disposal of idle or underutilised assets are other avenues to close the deficit. Some trimming of unnecessary current government expenditures can increase available fiscal space for social transfers.

Since the majority of the government expenditure is spent on salaries, pensions and interest, a recruitment freeze and a freeze on increments will halt further expansion. All discretionary expenditure unless directly welfare-related must be frozen along with capital expenditure at least in the short term. All transfers and support to state-owned enterprises must cease.

The imbalances will be resolved due to a combination of factors: contraction of demand due to higher interest rates and higher prices which follow from the adjustment of prices to the realistic exchange rate. Prices will need to rise to the market-clearing rate, critically energy prices, which are dependent on the exchange rate. This, however, delivers a huge negative shock to the poor, so it must be cushioned with social transfers.

These are purely stabilisation measures. If carried out properly, this can restore the economy to its state in 2019 but at a higher price level, higher unemployment, lower levels of output and higher levels of poverty. Those in the middle and lower-income groups will be pushed further down the income spectrum: large sections of the middle class will find themselves poor and the poor will be left in abject poverty. Due to low levels of productivity growth will be stagnant at 1-2 percent.

Some of the destruction that has been wrought on businesses will be permanent. The rate of increase in prices will slow to tolerable levels but prices for the most part will not decline from the current high levels. Lower incomes and high prices lead to much lower living standards for most people. The low levels of productivity within the economy mean that prospects for escaping poverty remain poor but on the positive side, things will stop getting worse.
If people are to have some hope, then growth needs to be restored, which means addressing the problem of productivity.

Growth – Restoring prospects for recovery 
The people will have little prospects unless growth returns but growth is impossible unless the barriers that impede it are addressed. 

Sustained economic growth and productivity improvement are intricately linked. These are two sides of the same coin: a faster rate of economic growth cannot be maintained without productivity improvement. Higher productivity must be achieved in all sectors of economy, including the government, public sector and agriculture, where it is weakest.

At its simplest, productivity is a measure of an economy’s ability to produce outputs (goods and services) from a given set of inputs. The more productive the economy, the more value it is able to generate, either through more efficient allocation of inputs, greater productive efficiency in converting inputs into outputs or through innovation – coming up with new products and processes. Achieving sustained economic growth ultimately depends on an economy’s ability to increase its productivity over time, so improving productivity should be the key long-term goal of economic policy.

Many of the barriers to increased productivity are the result of policies and regulations of past governments. Misguided or poorly implemented measures to protect or encourage particular sectors have stifled the competitive forces that drive productivity resulting in higher costs of production. Competitive intensity is a key driver of productivity. It is only in a highly competitive business environment that firms have a strong incentive to adopt best-practice techniques, and technology and engage in innovative activity. This works in three main ways. 

First, within firms, competition acts as a disciplining device, placing pressure on the managers to become more efficient. Secondly, competition ensures that more productive firms increase their market share at the expense of the less productive. These low productivity firms may then exit the market, to be replaced by higher productivity firms. Thirdly and perhaps most importantly, competition drives firms to innovate, coming up with new products and processes, which can lead to step-changes in efficiency. Protectionism shields them from these competitive forces and eliminates a vital incentive, stunting long-term growth. 

Increasing competition means opening the country to investment and trade, reducing the tariffs and regulatory impediments to both. This can help reduce consumer prices and prices of inputs. Import competition spurs local businesses to greater efficiency. With sound macroeconomic policies in place imports can flow in freely.

Within the government, productivity must be addressed through the process of privatisation of commercial activities that could be more productively undertaken by the private sector and the closing down of non-viable state-owned entities, reforming the legal foundations of the economy and substantially increasing the efficiency in critical government functions. For example, increasing the efficiency in the areas of tax and custom procedures and reducing trade and regulatory barriers to enhance competitiveness, digitisation and better systems that improve efficiency and ease of doing business.

Policymakers have no idea of how grave this crisis is or how bad things could get. It is a classic debt and balance of payments crisis, which, if mishandled, can result in a complete meltdown of the economy. The government has appointed, at long last, competent officials in the governor and the treasury secretary aided by a solid team in Indrajith Coomaraswamy, Shanta Devarajan and Sharmini Cooray. They must have unwavering support from the executive and legislature. All political parties need to work together towards resolving the political deadlock and restoring political stability to ensure economic change can be achieved without delay. 

Compounded crises: IMF the only way out

Originally appeared on The Morning.

By Dhananath Fernando

Economic crises are difficult to solve. In the case of a natural disaster, we know that it will come to an end at some point. We just have to manage for a short period until everything settles. By contrast, economic crises are different. They generally come in a package of five separate but intertwined crises if not managed well. It is clearly best to avoid crises, but when the crisis hits, and if we fail to manage it, the situation becomes significantly worse. Sri Lanka, unfortunately, seems to be managing the situation badly. 

What we are currently experiencing is the balance of payments crisis. Simply put, we don’t have sufficient US Dollars to import essentials, including fuel and medicine. As a result, the lifestyle that we used to live cannot be sustained as long as these conditions prevail. 

The second crisis just around the corner is the debt crisis. We have a $ 1 billion payment to be paid on 25 July and our usable reserves amount to only about $ 150 million. It has clearly come to the point where restructuring debt is unavoidable. Debt restructuring will be a painful process for creditors and debtors equally. This will have an unavoidable impact on the local economy. Additionally, the debt restructuring can be done with an IMF programme. The IMF is the only organisation that can bring credibility to a country that has proved that “it is not good for money”.

The critical question is, how is Sri Lanka going to finance its trade until we negotiate with the IMF and have an agreed-upon programme of restructuring debt? If we had sufficient reserves, we would at least have had a backup option, but we all know reserves are not built for day-to-day imports but for an emergency situation like Covid-19. The other option is to get support from bilateral partners until we finalise the negotiations. Even for that to take place, generally an IMF programme is essential as they need to have some assurance that the money will be utilised to import essentials but not to bail-out any bond holders. Hence it is essential to enter into an IMF programme as early as possible, rather than beating around the bush. 

In an ideal scenario, as a country we should have moved forward with reforms before going to the IMF seeking funds and advice. Indeed, if we had carried out these reforms at the right time, then we would not have needed to go to the IMF. But if we are not doing things correctly, it’s sensible to go to the IMF, not only because of the money, but for credibility and discipline. The current situation is that we are already late – and the clock is ticking. There are massive shortages nationwide, which have the potential to get worse. The Government is yet to be clear about whether we intend to have an IMF programme and even as this article is being written, the country did not even have a finance minister to initiate any such discussions.

The third crisis of the package is the financial crisis. Particularly in the process of debt restructuring, some of these bonds are held by domestic banks. So restructuring will affect the local financial system. Furthermore, most of the local banks have extended credit guarantees for State-Owned Enterprises (SOEs) and it is likely that their debt will also be required to be restructured. So the impact on the financial sector can trigger a third crisis.

As these triple crises bear down, the political capital enjoyed by the Government will undoubtedly wear away. As a result, political instability will start kicking in. Especially in a country like Sri Lanka, where most essential services like fuel, electricity, and water are provided by the Government, the moment interruptions start, public resistance increases at a higher rate. In the Sri Lankan case, the political crisis has overtaken the debt crisis and the financial crisis. We are in the middle of a political and balance of payment crises and the other two crises are just a matter of time. 

The final crisis in the package is the humanitarian crisis. Especially if we fail to secure some funding lines without also delaying IMF negotiations, there is a risk of extended power cuts and further deterioration of living conditions. This can trigger a humanitarian crisis. If we drift to a disorderly default, as the Financial Times reports, “Disorderly default is the same as civil war.”

Already there are stories in the news about shortages of medicine and medical equipment and postponement of surgeries, all of which impact the humanitarian needs of the people. So urgent action is needed! However, Sri Lanka is in a complete state of dysfunction; there is no solid Government or cabinet ministers to make decisions, while public resistance keeps mounting. 

The nature of an economic crisis is that one crisis will keep instigating another and it’s not going to just go away. It takes a lot of time to overcome after things go out of control. 

We are very far behind and we need someone who really understands the depth of reforms needed and the work plan we have to adhere to. The general optimistic sentiment of ‘this shall too pass’ really won’t work here. We have expected the same to happen for a long time but it really hasn’t happened. 

Before we move to reforms, we need to keep in mind, for future reference, the cost of bad economic policy. Self-sufficiency, protectionism, intervening in markets, and ad hoc policy decisions are a recipe for a disaster and sadly we are facing one now.

We have to immediately increase interest rates and remove all surrender requirements by the Central Bank. In an economic crisis, dimensions are different. We have to immediately go to the IMF with a short- and medium-term plan with political consensus on implementation for the next five to eight years.

The problem and the solutions are already known. We need credibility, commitment to undertake reforms, and competence for execution of reforms to overcome. 

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.

A cornucopia of crises: Refuge lies in reforms

Originally appeared on The Morning

By Dhananath Fernando

Many people call me and ask what the economic crisis looks like and how they should feel about it. I always say to them, “The economic crisis is like a long night where you can’t fall asleep even when you are sleepy. At the same time, you don’t know when the sun will rise and the night will be over. You are sleepy and tired but still you can’t fall asleep.” 

This economic crisis is the same; the future is becoming uncertain and we are not sure what will happen. As Prof. Riccardo Hausmann said at an Advocata session in September 2020, “An economic crisis comes slowly, and then suddenly.”

The nature of any economic crisis is that it often comes with many other crises. Currently we are suffering from a balance of payments crisis. Simply, it means we do not have enough foreign exchange to buy essentials such as fuel, food, energy, power, and other products that we need to survive on a day-to-day basis.

The second phase is generally the interruptions of services. For example, at present with long power outages, our telecom sector is in trouble; cell towers may not be able to provide the same voice call clarity, service, and internet services as in a normal environment. So every economic activity connected to the internet is going to be affected and the jobs and income will be affected. Many young people who are internet freelance workers will lose their income and the country will erode more foreign exchange inflows.

Another example is if vehicle battery manufacturers cannot get necessary packaging material. After a few months, there will be a vehicle  battery shortage which will impact all vehicles which use batteries to start their engines. All that is just the impact to the common man due to the BOP crisis.

The second crisis is the brewing debt crisis. At the moment the debt crisis has been overtaken by shortages and long lines. But with a $1 billion payment due in July the debt crisis is knocking at our door. We haven’t made any announcements to warn our creditors yet, so the impact of debt restructuring will be felt by our entire financial sector as well as all State Owned Enterprises with credit guarantees provided by banks. 

Economics is always connected with politics. With a BOP crisis combined with a debt crisis impacting the fiscal  sector is affecting the entire political structure. This problem is at a much deeper level where whoever and whenever in power will not be able to have quick fixes. Most of the solutions are painful and already we all have become victims of the pain of shortages of basic essentials such as fuel and electricity. 

However still we can attempt to do a few quick fixes but the actual solutions are with deep economic reforms, which this column has advocated for a long time.

We have to increase the interest rates and remove all forex surrender requirements by the commercial banks to the Central Bank. At the moment interest rates are too low compared to inflation. In simple terms our inflation is at about 17%. Our interest rates are at 7-8%. So if someone deposits money at a bank, the value of the money will fall at 17% and the interest rate is only 8% so the net loss would be 9%-10%. As a result, people are more encouraged to spend money than save. When people spend money, the demand for imports is going to increase regardless of some import controls or licensing schemes.

If you inquire from businesses, generally they have high demand but the problem is they can’t supply because of supply chain interruptions due to lack of foreign exchange. So interest rates have to increase to a viable level to stabilise the economy and minimise pressure on inflation. If an economy is functioning well, we can keep the interest rates low by making it easy to access capital. But in the middle of a forex crisis we can’t afford to keep interest rates low. 

One reason for the LKR to continuously depreciate is the low interest rates. The second reason is the surrender requirement of 50% from the commercial banks to the Central Bank. The simple meaning of this is that all banks have to sell 50% of their USD income to the Central Bank at a lower rate/price. So banks may only have 50% of the balance in the market to give it to the importers and everyone who is asking for foreign exchange. As a result the exchange rate is constantly increasing and people who have foreign exchange are holding it, expecting rates to go up further. 

The final outcome is that there is a massive shortage of USD in the banking system and the black market forex trades have been highly active. It was reported that the Central Bank had suspended the licence of one money exchanger. The prevailing system will most likely exacerbate the problem and forex shortages will further increase. 

We have to immediately clear many grey areas in our stance and policy. Then a clear direction has to be provided on the stance of whether we should approach the IMF or not. Since the IMF’s Article IV report states our debt is unsustainable, it is clear that we have to restructure our debt if we were to get into any IMF programme. Until then only technical advice can be accessed. Even in our debt restructuring, we haven’t been very clear and our messaging has been so weak for markets to make any concrete decisions. Not providing clarity on these critical areas is going to extend the crisis.

The dark night of the economic crisis will last longer than we think if we move at this speed and we may even run out of candles due to the unavailability of naphtha which is a petroleum product. The solution is reforming now! 

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.