The other side of parate execution suspension

By Dhananath Fernando

Originally appeared on the Morning

In India, there was a particular type of cobra that was causing havoc due to snake bites. People were protesting and social pressure was building. The then British Government had a brilliant idea to counter cobra bite-related deaths and bring down the reptiles’ population – it announced an incentive scheme for every dead cobra.

In essence, people in India were encouraged to kill cobras and hand over the animal’s dead body to established Government offices in India and collect cash in return. In the first few weeks, things worked out very well, but later the Government realised that the number of cobras being handed over was increasing exponentially.

Upon investigation, the Government realised that Indians had become somewhat entrepreneurial. They had started cobra breeding houses at homes and killing cobras as a means of revenue generation for the family. At one point, the Government withdrew the cash incentive system given the misuse of the entire scheme.

Since there was no incentive for people to maintain cobra breeding houses, they released the reptiles into the jungle. The cobra population then multiplied several fold more than what it was initially as a result of the same policy being implemented to reduce the cobra population. This is called the Cobra Effect.

The Government decision to suspend parate execution as a relief for Micro, Small, and Medium-sized Enterprises (MSMEs) is no different. It is true that MSMEs are going through a difficult time as a result of higher inflation, high interest rates, and economic contraction. It is necessary to protect the MSMEs as they comprise about 99% of business establishments and about 75% of employment in Sri Lanka.

However, whether the suspension of parate is really for MSMEs is a question; 557 parate executions have been undertaken as of November 2023. The total value of the parate executions was just Rs. 38 billion, which stands at just 0.4% of total loans and a mere 2.7% of total impaired loans. From the numbers, it is clear that most MSMEs have not been impacted by parate executions.

Effect on MSMEs

Parate is an execution power on the part of banks under the Recovery of Loans by Banks (Special Provisions) Act, No.4 of 1990, where lending banks can recover non-repaid debt by borrowers by selling assets without going through the judicial processes. In 1961, this power was only granted to People’s Bank and the Bank of Ceylon, and in 1985, the power was extended to regional rural development banks as well.

If MSMEs are not affected, what could be expected to happen when parate executions are suspended until December by the Government? This is likely to backfire on MSMEs given the nature of the banking industry, akin to the Cobra Effect.

Banks lend depositors money. Parate was a safeguard for depositors’ money in case someone was not repaying loans they had taken, giving banks a final resort to recover that money so they could honour the depositors.

Now with parate suspension, banks have a higher risk of not being able to recover the money from the loans extended, so they have to charge a higher risk premium when borrowing for anybody, including MSMEs. Therefore, if MSMEs want to borrow money now, they have to pay higher interest rates, which means further contraction of the economy at a time when it needs to grow.

Triple whammy

On the flip side, this will encourage borrowers to default as they now know the banks cannot execute parate even if they were to willfully default. Additionally, borrowers who are honouring their loan repayments with the greatest difficulty during this economic crisis will be discouraged, because their hard work in honouring the dues will not be rewarded. This does not mean that even the Rs. 38 billion through parate execution has to be understated, but it has to be addressed separately without changing a law which affects the entire banking sector.

The Government declared a Rs. 450 billion bank recapitalisation in Budget 2024 given the instability of the banking sector as losses and loans of State-Owned Enterprises (SOEs) have to be absorbed. On the other hand, licensed commercial banks including State banks are being exposed to sovereign debt restructuring, which is at its final stage. Accordingly, this is detrimental to the stability of the banking sector.

On the depositors’ end, they may be reluctant to deposit money as their risk is now higher on recovery.

Parate execution generally takes place at the last stage of recovery and must go through a court process. Suspension of parate without even consulting banks may provide wrong signals for the ongoing International Monetary Fund (IMF) review, since the IMF initially advised to conduct an assessment on the stability of the banks, although the context has now changed after a few months.

The Non-Performing Loan (NPL) ratios of banks are also on the rise, so banks basically face a triple whammy with this parate suspension – having to charge risk premiums, high NPL, exposure to sovereign default, and now difficulties in recovering money and incentives for not servicing existing loans.

However, the need to protect MSMEs is paramount, which requires a separate sequence of actions. Setting up a bank specifically to absorb bad loans, setting up bankruptcy laws, or moratoria on some of the bad loans under parate executions are options. Changing the entire parate system will indeed bring consequences similar to the Cobra Effect in India.

Prioritising SOE bill over OSA: A shift in economic direction

By Dhananath Fernando

Originally appeared on the Morning

While the Government has prioritised the Online Safety Act (OSA), which is extremely negative for our economy, there are other bills in the line-up which are expected to get through. One such bill is on the State-Owned Enterprise (SOE) holding company.

The SOE Restructuring Unit (SOERU) has outlined the principles of SOE reforms, which are in the right direction, but the Government’s prioritisation of bringing the OSA is definitely in the wrong direction.

Key principles

While the bill on the SOE holding company is yet to be released, the SOERU has outlined nine key principles on which they expect to base the SOE reforms. In the first principle it admits the Government has no role in commercial activities except for three instances.

(1) If there is a concern on national security, the Government can engage in business.

(2) If there will be no private participation in certain industries given the size of our market, the Government can engage in business. For instance, if we open the rural bus routes for the private sector, there may be a possibility that, given the nature of the low population density, no private bus operator will be interested in entering the market. While it can be to an extent addressed through allowing to charge a higher price and the Government providing a direct cash subsidy to the citizens in the rural area, there can be practical challenges. In that case the SOERU principals have left the space for the Government to enter business.

(3) If the service from the Government is essential in nature but if the regulatory mechanisms are weak for competition, where there is opportunity for market exploitation by the private sector, the Government can be in the business.

While the three areas are logically right, we have to wait for the final bill to see how exactly this has been worded. The danger is that governments are so powerful that even in the above three areas, it can leave a lot of room to keep a lot of existing SOEs under the government of the day if the political ideology is to keep SOEs, claiming it is under national security.

In the Right to Information (RTI) Act, there is provision that the authority can decline to disclose the requested information if it threatens national security. For most RTI requests, many Government institutions have been responding that the information cannot be disclosed due to national security reasons. Therefore, defining national security or the process of deciding how an organisation or industry comes under national security is important.

Unless the Government can always build a logical stand, even institutions like the Cashew Corporation will have to be under the Government as it can impact national security.

On the second condition, that in the absence of a private player due to limitation of the market size or another criterion for a service that is essential in nature, the guidelines have to be developed in the case of what could be a new player wanting to join the industry later.

For example, it could be an industry with high capital investment and low market penetration, making Sri Lanka unattractive at the beginning due to the market size. As a result the Government can be in that business as the service is in the nature of being essential.

But over the years as technology and other parameters develop, at one point there may be new players interested in joining the industry. At that point, a natural resistance may occur from the SOEs over a new entrant being in the market as they will lose their monopoly status. The same happened when Lanka IOC entered the market and still there is some resistance to the entrance of Sinopec and other players in the energy market.

Deciding what an essential service is also requires a framework. Otherwise, when a government wants to be in a business, it can easily announce that industry as an essential service and enter the business, bringing forth various reasons.

All of the above are beyond the scope of the SOE law, but we need to keep in mind that these are the loopholes governments always have when ideological stances are different. Even if the new bill passes, we should not underestimate the skills of policymakers in finding the loopholes.

Other principles

The fourth principle of the SOE holding company is to bring all SOEs under one registration format. At the moment, different SOEs have different structures with a very high degree of complexity. For instance, the railway is a commercial activity and runs as the ‘Railway Department,’ while the Ceylon Electric Board runs as a board under an act. Meanwhile, Lanka Hospitals is a hospital but operates as a private limited company. Therefore bringing them all under one registration is vital when we set up the SOE holding company.

The fifth principle mainly focuses on the governance of SOEs as the SOE reform process is a longhaul game. The SOE holding company and the subsidiaries are required to adhere to Colombo Stock Exchange guidelines. This includes releasing quarterly financial statements and the board of directors being required to conform to the Code of Best Practice on Corporate Governance.

The other principles in the list are on unbundling the regulator and the operator in certain industries. There are industries run by the Government where the Government is a player as well as a regulator at the same time.

Overall the SOERU’s principles to base the SOE holding company is in the right direction, although there is always room for politicians to exploit the principles.

It is sad to see the pushing back of such important SOE holding company legislation over the draconian Online Safety Act.

Non-negotiable reforms for election manifestos

By Dhananath Fernando

Originally appeared on the Morning

The year 2024 will be an election year. The general flow of events is that each political party and candidate will launch a manifesto of a grand-scale and present their plans for the people and the country. Most of these promises will not be implemented or will only be half implemented. In certain cases, the opposite of what was promised will be implemented. 

Most manifestos are presented in general terms with a target of 20 years ahead with little data. Many manifestos across all party lines are wish lists with no action plans.

In my view, this time there is a slight difference. 

Regardless of the party formation or whoever the presidential candidate will be, there are few reforms that are non-negotiable. Ideally, across all manifestos, there are five basic ideas which have to be the common denominator.

Strengthening social safety nets 

Following the worst economic crisis in Sri Lanka’s history and high inflation, about four million people have fallen below the poverty line. That puts seven million people under poverty. The recent Household Income and Expenditure Survey carried out by LIRNEasia and the World Bank indicates significant poverty levels and aftereffects of poverty due to the economic crisis. As a conscientious society, we need to take care of our poor people with the social safety net. 

The social safety net is not just an allowance. It is a system and a process of targeting the right people, providing an exit route, and with proper administration. The current Aswesuma programme is making some progress with World Bank assistance, but regardless of the political leader who comes to power, it is a non-negotiable condition that social safety nets have to be strengthened and improved. 

The current process has too many loopholes which have to be addressed and improved. Simplifying the process, providing the exit route, and monitoring and depoliticising has to be a continuous effort from the new leadership of the country.

SOE reforms 

Thus far, mandatory SOE reforms have been painfully slow. Many parties with vested interests are trying to delay it until the election. However, the continuation of SOE reforms is a must. 

Colossal losses, interference in the private sector, intervening in markets, creating an unfair playing field, and inefficiencies are a few reasons why SOEs played a pivotal role in Sri Lanka’s economic crisis. SOEs are vehicles of corruption and have diluted entrepreneurship and Foreign Direct Investments significantly. Without reforming SOEs, the future of Sri Lanka appears to be bleak. 

The principles announced by the SOE Restructuring Unit are in the right direction, but the SOE Act and reforms of the Ceylon Electricity Board, Ceylon Petroleum Corporation, and many other networking industries are a must. 

Anti-corruption and governance reforms

Execution of anti-corruption laws and governance reforms is another area which has no room for negotiation. The International Monetary Fund (IMF) Governance Diagnostic and many other locally-developed reports on governance provide direction on what needs to be done. 

Strengthening our Judiciary system, transparency and accountability in our tax system, removing tax exemptions, and repealing the Special Commodity Levy and the Strategic Development Act too falls under governance and anti-corruption reforms, as those acts provide the legal opportunity for corruption. 

There is a strong sentiment from people on the contribution of corruption to the crisis, so taking long-term measures regarding corruption is a must. Anti-corruption and governance reforms go beyond going after corrupt politicians. Rather, it is a system and framework for minimising government influence. Some reforms are complementary and reforming SOEs is also a key component of anti-corruption and governance reforms, as these SOEs play a vital role in corruption.

Following the IMF programme and debt restructuring 

Given the international financial architecture, we have no option other than sticking to the IMF programme. We can negotiate some of the actions that we have promised, but overall indicative targets and reforms have to be maintained. Otherwise, it will be yet another incomplete IMF programme and the debt restructuring process will be in jeopardy. 

Debt restructuring and the continuation of the IMF programme are very much interconnected. At the moment, external stakeholders are concerned about political instability and in fact, the IMF’s first review identifies the political risks for the continuation of the IMF programme. A commitment from any political leader on sticking to the programme will help Sri Lanka in rebuilding relationships with the world.  

Trade reforms and joining global supply chains 

We have to grow our economy to emerge from this crisis. Tax revisions make it likely that growth will slow down and the only solution to grow small island nations like Sri Lanka is through global trade. Our problems regarding global trade are mainly the problems in our own regulations and systems. 

We have to remove our para-tariffs and simplify the tariff structure for a few tariff lines. Not only will this help trade, but consumers will also have a greater choice of goods and services as well as competitive prices. 

On the other hand, the Government can improve the revenue from Customs since at the moment, the high tariffs are a main reason for revenue leakage in the form of corruption. Trade reforms are about growth, minimising corruption, encouraging exports, and assuring reasonable prices. Even at present, after very high taxes, there are levies such as the Special Commodity Levy, Ports and Airports Development Levy, and a huge array of taxes which hinder the competitive nature of our economy.

These five policies, in my view, are non-negotiable. If any administration deviates from them, it is very likely that we will fall back a few miles behind where we started. 

Looming political and economic challenges ahead of elections

By Dhananath Fernando

Originally appeared on the Morning

“We know what should be done to get the country on the right track, but we don’t know how to get power back after implementing the policies.” This is a popular statement I hear often when I meet quite a few politicians. The truth is that politicians do not know how to get back power because it’s not an attractive solution.

The popular policies that bring politicians into power are the very same that inspire their ousting at the very next election cycle. People hardly object to good policies unless the same politicians instigate false propaganda. The Right to Information (RTI) Act was just one such instance.

As an election is due next year, it is vital to understand and remember our priorities, otherwise our politicians are likely to take a wrong turn and pass the buck back to the people.

In an election year, the behaviour of any political party is to completely abandon rational economic reforms and play to populist narratives that result in outcomes that are the complete opposite, with the motive of coming to power.

Bringing down fuel prices and announcing other types of subsidies are common tactics. This is harmful, especially when those benefits cannot be financed sustainably, or in some situations, brought into life in the first place.

Even if it does not retain power, the newly-elected government will have a tough time preventing plans that have already been put in place and enacting better policies.

Political risk

In the current context, we run a very high risk of our politicians bringing us back to square one; i.e. another economic crisis. This, given the fact that 2024 is set to be an election year, is a recipe for disaster.

All political parties will shift their focus to slowly becoming more populist rather than being driven by objectivity. Therefore, the real risk is going back to another debt restructuring if we fail to grow the economy and our exports.

There are many politicians who do not understand the gravity of the need for reforms. Regardless of which party or coalition comes to power, there are fundamental issues that need to be addressed.

The process is more or less the same as handing over a house with structural issues from one tenant (government) to the other. The new tenant cannot function because neither the previous tenant nor the owner (people) is willing to fix the fundamental problems.

Risk of a second debt default

Given the unstable political environment coupled with a country already going through debt restructuring, the risks of a second debt default are astronomically high. As we are still struggling with finalising the first debt restructuring, adding a second one into the mix will leave us in dire straits.

The second one will undoubtedly be harder, especially given the significant increase in interest rates and being unable to print money with the new Central Bank Act. If we fail to raise money through markets in order to roll over debt and if we are not open to increasing interest rates, the only option we will be left with is to default again. At that point, most likely there will be pressure once again to amend the newly-enacted Central Bank Act to allow money printing.

Of course, that would be an inflationary measure and we will be back at square one with a balance of payments crisis, debt crisis, humanitarian crisis, and likely a banking crisis too.

Solutions: A common minimum programme for reforms

Reforms are easier in the first 100 days of any government. If we fail to enact reforms within the first 100 days, more often than not, no reforms will take place. Failing to undertake reforms in 100 days means a cost of a five-year delay plus many bad policy decisions in the middle, which are costly and difficult to reverse.

Ideally, if key political parties come to an agreement before an election on selected reforms and execute them regardless of who comes into power, it will at least ensure some stability for Sri Lanka. There are many ideas that all political parties have in common.

Regarding State-Owned Enterprise reforms, there is no political party that says the Government should run an airline. Even National People’s Power Economic Advisor Dr. Anil Jayantha, in an interview with Advocata, noted that they did not believe the Government should do any business with hotels.

Accordingly, there are many other similar areas where we can arrive at an agreement with little difficulty. Therefore, regardless of who wins elections, people can win and sustain some of the economic reforms.

The truth is that reforms are inevitable if Sri Lanka needs to move forward and for any political party to sustain its power. Implementing bad policies, especially considering the status of our country, will make it very difficult to sustain power, because then we will be setting the standard for a new normal in economics and politics.

Fiscal path amidst promises and uncertainties

By Dhananath Fernando

Originally appeared on the Morning

Starting from the second week of November, every minute in Parliament will be focused on the national Budget. Fortunately or unfortunately, many of the promises outlined in the Budget are unlikely to be implemented or fulfilled.

At the same time, items that are not in the Budget may be implemented midway through the year, based on the direction of the wind. Things are especially likely to take a completely different turn in an election year.

A key criticism against this Budget is that the revenue proposals to cover up the expenditure proposals are not adequately mentioned. A revenue of Rs. 4,100 billion is expected for an expenditure of Rs. 6,900 billion. It’s akin to wanting to spend Rs. 69 while only having Rs. 41 in hand. The challenge is that we are uncertain as to how we will earn even Rs. 41.

An earlier proposal to increase VAT by 3% and remove the exemptions on VAT can be seen as a measure to increase revenue. There are a few proposals to increase the tax base, which is a step in the right direction, such as the requirement of a Tax Identification Number (TIN) for opening a current account, obtaining a building licence, and for revenue licences for vehicles.

The question that arises is what would happen if we fail to generate even the expected revenue and I think there are three scenarios that can occur if we fail to achieve the revenue targets in the middle of the year.

Scenario 1: Cutting down on capital expenditure

Approximately Rs. 1,200 billion has been allocated for capital expenditure in the 2024 Budget. This includes some proposals such as a new airport and building a few universities. So we will likely have to rechannel some of the capital expenditure to recurrent expenditure if we fail to generate revenue.

What is important to note is that, compared to last year, capital expenditure makes up a lower percentage of total expenditure. So in a context of starting with an already lower capital expenditure base, cutting capital expenditure from key areas of growth such as health or education further will maim our growth in the long run.

Slower growth is also not favourable for Sri Lanka because the need of the moment is growth. Only growth will increase our tax revenue and create more employment opportunities and business opportunities.

Scenario 2: High inflation

The second scenario would be the Government exploring the opportunity to get finances from the Central Bank to bridge the deficit. With the new Central Bank Act, the space for doing this is very low, but if past experiences hold true, anything is possible. There is a transition period of about 18 months and we should not underestimate the crafty nature of our politicians to find legal loopholes.

If the Budget deficit is being financed through the Central Bank (money printing), further increases in cost of living and high inflation are unavoidable. It will also drain our forex reserves and build additional pressure on our currency and likely end up with a currency depreciation after a few months’ cycle: a cycle not so distant in memory.

The Central Bank financing this Budget deficit will also challenge the sustainability of the IMF programme. As the next year is an election year, politicians will mainly think about the elections before the economy, despite promises made. While the new Central Bank Act tries to stop this from taking place, the possibility cannot be ruled out fully.

Scenario 3: Hike in interest rates

The third scenario is where the Government borrows money from the market to bridge the gap and allow interest rates to move. This will not cause inflation as the Budget deficit is not being financed through the Central Bank, but the cost of money will go up (interest rates moving up).

When the cost of money goes up, growth will contract. When this happens, businesses start winding-up operations and expansions become difficult. Also, banks will lend more money to the Government at higher interest rates, slowing down credit for the private sector.

When the economy slows down there may be an impact on the tax revenue on one side. On the other side, with limited growth, achieving debt sustainability will be challenging.

Solution

In order to prevent these scenarios from taking place, it is imperative that we reduce wasteful expenditure. The key solution is to focus on reforming State-Owned Enterprises (SOE). SOE reforms can increase revenue, cut down expenditure, bring down our debt, and attract foreign investments.

The bank recapitalisation of Rs. 450 billion, mentioned in the Budget, is due to the debt owed by two SOEs that have losses which amount to Rs. 1,800 billion. The taxpayer is now expected to pay the bill. It amounts to about Rs. 20,000 per citizen from taxpayer money for bank recapitalisation. That is a staggering Rs. 80,000 per household of four members.

Boosting tourism is also another option. While there is a fund for tourism promotions which has to be utilised well for building our brand image, it will all be in vain if we do not do things as simple as removing regulatory barriers to tourism.

The final bird in our hand as a solution is the Colombo Port City. We have to accelerate the process and attract investments.

If we play our cards right, we can at least move a step ahead in 2024.

Competition: The way forward

Originally appeared on The Morning

By Dhananath Fernando

The recent conversation on taxi services at the Bandaranaike International Airport brought back memories of one of the times I travelled overseas as a youth. The Colombo-Katunayake Highway construction was not yet completed and I had just finished university.

I did not have the means to hire a vehicle to travel from Moratuwa to Katunayake in order to catch a flight, nor did Sri Lanka have the infrastructure or many affordable choices for a poor boy like me to reach the airport quickly at a reasonable cost. There was no PickMe nor Uber, and neither did I have a smartphone.

I left home early with my borrowed luggage from a friend and came to the Moratuwa Railway Station. I took the train from there to Pettah. From Pettah, I took an air-conditioned bus, paying extra to keep my luggage in the front of the bus and took a tuk from the bus depot to the airport departure terminal. I think the time I took to travel from home to the airport was just about 30 minutes less than the travel time of my flight.

All that I went through was due to unaffordability as well as the unavailability of affordable choices to travel. If there had been proper modes of public transport available connecting trains and airports, the lives of people like me, who could not afford a taxi to the airport, could have been easier. In the context of the availability of choices, we have to evaluate whether to allow mobile app-based and registered taxi services at the airport.

It is obvious why registered taxi services at the airport charge a higher rate. Their reasons to charge a higher rate include the cost to operate at the airport by paying rent for their operating offices and keeping an adequate fleet of vehicles. Further, their cost also includes licence fees and bribes that they have to pay to obtain the licence to operate at the airport.

However, their business model has been challenged by a more technologically-advanced operation where customers can choose the type of vehicle they want and are given the ability to check the rate for the journey prior to booking the taxi. This offers many more options including safety measures, such as the ability to contact the driver after the ride in case something is left behind after long hours of travel time.

While the operation of registered taxi services is perfectly reasonable, preventing someone else with an alternative solution from entering the market will make the lives of people more difficult. In a competitive world, competition should be encouraged.

The solutions suggested by our policymakers are absurd. Certain policymakers have wished to prevent the operation of mobile app-based taxi services at the airport. Others have suggested that the airport registered taxis should also register with mobile app-based taxi services. While the second option is somewhat reasonable, a business model being rendered uncompetitive due to the development of technology is not a problem for policymakers in the first place. Imagine bullock cart owners claiming that they are being impacted by engine-driven vehicles?

Simply, this is the evolution of the world and we have to adapt or we will lose in the market. Unfortunately, airport-based taxi services are becoming uncompetitive and more importantly, customers do not see any value in their services. If a customer sees the comparative value of one service being better than the other, they should be given the opportunity to make a choice based on the available options. This service should be valid even for customers whose hotel travel is coordinated directly.

Once we look beyond this and decide to connect our airport to multimodal transportation systems (such as connecting railways and highway buses to the airport), the airport-registered vehicles as well as Uber and PickMe taxis will witness an impact on the number of hires they receive.

Will policymakers delay connecting the airport to multimodal transport systems merely in order to protect our taxi services and drivers, overlooking affordable options for consumers?

In most airports around the world, the terminals are connected to some form of public transport while any type of taxi service is allowed. In fact, the infrastructure and signage enables mobile app-based taxis and other taxi services to pick up and drop off passengers at specific points. All modifications have been undertaken to make the lives of travellers easy, affordable, and safe, instead of protecting a group of politically-affiliated rent-seekers.

The manner in which our policymakers treat this issue is a good indication of how the majority’s choices have been compromised for political reasons, for the benefit of a few who are unproductive and uncompetitive.

This norm is not only seen in this particular scenario, but everywhere in our economy, including the State sector. Similar to how registered taxi drivers are objecting to mobile app-based taxi services, the Ceylon Petroleum Corporation wishes to keep other private companies out of the market. Some tile and bathroom fitting manufacturers wish for import bans on tiles and bathroom fittings, simply for their own benefit, as do aluminium manufacturers.

Things are the same in politics. They are all basically asking Sri Lankans and tourists who arrive in the country to take long journeys, wasting a lot of their precious time and call it a ‘beautiful life in the paradise island or Asia’s little miracle’.

‘So Sri Lanka’; is it actually a miracle?

A case for privatisation

Originally appeared on The Morning

By Dhananath Fernando

While many agree on the need to reform State-Owned Enterprises (SOEs), several counter arguments remain.

There is one main argument that is reasonable: how can we be assured that corrupt politicians will make transparent transactions? The weaknesses in the previous privatisations have completely affected the confidence of the public.

On the other hand, the positive results of privatisations in cases such as Sri Lanka Telecom (SLT) are very clear. Costs have decreased while productivity and quality of service have significantly increased, and the Government has made money.

However, SLT was a partial privatisation, with the Government having the larger share of 49.5% in the company. This oversight that the Government has over the telecommunications company has once again demonstrated that it is not operating to its full potential when compared to competitors.

This is not surprising, because there is a window for corruption and favouritism when politicians have control over the administration. An article published by Sanjeeva Jayaweera, who is the Chief Financial Officer of one of Sri Lanka’s largest conglomerates, revealed some comparative statistics on the telecom sector.

This market leader, a privately-owned telecom company with more than 17.7 million subscribers, manages the operation with about 3,631 staff members and has a wage bill of Rs. 10 billion for 2021. On the contrary, SLT operates with 8,058 employees, serving about 9.3 million subscribers and has a wage bill of about Rs. 20 billion for 2021.

This is a clear indication of the space available for political appointments and usage of excess resources from the economy. The private market leader generates a revenue of Rs. 142 billion and SLT makes about Rs. 102 billion.

The average dividend income earned by the Government over the last five years is only about Rs. 1.1 billion.

Passive earning

What many forget is that the private sector making more money on a competitive basis is very much beneficial to the Government on a large scale, rather than the Government trying to do business in an unknown territory, which also results in politicisation.

A private company has to pay 15% of its entire revenue and 30% of its profits to the Government. The Government earns a significant amount of money from businesses by doing nothing. Therefore, there is no logic in intervening in markets and bearing an unnecessary burden when there are options to earn money easily.

The Government can earn even more money through PAYE taxes when employees of a private company earn more than Rs. 100,000. Accordingly, the total amount the Government earns from businesses is quite significant. Hence, it is more lucrative for the Government to hold a regulatory role rather than to engage in business.

Unfortunately, Sri Lanka does not have a competition commission. It was reported that Sri Lanka’s market leader in telecommunications was planning on acquiring another company in the market. Ideally, this transaction should go through a competition commission to evaluate the impact on customers. Sadly, Sri Lanka does not have a competition commission; nor does the competition law include or address mergers and acquisitions.

In the process of privatising, it is vitally important to have independent valuations for the company and manage the transaction transparently with no unsolicited proposals. The bidding process must be competitive and the balance sheet has to be improved to reap the maximum benefit.

According to Jayaweera’s estimation, taking an average of the share price (prior to shares becoming overvalued by privatisation discussions), the Government should be able to earn about Rs. 50 billion by trading shares. If the Government were to earn that money through dividends, it would take about 50 years. If Rs. 50 billion is invested at 10% interest, it should provide a return of Rs. 5 billion to the Government, which is five times the current earning through dividends.

National security

The second argument is on national security. This is a common argument made by politically-appointed boards of SOEs, trade unions, and affected shareholders. However, this argument has questionable logic – government ownership and operational management does not automatically ensure national security.

For example, even though the Government operates the petroleum and electricity markets, we still experienced fuel shortages and 12-hour power cuts. In the 2000s, there was a case of importing substandard fuel and during the Yahapalana regime there were fuel lines due to supply chain disruptions. If you recall, there were also times when the internet was blocked during the Aragalaya.

Even during the Yahapalana era, the internet was blocked on several occasions over national security concerns. However, even with prior warnings by the Indian intelligence services, we were unable to avoid the Easter attacks.

Therefore, if we consider facts and logic, national security has a broader mandate which goes beyond arguing that sectors such as energy and power have to be managed by the Government. Even then, petroleum products are not manufactured in Sri Lanka. We are merely importing them in vessels not owned by the Government.

Simply having control over the distribution channel does not ensure national security when the ships and entire supply chain can be interrupted by many others. The same applies for electricity and telecommunications – all high-tech equipment is supplied by multiple countries and interruptions can occur at any point.

The resistance to SOE reforms is driven more by emotion than logic. In a context where we are emotionally attached, rationale does not make any sense. But the challenge is that emotions do not count when we consider the facts and figures of the economic crisis. Unfortunately, emotional attachments cannot rescue Sri Lanka from the crisis. I wish they could.

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

Reforms: The need of the hour

Originally appeared on The Morning

By Dhananath Fernando

Former Governor of Anambra State in Nigeria Peter Obi once wisely said: “No country can progress if its politics is more profitable than its industries. In a country where those in government are richer than the entrepreneurs, they manufacture poverty.”

This is quite relevant to the Sri Lankan scenario. If so, we have been manufacturing poverty over the years and the key tool used for it by politicians is weak governance structures. Even if we apply the best economic policy in the world, it would mean nothing in a society without governance.

The current reforms which are being discussed should also give equal weight to governance. Among the key reforms that have been discussed in Parliament, governance reforms should be given paramount importance. Suggested reforms related to the Central Bank, State-Owned Enterprises (SOEs), social safety nets, and reforms on trade accounts are key components.

Governance reforms and CBSL independence

In the current set-up where the President is also the Finance Minister, there is a possibility of diluting governance structures. Both tasks are quite challenging and attempting to facilitate both will likely result in nothing, especially during an economic downturn. When reforming the Central Bank of Sri Lanka (CBSL), in order to ensure its independence, appointment of positions should come through the Constitutional Council.

Conversely, if the integrity of the Constitutional Council is diluted, the process of appointment of members to both the Monetary and Governance Boards of the Central Bank will not be channelled through proper checks and balances. This lack of governance structures in the CBSL leaves room for diluted appointments, particularly at a time when there is a need for a dynamic and credible Central Bank.

Governance reforms for SOEs

State-Owned Enterprise reforms require a governance structure with depth. At the moment, the SOE Restructuring Unit has called for proposals for transaction partners, but the selection of the partners should be managed with transparency.

One way to ensure transparency is to avoid information asymmetry by providing access to information to potential interested partners of SOEs. Unsolicited proposals should be avoided and competitive bidding processes have to be adhered to. While we can consider privatisation of some entities, it is important that we implement governance structures for the remaining SOEs.

Governance structures on procurement have to be in the forefront. In a nutshell, SOE reforms have to be driven by governance reforms. Otherwise, one bad transaction can drive public confidence down and lead Sri Lanka back to square one. Managing as well as reforming SOEs has provided a window of corruption for politicians.

As Peter Obi said, one tool for politicians to become richer than the industries itself has been either to appoint their henchmen to maintain corruption, while sometimes they try to make profits when the reforms take place. Both have to be avoided and can only be minimised through governance reforms.

Governance reforms for social safety nets

Another set of key reforms which requires a deeper governance structure are the reforms related to social safety nets. It is no secret that the existing Samurdhi programme has been politically driven and poorly targeted. However, a new scheme has been gazetted and people have been asked to apply for the new social safety net.

Ideally, the new selection has to be verified again through a third party organisation where political intervention is at a minimum. The selection of these third party organisations have to be made through a transparent procurement process. Otherwise, the same political biases on selecting the most vulnerable people will prevail.

We have to keep in mind that every reform or every move provides a window for politicians to profit more than entrepreneurs. That is the very reason why we need to limit Government involvement and bring in governance structures. Only solid governance structures and people’s solidarity with governance structures can stop politics from becoming more profitable than industries.

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.

Economics behind much-needed reforms

Originally appeared on The Morning

By Dhananath Fernando

The three types of fears we endure as a country

Fear is a universal emotion and we have all come across three major types of fear in our lives. The fear of failure is the most common one that often paralyses us and prevents us from taking action. The fear of success is a lesser-known fear that keeps us from achieving our goals. Finally, the fear of judgement causes us to fear being evaluated by others.

Unfortunately, in Sri Lanka, the fear of reform has encroached upon all three of these personal fears. In public policy, there are currently three primary fears:

Fear of reforming State-Owned Enterprises

It is no secret that Sri Lanka’s State-Owned Enterprises (SOEs) have been one of the main reasons for the country’s economic crisis. Everyone agrees that SOEs need to be reformed, but there are different opinions on how to do it. Some believe that the losses are mainly due to corruption of politicians and political influence against reforming SOEs. Others believe that with capable management, SOEs can become profitable.

However, in my opinion, the absence of competent people to run State institutions and corruption are both symptoms of the absence of a market system.

In a market system, the focus is on making profits and minimising corruption. However, it doesn’t mean everything is perfect; rather, it is geared to minimise corruption and maximise profits. Therefore, opening up the market can help solve this issue.

One key fear that is brought forward is the risk of high prices when the markets are opened. However, based on our experience, prices decrease with the opening of markets and the allowing of more competition.

For instance, Sri Lanka’s telecommunications prices are some of the lowest in the region and the entry of Lanka IOC into the fuel market did not increase prices. On the other hand, the Ceylon Petroleum Corporation (CPC) incurred losses and it had to pass these on to taxpayers. Its losses of Rs. 632 billion over eight months in 2022 will have to be borne by the people of Sri Lanka through the contribution of about Rs. 28,000 per person.

It is evident that the absence of a market system is one reason for the profits not being sustainable, so we always drift back to where we started. The losses of the CPC for the first eight months of 2022 are greater than the allocation for both health and education together, which is about Rs. 550 billion.

Such high losses are indicative that all loss-making institutes, including the CPC, SriLankan Airlines, and the Ceylon Electricity Board (CEB), should be restructured to reduce the burden on the Treasury and thereby the taxpayer.

The focus is not only on prices but also on the quality and accessibility of the service. In the past, during fuel shortages, people paid Rs. 1,000 per litre on the black market. Therefore, simply claiming that the Government can provide fuel at a lower price is not very logical. We need a Sri Lanka where people can afford and decide what they want to use rather than the Government deciding what we should do. This is the Sri Lanka we envision.

Regulation is crucial and the Government needs to create a regulatory framework to ensure a level playing field. The current Public Utilities Commission Act has provisions, but we need to move towards a competition commission to ensure fair competition.

Fear of competition

The second fear among Sri Lankans is the fear of competition. We consider competition as one person winning and the other person losing. However, it is a formula where both sides can win. The fear of competition mainly arises in global trade and we often wish to block our competition by imposing high tariffs. However, this has been detrimental to Sri Lankans and to our businesses and we need to move past this fear.

It is also important to remember that competition is the key to maximising consumer welfare. Competition brings in choice to the market and leads to competitive prices. Simultaneously, it incentivises firms to optimise their processes and functions – the key to remaining competitive and profitable. Therefore, competition should be thought of as a win-win scenario where firms are incentivised to optimise their operations and grow while consumers enjoy maximised welfare.

3. Fear of imagining a prosperous Sri Lanka

It is understandable to have concerns and fears about the transition to a more prosperous Sri Lanka, especially when it involves a shift away from a State-dependent model. However, it is important to recognise that a prosperous Sri Lanka can bring many benefits and opportunities for its citizens.

A prosperous Sri Lanka can create jobs and provide opportunities for entrepreneurship and innovation. It can also attract foreign investment and contribute to the growth of the economy. With a thriving economy, the Government will have more resources to invest in areas such as education, healthcare, and infrastructure, which can lead to an overall improvement in the quality of life for its citizens.

It is also important to acknowledge the role of the private sector in providing essential services and goods, as well as contributing to the growth of the economy. While the Government has a role to play in ensuring the safety and wellbeing of its citizens, it is often the private sector that drives innovation and progress.

As Helen Keller once said, avoiding danger does not necessarily lead to safety in the long run. It is important to face our fears and embrace change, even if it is uncomfortable at first. With the right mindset and a willingness to adapt, a prosperous Sri Lanka can be within reach.

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

Why Sri Lankans fear development

Originally appeared on The Morning

By Dhananath Fernando

The three types of fears we endure as a country

Fear is a universal emotion and we have all come across three major types of fear in our lives. The fear of failure is the most common one that often paralyses us and prevents us from taking action. The fear of success is a lesser-known fear that keeps us from achieving our goals. Finally, the fear of judgement causes us to fear being evaluated by others.

Unfortunately, in Sri Lanka, the fear of reform has encroached upon all three of these personal fears. In public policy, there are currently three primary fears:

Fear of reforming State-Owned Enterprises

It is no secret that Sri Lanka’s State-Owned Enterprises (SOEs) have been one of the main reasons for the country’s economic crisis. Everyone agrees that SOEs need to be reformed, but there are different opinions on how to do it. Some believe that the losses are mainly due to corruption of politicians and political influence against reforming SOEs. Others believe that with capable management, SOEs can become profitable.

However, in my opinion, the absence of competent people to run State institutions and corruption are both symptoms of the absence of a market system.

In a market system, the focus is on making profits and minimising corruption. However, it doesn’t mean everything is perfect; rather, it is geared to minimise corruption and maximise profits. Therefore, opening up the market can help solve this issue.

One key fear that is brought forward is the risk of high prices when the markets are opened. However, based on our experience, prices decrease with the opening of markets and the allowing of more competition.

For instance, Sri Lanka’s telecommunications prices are some of the lowest in the region and the entry of Lanka IOC into the fuel market did not increase prices. On the other hand, the Ceylon Petroleum Corporation (CPC) incurred losses and it had to pass these on to taxpayers. Its losses of Rs. 632 billion over eight months in 2022 will have to be borne by the people of Sri Lanka through the contribution of about Rs. 28,000 per person.

It is evident that the absence of a market system is one reason for the profits not being sustainable, so we always drift back to where we started. The losses of the CPC for the first eight months of 2022 are greater than the allocation for both health and education together, which is about Rs. 550 billion.

Such high losses are indicative that all loss-making institutes, including the CPC, SriLankan Airlines, and the Ceylon Electricity Board (CEB), should be restructured to reduce the burden on the Treasury and thereby the taxpayer.

The focus is not only on prices but also on the quality and accessibility of the service. In the past, during fuel shortages, people paid Rs. 1,000 per litre on the black market. Therefore, simply claiming that the Government can provide fuel at a lower price is not very logical. We need a Sri Lanka where people can afford and decide what they want to use rather than the Government deciding what we should do. This is the Sri Lanka we envision.

Regulation is crucial and the Government needs to create a regulatory framework to ensure a level playing field. The current Public Utilities Commission Act has provisions, but we need to move towards a competition commission to ensure fair competition.

Fear of competition

The second fear among Sri Lankans is the fear of competition. We consider competition as one person winning and the other person losing. However, it is a formula where both sides can win. The fear of competition mainly arises in global trade and we often wish to block our competition by imposing high tariffs. However, this has been detrimental to Sri Lankans and to our businesses and we need to move past this fear.

It is also important to remember that competition is the key to maximising consumer welfare. Competition brings in choice to the market and leads to competitive prices. Simultaneously, it incentivises firms to optimise their processes and functions – the key to remaining competitive and profitable. Therefore, competition should be thought of as a win-win scenario where firms are incentivised to optimise their operations and grow while consumers enjoy maximised welfare.

3. Fear of imagining a prosperous Sri Lanka

It is understandable to have concerns and fears about the transition to a more prosperous Sri Lanka, especially when it involves a shift away from a State-dependent model. However, it is important to recognise that a prosperous Sri Lanka can bring many benefits and opportunities for its citizens.

A prosperous Sri Lanka can create jobs and provide opportunities for entrepreneurship and innovation. It can also attract foreign investment and contribute to the growth of the economy. With a thriving economy, the Government will have more resources to invest in areas such as education, healthcare, and infrastructure, which can lead to an overall improvement in the quality of life for its citizens.

It is also important to acknowledge the role of the private sector in providing essential services and goods, as well as contributing to the growth of the economy. While the Government has a role to play in ensuring the safety and wellbeing of its citizens, it is often the private sector that drives innovation and progress.

As Helen Keller once said, avoiding danger does not necessarily lead to safety in the long run. It is important to face our fears and embrace change, even if it is uncomfortable at first. With the right mindset and a willingness to adapt, a prosperous Sri Lanka can be within reach.

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.

Restructuring SriLankan Airlines can help reduce our economic woes

Originally appeared on The Morning

By Anuka Ratnayake

There is much discussion on the precarious financial situation of the island’s National Carrier SriLankan Airlines. A month ago, Minister of Ports, Shipping, and Aviation Nimal Siripala de Silva revealed that “The only way to rescue the National Carrier is via urgent restructuring” [1].
The airline has racked up significant losses while its debt obligations have increased significantly with the depreciation of the currency. Getting rid of the airline will allow the Government to focus on its limited resources to strengthen social security nets and improve social infrastructure.
The argument regarding the airline has been muddied by emotion, for it is ultimately the people who pay for it and who have the right to ask if this is the best use of taxpayers’ money.
SriLankan Airlines’ Annual Report for 2020/’21 (latest available annual report) provides that the SriLankan Airlines Group recorded a loss of Rs. 49.7 billion. However, the Ministry of Finance in its latest Annual Report records that the loss (before tax) of SriLankan Airlines for the year 2021/’22 is Rs. 170.8 billion [2]. The accumulated loss amounts to Rs. 542.5 billion as at 31 March 2022. The National Carrier lost Rs. 248.4 billion in the first four months of 2022 due to the volatility in exchange rates [3].
The airline is in debt to the Bank of Ceylon and the People’s Bank to the tune of $ 380 million in 2022, while another $ 80 million loan has been obtained from the Bank of Ceylon by mortgaging shares of SriLankan Catering. The banks have extended support to the airline on the basis of letters of comfort issued by the Ministry of Finance.

Further, the airline has a debt payable on an international bond on a Government guarantee of $ 175 million. The guarantees extended by the Government to banks and bondholders represent additional potential losses of public funds. The group owes an arrears amount of $ 325 million to State-Owned Enterprises (SOEs) such as the Ceylon Petroleum Corporation (CPC), the Airport and Aviation Services (Sri Lanka) (AASL), and the Civil Aviation Authority of Sri Lanka (CAASL) [4].
The group’s current liabilities exceeded its current assets by Rs. 214.6 billion by 31 March 2021 and the total equity of the company as at reporting date has declined to a negative Rs. 281.5 billion.
The Auditor General’s report has continuously warned the company that “a material uncertainty exists that may cast significant doubt on the group’s ability to continue as a going concern” [5]. The Auditor General has relied on the Cabinet approval dated 7 February 2022 and the letter issued by the Secretary to the Treasury on 24 February 2022 confirming the support of the Government to the company to continue its operations as a “going concern”. In simpler terms, the SriLankan Airlines Group is technically insolvent and it continues to operate using taxpayer money.
The airline last reported a profit in 2008, under the management of Emirates. It has failed to report a profit in any year since then. The airline industry is known to be a high-risk, low profitability business.

Future losses and lessons learnt from India

The International Monetary Fund (IMF) has now reached a Staff-Level Agreement (SLA) with Sri Lanka to assist its economic recovery process. It was agreed that the IMF would provide an Extended Fund Facility (EFF) of $ 2.9 billion on a 48-month arrangement.
The total debt of SriLankan Airlines (just over $ 1 billion) is nearly one-third of the EFF. Sustaining further losses is an impossible task since the Government can no longer fund the airline. Covering future losses of the airline through tax increases is unacceptable given the dire economic conditions faced by the public.
Sri Lanka needs air connectivity, but this is best provided by privatising air services and not by operating an airline. A good example is the Air India privatisation which took place in the past year. The Indian National Carrier was sold to the Tata Group for the relatively small sum of INR 180 billion [6]. Prior to the sale of the airline, it was losing $ 3 million a day on average, which totaled to over $ 1 billion per year [7].
The rising aviation fuel prices and airport usage charges were not sustainable after the pandemic restricted air travel. Further, competition from low-cost carriers and the poor financial performance of the airline made things worse. Air India’s poor client orientation, lack of punctuality, obsolete productivity practises, and poor revenue generation techniques were among the reasons for its incompetency [8].
The impact of the Air India privatisation was discussed at a panel at the ReformNow Conference hosted by the Advocata Institute. The panellists stressed how the Tata Group had already begun the process of value addition through efficient customer care services, improving fleet productivity, and focusing on budget flights for the domestic market.

Aviation hub

Singapore’s aviation policy has been a key factor in the growth of Singapore’s Changi International Airport, where air transport contributed to nearly $ 20 billion of value added to the Singapore economy or about 6% of the Singapore GDP in 2011.
There is much public support for restructuring SriLankan Airlines due to its heavy burden on State coffers and thereby the taxpayers. However, rather than selling the airline alone, bundling the sale of the airline with the other business units such as SriLankan Catering and SriLankan Airlines Ground Handling would be attractive to investors. At the same time, the airport too can be included and marketed as an aviation package with a similar potential to the Changi International Airport.
A national carrier is a source of pride, but it is not a priority for a cash-strapped Government. The airline should be disposed of or even closed, and a liberal air services policy should be adopted instead.
This could boost growth and truly turn Sri Lanka into an aviation hub, freeing taxpayers’ money to be used for health, education, and other priorities.

References
1. https://www.ft.lk/top-story/Answering-aviation-Aragalaya/26-739243
2. https://www.treasury.gov.lk/api/file/a7a35d1a-556f-49b2-81e0-20294eb5a519
3. https://www.treasury.gov.lk/api/file/bc1e8eaf-91eb-4cb3-94e0-35d81f65a949
4. https://www.ft.lk/top-story/Answering-aviation-Aragalaya/26-739243
5. https://www.srilankan.com/pdf/annual-report/SriLankan_Airlines_Annual_Report_2020-21_English.pdf
6. https://www.indiatoday.in/business/story/explained-air-india-handover-government-to-tata-group-changes-1904217-2022-01-25
7. https://www.advocata.org/commentary-archives/2021/10/11/air-india-sold-privatise-srilankan-now
8. https://www.bbc.com/news/world-asia-india-60150531

Anuka Ratnayake is a Research Assistant at the Advocata Institute. She can be contacted at anuka.advocata@gmail.com. The Advocata Institute is an Independent Public Policy Think Tank. The opinions expressed are the authors’ own views. They may not necessarily reflect the views of the Advocata Institute.

Reform or Perish. It’s not too late

Originally appeared on The Island, ColomboTelegraph and Groundviews

By K.D.D.B Vimanga and Naqiya Shiraz

The Sri Lankan economy faces a historical crisis.  The root causes are the twin deficits. First, the persistent fiscal deficit - the gap between government expenditure and income. Second, the external current account deficit - the gap between total exports and imports.  The problems have been festering for too long. Without urgent reforms, the crisis could easily morph into a full-blown debt crisis. 

Sovereign debt workouts are extremely painful for citizens. A mangled debt restructuring can perpetuate the sense of crisis for years or even decades. A return to normal economic activity may be delayed, credit market access frozen, trade finance unavailable.

With the global pandemic, these are unusual and difficult times. The next five years are going to be crucial for the country.  The problems can no longer be avoided and should be faced squarely. The journey ahead is going to be painful but the longer these are delayed the worse the problem becomes and the magnitude of the damage compounds. 

The State of the Economy 

The new government inherited a fragile economy, battered by the Easter attacks of 2019, the constitutional crisis of October 2018 and the worst drought in 40 years in 2017. With the pandemic in 2020 Sri Lanka’s economy shrank by 3.6% with all sectors of the economy contracting. 

Yet, the pandemic is not the sole cause - it only accelerated the decline of Sri Lanka’s economy that was weak to begin with.  The country has long been plagued by structural weaknesses, with growth rates in the last few years even below the average growth rate during the war. Mismanaged government expenditure coupled with a long term decline in revenue have characterised Sri Lanka’s fiscal policy. As of 2020 total tax as a percentage of GDP fell to just 8%, while recurrent expenditure increased. 

Borrowing to finance the persistent budget deficits is proving to be unsustainable. Total government debt rose to 101% of GDP in 2020 and has grown since. Sovereign downgrades have shut the country from international debt markets. The foreign reserves declined from US$ 7.6 bn in 2019 to US$ 5.7bn at the end of 2020 and to US$ 2.8 bn by July 2021. This level of reserves is equivalent to less than two months of imports. With future debt obligations also in need of financing, the situation is dire. 

The import restrictions placed to combat this foreign exchange crisis have failed to achieve their purpose and are doing more harm than good. imports rose 30% in the first half of  2021 compared to 2020 despite stringent restrictions.

The problem lies not in the trade policy but in loose fiscal and monetary policy that has increased demand pressures within the economy, drawing in imports and leading to the balance of payments crisis and consequently the depreciation of the currency.  

Measures by the Central Bank to address this by exchange rate controls and moral suasion have caused a shortage of foreign currency leading to a logjam in imports.

Fundamental and long-running macroeconomic problems were  intensified by the pandemic.Import restrictions, price and exchange controls do not address the real causes.

Treating symptoms instead of the underlying causes is a recipe for disaster.

The continuation of such policies will lead to the deterioration of the economy,  elevate scarcities, disadvantage the poor who are more vulnerable and in the long run lead to even higher prices and lower output due to lack of investment. 

Sri Lanka’s GDP growth over the last decade has been alternating between short periods of high growth and prolonged periods of low growth. This is a result of the state-led, inward-looking policies of the last decade.

A comprehensive reform agenda must be built around  five fundamental pillars:

i) fiscal consolidation - The need to manage government spending within available resources and to reduce debt are paramount. Revenue mobilization must improve but the control of expenditure cannot be ignored. Budgetary institutions must be strengthened and there must be reviews not only of the scale of spending but also the scope of Government.

 ii) Much of government expenditure is rigid - the bulk comprises salaries, pensions and interest so reducing these is a long term process. Reforming State Enterprises, especially in the energy sector and Sri Lankan Airlines is less difficult and could yield substantial savings. Continued operation of  inefficient and loss-making SOE’s is untenable under such tight fiscal conditions. Financing SOE’s from state bank borrowings and transfers from government reduces the funds available for vital and underfunded sectors such as healthcare and education. Excessive SOE debt also  weakens the financial sector and increases the contingent liabilities of the state. Therefore SOE reforms commencing with improving governance, transparency, establishing cost reflective pricing and privatisation are necessary. This can take a significant weight off the public finances and by fostering competition contribute to improvements in overall economic  productivity. 

iii) Tighten monetary policy and maintain exchange rate flexibility.  Immediate structural reforms include, Inflation targeting, ensuring the independence of the central bank by way of legislation and enabling the functioning of a flexible exchange rate regime. Further significant  attention has to be placed on the  financial sector stability with a cohesive financial sector consolidation plan, with special emphasis on restructuring of SOE debt. 

 iv) Supporting trade and investment. Sri Lanka cannot achieve economic growth without international trade which means linking to  global production sharing networks. Special focus has to be given to reducing Sri Lanka’s high rates of protection which creates a domestic market bias in the economy along with measures to improve trade facilitation and attract new export oriented FDI. 

Attempts to build local champions supported by high levels of protection have 

(a) diverted resources away from competitive businesses, 

(b) created a hostile environment for foreign investment, 

(c) been detrimental to consumer welfare,

(d) dragged down growth

v) Structural reforms to increase productivity and attract FDI - Productivity levels in Sri Lanka have not matched pace with the rest of the growing economies. The reforms mentioned above are extensively discussed in Advocata’s  latest publication “Framework for Economic Recovery”.

Sri Lanka  stumbled into the coronavirus crisis in bad shape,with weak finances; high debt and widening fiscal deficits. It no longer has the luxury to delay painful reforms. Failure to do so will not only jeopardize the economy; it could even spawn social and humanitarian crises.

Naqiya Shiraz is the Research Analyst at the Advocata Institute and can be contacted at naqiya@advocata.org.K.D.D.B. Vimanga is a Policy Analyst at the Advocata Institute. He can be contacted at kdvimanga@advocata.org.

The Advocata Institute is an Independent Public Policy Think Tank. Learn more about Advocata’s work at www.advocata.org. The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute

Sri Lanka’s Auditor General and Steve Jobs’ Garden Fence

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

---

By Dhananath Fernando

A few days ago, I read up on an interesting anecdote from the life of Steve Jobs. When Steve was a child, his father had asked him to paint the fence around his house. Steve took the task up and painted the outside of the fence. When he proudly presented his hard work to his father, the father questioned why only the outside of the fence was painted. Steve replied: “Dad, no one sees the other side of the fence!”

To that, his dad responded: “Steve, but we will see it.” Many years later, when Steve briefed his engineering team on the deliverables of the Macintosh computer, he said to them: “I want the outside of the computer’s aesthetics and design to be outstanding. But I also want the inside of the computer to be more outstanding than the outside.” To that, his team responded: “Why do we need to spend so much time, effort, and money on the inside of the computer? No one really sees the inside!”

Steve replied: “But we will see it.”

The ongoing debate on the dilution of the Auditor General’s powers has reminded us of the need to paint both sides of our fence if we want to see a developed and prosperous Sri Lanka.

The development, prosperity, and progress we see in any society or institution are a result of structural changes, self-discipline, and systematic advances of working on an in-depth value system. That is why self-control is always better than state control.

Audits and checks and balances are unseen on the inside. What we see on the outside is a reflection of our society on the inside. Therefore, Sri Lankans not reaching our full potential is interconnected to the absence of many systems of accountability and transparency. Audits and checks and balances should come from within. What we see outside is merely a reflection of who we truly are on the inside. Sri Lankan society lags behind for this very reason, as we lack the many systems of accountability and transparency necessary for growth.

Systematic misgovernance

If you ask any Sri Lankan why their country is still developing, they will give you three reasons: corruption, waste, and misgovernance. What we see on the outside as low productivity, inefficiency, and delays are a result of a lack of accountability, transparency, audits, and checks and balances. This is not only valid for our public sector but also for our private sector.

In the context of the 20th Amendment, the proposed Clause 31 repeals article 153 (1) of the Constitution which mandated that the Auditor General be a qualified auditor subject to the approval of the Constitutional Council (CC), following which, s/he would be appointed by the President. The removal of this by the 20th Amendment opens the risk of appointing an Auditor General who wouldn’t possess the qualifications required for the position.

The risk of providing constitutional leeway in appointing an unqualified Auditor General is multidimensional. A greater degree of Sri Lanka’s corruption and crime is white-collar crime, and given the legal structure of Sri Lanka, even qualified auditors are finding it difficult to audit.

The VAT (value-added tax) scandal reported many years ago and the more recent Central Bank bond fiasco all indicate the enormous cost of ignoring simple processes, which when multiplied can cripple our entire economy. Unfortunately, the need for such processes only come into the limelight when things go wrong, while the positive results of having due process usually don’t make it to newspaper headlines.

Accountability is key

Even under the 19th Amendment, the Auditor General’s powers did not include the ability to audit state-owned enterprises (SOEs) incorporated through the Companies Act in which the government has a stake of less than 50%. Maintaining accountability in most of our gigantic SOEs that the Treasury has supported with taxpayer money has failed! Most SOEs have failed to produce even a basic annual report over the years for the benefit of the public, even though the revenue of some public enterprises is nearly half a trillion.

There are more than 500 SOEs of different scales which waste a colossal amount of taxpayer money, and there is no excuse that can be provided for not producing annual accounts when earning half a trillion rupees in revenue.

The space created by the 20th Amendment for SOEs to not get audited by the Auditor General will set a bad example for all businesses. The collective losses of only 16 strategic SOEs in 2018 amounted to Rs. 156.73 billion, which is equivalent to more than thrice (Rs. 47 billion in 2017) the expenditure of the Samurdhi Programme.

One may ask why corruption levels were still high with the Auditor General having the power to audit under the 19th Amendment, and when there were additional checks such as having an Opposition member heading the Committee on Public Enterprises (COPE) and opening COPE meetings to the media; it is true that neither the Auditor General nor opening COPE meetings to the media will solve all corruption problems within SOEs.

If the level of corruption and misgovernance was high even with the Auditor General’s powers under the 19th Amendment, imagine how the situation would be without such supervision. We sincerely hope that at the committee stage, matters pertaining to the transparency and accountability of SOEs will be taken seriously.

Improving systems and doing things better than we did in the past must be the way forward if we are serious about a “system change”. In order to strengthen governance, we should at least list strategic SOEs at the Colombo Stock Exchange (CSE) so that these institutions will have no choice but to adhere to the governance structure of the CSE. One other measure is to provide the Auditor General with more power to investigate SOEs incorporated through the Companies Act in which the government has less than 50% stake, as most SOEs have the practice of incorporating subsidiaries and sub-subsidiaries under the main SOE with different stakeholder arrangements.

In public policy, dismantling an existing accountability measure without an alternative could be highly problematic, given the level of corruption rooted in Sri Lankan society. Sri Lanka has dropped from 89th to 93rd in the Corruption Perception Index for 2019 by Transparency International.

If you observe any successful private company or society, there are systems and procedures that have been refined over the years with the advancement of technology to reach where they are today. Our attitude towards accountability measures has to change as a way of painting the fence on the inside even though no one sees it. Ultimately, what we see on the outside is what we build inside.

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.

SOE sector: Promises of change on the horizon?

Originally appeared on Daily FT

By Maleeka Hassan

With the harsh reality of a global recession slowly descending on Sri Lanka, questions about Government expenditure and its allocation of resources have begun to dominate dinner table discussions. Fears of higher taxation to cover the losses earned and to sustain the blows from the impending recession have started to emerge.

There is a simple solution: introduce reforms to prevent areas for corruption and inefficiency within SOEs – thus preventing the State from bearing tremendous losses. However, there is hesitation and discomfort amongst the general public, when consolidation or privatisation of SOEs are discussed. This begs the question: why?  

Why are SOEs so popular amongst the public?

One of the reasons could be due to the portrayal and framing of the SOE sector, over the years. SOEs are perceived by the public as a source of stable employment as well as a source of goods and services at affordable prices. This perception is backed up by the fact that the SOEs hire over 200,000 people; framing the sector as ‘people-oriented’ over ‘profit-oriented’, with no consideration given to the losses sustained by these entities. Moreover, privatisation is often viewed in the same light as capitalism: cold, hard and unforgiving.

This perspective could be propelled by our history with the SOE sector. In the 1980s, the incumbent Government was pushed to reform the SOE sector. This was due to SOE products struggling to remain competitive amongst imported substitutes and therefore turning to the State to fund and sustain most of them. In addition, foreign aid agencies lobbied the Government to adopt a privatisation programme in order to secure external aid. However to avoid backlash from labour unions and state employees, the media and other campaigns around the policy were careful to avoid associating the policy with employee redundancy. Privatisation was concealed by the word ‘peoplisation’, and involved providing 10% of the shares to employees from former public enterprises.

Another reason behind the immense support for SOEs could be due to their heavily subsidised products. However, when products are sold below cost, the cost is still indirectly borne by taxpayers in the form of higher taxes, to recover the loss. The belief that privatisation will result in the prices of goods rising is contingent upon the creation of a monopoly. However, with the reduction of red tape and appropriate measures taken to prevent anti-competitive practices, prices may reduce or remain the same in a competitive market. An example of this was the conversion of Sri Lanka Telecom to a public company. This resulted in an improvement of internal operational efficiency and the number of new connections provided increased from 72,457 in 1997 to 143,075 in 1998.2

A similar reason that may have contributed to shaping current public opinion that SOEs are most effective at serving the people when they remain public, was the introduction of ‘The Revival of Underperforming Enterprises or Underutilised Assets Act’ of 2011 (also known as the Expropriation Act). This is where 37 businesses that were classified as ‘underperforming and ineffective’, were nationalised – suggesting to the public that privatisation wasn't always effective and ideal. However, these attitudes may be fuelling the problem.

Why are these perceptions wrong?

By utilising the narratives above, certain SOEs and officials attached are able to conceal corruption and nepotism behind the idea of employment, and ‘helping the people’. An example of this is the Sathosa scandal that emerged earlier this year, relating to 67 files that tied Sathosa to controversial transactions, such as land deeds that were purchased under various names and involved hundreds of acres, that cost the State billions of rupees.

Similar instances of bribery are easily carried out, and go unrealised, due to the absence of monitoring and oversight of the rest of the 524 SOEs that are ‘not essential’. The lack of transparency with regards to the financial reports of the SOEs makes it easier for these companies to commit such acts. In the Annual Report for 2019, published by the Ministry of Finance (MOF), only 14 SOEs had submitted their Annual Reports for 2018 out of the 52 that are monitored by the MOF and Public Enterprise Department (PED). Even more worrying is the fact that 21 out of the 52 companies hadn't submitted their 2017 Annual Reports either. 

Despite the introduction of the COPE reports and the appointment of the Department of Public Enterprises (PED) to monitor the operations and efficiency of SOEs, the SOE sector continues to amass tremendous losses. The recently published Annual Report by the Ministry of Finance estimates a total loss of Rs. 151,439 million from the 52 essential SOEs for 2019 based on provisional data.

These numbers would change drastically if they included data for the rest of the 524 SOEs (which include subsidiaries and sub-subsidiaries that have been gazetted but are not monitored by the Ministry of Finance, due to them not being ‘essential). The opacity of this sector would usually raise alarm bells amongst the Sri Lankan public if it was occurring anywhere else – and yet it doesn’t with SOEs. change drastically if they included data for the rest of the 524 SOEs (which include subsidiaries and sub-subsidiaries that have been gazetted but are not monitored by the Ministry of Finance, due to them not being ‘essential). The opacity of this sector would usually raise alarm bells amongst the Sri Lankan public if it was occurring anywhere else – and yet it doesn’t with SOEs.

Evolving circumstances propelling change

Despite these concerning particulars, there may still be hope on the horizon. The manifesto of President Gotabaya Rajapaksa indicated that whilst privatisation was not up for consideration, consolidation was still an option. Additionally, a board was appointed to select the heads for loss-making, inefficient SOEs, in order to reform and improve such entities.

More importantly, however, is the question of SOEs in a COVID-19 economy. 

With predictions for Sri Lanka’s estimated real GDP (percentage change) for 2020 amounting to -0.5 due to COVID-19, some economists predict that large scale reforms may be introduced in order to improve efficiency and increase its global competitiveness when seeking foreign direct investment and increased capital inflows. These reforms may extend to the SOE sector – in order to improve the financial accounts of the country and to reduce room for corruption and bribery.

What reforms can the Government adopt?

Reform of SOEs, focusing on underperforming entities, in particular, could create some much needed fiscal space for the treasury. The first phase of reform would be improving governance and accountability in SOEs. The Government should compile a comprehensive list of all SOEs; at present, the Government only tracks the financial of the key 52 entities. This should be expanded to include all entities. Clear reporting guidelines for SOEs should be introduced and enforced, with COPE and COPA strengthened to improve accountability. If these reforms are adopted, the SOE sector will increase productivity and efficiency immensely, saving the Government and the average taxpayer – millions of rupees.

The second phase of reform would be on the consolidation of SOEs. Of Sri Lanka’s 524 SOEs, the Government recognises only 52 of these as strategic or key entities. In line with Government policy, underperforming, non-strategic SOEs should be identified for a consolidation plan. 

This may be the golden window of opportunity to reform and improve the transparency of the sector, but if missed – may not come again for a long time. 

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 ingredients of a ‘system change’

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

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By Dhananath Fernando

The mandate given by the people of Sri Lanka to His Excellency Gotabaya Rajapaksa can be interpreted in multiple ways. All interpretations funnel down to a single insight: Change the system. The word “change” is powerful. However, “change” is difficult to execute. In contrast to setting up things from scratch, altering an existing system is not an easy task under any circumstance. 

The President’s desperation is clear. He has been given a mandate to “change the system” in five years; of which, seven months have passed. With elections coming up, it seems that it will take almost 10 months to really get to the starting line. In other words, the existing “system” itself has pushed the man in charge of “system change” to the wall and the clock is ticking.

Last week’s column discussed the systems that need change and how the President could start. We highlighted that state-owned enterprises (SOEs), public transport, land reforms, and e-courts would be the four big aspects that can be implemented with minimal capital investment. If the President succeeds, the people of Sri Lanka will be able to witness a considerable change in their standard of living, and it is important that the opinion leaders support this system change in a democratic framework, and leaders at the frontline make sure the changes take place within the same framework.

Today, let’s explore a few insights on how to execute a system change. 

Understanding the system

If you ask the common man: “How can we change the system?”, a popular answer is that we can do it by imposing strict laws and regulations. Some believe the leader has to be firm and critical and supervise their team closely.

While the aforementioned is true, a sustainable system change requires the establishment of three main components: (1) ownership of the system, (2) incentives and rewards, and (3) accountability and capable people who drive the system.   

If you look at the current inefficient system, it is completely faulty due to many factors. The incentives in most government institutions and systems promote inefficiency; a system where work is delayed, and individuals are paid overtime to reward that. 

Take our judiciary system for example. In most instances, lawyers charge their clients based on the number of appearances, so the incentive is to have more appearances. Therefore, postponing cases is common and as a result, the average time taken for contract enforcement is 1,318 days with 22% of claim value. There is no pressure to finish a case within a stipulated time frame, so there’s no accountability and monitoring. 

At the same time, there is no ownership for the system as individual performance is not measured and no one will be questioned on the delays in procedure. Imagine a scenario where you hire a mason bass for a small-scale construction project at a daily rate, but you fail to monitor his work. The obvious result would be that the work will go for months, making the system completely inefficient. 

Ownership of the system

Any successful system runs on the ownership of risk. A main reason investors want to engage in businesses is because they have invested risk in the form of money, reputation, time, etc. This means they have an ownership stake and an interest to recover what they invested. For a system change, the upcoming government and President are required to consider engaging people who invest risk in the form of money, reputation, time, etc. and provide them with the opportunity to own the system as well as the results of their action.

Public-private partnership (PPP) is a great model to consider and many forms of PPPs are available and it just requires detailed attention. This would be a fundamental factor in changing any system. 

On that basis, the appointment of the ministerial portfolios’ board for SOEs cannot be just a blanket appointment – an ownership of risk has to be associated with it. In implementing large-scale projects, the President advised a few months ago, to explore acquiring investment from the private sector instead of taking loans and expanding debt stock. That means getting private investors to invest their money (risk) in projects which they can recover through profits. 

The Government can incorporate similar practices to a range of sectors. The government sector is too large, from managing airlines to managing cashew production. It will be difficult to bring private risk ownership across the board, but we can roll it out on a priority basis. Until we get the election results, time can be spent on setting up ownership structures for key institutions and a mechanism on how they can invest risk into the system. The structures have to differ based on the sector and on the type of the business and service model. Take our President for example, who has an ownership of the trust of 6.9 million people where he has invested risk. Hence, he is under pressure to deliver results. Shouldn’t the same be applicable for the rest of his supporting divisions?

Incentives and rewards

Setting up the correct incentive structures and rewards is the second important factor in a fluid system change. The current incentive structure is driven by inefficiency and corruption. Regardless of whether you perform well or underperform, you get the same benefits. So no one has an incentive to take things into their hands and do it differently. The recent discussion on the Central Bank is a good example. Whether the Central Bank maintains monetary stability, regulates license banks and non-banking financial institutions (NBFI) in the right manner or not, their destination won’t change. 

Incentives can be negative and it should not need to be positive always. If there had been a positive or negative incentive structure bearing on salaries of bureaucrats on maintaining the stability of NBFIs, I am certain they would have taken matters more seriously instead of waiting for some financial institutions to collapse completely (institutions need to provide the necessary legal authority to regulate effectively). Having regulations without incentives is a sure way of not fixing the system. 

If you are surprised by the friendliness and politeness of hotel staff, it is not just because they were asked to do it or not because the management installed CCTV cameras, but it is because they receive a financial incentive for being friendly. At the same time, we should not misinterpret that the hotel staff is kind and pleasant just because of the financial incentive. The fact that their genuineness is incentivised, which in turn makes system efficiency sustainable, is the bottom line.

Accountability and people 

Checks and balances have to be maintained if we are to monitor and evaluate the incentives and ownership of risks. That is where “accountability” and the people who drive “accountability” matter. If we have the accountability structures, we can make decisions based on meritocracy.

For example, most of the SOEs haven’t produced their annual accounts or annual reports. Most of these institutions do not even have a website. Most of the institutions that have a website have only updated the welcome message by the newly appointed minister. 

The people who drive reforms have to make a significant contribution. However, we have to keep in mind that the people-driven regulatory model where a system change is driven by personality and personal charisma has a shorter life span. But without the right people, it would be difficult to drive a system change.

We need people who can drive the system to overpass their personal charisma, so even without their presence, the system starts to function. The next government will have the challenge of identifying the right people who can fix a system rather than just pushing on getting daily operations done.

For the right people who have been identified to change the system, the broader mandate is straightforward; identify ownership structures, identify incentive systems, and set up accountability procedures are the main mandate. We should not confuse the skill of “changing the system” with project management skills. “Changing the system” is a unique visionary sport. There could be good project managers, but transforming to a system change goes far beyond project management, although it has some components of project management. 

System changes are not popular

We need to remember that system changes are not popular. Most of the people who demand a system change are usually beneficiaries of the inefficient system. Changing the system will have a direct impact on them and resistance may come with it. That is why the transferring of ownership of risk comes to the forefront when looking to change the system. 

It is important that we learn from past mistakes. The previous government too received a mandate for a system change to establish rule of law, but the same people who gave them the mandate decided to pick a different regime, again, pretty much on the same promise, that is to “change the system”.

Ownership, accountability, and the right people who could drive system changes were not in charge of policy implementation during the last Government; all were preoccupied with micromanagement without looking at the bigger picture or considering rapid implementation.

Policy statements of the main leaders of the Government went in two different directions, as did the heads of ministries and their officials.

The Vision 2025 policy plan was introduced a considerable time after taking office. The policy statements on institutions were contradictory and as per media reports, and the basic composition of the security council was questionable. 

System changes are visible, and people will experience tangible differences, such as in the government balance sheet. There will not be a better time than one of crisis to engineer a system change – we should not waste this opportunity.

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.

Limited government – Ideal State

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

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Limited Government; Ideal State – Part IV

By Dhananath Fernando

This article completes Advocata’s four-piece series on “limited government”. Over the past three weeks, we have presented three arguments in favour of a limited government. We began the series by delving into the mounting costs associated with a government of this size. The article questioned the rationale behind expenditure on this scale, given that the services provided by the Government are characteristically inefficient. Erratic power cuts and railway strikes seen in the recent past are testament to this. From here, the series explored the question of how a government can best serve its citizens.

The main argument presented was that when the powers and responsibilities of the State are decentralised, voters are given a stronger voice and are better able to hold elected officials accountable. The result is that public finances are better managed and service delivery improves. The last topic tackled in this series was that of corruption, expanding on how the window of opportunity for corruption widens when a government grows in scope as well as physical size, without the necessary governance and accountability measures in place. All three articles concluded on the same point – the size and role of the Government needs to be re-visited.

At a fundamental level, a government exists to protect the life, liberty, and property of its citizens. This is the first and foremost responsibility of a government and it is vital that this is given priority. The danger of governments expanding into other sectors is that these foundational responsibilities are pushed to the sidelines. When a government provides subsidies, creates price ceilings, and gives ad hoc handouts, it loses incentive to focus on its priorities. Giving a subsidy has an immediate impact on its voters and a cycle of instant gratification begins. Parallel to election cycles, governments now have an easier, quicker method to win over voters. Ensuring the rule of law and enshrining the negative freedoms of a population does not have the shiny appeal of a handout – the positive, virtuous cycles these freedoms and protections create are strong, they can permeate institutions and change cultures of work. However, they can take years to come into effect and are difficult concepts to convey through the flashy advertisements of an election campaign.

Of course, this means that governments respond to the attractive incentive of a quick win and an extended term in office, and prioritises the handout over the fundamentals of freedom. As much as these freedoms can create virtuous cycles of growth and development, the neglect and deterioration of these freedoms can create dangerous cycles of corruption, misuse, and violence.

The best way to illustrate these dangerous cycles is through the justice system. Unfortunately, we witnessed first-hand the aftermath of the Easter attacks where virulent rhetoric against the Muslim community resulted in riots, with 500 Muslim-owned shops being attacked and set on fire. In the face of this outbreak of violence, the rule of law was flagrantly abused, and peace was not upheld.

Eammon Butler, in his book “Foundations of a Free Society”, expounds on this in some detail. According to him, the rules of justice are a cornerstone of any free society. While rules of justice would mean there are penalties for harming other people, in a free society, emphasis is also given to ensuring the role and power of a government is strictly limited. This will mean that the monopoly over violence a government has will not be used arbitrarily or in the self-interest of those who wield it. To quote: “The main problem of political organisation is not how to choose our leaders – that is easy – but how to restrain them.”

This seems reasonable and rational. No one wants an army-running rampant – you want to ensure the people with the guns and ammunition have clear rules on when and why they can use it. Most governments recognise this and have mechanisms such as constitutions and the separation of the executive, legislature, and judiciary to restrain those in positions of power. But the foundation of this is to ensure that citizens are all treated equally under the law – that all laws apply equally to all citizens and there is equal treatment and due process of justice. For freedom to have meaning, it has to apply equally to the whole population. When this does not take place and there is essentially a break down in the rule of law, the immediate impacts might seem inconsequential. It might mean that someone gets out on bail when maybe they shouldn’t. It might mean that tariffs are raised to protect politically important local business interests. Taken alone, these are singular events, which, while problematic, don’t cause much consternation. However, this is a slippery slope which often ends in widespread corruption in the best case, and a complete breakdown of law and order in other instances.

Once again, recent events illustrate that all citizens are not treated equally under the law, and that instances where law and order break down are increasing in frequency. The Wennappuwa Pradeshiya Sabha (PS) Chairman issuing a letter prohibiting Muslim traders from conducting business at the Dankotuwa Market is a case in point. It is of utmost importance that steps are taken to ensure the rule of law is maintained, and the Government prioritises its core functions putting the safety and freedom of all its citizens at the forefront.

Less spending, less corruption

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

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Why should we have a limited government? – Part III

By Aneetha Warusavitarana

The World Bank quite simply defines corruption as the “abuse of public office for private gain”. Accordingly, public office can be abused when private agents actively offer or accept bribes, institute practices of patronage and nepotism, and engage in the theft of state assets or misuse public funds. In Sri Lanka, corruption has become institutionalised and can range from the traffic policeman who accepts a bribe to a high-ranking bureaucrat siphoning public money for personal expenses.

In 2018, Sri Lanka ranked 89th out of 180 countries in Transparency International’s Corruption Perception Index. As a country, we score 38 out of 100, with 100 representing a clean, corruption-free country. The magnitude of this problem is clear.

What’s the big deal about corruption?

Is corruption really bad? You can’t deny that when your garbage is piling up, it’s easier to bribe the garbage collectors to take your garbage than visit your municipal council and file a complaint. Sometimes, it can just be easier to pay a bribe to the traffic police than go to court and settle a traffic violation, or to pay a little extra and get your driving license renewed faster. These are all very mundane, commonplace occurrences that have become normalised to the point one does not think of it as “corruption”. It’s just a small payment to make your life a little easier – a small payment to ensure an application is processed smoothly. So, if corruption can make things simpler, what’s the issue?

While corruption on this scale can appear to be insignificant, in reality, it is one component of a much larger, systemic problem which has far-reaching consequences. Corruption in government is institutional, and given the outsized role the Sri Lankan Government plays in markets and business, the impact is far-reaching. The difficulty in holding government officials accountable and the considerable discretion they can wield creates an environment in which corruption can flourish.

The far-reaching impacts of corruption

Large corruption scandals often focus on the amount of money that has been misused, placing emphasis on face value loss that is created by corruption. However, the impact of one act of bribery or corruption goes far beyond the initial monetary loss. Corruption raises the transaction costs of conducting business and creates uncertainty in the market. In an environment where corruption flourishes, a business will not win a contract based on merit and skill alone. Procurement-related issues (read: corruption) associated with the Kerawalapitiya Power Plant meant that it took three years to award the tender. This lowers profitability within firms and creates an overall environment of uncertainty which discourages foreign investment. The result is that the positive spillover effects from investments, like increased competition and technology transfers, will not take place. Corruption also reduces the attractiveness of entrepreneurship, resulting in higher prices and lower quality. The problem does not end there. The culture of corruption is one of impunity and complete disregard for the rule of law. When this culture permeates the government, it affects the independence and credibility of the legislature and the judiciary – the very institutions which should be ensuring that the rule of law is upheld.

State-Owned Enterprises and corruption

Sri Lanka’s state-owned enterprises are a prime example of institutionalised corruption. In Advocata’s flagship report, the State of State Enterprises in Sri Lanka – 2019, the problem of corruption is a key issue tackled. In this report, corruption is explained through the perverse incentives that exist in the Sri Lankan bureaucracy. In the case of state-owned enterprises, as the money invested in state-owned enterprises is not of the politicians, there are no incentives for politicians to work towards making these enterprises efficient or productive. However, given the deep-rooted culture of patronage that exists in Sri Lanka, there is a strong incentive for politicians to use state-owned enterprises for their own gain. The lack of oversight or accountability means politicians can hire almost indiscriminately, giving out jobs for political gain. The reports from the Committee on Public Enterprise (COPE) make this abundantly clear, highlighting the numerous instances where recruitment had taken place without the appropriate approval from the Department of Management Services.

This problem is exacerbated by weak systems of accountability and governance. While the COPE and the Committee on Public Accounts (COPA) do play a role in the governance of state-owned enterprises, they have access to limited resources and equipment and are in need of specialised skills such as legal aid.

What is the solution?

If corruption is the abuse of public office for private gain, then in order to stop corruption, we should focus our attention on how and where this abuse happens. When the government moves outside its core mandate to protect life, liberty, and property, it grows in size and in scope, making the government difficult to monitor and hold accountable. Additionally, as a government grows in size, so does its spending. Changing a culture of corruption will take a great deal of political will and leadership, as well as buy-in from the bureaucracy. While accountability and transparency play an important role in countering corruption, the effects of this are seen in the long term. In the short term, focus should be on limiting the scope of the government and thereby drastically reducing government spending. A 10% cut of Rs. 3 million is significantly lower than a 10% cut of Rs. 300 million; reducing government spending is the fastest way to reduce corruption in quantitative terms. A reduction in government spending will also make transparency within the government easier to enforce, helping create a culture of accountability.

If we are to seriously tackle the problem of corruption in government, the role and scope of the government needs to be revisited and limited.

Decentralisation: Taking governance to the ground level

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

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Why should we have a limited government? – Part II

By Aneetha Warusavitarana

When speaking of a limited government, the first thing that comes to mind is the fact that governments tend to be so expansive. A plethora of ministries and an innumerable amount of departments and agencies spring to mind. However, it is important to keep in mind that when speaking of a limited government, the rationale goes far beyond arguing for fewer ministries and reducing the duplication of work and responsibilities within the government system. A limited government is one that is limited in scope – it identifies its key functions and expends all resources to achieve them. When speaking of the role of the government, its primary functions can be described as the protection of life, liberty, and property. When a government’s main role expands beyond this, there is a strong likelihood that the government will prove to be ineffective and even harmful.

How can a limited government run a country?

It’s all well and good to say that the role of the State should be limited to the protection of life, liberty, and property, but governments also provide a myriad of public goods. Doing all this requires resources, people, and departments. Given that this requires a significant amount of administration, how do you ensure the government does this effectively, while staying within its key mandate and with minimal corruption or abuse of power?

Can decentralisation be the answer?

Why should Sri Lanka move away from a centralised system of governance and increase the levels of decentralisation in the country? While there are some very theoretical explanations for decentralisation (which are important in their own right), we will use a simpler approach. In a population of approximately 21 million diverse people with different interests, preferences, and disposable incomes, how do markets allocate resources efficiently? Any A/L economics student will reply with the brief answer of the “invisible hand”. In reality, of course, there is no puppet master moving fruits and vegetables from one place to another. Each individual business acts in their own self-interest, resulting in a more efficient allocation of resources. Prices signal to these businesses – and the profits or losses these businesses make guide decisions to produce or sell – and thus, without the convening of committees or the presentation of any findings, an entire country is provided with goods and services it requires. William Easterly sums up this phenomenon as such: “The wonder of markets is that they reconcile the choices of myriad individuals”.

Price signalling works well in allocating resources because at any given point of time, it is impossible for one bureaucrat, or even a host of committees of bureaucrats, to have all the information necessary to dictate the production and distribution of a single good in an economy, much less all goods in an economy. This is because information and knowledge are localised, time sensitive, and tacit. In other words, information and knowledge cannot be transferred effectively in their entirety or in time. The fall of the Soviet Union is a testament to this.

What do markets have to do with decentralisation?

The same principle applies. The decision-making in a market economy is never centralised. While decentralisation will, of course, function differently – the spontaneous order created by price signalling in markets will not be making administrative decisions – the principle that centralised decisions are not effective stands. The reason behind this is that the information problems, which plague centralised decision-making of economics, also plague centralised decision-making for administration and governance. As much as a bureaucrat will find it impossible to distribute exactly the number of potatoes required to each province of this country, it is equally difficult for a bureaucrat to be located in a central government and to take decisions on local infrastructure. Any decision taken at a central level will not be ideal. There will always be information and local contexts that a bureaucrat is not privy to, and as a result, the decision will not be as effective.

Decentralisation brings governance and administration down to the ground level – it means decisions are taken by local government authorities who are best placed to make that decision. They are aware of local contexts and have been elected into office by the people in the locality, which would mean they have an understanding of what is needed. Of course, where the rule of law is weak, decentralisation can mean that local government authorities succumb to crony capitalism, as a system it is not without its faults. However, when comparing central governance and decentralised governance, in the case of decentralisation, there is greater opportunity for electorates to hold their representatives accountable, make their demands heard, and push for the reform that they want. In other words, it puts more power with the people and makes elected individuals more accountable to their voters – an admirable objective not only in principle, but also because of its effectiveness.

The burden of unprecedented costs

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

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Why should we have a limited government? – Part I

By Dilshani Ranawaka

“The government that governs best, governs least” – Thomas Jefferson

A state has three core tasks within a society: Protecting the life, liberty, and property of the people. As societies evolved, these core tasks were overlooked when more emphasis was given to managing economies. Should the state intervene in economic affairs? Would that be more beneficial to the economy and society?

For the following four weeks, “The coordination problem” will discuss why large governments cause more harm than good when they engage in tasks beyond ensuring freedom and security of the citizens and the rule of law.

The series titled “Why should we have a limited government?” will justify why large governments are a bane to the economy through arguments on costs, problems of coordination, and corruption. The series will then conclude with a fourth piece on what an ideal state looks like.

It is intuitive that larger governments incur larger costs. This takes place through two avenues: recurrent expenditures and management expenditures. The present Government has lost count of the number of enterprises the State owns, as revealed by the Advocata Institute’s recently published report “The State of State Enterprises in Sri Lanka – 2019”.

As of 2017, 1,389,767 of the labour force in Sri Lanka are employed in the public service. This is around 14.5% of the labour force. The enormity of these numbers is clear when compared with developed countries. For instance, Canada, which has a population of 37.6 million, has a public sector of 262,696, according to the official Government of Canada website, making it clear that a government does not need to be expansive even in the instance of a large population.

To make things even worse, the Government introduces salary increments either at the onset of an election or during a new budget proposal, instead of having increments dependent on performance.

With the recently proposed increment of Rs. 10,000 for the public sector, the expenditure for wages adds up to Rs. 768 billion for the year. This is around 25% of the government’s expenditure, as per the Budget in 2019. This exceeds the amount allocated for public investment (Rs. 756 billion) for the year 2019, which is around 24% of the budgeted expenditure for this year.

These complicated numbers bring questions to mind: Is providing jobs a role of a government? What is the opportunity cost? What are the indirect consequences? What is the concealed political gain from this process?

A state’s role goes beyond providing job opportunities. Some of the crucial elements a state should look into are national defence and maintaining law and order. The Easter attacks and ensuing events highlighted that the Government should be focusing more on its core functions before moving beyond.

Furthermore, when looking retrospectively at political campaigns, politicians target the votes of government officers mainly through the introduction of wage increments. While increments are positive incentives for productivity, politicians use them for popularity. In such cases, two factors increase the costs for the government. Since larger governments require more state officers for administration purposes, the costs incurred just for administration purposes increase. When politicians promising higher increments become popular, the cost burden for the government piles up.

Every decision made in the economy has an opportunity cost. A state could allocate resources either for consumption or for investments. Investments generate direct income in the long run while consumption creates effective demand which indirectly generates income. Given this backdrop, it is important to answer why unregulated and irresponsible expenditure by a state is catastrophic.

Let us explain through a simple example. If a household spends on consumption which does not generate income, the household has to resort to loans. A similar argument can be transposed towards a state. If a state spends on consumption (in this case the cost for expansion of the government), they have to utilise other methods such as loans or taxes which are reflected back on the taxpayers of the country. These wage expenditures incurred by the government are utilised for consumption most of the time. Alternatively, if politicians stop promising salary increments and reduce the size of the government, these wages could be utilised for public investments – a critical requirement for economic growth and long-term income generation.

Leaving vital services aside, what do state officers incur to the government? Losses or revenues? Would an additional state officer cover the cost of their wages and generate revenue through their productivity? Would it increase the efficiency of the department? These questions should be standard criteria before unnecessarily expanding particular state departments. The experience one has at most government institutions speaks for the inefficiency that plagues these institutions.

What is the underlying cause of incompetence of the State in Sri Lanka? If the government is supposed to facilitate services, why do they operate their entities in a manner they generate losses? Why do we constantly see power cuts through the Ceylon Electricity Board (CEB) if larger governments are meant to provide better services? Could we keep our trust on the State, given the way they function with our money?

Do larger governments function better? The evidence seems to indicate otherwise.

How many committees does it take to fix an airline?

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

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By Dilshani Ranawaka

On 1 March, the International Monetary Fund (IMF) approved $ 164.1 million under the Extended Fund Facility after successfully completing the fifth review for the country. According to the IMF, restructuring and enhancing the governance of SriLankan Airlines and other state-owned enterprises (SOEs) and the implementation of price formula are key issues that should be addressed.

SriLankan Airlines has a new CCO and CFO as a result of the numerous numbers of commissions formed to assess and come up with a restructuring process. Presently, the losses alone had accumulated up to Rs. 40 billion in a time frame of 2016-2018.

The solution is pretty straightforward – find the root cause and then come up with recommendations. However, restructuring in the case of SriLankan Airlines appears to be a rather daunting process for the Government, with endless committees and subcommittees working on a strategy. The Government started off by appointing Cabinet members and state officials in the first commission. It took them three years to realise that it is crucial to appoint experts to look into this matter. Even after appointing four committees plus consulting the best in the aviation industry, Nyras, what they have achieved so far is the appointment of a new board and a new management along with the CCO and CFO. Given the climbing amount of debt from operating the airline and also knowing the intensity of the losses, why have they taken such a long time to plan a way out of this?

The first such committee was formed back in May 2017, focusing on privatising the airline. The council was headed by Prime Minister Ranil Wickremesinghe and consisted of officials from the Cabinet and other state officials. Following up on the process, it was reported that the Prime Minister was to take the decision on restructuring the airline in July 2017.

“By 31 July, we have to give an internal restructuring plan to the Prime Minister, basically looking at what we have to do internally with SriLankan – irrespective of whether we are getting a partner or not, we need to move forward,” a statement given by then Minister of Public Enterprise Development Kabir Hashim.

However, implementation did not materialise, and on 8 December 2017, the President appointed another special ministerial committee and a committee of officials to assist them to decide the fate of SriLankan Airlines with a deadline of two weeks, with a report due to be submitted on 20 December 2017. The actions regarding the airline were to be implemented on or before 31 July 2018. Why does the Government take such a long time – almost half a year – to implement these recommendations? The role of any government in an economy is to adjust market failures, not to cause more.

By 2018, Nyras, one of the leading aviation consultancy firms, was hired after the initial round of recommendations, and it presented a comprehensive report. However, the consultancy group has now filed a lawsuit against the Government because of delayed consultancy payments. While these measures were taken and international consultants were hired, SriLankan Airlines was still piling up losses at an exponential rate.

By 7 January 2019, the President formed yet another commission to conduct a comprehensive study – review the present vision and mission objectives, strategies, corporate plan, and action plan of the airline – and come up with recommendations for restructuring, which does not consist of any member of the previous committees formed by the President. Does this mean that the previous four committees appointed (two committees in 2017, one in 2018, and another in 2019) are redundant?

Exercising our rights as citizens, we need to push for fast reforms as this is a black hole sucking out tax-payer money. It has taken five committees, including consultancy from Nyras, to address various issues of SriLankan Airlines for the past three and a half years. With these five committees, what the Government has achieved so far is inducting the board of the airlines.

What we can take from this is:

1. The commissions have submitted recommendations that wouldn’t work

   or

2. The Government is incapable of implementing these recommendations

   or

3. The Government is being willfully negligent by not taking action and implementing recommendations.

Given past experiences, these failures indicate a combination of the second and third conclusions.
SriLankan Airlines, which was then operated under Emirates – a renowned carrier of United Arab of Emirates, enjoyed a profit of Rs. 4.4 billion for the year 2008. The next 10 years, once the airline was taken over by the Government, suffered heavy losses due to the decline in performance and poor governance. The national airline had been climbing down in terms of performance as well as losses.

How many committees would it take for the Government to really execute any of these plans? When the good governance regime started their office in mid-2015, the losses of SriLankan Airlines were Rs. 16.4 billion. The losses of the airline had more than doubled up to a cumulative loss of Rs. 40 billion for the time period between 2016 and 2018. It took losses of Rs. 40 billion, and three years’ worth of planning to appoint two vital roles, the Chief Commercial Officer and the Chief Financial Officer, to the airline. How enormous should the losses be for the government to implement restructuring procedures? What would be at stake by then? This is indefinitely an answer Sri Lankans would not like to find out.