How bad parenting leads to bad credit

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

Parenting a child is a difficult task. It is no doubt that educating and teaching a child takes a significant amount of time and effort for all parents. The bigger the pile of homework, the more it becomes an affair of the household, requiring the attention and time from either parents or caregivers.

Some parents take an easy route; instead of encouraging their child to get the work done, they do it themselves and bestow the child with all the credit. This may be owed to the fact that the assigned task is above and beyond the grasp of a child, or simply because parents can’t afford to allocate the time and effort required to assist their child. Undoubtedly, both reasons are not in the best interest of the child and will certainly hamper his or her learning curve and growth.

Given the above phenomenon, I can’t help but notice similarities between common parenting mistakes and the Sri Lankan economy. Our economy has adopted a habit of conveniently ignoring hard reforms for political motives and instant gratification. This has resulted in long-term damage to the country’s economy.

Moody’s Analytics downgraded Sri Lanka’s credit rating from B2 to Caa1 last week with a “Stable” outlook. While the Government has made a statement expressing their disagreement with Moody’s credit rating downgrade. It is important to understand Moody’s rationale in depth. Long-term measures to correct these problems are vital, and hard reforms may be the only way out.

The effective containment of COVID-19 and the recent performance of the stock market has been reiterated by the Government as part of their success story. Additionally, the rebound of exports and foreign worker remittances are highlighted as positives. The Government has further provided a commitment to reduce the debt-to-GDP ratio, serve all external creditors without delays, and uphold a clean record of debt servicing.

However, Moody’s evaluation, which was in the works since April, highlighted concerns over-servicing debt of about $ 4 billion (between 2021 and 2025) with a reserve level of $ 7.4 billion, along with low growth predictions. Moody’s estimation of raising the debt-to-GDP ratio of 100% exceeding the median of 86% in the Caa1 category has been highlighted as a fundamental reason for the downgrade.

Moody’s downgrade forecasts the possibility of Sri Lanka’s credit rating being further downgraded by other rating agencies such as Fitch and S&P in the coming months. This will thrust Sri Lanka into the “Speculative Grade: Very High Risks” category, raising serious concerns over the possibility of acquiring money in international capital markets. The risk attached to this doubles as the coming years are burdened with heavy debt repayments.

How can this be managed?

Prevalent data highlights that consecutive governments have resorted to borrowing in international sovereign bonds at high-interest rates of about 6.6%, with an average repayment period of nine years. It is no doubt that our economic woes are deep-rooted in these poor policy solutions.

It is vital that we acknowledge the damage caused by these measures and formulate a strategy to overcome it.

The diagnosis is clear – our interest payments take 47% of our revenue and 30% of our expenditure.

The first step to manage this downgrade is to build credibility in financial markets. This is both painful and time-consuming. However, this is not an excuse to postpone much-needed reforms. Doing too little too late would lead to severe consequences, further hampering our debt sustainability.

To build credibility, the Government enjoys the benefit of two main strengths, a key strength being the successful management of the COVID-19 pandemic, which has also been praised by the World Health Organisation (WHO). At the international stage, this can be our ticket for a possible debt restructuring, giving the Government leverage to convince the International Monetary Fund (IMF) of a credible debt restructuring plan.

As per the below graphs, a greater portion of our foreign debt is in international sovereign bonds (ISBs). The IMF programme, of course, will come with conditions which are painful, but it will also bring credibility to Sri Lanka within international financial markets. This will require a commitment from the Government to maintain fiscal discipline. Sri Lanka has spent 42% of the last 70 years under an IMF facility. We have approached the IMF 16 times for bailout programmes. This isn’t a point of pride but indicates how irresponsibly our economy has been managed over the years.

An IMF restructuring programme will not uplift Sri Lanka’s credibility to the point where a credit rating downgrade can be reversed. However, it provides additional confidence for creditors and investors who are looking to invest in high-risk markets even at a premium rate.

The second strength is the Government’s opportunity to present a convincing budget with serious reforms in November. The budget needs to have a comprehensive strategy on improving government revenue and achieving a positive primary balance. (Primary balance is the difference between government revenue and government’s non-interest expenditure.)

Both measures are painful, but the Government has the political capital and political strength to pass through key essential reforms. Unfortunately, although we measure ourselves with what we intend to do, the markets and outsiders assess us with what we have done and continue to do.

Similar to parenting a child and encouraging the child to complete their assigned homework, the path to hard reforms is difficult and time-consuming. But we all need to support and help the Government to carry out these hard reforms, as it is ultimately being carried out for the betterment of our beloved motherland and ourselves.

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

Sri Lanka’s 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

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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.

Why Sri Lankans aim low

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

Over the years, a lot of weight has been put on building “aspirational Sri Lankans”. Different terminologies have been used to define them; however, the core group of the so-called aspirational Sri Lankans remains the same – “intellectuals”, “business professionals”, “young professionals”, and “members of professional movements”. The key question then is what makes aspirational Sri Lankans aspirational, and why have they been unsuccessful in placing Sri Lanka back on the map?

Where are our aspirations?

Many Sri Lankans aspire to build a house, buy a vehicle, and probably have a grand wedding and proceed on to provide a good education for their children. Achieving these aspirations continues throughout their lifecycle. Then, the next generation takes the baton and runs the same race. This is the constant marathon run by our “aspirational Sri Lankans” for decades.

The serious question we need to ask ourselves is why basic needs such as housing and transportation have become aspirations for the average Sri Lankan in the 21st Century. Moreover, attention should be given to the opportunity costs of obsessing over housing and transportation by these “aspirational Sri Lankans” – what could be achieved if this was not the case?

Why people consume capital by building a house

While it is true that the financial literacy of Sri Lankans is low and that we have failed at the formation of capital due to excessive consumption from our initial capital instead of investing, we also need to investigate the economic rationale behind such behaviour. The reason as to why basic needs such as housing have become a distant dream to the average Sri Lankan is deeply rooted in the distortion of prices in the housing market due to the implementation of misguided economic policies. Most of the construction material in Sri Lanka is far more expensive than the prices of the said material in the entire region. The total tax Sri Lankans pay for imported steel ranges between 19% and 64%.

The tax on imported tiles ranges between 19% and 93%, and at present, the Government has imposed a temporary import restriction on tiles and sanitaryware, driving the prices of local goods up. Anyone who has attempted to build a house would know how ridiculous the prices for light fittings, curtains, aluminium, and other material are. Sri Lanka also has a shortage of skilled labour, and finding a mason or a furniture craftsman is not only difficult but also expensive. They have become expensive on the basis of productivity. If you are wondering why Chinese labour has expanded beyond large-scale construction to small-scale residential construction, the answer is rooted in productivity. Chinese labourers are five times more productive (according to an in-depth interview conducted by the author with an apartment builder) than the Sri Lankan labourer.

High import tariffs and import bans have led to skyrocketing domestic prices, and now the simple transaction of buying or building a house has become a lifetime dream of the aspirational Sri Lankan. If you ask a banker for their reason for remaining in that job, they will tell you that it is the concessionary “housing loan’” and “vehicle loan” that attracted them. While a fortune will be spent on building a house, there will be limited funds to explore better education opportunities, hereby pushing the tertiary education of young professionals to the grave due to extra prices paid for inefficiencies in housing.

The existing land issues, the inability to transfer properties, and lack of property rights have made the situation worse. So in real terms, the “aspirational Sri Lankan’s” capital that they couldn’t invest for returns was not invested in their house, but rather in the extra price they paid for construction. More importantly, potential aspirational Sri Lankans are expending valuable energy in trying to overcome the consequences of these misguided economic policies.

Where is the capital for the vehicle?

It is no secret that Sri Lanka’s vehicle market is one of the most distorted markets. Based on the usage of the vehicle, the value increases, and we pay exorbitant amounts of tax at the point of importing a vehicle. Making things worse is the vehicle permit system that is only available to VVIPS and few professions.

So what is the incentive to be an aspirational Sri Lankan? Is it to take the risk of investing the capital and trying to consume from the yield, allowing the capital to multiply, while lobby groups and politically connected pressure groups not only get a vehicle permit but also the legal blessing to sell despite tax losses to the government?

The permit culture is not only in buying vehicles, but it is also in the public transportation system where route permits for public transportation are more expensive than the bus itself, even though the cost of a bus is multiplied several times over when you factor in the tax.

Yet again in the real world, the aspirational hardworking Sri Lankan’s capital, which they never invested (which they did not have the knowledge to invest), gets gobbled down in distorted markets that are protected from competition. 

Even when looking at leisure and recreation, the cost of recovering capital invested in the construction of a hotel is passed on as room rates at prices that are higher than those of similar destinations in the region, because of our high cost of construction. At weddings, the costs of the food they serve, electrical appliances, storage, and prices of cutlery, liquor, etc. are added to the final cost of a plate at a wedding. Hence, there is no alternative but to eat away at the capital that belongs to the average aspirational Sri Lankan. 

It is true many Sri Lankans get into this trap by trying to live beyond their means, spending lavishly at weddings, building bigger houses than they require, and buying vehicles due to a lack of financial literacy. But the reasons why artificial value has been created for basics such as housing and commuting is misguided economic policies.

What young entrepreneurs chase as aspirations are not the real aspirations that could put Sri Lanka back on the map. The very reason for this is that our prices do not indicate the true value of the product or service and the real value it offers. The concept of “price” is of paramount importance. It is the single indicator of value, resource scarcity, productivity, supply, demand, and so many variables that are all encapsulated in that single number called “price”.

When governments and policies intervene in demarcating prices, the price set is a result of people chasing the wrong things and the entirety of society has to bear the cost and loss of it.

What we need is to set a culture of hard work and free exchange where young entrepreneurs are provided with a level playing field, right incentive structures, and motivation to be productive and innovative – that is the real expectation of the aspirational Sri Lankan which has now been shadowed by glittery basics such as housing and buying a vehicle. Until we work towards that, we will not be able to see a new Sri Lanka nor will aspirational Sri Lankans ever prosper.

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 ‘banning culture’ is no solution

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

Last week, the Government proposed a ban on sachet packets as a measure to protect the environment. And now, another proposal has been tabled – banning the slaughter of cattle. This is not the first time such strict measures have been imposed by consecutive governments, but it is paramount that we understand the economics and unintended consequences behind “banning”.

Before we jump to any conclusions, let’s just take a look at the results of similar policies adopted in the past, to get a taste of this “banning strategy”.

Previously, we saw a proposal to ban polythene below 20 microns in thickness to protect the environment and it was not too long ago when the former President announced a ban on chainsaws and carpentry sheds. A simple visit to the market is sufficient to demonstrate the extent these banning mechanisms have been productive.

Earlier this year, the Government learned a bitter lesson on imposing “price controls” (which is sort of a ban on selling at high prices) on tin fish and dhal. The price controls had to be revoked due to obvious market disruptions. Prices shot up, and there were shortages in the market, which was the complete opposite of what the Government intended.

A common belief is that the “banning strategy” often fails or is less effective due to poor implementation. This is far from the truth. There is very much a market and an economic dimension that show the concept in itself is flawed, which we often fail to understand.

Emotional policymakers often get the art of public policy drastically wrong. They view it through an accounting lens due to a lack of knowledge on human behavioural economics and the presence of the concept called “markets”. As a result, all good intentions result in far worse consequences.

Ban on sachets

The concept of sachets was introduced by FMCG (fast-moving consumer goods) market players on the basis of affordability and as a measure of resource allocation. Someone who cannot afford a full bottle of shampoo or any other equivalent product can use a sachet as a one-time useable product, based on the requirement. This is easy on customers’ wallets and provides value for money.

A good reason why sachets are predominantly available in general trade and mom-and-pop shops as opposed to modern trade is its easy access and affordability for the poor. On the other hand, from the manufacturer’s end, sachets help to allocate raw materials effectively and allow them to reach the market.

According to a recent article by Dr. Rohantha Athukorala, a Neilson Survey revealed that people have reduced the usage of baby soap by 18% and adult soap consumption by 17%. This indicates how people who find it difficult to manage their finances resort to eliminating basic hygiene products like adult and baby soap due to unaffordability. Cutting down on baby soap indicates a booming cost of living problem which goes beyond soap usage.

The ban on sachets will be a double whammy for most vulnerable people in society who are voiceless. All FMCG companies spend an enormous amount of money before they launch any SKU (stock-keeping unit), and we need to understand this was a market demand.

A sudden decision without prior engagement with the industry and relevant stakeholders will push manufactures to an extremely difficult situation, which will demand them to realign their manufacturing and marketing strategies in an already challenged Covid-19 economic environment. We have often forgotten that polythene is a wonderful innovation, and where its hydrocarbons are recycled to produce electronic chips and fabric.

MAS Holdings manufactured a special fabric for our cricket World Cup team with marine plastic waste which received global recognition. This can be utilised as an effective example to understand that the prime need is for setting up proper recycling methods coupled with incentives and disincentives.

Already, the discussion is heated on serious environmental concerns such as that of the Anawilundawa Wetland Sanctuary and many other places across the island, as highlighted through this column last week. The Government has to keep an eye on more macro issues pertaining to environmental protection rather than obsessively focusing on micro issues. These “banning strategies” will dilute the Government’s well-earned political capital, which will make hard reforms difficult in the coming years.

Import controls

Import controls are another form of ban on a temporary basis. The Government’s urgent need to manage its Balance of Payment (BoP) crisis is understandable. However, this requires a series of different actions coupled with temporary solutions such as bailout programmes from the IMF (International Monetary Fund) and clear policy decisions to help make our exports competitive.

Import controls hurt exports as the prices of import substitutes rise, especially where the goods are used as an input for the production of exports. In addition, import substitutes become more profitable to produce than exports.

The result of the current import ban is highly likely to affect our existing exports, as we have indicated in this column multiple times. Already, people are struggling to buy phone chargers, repair washing machines, and purchase goods which are required on a daily basis. We are running on existing stocks which will expire soon and prices have already started going up.

On the other hand, in our import bill, the big-ticket item is fuel and essentials such as pharmaceuticals, which are very difficult to control. The General Hospital has already announced a shortage of 70 essential drugs. These drugs are used to treat diseases such as Thalassemia and heart-related conditions.

However, trying to cut corners of other imports carry the potential to distort various other markets, businesses, and value chains horizontally, vertically, upstream, and downstream due to price hikes.

Prices of vehicle tyres and spare parts have shot up, which will have an impact on all goods and services with a transportation cost component. At one point, the collective effect of the rising cost of multiple consumable goods and intermediary goods may go beyond people’s affordability.

Releasing import controls at this point would be too late, given the situation of our currency. The higher cost of living will impact labour prices and most of our value addition in exports which are in the form of labour will be uncompetitive over a period, which will affect our main exports such as apparels, tea, and rubber products. In economics, the need is to take a look at the market from a holistic perspective. Otherwise, similar issues will arise over and over again.

The best example is higher prices requested by the poultry industry and the bakery industry. Sri Lanka’s maize production is not at all sufficient for domestic consumption, which is the main source of food for poultry. As a result of higher prices of maize, the prices of poultry products have shot up, which will have an impact on the bakery industry. Now you have a happy maize farmer but an unhappy poultry farmer and a baker. Eventually, this will translate to an unhappy consumer and a very unhappy voter.

Ban on slaughtering cattle

Adding to the banning spree, the proposed ban on slaughtering cattle is the latest. This may cause more damage rather than being helpful for the protection of cattle in Sri Lanka. However, the Cabinet Spokesperson mentioned the proposal was postponed by one month so as to allow for discussions with the relevant stakeholders.

Though the proposal may have been put forward with good intentions in terms of animal cruelty, India is a good example of how such policies don’t work. Cattle owners in India are left with no option other than to resort to the creation of illegal and unsanitary slaughtering houses and illegal markets.

Keeping aside the logical fallacy of placing a ban only on the slaughter of cattle and not the entirety of the poultry and meat industry, and the justification of leaving domestic demand to only be met through the importation of beef, the matter goes far beyond that.

The beef industry does not exist in isolation; our leather industry, dairy industry, and leather exports are also dependent on it. According to the Export Development Board (EDB), in 2016, about 1% of total merchandise exports consisted of footwear and leather products, which has now dropped to 0.6% of our merchandise exports.

According to the EDB, there are about five large companies, 10 medium-scale companies, and more than 1,000 small enterprises and seven tanneries that produce 25 tonnes of leather every day.

If passed by Parliament, this proposed ban on cattle slaughter will prevail at the expense of 1,000 small enterprises and exports worth $ 550 million. While animal cruelty is of grave importance, sometimes in life we have to keep some markets for the greater good and to avoid much greater negative impacts.

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.

Environment vs. development: It's all about land

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 question of how to develop Sri Lanka without obstructing our valuable environmental ecosystems has come to the forefront yet again. The recent incidents surrounding the development of a road in the territory of the Sinharaja Rainforest, a World Heritage Site, is one prominent discussion.

The deforestation in Haputale for cardamom cultivation and the establishment of a prawn farm in Anawilundawa, a Ramsar wetland, also raised serious concerns among the general public and environmental activists, adding more fuel to the debate on development vs. environmental protection.

This debate has come to a point where questions are being asked on whether Sri Lanka can be developed without disrupting the environment, and whether environmental activism is hindering the development of the country.

This is not the first time this topic had taken centre stage. “Save Wilpattu”, the Mount Lavina beach expansion project and the development of the Port City have been popular thematic stories over the years; the human-elephant conflict (HEC) is a continuous battle that gets primetime news coverage too.

What’s the real problem?

On the surface, it seems that all the incidents are a result of efforts to strike a balance between development and environment – which is true to an extent. However, if we dig a little deeper, in economic terms, it is a clear case of an attempt to maximise the utility of a scarce resource – “land”; at the same time, it is an issue of property rights.

And all that we’re seeing is an outcome of our inability to maximise the utility of land by improving productivity, alongside the absence of “property rights”.

Let me explain why and how.

Forests are sacrificed due to the absence of property rights

One of Sri Lanka’s most limited and precious resources is “land”; being a tiny island which is just a dot on the world map, land is not in abundance for us. Our size as a country is quite smaller than average cities or states in the rest of the world. Unlike other resources, land is fixed in size, and increasing the extent of land (similar to what was done with the Colombo Port City) is an extremely expensive affair, both monetarily and environmentally.

Sri Lanka’s total land extent is about 6.6 million hectares. Can you take a guess on the amount of land owned by the Government and the amount of land owned privately by its own Sri Lankan citizens?

Only about 18% (1.2 million hectares) of the land is owned privately by its citizens while about 82% (5.4 million hectares) of the total land is owned by the Government.

About 28% of our total land is forest cover, according to the FAO (Food and Agriculture Organisation of the US). Out of this, about 573,400 hectares (2,214 sq. mi.) of land is categorised as “Protected Nature Reserves”.

So in reality, the Government owns about half of Sri Lanka’s land (more than 50%), and this can be used for economic activity and environmental purposes. We should not be misled into thinking that private land is owned by anyone else other than our fellow Sri Lankans. In other words, many Sri Lankans do not have the rights to their property; they do not have deed titles; many of our fellow Sri Lankans do not have access to land, and the limited access some Sri Lankans have to government land is on a license basis.

According to news reports, a Sri Lankan has to visit 20 institutions just to get clearance (not to obtain a deed title) on land for cultivation on a lease basis. They have to take a licence from the government office if they are to cultivate on land owned by the government; as they do not own it, they have no incentive to use it sustainably.

As a result of agriculture, illegal settlements, and economic activity, the borders of forest land have always been blurred. It has been reported that usually, surrounding villagers and elite businessmen who have political and influential power encroach forest land for commercial purposes. Information reported on deforestation and obstructions on environmental ecosystems make up just a fraction of the ground reality. This is because most illegal deforestation takes place in obscure locations close to forest cover, which is difficult to track.

Inability to maximise on lands and its utility

The inability to protect our land and forest cover is a completely internal issue and of course a political football pertaining to a very sensitive issue. Whether we like it or not, the “market” works in good-case scenarios and worst-case scenarios. When Sri Lanka has a rising population with more households, and when people do not have land and property rights for agriculture or many more economic activities including housing and investments, what do you think would be the outcome if we fail to improve productive usage of land? For example, if we fail to improve the productivity of land by constructing vertical buildings, what would the outcome be if all five million households expect to build houses on 10 to 20-perch plots of land? The same applies to agricultural land, and this is one of the main contributory factors to deforestation across the globe.

According to the Economic Census in 2013/2014, about 2.2 million hectares were used for agriculture, an increase of 18% from 2002. It is obvious that in order to feed our population and sustain economic activity, our land usage has increased. However, we need to focus on improving productivity and efficiency by utilising it effectively for agricultural purposes if we are serious about protecting our forest cover. We have to move to high-yield varieties and vertical farming, and again, it boils down to accessing property rights if we were to increase the utility of land through investment. No person would invest in land they would not want to own. Unfortunately, most of Sri Lanka’s land is dead capital. No one uses it and there is no economic activity. Now, Sri Lanka expects to be self-sufficient in paddy, milk, maize, and vegetables and is aiming to supply the entire demand for rubber within the country. Sri Lanka is also aiming to expand coconut product exports by fewfold; where do we have the land to do all this? We need to take our land policy seriously or else we will put our forest cover into further risk.

President received firsthand information

The President received firsthand information on the gravity of the land issue. One of the main requests by the people or fellow Sri Lankans is for the Government to provide them with land.

His Excellency the President, in his policy statement, stated that land issues are one of his priority areas. Moreover, there were recent news reports on his directives to the relevant institutions to issue title deeds within three months which pertained to unresolved land issues.

Land issues are very sensitive, and all conspiracy theorists have a collective voice; they all suspect that foreigners and other parties may take over our land. However, since 1948, it’s been purely Sri Lankans who’ve owned the land. The responsibility cannot be passed on as it is our own leaders who control 82% of our land. (According to Sri Lanka’s regulations, there is minimal room for anyone who is not a legal citizen of Sri Lanka to buy land. Even the apartments and condominiums can be bought only if it’s above the fourth floor).

According to data, Sri Lanka lost about 490,000 hectares, or 20.9% of its forest cover, in just 20 years, from 1990 to 2010. If the majority of the land is governed by the State and if there is no room for any outsider to exploit our land, doesn’t this mean that we have really failed in our public policy and in understanding the economics of land management?

However, instead of looking inward, we have become masters of pointing fingers at outsiders and fearmongering to cover up our failure, and sadly, our forest cover has become the victim.

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

Can industry-specific ministers fix this issue?

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 appointment of cabinet ministers and state ministers is still a topic at dinner tables, especially on the state ministerial portfolios. This is mostly because specific industries or fields have been provided for state ministers. There is general criticism surrounding ministers being appointed to micro sectors of the industries while the general expectation from a minister is to serve a broader mandate, and do justice to taxpayers’ money by formulating and implementing policies.

Many critics question the role a minister could play in a comparatively small industry where the designing, production, marketing, and distribution are mainly done by the micro-entrepreneurs themselves. For example, the state ministerial portfolio for Batik, Handloom Fabrics, and Local Apparel Products has been a topic of discussion since the appointments. Another state ministry that is being widely discussed is that of Cane, Brass, Clay Furniture, and Rural Industry Promotion.

The counterargument is that previous state minister portfolios were just token positions with no decision-making power. It is argued that in this case, ministers have been provided a specific role, scope, and focus, and people can directly hold them accountable for their industries and industry-related concerns. At the same time, a measurable key performance indicator (KPI) can be easily implemented and the respective and relevant institutions can be assigned to each minister. According to a recent TV interview by President’s Secretary Dr. P.B. Jayasundera, state ministers and their teams led by the ministry secretary have been given the decision-making power in that respective industry. According to Dr. Jayasundera, it is a scientific way of structuring and utilising taxpayer money without just appointing state ministers for the sake of doing so.

I believe there is truth to both arguments on the method of assigning the ministerial portfolio. The ground-level reality is that most of these assigned domestic industries are run by micro, small, and medium entrepreneurs (MSMEs) or businessmen who represent the private sector. It is important to remember that these small businesses are still part of the private sector and not the Government. The Government’s role is more to regulate some industries and facilitate the business processes because micro and small enterprises have industry-specific challenges as well as common challenges in running their daily operations. The minister’s role is to work with these sectors and assist them with reducing regulatory barriers for the sector to perform to its full potential.

Common challenges

According to the Advocata Institute’s report “Barriers to Micro and Small Enterprises” in Sri Lanka, one main bottleneck across all industries is access to finance. Access to finance has multiple dimensions extending to the banking and financing sector, but it starts from the fundamental point of business registration.

Over the years, we have underestimated the potential of micro and small enterprises (leaving the medium enterprises aside). We have provided step-motherly treatment to the MSME industry to the extent of not even focusing on their ability to register their businesses.

According to the Advocata report, sole proprietorships comprise about 61% of total businesses in Sri Lanka and provide 27% of national employment. Interestingly, about 25% of the establishments are run by women and contribution from women-led enterprises increases up to 35% in rural areas.

While the whole country focuses on the big picture of revamping the entire domestic and specialised sectors such as batik, local apparels, handlooms, pottery, rattan, etc., our research has revealed that about 45% of micro-enterprises and 10% of small enterprises have not even obtained a basic business registration. The meaning of not having a business registration is that they do not have access to finance or any Government-sponsored programme or project.

Poor enthusiasm for business registration is mainly a result of the horrendous process of registering a proprietorship or partnership. A proprietorship or a partnership can be registered under the Business Names Ordinance Act No. 7 of 1987, which is under the authority of each provincial council and provides room for each provincial council to run their own procedure on registration of a proprietorship or partnership.

So even though a specific minister may have been given scope and specific task of revamping micro, small, and local enterprises, the minister may still face challenges due to common regulatory barriers starting from the business registration process, which is the entry ticket, to finance and markets, and even for relief schemes during Covid-19 brought in by the Government.

The good news is the Government and Department of Census and Statistics (DCS) have initiated an e- registry platform for registering micro and small enterprises. According to Advocata statistics, 97% of micro-businesses and 85% of small businesses are registered as sole proprietorships. This e-registration system is indeed a move in the right direction. Then, the authorities must also ensure that the e-registration process will be simple and not a replication where the same documents are just submitted online. A system of just submitting documents such as deeds, rent agreements, etc. online would add an additional burden for budding entrepreneurs; to scan and submit documents online in addition to the time they spend getting grama sevaka certificates, rent agreements, and a list of other documentation. Advocata has recommended the New Zealand model and a South Korean model where there is a three-step business registration process, while in Sri Lanka the current process has seven steps.

Daily survivors vs. entrepreneurs

Having a simplified business registration process is the first step of addressing the problem of access to finance and providing government assistance and accessing markets. Having a simple business registration process will ensure an effective tax collection system where businesses can grow and expand.

One other reason for the poor enthusiasm pertaining to registering a business is in the fear of paying taxes. As a result, most of these micro-businesses limit themselves to being “daily survivors” as opposed to them becoming real micro and small “entrepreneurs’’.

There is a significant difference between someone who just runs a small business for daily survival and someone who takes a risk in the form of money, property, time, or any form for entrepreneurship.

What Sri Lanka requires is for micro and small entrepreneurs to migrate from “daily survivors” to micro-entrepreneurs. The Government can facilitate the process by having a conducive environment for businesses, and the new state ministers can take this lead.

Industry-specific challenges

While the micro and small enterprises have been oppressed at the registration level, at the same time, there are industry-specific regulatory issues.

Most of these industries require a license for their sourcing and a license or a government authorisation that has to be taken at each touchpoint. In most industries, sourcing of raw material and transportation of raw materials both require licences. Some of the regulations are placed with good intentions, but most of it has ended up with extra bureaucracy burdening the industry and opening doors to corruption. All licences have just ended up being another hurdle for these entrepreneurs to cross. Additionally, these licences are also an opportunity for regulatory officials to earn extra money in the way of corruption and by providing preferential treatment to the affluent and higher classes of business that have networked with local political power centres.

The new industry-specific ministers’ primary mandate when developing these industries has to be a facilitatory role and not an interventionist role. The prosperity of micro and small enterprises will depend on this. The new ministers have to ensure that they do not apply the “brakes” by introducing more regulatory barriers; rather, they should remove those barriers in each sector for sustainable growth.

At the same time, they should not push the accelerator in the wrong direction to create market distortions which will impact other more productive sectors while bureaucratic powers work only thinking about their sector at the expense of others.

Sri Lankans are more than capable of competing at the global level and “daily surviving micro and small businesses” will jump to the seat of “micro and small entrepreneurs” if we facilitate and provide a more simple regulatory scheme.

We should never underestimate the common man’s skill and the ability of micro and small enterprises, which at present are already contributing more than 30% of our national employment.

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 first test of the President’s ‘power’

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

Power cuts in Sri Lanka are not a recent phenomenon. However, this phenomenon is going to be repeated over and over if we fail to find a sustainable solution. The media reported that during the 2019 blackouts, senior officials in the Ceylon Electricity Board (CEB) had to beg the rain gods with a special “poojawa” to fill our reservoirs faster as they ran out of any other option. As reported by media, pressure mounted to a level that the then President was very disappointed with their performance and requested that the Public Utilities Commission of Sri Lanka (PUCSL) and CEB agree on a common plan.

It is clear that the energy problem in Sri Lanka is extremely complicated. This problem has no simple solution, as structural constraints, economic limitations, technological drawbacks, and many other complications continue to ravage Sri Lanka’s energy sector. The current President has received a mandate for a “system change”. How he solves this problem will be a litmus test on his administration. His approach and ability to solve this complicated public policy problem will determine whether such an ambitious “system change” is possible.

Understanding the context

The uniqueness of electricity is that we cannot store it on a grand scale – until the world comes up with a cost-effective battery storage solution. This places the CEB in a challenging position, as it has to walk a fine line between undersupplying and oversupplying power to the country, without an option to store electricity and manage shortfalls. In other words, all electricity that is produced has to be met by demand, and the CEB has to have a constant supply available, as it would be impossible to predict electricity demand down to the last unit. If the electricity demand is higher than what is generated, the grid becomes unstable. Producing more electricity than is demanded will make it difficult to manage the grid. It would also be very expensive as our electricity supply comes from multiple sources such as hydro, coal, thermal, and few renewable energy sources.

When demand increases, we can’t just activate a power station and supply electricity to the grid, as activating some power plants, setting up the temperature, and resetting the grid takes a few days. That is one reason as to why the CEB requires a few days to overcome this situation with the Norochcholai Plant becoming dysfunctional. Even with low power demand due to the contraction of economic activity such as tourism and some industrial plants, resetting the grid without Norochcholai and managing the capacity with other plants takes a few days. To put it simply, the CEB does not have an easy task at hand. The most economical form of generating electricity is hydropower where the cost per unit is about Rs. 6. We cannot match demand only through hydropower, however, and we have to activate our coal power plants during peak hours when demand rises. The unit cost of coal-generated electricity is approximately Rs. 17.50 per unit and Rs. 25-35 is the unit cost of thermal-generated electricity. According to energy specialist Dr. Tilak Siyambalapitiya, the overall cost of production of a unit of electricity is Rs. 23.32 and the approved selling price is Rs. 16.29. In other words, our selling price only covers about 70% of the generation cost. The important fact is that the cost for each unit we consume is not the same; the cost of the energy we consume during peak hours from 6 p.m.- 1 p.m. is more, as it is mainly generated from thermal and coal.

Sri Lanka’s cost per electricity unit is comparatively high compared to our neighbours like Kerala, Tamil Nadu, India, and Bangladesh. But one real reason for the cost to be lower in these countries is they have blackouts during peak hours without activating their thermal and coal plants, and households have adapted to face blackouts with some capital investments such as battery power and installing inverters. In Sri Lanka, the economic cost of a blackout would be significantly higher than supplying power through coal, thermal, and renewable energy sources. Hence, our cost is high for a multitude of reasons.

The composition of Sri Lanka’s grid is based on domestic consumption, making our peak demand hours in the evenings between 6 p.m.-10 p.m. In contrast, countries with greater industrial development have peak demand hours during daytime working hours. Additionally, in Sri Lanka, there is a tug of war between the regulator, the PUCSL, and electricity supplier, the CEB, on developing a long-term power generation plan and maintaining our power mix. As a result of this cold war, not a single power plant has been commissioned to be built during the last Government. It is rather unfortunate that Sri Lanka’s inability to come to a timely consensus on solutions for this chronic issue has continued to weigh down our national potential.

The CEB monopoly

The CEB has an absolute monopoly in power generation, distribution, development, and technology implementation. It’s a monopoly within a non-tradable sector. They have blocked everyone else and kept complete control.

Even though power generation and power stations have been contracted to suppliers of renewable energy in the private sector, they too fall under the CEB’s control. It was reported multiple times by the media that the CEB buys power from private energy suppliers at a high cost, causing colossal losses for the CEB.

It’s a mafia ecosystem between bureaucrats and the private sector. The more thermal power we buy, the more beneficial it is for the cartel members to make more money. The grid and cable network is also maintained (generation, transmission, and distribution) by the CEB with no competition, making it completely inefficient.

When questioning the CEB on its colossal losses, one common excuse provided by all governments is that the CEB sells units of power at a cheap rate so that all Sri Lankans have access to electricity. However, it is important to note that if the CEB makes a loss, it would be indirectly passed to the taxpayer anyway, as no CEB official or parliamentarian pays the losses from their private money. Our cost of power has a greater impact on Sri Lanka’s investments, and its ability to get faster connectivity to the grid is one main parameter in the “Ease of Doing Business Index” compiled by the World Bank (WB).

The CEB’s losses have also extended into the Ceylon Petroleum Corporation (CPC). In the past, the CPC stated that they would stop the supply of fuel if the CEB fails to settle its debts. This continues to be an ongoing battle. Both the CEB’s and CPC’s losses are passed onto taxpayers, even though their claim that our electricity is reasonably prices is a flawed argument and proves to be counterproductive, given that our energy prices are not reasonable when compared to the region. 

Over the years, it was reported that a grant from the Asian Development Bank provided $ 17 million in 2012 to modernise the System Control Centre (SCC), which is the main control centre for managing demand and supply of electricity.

Even though an SCC is the heart of managing electricity demand and supply and stabilising the grid, it took Sri Lanka more than a decade to execute this decision. The CEB, a state corporation with an asset base of Rs. 500 billion, being unable to finance crucial infrastructure development such as the SCC is indicative of a culture of inefficiency and ineffectiveness that is inherently ingrained within monopolies.

One of the main promises of H.E. the President is creating an e-government system and digitising government systems and processes. If the Government is serious about this, installing smart meters as soon as possible under the digitisation programme must be a key consideration. With the installation of smart meters, a significant cost for the CEB would be reduced. In an age where our bank card is connected to a mobile-based platform, where private buses are in discussion about a smart card, can we as a country still afford to have a system where an officer has to visit every household in Sri Lanka to check the electricity meter and provide a bill? Especially in an energy market where the cost of the unit changes based on the period of the year and as per the time of electricity usage? Introducing smart meters will not be a popular solution, but a system change cannot be achieved without making unpopular decisions!

Possible solutions

The problems at hand have many tiers. The main barriers for reforms are structural. While operational and human resource-related reforms can be undertaken, without structural reforms, the operational issues and human resource issues sustainably fixed will continue to be chronic weaknesses.

Structural changes

With the Imposing, a strict leadership style or rolling heads at the senior level of bureaucracy in the energy sector will not be productive given the structural problems that exist. In fact, it will most likely worsen the situation if dealt with in this manner.

As a first step, the monopoly held by the CEB must be un-entangled and straightened out. The ecosystem of corruption, inefficiency, and malpractices has to be exposed to competition, with players entering the market.

There are multiple options to do this, and we have to unbundle the monopoly of power generation, transmission, and distribution as the first step. This will be a major structural change. To ensure competition, in the long run, a competition law has to be established which will not only be beneficial to the power and energy sector but for all Sri Lankan monopolies.

Opening energy for trading

Since Sri Lanka is an island, we are not in a position to trade energy, as our grid is not connected to any other energy market. Even if we generate a surplus of energy, we cannot trade, and in an emergency, we do not have the capacity to manage a sudden shortage.

One suggestion by Prof. Rohan Samarajiva in a report compiled under the chairmanship former Central Bank Governor Dr. Indrajit Coomaraswamy and handed over to H.E. the President is to connect Sri Lanka’s grid to the South Indian grid through an HVDC (High Voltage DC) cable.

Energy trading is already in place between Bhutan and India, and Bhutan is a net energy exporter and their energy cost is very low as their generation is mainly from hydropower due to their unique mountains and geography. This has to be taken up at the highest level with negotiations bilaterally if we are aspiring to be part of a big energy market and if we are serious about being a hub for energy in the Indian Ocean.

In an era of uncertainty and supply chain diversification, it is not a bad idea to move ahead from a simple self-sufficiency mentality to a mentality of generating a surplus and aiming to become competitive within the energy industry.

While we work on these long-term solutions, we have to make sure to build the necessary power plants in the short run to manage our energy supply, while diversifying towards renewable energy sources.

The energy mafia is so large and sometimes they work by planting big ideas that are backed by self-interest of the key decision-makers, including H.E. the President.

If we continue to think in isolation and settle for mediocre options yet again, we will just be postponing the problem before us. Our President has the rare opportunity to fulfil his mandate of a “system change” and tangibly change the system by reforming the energy sector. Alternatively, he could take the easy road by postponing any serious tackling of the problem. I hope the Government will have the courage to change the system, instead of giving into pressure.

By implementing this reform, the Government will be working towards bringing the average Sri Lankan out of the figurative darkness of the nation’s long-running electricity crisis.

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

Sri Lanka’s economy must follow Vietnam

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

With the appointment of the Cabinet of Ministers and state ministers, the real game has started. Now the challenge is transforming an ailing economy to a competitive economy within a short period of time. There are many debates among the public on the division of ministerial portfolios. However in reality, bigger economic challenges and a need to manage foreign affairs will outweigh all micro debates put together.

Problems at hand

The problems in our economy have been discussed extensively. We all know that we are burdened with short and long-term severe economic ailments. We have to literally unlearn, undo, and pay for the sin of economic mismanagement of over 40 years within the next four years. As a matter of fact, $ 4 billion is required each year for debt servicing in the coming four years. Just to put things in context, per year we need four times the value of the Hambantota Port deal to just keep our noses above water. We have to do it for four years provided that there are no major negative shocks in the global and local economy. The poor public finances management combined with deteriorating government income are just additional issues we have to deal with. Sri Lanka managed to contain Covid-19 well compared to our neighbours, but with New Zealand going back to a lockdown and many Sri Lankans working abroad planning to return within the next few months, there is an indication that the risk of a sudden uptick in COVID cases is still high.

Reading the mandate

In this context, people have provided a two-thirds majority for “Saubhagya Dakma”, the manifesto of His Excellency the President. Though it is a reasonable assumption to read this election victory as the citizenry’s overwhelming support of the manifesto, I believe it is also a voice of tiredness and displeasure by all Sri Lankans against the economic and political system that we marinated in for decades. This message can be put simply as a voice calling for a complete revamp of the existing system. In other words, making a competitive, efficient, productive, and sustainable system for a progressive Sri Lanka. The underlying voice is that Sri Lankans are not happy with where we are, although the same Sri Lankans are responsible for electing all governments in the past. It may also be read as a serious betrayal of people’s expectations and under-delivery in performance. A clear mandate was provided in November last year before COVID-19 and it has been re-assured post-COVID with another mandate. Since the world has come to a new equilibrium post-COVID on the economic front, it is important to keep an up-to-date pragmatic approach with the underlying principle of making our economy competitive, efficient, relevant to global markets, and productive.

Role model Vietnam

Through a pragmatic and dynamic approach, one country that has done exceptionally well, not only in the containment of Covid-19 but also in economic management, is Vietnam. Sri Lanka has many lessons to learn from Vietnam if we are serious about transforming our economy! Till 30 July no deaths were reported in Vietnam due to Covid-19 infections, despite Vietnam sharing a border with China and having a population of 95 million. However, over the last few days, according to data, there is a sudden uptick in cases and 16 deaths have been reported. This is also a reminder that Covid-19 management is a continuous battle that must be forged until the world comes up with a vaccine or sustainable solution. By 1986 Vietnam had suffered two wars and their economy and social condition was in shambles. Vietnam won the war with the US but the victory meant very little to overcome economic hardships. Making things worse, they had to fight another battle with Cambodia while it was believed that Cambodia was supported by China. After two crippling wars, Vietnam had lost about 1-3 million young people. Basically, at this point, Vietnam was worse off than Sri Lanka right after the war.

The post-war “Doi Moi” programme transformed Vietnam and put them back on the map in just 10 years. Vietnam managed to pick the right policy mix through the Doi Moi programme and managed to establish a strong economic foundation, stronger than our post-war reforms. This doesn’t mean that Vietnam has solved all their problems, but they have been able to create a strong economy which can withstand a global pandemic. About 97% of their population have health coverage and so far it looks like Vietnam is one of the biggest survivors of the Covid-19 pandemic. They were only able to do this as a result of the business and trade-friendly economic programme they introduced in the early 1990s.

Vietnam started labour-intensive productions similarly to Bangladesh and Sri Lanka, but unlike Sri Lanka, they managed to move on to more technologically advanced product categories. Although Vietnam is somewhat behind us in raw numbers, they are far ahead in the journey of being the next economic miracle in Asia.

How they did it

Simply, they carried out reforms to improve the competitiveness of the Vietnamese economy. Tariffs at the border were lowered to improve the competitiveness of Vietnamese products. The Government limited its role to that of a facilitator and the private sector and foreign direct investment were given the opportunity to lead the economy. Global co-operation was embraced and Vietnam signed 10 very well negotiated free trade agreements. Though I am not a strong proponent of free trade agreements and I believe in unilateral trade facilitation, Vietnam has signalled how serious they are on trade through their consistent collaboration with other markets.

With the Doi Moi programme, they first managed to get one main investor, Nokia, and then built confidence in capital markets. As a result, other investors rallied around the main investment and diversified rapidly. Today, Vietnam has become the China of China. Vietnam has good trade relations with both China and the US and have become the largest beneficiary of trade tensions between these two global economic giants. Due to trade tensions between the US and China, most Chinese-manufactured products were transhipped through Vietnam. On the other hand, most US-allied countries looked at a business-conducive market outside China to diversify their factories and Vietnam had the right ingredients for investments. While most other regional markets, including Sri Lanka, were trapped in labour-intensive industries, Vietnam had already moved to high-tech and advanced product categories through global co-operation.

Samsung shifted its smartphone production to Vietnam, Apple is reported to manufacture its Airpods in Vietnam, and Google plans to shift its smartphone production from China to Vietnam. As a result of co-operation with these global companies, homegrown Vietnamese companies are now emerging, showing competitive potential in global markets. A good lesson for Sri Lanka on understanding the recipe to improve local production is that local production can be improved only if we produce goods and services on a globally competitive scale. Vietnam has proven this.

China Plus One strategy

With Covid-19, ideologies on self-sufficiency are resurfacing, but the reality is that the world has decided to diversify its supply chain. China is the factory of the entire world, but due to rising labour charges even before Covid-19, companies were considering moving out of China. However, given the large infrastructure and business ecosystem and the availability of a range of skills (low-level skills to high-level, specialised skills) in one market, China is still competitive. But now companies are moving to a “China Plus One” strategy – meaning they keep their supply chain in China while investing in another Plus One market as a contingency. Again, Vietnam became the ideal location given the close proximity to China and more than that, its business-conducive environment. Sri Lanka too can get few investments if we play our cards right with big-ticket investors using a China Plus One strategy.

Lessons and solutions

Sri Lanka needs to unlearn from the era of producing everything on our own. That is history. Now the world is in a place where they produce only parts and components and have moved on to assembly. Sri Lanka needs to get onto this boat and begin producing parts and components and that too, competitively. Just producing products for the sake of producing them is not the way to boost local production. Like Vietnam did, first, you get the know-how and play with world-class players on your own soil which will produce results. This will not only improve our share in global markets but also improve local production. I hope the new Government and the respective ministers will understand the dynamics and capitalise on this wave. I wish them all the strength and vision to build a resilient economy and wish Sri Lanka’s economy will stand the test of 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.

New government must ‘unlearn’

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 election is over and a strong and secure mandate has been provided to President Gotabaya Rajapaksa and the Government. The President has already announced that the new Parliament will be convened on 20 August and I congratulate all the members who will represent our citizenry in this Parliament. It is certainly going to define a new era for Sri Lanka if the newly elected members take it seriously.

Regardless of which party won or the composition of the government, Sri Lanka’s challenges were always going to remain unchanged. A new government cannot create a new Sri Lanka unless the government takes a new approach and starts to unlearn and undo the wrongs we’ve been committing for decades. 

Challenge 1: A severe economic recession 

The official data released by the Census and Statistics Department just the day before the election indicated a 1.6% negative economic growth (economic contraction) in real terms in the first quarter (January-March). Considering the depreciation of the Sri Lankan rupee, in US dollar (USD) terms, it is approximately a 5% contraction of the economy in the first quarter. Sri Lanka took strict social distancing measures towards the end of March, so we have to expect further economic contraction in the second and third quarters. The new government’s biggest challenge would be realigning the economy. 

According to the Export Development Board (EDB), exports have been picking up almost on par with last year’s exports, which is a big relief. A potential reason behind the recovery in exports could be the fact that India and a few competing countries have failed to manage Covid-19. As a result, some degree of production has been parked in Sri Lanka even though our cost factors are high. In the long run, we should be able to keep those orders on our shores by offering competitive prices. Otherwise, once those markets (India, Philippines, etc.) open and bounce back to normal, we will have to fall back to square one.

The EDB has expressed concern about the apparel sector’s ability in securing orders after August. Therefore, the new government has to get prepared early by starting negotiations with the International Monetary Fund (IMF) as soon as the new Parliament is summoned. Our neighbouring countries such as Nepal, the Maldives, Bangladesh, and Pakistan have already managed to secure IMF bailout programmes to overcome the brewing global economic crisis. 

Challenge 2: Trust, cohesiveness, and diversity

Over the last few decades, Sri Lanka has had emotional wounds which haven’t recovered yet. Over the years “suspicion of others’ religious and ethnic identity” has taken root amongst our fellow Sri Lankans and petty politics have ignited these fears in order to polarise Sri Lanka.

All political parties created suspicion between each other for their political advantage. Now, the very same suspicion has become the main bottleneck for us to move forward towards economic development.

In my view, this paranoia of suspecting each other is one reason why Sri Lanka is lagging in economic development when compared to other competitive East Asian countries. For more than 30 years, our Sinhalese and Tamils were suspicious of each other and did not respect our diversity. This led to the creation of the LTTE, who also capitalised on these fears while all of us became victims and losers.

If you remember, thereafter tensions were created between religious groups for converting people to a different religion for financial incentives. The wounds are not yet fully healed between the North and South, and new tensions have erupted between Muslims, Catholics, and Buddhists.

Our suspicions go beyond that. Businessmen have been labelled as a group of people with an “only for profit” motive (“businesskaaraya”), regardless of the service and assistance they provide to our economy. Private enterprises have always been attacked for playing a villain’s role over the years. As a result, all our young graduates keep expecting government jobs.

Now, we are in a situation where our revenue is not adequate to pay the salaries, pensions, and social security expenses of the government. Going a step further, we have created suspicion on foreigners and foreign investors with the famous term “foreign conspiracy”, while completely disregarding diversity. Every white-skinned person has been labelled a threat for an invasion rather than an opportunity to explore opportunities for co-operation globally.

We are where we are now as a collective result of all these domestic perspectives. We all unanimously agree that we have played far below our potential and that we are a deeply divided nation.

We are further divided on political ideology, so much so that we kill each other and damage each other’s property. The new government has the challenge of undoing and unlearning these practices. “Suspicion” is the seed that can crack any relationship, friendship, partnership, or co-operation. Even in Buddhism, “suspicion” is considered an emotion to be treated with extra caution.

Sri Lanka’s strength is its diversity. Starting from our biodiversity, diversity in weather and cultural and architectural diversity have always been our edge. Our exports need to be diversified, our economy has to be diversified, and our Sri Lankan mindset and experiences need to be diversified.

How can we create diversity without respecting diversity between people and all Sri Lankans? One of the main challenges for the new government will be establishing diversity and bringing everyone together in heart and in practice rather than spending years on documenting regulations and strategies. All political parties need to co-operate with the new government, as Sri Lanka is wounded beyond her threshold of tolerance. 

Challenge 3: Establishing competitiveness

Making Sri Lanka an economically advanced nation can only be part of a broader strategy, which is dependent on making our economy competitive. To establish competitiveness we need to increase our productivity and efficiency. The game is like winning the World Cup, where the only way to do it is to play well and play better than all the other teams. The same applies to our economy. There are multiple ways to improve productivity and efficiency. We need to think on a global scale and produce in relation to global markets while joining the Fourth Industrial Revolution. That is the next challenge for the newly elected government. 

The recent reality TV programme performed by teenagers which is getting popular across the world is one good example of the miracles as a result of competition and a competitive environment.

Young Sri Lankan teenagers proved that Sri Lanka can compete. Some of the young artists have not only challenged local original musicians but also western original musicians in their vocals and musical capacity. Some have been compared in foreign media for their performance and this is an indication that the younger generation is ready to compete and they have the fire to compete on the global stage.

Another event that made headlines was Sri Lanka’s national debating team becoming the runner-up in the World Schools Debating Championship by debating in a language which is not their mother tongue – another good example of the benefits of competition and why Sri Lanka can compete on a global level if we pick our strengths right and create a competitive environment.

The new government should push Sri Lankans to work hard for free exchange and create an environment of opportunities for any individual to be successful regardless of religion, ethnicity, caste, or creed. Sri Lanka has been practising to avoid competition and be isolated from the world – the complete opposite.

The new government has the challenge of undoing and unlearning most of what we have been doing over the years. I wish all the courage to His Excellency the President, the new government, and the new Minister of Finance and all the strength to bring in the hard reforms and to put Sri Lanka back on the map.

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 Lanka cannot be developed?

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

Since Independence or even before that, as Sri Lankans, we have had one main question. How can Sri Lanka be developed? This same topic has been resurrected again, as usual just before another general election. Fighting terrorism, raising national security, adopting a new constitution, and many more popular topics, boil down to the same question over and over again – how can we develop Sri Lanka and why have we failed to do so for many years? 

We have analysed, reanalysed, and one can even claim overanalysed our economy. The same problems and the same solutions have been discussed for decades. The stories of how Singapore was behind us and how the then leaders in Singapore envisaged Sri Lanka as their role model for development is a story we have heard repeatedly.

How South Korea was just an underdeveloped nation compared to Sri Lanka in the 1960s and how Sri Lanka was just behind Japan at Independence are stories any Sri Lankan can repeat with their eyes closed. After having learnt lessons told by these stories, why couldn’t Sri Lanka accelerate growth to become a developed nation? This definitely is something hard to comprehend. 

After thinking this over and over again, I felt that “Sri Lankans do not want to make Sri Lanka a developed country”, is a reasonable conclusion as to why we failed. Simply, we do not have the fire in our belly to overcome the hard economic conditions we pass through. Over the years, we have become a nation which has become more dependent on the Government. Rather than us as individuals taking ownership of what we do and how we could overcome challenges in life, we have moved to the backseat, expecting governments to present solutions on a platter.

It is true that we have extraordinary talents and skills but collectively, we have been mediocre and settled in an “average” mindset. Making the “average mindset” an advantage over the years, our political elites across all political parties have been promising more government-centred solutions instead of empowering individuals to take and drive the economy at the ground level. 

Making our people purely dependent on the Government has become the main economic policy followed by all mainstream political parties. Such a dystopian economic policy advocated by the political parties is based on number play and talk show screens where they point fingers at each other. The unique selling point of a political party’s economic policies have been the size of the relief package, number of government jobs, and glittery promises, which are beyond delivery under any realistic circumstances.

While political parties and politicians have taken our citizenry for a ride, the citizens themselves have evolved to live in an average world, with an “average mindset”. The composition of Sri Lanka’s Parliament, and the calibre and quality of our representatives in Parliament, is an equal representation of the vast majority of Sri Lankans. Both seem to lack a burning need/desire to get our economy on the right track.

Even someone with a political party affiliation would agree that the choice of candidates before us to exercise our franchise is extremely poor. However, considering the support base across for all political parties, we have to agree the choices that are provided are a fair representation of our people. 

Regardless of which government is in power, our economic policy has been more or less the same. Though there are micro changes in certain policies, in a wider spectrum, our way of economic management has been the same for over nearly two decades. Different governments came into power and pretty much the same faces ruled the country (crossovers between political parties) without having the courage to drive a serious economic reform plan. At certain junctions of our political economic history, economic reform plans were discussed by the people and policymakers. However, certain cross sections of society with vested interests chose their personal benefits and perks over the good of the nation and they did not allow any progressive plans to take off. 

We burnt days into years and years into decades just enjoying the events, stories, and dreams created by the people’s representatives themselves. They crossed over from one party to another, made controversial statements, the rest agreed and disagreed; we brought in new faces to politics, criticised each other, and to this day, the same circus continues.

As a consequence of being ardent fans of this drama, Sri Lanka has become older instead of becoming rich. Sri Lankans have trapped themselves in this drama at the cost of a hardworking route based on the free exchange of ideas and limited ourselves to a more inward-looking approach, giving up the journey to improve a country that aspires to have a higher standard of living.

We proudly scream the words: “Sri Lanka has been a developing country and will be a developing country for the rest of our lifetime.”

Instead of passing the blame onto politicians, we the people have always been less aspirational about overcoming the deteriorating economic conditions, and that is the very reason we have failed over and over again. 

Though our literacy rates are high, our economic education and exposure levels are very poor. Lack of proper English knowledge and major gaps in our education system complements this vicious cycle. As a direct outcome of these weaknesses, our voters are easily misled as they are not trained to analyse and evaluate information and have become victims of misinformation. As a matter of fact, our knowledge on matters of the economy has been significantly poor even though we produce a significant number of economic studies graduates in our higher education system. Their lack of a skill set to fit into our job market speaks volumes of the expired economic theory most of them have internalised after spending three to four years cramming and memorising. 

Whichever government that’ll be formed next week will have the same challenge of making Sri Lanka a developed nation. It is an economic reality, regardless of any party affiliation or any ideological affiliation, that we badly need to make our economy competitive.

Without bringing in the reforms to make our economy competitive and having the will and courage to pick the right policy choice to make it competitive, Sri Lanka will hardly have a future. The main problem why we can’t go for a serious economic programme is because our people simply do not want to. We have become victims of our own attitudes, behaviour, and misinformation. 

Only time will tell whether the new government has the will and courage for an economic reform plan. Irrespective of whether the government picks a strong and viable economic reform programme or not, our clock ticks faster and we have to live only with the hope that things will get better, till time really tells us.

No strategy will work until we work!  

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

Two ways the private sector has failed Sri Lanka

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

There are two main models of growth and development, which have been discussed and used interchangeably. The state sector-led development model where the government maintains a fair share of businesses by expanding the state footprint is widely popular in Sri Lanka. The second model is a private sector-led model where private enterprises and individuals are provided the opportunity to lead growth and development. Interestingly, the state sector-led model doesn’t rule out the engagement of the private sector. Having a conducive environment for businesses, a high-doing business index, and maintaining a business-friendly environment have always been part and parcel of the promises made by political leaders including ideologues who favour a state sector-led model.

The state sector

In any business model, the main factor is “ownership” or the incentive to have ownership. Ownership comes in different forms, but in business, it is associated with risk. The higher the risk, the higher the gain. The person who risks their money, reputation, time and any form of capital has a natural incentive to recover it or make a benefit out of it. In private business, the individual or the shareholders have risked their private money (property) in the business, so they are psychologically driven to perform well, supervise their teams, recruit cutting-edge talent, and delegate responsibilities with the objective of growing together.

In the state sector, it’s different. The people who manage the specific organisation haven’t really invested any risk. They are just managers and responsible officers. So even if the business/organisation performs well or not, it hardly has any impact on them personally. They will not lose any private property or anything personal in the state sector business model. Instead, in a private sector investment, the investor and the person who takes the risk have so much to lose. In the state sector-driven model, the main source of money is taxpayer money, which was collected at different stages of the economy through imports, income, profit, etc.

As per the Sinhala folktale and anecdote, The Porridge Pot of Seven Villagers (aadi 7 denaage kanda haliya), no one is responsible for anything and everyone assumes the other person will perform. Ultimately, no one performs. When no one takes the responsibility, gaps are created for corruption. The question then arises: Without ownership or stake in your private property, why should someone take the risk of blocking corruption?

It is generally discussed that bribes are a necessity to be paid at all levels of a project/investment or else the project will be blocked at each stage from approval to functioning. This is a good example of the window for corruption that is caused by a lack of ownership. This is the inherent problem in the state sector model and the reason for its inability to improve productivity and efficiency.

Many Sri Lankans are of the view that the private sector running a business is equal to common people losing access to their common public property. A slightly different sentiment which is very deeply rooted in society is that when the state runs the business, it is more people-friendly and that prices tend to be more reasonable.

Also, government jobs are very popular during election times across all voters. Someone with basic mathematics can understand as to how unsustainable our state sector and state-owned enterprises (SOEs) are. According to the recent report by the Labour Department (1) (May 2020), about 1.2 million people work in the state sector. In addition, our SOEs are making eye-watering losses. According to the Committee on Public Enterprises (COPE), the total loss suffered by SriLankan Airlines from 2009 to 2019 sums up to about Rs. 240 billion (2), exceeding our expenditure on Samurdhi, our main social security programme for the poor, which is about Rs. 94.7 billion (3).

The private sector

While our state sector has really brought us to our knees, our private sector performance has been equally bad. There are about 3.4 million private-sector workers in Sri Lanka and another 2.7 million are own-account (self-employed) workers. More than 200,000 are employers. The private sector failed Sri Lanka miserably by adding burden on two fronts. One by burdening the common Sri Lankan by blocking the opportunity to consume good quality, reasonably priced, and competitive goods and services by hiding behind high import duties and adding most of the product categories into the negative list. When you impose a higher import duty for a consumable good, it increases the price of that respective product, making it impossible to compete in the local market.

As a result, consumers only have the choice to buy locally manufactured goods and services. Buying locally manufactured goods and services benefit these respective companies and local entrepreneurs. This can be argued as a good thing, but earning a profit by avoiding competition from the global stage and adding an additional cost to the Sri Lankan consumer to pay for the extra inefficiencies is unjustifiable. Instead, most in the private sector should be able to compete with global products by increasing their efficiency and productivity, rather than hiding behind government protection.

Below are some import protections and the numbers are extremely high. How can we justify an extra protection tax of 26.6% on a pair of school shoes, a protectionist tax of 19.6% on construction steel, and 53.62% on floor tiles and wall tiles in a country where the mean household income per month is Rs. 62,237 (4)?

Secondly, some businessmen are dependent on government contracts and licenses, creating an environment of symbiosis for corruption between politicians and the business community. Today, this has become a practice from national level to the local government level, and this is the private sector’s main contribution to taking mother Sri Lanka backwards. To keep this level of protection by higher import duties, most of the senior businessmen have to align with political powers. Even if Sri Lanka is to continue down the path of import substitution, our local products have to be competitive for this policy to succeed.

At the national level, high-level agreements, contracts, tax holidays, moratoriums, and loan reliefs have been provided by each government to their connected business circles. Instead of competing with technology and skills (except for a few players in apparels, rubber, tea, IT, and services), most business leaders have compromised their ethics, modesty, accountability, and genuineness over quick and short-sighted profit margins by avoiding competition at the global level. As a result, Sri Lankans have to pay the price for our domestic inefficiency, while the economy has become uncompetitive and irrelevant to global markets.

Some businessmen went a further mile to establish monopolies while hiding behind high import tariffs. Most of these private-sector monopolies rely on unethical business practices, giving rise to multiple situations of conflict of interest. They have pressured small players and have bought them over by unethical tricks or sometimes the use of power, rather than setting an example for Sri Lanka by empowering our youth to compete for ideas at the global level. Sri Lankan businesses have decided to remain isolated, being planted while isolating our consumers from access to world-class products that would improve their living standards significantly. Some Sri Lankan micro, small, and medium-scale businesses have been hindered from accessing world-class raw material and ingredients.

Another set of businessmen have been arguing on the need for global competition to all industries, except to the industry they are operating based on baseless excuses. One common argument is that the industry is at an infant stage, so they expect import tariffs or types of protectionism. But most of these industries are far from the infant stage. They have been in operation for more than a few decades.

The companies that were open for competition and competitiveness excelled and they extended their business to other parts of the world like India, Bangladesh, and Africa. This fear of competition in the vast majority of Sri Lankan businesses is one reason why Sri Lanka could not become a breeding ground for world-class businesses and have failed to operate beyond this tiny island. So now we have an extremely tail-heavy inefficient public sector and an equally protectionist political party-aligned business sector making all Sri Lankan’s suffer.

The solution for this is not moving back to the state-led business model, but to have an open mind to be open for competition. Till we reach that state of mind, Sri Lanka will suffer economically and continue to be irrelevant in global markets, while more graduates and youth will gather on our roads requesting more government jobs.

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 we can’t afford another lockdown?

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

With the sudden spike in Covid-19 infections over the last few days, we have seen a re-emergence of discussion on a possible second wave. Globally, the Covid-19 numbers are increasing on the one hand, while countries have decided to resume activities on the other. However, when there is movement and interaction of people, there is a higher probability of the virus spreading.

Sri Lanka’s economy is at a stage where we can’t afford to face any economic shocks, given the bad economic fundamentals we have been practising over the years. The pandemic has re-exposed these weaknesses and for this, we might have to pay a considerable price as compensation for our past sins of economic mismanagement.

A second wave of the pandemic would bring in a significant array of economic challenges for both the developed and the developing worlds. However, Sri Lanka’s challenges are structurally unique as our economic problems have reached a boiling point.

Our economic problems at a boiling point

Relief schemes provided by the Government during the first lockdown and the economic revival measures scraped the bottom of our barrel, and the ability to absorb a second lockdown is a serious question.

We require foreign currency to pay our external debt at an average of $ 4 billion for the coming three years. Our exports have been declining over the years and Covid-19 has impacted the remaining markets; with a second wave, it will continue to bring new challenges. Our tax revenue is declining and rating agencies have downgraded our credit rating. As a result, investor confidence is low, making it difficult to raise money from markets even to roll over our debt and interest repayments.

Most of our workforce is in the Government and our government expenditure is burdened by salaries, pensions, and welfare structures. These welfare structures (Samurdhi relief, support for low-income differently-abled persons, financial support for the elderly, financial support for kidney patients, flood and drought relief, allowance for preschool teachers, etc.) are inefficient and ineffective. Our remittances, which is one of the main sources of foreign currency, are expected to decline further with Covid-19.

To manage the existing limited foreign revenue and foreign reserves, the Government has imposed import controls. The need to manage our foreign currency income is understandable. However, we cannot rule out the consequences of a further decline in government revenue and the impact this will have on our export industries. Furthermore, prices of consumable goods in the mid and long run are very likely to go up, making things further difficult.

How import controls hit govt. revenue and exports

According to 2018 statistics by the Ministry of Finance, 49% of government revenue was generated from import-based taxes. As per the Mid-Year Fiscal Position Report 2020, from January to April, over 55% of government revenue had been from import-based tax (savings from the lower fuel prices in the world market are one reason for higher import revenue). The Government extending import controls will result in a further decline in government revenue in the next quarter. While income is declining, our main expenditure items such as salaries and pensions are on the rise. Our recurrent expenditure – salaries (Rs. 253.8 billion), pensions (Rs. 79.8 billion), interest payments (Rs. 336 billion), and other payments (Rs. 150.7 billion) – are at Rs. 820 billion from January to April 2020, but our total revenue including a profit transfer from the Central Bank is at Rs. 476 billion. Calculations illustrate that after paying interest payments, we are running short of revenue to pay even our salaries and pensions, let alone other payments.

While import controls impact our national revenue significantly, it will have a higher impact on local businesses – just take computers, for example. If there is a restriction on computer imports and spare parts over time, we will face a challenge in replacing and upgrading the computers we use at present. Needless to say, this would affect the work of government offices and decrease our work efficiency as a significant proportion of the work is done through computers. This is just one example. We haven’t really felt the impact of import controls as we are still using existing stocks. Most imports we use for the moment are, to an extent, durable product categories, but in the mid and long term, people would feel the drop in efficiency and witness price increases.

The very same import controls impact our export businesses as most of the imports are used by local businesses to produce consumable goods and exports. (Think on the same lines of restrictions on importing computers.) The efficiency drop will impact the prices of exports to increase, making it difficult to compete in global markets. Industries like plantations will have further pressure to increase salaries with the high cost of living. Already many industries have indicated the difficulty to sustain their operations due to import controls. From the Government’s point of view, the need to manage the availability of foreign reserves is justifiable, but there will be significantly bigger costs and consequences to the local economy and the consumer.

Can we afford another lockdown?

Looking at the problems at hand and as all problems are reaching a boiling point, it is difficult to have another standstill in our economy. The only possible solution is to keep the movement of people between selected borders between districts or divisional secretariats while adhering to health guidelines, thus keeping the economy afloat running. Of course, the commute of the workforce between borders will have complications, but since most of us have hit rock bottom in our economic conditions, we are left with a very few alternatives.

The ideal solution for the foreign currency shortage is to secure a programme with the International Monetary Fund (IMF), as recommended by us. Such an IMF programme will require significant structural reforms. Another significant determinant by the IMF would be the need for a democratically elected government, meaning that a possible postponement of the election would be detrimental to seek such financial injections.

Probable solutions

The problems at hand have no quick fixes, and quick fixes will only worsen the current situation. First of all, we as a community should take precautions, adhere to all health and safety guidelines, and thereby stop contributing to the spread of Covid-19; we really can’t afford a second lockdown. Secondly, the problem with our economy is neither the high imports nor the consumption of imported goods – our problem is that our economy is not competitive or efficient. Our problem is poverty and the poor man or woman’s only tradable good is labour. There are limited or no opportunities to trade this tradable good called labour to earn a decent living as our economy is not competitive enough. Until we resolve this issue by setting our economic fundamentals right, our current crisis will exacerbate, also meaning that we cannot afford a second lockdown.

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

Sri Lankans’ common enemy is poverty, not each other

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

We may worship different gods but as Sri Lankans, we all have one enemy – poverty. According to data on Sri Lanka’s poverty line, 4.1% of our population is “poor”, but nearly 50% of our population is eligible for the Samurdhi Programme. Another 1.4 million is employed in the government sector. Therefore, the majority of Sri Lankans are just above the poverty line.

This was confirmed recently by the World Bank (WB), when it downgraded us to a lower middle-income country from an upper-middle-income country, as our Gross National Income dropped in USD (dollar) terms. In other words, we have become poorer.

Our economy has grown by 2.3% in LKR (Sri Lankan rupee) terms but in reality, we have become poorer as our GDP growth in USD terms has dropped to the standard of living that existed in Sri Lanka in 2005. Even though we were an upper-middle-income country for a short period, Sri Lanka’s province-wise income told a different story. Apart from the Western Province, the other provinces were way below the upper-middle-income range. It is clear that our average income was skewed by Western Province data.

At a time when we have all become poorer, the last thing we need is to fight amongst ourselves based on cast, creed, religion, or ethnicity.

If you look at Sri Lanka’s history, our highest growth rates and higher levels of production were achieved when the country was in peace. Although there were many interpretations of it, after 2009, which saw the end of the civil war, the country experienced tremendous growth rates above 7% with the Northern and Eastern Provinces joining the national economy. 

However, unfortunately, we failed to establish the fundamentals of our economy post-war, and we have been paying constantly for our early mistakes. We only reaped the advantage of ending the war but we failed to utilise the opportunity to put in place basic fundamentals such as incentive structures, competitiveness, and price-based mechanisms in our economy. Till we establish that basic building block, we will have to go back and forth, and will not be able to experience sustainable growth to defeat our common enemy – poverty – and reach high-income status. 

An encouraging work environment as a country 

A country with a motivated workforce is one determinant the next Government needs to establish if we are serious about a prosperous Sri Lanka. Political parties may be victorious after the election but making Sri Lanka a victorious nation goes far beyond just securing a winning majority at an election. Winning elections is the same as an opportunity to play a cricket match representing the national team. In order to make Sri Lanka prosperous, it needs to put in a game-changing performance that ends in victory. A motivated workforce can only be built on unity between all Sri Lankans so that we can all work as one team, resulting in increased productivity. According to Frederick Herzberg’s Two Factor Theory (of Motivation), there is a hygiene factor instead of a motivator and in the absence of hygiene factors, people get demotivated easily. The biggest loser from tensions between the people and racial disharmony will be our economy, a fact that has been proven throughout history.

Most aspirational Sri Lankans are now tired of experiencing lost economic opportunities and revisiting these never-changing issues. Aspirational Sri Lankans expect to work harder, have better living standards, and to not be entangled in micro issues.  

The recent downgrade to lower-middle-income status has a greater impact, after the Easter Sunday attacks and tensions we witnessed thereafter. Even before the Easter attacks, the riots in Digana and internet blockages were indicators that alerted us about tension between ethnicities – a move in the wrong direction. International investors need stable and peaceful destinations to invest their money. Internal ethnic tensions and communal disharmony tend to scare away potential investments that could drive domestic economic growth.  

This phenomenon is key, among many other reasons, for our lethargic performance on the economic front over the last few years. Recent incidents connected to licensed banking institutes, which were shared widely over social media, highlight that tensions still prevail. If allowed to grow and fester, the price we all have to pay for these untreated wounds will be enormous. All Sri Lankans as well as the Government should understand that a peaceful, secure environment with a motivated and skilled workforce is a basic requirement for a small island nation of the calibre of Sri Lanka.

What should be our strategy and solution?

As outlined in this column, and as many other intellectuals have highlighted repeatedly, Sri Lanka’s strength is in its location and connectivity. Our weakness is that we are a small market and our resources are limited, while the available resources are not optimised. So we are left with no other strategy but to produce for a bigger market than our 22 million people and be competitive on all we produce by global standards. However, we cannot be competitive without having our house in order. 

Our success as a country depends on our ability to understand other people’s needs and the ability to provide goods and services for their needs and address gaps in the market. If we produce only for ourselves and for our own consumption, isn’t it a very short-sighted and selfish approach, which will limit us from reaching our full potential? 

If we blindly follow some trends in the US and other parts of the world which have far bigger domestic markets and very different economic indicators, we will be wasting our advantage of connectivity and location while also expanding our weakness as an isolated and divided society. 

As Frédéric Bastiat said, “when goods and services don’t cross borders, soldiers will”. We should ensure all Sri Lankans engage and trade with all Sri Lankans, beyond manmade intangible borders such as caste, creed, ethnicity, and religion. At the same time, we should trade beyond our shores and country borders if we are serious about making Mother Lanka prosperous again and defeating our common enemy – poverty. 

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

The pre-election opportunity ECT presents the President

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 and Shanaka Paththinigama

The East Container Terminal (ECT) has come into the limelight again.

Last week, a strike was ongoing by trade unions demanding to install gantry cranes, which were ordered a few years ago and which are now in the Colombo Port, at the ECT.

This was followed up with the Cabinet Spokesperson stating that it was “allowing the respective line Minister to conduct discussions at a diplomatic level on changing (the) Colombo Port Terminal deal with India and Japan”, according to Hellenic Shipping News Worldwide.

Subsequently, the Gantry Cranes were permitted to be unloaded and installed on the instructions of Prime Minister Mahinda Rajapaksa and the port workers decided to call off their strike on Thursday (2).

The fact of the matter is that the ECT is one absolute failure in terms of “getting things done”. Sri Lanka has been running it continuously and like many other economic issues, we have failed at getting our act together. This is despite being located at the heart of a strategic maritime route. Rather than taking advantage and converting the ECT to an operational level, we have lost a reasonable amount of credibility in the business world by opening the ECT for bidding and cancelling the bidding process on multiple occasions, thereby creating years of operational delays based on political favours. We hope, at least this time, Sri Lanka will be able to convert shop talk into actionable outcomes.

Understanding the shipping business

The shipping business is a technical subject and is very complicated. Ports are strategic geographical locations which are situated at the edge of oceans, seas, rivers, or lakes. These locations are then developed to provide facilities for the loading and unloading of cargo ships. The facilities provided for a port depends on the purpose for which the port is being used. A terminal refers to the set of facilities at a port where the loading and unloading of the cargo/container takes place. Terminals are named on the basis of the type of cargo that can be handled by it. Some of the most common types of terminals are container terminals, bulk cargo terminals, and LNG (liquefied natural gas) terminals.

Simply put, in one port, there are multiple terminals and the Port of Colombo has a few container terminals (CICT – Colombo International Container Terminal, JCT – Jaya Container Terminal, SAGT – South Asia Gateway Terminal, and UCT – Unity Container Terminal).

Global trade and most merchandise exports and imports account for a greater share of container terminals. The main factor that drives this business is efficiency and the networking ability to bring as many vessels as possible to the respective terminal. Simply put, when a ship enters the port/terminal how fast we can handle the containers and cargo (efficiency) and how networked we are to bring more vessels into the terminal are the two main determinants of making the business profitable.

Like most businesses, the price or the cost is a key determinant. To be profitable and bring the price down, over the years, shipping vessels have advanced to a point where there is capacity of more than 10,000 TEUs (20-foot equivalent units) in one vessel and those models (New Panamax – 12,500 TEUs | Triple E – 18,000 TEUs) have become popular with the development of global trade. These gigantic vessels can only be managed by deepwater ports which have a depth of more than 18 metres.

What’s all the fuss about the ECT?

There are two deepwater ports in the Colombo Port. One is CICT (85% owned by the China Merchant Port Holdings [for a period of 35 years, starting in 2013] and 15% by the Sri Lanka Ports Authority [SLPA] [owned by the Government]), which contributes to a higher share of the capacity and efficiency of the Colombo Port. The other deepwater terminal is the ECT. This is why the level of interest in this port is very high.

Geopolitical rivalries China, Japan, and India continue to seek operational ownership of the ECT through companies of their respective countries. The JCT (owned by the SLPA), SAGT (owned by John Keells Holdings – 42% , Mearsk – 26%, SLPA – 15%, A.P. Moller – 7%, Evergreen – 5%, and other investors – 5%), and UCT (owned by SLPA) are all shallow-water port terminals which can only handle smaller vessels (not economical compared to larger vessels) with about 10,000 TEUs capacity.

The ECT’s value is very high as it’s the only other deepwater terminal in the Port of Colombo except for CICT. As an additional benefit, it is located in the middle of the old port and the modern port, providing an added advantage for the movement of inter-terminal cargo, given its proximity to other terminals.

Despite the ECT having significant strategic value, consecutive governments have been just sitting on this, calling for bids and cancelling them, while competition is increasing every day – notably, the new Sagarala port development initiative by India, the construction of the Enayam Port in nearby Tamil Nadu, and also the Kerala Port, which is soon to be the world’s deepest multipurpose port.

With the agreement with SAGT due to expire in 2030 and with India developing their ports, the ECT has become a vital business asset as never before. Another deepwater port terminal operator adjacent to CICT will create more competition. However, the networking and other variables will matter to whoever gets the bid for the ECT.

At the same time, with the growth of global trade (not considering the effects of Covid-19), the Colombo Port is nearing full capacity of handling containers. The Port of Colombo moved to the top position of the Fastest Growing Port Index in the first half of 2018 by industry analyst Alphaliner and is one of the most connected ports in the entire world, handling about seven million TEUs in total. It is vital that the ECT is developed to maintain this growth.

Despite being situated in the centre of the Indian Ocean, and even though we are one of the most connected ports in the world, we are far from becoming a maritime hub. The root cause lies in our inability to be competitive and inadequacy to provide ancillary services such as logistics, bunkering, marine lubricants, fresh water supply, offshore supplies and ship chandelling, warehousing, and many more.

Our rules, regulations, and legal structures on the ownership of some shipping-related services and excessive government intervention, with the government acting as a player in the market and a regulator at the same time, has closed the space for private investment which could propel the Colombo Port to becoming a key global player.

Most experts have become weary of speaking about the same issues, while the opportunity of becoming a maritime hub in the Indian Ocean is slipping out of our hands.

Since the shipping business is based on efficiency and networking, the ECT has to be operated by a private operator and the Government should play a regulatory role and facilitate businesses by being the landlord of the port. This must be done while keeping the ownership of the port rather than trying to engage in the business and be a container terminal operator. Container terminal operation requires sizable capital investments. Private investments, which take the risk for the capital they invest, is the only possible way to create the right incentive structure and create the drive for efficiency and a very competitive business model.

Selecting a good terminal operator

After going back and forth, the previous Government signed a Memorandum of Co-operation (MoC) between Sri Lanka, India, and Japan. According to media reports, the current Government expects to discuss changes to the initial agreement, claiming that the previous deal was unfavourable for the country, and move to a new agreement.

At the same time, the SLPA unions claim that gantry cranes worth $ 25.7 million have been purchased for the development of the ECT, but concerns have been raised over the specifications of the cranes.

We really don’t know the truth

However, His Excellency the President, who received 6.9 million votes for a system change, should explore a method to select a proper operator. Undoubtedly, rather than handpicking operators based on introductions given by individuals, it has to be on a competitive bidding process, based on cost and pricing to ensure the competitiveness of the port with proper specifications. That’s the best system we can employ to find the most suited operator in a price-competitive industry.

Generally, Build-Operate-Transfer (BOT) agreements are provided with long tax holidays and the taxpayer has to be protected and prioritised as it is the people who gave the mandate for a system change.

At the same time, when the existing terminal operators bid for the project, their existing capacities and advantages need to be reflected in their pricing, investment, and proposal structure. The system change expected by the taxpayer, in this case, is to set up a system to ensure accountability and that things get done while getting the maximum benefit to the port and by establishing a level playing field for businesses and investors.

In countries like Sri Lanka where discussions revolve around high-value government transactions, there is a higher risk of such projects being influenced by many powerful businessmen and bureaucrats, leading to irregularities and corruption.

The President and the Government now have an opportunity to prove such assumptions wrong and set a prime example of how such a high-level transaction can be transparently managed. A single transaction with a conflict of interest can make a regime unpopular faster than anyone can expect. The Central Bank Bond irregularity is the most recent example.

On the verge of a crucial election and with the prospect of forming a fresh government, we hope Sri Lanka would move forward instead of dragging its feet on the ECT by ensuring and implementing a competitive bidding process (which will help avoid most of the geopolitical pressures) without getting sandwiched in between two global economic powers vying for regional dominance.

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.

Blaming the banks: Why a credit guarantee is better

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 Central Bank of Sri Lanka (CBSL) is in the spotlight yet again. Questions have been raised as to whether the CBSL and the banking system have been provided sufficient facilitation to contain the health crisis (that has been contained successfully at the moment) which led to an economic crisis.

The Government announced a series of economic relief packages since the beginning of the Covid-19 pandemic, including a Rs. 5,000 allowance for the most vulnerable sections of society and for the rescheduling of leases and loan facilities. Currently, the discussion is not on what the relief measures are, but rather on how we can execute them in the right way or whether we have better alternatives.

First, let’s understand the context. The CBSL offered a Rs. 50 billion refinancing facility in March, which was then increased to Rs. 150 billion in June. By the time the second scheme was announced, Rs. 27.5 billion of the original Rs. 50 billion had been given out. The CBSL offered the Rs. 150 billion credit facility to licensed commercial banks (LCBs) at 1% interest where the banks have to provide 4% interest to their customers affected by Covid-19.

Additionally, the CBSL brought the Statutory Reserve Ratio (SRR) to 2% from 4%, increasing liquidity (availability of money) in the market. The deposit that needs to be kept at the CBSL by banks as a percentage of total deposits is called the SRR. This means that when a customer deposits Rs. 100 in any LCB, the respective LCB has to deposit Rs. 2 to the CBSL which will not be paid any interest. Earlier, the banks had to deposit Rs. 4 and now it has been brought down to Rs. 2. As a result of this decision, out of the total deposits of all LCBs in Sri Lanka, 2% has been released to the market. That is depositors’ money.

The process of getting a working capital loan for a business is as follows: The businesses can apply for working capital loans from their respective LCBs and upon their approval, they send the application to the CBSL and the CBSL provides the money from the credit line they established, which is Rs. 150 billion. The CBSL provides money to LCBs at 1% and they give the loan to customers at 4%. The main question is how the CBSL got Rs. 150 billion in the first place. That was through money printing or money creation.

Additionally, banks now have more money from the reduction of the SRR, which can be used for other investments, to provide credit facilities, or as a deposit at the CBSL to earn an interest. The CBSL offers a 5.5% interest to LCBs parking excess money at the CBSL, which is called the Standing Deposit Facility Rate (SDFR). The CBSL has a similar facility where LCBs can borrow money if they run short of money, which is called the Standing Lending Facility Rate (SLFR) which is at 6.5%. A few challenges we may face in the future in this context are outlined below.

Challenge 1 – refinancing previous loans

When a loan scheme is available at a 4% concessionary rate, there can be instances when unnecessary loans will be applied for, to settle previous loans which have been taken at a higher interest rate. In the overall system, it may indicate that the CBSL and other banks have provided adequate loans under the newly established credit facility for Covid-19, but the ground reality may be that many businesses who have a solid working relationship with banks and bank managers will refinance their previous facilities.

The same has been experienced in large-scale loans under the previous Government’s Enterprise Sri Lanka loan scheme. It was reported that some established companies incorporated new companies just on paper to get the concessionary loan to refinance previous facilities. It was alleged that the majority of politically connected individuals received the loans and in most cases, the loans were canvassed to known businesses by bank managers themselves, avoiding customers who truly had financial needs. For bank managers, it is safer to provide a loan to a known business entity with a track record and good relationship, rather than taking a risk in a challenging business environment and risking underperformance in bank manager/branch key performance indicators (KPIs).

Challenge 2 – risk of market distortions and increasing expenses in CBSL

Since the CBSL pays 5.5% on deposits by the LCBs, banks have a higher incentive to simply earn a 5.5% interest with minimal administration cost, rather than providing a loan facility at 4% for the customers with a 3% interest margin, which also requires a significant amount of administration work. The banks will most likely park the excess money they received from the SRR cut and deposit it at the CBSL. This would increase the interest expenses for the CBSL. LCBs may also consider investing the excess money in bonds and other investment instruments which may distort those markets as well.

The positive side to this is that since banks park their liquidity back in the CBSL, the risk of inflation due to excess liquidity is somewhat minimised, but it will not bring the expected economic revival post-COVID-19. The non-performing loan (NPL) percentage has already increased to 5.1% as business recovery was very slow even before the Covid-19 pandemic, due to the Easter Sunday attacks. Similar concessionary loan facilities were provided to businesses impacted by the Easter attacks and it is highly likely that NPLs will increase.

As a result, banks may have a natural reluctance to provide facilities as they have a lucrative and stable option available without risking depositors’ money. The CBSL may push banks to provide loans as much as possible due to the lack of a correct incentive structure, which will lead to an impact on the stability of the banking sector and result in loans not reaching the right target audience.

Challenge 3 – pressure on LKR compared to USD and foreign currencies

By the time the CBSL announced the SRR cut and the Rs. 150 billion credit line, there was about Rs. 223 billion excess money in the financial system. The problem was not a lack of money (liquidity) in the financial system but the reluctance of banks to absorb risk to provide the facility to the impacted customers. At the same time, the mechanism of dispatching loans was not efficient and all banks were just depending on the Credit Information Bureau of Sri Lanka (CRIB) without having a risk-based credit assessment system to determine the borrowers’ ability to settle the loans and offering different interest rates based on the risk assessment. Additionally, the delays in banks’ internal approvals may not be supportive, given the urgent need of facilities and higher demand.

Now, as a result of excess liquidity, inflation may increase and the Sri Lankan rupee (LKR) will face further pressure to depreciate, leading us towards a Balance of Payments (BOP) crisis. Bringing the SDFR and SLFR down will bring down all interest rates in the market which will result in more money (liquidity) in the market, adding further pressure on the LKR.

In summary, the reluctance of banks to take the risk to provide loans in a challenging environment by risking depositors’ money is the problem, not the lack of liquidity in the market.

A workable solution

It is challenging to find an ideal solution for very complicated problems as our economic fundamentals have not been good for decades. Most variables are interconnected so we have to make a compromise in one of the areas. As the problem is not the lack of money supply, but rather the banks’ reluctance to take risks with regard to loan recovery, a credit guarantee by the Government could have been the first line of solution. That would minimise the risk taken by the banks without adding excess liquidity to the market and distorting other market sentiments.

Ideally, the Government credit guarantee has to be backed by a foreign funding line (USD funds) and this column has been promoting the idea of a bilateral loan with a neighbouring country or active engagement with the International Monetary Funday (IMF) for a fund facility, given the international sovereign bond settlements starting from October. The government guarantee can be provided on an agreed ratio where small loans are fully guaranteed by the Government and for bigger loans, the bank and the Government share the risk, where early instalments first cover the risk of the bank and their depositors.

One bottleneck for the Government in providing a credit guarantees scheme is the past mistakes made with our state-owned enterprises (SOEs). Multiple back-to-back credit guarantees have been provided to colossal loss-making SOEs like SriLankan Airlines, Ceylon Petroleum Corporation (CPC), and the Ceylon Electricity Board (CEB). Successive governments turned to these last resorts very early to fund completely unnecessary operations and now, faced with a real crisis, we have run out of solutions.

However, in a recent interview, Dr. Nandalal Weerasinghe mentioned that the Treasury wanted to create money and support businesses instead of providing a government credit guarantee. The reasons for these instructions are yet to be clarified by the Treasury. However, Dr. Weerasinghe has alerted the potential risk of excessive money printing on banking sector stability.

When the Easter Sunday attacks impacted the economy, we never expected a global-level pandemic of this scale. The lesson is that we should not underestimate the possibility of similar pandemics and market disruptions with climate change and a dynamic global environment in the future. I sincerely hope that there will be no calamities for the next few years as there is a lot we all have been hoping to achieve for decades.

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.

"Changing the system": How the President could start

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

A day has 24 hours but the clock ticks faster in some countries, and Sri Lanka is certainly one of them. We have many things to get done, but time is running out and the conditions are right to brew the perfect storm. Our economy’s fundamentals have been in poor shape for a few decades. The country’s economic growth was 2.3% in 2019, a budget deficit of 8.5% in comparison to the GDP of  2020 is expected this year, and we are already on an IMF (International Monetary Fund) bailout programme. There is nearly $ 7.2 billion as reserves in Treasury coffers, but debt servicing payments account for nearly $ 6 billion up to December 2021.

Amidst these conditions, a pandemic was the last thing we needed and its abrupt arrival damaged the main economic engines of Sri Lanka on a larger scale than ever before. Tourism, which brought in $ 4 billion revenue in 2018, and the export industry were severely impacted, and the unfolding events in the US, which is the market for 37% of our apparel exports, are not in our favour. The impact on the Middle East will not only bring down nearly $ 7 billion worth of remittances but will also result in job losses and the repatriation of Sri Lankans due to the global economic contraction.

In that context, it seems President Gotabaya Rajapaksa will have to sacrifice nearly nine to 10 months of his five-year tenure to address unexpected challenges. He has been pushed to a difficult corner with many restrictions from the system itself (postponement of elections, etc.) to convert decisions into actions. Leaving this gloomy story aside, let’s unpack a few opportunities hanging around to get things done along with priority actions to be taken during this difficult time up until the general election in early August.

Reforms through structural changes 

Considering our public finances are weak and the spending capacity is limited, we have a grand opportunity to make structural changes to the system rather than investing our time on micromanagement. The President’s mandate was to “change the system” within a democratic framework and set up a new, functional system. Since the clock is ticking at a faster pace, we need to identify a few major reforms that could generate faster results and meaningfully benefit the people of Sri Lanka.

Below are a few areas the President could focus on in carrying out major reforms through which an impact would be visible within his five-year tenure.

Governance structure and KPIs for State-Owned Enterprises (SOE’s)

The big gaping hole in our national account is the losses of state-owned enterprises (SOEs). In 2018 itself, 54 strategic SOEs out of 527 SOEs made a Rs. 28 billion loss and received government budgetary support of Rs. 58 billion. The total of these two figures is almost two times the entire allocation of the Samurdhi fund. The initial attempt to appoint a separate panel to appoint qualified members for state institutions was commendable, but it had its own challenges.

Since a new Cabinet and new ministers are to be appointed post general election, if we are able to set key performance indicators (KPIs) for SOEs at the soonest time as the first step at the year end, then the President can evaluate the performance of SOE boards and make them accountable accordingly. When every minister is given their appointment letters when the new Parliament is appointed in a grand red carpet ceremony at the Presidential Secretariat, every minister receives an additional file listing the institutions under their purview and indicators under which the minister will be monitored along with their respective institutes’ boards.

In the list of deliverables, we can start with including basic requirements such as presenting an annual report with profits, losses, and employment for each institute so as to ensure the newly appointed boards are accountable. Ideally, the KPIs can be published before the election in selected SOEs as there would be less reluctance from the newly appointed ministers when they take over the job. In terms of management, it would be easier to get the consent for already established guidelines rather than imposing guidelines after they take up the job.

If we have the political capital, we can consolidate a few institutes early on and publish the plan to facilitate the appointment of members for all 527 SOEs, of which the total number of people in the boards alone would be a factory of senior people. When the governance structures are in place, performance will improve and losses, in turn, will decrease. Therefore, the changes will be visible to showcase to the people, and it will bring significant relief to the Treasury. At the same time, it is easier to identify the poor-performing institutes and so the boards of those can be shuffled based on meritocracy.

Public transportation

As highlighted in “The coordination problem” column earlier, public transportation bottlenecks are mainly caused by structural issues rather than investment issues. One main issue every individual goes through every morning and evening is public transportation. Regardless of whether they travel in their own car or via bus/train services, the experience is essentially the same.

In this regard, re-implementing the bus lane structure is a positive move. Removing the route permit structure and having a more open and competitive system is an easy and quick way of improving the public transport system before moving on to large-scale infrastructuring projects, given the tight public finance situation. A period of four years is a good time frame to showcase improvements on public transportation, and these reforms are fairly easier to implement especially as Covid-19 has given the perfect opportunity.

Buses are already operating only under the capacity of the number of seats and we expect that the University of Moratuwa would release official data on the improvement in average speed with the new bus lane system. This is a golden opportunity to implement the long-awaited plans of reformation with the blessings of the people and the industry. 

Establishing E-courts 

Another hassle for a majority of Sri Lankans is the delay in court cases. The outside of every court is fully crowded on weekdays with disappointing faces seen in every direction due to a completely inefficient system. Mostly, the poorest in society have fallen prey to this problem and the problem extends to prison and every sector of the economy. In Sri Lanka, the time for contract enforcement is 1,318 days and it’s just 22.8% of the claim value.

An e-court is a system of services that ensures minimum use of paper during the course of a court proceeding with digitally captured information, an unbroken chain of data exchange, readily available case histories, electronic fee payments, and an overall streamlining of court proceedings. Since a plan already is in place to digitise Sri Lanka, a two-year time frame is more than enough to establish a functioning e-court with necessary legal reforms, given the Covid-19 social distancing guidelines. If less complicated cases are moved to e-courts, there will be space for more complicated cases to proceed with the physical presence. Isn’t this the main mandate of the Minister of Justice and Legal Reforms after the election?

Land reforms

Land is the most precious resource in Sri Lanka and it’s very limited given the size of our country. Most of our economic bottlenecks have a greater bearing on land titling. We should not forget that land is a stable capital asset and only 18% of it is owned by our people whereas the rest (82%) is owned by the government. It is well documented how badly we have managed even our forest cover and sanctuaries which account for 30% of our land. Most of the bottlenecks in agriculture and investments are due to our land concerns. Investment is slow (investments from Sri Lankans) and technology is not entering our shores.

In an age where Google provides live updates of real-time traffic movement at our fingertips, we Sri Lankans cannot spend anymore time without a digital land registry, with the decades-old land registry at government offices wasting our precious time. As long as we continue with the unresolved land issues, which are to an extent connected to our judiciary system, Sri Lanka will not see a connection to the Fourth Industrial Revolution.

Above are the big four insights the present Government should focus on. In my humble opinion, a four-year time frame (calculating for many unexpected events in the global context) is a reasonable period to achieve reasonable progress. Even more importantly, people across Sri Lanka will experience a tangible difference if the above reforms take place. Furthermore, except for e-courts and land reforms, the other two big reforms are comparatively less investment-driven.

Execution over politics

Most of the leaders who take up the challenge to lead the country find themselves preoccupied with micromanagement, appearing in one meeting after another or one ceremony after another. In building the needed political capital, we should not misread the President’s mandate to “change the system” and his voter base appears to be measuring him based on the execution of his big ideas rather than the traditional political micromanagement.

I hope the current Government is reading the peoples’ mandate correctly and would not drift away and lose sight of it after the general election on 5 August. I hope…

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.

Rice crisis: Just give our farmers their lands

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

Rice, the main source of carbohydrates for the majority of Sri Lankans, is a sensitive political topic. I am sure we have all been experiencing this in the recent past. Most often, it is a political football where everyone passes the blame to one another without unpacking the economics behind the rice problem.

Increasing the harvest

If you ask any Sri Lankan the question “what is the problem with the rice market?”, there will be a few common answers. “A rice mafia/monopoly or oligopoly by rice millers” is the most popular. The second most common answer is the fact that the intermediaries are earning more, resulting in farmers being at the losing end.

The third most frequent response is the lack of modern technology in paddy fields which decreases our yield. Many economists and politicians support this argument with a popular statistic which states that agriculture contributes only to 8% of our GDP in comparison to 25% of our labour force involved in farming. In my opinion, the aforementioned concerns are just the tip of the iceberg.

Sri Lankans consume approximately 108 kg of rice per annum per person while the global rice consumption average is 54 kg. The conundrum is that in a country where consumption is twice the global average, farmers continue to be relatively poor.

The main question with rice is: Should farmers increase the harvest or if the harvest drops due to external weather conditions, will they earn the same amount? At times when rice harvest is high, the prices plummet due to ample supply. During this period, we can frequently observe farmers protesting as they urge the government to purchase their seed rice for a guaranteed price or for the government to impose a minimum selling price for farmers as well as a minimum buying price for rice millers. Rice millers have two main solutions to this issue: Either they stop buying seed rice as they cannot sell it at a competitive price because their cost is higher, or they still buy it which results in rice prices in the market skyrocketing to Rs. 110-120.

The high price is not only difficult for consumers to afford but is also a price that political parties pay, which dilutes their political capital. As a result, the Government intervened in the market with limited and poor storage capacity and in some cases, rice was stored in airports. After a few weeks and months, the Government sold these rice seeds to large-scale millers for a lower rate than what they initially paid the farmers, incurring a massive loss of taxpayers’ money. Some of the harvest is wasted due to the lack of storage facilities and logistics failure. As a result, farmers lose out on their income and taxpayers’ money is lost.

The second scenario is the reduction in harvests due to harsh weather conditions which decrease supply and subsequently increase prices of seed rice. Since the total quantity of the harvest is low, the money earned by farmers too continues to be low. Regardless of whether there is a large or smaller harvest, the farmer’s earnings remain consistently low. Hence, farmers are not given an incentive to increase their harvest and overall yield. Playing to their advantage, rice millers have created an oligopoly and so decide on prices in line with their modern and expensive storage capacity.

Land issues

Then comes the question of why technology is out of reach for most farms. The preliminary reason is that most paddy lands are fragmented for small lands, so it is not possible to run a commercial-level operation with superior technology. The more significant reason is that 82% of Sri Lankan land is owned by the government (out of which approximately 30% is covered by forests) and the remaining 18% is available for people’s private usage.

A small proportion of government-owned land has been given to people for cultivation, but their ability to take loans from banks to invest in technologies such as greenhouses is far beyond their reach. Construction on paddy land is illegal, which means there is a lack of space for any transaction or technological investments.

Land issues are a sensitive political issue, but many believe that if farmers are given full ownership of the land, they will sell it to foreigners, which in turn challenges our sovereignty. However, the government ownership of farmlands for nearly a century does not change the destination or quality of life of our farmers. Making things worse, the regulation is such that the paddy lands cannot cultivate anything other than paddy and even if the farmer wants to move for a better high-yield crop, a license needs to be obtained via a cumbersome procedure at government offices.

Given these challenges, how likely is it that anyone would enter paddy farming even if they have a disruptive agricultural idea?

Loopholes in costing structure

Many Sri Lankans believe that we can easily upscale our farming for rice exports. I sincerely wish we could do that too, but unfortunately, this is far from the reality. Sri Lanka cultivates mainly short grain rice in comparison to long grain rice where the world’s demand mainly lies. Even following a good season and excess rice production after domestic consumption, it is not exportable and will further drive the prices down due to excess supply. Furthermore, water is becoming a scarcity due to environmental challenges and currently, we do not calculate costs for water consumed in farming.

Recent research has found that 1 kg of rice requires 2,500 (1) litres of water and more than half of that is consumed by the plant itself. If we consider the cost of water to be Rs. 0.20 per litre, the water consumed by the paddy plant itself adds up to about Rs. 280 which is almost three times the current-controlled price of 1 kg of rice. The cost of utilising land hasn’t been factored. Fertilisers have been provided with a subsidy and that cost needs to be added to our final cost if we are to create a comparable and competitive costing structure.

Solutions

The decade-long series of solutions are well known by most of us. For example, rice millers impose price controls on the selling price following raids by the Consumer Affairs Authority (CAA) at the retail level, and the list goes on. That has been the same response by most governments and it is pointless to further elaborate on what has happened. As a solution, we need to have an easier regulatory system and allow the farmers to own their land. The draconian regulations have trapped farmers in a never-ending cycle of poverty for decades.

From the supply and demand end, the only buyers are rice millers. When there is a single buyer in the industry, they inevitably get higher bargaining power. It is important to diversify our buyer category and the only way to do it is to make rice an industrial product. Today, rice is not only used as a source of carbohydrates; alcohol products, rice bran, rice perfumes, rice-based milk, and rice antioxidants are produced at a commercial level, which offer far higher prices to farmers at the buying stage. This is the solution to increase revenue for farmers and help them escape the vicious cycle of poverty.

The day our farmers have access to their own land will be the day the market is open for many categories of buyers, which will be revolutionary for farmers. Until then, we as the consumers need to patiently experience the price controls, higher prices for rice, and the political blame game.

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.

Production economy: Think small, Sri Lanka!

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

Why can’t we produce the goods we need? Why do we have to depend on all these other countries?  Why can’t we produce world-class brands? Over the years, these have been million-dollar, or to be politically correct, million-rupee questions. 

From agri-based economic planning to state-owned industries that left a stench not only on the economy but also on the shirts and the sarees of the public, policymakers have ignored or botched time and again economic reforms which could have made Sri Lanka a production-based economy.

Let’s get back to fundamentals – “producing an economic good” and “producing it competitively” are two completely different concepts. I can drive a car, but I’m no Ayrton Senna or Michael Schumacher. In cricket terms, many Sri Lankans can play cricket but only a handful can make it to the National XI. In today’s age, producing an economic good is like playing to win at a World Cup. Observe how the Australians go about their business at World Cups. They play to win. If we are not focused and fail to adapt, we will fail as a nation. As Charles Darwin said: “It’s not the strongest but the most adaptable that will survive.” 

Many centuries ago we produced goods and services for our consumption and all parts and components of that economic good or service had an ecosystem in the same country. With the invention of penicillin, arguably the most important life-saving drug ever discovered, by Scottish scientist Alexander Fleming, the world saw a burst in population and Sri Lanka was no exception. Keeping a growing population fed, housed, and employed paved the way for integrated supply chains to form the world over. 

This is because every country has a competitive edge in a particular good or service. For example, Germany and Japan have it in cars, Korea in electronics, New Zealand in dairy products, etc. Factors such as human capital, education, technical skills, natural resources, the climate, and trade agreements have a direct impact on what we produce. Since independence, Sri Lanka has relied heavily on the big three for foreign exchange, namely tea, coconut, and rubber, but failed to make it as an integrated member of the world supply chain mechanism due to poor branding and value addition. Other countries have successfully done it. There are French champagne, Swiss chocolates, California oranges, etc. 

However, the apparel sector which took off during the post-liberalisation period has eclipsed the rest as a major player in the world apparel sector and an integrated part of the world supply chain. The apparel sector competes on price, quality, service, and delivery with the rest of the world and has won due to specialising in high-value apparel such as lingerie and swimwear. With the exception of the aforesaid example, as a result of not understanding the need for producing goods competitively, we failed to catch up with the fast-growing East Asian tiger economies. 

Joining a global production network

Rather than producing all parts and components of a complicated final product, countries began producing a small component of a big product in a complex procedure. As an example, rather than producing a total computer, companies started producing microchips, transistors, and hundreds of other small components in large scale. Producing small components of large complex products in a gigantic scale brought the cost significantly down and as a result, the price of products became reasonable. This process became a common factor in the range of high-end expensive products like aeroplanes and even to lower-end products like sporting shoes. 

Source: Aeronews TV.com

Going back to my cricket example, winning a World Cup means not only having more talented players but a host of other elements and individuals which are already operating at a world-class level. This includes compatible cricket turfs, safety and cricketing gear (headgear, pads, gloves, cricket bats, boots, cricket bats), training techniques, professional administrators, supplements, and the list goes on. In simple words, now the production of even a simple component or a product is shared across the globe (which is called Global Production Sharing [GPS]). Everyone is contributing to a small component of a complex product and everyone is part of a big value chain (which is called a Global Production Network [GPN]). 

Sri Lanka’s strategy should be to join more and more GPNs if we are serious about converting our economy to a production-based economy. The good thing about joining GPN is that it only requires a basic-skilled workforce to join the network. This will lead to earning better income for unskilled and semi-skilled workers, so the poverty levels will be elevated, because for most vulnerable sections of the society the only tradable good they have is their “labour”, and by joining a GPN we provide the opportunity for them to sell their labour. Countries like China have the unique advantage of being able to produce parts and small components of a complex product as well as assemble it and make the final product due to their large population and availability of labour at all levels (starting from unskilled to supervisory and super skilled). 

How do we do it? 

Some Sri Lankans tend to believe that joining a part of a big production network is an underestimation of utilising full Sri Lankan potential of manufacturing all components under one roof.  Some believe it may hinder Sri Lanka’s ability to create world-class brands and labels. Certainly not; Sri Lanka can create a Sri Lankan label brand for a component rather than a final product. It is already done in Sri Lanka. Certain safety and rubber components that are vital for the automobile sector are manufactured in Sri Lanka. The entire world is aware that Apple computers are not made in the US and even the product itself mentions that it is made in China and designed in the US. The same is valid for Boeing aeroplanes. 

Sri Lanka makes high-end apparel. We manufacture for giant brands such as Victoria Secrets, Nike, and Adidas. But this doesn’t mean that if we launch it under a brand name of ours that there will be the same demand. An apparel manufacturer tried to launch its own brand in India but was not successful. Sri Lanka can move towards assembling and creating more Sri Lankan brands when we evolve from our basics, but as we would all agree, our basics are not right yet. This is where foreign direct investments (FDIs) become critically important. We need to attract one big company to set up here and Sri Lanka should actively capitalise on post-COVID-19 dynamics of companies that are forced to move out from China. If we attract one good investment for a GPN, the rest will follow. That is exactly what Vietnam did, attracting just one company as they knew then the tide would turn. 

Rethink import substitution

A popular strategy to convert Sri Lanka to a production-based economy is considering import substitution. As we have highlighted in this column previously, most of our imports are capital goods and intermediate goods used for many other products (57% of imports are intermediate goods and 23.1% of imports are capital goods). If we are to join GPNs, the inputs have to be competitive. Otherwise, the output will be expensive and uncompetitive.

If we are to carry out import substitution, then ideally it has to be based on the competitiveness of the local substitutes but not substitution through a complete ban or through exorbitant tariff rates for imports. If we are to substitute imports through bans and tariffs it would further impact other local industries due to higher costs and regulatory barriers creating difficulties in managing their input supply chains. That’s why the word “competition” has significant meaning in economic vocabulary. 

The best example for this is the construction industry. Importation of most of the construction raw materials are subjected to a 60%-plus tariff and as a result, our hotel room rates are higher compared to our competitive destinations such as Thailand, given the time taken to capital recover is high (there are more reasons contributing to high room rates but construction cost is one major determinant). So the tourism sector as a whole is impacted just because of one single attempt of import substitution in the construction industry. 

COVID-19 provides us the opportunity to convert Sri Lanka into a production-based economy again, but we need to take the correct path instead of being shortsighted as in the past. We should focus on making our inputs and outputs competitive and look at the broader picture rather than restricting ourselves to micromanagement.  

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.