Coming out a winner

Originally appeared on The Morning

By Dhananath Fernando

Can the Finance Minister come out on top of this crisis?

There are winners and losers for every crisis. The new Finance Minister can definitely be a winner if he understands the problem and tackles the economic crisis upfront. He can become a success story if he does the right thing at the right time. Kumar Sangakkara in his Colin Cowdrey lecture said “In cricket, timing is everything”. It is the same for an economy. Sri Lanka is at the doorstep of an unprecedented economic crisis since independence. Both the Government and opposition have expressed views on this matter. However, if we fail to act now and make the right decisions, it is most likely that the crisis will fail us fair and square. 

So today I am looking at discussing the possible solutions the new Finance Minister has at hand to overcome the situation. 

First, we have to understand that we are already in a crisis. Importers and exporters are having obvious difficulties opening letters of credit (LCs) and people are buying gold to reduce the impact of currency depreciation and inflation on their money. Under these circumstances there is very little rationale in creating a picture that things are rosy. Our supply chains are also under severe turbulence due to adhoc Government interventions. This is further affecting our export capabilities. In our debt servicing, we have resorted to borrowing more with short term liquidity tools such as swaps and short term borrowings to repay our creditors. 

Understanding the problem 

As this column always highlighted, our economic problems are beyond debt serving and opening LCs. Those are just symptoms of the problem. Our economy is like a diabetic patient who has been living on high sugar with no exercise with a bad lifestyle for more than a few decades. Now the patient is in a coma and completely unconscious. This is a serious situation where we need some strong medication and a lifestyle change. Just a few pills of Vitamin C is not going to be sufficient to bring the patient back to some sort of normalcy. 

The patient is diabetic because of a high inflow of sugar. Similarly, our economy is in the present crisis because of excessive Government expenditure on non-available resources. Simply, we do not have money to pay approximately 1.5 million Government workers, run an airline which costs about Rs. 24 billion just for four months which is almost half of our Samurdhi allocation for the year. We further do not have resources to run a petroleum corporation with losses of more than Rs. 100 billion, while continuing to depend on subsidised prices. Comparatively, the losses of the CPC are twice as high as our Samurdhi allocation which is an essential safety net for the country. 

Secondly, we do not have the right institutions to manage economic governance. For example the debt numbers are parked all over SOEs (State Owned Enterprises). Such is the cost of mismanagement. 

Thirdly, our economy is significantly unproductive. All our factor markets (Labour, Land, Capital) are completely inefficient with excessive regulation and protectionism coupled with rent seeking. As a result, in most industries our incentive structures are largely inefficient. Just take our judicial system. All stakeholders are incentivised to postpone the cases rather than reaching resolution quickly. Across other sectors the situation is the same or worse. 

Short-term solutions 

Like with the diabetic patient who is in a coma, in order to become better there has to be a  lifestyle change. However before all that the patient has to be given immediate care to come out of the coma. This involves hospitalised care and the immediate medical treatment in order for the patient to be properly conscious. It is the same with our economy. At present no one is willing to lend us money as we haven’t proved that we are good for our money. Markets are not lending to us. Even the countries we have good relationships with and our decades-old international organisations are requesting some sort of an assurance to work with us. The only organisation who can provide some credibility and assistance is the IMF (International Monetary Fund). The IMF is not an alien body. Sri Lanka is a member of the IMF, and since the next day we formed our Central Bank and our Governor and the Minister of Finance, who are the representatives of this global body. The IMF has no magic formula but the Governor and the Finance Minister have to agree on an economic programme to establish transparency, accountability and make immediate but necessary adjustments. Simply, they will ask us to take measures to increase revenue and reduce expenditure.  However, what is important is to make sure that the programme implemented by us is  good enough and well disciplined and effective in order to prevent us going to the IMF again. We have gone to the IMF 16 times since we became a member of the IMF. 

Secondly, in the short-term we have to let the price system work in the energy markets. Import of oil is our largest import and this needs to be priced properly. The market economy is nothing complex but is simply allowing the price system to work. There cannot be any magic formula for us to keep prices lower when the world market pieces are rising. Therefore allowing market prices to work will allocate the optimum utility for our resources. 

Thirdly, we have to freeze Government recruitments and even offer a scheme for unproductive workers to leave which may help in some level to control expenditure. Currently 86 cents of every 1 rupee collected is taken away by the Government employees as their salaries. Needless to mention that it is not sustainable. 

Medium-term solutions 

Implementing the above will give us some short term breathing space and prevent a full blown crisis. Same as the diabetes patient who was in a coma now became a little conscious. Then we have to make sure the patient does not go back to his old habits. So in the medium term setting up the right institutions for management of SOEs and restructuring and privatising some SOEs are of paramount importance. 

At the same time allowing the price system to work requires strengthening our safety nets. The current Samurdhi programme is our main safety net programme which is a politically driven list. Those who deserve the Samurdhi are not in the list while those who have moved out of poverty are still in the list. So we have to have a digital Samurdhi system where cash transfers are prioritised. When market prices change there will be additional allowances added based on the price change and when prices go downwards those benefits will come down proportionately. So even the poorest in the society are given an opportunity to catch up and contribute back to the society and markets. 

In the meantime deregulation of our factor markets as well as our product markets have to continue. The President appointed a commission to look into this and create a collective effort on deregulation of existing bureaucratic structures, regulations and  proceedings. 

By implementing these reforms the image and reputation of the country will be improved. As a result there will be a significant inflow of FDI. 

Long-term solutions 

Longer term solutions are similar to getting the diabetic patient to a healthy lifestyle. In the long run we have to provide a solution for our lands. Simply a digital land registry and transferring Government-owned land for productive use must be prioritised. Giving proper land titles will infuse more capital into the market and make our precious land more productive. 

Similarly, our judiciary system has to be digitised and the resolving cases and contract enforcement has to be strengthened. Currently needless to mention our court system is very unproductive and inefficiency is rewarded. 

In the meantime there has to be a better governance structure within the Central Bank to protect our currency. If we fail in our monetary policy the rest of the policies will fall apart. 

Above are just a few recommendations. Given the nature of our problem there has to be strong medication. Serious economic reform along with making structural economic changes have to take place. Without reforms the chances of an economic recovery is unforeseeable. If the finance minister becomes a reformer, then all Sri Lankans will succeed and emerge victorious, when coming out of this 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.

Losing GSP: End of the world or life goes on?

Originally appeared on The Morning

By Dhananath Fernando

A new conversation has begun over the GSP+ concession in Sri Lanka, with the European Parliament adopting a recent resolution on Sri Lanka. Diverse views have been expressed regarding the economy and our exports. 

One school of thought has been that the economic impact would be serious, as this is expected to directly impact our apparel exports, which form a quite sizable portion of our export basket to the EU.

Another school of thought that has been popularised is that it will have a very limited impact, as Sri Lanka is going to lose the GSP+ facility anyway if we are able to upgrade to the status of an upper middle income country. Some statistics illustrate that even after resuming the GSP+ concessions in 2017, our exports to the EU have not changed significantly over the last few years.

So the question is: How do we look at this in terms of economics? 

What is GSP+?

The Generalised Scheme of Preferences (GSP) of the EU is a trade arrangement that allows developing countries to pay lower or no duties on their exports to the EU. This programme helps vulnerable countries with access to markets to reduce poverty, improve governance, and move towards development. GSP+ is a special component of the same programme that provides duty-free access to beneficiary countries for over 7,200 product categories (HS codes). The beneficiary countries have to, in turn, agree to international conventions on human rights, good governance, labour rights, and the environment. 

Sri Lanka was a beneficiary of the GSP+ scheme since its inception in July 2005, and then lost the concession in August 2010. We regained the concession scheme in August 2017. 

When we look at the statistics after we received the  GSP+ concession in 2005, there was a big improvement in our exports. The end of the 30-year war and the boom of the post-war business environment too contributed to this improvement. 

However, even with the suspension of GSP+ in 2010, our exports to the EU increased, although the rate of exports slowed down. Before the suspension of GSP+, from 2005-2010, our share of exports to the EU increased from 28% to 38%. 

On the other hand, even after securing the GSP+ again in 2017, our exports to the EU recorded slow growth, seeing about a $ 250 million increase from 2017-2019. This can be traced back to the fundamental fact that even with or without GSP+, our exports will remain unchallenged. 

Looking at the problem from an economic point of view

As economists, we have to evaluate a few other variables before we jump to conclusions. One is the growth of our total exports. We can observe our total exports have not been growing by much over the last decade. The reality is that compared to our GDP growth, our exports are declining. 

So from an economic point of view, it reiterates the fact that the challenges to our exports are no longer from outside, they come from inside. Our Customs processes and barriers for international trade remain at a level that even a trade concession will not bring any positive impact to increase our exports. 

One the other hand, we have to consider the income levels and consumption patterns of the EU to see whether our exports have become irrelevant in that market. Markets change very fast, and if we do not adapt, trade concessions won’t help much. 

The diversification of our export basket has not materialised, and our exports have not been competitive in the global market. As a result, our total export growth and export growth for non-EU countries has also remained stagnant. 

Whether our competitors have become better 

We have to evaluate if other countries in the region, with GSP+, have increased the competition faced by our exports. According to European Commission data from 2019, Pakistan and Sri Lanka are the only two countries in Asia with GSP+. However, labour-intensive markets such as Philippines, Armenia, and Mongolia in the region too have received the GSP+ concession. So it is likely that over the years, the competition has increased, while our approach has remained the same, meaning we maintain the same export basket with higher protection and a lack of competition. 

On the other hand there is a discussion within Bangladesh to acquire the GSP+ concession, according to The Daily Star. This may not only increase competition for Sri Lanka, but also open an alternative for existing local companies who have business in Bangladesh. They will consider moving to Bangladesh and increase capacity there. Thus, evaluation of the GSP+ has to consider all the facts and market dimensions. We should also have a strategy to increase our exports without GSP+ when we upgrade to middle income country status.

At the same time, we need to understand that markets are driven by information and sentiments. If the EU suspends our GSP+ claims on the basis of human rights, good governance, and environmental mishaps, it is very likely that other markets and investors will also be driven by that decision, which will affect our investments and the country’s reputation. Additionally, Sri Lankan exporters are currently benefitting from concessions, and losing GSP+ will have a negative effect on them.

Solutions

The solution to improve our exports is to create competition. The development of exports has to be tapped from the import end. Trade is a two-way street, and we are in a world where every nation is linked in an interconnected global supply chain. They all manufacture parts and components and assemble those parts and components to create the final product. From an end-to-end total manufacturing process, the world has moved to an assembly of parts and components to keep the economies of scale and make it affordable for most of the citizens in the world. 

The solution is to integrate into the global production and supply chain network. To do that we have to unilaterally embrace the price-driven market system. Price is the best way to ensure allocation of resources. So that is definitely the best solution for Sri Lanka – but at the same time, we should remember our economic situation and retain the existing concessions that are currently benefitting our exporters.

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.