The Government’s dangerous honey

Originally appeared on The Morning

By Dhananath Fernando

Minister of Finance Basil Rajapaksa, moving two important bills in Parliament, recited a poem in Sinhala literature, which is also a proverb, to explain the sorry state of our economy. He compared Sri Lanka’s economy to a man in the jungle trying to rescue himself from three life-threatening challenges.

Firstly, a furious wild elephant, similar to our mounting debt obligations. Secondly, to avoid the elephant, the man attempts to hide in a pit, but before he jumps into the pit, he realises that there is a cobra in it. So instead of jumping, the man then decides to hang onto the roots of a tree that lies above the pit as an alternative. The cobra in the bottom of the pit is similar to our Balance of Payment (BOP) crisis. Our importers and exporters are in big trouble, having difficulties opening Letters of Credit (LCs) due to forex shortages, and currency is depreciating rapidly with attempts to keep interest rates artificially low by policymakers.

Then the man realises that one root he is holding onto is the tail of a venomous reptile. He now cannot release his grip on the tail as the reptile will bite back. So, the adventure of running away from the elephant waiting at the edge of the pit now has two more severe life-threatening risks. The Finance Minister’s analogy reflects that trying to avoid one problem without a proper estimation and analysis has now opened us to more vulnerabilities while the previous challenges remain as they are.

As the story goes, one tree root the man is holding in his other hand is attached to a bee honey nest. So when he tightens his grip, bee honey keeps dripping, and so he decides to indulge in some bee honey. While the man has three life threats from the elephant, the cobra, and the other reptile, he decides to enjoy the dripping bee honey for a moment.

The Sri Lankan economic crisis is exactly the same. At a moment in history where urgent, hard, and serious economic reforms are required to overcome the crisis in the midst of the global pandemic, some alternative policies such as self-sufficiency, Modern Monetary Theory (MMT), and import substitution have become sweet bee honey for some policymakers who really do not understand the gravity of the crisis.

Unfortunately, just as the man who attempted to jump to a pitfall without properly analysing the situation, some economic measures with little analysis are cornering us for a brewing crisis.

Fixing USD at Rs. 203

Attempting to fix our exchange rate at Rs. 203 against the USD to avoid currency depreciation is one such activity. Simply, it is a price control on US dollars. Every good or service with an economic value is naturally obliged to a demand and supply matrix. In other terms, there is no alternative to fix the price of a currency without someone intervening in the excess or shortage.

In the forex market, the Central Bank does not have adequate forex to intervene in markets any longer, with the mounting debt obligations. So it is natural that $ 1 for Rs. 203 is a complete misguidance where there is no USD in the market at that price. The downside of trying to fix the USD at an artificially lower price is the encouragement it would provide on more importers to open LCs, adding more pressure on banks as well as the USD.

“Imports” are incentivised at a lower rate than the market rate for the USD. Exporters, on the other hand, are discouraged to bring forex as they get a far less market rate if they bring USD to the market. As a result, exporters hold the USD as long as possible and many exporters maximise their offshore accounts, as it is very cost-effective and hassle-free. As such, banks’ forex market has now further dried up, with both importers and exporters falling into trouble. It is the same predicament faced by the man who tried to avoid an elephant and came across two more additional troubles.

Additionally, another restriction has been imposed on more than 600 HS codes where the full amount has to be paid upfront to open the LC. This move will directly impact micro, small, and medium-sized businesses that depend on imports in those categories. Consumers will have to experience higher prices and black markets in most of these product categories, and the quality of life will be affected drastically.

Concerns expressed by investors on property rights over seizing rice stocks

Recent raids carried out on rice mills in Polonnaruwa will worsen Sri Lanka’s image as a destination for investors. As previously written in this column, it is the lack of competition, along with political support, that leads to the creation of cartels in the rice milling industry. However, seizing private property of an individual undermines investor confidence – no investor will consider Sri Lanka if there is a fear that the government will take over their property rights.

This was the same point made by the President when he was questioned by Indian media in his very first international media interview about the Hambantota Port. Though his supporters claimed that the Hambantota Port will be taken back by China, the President mentioned that if we were to do it, it would completely provide a wrong message for the investor community. According to media reports, the Government is initiating a very important Selendiva project for investors (Hilton Colombo, Grand Hyatt, etc). However, property rights concerns will seriously erode attracting quality investors for the Selendiva project.

At the same time, exactly like the proverb in the speech by the Finance Minister, while we are in serious trouble on multiple fronts, ideological groups seem to be defending their ideology rather than finding solutions with pragmatism. Ideological groups are the same as the man who is focusing on bee honey dripping, by forgetting that we are already in a very serious situation. The narration created on self-sufficiency and import substitution are just an example.

The Finance Minister has to be objective and pragmatic instead of falling into ideological traps. Otherwise, he will be a victim of his own analogy and the proverb of the man who multiplied the problem by irrational decision-making.

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.

Closing the gate once the horse has bolted

Originally appeared on The Morning

By Dhananath Fernando

Can price controls rein in uncontrolled depreciation?

People are infuriated over the recent drastic price hikes on essential food items, and analysts and policymakers are attempting to make sense of what triggered this.

Some argue that the increasing global commodity prices are indeed the root cause of these local price hikes. In my opinion, however, global price hikes cannot be the sole reason. This conclusion is misleading as the domestic prices of these food items are higher than the percentage increase of global commodity prices adjusted for the depreciation of the Sri Lankan rupee (SLR).

Steep depreciation of the currency

It is no secret that the Government sought refuge in Modern Monetary Theory (MMT) in recent times. This has had a considerable impact on commodity prices due to the depreciation of the rupee. A depreciating rupee coupled with increasing commodity prices is certainly an ill-fated combination. Even though many economists alerted the Government of the risks MMT could pose, they fell on deaf ears.

When global market prices rise, it is inevitable that domestic markets adjust accordingly due to price signals. This means that people shift their consumption behaviours and patterns with price volatility. However, Sri Lanka’s essential commodity price hikes came suddenly and have given people no time to adjust their purchasing patterns.

As per Central Bank data, Sri Lanka’s food inflation is increasing. Advocata Institute’s Bath Curry Indicator, which tracks the weekly expenditure of a four-member household on rice and curry, found that prices increased by 45% on a YoY (Year-on-Year) basis in July and by 30% in August.

I’d like to conclude my argument by quoting Nobel Laureate Prof. Milton Friedman: “Inflation is always and everywhere a monetary phenomenon.”

Acute foreign exchange crisis exacerbated by MMT

The acute foreign exchange crisis we are in, too, is a major contributor to recent price hikes. Oversupply of money has drained our reserves and added additional pressure on the currency. For example, when the government provides Rs. 20,000 (which is beyond the government’s capacity) for low-income families, money will flow out of the system due to the purchase of imported goods. People will be inclined towards buying imported LP gas, lentils, sprats, and tin fish.

Further, maintaining a negative real interest rate, which is to keep interest rates artificially low by increasing money supply below the inflation rate, will motivate people to spend more money than to save. More spending equals more expenditure on imports, which will then exacerbate the country’s Balance of Payment (BOP) crisis.

Currently, banks have different exchange rates for different customers. The kerb market’s exchange rate for the US dollar is between Rs. 250 and Rs. 260.

If this trend continues, the country’s fuel prices, LP gas, milk powder, and many other commodity prices will continue to rise.

Price controls

The Government has announced strict price controls and has appointed a designated officer to curb hoarding by traders with the objective of decreasing essential commodity prices. Recent news reports claim that hoarded essential food items such as sugar have been confiscated from stores by the authorities.

However, price controls are proven to be ineffective and will lead to goods disappearing from markets, as a result creating black markets. Further, it is likely that price controls will result in importers stopping the importation of goods. The first lockdown saw an initial price control of Rs. 65 on lentils and a controlled price of Rs. 100 on tin fish. Later, the Government had to withdraw the price controls as it resulted in severe shortages, with traders halting imports and the sellers hesitating to trade at a loss. Price controls simply don’t work because the price structure is unique for each trader.

Competition is the only factor that drives prices down. For example, the cost structure of a trader who sells lentils in an air-conditioned shop and a trader who sells at the Sunday market is different. The price they mark is based on the cost, and consumers buy it based on the value they get. Price controls hamper the signalling mechanism, resulting in severe repercussions.

Why do traders hoard?

Even with increased raids by the Consumer Affairs Authority (CAA), traders continue to hoard. This behaviour is intricately linked with the foreign exchange crisis the country is in. The Central Bank introduced regulations stating that traders cannot buy US dollars for a future day (forward market) at the current exchange rate. Further, importers were requested to open Letters of Credit (LCs) for a 180-day credit period. As a result, importers brought essential commodities in agreement to pay the exchange rate to be in effect after 180 days. They brought the goods they already sold at a calculated exchange rate.

However, now the exchange rates are depreciating further. For example, when traders imported the consignments, our exchange rate was about Rs. 190. But with the currency depreciation, now they have to pay the current exchange rate as there is no forward market or interbank market in operation. This is pushing importers to hoard to secure stocks for the future. Importers will also be inclined to increase prices to cover their losses incurred due to exchange rate volatility.

All of these trickle down to the average consumer as higher prices on essential commodities. Higher prices, long queues for essential goods, and empty shelves are symptoms of wrong macroeconomic policies.

This column and many economists alerted the Government that it would come to this, and I am disappointed that the Government did not heed our advice.

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

Reforms required, IMF or no IMF

Originally appeared on The Morning

By Dhananath Fernando

At Advocata’s first deep-dive session on Sri Lanka’s debt sustainability, Harvard Prof. Ricardo Hausmann emphasised on the importance of avoiding an economic crisis at all costs. As he is of Venezuelan origin, it is safe to assume Prof. Hausmann has first-hand experience of having to live through the realities of such a crisis. He warned that “an economic crisis comes slowly and then suddenly”.

Every week, the Central Bank attempts with various tools to subjugate the situation, but unfortunately the intensity of the wind seems difficult to change. The Energy Minister initiating discussions with the UAE to purchase fuel on a long-term credit period while restricting the country’s USD payments with a 5% ceiling on USD deposits indicates how hazardous things can be in future.

The Central Bank’s recent inflation numbers have indicated high food inflation. Now the last resort in sight is to approach the International Monetary Fund (IMF). Opinions on this are many.

In my view, emphasis should not be on the IMF. A credible plan to drive economic growth must take precedence. However, I don’t see such a plan in place as of now.

So let’s discuss solutions we can incorporate into a credible plan as the problem is clear.

Immediate policies

Cash transfer system for safety nets

Given the nature of the pandemic, it looks like we have to expect more lockdowns or limited travel in the immediate future. This will affect Sri Lanka’s MSME (micro, small, and medium-sized enterprise) sector and informal employment. At the moment, 99% of our establishments are MSMEs and more than 60% of our labour force is in the informal sector. MSMEs contribute more than 50% of our GDP. So any policy to stop spreading the virus through travel restrictions will undoubtedly affect our informal sector. We do not have a mechanism to protect them.

Samurdhi targeting and distribution through grama niladharis is extremely poor. Therefore, what governments often do is bring down prices of all food items, fuel, and other essentials across the board. This is direct intervention in the market in the form of subsidies. These subsidies end up in rich households due to their high consumption of commodities.

The solution is to introduce a cash transfer system to the vulnerable households. This will give them the freedom to choose what they want to spend on. The cash transfers can have multiple tiers based on the poverty levels. For example, when the global fuel prices are increasing, the cash transfer on fuel can be increased, but when prices decrease, the cash transfer can decrease proportionately. Simply, we have to introduce an agile digital safety net system in the future because market reforms are painful, especially for the poor.

Cutting down govt. expenditure and voluntary retirement scheme for govt. servants

A reason the Central Bank has to continue to follow Modern Monetary Theory (MMT) is the ballooning government expenditure. It is true our expenditure is somewhat on par with our regional peers, but our labour market is completely distorted by about 1.5 million people, and most of them are unproductive and dissatisfied with their work conditions. Undoubtedly, this is beyond our government’s afforbality, especially with pension payments and other expenses incurred utilising prime property across the island wasting most of our resources. Our state-owned enterprises (SOE) absorb a greater portion of our government revenue, their debt in state banks adding a serious risk to the stability of the banking system. So a freeze in the government sector is a must and we do not have any alternatives left.

Debt restructuring and debt conversion

We have to leave our current strategy of trying to manage debt with short-term swap agreements. The more we wait, the more the pain we have to go through. Debt conversion is a strategy that can be explored. We can consider a few debts to equity swaps similar to what we did with the Hambantota Port on identified unproductive assets. Debt restructuring or reprofiling is another option, which, however, requires serious effort. It will be an extremely costly process, where we will have to work with foreign legal firms and our creditors. This will have both positive and negative consequences.

Unlocking our land supply

Land is one of the main factors of production. It is unimaginable that 80% of land is owned by the government and only 3% of the land have clear titles, as per a World Bank study. Without having land ownership for its people, there is no opportunity for capital flow that can expand the entire business ecosystem. The Government has to prioritise creating a digital land registry instead of other unproductive alternatives.

Above are just a few recommendations for a credible recovery plan, whether we go to the IMF or not. The real problem is not whether we are going to the IMF or not. It is looking at what reforms we have to make on our own and how we are going to make these changes, which are required to drive economic growth.

Prof. Hausmann said that the big bad wolf comes slowly and suddenly. I hope we move much faster and get the reforms done before “the big bad wolf that comes slowly and suddenly” comes for us.

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.

We too might lose everything

Originally appeared on The Morning

By Dhananath Fernando

I have a friend in Afghanistan. I met him about five years ago. He has been telling me how beautiful and resourceful Afghanistan is. After seeing the tragic stories in the media, I quickly reached out to him over email and checked his family’s wellbeing. He responded in just three words: “I lost everything.” His three-word response powerfully described the magnitude of what a crisis could look like.

Not only Afghanistan, Sri Lanka is also in a crisis. I have highlighted the enormity of our crisis through this column on many occasions. Many prominent economists have also alerted the subsequent governments on the same issue. Unfortunately, nothing has been done other than implementing short-term solutions. Our crisis can also lead us to Afghanistan’s predicament. “We will lose everything”, if we continue to go down this path.

It is not only terrorist activities or natural disasters that could lead to the loss of everything. An economic crisis can also pave the way to losing all our hard-earned money and dreams. Recovering from a crisis is not easy for a country like Sri Lanka, especially in the middle of a global pandemic. That is one reason why many experts have voiced the need to avoid such a crisis. Recovery is a difficult, long and painful process.

What we experience currently are signs of a potential economic crisis. People are already feeling the difficulties and it has been just overshadowed by the Delta variant. In simple words, like my friend in Afghanistan said, we are all at the risk of losing a significant amount of our wealth. Undoubtedly, the poor will be the most affected. Unlike during the 1970-1977 period, there is much to lose for people in a modern-day society with more complicated needs and wants. As well as huge debts of the private sector with multi-storey buildings, which may not be easily rented to pay off debts incurred for construction.

Shortages of some essential drugs have been reported. Minister of Energy Udaya Gammanpila urged the public to use the fossil fuel economy to save the foreign exchange for the importation of medicine and vaccines. Fuel imports are estimated to be about 25% of our import bill, according to the Minister’s statement. If this trend continues, it is likely that the Government will have to ration diesel and petrol. This will create a series of repercussions on people’s day-to-day living at unimaginable levels.

The existing USD crisis has already rationed the opening of Letters of Credit (LCs) and supply chains are already shrinking. The impact of this is that businesses will downsize or wind up and many people will lose their jobs. Our exports will drop and local suppliers of export business will face significant knock on effects.

Lower income and higher unemployment are breeding grounds for many illegal activities and extremist ideas to take root. Sri Lanka already has tension between different ethnic and religious groups. The eruption of one of these activities is the path for all of us to “lose everything we have”.

There are few notable events that took place over the last week which would provide an indication of the gravity of the crisis we are in.

At the time this article was written, a big conversation making rounds on social media was about the difficulties in proceeding with online payments in foreign currency, even for small amounts such as online subscriptions for digital platforms. Some banks have already announced an additional interest rate for USD payments. It is natural for banks to stop online payment as they have to prioritise their long-standing customers who need foreign exchange for their import and export businesses. At the same time, such actions will have a serious negative impact on all our online businesses and the digital economy.

In the meantime, the Central Bank increased the Standard Statutory Ratio (SRR) to 4% from 2%. This simply means that licensed commercial banks have to deposit Rs. 4 at the Central Bank for every Rs. 100 of savings they get, instead of the Rs. 2 rupees earlier. The impact would be that the banking system will have less money to lend for their customers, as they now have to deposit more money at the Central Bank. Also, the interest rates – both the Standing Lending Facility Rate (SLFR) and Standing Deposit Facility Rate – have increased by 50 basis points each to 5% and 6%, respectively. The outcome would be that this will incentivise people to deposit more money, spend less, and borrow less money with interest rates going upwards. However, this is taking place in a backdrop where low interest rates were leading to high demand for credit, which spills on to balance of payments.

We also received the first tranche of $ 50 million tranche of the Bangladesh swap facility of $ 250 million and our reserves are at a record low after settling nearly a $ 1 billion bullet payment last month. Avoiding going to traditional sources of credit like India, Malaysia, or Singapore shows the desperation of Sri Lanka.

The Sri Lankan rupee depreciated to 22-228 in kerb markets; prices have already been increased in some bakery products and the cost of living will go up, making people more poor.

In situations of this nature, it is natural for people to consider leaving the country, and what we saw in Afghanistan was one dimension of how humans react to such situations. The inability to do business, consume what we want, restrictions on the economy, or in simple words economic freedom, matter most to the people. When people realise their freedom, mainly in the economy, is shrinking in any form, they feel they are losing what they have and that the wealth they earned through years of hard work is starting to diminish.

So the obvious choice is to look for better places with freedom, respect, and dignity to start life over. Our dreams of a high-quality life are shrinking everyday and Covid-19 is just accelerating it. So like Afghanistan, Sri Lanka too is drifting towards an unprecedented economic crisis.

Solutions

There is no other solution than market-oriented reforms. Markets must be allowed to work and prices should indicate the scarcity of our resources. Before all that, we first need to have a credible plan on what we intend to do. With a credible plan, we can move towards action and raise money to keep our nose just above the water. When we have a plan, we can decide whether we want the IMF (International Monetary Fund) or someone else. But even without a plan, no one else can help or assist us to overcome the situation. However, the times are getting difficult and the clock is ticking faster. Before we lose all that we have, we need to fight back together in these difficult times which are about to come.

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.

Markets: We can’t see them, but they exist

Originally appeared on The Morning

By Dhananath Fernando

When I was a kid, my father used to share stories about heroes, science, literature, and many more. I still remember the day he shared the story of Sir Issac Newton’s famous story of an apple falling from a tree, which made him think more and discovered the theory of gravitational forces. I wasn’t very impressed with the story. I questioned back as a kid: “If there is a force, why can’t we see it. Can’t we avoid gravity during the night? How can gravity act on a water surface and how can water flow if there is gravity?”

Later I realised, just because we can’t see it, that does not mean it doesn’t exist. It was because as a kid I simply did not understand the concept of gravity. The concept of “markets” is the same. It’s there and we all are part of it. When markets work well, we do not feel the existence of it. We only feel the existence of markets when we try to intervene in markets.

The current milk powder shortage and long lines to buy LP gas is a classic case of market interventions. While we have long lines for LP gas and milk powder, there are no lines to buy shampoo or soap or similar household products. In both cases, the market exists, but we just don’t see it.

Milk powder shortage

In the case of milk powder, supermarkets have rationed the quantity that can be purchased and most of the milk powder shelves are empty. There are many sides to the story. One side is that milk powder is not good for health, so we should move to liquid milk. There is further argument that Sri Lanka has to be self-sufficient in milk and produce all the milk it requires. As a result, Sri Lanka has always imposed high tariffs on powdered milk as well as imported milk, as high as 33.1%, as per the previous tariff calculations. This has been carried out with the objective of promoting local milk farmers and industry.

In Sri Lanka, there is a conspiracy theory for anything. The conspiracy theory is that milk powder companies create artificial shortages to cause inconvenience for the government and promote milk powder.

When we look at data and numbers, however, the story is different and it is multidimensional. First, global milk powder prices have been increasing significantly over the past few years. Since most of the milk powder is imported, when the global prices are increasing and when our currency is depreciating, there is no alternative to keeping prices constant. However, the Government and it’s main price regulating body, the Consumer Affairs Authority (CAA), are not allowing price increases by milk powder companies. They have at present imposed a price control – if you visit their website, the price controls can be seen.

Different brands and different pack sizes have specified prices. However, when global prices continue to increase constantly at one point, milk powder companies will reach a point where the losses of selling one pack of milk powder exceeds the loss of not selling a packet of milk powder at all.

At that point, obviously, the supply will be curtailed by the companies as no company can survive by making losses. So in a market system, the shortages start taking place. The long lines or shortages of any product category is the outcome of the market intervention in the form of price controls. (Source: https://www.globaldairytrade.info/en/product-results/)

This is basic economics which this column has explained many times.

The second argument is on the health concerns of milk powder. Many people are confused about why people do not consume liquid milk regardless of much propaganda by certain trade union groups and ideological groups.

The answer again lies in economics. In Sri Lanka, the domestic liquid milk demand is at about 700 million litres per annum, whereas our production is only 374 million litres per annum. Obviously, the balance has to be matched if we cannot produce it. On the flip side, our milk production is extremely unproductive. The average production by a milking cow is about 4.3 litres per day, whereas the world average is about 28 litres per day. In some countries like Israel, the productivity is about 40 litres per milking cow per day. Obviously, our productivity is very low to match the demand and we have been protecting the inefficiencies in the milk industry by imposing high tariff rates as high as 33.1%, as per the previous tariff calculations on milk-related products in importation.

When the global prices move up and when our currency is depreciating, when banks are going through a hard time to provide foreign exchange for importations, there is no way we can keep our prices constant in the milk powder market.

Only if we allow the prices to move up will the people who value milk powder at those prices will buy it, and there will be an incentive for other alternatives for milk powder to enter the market. So people can decide what they want and shift to alternatives. Even the promoters of liquid milk should now support a move to raise the prices of powdered milk, so that there is an incentive for increasing the supply of liquid milk in the market.

The case of LP gas

The liquefied petroleum (LP) gas market follows similar dimensions. Global gas prices have increased rapidly along with crude oil prices, and Sri Lanka has only two players. One is the government-owned operator and the other is the private sector operator. Private sector local businessmen cannot increase prices and they cannot import due to the US dollar shortage in the country. When we only have two players in the market and when one player is going out of the market due to price controls and US dollar shortages, the markets react naturally. It reacts in ways such as shortages, hoarding, or people who are storing more than what they want for future usage/panic-buying. So naturally, products will start disappearing at an accelerated rate. (Source: Saudi Aramco LPG prices per metric tonne)

The prices should move up and there is no doubt it would burden people with an increasing cost of living. But having long lines and making people inconvenienced during a global pandemic would cause more harm than a rise in the cost of living. As a result, the Government has finally decided to let the prices go up by Rs. 386 for the private sector player, but the actual value will be determined by the market.

Markets work whether we like it or not. Thinking that we can oversmart markets by price controls and regulations is no different to a man who tries to avoid gravity without realising the entire concept in the first place.

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.

Hanky-panky under the blanket

Originally appeared on The Morning

By Dhananath Fernando

Who benefits from the licensing systems that come about with our blanket bans?

Recently I was thinking about why people do certain things and why they don’t. I realised there are things that have been banned but still, people do. Consumption of certain types of drugs is just an example. At the same time, there are things that are not banned,  but still, some people don’t use them. Smoking is a good example. It’s not banned but data shows that people are now less likely to smoke due to health reasons. Analysing human behaviour shows us that there are reasons to engage in some activities while reasons to avoid them. Undoubtedly knowledge, information, and many other factors influence and incentivise certain actions over others. However, there are certain activities, where the Government decides on behalf of the people, that such are either good or bad for the broader population and try to control the choices of people. Our ban on chemical fertiliser is one such instance out of many. 

Another round of discussions has erupted over whether the fertiliser ban is relaxed or not. In a recent statement, the Government reiterated that there are no changes in their policy announced earlier. This trend of banning product categories on the grounds that it is not good for society has been common over the past few years. Then-President Maithripala Sirisena proposed a ban on chainsaws and carpentry sheds as an attempt to protect forests. Another proposal was to ban glyphosate to maintain our soil structure and avoid unknown kidney diseases. Then recently another development was the banning of sachet packets, banning the importation of palm oil, numerous discussions to ban cattle slaughter, and now the blanket ban on the use and importation of chemical fertiliser. 

Whether these decisions were made based on grounds of scientific analysis or analysing data and economic principles, remains a serious question. These recent decisions will have serious consequences on economic activity, especially in the import sector. A key point to note is that these outright blanket bans have led to the proposition of issuing a license for the importation of the particular product category. 

Many policymakers as well as common Sri Lankans lack an understanding of the negative consequences of licensing. Having a licensing process, for example, to import chemical fertiliser will lead to an increase in prices, open avenues for corruption and bribery, activate informal black market activity, and allow inferior quality products to enter the market. This cost of maintaining a licensing regime will have to be borne by the general public. 

Any Sri Lankan who has attempted the construction of a house or shop or wall has to go through a process of getting the plan approved by the technical officer at the Local Government. It is a license or an approval that allows any individual to build any construction. Those who have gone through the system know how painful the process is. In the first place, meeting the technical officer is not easy. Secondly, regardless of how compliant the draft was, he/ she always has suggestions and changes. As a result many common people hand over the drafting process of the building to the technical officer himself so he can approve it. 

The economics behind this is that when anyone has an authoritative power to decide the “go” or “no-go” of a project the person who has the decision making power is naturally motivated to capitalise an incentive over the approval. On the other hand the person who wants approval is getting naturally motivated to incentivise the decision maker to provide the approval even compromising the quality and standard. The same dynamics work in every licensing process, including the licensing of imports. Examples of the licensing processes include the exercise department for alcohol shops, Sri Lanka Customs, passport office, driving license and Registry of Motor Vehicles (RMV). 

When we first impose a ban and secondly issue a licensing system it is a double whammy to the economy. By creating a blanket ban we are creating a scarcity of resources which is in demand. Then by issuing a licence we are making the utilisation of that scarce resource unproductive. Simply, the more we keep the discretionary authority the more we leave room for corruption and inefficiency. Secondly, the immediate  implementation of a licensing process can lead to increased scarcity, where fewer goods are available relative to the population. Therefore there can be market shortages putting thousands of people into hardship and inconvenience. Unfortunately in Sri Lanka’s case these interventions and restrictions have come into place when the market system was working perfectly well, especially for the benefit of the general consumer. This therefore needs much thought and reflection. 

If the intentions behind imposing a ban on a certain product category are correct, then logically, there cannot be a justifiable reason to allow a few people to import the particular product, especially if the product is harmful for human consumption in the first place. 

As an example, if palm oil is carcinogenic, the cancer-causing ability doesn’t disappear just because few people are importing it. Instead it could be higher as now the market system is completely broken down as a result of the ban and as a result of the license only a few players are able to import any substandard products due to the limited competition. Secondly, when a licensing system is in place it allows close associates and people connected with authority to be issued with licenses, reaping benefits at the cost of the general public. The flip side is that  these licenses are issued not on a competitive basis. So the room for the political authority to share profits with a person who is getting a licence is higher than operating in a competitive environment. 

In a market where different players compete to supply a product, the general consumer will benefit from lower prices. Now as a result of a license raj the majority will be made worse off as a few players connected to the political authority can keep prices higher.  

Allowing a few people to import essential compounds and organic fertiliser is not different in my view. This will end up in few people controlling the entire market causing very high prices for the farmers which will end up in very high prices on food for common people. 

Additionally, the politicians who would back the licensing process will defend the same importers of suppliers in any case of any malpractice or importation of any substandard products.  

Just like I thought about why some people do certain things while others don’t, there are reasons why politicians prefer licensing. Simply the licensing process incentivises them and that is why they push for it regardless of the colour of the political flags they host. The current trend of setting up a licence raj which India had until the 1991 reforms and which were experimented in Sri Lanka in the 1970s is the surest way of making our entire country unproductive. 

However the ultimate loser of this game is the consumer and the farmer. Overall, Sri Lanka will lose while few politicians get some short term gains and the entire ecosystem feels the effects of instability. 

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.

To get rich, reward the hardworking

Originally appeared on The Morning

By Dhananath Fernando

Market-oriented policy reforms needed

Bill Gates famously said: “If you are born poor it’s not your mistake, but if you die poor it’s your mistake.” I believe this statement is quite apt if applied to Sri Lanka’s economy. Our recent economic trajectory shows a deep struggle to maintain economic growth and reduce poverty. We also don’t have a strong record of building prosperity for Sri Lanka since Independence.

The reasons and solutions have been discussed consistently by many experts, most often analysed and even over-analysed. Some policymakers understand the problem but fail to implement solutions, while some neither comprehend nor implement known programmes. In worst cases, some fail to comprehend but instead implement policies that worsen the situation. Sri Lanka’s post-Independence failure is a result of a combination of the above scenarios. It is a sequence of half-hearted attempts for much-needed reforms.

Sri Lanka is reaching a crucial juncture in its history; of having to pay for the country’s past mistakes and struggling to keep up with global developments yet again. On a more optimistic note, this presents Sri Lanka with the opportunity to understand the pressing need and importance of implementing much-needed economic reforms. However, to much of our dismay, the current political discussion is solely concentrated on evaluating the symptoms of the problem and not on accelerating the process of implementing the solutions we desperately need.

There has always been a debate on the rankings provided by different rating agencies on our dwindling foreign reserves. Some argue that our little island nation can survive the current foreign debt crisis, given our cash inflow and outflow numbers. Others present the case on Sri Lanka’s poor debt management.

The policy discussion needs to move beyond this and expand its scope to discuss solutions. The most practical short-term solution available to Sri Lanka right now is to seek the International Monetary Fund’s (IMF’s) assistance. However, this is not to be confused with a “be-all and end-all” solution, as it is only a painkiller to provide temporary relief from the agony the country’s economy is in at the moment. Working with the IMF will give us the credibility needed to convince the rating agencies that we are serious about addressing our macroeconomic problems, slow growth, high debt, and twin deficits in the fiscal accounts and the Balance of Payments.

However, it is time Sri Lanka addresses the million-dollar question we’ve been avoiding for decades – the need to implement hard economic reforms. Today’s column discusses the desperate need for reforms from a market-oriented perspective.

Sri Lankan society can be broadly divided into four main subsections on a matrix of “working hard” and “getting wealthy/successful”. Getting wealthy or successful can be loosely defined as earning in proportion to the effort put in/risk they take.

Below are the four subsections that Sri Lankan society can be divided into:

1. Individuals who work hard and become prosperous

2. Individuals who work hard but don’t become prosperous

3. Individuals who do not work hard but become prosperous

4. Individuals who do not work hard and and do not become prosperous

If Sri Lanka wants to avoid the mistake of dying poor, Sri Lankans must work harder. Hard work takes place when the incentive structure works and people get rewarded for their hard work and the risks they take. That can only be done through the market. The market system allows prices to work. It’s not only a profit-making system but a profit and loss signalling system. This encourages people to utilise resources optimally.

It is vital that we allow the market to function independently if we are to fix the economic crisis at hand. Its proper function will ensure the prosperity of all Sri Lankans.

The more we delay reforms and preoccupy ourselves debating and evaluating the symptoms of the problem, the further away we get from the opportunity of setting the price mechanism right. This allows the sustenance of a system that rewards the non-hardworking over the hardworking. This will only encourage the latter to seek opportunities and prosperity outside of Sri Lanka.

While cartels and market manipulators thrive, the average Sri Lankan suffers from excessive regulations and red tape. Most micro, small, and medium enterprises (MSMEs) struggle to keep their heads above water. Their productivity is hampered with no return or reward for their hard work. The more we strengthen the cartels and market manipulators, the more we discourage the hard-working Sri Lankan. 

The quadrant of not becoming prosperous and not working hard could be a personal choice, but most often, when the incentive structures are not in place, people have no impetus to do the hard work. That is why our reforms have to be focused on improving competition and price mechanisms, as it would encourage people to work harder. 

Sadly, the policy discussion is not one of the myriad solutions we can adopt. It is solely concentrated on our short-term ability to pay our creditors.

If Sri Lanka intends on getting rich, the solution lies in market-based reforms.

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.

Show me the money: a magic trick waiting to backfire

Originally appeared on The Morning

By Dhananath Fernando

Will the new tax amnesty really help us in the long run?

This is the humorous storyline of a video I watched some time ago by the famous Sinhala comedian duo “Podi malli and Chooti malli”. A father was very worried that his little son had swallowed a two rupee coin. The son and father struggled to get rid of the coin. Then the father patted the son’s back and asked him to vomit, but he couldn’t. 

A gentleman passing by saw this entire incident, and asked: “Can I help you?” Helpless, the father allowed him to take control of the situation. The stranger glared at the son and ordered him to give him the two rupee coin. Suddenly, the son threw up the two rupee coin. 

The father was very happy and surprised. He asked the stranger: “How did you do it and where do you work? Are you a doctor?” The stranger replied: “No, I work for the Inland Revenue Department”. 

This story is definitely not to underestimate our inland revenue officers. But given the proposed Tax Amnesty Bill, this discussion has come back into the limelight. It is not a secret that most current and retired Inland Revenue officers are taken care of by the payroll from small, medium, and even some large corporations, as tax advisors who always find smart ways to go through existing tax laws. So what are the pros and cons of the Tax Amnesty Bill and what would be the aftermath of the proposed Bill? 

The proposed Tax Amnesty Bill provides a wide range of benefits for tax evaders who haven’t abided by tax law. Accordingly, they can pay just a 1% nominal tax and disclose taxable income or assets, and become a legal taxpayer. 

On the plus side, the expectation of the Government is to increase its revenue, which is now required to finance government expenditure, given the extremely tight fiscal situation of our balance sheet. The Government expects to increase the tax base by providing this tax amnesty, and then improve government revenue in the coming years.

Secondly, the Government requires a sudden cash inflow to our economy to manage the expenditure on the fiscal side and a US dollar inflow to manage trade and our mounting debt repayments.

However, if we look at history, in 2002/2003, then-Finance Minister K.N. Choksy proposed a similar tax amnesty, which was reversed in 2004 again.

In recent history, on 2 April 2020, the current Governor of the Central Bank appealed to domestic and international well-wishers on behalf of the Sri Lankan Government to deposit foreign exchange into Sri Lankan banks, with an assurance that no questions would be asked on the financial trail of the funds. In the appeal, the Governor of the Central Bank mentioned that the money would be accepted without any hindrance from the Central Bank and the banking system, and would be exempt from exchange control regulations and taxes for three months from 2 April 2020 onwards. This request was made when our foreign currency earnings came to a standstill with the Covid lockdown last year. However, this did not bring the expected results. 

After spending more than one year without any sustainable solution, we are now back to square one with a similar proposal. In my opinion, this would further generate negative signals to our markets and international donors on multiple aspects. 

In the first place, no tax hikes or tax amnesties will work without a significant expenditure cut. Markets work based on information and signals. When we spend about $ 50 million on buying fighter jets, and when there was a heated discussion on parliamentarians importing duty-free vehicles, the signal system does not work right when we bring about revenue collection proposals. Simply put, markets won’t adjust, and people will not be willing to fasten their seatbelts.

During the pandemic, many companies had announced salary cuts, and the CEO was first to take the salary cut, at a higher percentage, before announcing salary cuts for staff and factory workers. Otherwise – it is not rocket science – resentment and resistance would build within. It may be only a little money we would save from a 15% salary cut for a CEO, opposed to the total savings from 10% Salary cuts for 2,000 workers. But the message has to be right – the policy is moving towards a purpose and the leadership is walking the talk. 

Secondly, on the market front, this move to grant amnesty would first discourage and discriminate against genuine taxpayers. It is true that there are only very few tax files opened in Sri Lanka, but the people who have made an effort to pay tax would be now thinking: “What is the point? Why do I pay taxes while the evaders get an amnesty?” 

This sentiment would have long term implications on eroding our tax revenue further. This would be a double-whammy if we do not get enough tax evaders joining the proposed scheme, because then we have given the wrong signals to the market. In this case, even genuine taxpayers will be discouraged, while at the same time we fail to collect adequate revenue from the tax amnesty.

Thirdly, though the Government has provided assurances that the information would be kept secret, even tax evaders are aware of the absence of proper institutions and transparency measures making it hard to assure confidentiality. This would increase the risk of getting the tax evaders exposed to certain corrupt politicians and causing future problems in terms of bribery to keep their names under the radar. 

Finally, and very importantly, the announced Tax Amnesty Bill and the recent announcement by the Central Bank Governor will again expose Sri Lanka to the grey list of the Financial Action Task Force (FATF), which Sri Lanka was delisted from only in 2019 October. The FATF is the global policy setter on anti-money laundering and countering the financing of terrorism. 

A delisting from the FATF grey list is a positive indication to the market to attract quality investments that look for a credible financial system. The delisting from the grey list was achieved through hard work by the Central Bank and its officials. So they should be the first to stand up against the threat of losing it again. 

At the same time, we have to be vigilant to not breach the codes of conduct and ethical guidelines of international donor agencies, as there is a high possibility of Sri Lanka having to knock on their door as a fallback option. 

So there is simply no magic formula for us like the story of the comedic duo, to just throw up the coins people have swallowed. It has to start from consolidating our expenditure and giving the right signals to the market if we are serious about raising government revenue. Otherwise, by trying to provide tax amnesties and implement unorthodox methods, we would only end up further exposed to unexpected risks.

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.

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.

Knocked down by policies made under the influence

Originally appeared on The Morning

By Dhananath Fernando

I recall quite a humorous story. One night two friends under the influence of alcohol were attempting to cross the road. They saw two headlights in the distance and assumed they were from two speeding motorcycles. With determination to display their fearlessness to the motorcyclists, the two friends decided to stand in the middle of the road so the two bikes could pass them on either side. However, it turned out that the headlights were from a speeding four-wheel vehicle and the two friends were badly injured. Being too drunk to make sense of what had just happened, the two went on to assume that there had been a third motorcyclist in the middle that they failed to see. 

Sri Lanka’s policy makers’ approach to the dire economic condition we are in is quite similar to the assumptions of the two drunk friends. With the optimistic expectation that two harmless motorcycles would pass us by, we run the risk of being badly hit by one big vehicle. 

Last week the Cabinet approved the proposal for Sri Lankan companies registered under the Company Act No.7 of 2007, Licensed Banks, and Savings Banks to raise money overseas and invest in Sri Lankan Sovereign Bonds and Sri Lanka Development Bonds. Foreign exchange remittances have been further extended by another six months. Since last week, banks have been rationing their clients on opening up letters of credits (LCs). 

So let’s evaluate the potential impact of these actions. We have been trying too many options over the last two years and we have to ask ourselves why nothing is working. The simple reason is markets don’t believe we are worthy of money. That is why regardless of decisions at every week’s cabinet meeting the forex market is still in peril. Our solutions don’t seem to address the problem of being worthy of money. 

When we allow private companies to raise money offshore and allow investment in Sovereign Bonds and SLDB, we are incentivising non-financing companies to enter into the radar of finance companies. That will dilute the focus of the existing business operations of the non-finance companies. Also it would indicate a wrong signal to the market that we are stretching ourselves too much without taking necessary actions. 

All these cabinet decisions and daily developments are a clear indication of the seriousness of the problem which we should not underestimate or misinterpret like the two friends did. 

Allowing banks to ration Letters of Credit (LCs) is also an indication that the Government has prioritised Sovereign Debt settlements over conducting trade. This is a result of the shortage in the Forex or foreign currency. As a result banks have to ration LCs and obviously they will provide priority to their long standing best customers. That means some of the customers who may have a forex requirement will not have the ability to access finance and they will run out of business. Some may be export industries who depend on imports. 

For example if we look at tea exports, some polythene films, packaging material, printing material are imported. As a result of the rationing process in banks, some of the exporters will not be able to keep their supply chains stable without the ability to open letters of credit. When the supply chain starts breaking down companies have to wind up or downsize their operation. The nature of the modern economy is that different  parts and components are produced and assembled all over the world, this is why we need to understand the importance of the global supply chain network. When we are kept outside of that chain, survival in a competitive environment is impossible. 

In simple terms banks have asked to ration and prioritise their customers. The next step for us would be to prioritise whether we settle our creditors or continue our trade operations. In my view we can ask our creditors to wait for sometime but we can’t ask our businesses to wait. They are already bleeding with back-to-back shocks from the Easter Sunday attacks to Covid-19. If we ask our businesses to wait, it is very unlikely they will be able to survive, especially in light of worsening market restrictions. 

At that point, choices will be very limited. So the solution is to prove to the markets that we are good for money and do it as fast as possible. Over the last decades we really haven’t proved that we are good for money. To do that as this column always advocated we have to make hard economic reforms. There was a time that we could have gone to markets and said that we will do reforms on our own. That window is closed now. When we go out and say the same thing now, no one trusts us now. So now we have to have an additional partner who can bring credibility and hold us accountable and help us put our own house in order. So far in the current set up it’s the IMF who can do it. Otherwise we have to get into a geopolitical game which is too risky to play. 

There are rumours of a cabinet reshuffle and a new minister on Economic Development and Management. Their task would be a gigantic one. However, we should reevaluate the context and do the right thing, unlike the drunkard friends who misread a vehicle as a motorbike. If we misread the situation and context we will be not different from friends who got knocked by a car but thought it was a rider without his headlights.

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.

Living the same economic year 73 times

Originally appeared on The Morning

By Dhananath Fernando

Both the Government and the Opposition are in agreement that Sri Lanka’s ailing economy is at peril. A few weeks ago, the Minister of Energy admitted that buying fuel has become a challenging task with import payments only being settled after nine months. These same sentiments were echoed by the former Prime Minister when he was recently sworn in as a Member of Parliament. However, the diagnosis of the problem at hand and building an action plan to address it is continuing at a snail’s pace.

The problem has reached a level where letters of credit (LCs) are opened on a rationed basis and some importers have claimed that private banks do not facilitate foreign currency for their imports. On the other hand, forex dealers have been barred from quoting above Rs. 200 for the dollar.

This will simply create more forex shortages as people who have USD now would not sell it to the Government as it does not reflect the market value. Instead, people may consider parking money outside or keep it in USD terms considering the devaluation of the Sri Lankan rupee in real terms. Owing to the Central Bank regulation, even though the USD rate is less than Rs. 200, in the open market the rates are much higher.

Shortages in foreign exchange is not a recent phenomenon. The Minister of Trade mentioned at Parliament that the current foreign exchange crisis is the worst ever in history. However, our solution for the problem so far has been “not proposing any solution”.

We are doing the same thing over and over again and expecting different results. If we rewind back to 16 June 2020, the President criticised the Central Bank for not extending their support and not utilising the tools to revive the economy.

In February this year, the State Minister of Finance mentioned that the fears of debt sustainability have no grounds as we expect $ 32 billion of inflows and total International Sovereign Bonds (ISBs). He went on to say that the country’s outstanding debt is only about 16% and annual debt servicing of $ 4 billion is manageable compared to $ 32 billion of inflows.

Depending on the same figures, the President in November last year assured debt sustainability after a credit rating downgrade by Fitch.

However, the forex crisis pops up again and the frequency of the problem is getting higher. Earlier imports were controlled and then exporters were requested to convert 25% of their earnings on an immediate basis. However, regardless of strict measures and stringent regulations being imposed, the results have been the same or are getting worse.

Now even the members of the ruling party have started to admit the forex challenge at hand.

Earlier, the Leader of the House said answering a question posted by a journalist that the Government has enough money to take up mega development projects. However, last week, the Minister of Trade and the Minister of Energy were open about how difficult the situation is.

It is an indication that things are getting challenging. On the flip side, it’s a positive indication. At least, everyone is getting to realise the gravity of the problem in the first place. Until recently, there was denial of the fact that there is even a crisis to begin with. A Citi Bank report in December last year was titled “Denial is not a strategy”. This shows that even our international stakeholders were aware that we as a country have been denying the problem rather than providing a solution.

According to the current Government, the previous Government is mainly responsible for the economic crisis at hand as growth numbers were low and the debt numbers were high at the point of the transition. According to the main Opposition, this Government’s tax cut programme introduced in December 2019 and poor Covid management are the main reasons for where we are now. In politics that is how things are. It is always someone else that is responsible for the problem.

The common belief is that bad politics is leading to bad economics as the politicians lack understanding of economic policy and the inherent corruption. While there is some truth to it, often bad economics leads to bad politics.

It is unavoidable that bad economics fuel political storms. If we look at the defeat of the previous Government, it was too led by bad economics. Policies by the two Heads of State were in two different directions. The very first interim budget was stretching the government balance sheet beyond our capacity with massive pay increases for government employees. A proper economic plan was absent and by the time the V2025 policy formulation was done which was poorly implemented, it was too late to come back to a growth trajectory. The Cabinet Committee on Economic Management (CCEM) was dissolved and a National Economic Council (NEC) was appointed and later even the NEC was dissolved. The same policy contradiction on the top led to a constitutional crisis and a vacuum in national security ended up in a terrorist attack that could have been prevented. The Easter attacks were a big negative shock to our entire economy.

As a result of this sequence of events, the then ruling party, United National Party (UNP), was divided into two and the then Prime Minister had to experience a historic defeat in the last general election, which was just 10 months ago with a roaring two-thirds majority for the current ruling party.

It seems back-to-back economic decisions by the current administration are repeating the same mistake of the previous administration and another political crisis spiral is brewing.

Growing import bans, not implementing a proper economic reform agenda, and inward-looking policies of self-sufficiency combined with Modern Monetary Theory (MMT) has created instability in the entire financial system leading to a historic balance of payment crisis. Politically, it has opened a window for the same Prime Minister who was defeated just 10 months ago and has challenged the Government on economic and Covid management. So we are back again on the vicious cycle of bad economics leading to bad politics. The irony is that bad economics not only leads to bad politics but also has a serious negative effect on the quality of life and poverty of all Sri Lankans. Unfortunately, we as a nation have become victims of this vicious cycle. Robin Sharma popularly said: “Don’t spend the same year 75 times and call it a life.” There is no doubt that here in Sri Lanka, we have been doing exactly that for the past 73 years since Independence.

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.

Rich man plays, poor man pays

Originally appeared on The Morning

By Dhananath Fernando

How we end up footing the bill for Government price controls

Purchasing alcohol was an expensive endeavour back in college. I remember the total alcohol bill being shared equally amongst those who drink and those who don’t. Sri Lanka’s fuel pricing mechanism is quite similar to this. The subsidised prices are a blessing for direct users of fuel who can afford it. The majority, who are secondary users, end up paying for the subsidy indirectly. Sri Lanka’s fuel problem is quite complex. If we are to overcome this issue it is vital that policymakers understand the concept of “markets” and “prices”. 

It is important that Sri Lanka integrates with global markets and continues to allow fuel imports. This costs the Government approximately about $ 3.5 billion per annum. Global fuel prices fluctuate based on market conditions, and it is crucial to understand why prices fluctuate and the indicators of these fluctuations. Some oil deposits in the world are located such that their extraction process is relatively easy and less costly. Some others are very costly to extract. The Middle East and the OPEC (Organisation of the Petroleum Exporting Countries) are reputed for their oil reserves, whereas the extraction of oil is comparatively more costly in areas like Alberta, Canada. Global oil prices are determined based on this ability of countries to supply to the global market. Political, economic, and climatic developments, and changes in these countries have a direct impact on global oil prices.

So what does the “price” increase communicate? It communicates to the consumer the scarcity of that particular resource within the particular time frame. So increases in global oil “prices” is an indication to consumers that fuel is becoming a scarce resource, and we have to use it optimally. It is also an indication to producers that they can earn more by producing more. This narrows down to the basics of supply and demand. Price is an indicator of scarcity. The “market economy” is not complicated, it is merely allowing the “price system” to work. This allows prices to indicate what should be done. Price is not just a number or a sum a consumer pays. Final retail prices are an accumulation of labour costs, material costs, scarcity, externalities, and factors of production. This is fundamentally why we must not intervene in the market price mechanism.

Sri Lanka has always ignored market principles. The island nation has been trying to artificially keep fuel prices constant despite the continuous fluctuations of global prices. We have failed to understand that such fabricated interventions to either inflate or deflate prices will only result in ceasing to keep up with global indications on whether the resource is scarce or not.

Sri Lanka’s fiscal discipline and stability has always been connected to fuel and the Ceylon Petroleum Corporation (CPC). As a result of fuel price changes, there are significant knock-on effects on all utilities, including electricity and water. CPC provides fuel at a lower price to the Ceylon Electricity Board (CEB), which is one of the main sources for electricity generation. As a result, the pricing of electricity is also now not indicative of scarcity. The CPC, which buys fuel at higher prices and sells it lower, now owes significant debts to most of the state banks. 

The debt incurred is in US dollar terms. A delay in payment or a default may adversely affect the entire financial system. The heavy impact this would have on the banking sector will consequently impact the Central Bank of Sri Lanka (CBSL). It is no secret that the CBSL bails out the CPC and CEB through Treasury Bills, or by printing money. Therefore it is clear that by intervening, we have successfully exposed the entire financial system to deep peril.

The current Minister of Energy said the banks have informed the  CPC Chairman that they do not have foreign currency to pay for fuel imports. This was informed to the Secretary of the Treasury, who then summoned all the heads of banks, who collectively assured the payments for fuel imports. He further stated that the CBSL said it cannot offer any reserves, given the country’s economic woes. It is perplexing to say that the problem is really this severe. It is clear that intervention in the price system has caused a massive domino effect beyond comprehension. 

According to a World Bank report, the biggest beneficiary of subsidised fuel prices are the highest echelons of society. “The non-poor are the largest consumers of fuel and electricity (the top 30% of society consumes 70% of fuel. This is well ahead of direct and indirect consumption of fuel by the bottom 40% through public transport). The administered fuel prices are an effective subsidy to the non-poor funded indirectly by fiscal resources,” stated the World Bank in its Development Update for Sri Lanka in November 2017.

I see no difference in this fuel pricing phenomenon and how the final alcohol bill was shared amongst those who drink and those who don’t in my college days. The poor are bearing the burden of fuel subsidies so the rich can buy fuel for much cheaper. The weighed-down poor only consume fuel in the form of transport, electricity, and other secondary forms. We have to understand that the losses of the CPC have to be paid by someone. Currently, that someone is constituted by both the rich and the poor. 

One important aspect is that the Government also collects revenue through the consumption of fuel. Changes made to the duty waiver have caused enormous losses to the Government. Giving cash subsidies to the poorest section of society could have been a much better strategy than tampering with duty waivers and underpricing fuel, ignoring market signals.

According to the calculations shown in Figure 1, the recent price changes do not reflect market prices of diesel, as illustrated in Figure 2.

What is the solution?

The first solution lies in addressing the problem. As of now, Sri Lanka’s fuel prices fail to indicate scarcity, hampering the independent function of market prices. One way of doing this is by setting up a transparent mechanism and changing the prices to reflect market prices. It may be a price formula or a process where transparency is assured. 

Such a step will incentivise better resource allocation. Consumers will be able to shift between alternative choices and manage their decisions based on price signals. The previous administration introduced a pricing formula that was very poorly administered. The method of calculation was not properly communicated. 

I recall a time when elections were approaching, with a simultaneous spike in global oil prices underway. However, Sri Lanka’s oil prices remained the same. The same was seen when global prices reduced during the first lockdown, and the local consumer was deprived of the deflation. 

One common misperception on this strategy was voiced politically as: “Why do we need a Government if the prices are going to change according to the world market prices?” Simply because we are now experiencing the consequences of such control by the Government. As The Morning reported, the fuel fund has a negative Rs. 26 billion and there are many discrepancies over the numbers in numerous reports. 

Another common misperception is that based on the price changes of fuel, we are going to allow bus fares and other connected prices to change daily. It may be daily changes or it can be changes over a month or a quarter, and there are so many ways we can structure it based on market forces. We have all forgotten that we deal with so many daily price fluctuations. Vegetable prices, Gold prices, stock market prices, and even the prices we pay as interest for Treasury Bills and Bonds change everyday. Price changes for a reason: they communicate the market conditions, which is the ultimate objective of “price”, and allowing the markets to work. 

It is true that this price hike has an impact on the poor. The Government can consider direct cash transfers. The cost of cash transfers will be lower than the losses we collectively incur from the CPC, CEB, and other fuel-dependent state institutions. The current price hike is just another temporary solution; it does not fix the problem. 

Increasing the share collected by everyone at my university party does not change the unfair division of the cost. Likewise, a price increase without setting up a market system and price signals to operate won’t solve Sri Lanka’s fuel and economic crisis.Purchasing alcohol was an expensive endeavour back in college. I remember the total alcohol bill being shared equally amongst those who drink and those who don’t. Sri Lanka’s fuel pricing mechanism is quite similar to this. The subsidised prices are a blessing for direct users of fuel who can afford it. The majority, who are secondary users, end up paying for the subsidy indirectly. Sri Lanka’s fuel problem is quite complex. If we are to overcome this issue it is vital that policymakers understand the concept of “markets” and “prices”. 

It is important that Sri Lanka integrates with global markets and continues to allow fuel imports. This costs the Government approximately about $ 3.5 billion per annum. Global fuel prices fluctuate based on market conditions, and it is crucial to understand why prices fluctuate and the indicators of these fluctuations. Some oil deposits in the world are located such that their extraction process is relatively easy and less costly. Some others are very costly to extract. The Middle East and the OPEC (Organisation of the Petroleum Exporting Countries) are reputed for their oil reserves, whereas the extraction of oil is comparatively more costly in areas like Alberta, Canada. Global oil prices are determined based on this ability of countries to supply to the global market. Political, economic, and climatic developments, and changes in these countries have a direct impact on global oil prices.

So what does the “price” increase communicate? It communicates to the consumer the scarcity of that particular resource within the particular time frame. So increases in global oil “prices” is an indication to consumers that fuel is becoming a scarce resource, and we have to use it optimally. It is also an indication to producers that they can earn more by producing more. This narrows down to the basics of supply and demand. Price is an indicator of scarcity. The “market economy” is not complicated, it is merely allowing the “price system” to work. This allows prices to indicate what should be done. Price is not just a number or a sum a consumer pays. Final retail prices are an accumulation of labour costs, material costs, scarcity, externalities, and factors of production. This is fundamentally why we must not intervene in the market price mechanism.

Sri Lanka has always ignored market principles. The island nation has been trying to artificially keep fuel prices constant despite the continuous fluctuations of global prices. We have failed to understand that such fabricated interventions to either inflate or deflate prices will only result in ceasing to keep up with global indications on whether the resource is scarce or not.

Sri Lanka’s fiscal discipline and stability has always been connected to fuel and the Ceylon Petroleum Corporation (CPC). As a result of fuel price changes, there are significant knock-on effects on all utilities, including electricity and water. CPC provides fuel at a lower price to the Ceylon Electricity Board (CEB), which is one of the main sources for electricity generation. As a result, the pricing of electricity is also now not indicative of scarcity. The CPC, which buys fuel at higher prices and sells it lower, now owes significant debts to most of the state banks. 

The debt incurred is in US dollar terms. A delay in payment or a default may adversely affect the entire financial system. The heavy impact this would have on the banking sector will consequently impact the Central Bank of Sri Lanka (CBSL). It is no secret that the CBSL bails out the CPC and CEB through Treasury Bills, or by printing money. Therefore it is clear that by intervening, we have successfully exposed the entire financial system to deep peril.

The current Minister of Energy said the banks have informed the  CPC Chairman that they do not have foreign currency to pay for fuel imports. This was informed to the Secretary of the Treasury, who then summoned all the heads of banks, who collectively assured the payments for fuel imports. He further stated that the CBSL said it cannot offer any reserves, given the country’s economic woes. It is perplexing to say that the problem is really this severe. It is clear that intervention in the price system has caused a massive domino effect beyond comprehension. 

According to a World Bank report, the biggest beneficiary of subsidised fuel prices are the highest echelons of society. “The non-poor are the largest consumers of fuel and electricity (the top 30% of society consumes 70% of fuel. This is well ahead of direct and indirect consumption of fuel by the bottom 40% through public transport). The administered fuel prices are an effective subsidy to the non-poor funded indirectly by fiscal resources,” stated the World Bank in its Development Update for Sri Lanka in November 2017.

I see no difference in this fuel pricing phenomenon and how the final alcohol bill was shared amongst those who drink and those who don’t in my college days. The poor are bearing the burden of fuel subsidies so the rich can buy fuel for much cheaper. The weighed-down poor only consume fuel in the form of transport, electricity, and other secondary forms. We have to understand that the losses of the CPC have to be paid by someone. Currently, that someone is constituted by both the rich and the poor. 

One important aspect is that the Government also collects revenue through the consumption of fuel. Changes made to the duty waiver have caused enormous losses to the Government. Giving cash subsidies to the poorest section of society could have been a much better strategy than tampering with duty waivers and underpricing fuel, ignoring market signals.

According to the calculations shown in Figure 1, the recent price changes do not reflect market prices of diesel, as illustrated in Figure 2.

What is the solution?

The first solution lies in addressing the problem. As of now, Sri Lanka’s fuel prices fail to indicate scarcity, hampering the independent function of market prices. One way of doing this is by setting up a transparent mechanism and changing the prices to reflect market prices. It may be a price formula or a process where transparency is assured. 

Such a step will incentivise better resource allocation. Consumers will be able to shift between alternative choices and manage their decisions based on price signals. The previous administration introduced a pricing formula that was very poorly administered. The method of calculation was not properly communicated. 

I recall a time when elections were approaching, with a simultaneous spike in global oil prices underway. However, Sri Lanka’s oil prices remained the same. The same was seen when global prices reduced during the first lockdown, and the local consumer was deprived of the deflation. 

One common misperception on this strategy was voiced politically as: “Why do we need a Government if the prices are going to change according to the world market prices?” Simply because we are now experiencing the consequences of such control by the Government. As The Morning reported, the fuel fund has a negative Rs. 26 billion and there are many discrepancies over the numbers in numerous reports. 

Another common misperception is that based on the price changes of fuel, we are going to allow bus fares and other connected prices to change daily. It may be daily changes or it can be changes over a month or a quarter, and there are so many ways we can structure it based on market forces. We have all forgotten that we deal with so many daily price fluctuations. Vegetable prices, Gold prices, stock market prices, and even the prices we pay as interest for Treasury Bills and Bonds change everyday. Price changes for a reason: they communicate the market conditions, which is the ultimate objective of “price”, and allowing the markets to work. 

It is true that this price hike has an impact on the poor. The Government can consider direct cash transfers. The cost of cash transfers will be lower than the losses we collectively incur from the CPC, CEB, and other fuel-dependent state institutions. The current price hike is just another temporary solution; it does not fix the problem. 

Increasing the share collected by everyone at my university party does not change the unfair division of the cost. Likewise, a price increase without setting up a market system and price signals to operate won’t solve Sri Lanka’s fuel and economic crisis.Purchasing alcohol was an expensive endeavour back in college. I remember the total alcohol bill being shared equally amongst those who drink and those who don’t. Sri Lanka’s fuel pricing mechanism is quite similar to this. The subsidised prices are a blessing for direct users of fuel who can afford it. The majority, who are secondary users, end up paying for the subsidy indirectly. Sri Lanka’s fuel problem is quite complex. If we are to overcome this issue it is vital that policymakers understand the concept of “markets” and “prices”. 

It is important that Sri Lanka integrates with global markets and continues to allow fuel imports. This costs the Government approximately about $ 3.5 billion per annum. Global fuel prices fluctuate based on market conditions, and it is crucial to understand why prices fluctuate and the indicators of these fluctuations. Some oil deposits in the world are located such that their extraction process is relatively easy and less costly. Some others are very costly to extract. The Middle East and the OPEC (Organisation of the Petroleum Exporting Countries) are reputed for their oil reserves, whereas the extraction of oil is comparatively more costly in areas like Alberta, Canada. Global oil prices are determined based on this ability of countries to supply to the global market. Political, economic, and climatic developments, and changes in these countries have a direct impact on global oil prices.

So what does the “price” increase communicate? It communicates to the consumer the scarcity of that particular resource within the particular time frame. So increases in global oil “prices” is an indication to consumers that fuel is becoming a scarce resource, and we have to use it optimally. It is also an indication to producers that they can earn more by producing more. This narrows down to the basics of supply and demand. Price is an indicator of scarcity. The “market economy” is not complicated, it is merely allowing the “price system” to work. This allows prices to indicate what should be done. Price is not just a number or a sum a consumer pays. Final retail prices are an accumulation of labour costs, material costs, scarcity, externalities, and factors of production. This is fundamentally why we must not intervene in the market price mechanism.

Sri Lanka has always ignored market principles. The island nation has been trying to artificially keep fuel prices constant despite the continuous fluctuations of global prices. We have failed to understand that such fabricated interventions to either inflate or deflate prices will only result in ceasing to keep up with global indications on whether the resource is scarce or not.

Sri Lanka’s fiscal discipline and stability has always been connected to fuel and the Ceylon Petroleum Corporation (CPC). As a result of fuel price changes, there are significant knock-on effects on all utilities, including electricity and water. CPC provides fuel at a lower price to the Ceylon Electricity Board (CEB), which is one of the main sources for electricity generation. As a result, the pricing of electricity is also now not indicative of scarcity. The CPC, which buys fuel at higher prices and sells it lower, now owes significant debts to most of the state banks. 

The debt incurred is in US dollar terms. A delay in payment or a default may adversely affect the entire financial system. The heavy impact this would have on the banking sector will consequently impact the Central Bank of Sri Lanka (CBSL). It is no secret that the CBSL bails out the CPC and CEB through Treasury Bills, or by printing money. Therefore it is clear that by intervening, we have successfully exposed the entire financial system to deep peril.

The current Minister of Energy said the banks have informed the  CPC Chairman that they do not have foreign currency to pay for fuel imports. This was informed to the Secretary of the Treasury, who then summoned all the heads of banks, who collectively assured the payments for fuel imports. He further stated that the CBSL said it cannot offer any reserves, given the country’s economic woes. It is perplexing to say that the problem is really this severe. It is clear that intervention in the price system has caused a massive domino effect beyond comprehension. 

According to a World Bank report, the biggest beneficiary of subsidised fuel prices are the highest echelons of society. “The non-poor are the largest consumers of fuel and electricity (the top 30% of society consumes 70% of fuel. This is well ahead of direct and indirect consumption of fuel by the bottom 40% through public transport). The administered fuel prices are an effective subsidy to the non-poor funded indirectly by fiscal resources,” stated the World Bank in its Development Update for Sri Lanka in November 2017.

I see no difference in this fuel pricing phenomenon and how the final alcohol bill was shared amongst those who drink and those who don’t in my college days. The poor are bearing the burden of fuel subsidies so the rich can buy fuel for much cheaper. The weighed-down poor only consume fuel in the form of transport, electricity, and other secondary forms. We have to understand that the losses of the CPC have to be paid by someone. Currently, that someone is constituted by both the rich and the poor. 

One important aspect is that the Government also collects revenue through the consumption of fuel. Changes made to the duty waiver have caused enormous losses to the Government. Giving cash subsidies to the poorest section of society could have been a much better strategy than tampering with duty waivers and underpricing fuel, ignoring market signals.

According to the calculations shown in Figure 1, the recent price changes do not reflect market prices of diesel, as illustrated in Figure 2.

What is the solution?

The first solution lies in addressing the problem. As of now, Sri Lanka’s fuel prices fail to indicate scarcity, hampering the independent function of market prices. One way of doing this is by setting up a transparent mechanism and changing the prices to reflect market prices. It may be a price formula or a process where transparency is assured. 

Such a step will incentivise better resource allocation. Consumers will be able to shift between alternative choices and manage their decisions based on price signals. The previous administration introduced a pricing formula that was very poorly administered. The method of calculation was not properly communicated. 

I recall a time when elections were approaching, with a simultaneous spike in global oil prices underway. However, Sri Lanka’s oil prices remained the same. The same was seen when global prices reduced during the first lockdown, and the local consumer was deprived of the deflation. 

One common misperception on this strategy was voiced politically as: “Why do we need a Government if the prices are going to change according to the world market prices?” Simply because we are now experiencing the consequences of such control by the Government. As The Morning reported, the fuel fund has a negative Rs. 26 billion and there are many discrepancies over the numbers in numerous reports. 

Another common misperception is that based on the price changes of fuel, we are going to allow bus fares and other connected prices to change daily. It may be daily changes or it can be changes over a month or a quarter, and there are so many ways we can structure it based on market forces. We have all forgotten that we deal with so many daily price fluctuations. Vegetable prices, Gold prices, stock market prices, and even the prices we pay as interest for Treasury Bills and Bonds change everyday. Price changes for a reason: they communicate the market conditions, which is the ultimate objective of “price”, and allowing the markets to work. 

It is true that this price hike has an impact on the poor. The Government can consider direct cash transfers. The cost of cash transfers will be lower than the losses we collectively incur from the CPC, CEB, and other fuel-dependent state institutions. The current price hike is just another temporary solution; it does not fix the problem. 

Increasing the share collected by everyone at my university party does not change the unfair division of the cost. Likewise, a price increase without setting up a market system and price signals to operate won’t solve Sri Lanka’s fuel and economic crisis.

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

The bottomless pot of Sri Lankan monetary policy

Originally appeared on The Morning

By Dhananath Fernando

A student asked their teacher: “What’s the most amazing, incredible thing in the world?” The teacher responded: “The most incredible thing in the world is that we see people leave all around us, but we never think it’s going to be us. It’s an everyday experience, that people known to us and loved ones leave us. Even experiencing it every day, our mind can’t think that we would also be one of them. Isn’t that incredible?”

Sometimes, it is the most obvious things that we fail to understand. Sri Lanka’s monetary policy definitely falls into this category of things. We see it and experience it every day, but still fail to understand or notice the big elephant in the room. 

The monetary policy is the set of rules under which a monopoly state agency produces paper money. The public is forced to use the money because the government has given it a monopoly and arrests anyone who keeps large volumes of foreign money. There are also restrictions on keeping deposits in foreign money to protect against inflating and depreciating money.

Good central banks will produce stable, low-inflation money. Bad central banks will produce large volumes of money, which generates high inflation and also results in foreign exchange shortages and depreciation.

Some people who run central banks try to avoid printing excess money, if they believe that high inflation and currency depreciation is bad. But sometimes, the Finance Ministry will pressure them to print money to finance the deficit or keep interest rates down.

And central banks will be forced to follow the orders of politicians. To avoid this kind of pressure, which is called fiscal dominance monetary policy, central banks ask for independence from the Finance Ministry.

But there are other activist central banks that will try to push growth on their own by printing money and artificially pushing interest rates down. Such banks will create monetary instability regardless of whether they are given independence or not. 

Some countries have solved this problem by putting controls on their central bank so that its officials are unable to print excess money, whatever their ideology or economic beliefs are. To do this, it is necessary to reduce discretion and bring them under the rule of law.

One such law is a strict inflation targeting law of around 2%. To target inflation, however, it is necessary to have a pure floating exchange rate.

Countries with central banks that create the most trouble or instability usually have pegged exchange rates. They are usually called soft-pegged exchange rate regimes.

The simplest way to restrain them is to fix the exchange and take away their ability to manipulate the interest rate by prohibiting the purchase of domestic securities. This is done by a currency board law which results in a fully credible peg or a fixed exchange rate.

The exchange rate can also be fixed to a great extent by having a wide policy corridor and managing the ability to control short-term interest rates on a daily basis.

The more discretion that is given to the central bank, the more tools they will use to inject liquidity to manipulate interest rates and then create instability. 

A third way is to dollarise. That is to allow foreign currency issued by a better central bank – such as one that is restrained by an inflation targeting law, or a currency board law – to be used in the country. It can be extended to allow multiple foreign currencies to be used as well.

Then, there cannot be any Balance of Payments crises anymore. This is what the Colombo Port City has done. It will be a multiple currency area.

The Central Bank’s recent strategy has to be evaluated with its policies over the last few months and in recent weeks. Below are a few decisions taken over the last few weeks:

1. Over the last week, the Central Bank urged the private sector to borrow foreign currency offshore funding and promised to give a zero-cost swap facility. Put simply, this means private firms are encouraged to borrow money in foreign currencies and “sell” it to the Central Bank for rupees. The Central Bank gives them the foreign currency back at the same exchange rate they sold it at a specified future date – say, one year, at the exact same rate. However, if the rupee rates are very low, it is doubtful whether this will be a very profitable activity. Companies that could borrow in foreign currencies can invest in Sri Lanka Development Bonds and government securities which are denominated in US dollars

2. In another news story, Sri Lanka requested and received a $ 200 million swap facility from Bangladesh. Interestingly, the IMF (International Monetary Fund) approved a $ 732 million facility for Bangladesh in May 2020 as emergency assistance to address the Covid-19 pandemic

3. In another move, the Finance Ministry has raised the limit on borrowing through treasury guarantees to 15% of GDP (gross domestic product) from 10% of GDP. This will allow the Government to borrow more off the balance sheet through state-owned enterprises and spend it through those enterprises. So the loans taken through treasury guarantees will not come under central government debt. Central government debt is already at 101% compared to our GDP, so space is limited for the Central Bank to borrow. The Bangladeshi Central Bank has also asked for a treasury guarantee, according to reports in newspapers in that country

When evaluating all these moves, it is clear that Sri Lanka is drifting towards a very hard situation on raising foreign exchange, as it has been highlighted in this column as well by many experts during the last 12 months. 

We have to ask ourselves: “With so many reactive and stringent measures such as import controls, why are we struggling to fix this problem?” That is where we have to recall the story of the student and the teacher. Sometimes it’s the most obvious thing that we fail to understand. That is, our monetary policy. That is, demand and supply of money. Our Central Bank has been supplying money following MMT (Modern Monetary Theory) utilising the space of low inflation. It is true the inflation is low, but the excess money we print will chase behind imports. It is the same as trying to fill a pot without a bottom. 

Let’s consider a simple example. Even if I grow all the food items that I require in my backyard, the moment I switch on a light at my home, I am spending on imports in the form of fuel for electricity. The moment I switch on my internet router, which consumes electricity, it is the consumption of imports. The moment we build flyovers, highways, and even a simple act of giving away 1 kg of dhal to an affected family mean we are spending on imports. So the only way to cut imports, if we really want to, is by minimising our consumption. 

Or else, we have to increase taxes. The Government has clearly stated that they do not intend to increase taxes. Even increasing taxes will not be a solution without fixing government expenditure, however. Currently, 86 cents of every rupee of tax collected is spent on government employees.

So to minimise consumption, the Central Bank has to absorb money from the system by selling the treasury bills they have rather than buying it from the market. When the Central Bank buys treasury bills, we call it money printing or quantitative easing. The more money we inject into the system, the more we spend, and we will spend more on imports. That is the Balance of Payments crisis we face at the moment, and that is why so many hard and well-intentioned efforts by the Central Bank haven’t seen the expected results materialising. 

Many are of the view that reactivating tourism and attracting higher foreign direct investments (FDIs) will be a permanent solution for this problem. Increased numbers in tourism and FDI will help to ease the situation, but it is not the permanent solution. There have been grand expectations expressed at the recent Sri Lanka Investment Forum to bring the per capita GDP to $ 8,000 by 2030 and a list of very aspirational goals. All the outputs are welcome, but without fixing our monetary policy and failing to understand the most obvious reason why we are failing, Sri Lanka will remain where it is today for the next decade. We must remind ourselves of the story of the teacher and the student on how we have failed to understand the obvious realities and realise that current policies have failed while trying to fix all the other issues in the periphery. Monetary stability is not everything, but without monetary stability, everything is nothing

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.

MV X-Press Pearl: lack of preparedness fanned the flames

Originally appeared on The Morning

By Dhananath Fernando

There have been many sentiments expressed on social media that Sri Lanka did not have luck in the recent past. Adverse weather, a third wave of Covid-19, and the sinking ship are just the most recent incidents from a much longer list. I was reminded of the meaning of luck when I was watching a documentary on Hollywood star Will Smith. Smith recalled his father’s advice on his successful career from his humble beginnings. “There is nothing called luck. Even if there is anything called ‘luck’ it is where opportunity meets preparedness.” Smith recalled how his father used to call him at 3 a.m. after seeing his box office numbers.

When I think about Sri Lanka; it is true we really haven’t had any luck for the last decade, but I believe it is simply because we haven’t been prepared. So when the opportunity comes or even when a crisis occurs, we are not prepared. The delay in preparing our policies costs us each time.

Reforms in the shipping and maritime industry is one such area of policy reform that we have postponed for too long. With the X-Press Pearl sinking near the “Pearl of the Indian Ocean” in our territorial waters, it is clear that the economics and our policy of a maritime hub have to be re-evaluated.

One may be surprised at the connection I am implying between a fire in a feeder vessel and the country’s shipping and marine policy, and one may even wonder what economics has to do with it. Whilst it is true that there is no recipe or economic model to douse a fire, economic policy can create an economic ecosystem where we have many firefighters, technology, and partners capable of dismantling an emergency of this scale or even at a bigger scale. If we did have such a policy, it could have presented may options, which in turn could have helped us avoid such a catastrophe for the economy, our invaluable marine environment, and our pristine beaches. 

How good policy could have helped

An incident like an emergency fire and an event of this scale and the ability to avoid it will undoubtedly have numerous variables. It is a rare incident. There are thousands of feeder vessels and mainliners passing our Colombo Harbour and Sri Lanka ranks 24th on the list of “Best Container Terminals” in the world, so how is it that we did not have a system in place to fight a fire? This is a question we have to ask ourselves as a nation aspiring to become the centre of the Silk Route.

The adverse monsoonal weather and the Indian fire brigade vessels taking about two to three days to arrive, have fuelled discussions surrounding “luck”. However, something that should be explored immediately is why Sri Lanka did not have sufficient auxiliary services such as maritime fire brigade services, especially in a backdrop where the Port of Colombo is a regional transhipment hub.  

It is not a question of our commitment to overcome this particular emergency but about the absence of policy to bring in technology and international businesses to arrest the situation. Undoubtedly, it is one out of many alternatives. There are incidents where even with superior technology, ships have been sunk into deep depths.

The economic argument brings in the question of what alternatives could have been available to us to control the fire and avoid damage to marine life. The Sri Lanka Port Authority Fire Brigade and Sri Lanka Air Force did their best to stop the fire at its initial stages. In one reel of footage it was clear the officer in a helicopter was throwing some chemicals from bags to douse the fire. While their efforts are appreciated, in the modern world, there are more advanced helicopters, aircraft, and vessels for fire-fighting, and our Air Force helicopters or Navy vessels are not crafted to fight a fire of that scale. In the industry of shipping there are more and more companies that provide such facilities. The shipping industry is an ecosystem and container transhipment is just a one tiny part of it. 

It is easy to point fingers at the Government and ask why it can’t have such high-tech vessels and aircraft to combat fires at sea. The answer is simply that it is not the Government’s responsibility to douse fires nor does our Government have the money to make such massive investments. But it is the policymakers’ responsibility to create a business environment in the shipping industry where such supportive services can be established within our country. 

There are many reasons why such companies do not establish their businesses in Sri Lanka. One main reason is that there is no reason for smaller, supportive businesses to enter the Sri Lankan market when none of the bigger shipping companies or principals are based in Sri Lanka. Then, we have to ask the question why the main shipping companies or giant players are not entering the Sri Lankan market. The reason is there is a law that 51% of the ownership of the company has to be kept with a local agency. There is no reason for a globally reputed big shipping company to enter Sri Lanka by offering 51% of the ownership to a local company where there are many better options available in the region and globally.

As a result of Sri Lanka not transforming to a maritime hub because it is sticking to its archaic laws, none of the advanced technologies or support services that exist in the industry will enter Sri Lanka, and we will have the same discussion even in five years unless the reforms are made. 

Our snail’s pace movement in a dynamic industry has driven Sri Lanka away from becoming a maritime hub and we have become just a port with high container transhipment volumes – which is also now coming to a saturation with delays in operationalising the East and West Container Terminals. The lobbying against reforming these laws is very high, as there are many beneficiaries in the current system. Policymakers who attempted to do the reforms have failed or are set to fail. 

There has been another discussion on getting a reasonable insurance claim for the damages caused to our marine environment through this recent incident. Some policymakers even mentioned that the claim will be supported to overcome national financial difficulties. However, we have to re-evaluate whether our policymakers have enacted the supporting legislations on global conventions under the International Maritime Organisation, in our Parliament. Since the ship is still within our territorial waters, it is the domestic legal framework that the shipping company has to abide by. But without the necessary legal framework in place to become a maritime hub, facing such incidents in Sri Lanka with the big insurance companies and their experienced lawyers will be challenging. They will always find legal reasons to escape from paying compensation, the same as our motor insurance companies. Ultimately, poor Sri Lankan taxpayers have to bear the entire loss that will be caused to our pristine beaches, marine environment, fisheries sector, tourism sector, and all industries and livelihoods connected to the incident.

Many Sri Lankans are of the view that during the incident, luck was not on our side. If Will Smith’s father was right, it is true that Sri Lankans did not have the luck of combating the fire; it was that the opportunity in the form of the fire met our lack of preparedness for decades in the shipping and maritime industry. The rest is history.

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.

Education and economic success: How Covid-19 could have saved us

Originally appeared on The Morning

By Dhananath Fernando

It’s been over a year since the Covid-19 pandemic hit Sri Lanka. The pandemic entered our nation at a time when all Sri Lankans, regardless of their party politics, had very high hopes about a change in the political economic system – a “system change”. While Covid has posed a real challenge for any system change, it could have been interpreted as a blessing if we were to shift our gears from “needing a system change” to working on “implementing a system change”. In my mind, education reforms are probably the best place to start.

We tried to restrict Covid to being a healthcare crisis without letting it spill over to become an economic crisis, but to no avail. Now there is another crisis brewing in the corner, which hasn’t been given much attention – the “education crisis”, which has been exacerbated by the Covid pandemic and its economic aftermath.

Let’s understand the crisis first.

Even before Covid, it was not a secret that our education system was not supporting our economic aspirations. Starting from preschool to tertiary and vocational education, the education reforms have been mere promises; they have been limited to the pages of election manifestos, without any real work happening on the ground. This education crisis is far more complicated than ever before. There are significant flaws in the education structure as well as in the content taught.

Sri Lanka’s inability to produce complicated products and services is a good case study to evaluate our education system. What we have been taught over the years does not satisfy the areas of knowledge that are in demand. People who have had the talent and acquired the skills that meet global demand have been offered citizenship and very attractive opportunities all over the world, and Sri Lanka has not even thought of attracting them back.

The more serious problem is that we have not been taught the things that are important for the present and future. From my experiences, we haven’t been provided with the opportunity to really learn by ourselves, even if we wanted to. Most content and many curriculums are outdated and so we have been made incompetent and unable to meet global competition. From 2000- 2015, Sri Lanka has introduced only seven HS codes to our export basket. Our competitor Vietnam has introduced 48 and Thailand has introduced 70 HS codes to its export basket. Therefore, one of the main contributors to our ailing economy is education.

As a result, even after 70 years of independence, we are finding it difficult to compete, and our inability to compete and understand the market dimensions have pushed us into a corner. In order to counter our own lack of competitiveness, we are building walls of protectionism against a far more competitive world, which has further isolated us as a nation in a fast accelerating world.

It is not only about our knowledge of technical subjects; human values and qualities such as empathy, equality, caring, taking responsibility, self-discipline, and many other soft skills have not been developed to levels at which they should have been. The way our senior educated officials and some trade union leaders, who have had a science and technology-focused tertiary education, are attempting to manage a global-scale pandemic, is a classic case study to understanding the gaps in our education system.

With all these flaws we have continued on the same journey without making improvements. With the pandemic, our preschools, universities, and most of the tertiary education institutes have been closed or operating virtually for more than a year; some have adopted online teaching methods but some of the students who do not have internet or device access have been completely left out. Some students and families have been completely left out due to being unable to afford the internet (even though Sri Lanka is one country with comparatively low data charges), and for practical reasons such as a few kids requiring to study online at the same time. Additionally, learning how to learn online is the first step for a productive online learning experience, rather than just sharing the same notes online and delivering the same content in front of a camera.

Education reforms are complicated, but it is one area that can bring us significant economic benefits in the future – if done right, and in line with global education standards. To do this, reforms sacrifices in terms of political capital will have to be made.

Implementing such reforms will bring in newer opportunities.

First, the tertiary and university education system could have expanded through a new online platform. One of the main complaints has been the capacity of our universities. An online mechanism with proper online examinations could significantly increase the numbers getting enrolled at our universities. A parallel curriculum change could have been done with industry consultations, as the post-Covid economy in the world has opened more opportunities for hundreds of new subject streams. Even world-reputed universities such as Harvard and MIT are now offering new courses with the same credibility online at a very reasonable price.

Secondly, the teachers are at home, and this time, they should have been better utilised for teacher training and curriculum changes to uplift education standards.

To overcome the current crisis, ideally a special curriculum could have been made for primary and secondary schools with special focus on the critical content from the existing curriculum. That would have helped students focus on the important subjects and themes and catch up for time they already lost due to Covid. The same special curriculum should be the gateway for updating our education system and curriculum.

While we work on long-term curriculum changes and online education methods, teachers and the school administrations should be identified as frontline workers and vaccination drives should prioritise them so that schools can be reopened faster.

There have been attempts to utilise the current television network for education purposes, but it seems to have not been done in an organised manner. In the third wave, we are back to square one in facing our educational challenges and it is obvious that we have not learnt anything from the first and second waves of the pandemic.

We have to remember that reviving the economy from an education crisis is far more difficult than recovering from a healthcare crisis. If our people’s brains don’t work at the right speed and in the right direction, there is no way that we can drive the economic engine in the right direction.

That may be why former late South African President Nelson Madela eloquently said:

“Education is the most powerful weapon which you can use to change the world.”

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.

Work Together or Die Alone

Originally appeared on The Morning

By Dhananath Fernando

How the pandemic highlighted the greatest benefit of globalisation – co-operation

The provision of Covid-19 vaccines has become a serious issue, not only in Sri Lanka, but in all parts of the world, but governments could have faced this issue better if they had understood the economics behind it – especially because it is the science of managing scarce resources by making the right choices in resource allocation.

Understanding this is much more important today because Covid-19 vaccines have become a limited and scarce resource globally. Sri Lankans who got the first jab of the Oxford AstraZeneca vaccine is now in a stage of confusion, as they have lost access to the second jab. This is mostly due to the unfortunate Covid uptick in India, which is globally the main manufacturer of vaccines.

Let’s rewind to about a year ago. This was when Sri Lanka managed the first wave of Covid-19, with a strict lockdown, active contact tracing, and effective quarantine mechanism. The number of infections and fatality cases in the USA, Italy, and some other European countries were very high during the same period. But things have changed. 

Economically, this was the time Sri Lanka embraced self-sufficiency. Many argued that globalisation and global convergence have come to a standstill, and that we have to go for self-sufficiency, and even for a homemade recipe for Covid-19 pandemic management. 

After one year, the entire world – and even the Sri Lankan authorities – has unanimously agreed that the best solution to manage the pandemic is vaccination. At one point, some policymakers even questioned and argued, saying: “Why are we making our people guinea pigs for vaccination testing of the products developed by other countries?” However in just one year, it was proven that global cooperation is needed for us to prosper; and the main vaccines currently in use in Sri Lanka, namely Oxford AstraZeneca, the Russian-developed Sputnik V and Chinese-developed Sinopharm are the result of global cooperation. 

The vaccines Sri Lanka received as a result of Covax are part of a global co-operation programme, where many countries and international donors contributed to developing the vaccines at a rapid pace. The US invested about $ 4 billion in Covax, as did the Bill and Melinda Gates Foundation. The Coax programme is a global mechanism, where countries and donors donate money to the programme, similar to the Paris agreement, for the vaccinations of middle and low-income countries. 

However, it is true that as usual, the countries with deep pockets received an additional advantage of securing more doses than middle-income countries. It is a classic case of “higher the investment, higher the return”. In this case, the higher return is in the number of doses for countries that invested billions of dollars for vaccine development and manufacturing. 

First world countries including Canada, the USA, Japan, and the UK have made multiple bilateral deals with many pharmaceutical companies, and have managed to secure doses more than they require for the entire population. Those countries made the risk of investing in multiple companies in case of the failure of certain vaccines during the development process. As a result, some countries like Canada have now reserved enough vaccines to vaccinate 8.7 times the doses required by their population. The UK and USA have reserved vaccination doses for about 7.7 and 4.0 times the sizes of their population. 

Globally, this has created a debate on the waiver of patent rights for vaccines. Some economists and policymakers have requested a waiving-off of these globally so that  the developing world will be able to produce its own vaccines – thereby increasing the supply of vaccines and bringing the pandemic to an end. 

However, intellectual property (IP) rights is a big component of pharma manufacturing. Companies and scientists embraced taking such a significant risk because of the large returns they could have made. Requesting a waive-off on these IP rights may affect the incentive of developing similar high-demand pharma products in the long run.

In this context, the question is what Sri Lanka can do to accelerate the vaccination programme. 

First, we have to realise we are already late to catch the train. The cost of the delay is a serious economic storm to an already ailing economy. Ordering vaccines and rolling out vaccinations could have started about six to seven months before. However, what we can do now is to open up the vaccine rollout to the private sector. With the global agent agreements, private sector companies may be able to secure some doses, so those individuals who could afford a vaccine may be able to get it by paying a higher price. 

Thereby, the most vulnerable sectors who can’t afford a vaccine could have access to the government programme. Big corporations and exporters in Sri Lanka most likely will pay the vaccinations for their employees. This is the same as PCR testing at the initial stage. The private sector was not allowed to conduct PCR testing. As a result, even someone who could afford a PCR test had to stretch out the resources of the Government, and as usual, it is the most influential people who got a preference in the government system. 

Most healthcare providers currently conduct PCR tests in collaboration with the private sector, which has helped immensely for active contact tracing and quarantining. The same actually happened for the vaccines as well. With the absence of a proper priority list, many who could afford to purchase a vaccine, and who could have survived without a vaccine for some time, got preference over someone who was deeply in need. 

We also have to admit that global co-operation in the modern world is a normal thing, and depending on each other is not a weakness, but a strength.

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

Budget 2021 : A good or bad kettle?

Originally appeared on The Morning

By Dhananath Fernando

Then school principal of my alma mater, late Rev. Fr. Bonnie Fernandopulle used to mentor students through the use of anecdotes and examples. One of his favourite questions for students he was mentoring was: “Do you know the difference between a ‘good kettle’ and a ‘bad kettle’? They both look the same. They both sound the same. They both serve the same purpose of boiling water. But only time will tell which one is which.” He used to say: “It is not the ‘term-end exams’ nor the ‘semester-end test’ that are the difficult tests of life. The ‘test of time’ is a test that you, as students, should train yourselves to face.” I hold this advice dear and remember it up to date.

One year into a global pandemic calls for a litmus test on the effectiveness of our economic policies and the presented “Budget 2021”. This will help one evaluate where Sri Lanka stands in the “test of time’ metric. 

The Annual Report of the Central Bank of Sri Lanka (CBSL) for 2020 provides some statistical insight for evaluation. Our economy has contracted by about 3.6%. Our debt-to-GDP ratio has increased above 101%. Government revenue has shrunk from about half a trillion rupees. Revenue as a percentage of GDP has shrunk to 9.3% from 12.6% in 2019. The present revenue-to-GDP ratio is among the lowest for countries at our level of development. This would induce us to print more money in the near future, while additionally we have printed about Rs. 650 billion. By contrast, in the year 2019, Sri Lanka printed only about Rs. 4 billion. The two lockdowns and the mounting economic woes that the island has been facing for decades have led us to where we stand now. These figures do not come as a surprise. The end of 2020 left all of us with severe concerns and reasonable estimations of the country’s sorrowful performance of the year.

The 2021 Budget presented Sri Lanka with a good opportunity to take necessary measures to curb the approaching economic downturn. Looking back at the Budget, five months later, it is somewhat evident that we could have done better in certain policy areas.

This column previously highlighted two main loopholes in the 2021 Budget. One was the inadequate allocation of resources and the lack of a solid plan for healthcare services to combat Covid-19. The second was a credible action plan on debt servicing challenges for Sri Lanka. It was evident that without combating Covid-19, mitigating the impact on the economy will be difficult. Some sentiments expressed by members in Parliament questioned the need for the resources for vaccines which were produced by some other countries and highlighted the need for making Sri Lankans guinea pigs for vaccines by multinational pharma corporations. It was personally alarming for me to watch business leaders speaking at budget discussion forums with excessive emphasis on their respective businesses with no regard extended to the larger economic adversity at hand.

As a result of these poor policies and mitigating strategies, we are now in the midst of a raging third wave of the virus. This continues to affect the economy, proposed budget promises, and businesses adversely. Simultaneously, the global demand for vaccines has skyrocketed. Therefore, it is evident that Sri Lanka will have to wait for some time to receive the required amount of vaccines.

The 2021 Budget did not successfully address Sri Lanka’s problem of debt servicing. The only thing concealing the severity of this issue is the burden placed on the country’s healthcare sector at the moment. 

Moreover, Sri Lanka faced international pressure in terms of human rights violations coupled with geopolitical tensions which brings its own economic constraints and impact. As stated by the Central Bank Annual Report 2020, the destinations of more than 60% of our exports are the US, India, Japan, Australia, and the European Union (EU). All these nations have expressed concerns over Sri Lanka’s reconciliation efforts. 

Unlike the first-time shocker of the Covid-19 pandemic, after one year, some countries have made progress even with gigantic challenges. So from the perspective of investor sentiment and businesses, over time, the innovators and early adaptors, who are good to do business in the region and globally, are getting noticed. The attention and priority we received in the initial Covid-19 wave from investors, businesses, local donors, international donor agencies, and the rest of the world may not return during this new wave. Especially if our  policy decisions lack foresight and common sense. The current story published on PublicFinance.lk is that only 6% has been spent from the Yuthukama fund which was set up for Covid management and the availability of Rs. 1.7 billion remaining as the balance is just one example. The fund was supported by many Sri Lankans, and now, local and international companies may doubt the seriousness of our efforts.

We are between two hard choices which will have equally bad negative consequences. Minimising the mobility of people impacts our economic activity but increasing the mobility affects the Covid-19 spread which hits back again on the economy and people’s livelihoods. We need vaccines to control the spread of the virus but we should be able to get the vaccines first, while also balancing our foreign exchange. Economic policy formulation and execution is a team sport. It is not only the right policy but also the execution that matters. Even if we have a good execution team, if we are implementing the wrong policy prescription, the results won’t stand the test of the time. Unfortunately, five months after the Budget 2021 none of our policies nor our policy execution was able to stand the test of time. It is not only the Budget for 2021; the previous budgets and our economic policy over the years have failed to make a positive impact. We should pause for a moment and think about which sort of kettle we are. Are we a good one or a bad one? We should ask ourselves: “Have we been able to stand the ‘test of time’ with the economic policy we have been practicing?”

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.

Understanding economics, understanding life

Originally appeared on The Morning

By Dhananath Fernando

Why Sri Lanka needs to comprehend economics to tackle its other problems

It is said that when John Lennon (the singer/songwriter) was five years old, his mother used to say that happiness was the key to life. When he went to school, the teacher asked him:  “What do you want to be when you grow up?” John replied: “To be happy.” The teacher told him: “You didn’t understand the question,” to which John responded: “You haven’t understood life.” 

John Lennon’s thinking is valid in economics as well. When we fail to understand economics, most of the time we just don’t understand life. 

It is a more serious problem for the common man’s life when our policymakers don’t understand economics. Asking the common man to pay for someone else’s decisions and choices is not the right way to think about economics. 

Sri Lanka’s continuous battle with Covid-19 is a good case study, not only in economics, but also in understanding what is happening to our quality of life. Especially with the risk of a Covid-19 third wave at hand. 

Public Health Inspectors (PHIs) have recommended another lockdown. A record number of patients have been reported per day, far exceeding our testing capacity. Newspapers have reported about a UK variant and asked the public to keep a two-metre physical distance, instead of one metre, to combat the new variant. 

As the nation went through a second lockdown, this column highlighted why Sri Lanka cannot afford another lockdown. 

Simply put, our government revenue is declining, our foreign currency debt repayments are mounting, our channels of foreign currency earnings have been interrupted negatively, and most of our economic challenges have reached a boiling point. 

None of these problems have quick fixes. The only quick fix we can apply is to buy more time. All the above are symptoms of wrong economic thinking rather than problems that cannot be solved. The right economic thinking is more important than ever before, as we slowly drift towards the brink of a third Covid-19 wave.

Economics is the study of maximum utilisation of scarce resources that have alternative uses. On the health care front, our hospital beds, PCR testing capacity, ventilators, vaccines, and oxygen supplies have now become crucial, scarce resources. 

If we fail to utilise these scarce resources to their  maximum, as a country we will face a health care crisis. This is taking place in the backdrop of a grave economic crisis that has been multiplying over the years. Globally, vaccination is in high demand, and even the slightest delay to place an order could cost human lives. To get vaccines faster, we need foreign currency and a good working relationship with other countries to get the vaccines down. Unfortunately, things are a bit difficult at the moment.

When resources are scarce, the only way to maximise that resource is to prioritise them – this means removing barriers for more players to enter the market and allow market forces to work, thereby allowing new channels of supply to be established. 

On the demand side, we have to constantly build public awareness on action on better sanitisation and minimise the spread of the virus.

During the first lockdown, this column recommended a strategy of testing based on symptomatic cases and asymptomatic cases, with the ability to do contact tracing and random testing. Basically, to highly prioritise the symptomatic contact traces, and assign low priority to the asymptomatic cases that are difficult to contact trace. 

The column also recommended conducting regular testing for frequent commuters and touch points such as taxi drivers, bus conductors, and others who interact with many people. During the initial wave, the testing was only allowed to be conducted through government hospitals, while the private sector was not allowed to conduct PCR testing. That decision was later relaxed.

Similar restrictions and guidelines were available for health care and treatment by private hospitals. What economics teaches us is that when resources are scarce, the actual cost of utilising that particular resource is the cost that we have to forego for the usage of the same resource. 

When it comes to PCR testing, when everyone is attempting to get the test from the government system, we have to forego the opportunity cost of someone with the disease getting tested, and someone who could afford to get the test done with a payment. 

The more we overstretch the government system, it is the more affluent and politically connected who get the opportunity of obstructing the poor man’s opportunity. 

Now the context has changed. Our existing problems remain as they are, a similar situation has occurred on our hospital beds, oxygen, and vaccines. The solutions to these problems have to be evaluated in multiple facets, as there are many dimensions. What often takes place in Sri Lanka is considering all aspects except economics. 

Given the scarcity of hospital beds, we now have to consider all methods of increasing the number of beds, PCR testing, and getting vaccines on the supply side.

At the same time, we must restrict the spread by continuous public education to manage the demand side. After seeing news stories from India, we may have to look at opening our health system for more private sector involvement. This can be through requesting hotels and unoccupied tourism properties to convert to hospital wards based on their consent as a backup plan, and allowing regulatory relaxation to bring down life saving medication. 

That is just healthcare economics. Vaccines and all medical equipment require money to purchase and upscale. We need both local currency and foreign currency. We have to think about financial resources on the other hand. To save foreign currency, policymakers are running a marathon of banning some import product categories every week, without understanding the overall impact the public has to face. 

Last week, it was fertiliser, and the week before it was palm oil. There have been many on the list. All these controls have a ripple effect, and impact the economy and public life. 

The ban on tyre imports has created a new market for secondhand tyres, which is a serious road safety concern. The ban on palm oil adds additional risk of multiple usage of coconut oil, which also adds to health risks and increasing the smuggling of coconut oil. As a result, the little quality of life we have is diminishing everyday. 

According to John Lenon’s understanding of life, we should not misperceive economics only in monetary terms. Economics is the science of maximising scarce resources with alternative usage. It is everywhere in life. 

We see the importance in healthcare economics better now than ever before due to the pandemic. The objective of economics is to take more people out of poverty by utilising our resources. Controlling imports or defending our current account is not a form of economic governance. It is important to understand the problems and the symptoms of the problem. But we need to comprehend economics to understand the problems first. 

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.