From the frying pan..

Originally appeared on The Morning

By Dhananath Fernando

The dangerous precedent set by the sudden, outright ban on palm oil

Chief Seattle, a native American tribal chief back, in the 18th Century said: “Man does not weave this web of life. He is merely a strand of it. Whatever he does to the web, he does to himself.” Such wisdom is not only valid to man and the environment – it’s also valid to the concept of a market. 

Any interventions we make to one single market results in damage to the rest of the whole market, and to our own selves, but policymakers still don’t seem to understand this basic fact.  They do things with good intentions, but at an enormous cost to everyone else in the system. In the Sri Lankan context, some of the market interventions are made to gain political advantage, which ultimately ends up diluting political capital and worsening the problem further.  

Sri Lanka has a history of banning goods, and banning palm oil is only the latest example.  

Sometime ago, there was a discussion on banning 20-micron polythene, and then His Excellency  President Sirisena wanted to ban chainsaws and carpentry sheds. Then there were discussions on banning cattle slaughter and sachet packets – and now the spotlight is on banning palm oil.

It was reported that the Government decided to not only ban importation of palm oil, but also the operation of palm oil plantations. The decision further stated that the existing palm oil plantations are required to uproot the palm cultivation with a 10% annual phasing out, while replacing the cultivation with rubber and other products. It was justified on the grounds that the objective of this decision was to protect consumers from carcinogenic compounds in the market. However, on the very next day, it was announced that the Government expects to provide a license for palm oil importation, after listening to the concerns raised by the bakery and confectionary industries, where palm oil is a main ingredient. This creates a serious and valid  question: How can we import palm oil and allow the confectionery and bakery industries to operate, if palm oil has carcinogenic content? The justification does not make logical sense. 

The global palm oil industry 

Let’s first take a look at the numbers to understand the palm oil industry. According to United Nations statistics, palm oil is a $ 60 billion global industry that provides direct employment to 6 million and indirect employment to another 11 million. In 2018, around 21 million metric tonnes (MT) of palm oil was produced. Indonesia and Malaysia are the main palm oil producers in the world, where India, China, and the EU are the main importers. In terms of global vegetable oil production, palm oil has taken the lead over the last decade, compared to other edible oils such as soya, sesame, and sunflower oil. 

Local palm oil industry

If we look at the Sri Lankan palm oil industry, about Rs. 26 billion has been invested, with cultivation on over 11,000 hectares, which is just over 1% of the extent of our entire tea plantations, according to a research report published by Capital Alliance Research Team.

According to the same report, Sri Lanka’s actual coconut oil production is about 27,000 MT, whereas the palm oil annual requirement is about 217,000 MT. Industries such as margarine, soaps, shampoo, ice creams, and biscuits use palm oil as a main ingredient. 

Some of the organisations dependent on palm oil are multinationals and large locally-owned corporations. At micro level, small businesses such as restaurants and small-scale confectionery businesses and bakery industries, who are the main users of palm oil, will feel a significant impact from the decision. Additionally, five publicly listed companies (Watawala Plantation PLC – annual revenue of Rs. 2,675 million; Namunukula Plantations PLC – annual revenue of Rs. 1,049 million; Elpitiya Plantations PLC – annual revenue of Rs. 780 million; Agalawatte Plantations PLC – annual revenue of Rs. 456 million; and Kotagala Plantations PLC – annual revenue of Rs. 109 million) will be  directly affected.  

 Economic impact 

Like Chief Seattle said, humans and the environment are strands of the same web. Similarly, the palm oil industry is connected with so many other industries. This affects our overall economy, as all markets are interconnected. So the sudden decision will have an impact on the economy,  starting from the small “wade” shop down the road that uses palm oil as the main frying source, which is available for a reasonable price to large scale companies who are in plantation, confectionery industries along with listed companies.  

Most likely, the unavailability of palm oil will affect the higher demand for coconut oil, which will increase the demand for coconuts. Higher demand with stagnant supply will lead to increase in the domestic prices of coconuts and coconut oil. Higher coconut prices would negatively affect coconut exports, sales, and exporter margins. 

Since shifting to coconut oil is expensive for  small-scale businesses, usage of the same coconut oil multiple times for frying purposes will be incentivised. Black markets will be created for palm oil, or market manipulation will take place with further carcinogenic substances, which will be even more difficult to track. In some instances, prices of food may further increase, and some shops may have to close down permanently. 

 Negative signals to other markets undermines property rights 

Banning palm oil plantations overnight without any consultation, and requesting to uproot the existing plantations, will be considered by investors as undermining of private property. Uprooting incurs extra costs in addition to the losses that will be faced by plantations. Even if they shift to other cutivations such as rubber, the challenges imposed to these businesses would affect the ease of doing business and investor confidence, at an hour where we need their support the most. 

 Setting up a licence regime

The last few decisions made by the economic policymakers on banning certain products and services have seen Sri Lanka drifting towards a complete licensing regime, in which only the politically connected and privileged would be benefitted. Such culture would set up a bad example for all other markets and businesses, and it opens room for more corruption. Starting from banning tyres, bathware, and many other imports, the sequence of actions has been: Ban first; face resistance from the industry; and provide special licenses for importation to a handful of suppliers. 

This sequence of events is the setting up of a license regime. Such regimes are harmful to consumers and distribute profits to palm oil substitutes, which may not produce enough to make up for the reduction in imports. Consequently, such action would raise the price of coconut oil, which is used widely in Sri Lanka. In terms of economics, banning products creates the ideal situation for “rent seeking”, where an intervention distorts incentives. And, resources used to gain access to these profits creates deadweight losses (meaning both the consumer and the producer lose out).

Concerns of health and water usage of palm and palm oil 

Health concerns have been highlighted by scientists all over the world on edible oils, which are mainly not limited to palm oil. According to European Food Safety Authority (EFSA), the risks of cancer are mainly due to glycidyl fatty acid esters (GE), 3-monochloropropanediol (3-MCPD), and 2-monochloropropanediol (2-MCPD), and their fatty acid esters, which form when processing vegetable oil at high temperatures, which could be carcinogenic. 

Like consuming substandard sugar and salt, the edible oils could bring health concerns. This has been highlighted in many parts of the world. On the other hand, the usage of soil water has been a main concern for the resistance for palm cultivation. Palm cultivation is way more productive than coconut and other edible oil products, because it consumes more water than any of these. In other words, by utilising way less land, we can match the same oil requirement by palm, so at an overall level, it consumes less water and provides for more productivity. 

The way forward and solutions

As a way forward, there are multiple fronts the Government needs to address: First, to make sure not to make uninformed decisions – without industry consultation – which have a direct impact on their political capital and the wider business confidence. Secondly, banning is not a solution to the problem, but only worsens the problem further! 

Even if palm oil is proven to be carcinogenic and damaging to the water bed, then incentive structures have to be used to discourage its usage. Just because we are all aware that cigarettes, alcohol, and white sugar are cancer-causing, we don’t ban these products, as it would create further distortions. 

Thirdly, property rights have to be respected to attract investment; and fourthly, creating a licensing regime will further make the process unproductive, while further creating public health calamities that will end up in tarnishing the Government’s reputation and pushing public health towards further risk. Like Chief Seattle said, we all are a part of the same system. Banning is the same as distancing ourselves from the strands of a complicated web. It further weakens the web instead of straightening it out. 

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 state minister is right on alcohol

Originally appeared on The Daily FT

By Prof. Rohan Samarajiva

State Minister of Coconut, Kithul, Palmyrah and Rubber Cultivation Promotion and Related Industrial Product Manufacturing and Export Diversification Arundika Fernando was wrong in asking ASP Eric Perera to go easy on small-scale producers of illegal liquor. 

As ASP Perera correctly explained, police officers cannot make arbitrary distinctions between law breakers who are small scale and who are not. This country is plagued by abuse of prosecutorial discretion. It is wrong to demand that investigatory discretion be further abused too.

But the State Minister has a point. We should not be misdirecting scarce police resources on prosecuting producers of alcoholic beverages. We should change the law to reduce the financial incentives of operating illegal stills. 

The Minister of Public Security was wrong to transfer a law-abiding and apparently efficient senior police officer. Instead of engaging in such actions harmful to the efficient functioning of government (another consequence of the 20th Amendment), he should have focused his attention on the parlous state of law and order in this country. 

More than half of the police force of over 88,000 is still deployed on VIP security almost 12 years after the decapitation of the LTTE; and 30 years after the decapitation of the DJV, the military arm of the then JVP. Laws are not enforced without fear or favour. Most people are told to catch the law breakers and bring them to the police station. Sometimes the police are a greater threat to citizens than criminals. 

The story of Scotch 

Most decision-makers in this country have a liking for Scotch whiskey. Therefore, the story of Scotch may be more persuasive than the stories of arrack and baijiu (which will also be told).

As the distilling of whiskey became more popular in Scotland, legislators sought a piece of the action. The first taxes on Scotch were introduced in 1644 which led to an increase in illicit whisky distilling across Scotland. By the 1820s, as many as 14,000 illicit stills were being confiscated every year. More than half the whisky consumed in Scotland was illegal. It was even said that King George IV drank nothing but illegal Glenlivet.

In 1823 the Excise Act was passed, which permitted the distilling of whisky on payment of a license fee of GBP 10, and a set payment per gallon of proof spirit. Next time you partake, examine the label. It is likely that the bottler of your favourite beverage traces its origins to around 1823.

Even after COVID-19 and a punitive tariff imposed by the United States, earnings from the export of Scotch whiskey amounted to GBP 3.8 billion in 2020. The year before, it was GBP 4.9 billion. This does not include earnings from related activities such as whiskey tourism. Over two million visits to Scotch distilleries per year were reported before the pandemic hit. 

The story of arrack

Arrack manufacturing was developed during Dutch rule of the coastal areas. Exports grew rapidly under early British rule. Unlike its Scottish counterpart, the Excise Ordinance of 1834 consolidated legal production in a few large companies and made the pot still distillers illegal. Exports ceased.

It is possible that concerns over quality of the product, including periodic methanol poisoning, led to restrictive licensing. The manufacturing and consumption of hali arakku (arrack from pot stills), derogatively described as kasippu, was a major element of life in the coastal belt. The battle between the police and illicit distillers was never ending. When the men got incarcerated, women ran the business. 

It is this ancient tension that Arundika Fernando gives voice to. People believe the Government-sanctioned liquor is too expensive or that its quality has been compromised because of the incentives set in place by the excise taxes. Or they simply prefer the taste of the local product. The gap between what the Government-sanctioned liquor is sold for and the cost of producing hali arakku is large, permitting significant expenditure on bribes.

The State Minister should not be asking for selective enforcement of the law and ‘rehabilitation’ of small producers. There is no way a practice that has survived for a century or more can be eliminated by any form of ‘rehabilitation’. What he should be advocating is the reform of a law that criminalises industrious people and is an engine of black money that then poisons the rest of society. 

Reform the law

There are reasons to worry about excessive consumption of intoxicants. People can get sick and, in a publicly funded healthcare system like ours, the costs of treatment will be borne by all. People have been using intoxicants of various forms throughout history, suggesting that stamping out the practice is unrealistic. Yet it is wise to do things like control advertising of alcohol, which Sri Lanka has been doing since the 1990s, and to promote moderation. 

It is unlikely that the Sri Lankan excise and police authorities will ever be able to fully stamp out pot still production. The resources needed for stronger enforcement would cause further harm to the weakened law enforcement that exists today. 

Government should look at a comprehensive solution that includes rationalisation of excise taxes, whereby what now goes under the table to politicians and police personnel comes to the State. Encouragement should be given to the development of premium brands associated with colourful narratives that can do well in export markets and even in the wealthier market segments within the country.  Arrack-centric tourism should be promoted. Reduction of excise taxes combined with a reallocation of enforcement resources will create the right conditions for the needed focus on ensuring the quality of the manufactured output, putting a stop to what many believe to be rampant tampering. The world’s most consumed alcoholic beverage is not whiskey. It is Baijiu, the most famous brand being Moutai. What used to be quick way of getting drunk has been undergoing an extraordinary transformation in recent times, with all sorts of premium products and brands being developed and marketed outside China. Some bottles are priced in the thousands of dollars. 

Sri Lanka’s arrack has greater potential than the Chinese firewater. But the potential cannot be realised only by the old established big companies. Legalising small producers and unleashing their innovative energy is the essential precondition for Sri Lanka regaining its position as an exporter of premium alcohol products from coconut, kithul, and palmyrah.  The State Minister should proceed with confidence. If the President is against this kind of initiative, he would not have created a separate Ministry for Coconut, Kithul, Palmyrah and Rubber Cultivation Promotion and Related Industrial Product Manufacturing and Export Diversification. There is only so much you can do with coconut ekels.

Rohan Samarajiva is founding Chair of LIRNEasia, an ICT policy and regulation think tank active across emerging Asia and the Pacific. He was CEO from 2004 to 2012. He is also an advisor to the Advocata Institute.

Confused by the coconut oil conundrum?

Originally appeared on The Morning

By Dhananath Fernando

As usual, Sri Lanka is cruising through another eventful week; this time with discussions on the topic of imported coconut oil that is said to contain carcinogenic compounds called aflatoxins. On social media, I saw people sharing posts saying that, to date, they were under the impression that the coconut oil they have been consuming was produced in Sri Lanka.

The government authorities, public health officers, Sri Lanka Customs, Sri Lanka Standards Institute (SLSI), and many other government agencies are running around scrambling to check whether the carcinogenic coconut consignments have been released to the market. As we get closer to the Sinhala New Year, it is the norm that the prices of coconuts increase, and also that coconut oil consumption increases. So, people were already confused as to whether to buy coconut oil or not and as to what substitutes are available.

This is yet again another example of closing the stable door after the horse has bolted. It’s quite unfortunate that no one thinks about the economics behind the coconut oil issue. Instead of trying to take political advantage of the situation, we need to explore the root cause of the issue.  

Let’s understand the numbers first. According to Coconut Development Authority (CDA) Director General Dasitha Niroshana, Sri Lanka’s total demand for coconut oil is about 180,000 MT (metric tonnes) per year. Out of that, about 90,000 MT are for domestic usage and the balance is for industrial usage. Over the last few years, our local coconut oil production was about 40,000 MT. Due to climate challenges, higher prices, and thin margins, coconut oil production has been negatively affected. For the last few years, local coconut oil production has come down to about 25,000 MT. According to these statistics, about 140,000-155,000 MT of coconut oil are being imported for industrial and domestic use. Refined as well as non-refined coconut oil is imported. Given the nature of the product, microbial activity can take place when it’s stored for a long period of time and also based on the handling process.

It takes about eight coconuts to produce 1 kg of coconut oil. For the domestic usage of coconut oil, estimating that the production levels are at 25,000 MT, about 200 million nuts will be required for domestic consumption alone. The total nuts we can produce per annum is about 2,600-3,000 million by utilising 20.6% of our arable land. As Sri Lankans consume quite a lot of coconut for personal use and for their cuisine, we are still short of about 600 million nuts per annum to meet the total national demand for coconuts.

As the coconut yield is somewhat sensitive to water levels, changes in weather affect the harvest and supply. Additionally, the coconut trees in Sri Lanka are very old, and only about 62 nuts can be produced per tree. Meanwhile, the best Sri Lankan yield amounts to about 6,000 nuts per hectare. If we look at competitive markets like Kerala, Malaysia, and the Philippines, it’s as high as 11,000-14,000 coconuts per hectare, while Indonesia has the highest productivity with 15,000 coconuts per hectare. However, the Sri Lankan coconut is specifically preferred for some industrial uses, as the aroma and taste of the Sri Lankan coconut is quite unique. However, we can’t match the demand. 

On the other hand, the edible oil market is changing drastically. With consumption patterns of customers who want a healthy heart and less cholesterol content, markets in Europe and America shifted to edible plant fats of soybeans, corn, peanut, sunflower oil, and other oil sources. 

The price of coconut is one key determinant for the import of coconut oil. Given that the margins are thin in the coconut oil industry, when the coconut prices go up, there is more incentive to import coconut oil instead of manufacture it locally at a higher cost.

Most of the coconut-based export businesses are also affected when coconut prices go up, as they have signed agreements with their buyers overseas. 

On the demand side, locally, the demand is increasing with the increase in population and usage in Sri Lanka. On the supply side, it’s stagnant or decreasing due to extremely low productivity. As a result, coconut prices go up, which affects the entire value chain of the business cycle. 

So the big question is, what have we done to increase productivity and take a count on the policy prescription we have been following?

When the coconut prices went up during the tenure of the last Government, they imposed a price control. Following in the same footsteps, the current Government too imposed a price control last November. Needless to say, none of the price controls really worked. Instead, it further distorted the market. When you have price controls, inferior-quality products are entering the market or the available products are disappearing and black markets are created. In the case of coconut oil, the market distortion by price controls on coconut has incentivised people to bring low-quality products and manipulate the market.

Additionally, one substitute product, which is palm oil, has been discontinued, due to environmental reasons. Palm oil is a substitute for coconut oil and produces a higher yield than coconuts. Rather than finding a solution for proper water management, complete interference in the market has now distorted the entire market with the introduction of products that allegedly contain carcinogens to the market. As a remedial action, the CDA has issued a five-star label to seven selected coconut suppliers where the production method is evaluated from end to end and monitored by government authorities so that consumers can be assured that the coconut oil is pure and good to use. Yet again, however, the prices are about Rs. 100-200 higher, according to the CDA Director General. Obviously when you only allow only seven players to supply authorised coconut oil, the suppliers are going to increase the prices, as they lobby to keep higher profit margins. In economic terms, we can call this a “rent” , due to the advantage of the restriction of access by new players.

In summary, we have distorted the concept of markets by introducing price controls and providing licences. As a result, our productivity is very low in the coconut sector and our solution for all problems has been market intervention again and again by consecutive governments. At the same time, as a result of focusing on unnecessary state-owned enterprises, the State has forgotten the role of necessary market regulations to ensure consumer protection. As a result, from time to time, we hear news stories of the importation of rotten tin fish and carcinogenic coconut oil, and we kill time till another similar story explodes. The problems remain the same or become worse; our attention diverts; life goes on… 

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.

Port City more crucial by the day so don’t delay

Originally appeared on The Morning

By Dhananath Fernando

Debt repayments, human rights issues, credit rating downgrades and pandemic make Port City our big hope.

The company Google maintains the idea of “10X thinking”. What 10X thinking means is that if one is serious about innovation, one would ideally improve things by 10 times, rather than by 10%. While Google believes we have to move at 10 times the speed for real transformation, the Japanese believe in a business philosophy that goes by the name “Kaizen”. The Kaizen theory emphasises that small-scale productivity improvements, if done consistently, with the engagement of employees, will lead to effective transformational change over time.

In hindsight, looking at Sri Lanka’s development pipeline, our own 10X ideas or Kaizens are not something we can be too proud of. We’ve hardly had any 10X ideas, and have had little consistency in our policy. In fact, one could say that the only consistent aspect of our policy is that it is inconsistent.

One of the main 10X ideas for Sri Lanka that this column has extensively discussed is land reform, chiefly through building a digital land registry that could infuse capital into the economy and improve agricultural productivity. The other 10X idea we have on our table is the Colombo Port City, a project by China Harbour Company. 

The reclamation of 269 hectares of land was completed in January 2019. The construction of the water breaker was completed in June the same year. In this backdrop, it has been reported in the media that last week the Cabinet approved the Colombo Port City Economic Bill, which allows the establishment of a special economic zone within Port City.

What is so special about Port City? I am sure most Sri Lankans would say they know nothing much, other than the fact that it is a Chinese investment, and an ambitious project to build a city on the sea. Many view it as an infrastructure project to build a financial city with tall buildings, including hospitals, residential areas, hotels and schools, and many other ancillary services, to make Sri Lanka a financial hub. 

Then the main question we have to ask ourselves is: Why would investors want to come to Port City? The simple reason is that the Port City would act like a special economic zone with special laws and regulations. Therefore, it would be a more convenient place to operate. Secondly, reduced regulations would make it easy to connect with other centres, creating a conducive environment to make profits.

However, people are largely unaware that the new law in force in the Port City actually makes it a project with 10X additions, and gives it an opportunity to become a financial hub in the region. The significance is not in the skyscrapers or other physical infrastructure, but instead lies in its potential to create an easier operating environment with lower regulations.

The next question you may ask is: Why do we need a new law for the Port City? Why can’t it fall under existing Sri Lankan business law? The answer to that is simple: If businesses in Port City come under Sri Lankan law, and under the current jurisdiction and regulatory framework – starting from business registration to resolving a business conflict, or any transaction for that matter – then these businesses would experience the same inconvenient and cumbersome process of doing business that all investors in Sri Lanka presently have to endure.

To attract an investor to Port City, the laws and regulations it comes under should facilitate the creation of speedy business services, and have significant synergies in productivity, thereby significantly lowering business transaction costs. In addition, the laws incorporated will have to be competitive and on par with other competing financial hubs, such as Singapore.

The draft law will be a critical factor that determines the future of this multi-billion dollar project. It has to be competitive with other financial centres in the region if it is to succeed. If it fails to meet these standards, investors have no reason to bring their money, or to move their financial institutes and headquarters to Sri Lanka.

We cannot comment on this law until it is placed before Parliament, but we know for sure that this should have happened far earlier. The Port City project was launched in September 2014, but even after seven years, investors are yet to see this law. This is essential to their investment decisions.

Under the previous Government, it was reported that some attempts were made in drafting the law, but it was not presented to Parliament, and the project was on hold for renegotiation. While the Cabinet clearance of the Colombo Port City Economic Bill could renew hope for the project, we should not delay the process further. At the same time, we have to be absolutely confident that the law has been drafted with the right specifications to meet investor expectations. Because of the current delay in producing the legal draft to Parliament and getting it approved, a quick sale on land in Port City has been affected. Just by the sale of land, or 99-year lease agreements, the Government expects a minimum of $ 1.8 billion in revenue, and $ 3.4 billion for the China Harbour Company. However, in making an investment calculation, we look at not only the amount of money we invest, but also the time spent.

According to State Minister of Money, Capital Markets and State Enterprise Reforms Ajith Nivaard Cabraal, out of $ 32 billion expected in foriegn currency inflows to the country, $ 15 billion in exports and about $ 7-8 billion in remittances has been forecasted. More than $ 3 billion is expected in total only for this year in the form of Foreign Direct Investment, and the main investments are expected through the Port City project. Therefore, the development of the Port City is a significant source of income for the country.

With mounting debt repayments for the next three to four years, and now with the UN Human Rights Council’s human rights-related issues, we should understand the importance of the collective effort of maintaining Sri Lanka’s image as a credible global partner. In this backdrop, placing all our investment expectations into the sole basket of the Port City is going to prove risky.

Let’s think through this in the shoes of an investor. Imagine you have about $ 1 billion and you’re considering investing in the Port City project. But to date, you do not know the law that will be enforced, while concerns have been raised by the UNHRC. In addition, the country’s credit rating has been downgraded by rating agencies, particularly in the face of the pandemic. Would you, as an investor, confidently bring your $ 1 billion to Sri Lanka – or would you delay the investment and consider markets such as Singapore, Malaysia, and Vietnam?

On the other hand, the Government has to be very careful of the potential opposition from anti-competition lobby groups who will be affected by the Port City. A successful Port City project means the presence of international law firms, IT professionals, health care workers, and education experts; opening up competition with the best of talent and skill at the global level. Sri Lanka’s experience in the recent past has not been very positive when it comes to opening up to competition. Our strategy has always been to look inwards, rather than outwards.

Therefore, the Government has the twin challenge of first getting the legal draft right and getting it out fast; and providing investors with confidence and addressing investor expectations with a collective effort of easing businesses in Sri Lanka. Secondly, the Government will have to manage the resistance that is likely to pop up from lobby groups for changes in the legal draft, blocking international competition in certain sectors. 

If we are serious about a transformed Sri Lanka, we need a combination of Kaizens and 10X ideas; meaning we have to consistently implement 10X ideas for a significant period of time. But only time will tell what we will do.

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.

Enough rent seeking, bring on competition

Originally appeared on The Morning

By Dhananath Fernando

I studied at a semi-government school. Students studying in these schools pay a school fee every month. Due to financial constraints, some students found it rather difficult to pay this fee. As a solution, we decided to organise a food fair to raise funds as opposed to collecting money, which we thought would be a direct burden on most parents. The fair required students to bring food that was tradable. I remember referring to this as a “salpila” in Sinhala. Most parents contributed by sending in homemade food items such as hot dogs, sherbet, short eats, faluda, and sweetmeats.

However, the food fair faced a significant challenge. We were only permitted to have the fair within the 20-minute lunch break and were strictly advised not to disturb the academic timetable for the day. I was not too pleased with this and proudly suggested a “brilliant” idea to increase the demand and sales of our little “salpila”. My “brilliant” idea was to close down the school canteen during the lunch break on that particular day, so students will be left with no choice but to purchase from the “salpila”. However, to my dismay, the then principal explicitly turned down my request. He then explained to me how short-sighted my proposal was.

It was then that I was introduced to the concept of “rent-seeking. Rent-seeking is the manipulation or alteration of the market for financial gains. This exactly was what we had proposed. The principal went on to question us on how we could match the demand of 3,000 students and the plight of the canteen owner who was on a rent agreement with the school.

I argued back, questioning “what is the big loss the canteen owner is going to make just for closing down the canteen for 20 minutes” and “why can’t the principal support us in such a noble effort of assisting our classmates to continue their education”. Our principal explained to us that bending the rules to make profit is not the way to do business or to help our classmates. However, he said that we can compete with the canteen focusing on goods that are not available there.

Now, as an adult, every time I see an overnight gazette notification or stories of import taxes on sugar, CESS on tiles, import duties on menstrual hygiene products, I revisit my school days and my short-sighted thought process which I believed to be “brilliant” at the time. The most recent story on the matter is the sugar importation conundrum which took the limelight with the COPA report. There is one school of thought that it is just a revenue loss for the government and there is another school of thought that this is a fraud. However, it is clear that the consumer has become the net loser. It is unfortunate that the discussion is not on the economics of it but rather pointing fingers at each other and comparing which losses are greater: Bond fiasco or sugar tax reduction.

Overnight gazettes: Open window for fraud and corruption

Having low duties on imports is always better for imported commodities as ultimately the tax has to be paid by the consumer. While the taxes have to be low, it is equally important for the taxes to be consistent and predictable so the room for market manipulation is limited. On the other hand, using quantitative restrictions to limit imports would encourage rent-seeking, a concept proposed by Prof. Anne Krueger.

It has become the habit of all consecutive governments to impose various import duties and taxes on various import items which affect the prices drastically. When the taxes are changed overnight in significant amounts inconsistently across and selected commodities, it will act as a barrier for small players to enter into business as they do not have the capacity to absorb tax losses or match massive quantities as it is difficult to decide on prices.

As a result, the importation of commodities such as sugar only has a handful of importers who act as an oligopoly and can manipulate market prices. Especially when taxes are brought down from large amounts such as from Rs. 50 to 25 cents, there is a higher chance of getting insider information and manipulating the market. As a result, few traders have the opportunity to get to know information early and bring in stocks early and store in bonded warehouses where only the taxes are applicable on rates where the consignment is released. This allows them to take the tax advantage by keeping prices unchanged. Or in worst cases, taxes can be brought down overnight and it can be increased again overnight, favouring a few individuals just after the goods are cleared at the port, and this is how the overnight gazette notification opens the window for rent-seeking. This can be seen every time when a budget is presented and many speculations float around on the vehicle market and many other commodity markets.

Consecutive governments are of the belief that overnight gazette notifications have become a tool to raise revenue for the government as well as to regulate markets, and this sugar tax has proved that it is not only a completely ineffective tool, but also a window for corruption.

Government’s policy inconsistency with tax policy

One of the main reasons provided by the Government to keep the corporate tax and income tax unchanged is to provide policy consistency so the business can predict future trends and support growth. The same thinking process needs to be applicable for indirect taxes as well. Both direct taxes as well as indirect taxes have similar consequences when it comes to inconsistency. Finance Ministry officials have agreed that high tariffs on sugar add a burden on the cost of living and that is one reason to bring down taxes, which is the right way to think about it.

At the same time, we should not forget the tariff on other commodities such as tiles, bathware, menstrual hygiene products, construction steel, other food items, cement; all product categories and commodities too add to the cost of living of people. When we have double and multiple standards on tariffs, that too distort markets and open opportunities for rent-seeking.

The policy of self-sufficiency has been challenged

On the other front, with the reduction of sugar tariffs, acknowledging that the tariffs have caused to increase the prices and shrink the supply has proved that self-sufficiency in sugar is an impractical concept to achieve. In a recent interview, Trade Minister Bandula Gunawardana has mentioned that import controls caused small-scale exporters who export coconut-related products and food items to be badly affected. The same argument has been highlighted by this column since the day the self-sufficiency policy was pronounced, highlighting the consequences on both losing our export markets, volumes, as well as our export competitiveness. 

Imports restrictions by themselves cannot cause pressure on the LKR, as it does not reduce the demand for sugar. What can cause pressure on the rupee is the ill-managed Monetary Policy that causes the pressure on the LKR and the balance of payment crisis. After serious import controls and trade restrictions, that is one reason why the rupee has achieved a historic low last week.

Though how good may be our intention, not knowing the right concepts not only distorts markets, but also brings united consequences for people and their quality of life. Like my principal advised me many years ago, the way to combat issues is not by rent-seeking but by competition.

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.

Poverty reduction needs to be prioritised with cohesive export-led growth policy framework

Originally appeared on The Daily FT

By Prof. Sirimevan Colombage

In Sri Lanka, around 40% of the population lives below the poverty line, according to expert opinion based on the survey data for 2016, in contrast to the official poverty ratio of only 4%. In the backdrop of the COVID-19 pandemic, the poverty ratio is likely to have reached nearly 50% of the population by now.

Adequate attention has not been given to poverty reduction in policy formulation agendas in recent times. 

An outward-looking trade policy aiming at export-led economic growth is imperative for poverty reduction, as evident from the fast-grown East Asian countries and emerging Asian economies such as Vietnam and Bangladesh. 

SL’s actual poverty 10 times bigger than official estimate

According to the Department of Census and Statistics (DCS), Sri Lanka’s headcount poverty index dramatically declined from 22.7% in 2002 to 4.1% in 2016, as per consumption approach. In computing this poverty index, DCS has used the National Poverty Line (NPL). 

The limitations of using the NPL for poverty estimation have been articulated in his incisive article by Wimal Nanayakkara, Senior Visiting Fellow at the Institute of Policy Studies (IPS) and former Director General of the Department of Census and Statistics. 

He suggests that the World Bank’s Global Poverty Line (GPL) is more appropriate for estimating the headcount index in keeping with international standards. The current NPL is based on the market values of an outdated basket of goods and services drawn from the Household Income and Expenditure Survey conducted by DCS way back in 2002. 

The World Bank’s poverty thresholds vary with the member country’s per capita Gross National Income (GNI). With her per capita GNI of $ 4,060, Sri Lanka reached the Upper-Middle Income Country (UMIC) status ($ 3,996 – $ 12,375) in July 2019, and hence, people who live below $ 5.5 daily income per person are poor based on GPL relevant to UMIC, according to Nanayakkara. 

Sri Lanka’s per capita GNI declined to $ 4,010 in 2019. As it was lower than the revised July 2020 UMIC classification ($ 4,046 - $ 12,535), Sri Lanka quickly slipped back to the Lower Middle-Income Country (LMIC) status ($ 1,036 - $ 4,045) along with Algeria and Sudan, as rightly predicted by Nanayakkara.  The applicable GPL for LMIC is $ 3.20. 

In terms of the GPL of $ 5.5, which is applicable for UMIC, Sri Lanka’s headcount poverty index for 2019 is as much as 40.4%, according to Nanayakkara. This can still be considered as the current poverty position of Sri Lanka, as her per capita GNI is still very close to the lower end of per capita GNI of UMIC, though she is now in LMIC category. 

Thus, the actual number of people living below the poverty line in Sri Lanka is about 10 times bigger than the mere 4.1% of population, as reflected in official statistics. 

Export-led growth for poverty reduction

It is essential to accelerate the rate of growth of Gross Domestic Product (GDP) to overcome poverty. The main ingredient for growth acceleration is foreign trade expansion which enables developing countries to gain market access, economies of scale, capital inflows, technology infusion, productivity improvements and efficiency. 

Open trade has been increasingly recognised as the key driver of employment creation and poverty reduction across the world in recent decades. Exports are critically important for economic growth, particularly for developing countries where domestic markets are small. Exports allow domestic producers to access international markets, and thereby to benefit from economies of scale. 

The world-wide evidence proves that those countries that achieved high export growth are the ones that enjoy high GDP growth and extensive poverty reduction. 

Sri Lanka’s backward technology and innovation

The formidable challenge currently faced by Sri Lanka is to raise her export growth at a rapid pace to achieve high GDP growth so as to reduce poverty. 

The country’s export sector, which is limited to a few low-tech products particularly apparels, has failed to graduate to high-tech and high value-added exports such as electronics and bio-technology products, unlike East Asian countries. This was due to the country’s backwardness in technology and innovation. 

In this regard, Foreign Direct Investment (FDI) can play a major role in fostering export growth by way of facilitating foreign capital inflows, technology infusion and foreign market access.

Trade opening and FDI inflows are found to be the major driving force behind the success stories of East Asian economies. More recent examples are India, China, Vietnam and Bangladesh. Outward-oriented economic strategies adopted in these countries, much later than Sri Lanka, led to foster export-led growth enabling millions of people to come out of poverty. 

Bangladesh: from a “basket case” to an economic powerhouse

Bangladesh is a good example to illustrate how prudent economic policies can turn a poor country, which was once branded as a “basket case”, into fastest growing economy in the Asian-Pacific region. It has become the new economic leader in South Asia with annual GDP growth rate over 6% in recent years, which was driven by the three star-performers – agriculture, garment exports and worker remittances. 

The key factor that fosters export-led growth in Bangladesh has been the liberal foreign investment regime by means of legal protection for foreign investment, generous fiscal incentives, concessions on machinery imports, unrestricted exit policy and full repatriation of dividends. 

Prudent fiscal management too was achieved in Bangladesh containing budget deficit to 3.5 - 4.0% of GDP. It helped to lessen inflationary pressures and to maintain exchange rate stability so as to facilitate the export drive. 

Export-led growth has enabled Bangladesh to reduce poverty from 40% of the population to 14%. In parallel, there have been substantial improvements in social indicators – infant mortality, maternal mortality, undernourishment, school education and adult literacy

Phases of foreign trade regimes

Sri Lanka has oscillated between inward-looking and outward-looking trade policies from time to time since Independence, and therefore, failed to sustain steady export-led growth path so as to bring down poverty levels. 

Perhaps, such policy changes can be conceptualised by using the theoretical framework developed by the US National Bureau of Economic Research (NBER) in its series of studies on trade liberalisation under the direction of Anne Krueger and Jagdish Bhagwati in 1978. They divided a country’s liberalisation process into five phases from trade controls to liberalisation, as shown in the Table.

The NBER studies, drawn from the experiences from different trade regimes in a number of countries including India, Ghana, the Philippines, South Korea and Chile provided ample evidence on the benefits of trade liberalisation.

Sri Lanka’s trade liberalisation under stress

In 1977, Sri Lanka moved from Phase II (NBER classification) of stringent trade and exchange control controls to Phase III marking the initial stages of trade and exchange liberalisation. The liberalisation process had been intensified since then.

In 1994, the Sri Lankan Government accepted the obligations under Article VIII of the Articles of Agreement of the International Monetary Fund (IMF). Accordingly, all restrictions on current account transactions of the balance of payments (BOP) were removed and the Sri Lankan Rupee was allowed to be freely convertible for such transactions. This shift to Phase V (NBER classification) was a major step towards trade liberalisation. 

However, the momentum of liberalisation was short-lived as various types of controls had to be imposed frequently due to the ethnic conflict, balance of payments difficulties, macroeconomic instability and external trade shocks. Thus, the country reverts back to Phases I and II from time to time.

Recent import controls

The country’s BOP situation has worsened since last year due to the COVID-19 pandemic which has adversely affected the export and tourism sectors. The external payments problems have been compounded by foreign debt commitments which amount to $ 6 billion this year. The rise in global market prices of crude oil and other commodities has further pressurised the BOP situation. The likely decline in worker remittances will further enhance the BOP deficit. 

In the backdrop of BOP difficulties, the Government has imposed import controls on a number of “non-essential” goods since last year. These include motor vehicles and various other consumer durables.

These import controls have adverse implications for economic activity, GDP growth and poverty reduction. 

Debt sustainability risks ignored through swaps  

The Government was able to secure $ 1.5 billion swap from the People’s Bank of China last week to meet immediate BOP needs. It is reported that the Government is negotiating with India to obtain another $1.1 billion under swap facility, debt freezing arrangement and development aid.

These swap facilities are temporary solutions to overcome BOP difficulties, and hence, deeper policy adjustments are essential to address the disarrays in macroeconomic fundamentals, particularly debt sustainability risks.   

Keeping IMF at distance

Overwhelmed by the Chinese swap, State Minister Ajith Nivard Cabraal claims that the Government can manage without IMF assistance. In fact, the challenge is to resolve the macroeconomic imbalances, rather than stubbornly refusing to go to IMF. 

Malaysia, which had strong macroeconomic fundamentals during the Asian financial crisis, could afford to refuse bailout from IMF. 

Sri Lanka’s case is totally different with her high budget deficit, unsustainable debt commitments, balance of payments difficulties, slow economic growth and more than anything else, acute poverty. 

It is ideal that if these deep-rooted problems can be resolved by ourselves without seeking anybody’s assistance, leaving aside the IMF.

IMF’s conditionality requires correction of macroeconomic fundamentals with stipulated deadlines. We ourselves can make these corrections without obliging to IMF. It is not happening that way, and therefore, swaps which do not impose any corrective measures, are the easy way out for the authorities to evade the much-needed policy reforms. 

So, the macroeconomic disarrays will remain unresolved forever exerting disastrous effects on the country’s economic growth. As a result, the poor who represent about one half of the population will continue to suffer without having basic human needs met. 

Outward-looking strategy imperative for poverty reduction

The current restrictive trade policy measures, which are based on the inward-looking approach, have been imposed to tackle the BOP difficulties. However, they are detrimental to export-led growth and poverty reduction.  

Hence, a cohesive export-led growth policy framework is essential to address the socioeconomic problems faced by nearly 50% of the population living below the poverty line. Poverty reduction, which is almost ignored in the current economic policy formulation, should be an explicit target of any future growth strategy. 

(Prof. Sirimevan Colombage is Emeritus Professor in Economics at the Open University of Sri Lanka and Senior Visiting Fellow of the Advocata Institute. He is a former Director of Statistics of the Central Bank of Sri Lanka, and reachable through sscol@ou.ac.lk)

Falling in love and developing a country

Originally appeared on The Morning

By Dhananath Fernando

Why both are about processes and not single moments

Simon Sinek, a management consultant and the author of the book “Start With Why”, in a video interview provides some interesting thoughts about measuring “how much you love”. He questioned the moderator: “Do you love your wife?” and the moderator answers: “Yes, of course,” and Simon asks back: “Can you prove it? What are the metrics that you use to prove that you love your wife?”

Obviously it’s a difficult question to answer by anybody, because while love is a feeling which we know exists, it is very difficult to prove in which form it exists. Simon then explains how “falling in love” is a process rather than just an event. It is true there is love at first sight but proving how much you love someone and quantifying it is not easy. Simon explains how tiny little acts like greeting, listening, sharing, caring, dating, and understanding convert to love over a period of time, and that it’s really difficult to pinpoint at which point it became love or how much we love someone. You can check it yourself by trying to recall at what point you really fell in love with the ones you love.

I feel that Simon’s thoughts are not just relevant to love but also applicable to the concept of development of a country. Many of us think development is just a one-off event without really understanding it as a process that occurs over time. We always associate the “development of Sri Lanka” to actions and outcomes such as electing appropriate leaders or utilising an existing natural resource. If we look at recent Sri Lankan history, we have always been of the opinion that one single event can transform Sri Lanka into a high-income country. As a country, we were excited when there was news of a gold mine or even a single incident about a herbal syrup developed for Covid, thinking that this could have taken Sri Lanka out of poverty, by exporting the syrup to the entire world. We tend to get excited when we see news stories on exploring our valuable phosphate mines or hear about explorations of crude oil in our marine territory. We repeatedly forget that all these resources have zero value if we do not have the right institutions as a country. Just take Venezuela for example. They were the fifth largest crude oil supplier in the world, but the exploitation of such a valuable resource is not reflected in the ailing economy.

Sri Lanka’s case remains quite similar. We too have an adequate resource base, but the same resources have become a barrier to our development. This is mainly because we have failed to set up the right institutions. As a result, we always tend to celebrate events and just spend the days, rather than thinking about our economic development in the long term. Now the public discussion on economics is on the China swap agreement of $ 1.5 billion and on the investments in the West Container Terminal (WCT). In both cases, we have failed to propose a credible plan for our debt sustainability or to set up an open transparent tender process on selecting investors for the WCT. This has been the same operating procedure across all governments. So, most likely, these two discussions would just become events to celebrate, which will then be forgotten after a few weeks’ time. Then, we will be back at square one after a few months’ time on our development agenda.

Many have misunderstood the role and purpose that institutions play in the road to development, here in Sri Lanka. Sri Lankans generally perceive a building or an agency as an institution. The Supreme Court or Election Commission are also associated as the bedrock institutions of a country. However, in reality, it is what they represent in a democracy that really defines the meaning of an institution. So the meaning of an institution goes beyond physical places.

According to Jim Collins’ book “Good to Great: Why Some Companies Make the Leap…and Others Don’t”, it is not the time tellers but the clock builders that matter. Building an institution is something like building a clock where the concept of time is communicated to anybody at any time without any discrimination. It is a platform where time is shown to all, even without the presence of the actual builder. Just take the election process as an example. The election process is an institution where people have the right to exercise their choice in selecting the person who is suitable to govern. It is not the Election Commissioner or the Election Commissioner’s office that matters. Of course the physical building matters, but it is the concept of election that matters rather than the office.

It is the same when it comes to our economy and facing economic challenges. The recent swap we received would be a great relief for Sri Lanka. Especially at this juncture, as this column highlighted many times, this creates a need to engage with our bilateral partners and international agencies. But instead of just celebrating the swap, we need to direct the institutions to ensure our debt sustainability. We should establish a mechanism for managing our debt, under a single office and a system to avoid borrowing beyond our capacity to repay. Our currency and Central Bank must have the institutional power to roll out the right monetary policy to ensure that our currency is worth holding and people’s hard-earned money is not devalued due to higher inflation.

When it comes to ports and foreign direct investments (FDIs), our need is not to speak to investors and select them single-handedly and offer unsolicited projects, but to set up the right institutional framework, so that any investor will have the ability to invest and to make the process simpler, easier, competitive, and transparent. That is a “clock” that we have to build instead of celebrating the short-lived “time telling” moment. We have to face the moment of truth at one point and our moment of truth for the last few decades is that we have failed to reach $ 4,000-plus per capita income except for a short period before Covid. Our basic needs such as housing, transportation, education, and healthcare have been the same as the last few decades and the improvements are not taking place. As a result, Sri Lanka has become what it is today.

The fundamentals behind sustainable development involve setting up the institutions. When institutions are built and strengthened, the physical infrastructure falls in place, human values such as genuine, integrity, and hard work get recognised. 

The path to development is like falling in love, as per Simon Sinek’s example. It’s a result of so many tiny little actions. Same as “love”, the importance of institutions cannot be seen sometimes or even cannot be measured. But it’s there and it’s the foundation of the development of a country if we are serious about making Sri Lanka a free and a prosperous nation.

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

A sportsman’s advice for the ports game

Originally appeared on The Morning

By Dhananath Fernando

The problem with GoSL’s ‘East to West’ plan

I was of the opinion that rugby was always a big boys’ game, till I met Sudath Sampath, the legendary former Sri Lankan rugby Captain who was fondly known as “Little Serevi” (Waisale Serevi is a Fijian former rugby union football player and coach, and is a member of the World Rugby Hall of Fame). 

I met him at the University of Colombo when he was the head coach. I was surprised how he became one of the best rugby players Sri Lanka has ever produced, given his physical stature. He did not fit into the typical rugby player profile of six feet tall and about 90kg in weight; but he was agile, fast, and very sharp at assessing the game.

He is also a master of the rules of the game. Rugby is a complicated game with many rules. There is one set of rules for the scrum, another set of rules for a ruck, and separate set of rules for a lineout, in addition to the general rules, such as not dropping or passing the ball forward. 

One main advice by Mr. Sampath to be successful in the game is to “know the rules of the game and know it really well”. He wanted players to watch the same game many times on how the “All Blacks” understand the game and its techniques.

His second advice was that “it is better to be agile and be a team player than being stiff and play an individual game”. I not only often recall Mr. Sampath’s advice in personal life, but also in Economics, especially when it comes to the Colombo Port and its container terminals.

“As a country, do we know the rules of the game in ports and do we have an efficient and flexible turnaround system?” is the question we have to ask ourselves everytime we see the debate on Colombo Port. After a massive national debate on East Container Terminal (ECT), the discussion is now moving towards the West Container Terminal (WCT). According to media reports, it will be a 35-year agreement with an 85% share to India’s Adani Group of Companies to operate it on a Build-Operate-Transfer (BOT) basis, and keep a 15% share for the Sri Lanka Port Authority.

So first let’s try to understand the game behind the port operation’s business model. Then let’s try to debunk the myths. It must be first understood that a port cannot survive just because it has a strategic location. The strategic location is important, but it is no more the single deciding factor for a port to be successful. 

The Port of Djibouti in Africa is strategically located, while it is also a member of the Belt and Road Initiative. However, the port is not considered a successful one. On the other hand, the port of Salalah in Oman and the Port of Tanjung Pelepas in Malaysia are thriving ports in the world, handling significant container volumes, but are not strategically located.

The simple reason behind the latter two ports’ success is that they know the rules of the game, and have a sharp understanding of how the port business works. It is a networking industry, requiring investors and their management practises that can increase the efficiency or number of moves per hour and the turnaround time, thereby making the port operations faster  and helping shipping lines process their containers faster. 

Distance to a port from the main shipping route matters, but efficiency matters too, as they both determine the cost for the shipping line. Therefore, in order to be a global player in the shipping business, Sri Lanka must be connected with the main shipping lines, as well as being efficient and agile in our delivery of our port operations. 

To maintain that connectivity with shipping lines, Sri Lanka should be open to foreign direct investments and create an investment-friendly environment. Improving efficiency must be the bedrock of this business model, along with private domestic investment. This way, any investor who risks his money, time, and resources is psychologically motivated to recover the investment. 

One can understand the importance of this factor by comparing employment numbers and efficiency rates (number of movements per hour) of the SLPA-operated JCT, and private sector-operated joint ventures, SAGT and CICT.

So what would be the consequences of picking WCT before ECT? First, being open for foreign direct investment and attempting to get global partners is a decision in the right direction. Foreign direct investment brings much-needed knowhow, which spills over to other industries and increases productivity. 

However, the ideal procedure should have been an open tender process, so that the best business offer of foreign direct investment could have been evaluated competitively. To avoid the geopolitical tug-of-war between China and India, the tender procedure could have been structured by the respective geopolitical interests. 

If the Government is to be believed, the current procedure has been to request the respective governments to nominate their business partners. However, this prevents the achievement of best possible outcomes for the country as it is brought by a competitive bidding process.

Secondly, is there an incentive in leaving the SLPA to operate the ECT, and opening the WCT to foreign direct investment? Well, this simply doesn’t make much sense, for it will be disadvantageous for the ECT! 

Given the financial situation in Sri Lanka, it is very unlikely that the Sri Lankan Government and the SLPA will have the fiscal space to invest in the  ECT. The gantry cranes and all other machinery for the necessary infrastructure will need to be imported, and the availability of foreign currency for such an investment remains a question mark. 

The ECT is already late by more than two years, and it will take another 18 months from the date of commencement for the infrastructure development to be completed. So in simple terms, chances are limited for the ECT to take off in the next few years.

If the operation of the WCT, which requires more infrastructure development compared to the ECT, does get off the ground soon, the business ecosystems will be focused towards the WCT, as they can be more efficient and have the scale to connect with other global partners. 

That may leave the ECT in its current stage with only hollow ownership for the Government, without generating revenue and profit, or its full capacity being utilised. Ultimately it will affect the entire efficiency of the port. 

The concept of making Colombo Port a maritime hub will be just another daydream. The original design of the entire port is to handle about 30 million TEUs with the development of the port along identified phases. 

This was the identified strategy to become a maritime hub but the delays we incurred from political parties and trade unions is most likely to pull us back and make us more insignificant in the Indian Ocean.

The Galle Port, which is under SLPA, was involved in discussions for years to be developed as a yacht marina. However, the opportunities have now shifted to Oman and Dubai. We haven’t been able to optimise the Trincomalee Port, even more than a decade after the war ended.

All these resources remain under our ownership but remain underutilised or underperforming. Unfortunately, we continue to play the ports  game without knowing the rules, thereby losing lucrative opportunities and playing self-interested petty politics without being a team player, whereas the entire country could have been a beneficiary of the competitive transhipment business. “Little Serevi” Sudath Sampath would not have approved.

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.

Our depressing debt diagnosis

Originally appeared on The Morning

By Dhananath Fernando

Sri Lanka must understand how it got here before getting out of here

Last week, the Central Bank announced all export proceeds should be brought into the country within 180 days of shipment. Additionally, they stated that all exporters should convert 25% of their foreign currency earnings to LKR from the invoice value upon entry into the country. This was brought in just a few weeks after they restricted forward purchasing for importers. With these two moves, Sri Lanka’s debt sustainability has come under the spotlight once again. Recent reports from Standard Chartered Bank and Barclays Bank have also contributed to the discussion.

It is clear that the Government and the Central Bank are looking at the problem differently to how investors, financial markets, and other stakeholders perceive the problem. Indeed both sides share their opinion with good intentions of overcoming the current turbulent time. 

As per recent media reports and a press release by the Central Bank, their objective is to build non-borrowed foreign reserves in order to meet our debt commitments. The Government is looking at the problem as a cash inflow-outflow problem. Accordingly, the Government expects about $ 32-35 billion inflows, about $ 15 billion from exports, about another $ 7 billion from remittances, and about $ 1.5 billion from tourism, with foreign direct investments (FDIs) and other transfers, etc. filling the balance.

On the outflow side, the Government expects about $ 19 billion for imports and sovereign bond payments are about $ 2 billion every year, so the debt can easily be served without any problem according to the reports. It further states that total sovereign bonds are about $ 15 billion which is about 17% of total debt, and none of the other creditors have made any concern over our debt sustainability. Recently, the Governor made remarks that the Central Bank buys about $ 10 million per day to build up reserves so we can cover all debt commitments. According to his view, the outlook on exports, FDIs, tourism, and remittances looks positive with the vaccination drive. 

On the other hand, investors and other agencies are of the view that reprofiling debt with International Monetary Fund (IMF) support is the best solution at hand as our foreign reserves are eroding faster than expected. They see the problem as a solvency problem rather than a cash flow problem; that we need to buy time to bounce back with a lesser impact on the entire economy. It’s not that all reserves are liquid as some reserves are in gold and some IMF commitments and swap commitments are already included in the available reserves of about $ 5 billion. The question from the investors is: “If the cash flow is smooth, why does it continue to erode the reserves which are now at a historic low?” In this context we have to evaluate what we should do and what is possible to do.

Let’s get into the basics. In the debt discussion, we have all been debating on how we can settle the debt and how we can keep our noses above the water. But we should not forget the reasons that brought us to where we are today. We borrowed beyond our capacity at high interest rates and invested in projects which generate returns far less than our payment capacity. In other words, we borrowed at market rate and invested in non-tradable goods which did not generate any tradable return necessary to repay a part of the debt. Since we have failed to avoid the causes of the problem, now we have to pick the best possible escape route from the problem.

Secondly, in my view, we have to estimate the extent to which we can build up reserves by buying USD from the market given the current policy stance. The Government has committed to a policy to keep the interest rates unchanged and keep the exchange rate to USD in the Rs. 185 range. We need to understand that the USD inflow estimate of about $ 15 billion is not owned by the Government but by the exporters, and so are our remittances. The same applies for the imports where importers have to have money from the market to import the basics such as fuel, pharmaceuticals, etc. In this context, to build up the reserves, the Government has to buy USD from the market and that is how the Government can capture the USD available in the market from exporters. To do that, the incentive structures have to be there for exporters to sell more USD rather than save USD. Currently, the interest rates for USD are higher than interest rates for LKR accounts, so expecting a currency depreciation, the market perception is more skewed towards keeping their money in USD form. To overcome that incentive discrepancy, when the Government imposes a regulation to procure the USD earnings by exporters within 180 days and to convert 25% upon shipment, it is likely that the exporters under invoice consider options to park their money in offshore accounts, which will further erode our inflows. 

At the same time the regulation will impact some exporters who run on thin margins who have a portion of imports in their exports. On the other hand, the companies who have USD commitments and agreements with other companies now have to face extra pressure and loss on conversions due to this regulation. 

In my view, the sovereign debt problem has a broader dimension beyond just calculating cash flow. Because the Government owns the debt and because the USD cash flow is owned by private businesses and individuals, the Government requires a mechanism to capture it either by taxation or mopping up the liquidy from the market by tightening the systems by allowing the interest rates to move upwards. That will slow down the economy. The Government’s current strategy of buying their own Treasury bills and bonds, in other words printing money, will add constant and excessive pressure on imports through channels where the imports are open, though we have a import control policy. At the same time, it is highly likely that the excess liquidity will convert to credit with the economic recovery from Covid-19 and add pressure on inflation and cost of living. We have to keep in mind that while we build reserves by buying USD from the market, we might have to sell some of it again to keep the exchange rate stable. Changes in the exchange rate will affect our debt-to-GDP ratio.

It is true the sovereign nations have the legitimate power to print money, but ultimately what consecutive governments consumed by taking debt has to be paid in real terms by earning it real value, and there is no shortcut for it. Very importantly, while the debate is on as to what route we need to take, we should not forget the reason that brought us here.

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

Why is the President being ‘landed’ with this request?

Originally appeared on The Morning

By Dhananath Fernando

A digital land registry could help our rural masses 

The “Gama Samaga Pilisadarak” is the President’s most recent engagement programme. Positives and negatives of the programme have both been openly discussed on mainstream and social media. As per media reports, the programme is structured in such a way that officials of key ministries, such as Land, Education, and Road Development, visit villages with the President. 

People are then requested to put forward their problems before this entourage of officials. They try to solve the problems at the location itself, directing the state officials to act faster. The President mentioned that following such a course of action has helped build local infrastructure and helps him understand people’s problems better. 

On the contrary, on social media, views have been expressed on forest destruction concerning areas where the President has been visiting, and describing this as an attempt to prioritise development at the expense of our green cover. 

The objective of today’s column is not to provide a commentary on “Gama Samaga Pilisadarak”, but an effort to put things into perspective regarding the most common concerns people have been putting before Sri Lanka’s First Citizen. Secondly, we aim to explore why the very same issues are being repeated in most of the villages. In my understanding, the problems presented to the President are just symptoms of a bigger problem, and it looks like the solutions instantly provided by the officials are just temporary solutions without understanding the problem at its root. 

Most frequent requests made to the President, as have been telecast in the news, are requests for land to conduct agricultural activities. The fundamental question is why solving issues surrounding land has become a common-priority request, as we saw on television, with people screaming and pleading the President to get their land matters solved.

As indicated multiple times in this column, about 80% of Sri Lanka’s land is owned by the Government. Out of that, about 30% is our forest cover. As a tiny island, land is obviously a limited resource in economic terms. Therefore, if we fail to optimise the utilisation of land, all the natural beauty and biodiversity we brag about is most likely to fade away from us. 

Creating land, like what we did with the Port City, is extremely expensive and environmentally costly. The problem lies in the fact that most of the land our farmers cutivate is only under a licence, and they do not have a title. As a result, the farmer has to visit the Divisional Secretariat to obtain a license, renew the license, or even to obtain approval to change the crop they cultivate. 

Smaller and smaller portions

Most of these lands our farmers cultivate are provided under different land and agricultural projects. Over generations when the original land is divided among family members, the land plot becomes smaller and smaller.

For example, look at what happens when the original land of five acres is provided to a farmer, which in turn is divided among his four children. This will get subdivided after the next generation. Now, instead of five acres, only about 25 perches of land will now be available, and this has limited scope for agriculture. As a result of these smaller land plots over generations, industrialisation or commercialisation of cultivating lands is unfeasible.

Employing technology and machinery to increase productivity on a 25-perch land plot is not feasible. As a result, people ask for more lands from the Government, or encroach on forest cover to do their farming.

On the other hand, these lands do not have titles. So farmers are unable to optimise the maximum usage of the land using technology, because they have no source for capital. They don’t have other assets to use as collateral to access finance, nor are the banks willing to provide them loans without any valid collateral.

As a result, the land problem has become a vicious cycle. These circumstances have led to a scenario where a combination of factors continue to make our farmers poorer and our agriculture unproductive, while trapping our farmers in informal loans and creating severe social concerns such as suicide. There is the additional issue of contributing to the loss of our forest cover and destroying our biodiversity. 

If we look at countries that are in deep poverty, one of the common denominators is that the people of those countries do not have their land and property rights. There is no magical formula for an economy to take off without establishing property rights for their citizens. 

The President expressed his displeasure at rumours circulating on social media on the destruction of forest cover, but until we provide a permanent solution to this problem, we will lose out on every front. The President will have to hear the same complaint at every location he visits.

On top of that, the Government has decided to stop all agricultural imports for the next four years, as per reports by The Morning. This will most likely worsen the situation. Food prices will go up, and more farmers will attempt to do agriculture by practicing their unproductive farming methods. 

The rising prices will punish all our poor consumers already suffering from the high cost of living. At the same time, our tourism will suffer, as it needs some imported agricultural products to prepare the cuisine. However, it is understandable that balancing such a dilemma when foreign reserves are depleting is going to be a serious challenge.  

What is the solution?

The President has a greater opportunity to capitalise on this matter economically as well as politically. We have to have a digital system and a digital land registry. As soon as the “digital land registry” is spelled out, many associate it to the three-letter “MCC” agreement. That is now gone, and there is very little value in debating it now. 

But over the next four years, the President can prioritise the digital land registry, which will mark forest cover on the cadastral survey system with GPS coordinates. It will increase Government efficiency drastically, release the dead capital of land among farmers, and investments will start kicking off. Most of the back-end work has been done, and cases for the need for a digital land registry have been developed. 

The question is: how are we going to find money to implement the survey and purchase the technology? We have to seek out multilateral donor agencies, or a potential bilateral loan, to secure the funding, as this will create massive economic potential. Setting up a digital land registry will be significantly impactful, rather than just developing a road or incurring another massive capital expenditure. 

This is an action which will move us upwards in the Ease of Doing Business Index, and build investor confidence. At the same time this will fall perfectly in line with the President’s manifesto of “Vistas of Prosperity and Splendor” under a digitised economy. 

The ripple effect will trickle down to smaller cases at courthouses, as well as to micro and small business enterprises when the project unfolds. 

Since there have already been many land deed programmes such as “Jayabhoomi” and “Swarnabhoomi”, this will not be a simple and easy project. Having the simple digital infrastructure ready is the first step to address these issues, both at present and in the long term. 

The main opposition comes from lawyers, as they are the main beneficiaries of delayed court proceedings. If the President focuses on this single reform, it will not only be the best-ever environmental conservation reform to protect our green cover, but also a historic economic reform to unlock our dead capital, and reactivate capital markets and agriculture. Most importantly, it will be a big relief for our farmers and fellow Sri Lankans.

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.

When floor tiles go sky high

Originally appeared on The Morning

By Dhananath Fernando

Sri Lanka can’t win by obstructing its competitors

I still remember some silly things I did when I was in school. It was an inter-house pre-selection race for 400 metres for the school sports meet. As you all may know, to match the equal distance for each athlete, the most outer track athlete is placed slightly ahead at the start of the race and the most inner track athlete is placed at the very behind at the start. So during this race, I got lane eight, the most outer track. Without realising that the starting point placement was done to provide a level-playing field I thought I have some added advantage to start the race well ahead.

The race started and we were all accelerating to the finish line. After a few metres, from the corner of my eye I saw the athlete next to my lane running faster and he was getting closer to overtake me. So I changed my track to lane seven and obstructed him. Just after a few seconds, I realised that the lane six athlete was about to overtake me. I changed my track to lane six. Then the athlete on lane seven overtook me. Throughout the race I was trying to obstruct the other athletes without running my race in my own track.

I was disqualified from the race. I was not only disqualified from the race because of my silly way of obstructing all athletes, but also because they had to redo the race. I still remember what my house master in charge told me after disqualifying me from the race. “Son, you can’t win a race by obstructing your fellow competitors. You have to work hard and practice to run faster than them. That is the only way you can become competitive and win a race.”

When I saw headline news stories on the Sri Lankan floor tiles, wall tiles, and bathware cess tax revisions and Customs import duties, and collective voices against obstructing imports of these product categories as per the new tax revisions, for a moment I wondered whether we as a country are trying to make the same mistake I did as a schoolboy athlete by trying to win a competition by obstructing our competitors without trying to be competitive by ourselves.

The bathware story took the limelight with a gazette notification allowing the importation of bathware with a 180-day credit period when the forward purchasing of foreign currency was not facilitated by banks. In simple terms, this is a condition where the importer has to negotiate with the supplier to give goods for a credit period of half a year and the importer has to bear the cost of exchange depreciation. So it was not at all very favourable for importers. Even in that context, the Imports and Exports Commissioner General instructed banks not to facilitate any imports of tile and bathware products on the next day itself. 

It was reported after a few days on some news stories (gazette notification is not yet up on the Government website) that the industry associations agreed to increase the Customs import duty to 30% from 15% and increase cess to a flat rate of Rs. 125. Currently for certain sanitary products cess is 0% and some other product categories are charged at 15% or Rs. 40 per kg.  

Essentially, if the media report is true, our Customs duty has increased by twofold and our cess has increased by threefold. According to the same media report, even before 2015, cess was 25% or Rs. 75 per kg. So even after a good seven years, we still want to obstruct our competitors at a higher degree with the higher cess. Let’s try to understand the overall impact 

First, many people do not know how the tax calculation is done. The import tax formula is not as simple as saying that it is the addition of one tax to another tax. There are taxes on taxes (Value-Added Tax [VAT], Port and Airport Development Levy [PAL], etc.). So if the Customs duty doubles from 15% to 30%, the impact on the final tax on the consumer can be larger than just adding 15% to the final tax rate. According to the current calculation revealed by Sri Lanka Customs, the effective rate can go up as high as 89.80% of the actual imported value. 

What does this mean for the local consumer? This means the local consumer has to pay twice the price to buy a bathware set, floor tile, or wall tile. In other words, our fellow Sri Lankans have to pay the cost of two bathrooms to build one bathroom. Needless to highlight, the bathrooms constructed by Sri Lankans are not royal-class gold-plated commodes and silver flushing systems; a basic commode and even a squatting pan have been taxed at a high rate as 52%. This will not only impact the local consumers but also other local micro, small and medium enterprises (MSMEs) as well. 

When most of the MSMEs do their small constructions, they have to spend twice as much for the bathware and tiles, which increases the capital they require to start business. Most of them take loans to start businesses. Ultimately, this high cost of tiles affects their competitiveness in the business as well. Think of a small clothing shop in your town. Most of the time the floor is tiled and the shop requires a bathroom, so can we justify asking that entrepreneur to pay twice as much for some of his construction items which is a main part of the building when he is starting the business?

It does not affect only the small entrepreneurs, but rather creates a ripple effect across the economy. In the tourism industry, construction materials such as wall tiles, floor tiles, and bathware are used for most constructions. So as a result, their capital investment goes up and they have to cover capital through the room rate. As such, in the same room category, Sri Lanka’s hotel room rates are higher than the competing destinations in the region.

It is the same for luxury hotels as well as medium and small leisure sector entrepreneurs. It is not just the leisure sector, but even the Government has a big problem with the cost of construction. If you list down requests from rural students to the President in the programme “Gama Samaga Pilisadarak”, they are all about a building to do their studies, toilet facilities, a laboratory, or a playground. The cost of construction is as high as the sky so even the Government has a problem in allocating money for construction capital expenditure.

Further, think about the young professionals and all Sri Lankans who want to build a basic house but consider it a dream house. They take a bank loan with the greatest difficulty and pay twice the price for wall tiles and floor tiles from the money they borrowed.

Protecting local manufacturers and industries?

The main argument that has been put forward on increasing the tariff on bathware and tiles is that it is a move to protect local manufacturers. As Sri Lankans, we unanimously agree that local industries should be protected, but we have to evaluate how we are going to protect them without punishing our consumers. The only solution to protect them is to become competitive and that is a win-win for local manufacturers as well as the local consumers. 

Many policy-makers and, to an extent, Sri Lankans are of the opinion that when we allow imports, it will affect the local manufacturers’ sales volumes. Some consumers are of the opinion that the higher import duties don’t affect them because only the prices of imported items are increasing and the prices of local manufactured products will remain the same. I too wish that the market acts the way we think. What happens in the market is actually the same thing I tried to do in the 400-metre race.

When we obstruct the competitor’s imported products, we narrow the window of competitiveness in the market and limit the entry of similar products to the market. In other words, we limit the opportunity for the consumer to buy a reasonably priced product from the market by imposing a higher tariff and making them uncompetitive. By doing that, like I obstructed the entire race which created an absolute disaster, all other connected industries will be affected. It will affect the pricing of apartments, roads, government infrastructure, wages, and the aspirations of young professionals. The tariff rates are extraordinarily high, not only with regard to tiles but in terms of most construction items. This obstruction of competition is not a recent phenomenon but it’s been there for decades in the tile and bathware industry. However, even after a near tariff imposition of over 80% on cost in some instances, we have managed to fulfil only about 50%-60% of the local market demand. As a result, Sri Lanka is stagnated in the same place without being competitive in industries, but rather complaining that our export portfolio is not diversified. 

How can we protect the local industries?

Local industries can only be protected by being competitive and the definition of protecting local industries should not be punishing the fellow voiceless Sri Lankans. The only sustainable way of winning a game is hard work and being competitive. Instead of being competitive, if we lose our focus and try to obstruct the competition, we will not be able to achieve anything more than what we have been experiencing so far. This was the same policy we adhered to for decades and we have to question ourselves as to why we haven’t succeeded. We have to remind ourselves what my house master in charge said many years ago and redefine the way we think as Sri Lankans.

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.

Celebrating all the wrong things

Originally appeared on The Morning

By Dhananath Fernando

There can be no independence without economic freedom

The lockdowns amidst the pandemic left all of us with ample time to explore new avenues in life. A friend of mine, excited to learn, enrolled himself in a bunch of online lessons with the motive of productively utilising this time. However, as time progressed, he got too lazy to keep up with the lessons and succumbed to the comforts of his home. He watched television, read novels, and baked way too many cupcakes. He did everything except follow through with his lessons, all the while feeling immensely guilty for failing to do so.

Every independence day, I can’t help but draw parallels between my friend and my motherland. We, Sri Lankans, are quick to celebrate independence with much excitement, just like my friend was to learn, but we fail to actually do the hard work to follow through with the initial commitment. We are quick to identify that learning is vital and even advocate for education. However, we lack initiative. Similarly, we proudly celebrate the British leaving us but have failed to do the work to achieve freedom in real terms.

As a result, over the years, Sri Lanka has only achieved certain elements of independence and democracy. Economic freedom remains an enigma up to date. Whether our fellow Sri Lankans have the ability to engage in business and trade with each other voluntarily has become a serious question. 80% of our land is owned by the Government. People have to wait in long lines and oil the palms of bureaucrats with discretionary powers to obtain a licence to cultivate a crop they think is best to earn a living.

Whether our fellow Sri Lankans can make economic decisions for the betterment of themselves and their children is a question which still remains unanswered. Yet, we opt to proudly celebrate “independence” with minimal comprehension of the true essence of freedom. I fail to see a big difference between my friend and this popular uninformed “patriotism”. 

Over the years, we have been excessively reactive rather than being proactive. Similar to my friend who celebrated the opportunity he had to learn but failed to follow through with it, we too continue to celebrate independence in its literal terms. To put things into perspective, let’s take a look at Sri Lanka’s economic incidents in the recent past.

We signed a Free Trade Agreement (FTA) with Singapore and went against our own terms and celebrated the “victory”. Since then, we have done very little to enhance Sri Lanka’s involvement in global trade. Instead, we continue to hamper the island’s economic growth and development through consistent import and export restrictions as highlighted by this column on numerous occasions.

We spent way too much time debating the Millennium Challenge Corporation (MCC) Compact for more than two years and eventually celebrated not signing the agreement. The agreement could have helped Sri Lanka enhance her land use and improve transport and traffic. It is clear the issue was politicised. However, we could have informed the donors as to why we opted not to sign the agreement before they directed the funds elsewhere. Even without the MCC Compact, we have done very little to reform the island’s myriad transport, traffic, and land use issues.

Recently, we celebrated withdrawing from signing a Memorandum of Understanding  (MoU), foregoing much-needed Foreign Direct Investment (FDI) for the development of the East Container Terminal (ECT). The development here had already been delayed by more than five years. Do we have a plan for the ECT’s development? Have we thought of competitive bidding? Do we have a better cost structure to implement investments on strategic assets? Sadly, the answer is “no”, yet again. It is clear that we Sri Lankans celebrate poor policy measures as victories and fail to embark on proactive actions that cause real change.

What causes real change?

Instead of celebrating policy measures that stunt Sri Lanka’s growth, we have to work towards establishing economic freedom and initiate important but hard reforms. What we should celebrate, however, is the implementation and impact of progressive policies.

The Economic Freedom of the World Index by the Fraser Institute states that countries with high economic freedom are more likely to prosper. The quality of life in these countries is evidently much better than countries with low economic freedom. If we wish to be free and independent, we have to prioritise economic freedom.

Sri Lanka has to implement reforms that ensure people’s ability to do business with ease, voluntarily without any barriers. We have to strive towards attaining a small government. The legal system and property rights have to be strong. People should be able to resolve their court cases faster and with improved efficiency. Sri Lankans should be given the right of ownership to their land and property especially on what they wish to do and grow on these lands.

Sri Lanka’s monetary system has to be stronger. We should have sound money where people do not lose the value of money in hand, due to the use of a bad monetary policy. When the value of money depreciates (from inflation), it is the poor who lose their freedom to buy what they want. Vulnerable sections of Sri Lanka are definitely the most affected.  Inflation is the unkindest tax of all as the poor have no defence against it.

Our businesses should have the freedom to trade internationally and barriers to trade have to be removed. Sri Lankans should not pay about 80% on their tiny bathroom tiles or 300% for the vehicles they use as taxes. They should be given access to trade internationally without any barriers. A minimum and appropriate regulatory environment is fundamental if we Sri Lankans wish to enjoy real freedom. Currently, to register a sole proprietorship or a partnership, a library of documents have to be submitted to authorities. It takes weeks for these documents to process when it should be a matter of a few minutes. The Government should not hinder the growth and development of our own people and their businesses.

On last year’s Independence Day, President Gotabaya Rajapaksa stated that he wants to remove regulatory barriers at all levels. A few weeks ago, he appointed a committee to evaluate unnecessary regulation for businesses.

The Economic Freedom of the World Index compiled by the Fraser Institute is a good indication of whether a country is moving in the right direction in terms of economic freedom. I wish and pray that we celebrate actions and reforms taken to improve economic freedom instead of celebrating the wrong forms of independence. If we fail to initiate hard reform and establish economic freedom, we will continue to celebrate independence for the wrong reasons. Then Sri Lanka’s prospects would be the same as my friend who makes no progress.

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.

Bribes and ‘service charges’

Originally appeared on The Morning

By Dhananath Fernando

Deregulation commission good only if it actually deregulates

While having a conversation with a businessman, I brought up the topic of bribery in Sri Lanka. I put him on the spot by asking: “Have you ever paid a bribe to sort out your business matters?” He responded: “The answer depends on your definition of a ‘bribe’.” He added: “If your definition of a bribe is dishonestly persuading someone to act in an illegitimate manner by a gift of money or another inducement, my answer is ‘no’. But I have paid and continue to pay ‘service charges’ (which I believe is the new term for bribery). This is ‘paid’ to get legitimate things done faster. Without oiling the palm, I cannot get any legalities processed,” he stated. “Following that definition, my answer is ‘yes’,” he went on to say. He further explained: “Paying money to get things done as per procedure is termed a ‘service charge’, and paying to get anything illegal done is a bribe.”

Unfortunately in Sri Lanka, following normal procedure to get things done requires the paying of bribes. If you don’t pay, you can’t get anything done, even if you have followed protocol and procedure to the dot. This is a common practice, from the security guard up to the director generals of many institutions; from getting a passport to getting approval for a million-dollar investment. 

This issue has been discussed over the years and it is not only a problem in Sri Lanka but across the world. But we all agree that in this part of the world, bribery is painfully common. Fear surrounding the act too has started to erode. That is the reason my friend, who is a businessman, prefers the term “service charge” instead of bribe. The main reason for high levels of bribery is excessive regulation and discretionary power assigned to certain officers. When we have too many gatekeepers with discretionary powers, bribery or service charges, as we term it, becomes unavoidable.

With this context in mind, President Gotabaya Rajapaksa has appointed a deregulation commission. The committee is assigned with the objective of easing business processes with a 90-day time frame. Identifying deregulation as an urgent need to ease the process of doing business is a step in the right direction. Many a time this column emphasised the importance of deregulation and its impact on easing the process of doing business. It is a low-hanging fruit that can be plucked easily with minimal financial resources. The President’s initiative and the Government’s efforts on deregulation have to be appreciated without a doubt. This will be a big game-changer if we utilise this opportunity with good intentions. 

Understanding the gravity of this assignment is of vital importance. Developing a feasible framework to achieve its objectives, too, is of high importance. There are two sides to deregulation. One is deregulating the factor markets. There are regulations at a higher level on main factors that contribute to productivity. That is land regulations, labour regulations, capital regulations, and entrepreneur regulations. Deregulation in each sector is an assignment on its own. 

Just take land regulation as an example. Eighty percent of the land is owned by the Government, and our farmers do not have the property rights to cultivate what they want and develop their lands. Different types of land registrations are in place by the name of Swarnabhoomi, Jaya Bhoomi, etc., but nothing can be used as collateral at a bank to obtain much-needed capital. As a result, for decades, our farmers have been using the same technology and very inefficient methods of farming. This is evident in how 25% of our labour force contributed about 8% in terms of GDP. 

The situation is not very different in other sectors in terms of capital market regulations and labour market regulations. Our hiring and firing guidelines are rigid, so doing business is a complete nightmare. Under the existing regulatory framework, it is therefore unlikely that investors will come to Sri Lanka more often. One reason why investors are actively looking at the Port City is that businesses at the Port City will have a separate regulatory framework. Faster and convenient systems and processes, and minimum yet strong regulation are what all investors are looking for. They want to invest easily without excessively spending their energy and money on unnecessary regulatory work which increases their transaction costs or by paying “service charges”, as per my friend’s definition. 

The business registration process is a nightmare for budding entrepreneurs. Small businesses registering proprietorships require a grama sewa certificate, rent agreement, nameboards, and have to provide so much more unnecessary documentation and go through unnecessary processes, that it kills the aspiration of the entrepreneur even before they commence the business. The company registration process can be done via an online system to get the business registered. However, getting copies certified by directors and other documents that are required, has become a long and tiring process.

Many exporters have said their main challenges are not issues such as finding opportunities in outside markets. Their biggest concerns are in Sri Lanka where their activities and scope of innovation are restricted by a regulatory framework.

The other side of regulation is product regulation, which calls for unnecessary documentation at every office. This is common for all product sectors of the economy. The National Medicines Regulatory Authority (NMRA) has so many various processes and procedures on getting medical equipment and issuing licences; so does the Telecommunication Regulatory Commission, which has another set of regulations on products. These are all fine examples of excessive regulation restricting product markets.  

When considering all these products and licence requirements as the general regulatory framework, then the scope of the newly appointed commission will be very broad. So, most likely, they may have to identify a few big-ticket items where deregulation can be done faster, with a higher impact on business and investment. Sri Lanka’s Customs’ regulation, land regulation, and capital market regulation are definitely a few areas where the problems are known yet nothing has been done over the years. The problem for many businessmen is not that they want to bend the law or do anything illegitimate, but rather that the authorities do not provide any answer for the applications and delay the process. For an investor, a very delayed date is an expense, as he/she has to repay the capital and interest on capital, and he/she is losing an opportunity to make a profit.

It would be a gigantic task for the committee to cover the scope of all regulations just in 90 days, and all the members are already on different fulltime assignments. Since this committee comes under the purview of the President, the business community will keep a close eye on the outcome of this initiative. 

We need to learn lessons from the past committees where nothing happened apart from the spending of public money and kicking of the can down the road. This Government, unfortunately, fell into the same trap with the committee appointed to appoint heads for SOEs (state-owned organisations), which did not achieve the expected outcome. There were media reports of political appointees, and some members even submitted fraudulent documents as qualifications to sit in high-level director boards at state institutions.

The deregulation commission is undoubtedly an initiative in the right direction, but the real victory for business and investment would be the day actual deregulation takes place – where the businessmen do not have to pay any “service charge” to speed up the process or bribe to get anything illegitimate done.

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.

Vaccine policy : is it time for the paid option ?

Originally appeared on Daily FT

By Prof. Rohan Samarajiva

When there is a population of 22 million and vaccines sufficient for 300,000, it is logical to give priority to frontline workers (health and other) who are most exposed to risks of infection. They are exposed by the nature of what they do for all of us. If they get sick, everyone suffers, not just them. There won’t be trained people who can care for the sick and bring the pandemic under control.

Comments on the efficacy, risks, etc. of vaccines should be made by those with specialised knowledge on the subject. But those of us working at the intersection of economics, law and technology can make useful contributions as well.

What kind of good is vaccination?

There is a limited stock of vaccines available in a country at a given time. A vial of vaccine is not a public good that cannot be sold for a price. One person getting a jab means there is one less for another. It can easily be given or denied. It is a private good that can be supplied through the market.

But vaccinations have strong positive externalities. The true benefits come to individuals (and countries) only when a significant majority of the population (or countries with which the country is interacting) are vaccinated. Benefits flow not only to the person getting the vaccination, but to others in her environment. 

Vaccinations can be sold through the market, but it is better if at least some quantity is given away free to those who are hesitant to pay. In fact, if there is resistance to vaccination for whatever reason, additional inducements or penalties can be justified.

How should limited stocks be allocated?

When there is a population of 22 million and vaccines sufficient for 300,000, it is logical to give priority to frontline workers (health and other) who are most exposed to risks of infection. They are exposed by the nature of what they do for all of us. If they get sick, everyone suffers, not just them. There won’t be trained people who can care for the sick and bring the pandemic under control.  

Who is next in priority? Most societies would privilege those most at risk, in the case of COVID-19 those who are elderly with other illnesses. The expected short duration of vaccine effectiveness makes this a relatively easy choice.

Those engaged in processing food perform essential functions. Infections in other countries show that such workers are facing high risks. Should they be next in priority after frontline health workers? What about those who work in close proximity in factories to keep the exports going? Without them, we may not have the resources to fight the pandemic.

What about persons such as politicians and religious functionaries whose functions require extensive human interactions and thus place them at some risk? They may be distinguished from frontline health workers who are compelled to expose themselves to risk. 

Should it be possible to pay?  

The various vaccines that are being made available are priced from around $ 3 (AstraZeneca-Oxford/Covishield) to $ 33 (Moderna). Bulk purchases by governments and programs such as Covax will make some vaccinations free of charge to citizens. Should those willing to pay be allowed to obtain vaccines on a parallel track?

For example, an export firm may be willing to spend its own funds to protect its workforce. As long as it does not disturb the priority list for free vaccines, is there any harm?

If vaccination for payment is acceptable for companies, why not for individuals? Those who wish to travel may require vaccines even if they do not fall within priority categories. It may be cleaner to allow them access to a payment-based option, than make case-by-case determinations on jumping the queue. Should the pay option be limited for those with cause as above, or simply open to anyone who is willing to pay?

This is how the Sri Lankan healthcare system works anyway. Those willing to pay can reach the specialists of their choice, technically with shorter waiting times, than those who go through the free channels in State hospitals. 

The same with hospital care. Those wanting the conveniences of attached bathrooms and TVs, can use private hospitals. Not perfect, but works. And in conditions of resource constraint, it may be the sensible option if the free channel can be protected from harm by the pay option. 

Vaccination and trust

Injecting one’s body with foreign substances requires trust in science and scientists. It is because vaccinations are risky that extensive trials are conducted, and rigorous approval procedures have been put in place. Government officials are instructed on how to communicate about vaccinations, specifically about the associated and unavoidable risks and unknowns. 

There is some percentage of the populace that is fearful of injections and untrusting of science. There are also those in the media who seek to profit by creating distrust, for example by peddling patent falsehoods about microchips being injected along with the vaccines. Stories about genes being altered are also in this category.

It is hypocritical for a political coalition that demonised the then Government and minorities by vigorously promoting the principle of ‘one country, one law’, to then propose to carve out the Port City development as a geographical area exempt from many of the laws and practices prevalent in the country. Those who sow the wind, reap the whirlwind. Because of this hypocrisy, the Government has great difficulty doing what it knows is the right thing for the country.

It is hypocritical for members of the dominant party in the previous Government (now split) to protest vociferously against the special treatment proposed for investors by the Colombo Port City Economic Commission Bill. They full well know the dysfunctions of the investment environment in Sri Lanka. The then Government was working on a bill on the same lines. There was discussion on placing the financial city within the jurisdiction of the English courts then.

It is not hypocritical for the Bar Association and other interveners to object to the proposal to establish an International Commercial Dispute Resolution Centre and to the associated legal workarounds. But it is wrong and self-serving. Members of the legal profession, more than anyone else, should know how dysfunctional the country’s legal system has become.

At the 47th Annual Convocation of the Bar Association, the Minister of Justice said that the average time to enforce a commercial contract in this country is 1,318 days (3.5 years). It is said to take one year to get a date for an appeal to be fixed for hearing on a criminal matter.

All of us who worked on improving Sri Lanka’s rank in the Ease of Doing Business Indicator know that the legal-system-related factors are a major factor in Sri Lanka being relegated to the back of the class. Poor performance in resolving insolvency and enforcing contracts are major contributors to Sri Lanka being ranked 99th out of 190 countries. On enforcing contracts, we are ranked 164th.

So, the previous Government was right when they considered placing contracts of investors in the Port City under English commercial courts. The experts who crafted the present bill were right in making arbitration by the International Commercial Dispute Resolution Centre mandatory and allowing for a fast-track engagement with the Sri Lankan courts as needed. Commercial arbitration is nothing new in Sri Lanka. To argue that it violates our Constitution is a little farfetched.

But of course, professional associations rarely allow logic and the national interest to come in the way of the financial and related interests of the members. The Sri Lankan legal system is one of the worst in the world, partly because the powerful private interests of the legal professionals are given priority over the interests of litigants and the country. It is not in their interest to admit how broken the system, they profit off, is. The Colombo Port City Economic Commission Bill is an indictment of that system. Lawyers, individually (as a prominent politician/President’s Counsel so vividly demonstrated) and collectively, are likely to oppose it.

The Port City bill is a workaround. It is needed because our systems are broken. President J.R. Jayewardene established the Greater Colombo Economic Commission (predecessor to the Board of Investment) as a workaround solution, by Act No. 4 of 1978 because our systems were a barrier to the attraction of needed foreign investment. We have the Katunayake and Biyagama zones and the various value-added manufacturing industries that are keeping our economy afloat, thanks to that workaround.

The tragedy is that 43 years later we are still doing workarounds. We need these stopgap measures, but we need to give the highest importance to fix all the systems that affect all our citizens, not just the foreign investors. Despite the specific mention of the doing business indicator in the Port City Commission Bill, the indicator is not done for enclaves but for the country as a whole. Improving the key systems across the country is what others are doing. India is now more than 30 places ahead of Sri Lanka, thanks to dedicated task forces. China is ranked 31st, more than 30 positions ahead of India and more than 60 ahead of Sri Lanka. I invite the readers to look at how well our competitor, Viet Nam, is doing.

If we do not improve the ease of doing business for all, we will be overtaken by Pakistan soon. They are taking concerted action to improve performance on the components and are now just nine places behind. Do the work around, but for God’s sake, focus on system improvements throughout. Define threshold levels in the Port City Bill itself when the workarounds can be discontinued, and we can celebrate living in a country where the legal system does not require bypass.

Rohan Samarajiva is founding Chair of LIRNEasia, an ICT policy and regulation think tank active across emerging Asia and the Pacific. He was CEO from 2004 to 2012. He is also an advisor to the Advocata Institute.

The East Container Terminal incentive

Originally appeared on The Morning

By Dhananath Fernando

I generally buy my toothbrush from a neighbouring grocery store. I usually gravitate towards one particular brand, but the shopkeeper convinced me to buy a different brand. The way in which he convinced me was so appealing, and to date I can recall the brand of toothbrush he recommended.

“Sir, there is a new brand in the market, which is the best. The thickness of the bristols are better and the handle has a special shape which can easily reach the teeth in your lower jaw.” He further explained the impact on my gums, how this model helps with oral hygiene and fights tooth cavities, etc. For a second, I thought to myself, this storekeeper must be a part-time dentist.

Later on, when I worked at a market research agency, I did a study on toothbrushes and I analysed the margins provided for retailers. Here I realised the particular brand my neighbouring storekeeper promoted provides a significantly higher margin than the rest of the brands for the retailer. So the business model is designed to influence the buyer by providing a better incentive. For any business, understanding and setting up the right business model will determine the success of that business in a competitive industry.

Sri Lanka’s debate on the East Container Terminal (ECT) has come into play in this context.

Sri Lanka doesn’t have a bright history of creating sustainable business models. The shipping business is a networking business. There are many stakeholders and decision-makers who could bring the businesses into the port at many levels based on the incentive structure. Our strategic location of the port is one advantage, but in modern days, a strategic location will not be sufficient to bring in the expected benefits in a broader economic context.

The Colombo Port is mainly a hub for transhipment business. According to Shippers Academy Colombo CEO Mr. Rohan Masakorala, transhipment is a very sensitive business as the business can move from one port to the other based on developments, if we fail to attract the right business partners. He has further provided an example of how Singapore learnt a lesson by removing a major shipping alliance from a partnership and the transhipment business moved to Malaysia. As a result, Singapore had to reverse the decision.

According to Mr. Masakorala, the lack of knowledge and willingness to take an outward-oriented approach on economics has resulted in Sri Lanka not reaching the benefits from ports as we should have. About 80% of ports and terminals in the world are managed by private-public partnerships (PPPs) and only 20% is managed by governments. In the case of the Colombo Port, through the Sri Lanka Ports Authority (SLPA), the government has a stake in all terminals whilst also playing the role of the regulator. It is the same as becoming the umpire of the game while contesting in the same game.

Usually, it is the ship owners who decide which port or terminal that has to be used. That decision is taken after considering the efficiency of the port/terminal and their business interest and the terminals in their network, in addition to the location. Shipping is a very cost-competitive industry and profits are based on volumes.

At the same time, the investment is front-loaded, which means you have to do a significant investment even before you start the operation. The higher the investment, the higher the risk and liability. In a dynamic business environment, a minor disruption in operations can cause significant losses and result in the loss of competitive advantage in this industry. This is the nature of this business.

The Port of Singapore is a classic example of the importance of entering into joint ventures.

Identifying the correct business model when managing ports and their terminals is of paramount importance. The business works in such a way that you opt for joint ventures and network with other stakeholders with the objective of attracting as many volumes as possible, while keeping  productivity and efficiency at a maximum. In a joint venture, it is not only the investment, but also the knowledge, knowhow, and the use of better management that are going to reap the real benefits.

If such a joint venture that reaps such benefits is implemented, then the country gets economic benefits across other sectors. As a country, we have to look at the broader economy and not a single industry, because at a broader level, all industries are connected with main factors of production – land, labour, capital, and entrepreneurship.

On the other hand, over the years, consecutive governments made the ECT project very complicated by signing Memorandums of Corporation (MoCs) and calling bids for operators and cancelling it multiple times. As a result, we have delayed this process for years. Our reputation  has been irreparably damaged by such prolonged delays, especially when taking into account the losses due to delays and the impact on investor confidence.

As this writer highlighted in this column before the general election, it could have been an opportunity for the then interim government and president to reflect not only the transparency, but also the importance of having a competitive business model. Following such a competitive focused model with partners across main shipping alliances and getting the ECT networked for more businesses would have reaped significant benefits by now.

Similar to the business model created by the toothbrush manufacturer with the retailer, we had the opportunity to arrive at a win-win business model, creating synergies and respecting local businesses as well as other stakeholders. From a geopolitics angle, if a transparent bidding process was followed with clear guidelines, then such external influences could have been completely avoided, as transparency and competitive bidding are the standard global good practice principle.

If the SLPA was to invest in the ECT in full, then the question arises as to why we wasted so many years without investing in the first place. It raises questions as to why we wasted time and who is responsible for the opportunity we missed for making profits. Therefore, the fundamental  business principle of ownership of risk must be considered with foresight. When private investors are brought into the business and when they risk their money, they are responsible to make matters efficient and productive. That doesn’t happen when governments invest taxpayer money. Many Sri Lankans fail to understand the basic role of incentives in economics and tend to only look at the ownership angle without realising the synergies of business models.

The second question is that the Sri Lankan rupee is under pressure. The recent Sri Lanka development bonds issuance has been undersubscribed by 25%, so the foreign exchange needed to invest in the ECT remains an enigma. All equipment and machinery has to be imported to keep it at a world-class level. We cannot afford to spend our valuable foreign reserves on this matter at this juncture. So are we going to delay the ETC further?

As always, only time will tell us whether Sri Lanka created the correct business model similar to the incentives given by the shopkeeper, or whether we opt to keep postponing this for a few more years and forget the opportunity to make profits from the port for business and the people of Sri Lanka.

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

Can we print our way out of this economic hole?

Originally appeared on The Morning

By Dhananath Fernando

I had a friend in school whose aspiration was to be the president of Sri Lanka. One day, our school teacher asked him: “So what are you going to do when you become the President?”

He had a simple answer. “I am going to end poverty in Sri Lanka and make all citizens wealthy by ensuring they all have enough money.” In response, the teacher further questioned: “How are you going to do it?” To which my friend answered: “It’s not difficult. I will print money and distribute one million per citizen among all citizens so they have money to buy all the goods and services they want.”

This sounded like a great idea to schoolboys who did not know anything about economics. “Why can’t governments print money and increase the income of people and allow them to buy goods and services as they wish?” were our initial thoughts.

The teacher then questioned: “What if the market doesn’t have enough goods and services to buy with the money you expect to give away. Do you think that having money in hand but no goods and services in the market will help people consume what they need?”

Through my teacher’s counter-questioning I realised that “money” or fiat currency is just a piece of paper. The amount of goods and services we can buy from that money is what matters instead of the quantitative or numerical amount of money in hand.

Take a Rs. 100 note and a $ 100 note for example. Both of them might represent a 100 but we can buy more goods and services from $ 100 than Rs. 100. Therefore, managing “money” or the currency must be done very carefully. 

The economy is a broader concept where the supply of money is just one tool within this system. This economic system performs the function of optimising limited and scarce resources to meet unlimited wants. Prices determine what could be bought or sold by the quantity of money.

If there is strong demand for one good over another, its price will go up and the supply of that good will go up, as producers try to make more money to get more profits.

Excessive creation of money without regard to the number of goods and services produced in a country leads to price inflation, which distorts relative prices. Sri Lanka’s economic problems are multifaceted. Therefore, we have to evaluate whether we can overcome our economic challenges by printing money as suggested by my school friend. This dilemma brings Modern Monetary Theory (MMT) into context.

Some advocates of MMT say money can be printed by governments without a problem. Other advocates say governments can borrow large amounts of money without a problem. At the end of the day, printing money is also a form of borrowing from the Central Bank. Still, other proponents say taxation can be used to stop the inflationary effect. 

While different proponents of MMT have proposed slightly different views, some of the key ideas are that governments can increase deficit spending without a problem and that they can also print money. Still, others argue that money can be printed to repay bonds, and therefore there will be no default on debt.

However, it is important to remember that the comparison of a government to a household only goes so far. This is because sovereign nations can print money which a household cannot. Some believers of MMT claim that in an environment where a country hasn’t reached full employment, printing money or quantitative easing doesn’t cause inflation. Some others argue that if inflation picks up, taxation can be used to take spending power and reduce inflation.  

When a country like Sri Lanka prints more money it can cause two problems. One is that it will

create a balance of payment problem when economic activities and credit picks up. Sri Lanka or any other country cannot live in complete isolation. We have to import some basics such as fossil fuel, pharmaceuticals, and inputs for our exports. Statistics by the Central Bank show that about 80% of our imports are capital and intermediate goods, required for consumption and for our exports. When we print excessive money, that will increase imports and create a balance of payment crisis. In addition, the fall in reserves and the fall in exchange rate will lead to a loss of confidence. Then, foreigners who had loaned money and other investors will take their money back. This is called capital flight. That is one reason the yields of sovereign bonds have increased to very high levels and we cannot issue more sovereign bonds.

But what about rupee debt, you may ask.

One question commonly asked is why Sri Lanka cannot print money if the US and Japan can print money in trillions. This is possible for the US and Japan to some extent because both the US dollar and the Japanese yen are pure floating exchange rates. The US dollar in particular is also used abroad. However, that did not prevent the collapse of the US dollar in 1971 when it was pegged to gold and money was printed in excess.

When the US dollar was a floating currency also it was not immune. After very low rates from 2001, a massive credit bubble was fired in the US and the dollar weakened. Inflation and oil and house prices went up and then collapsed.

Sri Lanka does not have a pure floating currency. Sri Lanka collects reserves through the purchase of dollars and then the sale of dollars to defend the value of the rupee against the US dollar at different rates. 

Such countries are much more at risk from printing money than those with a pure floating exchange rate. Consecutive governments of the past resorted to the practice of financing our budget deficit by money printing. One reason Sri Lanka has had to go to the International Monetary Fund many times over the last 70 years is mainly due to such balance of payment crises caused by the excessive printing of money.

Restricting imports reduces the amount of goods and services available in a country and leads to higher prices. When countries without floating exchange rates print money, not just inflation but hyperinflation also can happen.

Zimbabwe created excessive amounts of fiat money that led to inflation rates of more than 1,000% per year. As the currency crashed, notes of million-dollar Zimbabwe banknotes were printed. Eventually people shifted to US dollars. Inflation then stopped. But many were left destitute. Large numbers left as refugees. Creating money without regard to the availability of goods and services can ruin an economy. And worse. It devastates the poor.  

It is true that the economy of a country cannot be compared to the economy of a household because people trade in different currencies and trade between countries is a global phenomenon bringing in competitive synergies.

But when money is printed, the main objective of economic policy becomes “saving foreign exchange”.

The MMT advocates of the West did not say to control imports. Some people hold up Japan as an example due to its high debt levels and attempts at trying to ignite inflation there through money printing. But there is no import control in Japan.

So we should not forget that the main objective of an economy and economic policy is not to just have money in every citizen’s hand or saving US dollars to pay our debt. The prime objective of a well-functioning economy is to improve the quality of life of the people and reduce poverty. We can only achieve these objectives by utilising our scarce resources optimally. Hence my teacher’s question, “what if we all have money but not enough goods and services for our consumption?” must be analysed in depth.

Therefore, improving the quality of life, eradication of poverty, and using our resources optimally have to be the broader objectives of the economic policies we implement. This does not mean that we divert from our focus of facing the ever-growing economic challenges before us. However, our solutions to meet short-term economic challenges should not dilute our aspirations or our long-term economic goals of improving quality of life and eradicating poverty.

Monetary history has shown over and over again that the oversupply of money causes inflation and currency depreciation and balance of payments problems. When money printing is continued, it will end in hyperinflation like in Zimbabwe. The poorest sections of the society will be most affected by hyperinflation.

Countries like Venezuela and Zimbabwe are prime examples of the various consequences that can occur as a result of governments running their money printing machines overtime. It results in a situation where they have money, but not the adequate amount to afford their necessities.

What is the solution?

It is understandable that in a global pandemic and a credit collapse some countries printed money, especially when there was no economic activity to make use of the money. But expecting to use it as a permanent solution may cause long-term damage to our economy. 

To optimise the use of our resources, we have to remove the structural impediments that stop the people from doing growth-creating economic activity. 

We must restructure our state-owned enterprises (SOEs) and open public sector resources to the private sector, in order to attract money, for example, rather than print money. Ultimately, it is the production of goods and services and getting all Sri Lankans to contribute to economic growth that will help meet our long and short-term economic objectives. Expecting that production will kickstart when excess money is supplied through money printing is surely a not solution. Instead, we should examine the barriers that have to be removed in order to ramp up production. These barriers keep dragging our economy behind.

We should not forget the scenario where everyone was given money through money printing but there were insufficient goods and services to purchase. This lesson taught by my school teacher to my aspirational friend who wanted to lead the country, is a lesson for the whole country. A lesson as to why such thinking is fundamentally flawed.

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.

Long-awaited economic revival: Will we ‘make it happen’ this year?

Originally appeared on The Morning

By Dhananath Fernando

Every year, as a kid, I used to write down my new year’s resolutions on a piece of paper and place it in a sealed envelope and revisit it on the last day of the year. Some of these resolutions were plans like scoring 85 marks for mathematics, learning to ride a bicycle, and scoring 12 half-centuries when playing cricket with my friends. The idea of revisiting them was to evaluate how far I have realised my goals for the year.

A quote by basketball legend Michael Jordan, which goes as “some people want it to happen, some wish it would happen, others make it happen”, made me realise that my dreams were merely wishful thinking without my conscious effort and action to pursue them.

In my opinion, this same scenario could be applied to realising the dream of a dynamic Sri Lankan economy. Choices spelt out by Michael Jordan are relevant to policymakers and the Sri Lankan people. Are we wanting to make it happen? Are we wishing it would happen? Or are we really making it happen? Only at the end of 2021 will tell what choices we have made as a collective.

In this light, this week’s column will explore possibilities for Sri Lanka’s economic revival for the year 2021, drawing on Michael Jordan’s wisdom, my experience as a common citizen, and the ways in which economic matters have been handled post Independence.

Scenario 1: Want it to happen

A possible scenario that could play out in 2021 is the political and economic leadership wanting to revive the economy but with the wrong tools. This is a classic scenario. Despite a genuine need and effort, things fail to work out in the expected manner due to multiple unintended consequences. Many academics and economic experts over the years have diagnosed Sri Lanka’s economic problem. However, we have spent way too much time on our diagnosis alone.

Even economists with conflicting ideologies would agree that the Sri Lankan economy has a severe productivity problem. This means that we waste large amounts of Sri Lanka’s valuable resources only to receive a very low output in comparison to the substantial input. The island’s structural situation has been deficient, creating sizable distortions in the economy. Sporadically, macroeconomic instability also occurs, arising from fiscal deficits leading to the creation of money and unsustainable current account deficits in the balance of payments. These have been the norm for decades.

The multitude of economic issues springing up in public discourse from time to time is a byproduct of these fundamental problems. Challenges on debt sustainability, poor performance of our exports, and lack of competitiveness are all just symptoms of a severe illness in our economy. If we deal with the symptoms of the problem rather than fix the root cause, 2021 will be yet another year where we “want it to happen but something else happened”.

There is a tendency to sell the same expired policy recipes wrapped in a new glittery package back to policymakers as an effective policy measure for economic revival. This may happen due to misunderstanding the diagnosis or lack of comprehension of the gravity of the problems at hand. If Sri Lanka picks the choice of “wanting it to happen”, our economic destination would be more likely the same or worse, coupled with many other unexpected challenges.

Scenario 2: Wish it would happen

The second possible scenario would be policymakers prioritising other political motives over economic reforms and simply wish the “economy would be revived”. Over the years, all parties have compromised the Sri Lankan economy for political power. Starting from the 1953 Hartal, 1981 riots, 1983 Black July riots, and the formation of the LTTE (Liberation Tigers of Tamil Eelam) up to the recent 2018 constitutional coup and the 2019 Easter Sunday attacks, the political agenda has always been prioritised over the island’s economy.

This sparks a two-way reaction which is a never-ending vicious cycle: When economic conditions are bad, it converts to political instability, and political instability fuels economic downturns. In all cases, we have had the wishful thinking that our economy would do better without the necessary steps to prioritise what needs to be done.

In 2021, all stakeholders and policymakers should leave wishful thinking aside and become more action-oriented to face the mounting debt sustainability challenges. With available foreign reserves and securing few swaps from neighbouring countries, we will be able to float through this year. However, failing to adapt necessary policies will mount up the pressure in the last quarter and in the beginning of 2022, if the environment for growth is not created.

In the back of our heads, we have a positive sentiment and wishful feeling that we can soldier through the debt challenge. The reality is that we should provide serious attention on the matter without taking it lightly. There is a higher possibility that a bilateral relationship with China will come for the island’s rescue; however, if China provides special treatment for Sri Lanka, they will have a long list of countries lined up expecting the same treatment. A recent article on Financial Times has revealed that the funding by China Development Bank and Export-Import Bank of China, which are the main two funding engines for the Belt and Road Initiative (BRI), has cut down the funding for BRI to $ 4 billion in 2019 from $ 75 billion in 2016.

There is a counter-argument that China will provide funds through Chinese SOEs (state-owned enterprises) as a novel strategy of financing the BRI. However, wishful thinking and placing all our eggs in one Chinese basket will not help Sri Lanka to overcome challenges at home. Sri Lanka requires action. It is unfair to have higher expectations from China as they have bigger interests over the entire BRI project, and at the same time, there will be geopolitical tensions. Incorrect prioritisation of reforms is a sure way for deepening the crisis.

So far, the tragedy of our economy is that we didn’t do anything. In a dynamic world, not doing anything is sometimes worse than even attempting to do the wrong thing. Settling in stagnation without moving in any direction and postponing the problem by kicking the can down the road of wishful prosperity is a distant recipe for actual prosperity.

Scenario 3: Make it happen

The third and most favourable scenario would be the policymakers making it happen. It’s easier said than done, but I still believe there is a good opportunity to make it happen if the correct tools are available and correct prioritisation is done. Every crisis brings opportunities and opens up windows for reforms. We have to just get the right reforms done. Very importantly, when the right tools are used, investor confidence will be restored and the market signaling system will work.

To “make it happen”, policymakers have to realise that there are no shortcuts, nor can there be any alternative method to be adapted. It has to be hard economic reforms to improve productivity by allowing markets to operate based on price signals and improve fiscal management and monetary stability. “Making it happen” requires commitment and comprehension of the problem diagnosis.

We need to understand that the solution mix we have at hand is not the most convenient, given our bad economic management over the years. There is a cost for every action, reaction, and choice we make. Since the Government has kept the solution with the International Monetary Fund (IMF) aside, now we have to evaluate the other available solutions. Financing through FDI (foreign direct investment) and bilateral swaps is one way to look at it. How far we can accelerate our growth realistically is another way to estimate where our possible landing would be.

As the Government is unwilling to amend the tax concessions, then we have to evaluate where we can cut the expenditure and if we are willing to let go of at least a few of our loss-making SOEs for private investors to run it. Or else, we can utilise some untapped resources and open it up for investment and take our economy back on track. We have to evaluate the pros and cons of going with the IMF vs. going without the IMF with a cost-benefit analysis and see where we really want to mix and match our solutions.

There are suites of solutions even in the darkest hour, but to make it happen, we have to move to the driving seat and get things done. Using wrong tools, not doing anything, and wishful thinking of an economic revival will surely not help Sri Lanka to move forward. Only time will tell us whether we just wanted things to happen, whether we were a bunch of wishful thinkers waiting for things to just happen, or whether we were a courageous nation which made things happen.

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.

Preserving foreign exchange or earning foreign exchange?

Originally appeared on The Morning

By Dhananath Fernando

A cricket game I played as a kid is still fresh in my memory. I did not know the rules of the game at the time. It was just me and my friend. We played against each other taking turns to bat and bowl. My friend batted first and I got him out when he had scored 25 runs after three overs in a five-over match. Then he started bowling. I was defending most of his deliveries and I scored 20 runs not-out after the end of five overs. I claimed the victory because I defended my wicket. My friend too claimed the victory as I couldn’t exceed the runs he scored. After a few arguments, my friend explained that in cricket, the victory of a game is decided not on the number of wickets defended, but by the runs scored. 

This childhood memory makes me question as to whether Sri Lankans and local policymakers, throughout history and to date, have ever fully comprehended the basics of an economy.

The recent commentaries and people’s reactions to the national GDP data for the second and third quarters by the Department of Census and Statistics and the external sector performance report by the Central Bank, make me question whether we in Sri Lanka understand our economic problem. Or are we continuing to drive further in the wrong direction?

The main objective of a well-performing economy is to raise national income, which will also help to reduce poverty and to allow more people to consume a wide range of goods and services in order to improve their quality of life. Simultaneously, sustainable consumption too is important to ensure long-term prosperity. To achieve these objectives, our strategy has to have a concentrated focus on providing equal access for all people across the country to enter into the economy. Special attention should be given to vulnerable sectors of the economy whose only tradable good is their labour. Efforts must be actively taken to integrate these vulnerable sectors to global production networks, as it will not only provide them with new opportunities to trade their labour but will also eventually help to eradicate their conditions of extreme poverty.

The Central Bank’s recent report on the external sector for October 2020 reveals that in the first 10 months, Sri Lanka’s exports have dropped from about 16% and our imports have reduced by about 19%. As a result, our trade deficit has shrunk to $ 4.8 billion from a corresponding $ 6.4 billion in 2019. 

It is imperative that we understand that the trade deficit/surplus (balance in the trade account)  is not necessarily the main indication of the direction of our economy. In reality, the most important indicators are the level of income and poverty, quality of life, and purchasing power of income. These indicators provide a better signal of the state of our economy and the wellbeing of Sri Lankans than mere trade balances and fiscal deficits and surpluses.

Our imports have shrunk, mostly as a result of the import restrictions, and our exports have dropped as a result of Covid-19 and the bias against export in our trade regime. The impact of Covid-19 was the very same reason why import controls were placed in the first place. Most of the imports are inputs for the manufacturing of goods to be exported. The scarcity or the lack of these imports result in exports being uncompetitive in the global market. Following an ideology that calls for defending the foreign exchange rate and targeting only the trade deficit as a strategy, may bring some long-term adverse consequences to our economy. Solely targeting a trade account deficit or surplus is similar to how I tried to defend the wicket without understanding the need to surpass the runs the opposing team has already accumulated. 

We need to realize the problem of trade is mainly due to the larger macroeconomic problems that have been ignored for the last few decades. Of aggregate demand running ahead of aggregate supply

We need to realise the problem of trade is mainly due to the larger macroeconomic problems that have been ignored for the last few decades; of aggregate demand running ahead of aggregate supply. Imports and exports are mainly a function of the private sector. What a government imports and exports compared to the private sector is negligible. In other words, the Government doesn’t import or export (except for direct government imports such as vehicles, food items for Sathosa, etc.), yet their intervention, through the imposition of restrictions through tariffs and non-tariffs, is very sensitive for the functioning of both import and export markets. So improvement of trade is a market function, and the Government should not intervene, except in the case of public goods. The role of the Government should largely be to set up a level playing field for our exports and assist and boost competitiveness. The current state of the trade account is just an outcome of poor macroeconomic policies implemented by consecutive governments.

On the fiscal management side, money printing (quantitative easing) to finance our budget deficit every year, while maintaining a long list of loss-making and unproductive SOEs (state-owned enterprises) is like adding fuel to fire. When we do quantitative easing to bridge the budget deficit, it may automatically distort markets as demand for available imports may increase, causing further market distortion, leading to further pressure on our currency.

It is a positive indication that our economy has achieved a growth of 1.5% compared to the corresponding period in 2019 as per the recent numbers by the Department of Census and Statistics. However, without addressing macroeconomic reforms and solely targeting the trade deficit alone, Sri Lanka will have a feeble chance in achieving the main objective of a well-performing economy. 

Rather than focusing on defending our foreign exchange rate, we have to shift our gears to a better strategy where we focus on a competitive exchange rate. To do this, we must acknowledge the problem and find a suitable strategy to meet this objective. 

The fundamental understanding has to be that the Sri Lankan economy is plagued by macroeconomic imbalances, and governments cannot fix the outcome of a problem without fixing the problem in itself. The island’s low growth, from the recent low exports to GDP, quality of life, pressure on external debt, pressure on the currency, poor productivity, and a stagnant economy are a result of poor understanding on the way the system operates. As we did not comprehend the magnitude of our problems, we failed to address macroeconomic reforms or we postponed it every year.

If we continue to defend our foreign exchange like defending wickets in cricket and continue to fail at earning foreign exchange by fixing our macroeconomic fundamentals, the situation is prone to worsen. Sri Lanka must strive at scoring runs that exceed our opponents’ instead of defending wickets.

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.

Unlocking the Potential of Micro, Small and Medium Enterprises Essential to Sri Lanka’s Post Covid Economic Recovery (Part 2)

Originally appeared on Colombo Telegraph, Daily News and Daily FT

By Ayesha Zainudeen

Small and medium-sized businesses (SMEs) represent over half of the businesses in Sri Lanka. They also provide an important source of employment for a large part of the labour force. They have been dubbed the ‘backbone’ of the economy in national policy frameworks. Supporting this sector and helping small businesses to grow should be an important part of the national strategy for post-COVID economic recovery. 

This article is the second in a multi-part series by the Advocata Institute and LIRNEasia on what needs to be done to empower Sri Lanka’s micro, small-medium businesses for post-COVID economic recovery. In Part 1, the Advocata Institute examined the barriers faced by small businesses to formalization and what needs to be done to lower them. In this part, LIRNEasia looks at what is holding SMEs back, through the lens of digital exclusion.

Connectivity is related to better business performance

 A 2019 LIRNEasia survey of SMEs across Sri Lanka showed that businesses classified as ‘high’ ICT users performed considerably better on a number of indicators such as revenues, profits, number of customers, etc. (Figure 1).  Perhaps most interestingly, they were also connected to a global value chain in some way. 

Figure 1: How SMEs classified as high ICT users are different to those classified as low ICT users (Source: LIRNEasia AfterAccess SME survey, 2019)

Dear sir, optimism is not a strategy

Originally appeared on The Morning

By Dhananath Fernando

The Govt. must start pulling the economy in one direction

The former Chief Pilot of Air Lanka and former Boeing 747 instructor Captain Elmo Jayawardena is someone I know well. He has had a long career as a pilot at Singapore Airlines. Out of curiosity I often question him on how flight operations work. He describes vividly the level of detail with which pilots go through pre-flight checklists before they sit in the cockpit; fuel levels, weather patterns, emergency landing at each phase of the journey, and so many technical details get evaluated by them.

He always talks about a “plan B”. As pilots always operate on the basis of something going wrong and having a back-up plan for it, I feel they are very pessimistic – my judgemental thoughts on their level of planning and carefulness. However, one day I asked Captain Elmo: “Can’t you become an optimistic pilot, thinking that everything will be fine? There are so many aircrafts taking off and landing safely and very rarely do we hear about plane crashes. So, do you have to really go into that level of planning?” He answered: “Optimism is not being ignorant or denying the possibility of a potential risk scenario. Optimism must be grounded in reality that all events and decisions have a risk factor.” I then realised that one can be genuinely more optimistic if you have a plan to face the worst-case scenario.

Looking back at Sri Lanka’s economy provides some important lessons on how we have dealt with optimism. We as a people have always lived in an optimistic state. After Independence, we thought it was all over. Then following the end of the youth insurrections and  30-year long civil war, we looked forward with optimism. This period was followed by a window of economic reforms, with the end of the war adding to our economy.

However, we missed that grand opportunity of reform as we only focused on short-term development.  We failed to put our economic fundamentals right! As this column has highlighted previously, since 2015 up to date we have faced five major shocks to our economy – the Central Bank bond fiasco, drought in 2017-2018, a constitutional coup in 2018, Easter attacks in 2019, and Covid-19 in 2020. These events have decided the fate of our current economy and pushed it to where it is today. However, some of these events are due to misfortune and the others are examples of mismanagement. 

In this context, the Government still looks very optimistic about the growth numbers for next year and provides messages of absolute confidence that Sri Lanka can overcome the current situation through medium and long-term growth. In order to walk the talk, the Government did not reverse any tax concessions announced in December 2019, even with two rating downgrades by Moody’s and Fitch. Likewise, the Government has provided an optimistic message to all our creditors, assuring them that we will pay all our debts, taking into account our track record of servicing the debt without any default (with rescue efforts from the IMF [International Monetary Fund], World Bank, and the ADB [Asian Development Bank]).

All the positivity and clear, focused messaging by the Government is commendable. However, the Government should not divert from the real situation on the ground in this Covid-19 world, where external support may not be easily available as in the past. The Government must understand the impact of this on our short, medium, and long-term credibility.  A recent Citi Bank report for their investors highlighted the same concerns again. What is missing in this puzzle for many investors is a credible action plan. Having a credible action plan is similar to the planning that a responsible pilot carries out. It illustrates accountability for creating a safe and pleasant flying experience. This helps build trust and confidence about the pilot among passengers and also provides them the peace of mind that they will reach the destination safely.

This is done by having a plan on how to achieve the goal and what needs to be done in case of an emergency.  When we provide a positive message without a strategy or action plan to back these arguments, then this affects our credibility and our partners may not take us seriously. Even if we have a strategy and if we fail to disclose it with objectivity, then this raises concerns about our sincerity and commitment to overcoming the looming economic crisis.

The Government’s growth is expected through Foreign Direct Investments (FDIs) and exports according to the Budget 2021. Both these inflow sources are very sentiment-driven and an optimistic psychology without an action plan may not build the image we want to project – an image that attracts top investors, companies, and gives the edge to reach export markets. Tourism, which we expect to open in the first quarter of 2021, is even more sentiment-driven than the above two. Over the years, none of the necessary and serious reforms have taken place to signal the markets to attract more investments or encourage exports to take off.  We should explain our logic of how Sri Lanka is going to pay on average $ 4 billion every year for the next five years. It must be noted that we have $ 5 billion in reserves at hand and with two credit rating downgrades, interest rates will increase on further borrowing. If we can explain the logic of how we are going to manage the numbers with a credible plan, then the key stakeholders can work towards materialising the plan and achieving results.

On the other hand, we should not forget that our strategies are comparative to the strategies of the rest of the world. The rest of the world competes with us for the same export markets, for the same investors, with their own advantages and disadvantages. So reaching new export markets and attracting new investment is a competitive process which we can’t ignore. It is credibility and reasoning that matters when attracting these inflows.  Looking at the past, we cannot ignore the possibility of new shocks that might occur during our recovery period. So we have to be prepared!  

As his Excellency the President mentioned in his meeting with the Central Bank a few months ago, we can’t let the health crisis lead to an economic crisis. Likewise, we cannot let the economic crisis lead to a social crisis. Our optimism cannot lead to denial or a blindness to the ground reality – that there is a significant challenge right at our doorstep. I am all for optimism and positive thinking, but as my mentor, Captain Jayawardena said: “We can be genuinely optimistic only if we have a plan to manage the worst-case scenario.”

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.