Coming out a winner

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

Understanding the problem 

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

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

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

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

Short-term solutions 

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

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

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

Medium-term solutions 

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

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

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

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

Long-term solutions 

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

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

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

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

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

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

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

What is GSP+?

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

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

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

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

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

Looking at the problem from an economic point of view

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

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

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

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

Whether our competitors have become better 

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

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

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

Solutions

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

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

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

Knocked down by policies made under the influence

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

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

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

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

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

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

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

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

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

Living the same economic year 73 times

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Rich man plays, poor man pays

Originally appeared on The Morning

By Dhananath Fernando

How we end up footing the bill for Government price controls

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

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

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

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

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

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

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

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

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

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

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

What is the solution?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

What is the solution?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

What is the solution?

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

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

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

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

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

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

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

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

The bottomless pot of Sri Lankan monetary policy

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

How good policy could have helped

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

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

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

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

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

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

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

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

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

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

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

We have a COVID education crisis; do not turn it into a catastrophe

Originally appeared on The Daily FT

By Dr. Sujata Gamage

We may recover from the health impact or the economic impact, but the impact of lost years of education for children or children lost to the system due to dropping out will present a COVID education catastrophe with long-term implications

Schools have been closed for more than 16 months. News of school closures and brief re-openings have dominated the news. Success at holding examinations gives us a false sense of achievement. The Minister of Education has been heard to say that online education is continuing despite school closings. Such statements show a complete lack of understanding of the ground situation.

At the ground level, yes, teachers have been reaching out to students as best as they can. According to a survey carried out by the Education Forum Sri Lanka in November 2020, almost all teachers have used social media such as WhatsApp to reach out to their students, but they have been able to connect to only 45% of the students on average. Of those only ~5% were reached via software such as Zoom or Teams which give a real-time online education experience. Even for the 45% total who were contacted by schools, the mode of education is really a repeat of the usual chalk-talk education, but now in distance mode. The objective is to ‘cover’ the syllabus.

However, more important than covering the syllabus is having the school contact each child to inquire after his/her situation. We all know that it is difficult for children to be trapped inside. But in addition, not every home is a safe place for children. Domestic disputes affect the kids. These disputes can turn violent. In some homes, children are abused. Some disadvantaged children who receive school lunches could go hungry when schools are closed. 

 Warnings by experts

At a recent policy dialogue by the Education Forum Sri Lanka, Dr. Tara de Mel warned that we may recover from the health impact or the economic impact, but the impact of lost years of education for children or children lost to the system due to dropping out will present a COVID education catastrophe with long-term implications. She made a plea for short-term remedies to reach out to each child, and for planning NOW to reopen schools as soon as the present third COVID-19 wave subsides. 

Weerasinghe, the Director of Education responsible for the Vavuniya South Education Division, echoed Dr. de Mel’s sentiments saying that the Vavuniya South division he represents has a diverse community from farmers in the interior to fishermen in the coastal areas, and children of such communities were difficult to contact. These children may have dropped out of education altogether.

Weerasinghe further said that during the lockdowns in 2020 rural schools gained somewhat on urban schools presumably because the small rural schools were able to work under the radar to bring children to school under health guidelines of local medical authorities. That is not possible now because the Ministry of Education has issued an all-encompassing closure of schools. Weerasinghe questioned the logic of applying equality of policies to a widely diverse set of schools. 

For example, policies regarding school openings are made with crowded urban schools with students from across the country in mind, when smaller schools serving a contained community could well stay open. We need school-based solutions, he emphasised. Further he noted that we need to give pride of place to teachers and expect them to take responsibility for the education of children under their charge and supporting the teachers to do their job.

Renuka Peiris, former Director of Health and Nutrition at the Ministry of Education, noted that children are now expected to learn in a home environment which is quite different from the school environment. To compensate, they need to be given a timetable appropriate for self-study in a home setting and teachers need access to model lessons. 

The teacher-student interactions should be tracked randomly to make sure that teachers are adapting well to the new mode. The focus in distance education is only on educational achievement and the three national examinations. Is that the objective of education, she asked?

There was consensus that there must be equal emphasis on student educational achievements, their social-emotional learning, and their health and well-being. In distance education the focus has entirely been on transmitting educational content, missing all three purposes of education.

Decentralising education management

Regarding decentralising education management allowing schools to make decisions about opening or closing of schools, Renuka Herath said that by statute the Director General of Health is the ultimate authority for all decisions related to a pandemic, but that power is delegated to Medical Officers of Health (MoH) at divisional level. At the school level, the principal may make the decisions in consultation with the MoH for the area, if power to make such a decision is delegated to the school level by the Ministry of Education. 

There is indeed a circular from the Ministry that authorises schools to just that (Circular 2020/15) but when the ministry decides that all schools, say in the Western Province, should be closed, school-based committees cannot override such a directive. The Ministry of Education should make decisions on school opening or closing with sensitivity to children attending smaller schools serving small communities.

Time to act

Taking the ground reality into consideration, the Education Forum Sri Lanka has called upon the Ministry of Education and Provincial Departments of Education to recognise and act on the following without delay:

1. Content delivered over TV, WhatsApp or in print form is not education: The archaic transmission mode of education practiced in the Sri Lankan education system came to the fore during COVID-19. Teachers sent PDF files over WhatsApp to parents with smartphones, clogging their phones and forcing them to get pages and pages of notes printed. Learning happens not in transmission but in the engagement of the child with the content under the guidance of a teacher. Teachers need only send instructions to use existing textbooks and workbooks which should have been made available free to students at the beginning of the year.

2. Parents cannot replace teachers. Schools are responsible for keeping home-bound students engaged 7:30 a.m. to 1:30 p.m. on designated school days: A bi-weekly self-learning plan should be provided for each child and a teacher should follow-up with him/her at least once a day. Ninety six per cent of households in Sri Lanka have access to a mobile phone. Teleconferencing is possible with analogue phones. There is a teacher for every 16 students on average. There is no excuse for not reaching out to every child.

3. A reduced curriculum covering the essential learning outcomes in language and math, for example should be provided and teachers given the freedom to integrate learning outcomes in other subjects. The Academic Council of Bhutan, for example The Royal Education Council of Bhutan, for example, released an Education in Emergency (EiE) Prioritised and Adapted Curriculum as early as July 2020. National Institute of Education Sri Lanka has already identified ELC for primary education. 

4. Diagnostic tests to identify the “learning lags” in essential competencies should be made for Grades 5 onwards for use by students for self-assessment or by teachers for keeping track. These can be developed and administered by Provincial, Zonal or Divisional directorate level.

5. Modalities for engaging in learning should be entrusted to schools, with supervision by closest authority and subject to schools covering essential competencies: On average only 50% of students engage ‘online’ learning. If the curriculum is reduced, teachers can use the time saved to reach out to those unreached using offline methods suitable for each locality.

6. School attendance committees at GND Level should be reactivated to monitor and support home-bound children: Children’s anxieties and mental health issues, abusive homes, poor nutrition are other critical issues. Regulation 1005/5 of 1997 mandated School Attendance Committees comprising principals, school development society representatives, and education health, and welfare authorities in each GND to keep track of families with school-age children. These committees should be reactivated immediately. 

7. Decisions regarding school opening/closures should be delegated to authorities as close as possible to the affected communities: Schools in low-risk areas should be allowed to keep open. Even in high-risk areas, principals, and teachers in consultation with relevant committees can decide on appropriate school re-opening schedules and isolation modalities. Strategic plans for a more permanent way of keeping schools open should be developed with vaccinations and testing underpinning such plans. 

8. Teachers are frontline workers. They should receive priority in vaccination: When health-care-workers are considered as frontline workers deserving immediate vaccination, the same should follow for teachers considering the repercussions of school closures across the society and the economy. 

9. Personnel and students in schools in high-risk areas should be tested regularly: A cost-effective testing system should be designed so that teachers and students are tested regularly. If a student or a teacher is tested positive, individual classrooms or groups of students should be isolated, instead of closing the entire school. 

10. Blended learning should be adopted as the norm when schools are in session so that teachers and students can transition smoothly to home-based learning during an emergency. Best-practices in this regard can be sourced from countries which have already adopted this kind of learning.

Dr Sujata Gamage is a Senior Research Fellow at LIRNEasia, a regional think tank based in Colombo, Sri Lanka. She specializes in planning, evaluation and capacity building in education, ICT in education, research and research networks, and public sector performance using data analytics, institutional research, scoping studies, systematic reviews, statistical methods and simulations. She is also an advisor to the Advocata Institute.

Prof Colombage: Central Bank's V shape recovery projection unrealistic

Originally appeared on The Daily FT

By Prof. Sirimevan Colombage

There is an impending danger that delaying corrective policy decisions might push Sri Lanka towards an L-shaped recovery, prolonging the pandemic-led recession indefinitely

Sri Lanka’s economy contracted by 3.6% in terms of Gross Domestic Product (GDP) in 2020 in the aftermath of the outbreak of COVID-19 pandemic, recording the worst economic performance, as in the case of many countries. Industrial output declined by 6.9%, largely reflecting the adverse performance in apparel, manufacturing and construction. The services sector contracted by 1.5% due to the setback in tourism, transport and personal services. Agricultural production too fell by 2.4% in 2020.

In an effort to revive the economy and to mitigate the adverse impact of the pandemic on individuals and businesses, the Government has implemented a series of measures including health allocations, cash transfers and tax postponements.  These have been supplemented by the monetary easing policy adopted by the Central Bank since last year.

Despite such proactive measures, Sri Lanka is experiencing a prolonged economic recession due to the outbreak of the third wave of the pandemic. The economic recovery has become even more difficult due to the macroeconomic constraints faced by the country even before the pandemic. They include growth slowdown, high fiscal deficit, debt burden and balance of payments difficulties. 

 Alphabet of economic recovery

Questions have been raised across the world regarding the shape of the economic recovery from the COVID-19 pandemic applicable to different countries; whether it is V-shaped, U-shaped, W-shaped or L-shaped.

The best-case scenario is the V-shaped recovery in which the economy rebounds quickly after a sharp decline. In a U-shaped recovery, it takes months or years to revive economic activity. In a W-shaped recovery, the economy recovers quickly but falls into a second recession. Hence, it is known as a double-dip recession. 

The worst-case scenario is the L-shaped recovery in which the economy fails to recover in the foreseeable future.

Central Bank’s V-shaped projection unrealistic

As per the medium-term macroeconomic outlook presented in the Central Bank’s Annual Report-2020, the Sri Lankan economy is expected to rebound strongly in 2021 and sustain the high growth momentum over the medium term, buoyed by growth-oriented policy support. 

Accordingly, the economy is expected to achieve a V-shaped recovery with GDP growth jumping exorbitantly to 6.0% this year from the negative growth experienced last year, as shown in the chart. The growth momentum is projected to remain in the next five years accelerating the growth to 7.0% by 2025.

The Central Bank’s above projection seems to be over-optimistic, given the structural economic imbalances that have been prevailing in the country for a long time, leaving aside the adverse effects of the pandemic. This is clearly reflected by the fact that the economy was already on a downward path even before the pandemic. 

GDP growth averaged only 3.7% during the ‘Yahapalana’ regime of 2015-2019. The average growth rate was down to mere 3.1% in 2017-2019, the period immediately preceding the pandemic. 
Based on our time series projections as shown in the dotted line in the Chart, the annual GDP growth would not have been more than 2% from this year onwards, assuming there is no COVID-19 pandemic. The scenario appears even worse when a non-linear trend projection is applied, which indicates negative growth in the medium-term even without the pandemic. 

Thus, Sri Lanka’s economic downturn is deeply rooted in factors beyond the pandemic which call for immediate policy action.

As the pandemic has exacerbated the economic slowdown, it is highly unrealistic to anticipate a V-shaped economic recovery overtaking the pre-pandemic growth, as projected by the Central Bank.

SL’s poor growth record

Following the cessation of the war in 2009, the economy followed a high growth path supported by the revival of production activities in the north and east together with post-war reconstruction and infrastructure development. However, that construction-based economic recovery was short-lived due to the lack of sustainable growth strategies, fiscal imbalances and export setback. 

The weak economic performance has continued during the ‘Yahapalana’ regime during 2015-2019 in the absence of a coherent economic reform agenda aimed at export-led growth. 

SL lacks technology-driven growth

Economic growth achieved thus far has been driven by using more factors of production – capital and labour. Such growth is identified as ‘factor-driven growth’.  The economic slowdown immediately prior to the COVID-19 pandemic indicated that the economy could not grow any further solely depending on labour and capital inputs. 

In other words, Sri Lanka has reached the ‘Production Possibility Frontier’ (PPF), in economic terminology. Raising the output beyond PPF requires application of technology and innovation thus enabling the economy to materialise ‘technology and innovation-driven growth’. 
In the current global set up, technology and innovations based on human capital are the core growth drivers in many fast-growing countries, which have achieved the knowledge-economy status. Sri Lanka has been lagging behind in terms of knowledge economy indicators: economic and institutional status, education and skills development, Research and Development (R&D) and information and communication technology. 

Unless appropriate policy measures are adopted to fill such gaps targeting technology and innovation-driven growth without further delay, it would be impossible to revive the country’s economic growth hampered by the pandemic in the near future. 

Sri Lanka has lost numerous opportunities to achieve such growth in the post-liberalisation period mainly due to the politically-motivated decisions adopted by successive governments leaving aside economic priorities.

Import-dependent export growth 

A country’s long-run growth rate is constrained by its export capacity and import demand, according to the well-tested theory introduced by Prof. Anthony Thirlwall of University of Kent in 1979. It is known as ‘Thirlwall’s Law of ‘Balance of Payments – constrained economic growth’. The larger the trade surplus (exports minus imports), the faster the economic growth. 

In the long run, therefore, no country can grow faster than that rate consistent with balance of payments equilibrium on current account, unless it can continuously finance ever-growing deficits by foreign borrowing which, in general, is impossible, as evident from Sri Lanka’s experience. 

The country’s envisaged economic recovery largely depends on its ability to raise exports. The pandemic-hit export sector showed some resilience in the first quarter of this year recording a 12.6% increase in total export earnings; industrial exports rose by 7.9%, and agricultural exports by 31.0%. Nevertheless, the trade deficit expanded in the first quarter due to a 12% increase in import outlays. 

The Government has imposed import restrictions on a variety of goods since last year to ease the balance of payments difficulties. Given the high import content of domestic production, such restrictions have downside effects on the export sector as well as on overall economic growth. The recently-announced import ban on chemical fertiliser will adversely affect the agriculture sector, causing food security problems during the pandemic.

Thus, import controls are likely to prolong the pandemic-led recession, as per Thirlwall’s law. 

Selective import relaxation for lawmakers

Whilst import restrictions on some of the essential goods consumed by ordinary people (including turmeric) are in force, the Cabinet is reported to have given its nod to permit importation of luxury vehicles for MPs, reflecting the Government’s absolute insensitivity to the country’s fiscal and foreign exchange crisis amidst the pandemic.  

In contrast, New Zealand’s Prime Minister has said she and the ministers will offer a 20% pay cut lasting six months to show solidarity with those affected by the coronavirus outbreak, as the death toll continues to rise. 

CB’s frequent tinkering with export proceed conversion rules

Last week, the Central Bank once again revised the rules on repatriation of export proceeds, requiring 25% of the proceeds to be converted within 30 days after receiving such proceeds. 

The Monetary Board keeps its discretion to determine the specific export sectors or industries or individual exporters, who or which may be permitted to convert less than 25% of the total of the export proceeds received. This, however, will continue to be subject to not below 10% conversion of the export proceeds and received no later than 180 days from the date of shipment. 

Such discretionary rules introduced in a bid to salvage the country’s foreign exchange situation have severe detrimental effects on the export sector hit by the pandemic, as reiterated in this column earlier. 

Fiscal deficit and debt burden

A crucial macroeconomic imbalance that impinges on Sri Lanka’s growth recovery is the fiscal deficit and the accumulating debt service payments. The budget deficit rose to 11.1% of GDP in 2020 and the available indicators show even a higher increase in the deficit over 13% of GDP this year. 

The continuation of the arbitrary tax cuts and the expenditure hikes already worsened the fiscal situation requiring frequent borrowings from domestic and foreign sources. Annual debt service payments amounting to around 150% of the Government revenue exert enormous pressure on budgetary management. 

While the Central Bank’s low interest rate policy helps to ease the domestic debt service burden, the depreciation of the rupee in recent weeks makes external debt service payments extremely costly. 

Overdependence on foreign loans and swaps

Instead of pursuing the Government to stick to a fiscal consolidation programme targeting a lower fiscal deficit so as to ease the debt burden, the Central Bank continues to rely on short-term foreign borrowings and swap arrangements. This is in addition to its accommodative monetary policy stance with regard to Government’s domestic borrowings.  

Last week, the Bangladesh Bank has agreed to provide a swap facility of $ 200 million. Sri Lanka received renminbi-denominated swap of $ 1.5 billion from China last month. In addition, the Republic of Korea last month agreed to provide concessional loans amounting to $ 500 million to finance the identified projects. 

More swap facilities are in the pipeline, according to the Finance Ministry sources, as reported in the media. 

Fresh debt-funded infrastructure projects 

Meanwhile, the Government is reported to have launched several major debt-funded infrastructure projects including highways a few days ago amidst the pandemic and severe external debt problems. Such borrowings will certainly aggravate the country’s staggering macroeconomic imbalances.

U- or L-shaped recovery for Sri Lanka?

In the backdrop of Sri Lanka’s growth slowdown even prior to the pandemic, the V-shaped recovery projected by the Central Bank is far from reality. 

Assuming a best possible scenario, hopefully the economy would revive after two to three years characterised by U-shaped recovery. The bottom of the U shape represents the extended period of the recession before recovery. 

A longer post-pandemic U-shaped recovery implies that the economy will take a number of years for recovery. First and foremost, the length of the economic recession depends on how long it takes to eradicate the coronavirus at the national and global levels.

Proactive policies are essential to correct the macroeconomic imbalances, specifically the fiscal deficit, bad debt dynamics and the balance of payments deficit so as to revive the Sri Lankan economy at least with U-shape recovery, which is considered to be the second-best option below V-shape recovery. 

There is an impending danger that delaying corrective policy decisions might push Sri Lanka towards an L-shaped recovery, prolonging the pandemic-led recession indefinitely. 

(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)

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

Originally appeared on The Morning

By Dhananath Fernando

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

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

Let’s understand the crisis first.

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

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

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

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

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

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

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

Implementing such reforms will bring in newer opportunities.

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

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

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

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

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

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

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

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

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

Work Together or Die Alone

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Are we getting the Port City Right?

Originally appeared on The Morning, Daily News, Lanka Business, Daily FT

By H. Dabarera and K.D. Vimanga

The Supreme Court determination on the Colombo Port City Economic Commission Bill will be announced by the Speaker to Parliament today (18) and the Bill will be debated in Parliament tomorrow (19) and Thursday (20).

Over the last few weeks, Sri Lankans have contemplated if the proposed Colombo Port City is the messiah that will rescue the country’s economy or whether it is another Trojan Horse that will throw firewood into the already smouldering regional geopolitical furnace. 

The Port City as a model has the potential to be a driver of growth. For that, it must be governed well within a globally accepted, transparent and accountable regulatory framework. The project can bring in much needed foreign investment and kickstart growth especially at a time when the state of public finance is weak with a looming risk of default of debt. 

The major part of the investment for the Colombo Port City is already made, hence there’s no option other than making use of it and making it work. However, it must be done in a manner that does not compromise the best interests of Sri Lanka and our regional partners. 

The proposed bill aspires to have a financial centre within the proposed “special economic zone” in the likes of financial centres such as Singapore, London and New York. Then it is crucial that such a centre maintains a separate legal and regulatory framework that is unhindered by the delays and loopholes in the local court system and is established in accordance with international norms and practices. If implemented correctly, a financial centre can open up opportunities in investment banking, insurance, off-shore financial services, hedge funds, institutional investors, clearing houses, etc. A financial centre combined with international living standards and financing options can also be attractive for tech startups especially those aspiring to operate in the South Asian region. This creates opportunities for ambitious Sri Lankans for jobs they have to now go overseas. 

However, this is a process that is protracted over a longer period of time and is dependent on the confidence and trust that the project invokes for investors. The key to building trust and confidence is dependent on two main factors. One, having a sound financial regulatory system. Two, having global recognition and acceptance for the governing law. As a matter of fact, most financial centres resort to a framework based on English Common Law. 

Challenges 

The comparative advantage Sri Lanka has compared to regional financial centre’s such as Dubai, Mauritius, Singapore, Hong Kong, etc. is limited in its strategic location, hence attracting investors to bypass established financial centres will take significant effort. The comparative advantage Sri Lanka offers must be unique to attract the global investor! 

The island’s geographic proximity to the sub-continent and the present geopolitical landscape of securing friends and off-shore assets by the regional super powers makes a compelling case for many to develop the Colombo Port City as a regional hub to manage money from the heavy rollers in the region. 

However, becoming such a magnet for investment can only be done by building bridges with our regional partners. But the question is, is that simply enough? One might argue yes, as Sri Lanka’s economy is only a shade above $ 80 billion. However, the question arises if the global financial elite such as HSBC, Deutsche Bank, Citibank, Bank of China, IOB, JP Morgan etc, will enter Colombo Port City to do business. 

Is providing tax concessions simply going to bring in these reputed banks? Observing the behaviour of these banks simply illustrate that a vast majority of these banks make big investment decisions such as opening onshore operations by assessing a whole range of factors including the regulatory environment, especially in the case of emerging markets. 

So, is the proposed financial regulatory arrangement sufficient? At present the act vests power onto the proposed commission to regulate and monitor and steer banking operations within the area of the Colombo Port City with the concurrence of the identified national bodies such as the Minister of Finance and the Monetary Board. Therefore, the bill lacks a regulatory framework conforms with international best practices set out by institutions such as the Basel Committee on Banking Supervision and the Financial Action Task Force (FATF). This is done in order to facilitate such capital flows due to the serious concerns on money laundering. So, it is vital that this issue of a lack of a supervised financial regulatory system is addressed, if the Port City is to be operated as a productive financial centre. 

A second serious drawback of the drafted bill is the lack of an accepted global recognised governing framework such as English Law. If we are going to benchmark ourselves with established financial centres such as Singapore and Dubai, the said financial centre must be framed around English Common Law. The rationale for this stems from the fact that, English Common Law underpins the legal systems of the world’s four top international financial centres – London, Hong Kong and Singapore. This is further exemplified by how the Dubai financial centre functions as an independent jurisdiction governed by an English Common Law framework which is distinct from the rest of the UAE. Such a framework will bring in operational and cross jurisdictional mobility. This is because the global financial sector already functions on an English Common Law dominated platform. Moving to complaint jurisdiction with the same legal norms is the standard best practice. 

In fact, Sri Lanka ranks poorly in the World Bank’s Doing Business Indicator (99 out of 190 countries), due to the country’s fledgling legal system related issues and has fallen behind regional peers such as Nepal and India. 

So to attract the global banking elite such a framework is preferable and will not only open the core financial sectors such as banking, securities and derivatives, but also related sectors such as insurance, shipping, international trade, commodities and logistics. 

The legal framework for settlement of disputes 

For resolution of disputes the Commission is expected to establish an “International Commercial Dispute Resolution Centre.” Any dispute that arises within the Port City between the Commission and other entities within Port City shall be resolved by way of arbitration. Further, all agreements made by every authorised person with the Commission should have a provision on mandatory reference to arbitration for any dispute that arises within Port City. The International Arbitration Centre shall be the sole authority to hear all such disputes within the Port City. 

However, with regards to disputes that authorised persons within Port City can face over business activities carried out with other entities from all over the world, they will have the discretion to resort to any form of conflict resolution; litigation or any form of Alternative Dispute Resolution (ADR) mechanism in any jurisdiction of the world. Hence, the reputation of our International Arbitration Centre will matter immensely. Especially if we are to ensure that these disputes can even be heard within the Port City in the form of ADR. This will bring in much needed business to the arbitration centre while reducing the cost to the investors within the Port City as other centres such as London, New York, Singapore, Hong Kong, Dubai, etc. will be a costlier option than Colombo. 

International Arbitration Centres in Singapore and Hong Kong have gained worldwide recognition as leading arbitration hubs. They have made a significant contribution to the economic growth of these countries and helped them attract international business, trade and FDI. Thus, if strategically utilised, an international arbitration centre can be complementary to the growth of international business within the country. However, in order to ensure such results, it is essential that the International Arbitration Centre has in place a proper set of rules and principles to ensure swift resolution of disputes and ease through predictability and consistency to the business community. 

The current International Arbitration Centre in Sri Lanka, despite being based upon the UNCITRAL model law of Arbitration, has ultimately failed in winning over the confidence of the public and investors due to the arbitration proceedings dragging too long (as long as three years in certain instances). In the world of finance, time is money as money never sleeps. So special emphasis must be placed on maximising efficiency within the arbitration centre. Additionally, constant political instability in the country and the failure of the judiciary to uphold rule of law has also acted as hindrances to propel Sri Lanka as a global hub for International Arbitration. 

Drawing from these failures, it is evident that if the Port City is to become like Singapore or Hong Kong as an International Arbitration Centre it needs to introduce sound principles that are able to win over the confidence of the business community. 

A case for legal neutrality and jurisdictional independence 

It is also important for the International Arbitration Centre at the Colombo Port City to establish legal neutrality in the eyes of international stakeholders. Legal neutrality is of utmost importance for a financial centre as impartiality is key to attract investors and reputed financial institutions. Hence, ‘trust’ in resolving disputes impartially and transparently will be a deal maker for the Colombo Port City to become a success. Especially as it will be competing with financial centres in the region, of the likes of Dubai and Singapore who enjoy reputational synergies due to the merits of maintaining neutrality and also efficiency. This further makes a serious case for the Colombo Port City to be an independent jurisdiction within an English Common Law framework. 

An International Arbitration Centre, manned by local expertise may not deliver the credibility investors seek from a virgin financial zone that has to compete with established facilities that operate with a proven track record on efficiency, transparency and infrastructure. Hence, the International Arbitration Centre can be opened to accommodate foreign professionals with a proven track in arbitration. The addition of such provisions to the existing Bill can make the International Arbitration Centre at the Colombo Port City attractive and marketable to become an alternative financial centre for the South Asian region. Further the inclusion of English Common Law which the international financial markets are very well versed in can bring in significant benefits when functioning as a financial centre. If this fundamental issue is not addressed the Colombo Port City will yet again be a case of missing the bus yet again. 

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

Sri Lanka state fails in the core business: administration of justice

Originally appeared on the Economy Next

By Prof. Rohan Samarajiva

In a previous column I stated that “no political or economic theorist would argue that the state should not be engaged in the provision of law and order. . . even extreme libertarians would see a role for the state in law and order.”

Sri Lanka presents a façade of a functioning legal system. Justices and judges get appointed; ceremonial sittings are held. Funds from World Bank loans are expended; buildings are constructed. Lawyers walk around briskly in court premises; many of them live well.

But it is rare to see a modern state fail so badly in this core function.

Evidence of failure

The President’s Counsel currently serving as Minister of Justice presented the evidence in a speech to the 47th Annual Convocation of the Bar Association of Sri Lanka:

– the average time to enforce a contract in Sri Lanka is 1,318 days

– We have been ranked 161 out of 189 countries for the enforcement of contracts

– Our legal system is ranked 5th out of 8 in South Asia.

– Land, Partition and Testamentary cases on average take a generation to be settled.

– A criminal trial takes on average 9½ years to conclude in the High Court.

– A criminal matter on average will take a year to be fixed for appeal and 3-4 years for the said appeal to be completed.

But this is not all. From 1978, we have had justiciable fundamental rights. Fundamental is defined as “forming a necessary base or core; of central importance.” Therefore, one would expect fundamental rights cases to be given higher priority than the cases listed above.

But that is not the case. It took the Supreme Court until 2021 February to issue a decision on a fundamental rights case, Kurukulasuriya v Sri Lanka Rupavahini Corporation (SC FR Application No. 556/2008 & SC FR Application No. 557/2008), notwithstanding the unequivocal language of Article 126(5) of the Constitution: “The Supreme Court shall hear and finally dispose of any petition or reference under this Article within two months of the filing of such petition . . ..” Instead of two months, it took 145 months.

It is said that justice delayed is justice denied. Can it be said that justiciable fundamental rights exist in Sri Lanka?

Then let us look beyond law’s delays, at egregious injustice. At qualitatively bad decisions. We had a Chief Justice who publicly admitted that he absolved the current Prime Minister in the Helping Hambantota case on political grounds.

But this man’s unjust decisions were many, as I documented in an article published in the Financial Times of 27th November 2008. A bench headed by this Chief Justice decided on the 21st of July 2008 (CS/FR 209/2007) a matter that only came up for argument on the 27th of November 2008 before a different bench. That’s right. The case was to come up in November, but the decision was given four months earlier.

The bench headed by the Chief Justice ruled on the tax exemption in July: “The tax relief granted to JKH was not permissible under the existing Regulations and JKH got an amendment tailor made for its purpose and secured the tax exemption” (CS/FR 209/2007, pp. 60-61). Yet, the respondents in the case that came up for argument in November, including the then BOI Chairman Dhammika Perera, the BOI Chairman when the tax exemption was granted Arjuna Mahendran, and former Commissioner General of Inland Revenue A.A. Wijepala, all needed to determine the legality of the exemption, were not among those noticed in CS/FR 209/2007.

By initiating a separate case that was taken up for argument on 27th November and serving notice on the above individuals, the plaintiffs of CS/FR 209/2007 conceded that the tax matter was not part of that case. Yet, the Chief Justice issued a ruling, violating natural justice.

Was the former Chief Justice the only malefactor? What about the other justices on that bench? What about the counsel? I purposely published my indictment on 27th November 2008, the day the tax-exemption case was to be taken up.

It would have been difficult to miss because the editors had put a black border around it and stated that they were not responsible for the content.

Did anyone in the judiciary or the legal profession do anything about it? Was an inquiry initiated? No. Is it unreasonable to conclude that the rot in the legal system was not limited to one out-of-control Chief Justice?

Has the Attorney General’s Department, which wields enormous power, been insulated from the rot? Does it exercise prosecutorial discretion in a fair and reasonable manner? The large number of prosecutions dropped when governments change raise legitimate doubt.

Does the Legal Draftsman’s Department do its job in a professional manner? How could a Constitutional Amendment that sets a quorum of three for an Elections Commission with a membership of three have been cleared by that Department?

How could it have neglected to include the Consolidated Fund as a continuing source of revenue for the Fund of the Disaster Management Council in the Disaster Management Act, No. 13 of 2005?

What is being done?

The current Minister of Justice is striking the right notes:

“It is vital that we look at a complete structural change from end to end and roll it out in a targeted and efficient way. We have to stop looking at the legal profession as one which exists solely for the sustenance of its members, but as one which plays a much more important role as a public centric body which is driving the justice system forward – one which is ready to innovate, to evolve and to take the right decisions at the right time to create a paradigm shift in the administration of justice.”

Even if done in a way that was not quite proper, the Minister has increased the number of judges in the superior courts. Funds have been allocated for court automation. It is hoped that the foundation laid by the comprehensive study completed in 2017 and the extensive consultations the ICT Agency conducted with the judges of the superior courts in 2019 will be built upon.

The above actions will, if adapted from a working system in another country, carefully piloted and scaled up, and supported with the necessary technical personnel, fix the dysfunctions in the “registry” part of the court system, which involves, or should involve, low discretion. If the system is transparent to lawyers, litigants and the public and is hardened to resist malicious attacks and manipulation, a key piece of the solution will be in place. But this will not, by itself, yield the desired outcomes.

The procedures and rules must be redesigned placing the needs of the litigants at the center, and not those of the lawyers and the judges. Even if it is a monopoly buttressed by archaic and arbitrary contempt-of-court rules, what the courts do is supply a service.

The litigants want a service, and they pay for it, either directly or through their taxes. They should be treated with respect and provided the services they seek at high levels of quality.

Decisions, even against those charged for criminal offenses should be of high quality in that they have been reached based on the relevant procedure, and are based on the best possible evidence. High quality also means not having to live in limbo for years, while lawyers and judges take their own cool time.

Unless procedures are reformed to put the litigants at the center, law’s delays will continue. Judges must work reasonable hours and they must impose discipline on lawyers by refusing frivolous requests for postponements. Section 63(2) of the Colombo Port City Economic Commission bill illustrates the dysfunctions of the current system:

“In order to foster international investor confidence in the ease of doing business and in the enforcement of contracts, in the national interest and in the interest of the advancement of the national economy, the inability of a particular attorney-at-law to appear before the Court on a particular date for personal reasons (including engagement to appear on that date in any other court or tribunal) shall not be a ground for postponement of commencement or continuation of the trial or be regarded as an exceptional ground warranting such postponements.”

For cases involving companies registered with the Port City Commission, the conventional rules that privilege the convenience of the lawyers are not to apply. But the rest of us will not only have to continue to put our lives on hold for the convenience of the lawyers and judges; we will also have to suffer the indignity of the fast-track litigants from the Port City cutting in front of us in the queue.

Simply reforming the rules will not suffice. The overall quality of legal education must be improved with a greater openness to innovation. The lowering of the protectionist barriers erected to safeguard the earning potential of members of the legal profession is a necessary condition. In recent debates around bilateral agreements dealing with trade in services, activist engineers told me that they need the kinds of protections the lawyers had erected for themselves against foreign competition.

Innovation requires the transfer of tacit knowledge possible only by day-to-day interactions. It is energized by competition. It is only when the legal profession becomes open to innovation that the judges who are drawn from it can become innovative and responsive.

All professions are protective of the pecuniary interests of their members. They fight back when those interests are threatened in any way. Lawyers are fearsome adversaries. Even the most astute and committed politicians approach legal reform with trepidation. They understand that the reform will take the form of trench warfare unlikely to yield results within the political cycle. They devise workarounds.

Politicians can at least try. System-level workarounds are unavailable to ordinary citizens and businesses. Their workarounds are petty and, in some cases, illegal. They limit transactions to trusted parties, knowing unenforceable contracts are meaningless. They seek the services of thugs to enforce contracts. They keep buildings that can be rented for revenue empty.
Workarounds

The proposed Colombo Port City Commission is a workaround.

Legal-system-related factors are a main reason Sri Lanka is ranked 99th out of 190 countries in the Ease of Doing Business Indicator. Even Nepal is ahead of us; Pakistan is about to catch up. Poor performance in resolving insolvency and enforcing contracts are major contributors to Sri Lanka’s low rank. On enforcing contracts, the country is ranked 164th.

It is unlikely that high-profile financial and service businesses will want to locate offices in Sri Lanka in these circumstances. Despairing that the legal system can be improved, the drafters of the Port City Commission Bill propose to make arbitration by the International Commercial Dispute Resolution Center that is to be established within the Port City mandatory for disputes arising within its area of authority. They also propose a fast-track, exemplified by section 63(2) quoted above, for engagement with the Sri Lankan courts if required.

Despite all the talk of how bad bypassing the Sri Lankan legal system is, this has been going on for a long time.

The disputes between several international banks and the Ceylon Petroleum Corporation over hedging contracts entered in 2008 in the first Mahinda Rajapaksa government were not resolved by the Sri Lankan courts. Arbitrations on the contracts with Standard Chartered and Citibank commenced, respectively, before the English High Court and the London Court of International Arbitration.

Deutsche Bank’s arbitral proceedings against Sri Lanka for the actions of the CPC, Central Bank and the Supreme Court in relation to the failure to perform the hedging agreement were at the International Centre for Settlement of Investment Disputes (ICSID), an organization established by the 1965 Convention for Settlement of Investment Disputes between States and Nationals of other States (ICSID Convention).

The CPC lost the cases. They also bore the considerable costs of participation in expensive cities.

The legal agreements governing the Sri Lanka Telecom privatization by the first Kumaratunga government in 1998 did not give rise to a need for dispute resolution. But had such arisen, the arbitration would have been in Singapore under that country’s laws.

In this context, it is unlikely that commercial disputes where referral to the Dispute Settlement Center within the Port City is not mandatory will come to the Sri Lankan courts. They will go to Singapore, London, Geneva, or Washington DC. They will bypass the Sri Lankan legal system, understandably. At least the International Commercial Dispute Resolution Center will be on Sri Lankan soil and the lawyers need not be paid per diems.

Effects of workarounds

The petty workarounds of the citizen and the businessperson yield no good results. They simply overburden other parts of the system and let resources lie fallow.

We like to teach the Coase Theorem which describes the economic efficiency of an economic allocation or outcome in the presence of externalities. The theorem postulates that if trade in an externality is possible and there are sufficiently low transaction costs, bargaining will lead to a Pareto efficient outcome regardless of the initial allocation of property.

But with a dysfunctional legal system, the condition of properly defined property rights does not exist. Coasean bargaining is limited to the classroom. We are compelled to fall back on the command-and-control capabilities of the state, overburdening it further.

The system-level workaround of the Port City Commission Law could be a holding action until we improve our legal system and associated processes of relevance to investors and service industries that are to be attracted to the Port City.

In the same way that the Greater Colombo Economic Commission (GCEC) was to be a holding action until we improved the provision of planning, utility and related services throughout the country, there could be a plan to gradually bring the enclave within the general legal system which has been improved in the meanwhile. The doing business indicator measures good governance in the country as a whole (though for some components they focus on the capital), not in special enclaves.

It would be good if that were the case. But looking at the situation in the zones managed by the Board of Investment as the successor to the GCEC, we can see that the transition has not been completed even some 40 years later.

Even today, the services offered by the BOI in the zones are superior to those outside. We in Sri Lanka appear to be content with running superior systems and single windows for foreigners (and Sri Lankan who achieve such status) while letting the rest of the country suffer under second-rate systems and multiple windows.

The hope, always, is that the island of good governance will catalyze and drive reforms in the surrounding ocean of bad governance; that the land will take over the sea. We keep hoping.

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.

Budget 2021 : A good or bad kettle?

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

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

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

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

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

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

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

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

Fertiliser ban is flawed

Originally appeared on The Daily FT

By Prof. Rohan Samarajiva

The Cabinet Paper banning fertiliser, pesticide, and weedicide imports with immediate effect that was rubber-stamped last week without discussion constitutes a sea change in Sri Lanka’s agriculture policy. Its implications for consumers, for the livelihoods of farmers, and for those who have invested in agriculture and related sectors are vast. 

Despite the 20th Amendment, it is wrong to marginalise Parliament and to ignore State agencies with expertise. Because agriculture is a devolved subject, officials in the Provincial Councils should be consulted even in the absence of elected Council members. Given the expropriatory effects on the private property of those whose investments are affected, the authority of the Courts as the guardians of fundamental rights and as the upholders of equity is likely to be invoked.

No mandate for change

The Cabinet Paper is rather unusual. The entire justification for the proposed actions is anchored on the President’s election manifesto. No references are provided to studies, committee reports, etc.

It is foolhardy to build national policy on the weak foundation of manifesto promises. Each manifesto contains a multiplicity of promises. Was the vote a considered approval for each of those promises? 

The primary purpose of a manifesto is to convince citizens to vote for the candidate or political party presenting it. The secondary purpose is to gain legitimacy for specific actions. Manifesto making is political not scientific or systematic. 

Those who have been involved in manifesto making will testify to the opacity of the process, wherein what is accepted one day can disappear the next and new clauses and conditions can mysteriously appear even after “finalisation”.

Contributions can be sought, and consultations conducted, but in the end, decisions are made by a few in proverbial “smoke-filled rooms.” A manifesto is, at most, broadly indicative of orientation and priority-setting. Given the partisan and opaque procedure used to develop a manifesto, errors and impossible promises are unavoidable.

But because the Cabinet Paper lacks any other justification, one must look. Rather than rely solely on the quoted excerpts, I went to the source. The proposed actions are inconsistent with the language of the manifesto.

In order to guarantee the people’s right to such safe food, the entire Sri Lankan agriculture will be promoted to use organic fertilisers during the next 10 years. For this, production of organic fertiliser will be accelerated.

• To resuscitate the farming community, we need to replace the existing fertiliser subsidy scheme with an alternative system. In the new system, the inorganic and organic fertiliser both will be provided free of charge to farmers. They will be promoted to shift gradually into a complete system using entirely carbonic fertiliser.

• A system of assistance will be introduced to convert traditional farming villages into users of only organic fertiliser.

The language is anchored on food safety. But the ban affects fertilisers and chemicals used for all crops, not just what is consumed by citizens. There is a commitment to provide inorganic fertiliser free. The transition is to take place over a decade. These actions are to be taken in the context of “a new national agricultural policy would be introduced after an in-depth review of the present policies.” This promise is prefaced by a condemnation of “policy that changes from one season to another”.

No national policy based on review of existing policies and experience; no assessment of the experience of other countries; a policy that changes things in one week not a season. And most importantly, the telescoping of a 10-year process into a few months. Sudden, not gradual. Instead of free inorganic fertiliser, a ban. Not limited to traditional villages but across the board. The proposed bans lack a mandate.

Procedurally flawed

A change in a policy with broad impact requires care and caution. 

The change may do much good, as the Cabinet Paper claims. Because of the repeated claims that our food is contaminated with “vasa visa,” most consumers would support a change away from chemical fertiliser and pesticides. But they are unlikely to accept higher prices and unavailability. Hotels are unlikely to accept “ugly fruit”. Growers are unlikely to accept drastically reduced yields and/or inability to market their produce at prices that are above costs of production. The net benefit must be demonstrated, not simply asserted.

Growers large and small will be unhappy about being unable to recover the investments they have made in preparations for growing or in crops in the ground by this sudden reversal in policy. This response will also be shared by other participants in the sector who had entered perfectly legal contracts but are now unable to clear their shipments from the port. It is common sense for the government to give adequate notice of a change in policy or the law so that affected parties can make the necessary adjustments to their business practices minimising losses.

Policy changes that can do good, can also do harm. It is customary in policy formulation and implementation to look at relevant cases in other countries or in this country. Risk assessment, identification of collateral effects, and careful structuring of rules to avoid negative outcomes can be done by government officials or by external consultants with the required expertise. When the government liberalised the market for international telephony in 2003, we studied prior experiences in countries including Hong Kong (the most liberalised market in Asia) and India (to learn what missteps to avoid). 

The President claims that Sri Lanka will be the first to go all-organic. A cursory internet search will show that a fellow SAARC country, Bhutan, announced the intention to go all-organic in 2008; and that its experience has been assessed by independent scholars and published in the peer-reviewed and open scientific publication PLOS ONE in 2018 (DOI =10.1371/journal.pone.0199025). The abstract states: 

Organic agriculture (OA) is considered a strategy to make agriculture more sustainable. Bhutan has embraced the ambitious goal of becoming the world’s first 100% organic nation. By analysing recent on-farm data in Bhutan, we found organic crop yields on average to be 24% lower than conventional yields. Based on these yield gaps, we assess the effects of the 100% organic conversion policy by employing an economy-wide computable general equilibrium (CGE) model with detailed representation of Bhutan’s agricultural sector incorporating agroecological zones, crop nutrients, and field operations. Despite a low dependency on agrochemicals from the onset of this initiative, we find a considerable reduction in Bhutan’s GDP, substantial welfare losses, particularly for non-agricultural households, and adverse impacts on food security.

Does this mean that no other country should go all-organic? No. Is this the only study? No. The purpose of looking at the experience of others is to learn from them. It is irresponsible not make the effort to mitigate the negative impacts will fall upon consumers, growers and others in the sector and to design the policy most suited for local conditions.

Even within the country, prior knowledge existed because the fiasco of the previous Government’s effort to promote organic farming at the behest of Ven. Athuraliye Rathana, MP. That ended with much waste of public funds and the shutting down of the implementing agency, SEMA. It would not have been all wasted if the present Government made the effort to learn from it. 

The Government appears to have learned little from the palm oil ban that had to be walked back and modified. It is normal procedure to circulate a Cabinet Paper to all relevant Ministries for their input to and to win concurrence. Walking back and modifying is what happens when this procedure is not followed.

This blanket ban does not affect only food items consumed within Sri Lanka. It affects subjects under multiple Ministries. It can devastate non-food segments such as foliage exports. It is likely to strangle the fast-growing fruit and vegetable export industry which was subject to rigorous enforcement of standards such as Euro GAP that my organisation worked on with the Department of Agriculture and the exporters association. The Legislature can choose to take actions that result in such collateral effects. But it should at least have considered them. This Cabinet Paper does not.

What should be done

The Government should suspend the implementation of the Cabinet Paper and appoint an inter-Ministry committee of experts with the power to co-opt external experts to report back on a practical method of achieving the objectives of ensuring food safety and environmental conservation. Given the complexity of the changes and the collateral effects, it is best that a pilot be conducted. The larger program design should be based on those learnings. 

If the Government does not act responsibly, the Opposition should demand a select committee, or at least a debate in Parliament. Stakeholders should move the courts. Our food and our livelihoods are too important to be cavalierly toyed with by those learning on the job.

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 way forward for the Proposed Colombo Port City Economic Commission Bill

The Advocata Institute carried out an independent analysis on the proposed Colombo Port City Economic Commission Bill.

Following observations and analysis were formulated using insight from key public policy experts and scholars. We have written to all members of Parliament, highlighting these observations and made recommendations to maximise the economic outcome of the Colombo Port City Project.

To read our analysis and the elaborated outtake of the issue.

To read the letter in Sinhala

To watch the video on PORT CITYය චීන කොලනියක්ද?

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03 May 2021

Honoured,

Member of Parliament / Minister

The way forward for the Proposed Colombo Port City Economic Commission Bill

The Advocata Institute wishes to make the following observations on the proposed Port City Economic Commission Bill (the "Bill"). The Bill in its present state has weaknesses that should be addressed in order to maximise economic opportunities and outcomes. We would like to emphasize that the Port City could form an important step forward for the country but to be successful it must address the shortcomings highlighted below.  We call upon all parliamentarians from all parties  to work together to address these issues.

1. A Case for Special Economic Zones in Sri Lanka 

1.1 Special Economic Zones (SEZs) are a tried and tested means of bringing in positive value addition to an economy. They also have the potential to accelerate economic growth. This is best reflected in how SEZs such as Shenzhen in China, the Dubai International Financial Centre and Luban IBFC in Malaysia have grown into booming global financial, manufacturing and technological hubs. If implemented with the right policies and a globally accepted regulatory framework, the Colombo Port City is capable of achieving such outcomes.    

1. 2 According to our analysis SEZs benefit an economy by acting as:  

1. A magnet to attract Foreign Direct Investment.

2. A laboratory of experimentation to achieve a particular objective and then scale it up. 

3. A catalyst for structural transformations and ultimately diversify the local economy.

4. A regional pressure valve to increase employment in disadvantaged areas. 

1.3 However, the success of an SEZ can only be determined by evaluating the linkages generated within the local economy.  In other words, they can only be considered a successful policy tool if they encourage technology spillovers or knowledge diffusion that enable the local economy to acquire new productive capabilities. Following this rationale the Colombo Port City must be developed as a stepping stone to enhancing productivity, upgrading industrialization, and achieving export diversification. 

1.4 The productive capabilities of SEZs lie in how they allow governments to provide all the conditions necessary to attract investment within a limited budget. In their ideal form, SEZs are places that have all the facilities that firms need to thrive. Since each industry needs many complementary (public) assets to succeed, SEZs can play an important role in creating the right conditions for industrial success. This might include suitable land plots, hard infrastructure, and site-specific policies or clearances. Moreover, firms in SEZs can benefit from each other’s proximity – they can be each other’s suppliers and customers – thereby making a strong case for Sri Lanka to utilise SEZs to achieve economic growth.   

1.5 Given the thicket of red tape in Sri Lanka, in order to become truly effective SEZs require a degree of plenipotentiary powers. Following the literal rule of interpretation, plenipotentiary powers can be defined as “someone who is fully authorized to represent a government as a prerogative or having full powers”. The provision of such powers allows SEZs to operate independently and achieve productive targets without having to deal with tedious and time-consuming  processes that hobble businesses in the  rest of the country. This is why SEZs can effectively accelerate economic growth, while also being an incentive for Foreign Direct Investments.  

1.6 Sri Lanka has resorted to the use of plenipotentiary powers as a policy tool in 3 previous legislations. These are the Gal Oya Development Board Act No 51 of 1948, River Valley Development Board No 4 of 1975 and Greater Colombo Economic Commission Act No 4 of 1978. To understand what these plenipotentiary powers are, see Annexure 1. Hence, the use of plenipotentiary powers as seen in the Bill is not new to Sri Lanka. The Greater Colombo Economic Commission Act, which forms the precursor to the current BOI Act, provides the legal framework for these economic zones to act independently and prerogatively to achieve economic outcomes. According to a study by Boyenge (2007), in 1980 the zones accounted for only 8.8 per cent of total industrial exporters, however, by 1991 their share had risen to 44 per cent. By 2007, Export Processing Zones (EPZs) were contributing 38 per cent of the country’s total 9 exports in terms of value. A more recent overview of EPZs in Sri Lanka (Japan Development Institute, 2011) showed that 1,726 projects were in operation in the 12 zones, generating 346,516 employment opportunities. Therefore in our view the Colombo Port City Economic Commission having plenipotentiary powers streamlined towards the achievement of economic goals, satisfies a timely requirement.

2. Tax concessions

2.1 Taxes are the most important source of revenue for the government to fund essential public goods and services. However, in 2020, tax revenue fell to 8.1% of GDP exacerbating Sri Lanka’s already precarious fiscal situation. With a history of fiscal deficits, the compounding effects of debt financing has snowballed into serious concerns regarding debt sustainability. In 2020, central government debt is estimated at 101% of GDP and is expected to worsen in the coming years. 

2.2 The tax concessions as provided for in the Bill can create distortions within the economy while seriously impairing fiscal sustainability. For instance, in the labour market, it could lead to higher attrition rates in enterprises located outside the Port City due to tax concessions to local employees not being offered outside the SEZ. Businesses located within the Port City will also benefit from agglomeration effects of being in the Port City and having access to world class transport systems, utility services, preferential access to the highway and maintenance services. Therefore an investment in the Port City  should yield a much higher return, thus not requiring further fiscal incentives. There is of course a need for the zone to be competitive vis-a-vis other zones but the generous tax incentives being offered over and above the tax concessions already provided for under the Inland Revenue Act No.24 of 2017 will further compromise the progressivity of the tax system and affect competitive neutrality. 

2.3 There are however, instances when fiscal incentives (tax credits, grants etc) may be warranted, for example where private returns are below the cost of capital but social returns (positive externalities) can be generated. However, the existing Inland Revenue Act provides for such incentives- we recommend that the power to grant fiscal incentives be retained within the Ministry of Finance. Hence, we call upon the government to make the necessary amendments to the Bill to establish fiscal accountability under the Ministry of Finance. 

2.4 Research also suggests that the effectiveness of tax incentives in attracting FDI is low. The list of priority factors for investors is highlighted in Annexure 2. Tax incentives are marginally effective in terms of attracting FDI in comparison to other factors.

3. Financial Regulations

3.1 Developing a fully fledged OFC (Offshore Financial Centre) requires the relaxation of  capital controls to permit free movement of capital improving the ability to compete globally. However, given Sri Lanka's current status of debt sustainability, sovereign rating downgrade, and foreign exchange crisis, it may not be the most appropriate time to set up an OFC. Stringent foreign exchange controls in place as of now may not allow the relaxation of capital controls. Hence, it is prudent to delay the setting up of an OFC within the Port City, or risk the entire project failing.

3.2 The success of a financial center depends on the confidence and trust that it evokes in investors and customers. The key to building this trust and confidence is dependent on two factors. First, the governance structure in place, i.e., the laws, rules and regulations governing financial products and services. Second, the way in which the regulatory authority/ies apply and enforce the regulations. Further, these regulations must conform to international best practices set out by institutions such as the Basel Committee on Banking Supervision (BCBS) and Financial Action Taskforce (FATF) recommendations on anti-money laundering and combatting the financing of terrorism and proliferation (AML/CFT), to ensure global acceptance.  Any attempts to circumvent these standards could have adverse impacts on financial institutions operating in the rest of the country as well. There is, however, a case for moving from a rules based financial regulation, as is currently in place, to a more principle based financial regulation. Such a move encourages financial innovation and facilitates the expansion of  financial services in a dynamic global environment. There is also a case for unified regulation of financial services (a single omnibus legislation which has been adopted by other financial centres). The Bill only refers to regulation of banks and capital market institutions. It is silent on whether insurance companies would be allowed to operate within this jurisdiction and who would regulate that sector. It is of vital importance that this issue be addressed if the Port City is to be operated as an OFC.

3.3 According to the draft Bill, licensing (Section 42(4)) and regulating (Section 45) for offshore banking businesses is done by the Commission with the concurrence of the Monetary Board under the Banking Act No.30 of 1988. However, as per the bill the examination of such entities would be undertaken by a “competent authority” appointed by the Port City Commission (Section 49) and the Monetary Board may only call for information and reports from these entities through the Commission (Section 51).  But the Bill is silent on the expertise and experience of those who would be appointed by the Commission to undertake examination of these entities. Our recommendation is that until a separate financial regulatory framework for the OFC is set up in the Port City, and until persons with the necessary capabilities are recruited, the existing regulators must undertake both the regulation and supervision of financial institutions set up within the Port City.  

3.4 We also call upon members of Parliament to make an addition to clause 5, as subsection (k) reading “Uphold laws and regulations on anti-money laundering and terrorism financing” in light of the above mentioned AML/CFT issues.

4. Labour Regulations

4.1 The Colombo Port City expects to operate as a service-oriented SEZ that propels Sri Lanka to be a major trading and services hub within the Indian Ocean. It hopes to attract top-notch IT, financial service firms and types of businesses and economic activity that will be highly innovative. In order for such firms to thrive and grow, a labour environment that accommodates failure, mistakes and high rates of experimentation is crucial. 

4.2 This requires a flexible labour market with low redundancy and restructuring costs that promotes swift adaptability to market changes. Prioritizing labour solutions over capital will result in job creation that will ultimately benefit the country. However, the labour regulations in operation in Sri Lanka does not facilitate the same.

4.3 For instance, the Termination of Employment of Workmen Act (TEWA) was enacted in the early 1970s when the government in power at that time promoted inward-looking economic policies. It regulates the termination of workmen by employers with 15 or more workers employed and applies to only around 15% of the labour force in Sri Lanka. TEWA has been identified to pose two main issues: making dismissal of employees too difficult and expensive. The high severance costs TEWA imposes along with EPF payments for the formal sector are prohibitively expensive for employers. Hence, TEWA is challenged as an impediment to healthy development of the labour market, preventing the private sector from adjusting to the globalized economy. The rigid conditions imposed by TEWA has acted as a catalyst for the creation of a large informal sector that amounts to almost 70% out of total jobs in Sri Lanka. 

4.4 The formal sector offers many benefits, in comparison to the informal sector, that outweigh its costs. They are higher productivity, lower capital costs, increased access to finance, social insurance benefits like health insurance, pensions and most importantly higher pay. Hence, formal jobs need to be encouraged within the Port City by making its compliance standards more flexible. Unemployment is a social problem and its burden and economic costs must be borne by the society in totality instead of the retrenching firms alone. Such costs weaken them and leave less room for them to restructure and expand their firms. Therefore, the option of an Unemployment Insurance Scheme is a better mechanism to provide unemployment benefits funded through monthly contributions similar to the EPF and ETF.

5. Recommendations on Parliamentary oversight and Accountability

5.1 At present, the Bill states that the Commission should submit to the President or Minister in Charge, an annual report setting out the status of operations, income and expenditure of the Commission. Alongside this, it also provides for the audit of accounts of the Commission.

However, as the main parliamentary oversight mechanisms in place to examine the activities of the government bodies responsible for public accounts and public enterprises are the COPA and the COPE, we recommend that the Port City Commission be made accountable to these committees. 

5.2 In relation to the composition of the Commission, it is our recommendation that the Secretary to the Treasury be appointed as an ex-officio to the Commission since this would allow for fiscal accountability.

5.3 We believe that the nationality of the Commissioners should not be prescribed to avoid the exclusion of global talent. However, at the maximum, to only have it restricted to the appointment of a majority of Sri Lankan nationals. We also believe that the Director General of the Commission should be the best executive talent and therefore, should not be restricted to being a Sri Lankan national. 

5.4 We also believe that staggered appointments to the committee would ensure institutional stability, preserve institutional memory and political representation. This process entails the availability of a vacancy every year, allowing the government in power to make an appointment subject to procedures whilst ensuring that there is continuity as well as working across party lines. 

5.5 To be in line with the international governance standards, Advocata also recommends affirmative action to ensure that the Commission mandates a minimum of 1, preferably 2, qualified women to be appointed to the Commission. 

By approaching the Colombo Port City Economic Commission Bill from such an analytical perspective, and with the specific conditions of Sri Lanka in mind, at the minimum, the Advocata Institute recommends the consideration of the reforms outlined above to achieve maximum economic outcomes.

Yours Sincerely,

Signed by,

Murtaza Jafferjee  (Chairman, Advocata Institute)
Dhananath Fernando (Chief Operating officer, Advocata Institute)

---

Annexure

Annexure 1 

1. Gal Oya Development Board  Act No 51  of 1948

By way of Plenipotentiary powers the Gal Oya Development Board could: 

Article (5) -  The Board being given  absolute power to appoint officers and servants. 

Article ( 9) - Authority over roads and irrigation 

Article ( 10) - Determine fees and levies over the supply of water. 

Article ( 14) - Establish own departments 

Article (15) - Power over crown land 

Article ( 16) - Power over the acquisition of land. 

Article (21) and Article (22) Power to make laws and bylaws. 

1. River Valley Development Board Act No 4 of 1975 

By way of Plenipotentiary powers the River Valley Development Board could 

• Article (4) - Power over the appointment of  officers and servants

• Article ( 20) - Special powers over the administration of underdeveloped areas. 

• Article (21) - Power to make rules 

• Article ( 22) - Power to make laws 

1. Greater Colombo Economic Commission Act No 4 of 1978 

By way of Plenipotentiary powers the Greater Colombo Economic Commission could 

Article  16 

•  Implement the objectives of the commission

• Acquire, lease or sell land 

• Lay out industrial estates for sale or lease

• To enter into agreements with enterprises 

• Exercise, discharge powers and duties. 

• Carry out general duties 

Article  17 

• (1) Power to enter into agreements with any enterprise in and outside the authority and to grant exemptions from any law referred to in schedule B. 

Article 25 

• (1) Power to authorize any enterprise carrying on the business of banking. 

• (2) Authorize the operation of the banking business. 

Annexure 2

List of factors that are  more important than tax incentives for investors -  study done by the United Nations Industrial Development Organisation (UNIDO) in 2010:

1. Economic stability

2. Political stability

3. Costs of raw materials

4. Local markets

5. Transparency of legal framework

6. Availability of skilled labour

7. Labour costs

8. Quality of life for expatriate staff

9. Availability of local suppliers

10.  Bilateral agreements and treaties. 

Understanding economics, understanding life

Originally appeared on The Morning

By Dhananath Fernando

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Missing the boat again

Originally appeared on The Morning

By Dhananath Fernando

The many wasted opportunities to capitalise on Port City

This is just a funny story I have heard before; not a true one. Once upon a time, a man was caught amidst a flood, and his life was in danger. This man was extremely religious and believed that his God would rescue him from any threat to his life. A boat came to rescue the man, but he refused, saying that his God was going to help him. Then an emergency rescue team arrived, and he rejected them as well, saying: “I don’t need you. My God is coming to rescue me soon.” Flood became very serious and a helicopter arrived, but the man said he didn’t want anyone’s assistance and the same answer was provided.

Unfortunately, the man died in the flood and he met his god after death. At the very first meeting with his God, the man said: “I am very disappointed with you my God. You didn’t rescue me from floods”. God said: “I first sent a boat to rescue you, and then another emergency rescue team, and finally I sent a helicopter as the floods became severe, but you didn’t consider any of my attempts!”

When it comes to our economy, isn’t that the same case for Sri Lankans? Sri Lankans leave the country, claiming we do not have economic opportunities. Some Sri Lankans even risk their lives by attempting to go to Australia and Italy by boat. When Sri Lanka attempts to implement policies where we could navigate towards the same development as some of the countries they aspire to run away to illegally, the same Sri Lankans oppose and protest.

Think about the recent discussions on the Singapore Free Trade Agreement (FTA), the Millenium Challenge Compact (MCC) agreement, East Container Terminal discussion, and now, the Port City public debate.

Instead, many believe working with a foreign nation is a part of a whole conspiracy. We are overwhelmed with the belief that we can become self-sufficient in everything under the sun. We have forgotten that the global context has changed. Global supply chains have changed over the last few decades. We as Sri Lankans have forgotten the power of mankind when we share ideas with each other. Connecting with each other and sharing ideas is sharing and creating wealth.

It is true that working with other countries is not a one-way street; it has to have mutual benefits. The way forward is not to isolate ourselves and attempt to do things on our own, but to connect with the world. That is how small countries like Sri Lanka can succeed.

As of now, Sri Lanka is at the critical juncture of getting the fundamentals right with the Port City Bill, which is now being challenged at the Supreme Court. Of course, constitutionality and the legal aspects have to be considered and cleared before we move forward. What is missing in the discussion is the concept of the “Special Economic Zones (SEZs), and the ability to understand that Port City has to be a special economic zone instead of a real estate project, where we just sell land to investors without creating a business- and market-friendly environment.

“Special Economic Zones” are a concept where a separate and an easy regulatory mechanism is set up in a region to create a business-conducive environment. Businesses can be done easily and people can live conveniently only when markets operate right. We have to establish special economic zones because the rules and regulations in the mainland or other parts are so laid back that doing business or convenient living is difficult.

Take current Sri Lankan regulation as an example: 80% of our land is owned by the Government, where the citizens haven’t been provided property rights. Which investor would invest in a business when the ownership of the property is not secured? According to Minister of Justice Ali Sabry, contract enforcement takes 1,318 days on average, where it is just 164 days in Singapore. The average time to resolve a criminal case is about 10 years, while our business registration takes months. Small and Micro enterprises have tiers of regulatory barriers. Granting a permit for construction takes more than three months or so for accessing electricity. Those are the fundamental reasons why people leave Sri Lanka – because the rules we have set for ourselves are not supporting our aspirations.

What we need to do ideally is to make the rules of the entire country easy for business, and for people to live. Since we haven’t had the political will nor the knowledge to do it, we have to go with second-best solutions. One of the second-best solutions is “Special Economic Zones” such as Port City.

What ultimately decides whether a country and its people are going to prosper or not are the rules that it sets, because our opportunities for investments, doing business, employment, real wages, and quality of life will depend on what we set as rules to govern ourselves. Those rules cannot be excessive, but have to support markets.

While the concept of a “Special Economic Zone” is in the right direction, we should not think that Port City is going to solve all our problems. We can attract investments only if we set an example by allowing market forces to operate. Our immediate term debt repayment challenges, and our regulatory barriers in the mainland, remain as they are, and we have to take a holistic approach on serious economic reforms connecting with the world.

The tax concessions suggested have to be reconsidered, as these would not only further distort our markets by giving just a few politically connected businesses tax benefits, but also a serious burden on our balance sheet when the Government expects to develop infrastructure near Port City, such as the connecting roads to the airport highway and the tunnel connecting Port City and Marine Drive.

We have to be sensitive about the geopolitics coming into play with Port City, and we should not lose our friends internationally. It’s a long-term project, and things change very fast in this era of time.

Like the man who said no to his god’s rescue attempts, we too have missed so many opportunities that could have complemented the Port City project further. If we had implemented the projects with the MCC (after clearing all constitutional matters), it could have been a better attraction to investors. On the MCC project that was developed by local experts, the project on facilitating the proving of land rights could have attracted more investors to Sri Lanka to set up manufacturing plants, and the Port City could have served as the financial service center.

The traffic plan and the infrastructure projects could have added significant value to the entire project. At the same time we could have managed our geopolitics better.

The same goes for the Singapore FTA. We could have provided a strong signal that we are a nation open for business by creating rules that support industry and strengthening trade relations with countries like Singapore. Investors expected to come to the Port City could have tapped into global talent, taking Sri Lanka one step closer towards becoming a global hub for business.

Again with the East Container Terminal, where more Indian investors could have attracted and created a Port City, a truly multicultural, multinational special economic zone. What history teaches us is that we have been provided with so many opportunities, like the man who was provided the chance to save his life from the flood. How we managed and what we did with it is something we have to rethink.

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 Port City We Need

Covered in the Daily Mirror, Daily FT, Daily News, The Morning, Lanka Business Online,

By Resident Fellows of the Advocata Institute

Better economic rules, not giveaways should be the focus of the new governance zone

Deng Xiaoping China’s great reform leader, faced a serious problem in the 1970s. Thousands of young Chinese were crossing to Hong Kong risking their lives. Rather than cracking down on the migrants, Deng sought to understand why they were migrating. Clearly the economic opportunities in Hong Kong were greater than in mainland China. Deng was also impressed by the rapid rise of the some asian economies, in particular the modernisation of Singapore.  Singaporeans, like the residents of Hongkong, were majority Chinese by descent and had even less natural resources. How did they achieve something that China couldn't?  

The answer was that these countries had better rules, better incentives, and a better economic governance system. Deng knew he needed to ‘reboot’ China with reforms that allowed markets to coordinate economic activity,  protect private property, and allow for Foreign Direct Investment: radical reforms in communist China at the time. He also knew that implementing these reforms in the entirety of the country would be a nonstarter. Entrenched interests who benefit from the status quo would fight to keep the existing order. To solve this, China demarcated the Shenzhen area as a special governance zone and implemented a new - more open - economic system. This was the start of the Special Economic Zones (SEZs) in China. It was promoted as a laboratory to experiment with market principles to serve “socialism”.  

The results are astounding. In the past forty years Shenzhen has been transformed from a fishing town of less than 30,000 to the third largest city in China with a population of more than 12 million. By 2018, the economy of Shenzhen was $366 billion, four times that of Sri Lanka. 

In some ways, Deng’s problem is now Sri Lanka’s problem. To be sure, emigration out of Sri Lanka is not as severe as it was in 1970s China. Sri Lanka’s business environment is also not as bad as the Chinese system at that time. Yet market based reforms started in 1977 have all but stalled.  

Like China, in “mainland Sri Lanka” too an entrenched elite who benefit from the existing rules lobby to maintain the status quo. The result is that very little progress has been made over the last 15 years on reforms necessary to boost economic growth. After a brief post-war spurt between 2010-2012, economic growth slumped and has remained stagnant.

This is visible in Sri Lanka’s low scores on various rankings that measure the efficiency of the business environment. In the World Bank’s influential Ease of Doing Business report, Sri Lanka is ranked 99 out of 190 jurisdictions. The country has fallen behind regional peers like India, Bhutan and Nepal, having once been an early economic reformer in the region.  

Take the legal system, where Sri Lanka is one of the worst performers in the world. In contract enforcement, the World Bank ranks Sri Lanka 164 out of 190, taking on average nearly four years to enforce a contract. In Singapore, it takes just over five months. It's no wonder that foreign investors prefer easier destinations to deploy their capital. 

This is the logic for the Colombo Port City. Poor governance is a barrier to growth in many developing countries but implementing broad reform for better governance is extremely difficult. The idea is that by building special governance zones, governments could adopt completely new systems that overcome the problems that exist in the rest of the country. These zones would operate like “one stop shops” with pre-approvals and fast-tracked court systems, making doing business easier and hopefully attract foreign investment.  

Special zones are not new in Sri Lanka. Much of Sri Lanka’s export industry resides in the country’s dozen or so Free Trade Zones. Colombo Port City is different by virtue of being the first special zone developed by an international operator.  Unlike the FTZs, the focus is on white collar jobs and financial services instead of manufacturing exports. It also has a broader remit: the proposed legal structure lists seven laws that don't apply to Port City, and a further 14 that could be exempted in the area by the proposed oversight body. The Port City masterplan promises world class living facilities, entertainment, financial services, and business.

Yet Port City’s success, and indeed its importance to the country at large, will only depend on its ability to provide a superior economic governance system. To be a success Port City will need to guarantee greater economic freedoms to its investors, have an efficient legal system with clear and predictable laws. It needs to minimise discretion of the commissioners and have a fair and transparent regulatory structure. These are the critical features that have made several small cities like Hong Kong and Singapore prosper. 

This is the Port City we need. A better governance zone that can attract FDI, skilled people, spread knowhow, and serve as a lab for policy experiments. Get this right, and Port City could create positive spillover effects and expand economic opportunities for Sri Lankans. By learning from it’s successes, we can hope to scale some of the policies in the enclave to the rest of the country.

What of the Port City we will get? In the coming weeks, the country will debate whether the specific provisions in the Port City bill are prudent.  The supreme court is already hearing 19 petitions that challenge its constitutionality.  Like any project of this nature, there are also political and economic risks that need to be considered.  

Managing the geopolitical risk is going to be an enduring challenge in Sri Lanka. Here there are no easy answers, except professional management of our foreign affairs and dealings. Big picture thinking is needed instead of the current win/lose mindset and transactional diplomacy.

Another risk is in the domain of economic distortions. Unlike in Shenzhen which was conveniently located far from the commercial centres at the time, Port City is on the doorstep of Sri Lanka’s capital. After the operation of the Port City, life as a businessperson could be very different depending on which side of the Chaithya Road your business is situated. You may be competing for the same resources but face very different rules and taxes. The latter is a deeper malaise.

Already stretched for revenue to cover even its debt obligations, the Port City may prove to be a leakage point of taxes for the State. Finally,  given its proximity to Colombo, there is a risk of capture of the regulatory framework of the same elite who have secured rents for themselves in the existing system. It’s no accident that successful SEZs tend to be away from the established power centres, such as Shenzhen was to Beijing. 

Only good rules, predictable policies, and oversight can overcome these challenges. A focus on better governance rather than tax breaks and giveaways would help keep the house in order.  

It would be better for the entire country to be governed by better rules and efficient systems that enhance ease of doing business. Given its size and scope, the Port City cannot perform miracles, but we can hope that Port City would be a catalyst in bringing about some of these changes to the country proper.

The project itself is an admission of failure in governance. Even when Sri Lankan leaders know what to do, a combination of backward ideology, political opportunism, vested interests, and lack of state capacity seem to hold back the vital growth oriented reforms. It is these reforms that are needed to expand economic opportunities for all Sri Lankans.  

The Port City can give the country a shortcut to attract foreign investments, provided it focuses on the right thing -- better economic governance.

The authors are resident fellows of the Advocata Institute, a free-market think tank based in Colombo. Learn more about Advocata’s work at www.advocata.org. The authors are grateful to the many useful conversations with the think tank’s advisors whose ideas helped this article.

In the Port City debate, hypocrisy is bipartisan

Originally appeared on The Daily FT

By Prof. Rohan Samarajiva

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.