By W A Wijewardena –
Aseni, the Whiz Kid, and Sarath Mahatthaya, Economics Guru, have been in a passionate exchange of views on Sri Lanka’s present economy, codenamed Economy.20, and what Economy.21 will offer to the country the next year. Following are excerpts:
Aseni: Grandpa, I have been reading about the present condition of Sri Lanka’s economy. Official sources like the Central Bank, Ministry of Finance, and top leaders of the Government have been trying to assure us that there is no problem and they have taken care of all the burning issues. At the same time, the independent analysts and the external reviewers like rating agencies have warned us that we are heading toward an inescapable disaster. I know President Gotabaya Rajapaksa came to power through a massive support of the public that had placed confidence in him. Where are we now? Can we go to bed today without the fear of our economy coming to an end tomorrow morning?
Sarath: You are correct that President Gotabaya Rajapaksa – I will call him Gota because that is how he is fondly addressed – very skilfully exploited the economic woes of people. He had assembled a very creative thinktank called Viyath Maga which can be loosely translated into English as the Path of the Erudite. It was a master coup because people of Sri Lanka have the tendency to accept without questioning whatever that is uttered by learned people.
Members of Viyath Maga began their job from day one to gather weapons against the previous Government and were successful in convincing people that its economic management was a disaster. They became a very powerful force of ‘alternative thinking’ and by the time the Presidential Election was held in November 2019, they had a massive following in universities, business, state service, and, above all, among young professionals. So, Viyath Maga was basically responsible for formulating Gota’s economic plan.
About your second question, you can go to bed tonight without the fear of the economy collapsing on your head tomorrow morning. That is because, an economy, made up of millions of small units, does not collapse suddenly like a tree falling. This was proven during the COVID-19 pandemic. Though the economy had been locked down for prolonged periods, people still produced and exchanged their products. Some had even exported them to other countries. That is why in the second quarter, Economy.20 produced as much as 84% of what it had produced in the corresponding quarter in the previous year. But we may wake up for greater hardships and difficulties every passing day. It does not entail a collapse of the economy.
Aseni: If Viyath Maga had done such a great job, why did Economy.20 go wrong? Every economic indicator pertaining to that economy is disappointing.
Sarath: In my view, Viyath Maga had dug into those areas of the economy in which emotions of the masses could be easily roused. In that sense, they had functioned not as a professional thinktank, but as a political campaigner. Therefore, they had not done a proper assessment of the state of the economy. If they had referred to the State of the Economy reports published by the Institute of Policy Studies and papers written by independent analysts, they would have easily made that assessment. Economic downturn began not with the previous Government, but many years earlier. For example, State of the Economy reports, and independent analysts had repeatedly told the public that the economy was sick from around 2013, when multiple symptoms of the ailment began to manifest themselves. They included slowing growth, ballooning budget deficits, balance of payments problems, rising public debt and increased pressure for the exchange rate to depreciate. These were all structural issues in Sri Lanka’s economy, and they all needed very quick permanent fixes.
The previous Government had failed to arrest this downward trend. As a result, the economy had reached a point of no return by 2018. It was clear to every independent analyst that the ongoing deterioration was beyond redemption. I believe Gota had not been apprised of the gravity of the problem because his manifesto did not talk about it. So, ignoring the major macro issues, he had promised to establish a citizen-centric economy through several micro level interventions.
Aseni: Grandpa, you are refuting yourself. You said that an economy is made up of millions of micro units. Without addressing their problems, how can we address the main macro problems? After all, the macroeconomy is simply an aggregation of all the micro units, isn’t it?
Sarath: Yes, indeed. There is nothing wrong in addressing the micro-ones. But they should be compatible with the overall macro picture. All his micro interventions needed huge expenditure by the Government. But there was no indication how resources would be acquired to incur those expenses. No plan is successful unless there is an assured resource base. It is like when you have a wish to build a house. But you do not have money for that. And you do not know from where the needed money would come. The incompatibility in micro interventions and macro picture has been worsened by the promised generous tax cuts and concessions offered by the Government. They have cut the resource base at least by Rs. 450 billion. That is where it has gone wrong.
Aseni: But Gota is not responsible for the current economic malaise because it had started well before he became the President. Therefore, he had inherited a sick economy and he should not be blamed for that.
Sarath: Yes, it was an ailing economy that he had inherited. In the post-independence period, Sri Lanka had an average economic growth of 4.5%. But the economic growth in the last three years, that is, from 2017 to 2019, was only 3%. It was continuously falling and year 2019 ended with a growth rate of only 2.3%. This was continued to 2020 too. In the first quarter of 2020, growth became negative at 1.6%. That was a continuation of the declining trend observed in the previous period. Without a budget, and an expenditure program, he could not arrest it. Then, the country was hit by COVID-19 pandemic. We economists call this type of adversities ‘negative external shocks’, that delivered a fatal blow to eEconomy.20, because the country had to be placed in a locked-down position for most of the second quarter. That was why growth became further negative at 16% in the second quarter. Though there was a mild recovery, according to the data released by the Department of Census and Statistics, in the third quarter which was in comparison to the same quarter in the previous year, the overall economic growth in 2020 is expected to be around negative 5-6%.
But he also deserves blame for the difficulties he is facing today on two counts. One relates to proposing expenditure programs without resources. The other pertains to the creation of a huge hole in his own budget. That he did by proposing a very generous tax cut program when the economy could not afford it. It has deeply cut into his revenue base. Many analysts had warned him against its implementation. But his economic advisors were stubborn and implemented it to the letter. Even after it was realised that it had not worked but created more problems for the country, the Budget 2021 had reaffirmed it. Now it is too late, and we are in deep trouble.
Aseni: I just casually went through the latest statistics published by the Central Bank. They indicate that the revenue of the Government had fallen, compared to the level reached in 2019, by Rs. 386 billion during the first nine months of the year. At the same time, Government’s expenditure has increased but contained by cutting the capital expenditure drastically. For instance, the Government’s current expenditure has increased by Rs. 109 billion.
If the capital expenditure had been maintained at the level of 2019 which the Government should do under the Vote on Account arrangement, the capital expenditure would have been Rs. 445 billion and not Rs. 246 billion. The real impact on the budget, and hence the negative impact on the economy due to the tax cut would have been Rs. 686 billion made up of a revenue loss and the cut in the capital expenditure. It has led to a huge deficit in the budget, on the one hand, and a hole in the cash flow of the Government, on the other. How has the Government filled the hole in the budget which has been created by it?
Sarath: In these circumstances, there is only one way available to Government. That is to get the Central Bank to print new money and borrow from the banking system. This is exactly what the Government has done. During the first 10 months of the year, the Government has borrowed from the banking system on a net basis, that is, Government’s borrowings net of its deposits with banks, Rs. 1,920 billion. In addition, public corporations which comes under the wider public sector have borrowed Rs. 519 billion making the total borrowings of the wider public sector Rs. 2,439 billion. The agony does not end there.
During November and December till 30th, the Government has borrowed from the Central Bank Rs. 356 billion. Roughly, we can say that during 2020, the Government’s total borrowings from the banking system are Rs. 2,276 billion. This is also a debt issue outside the normal public debt we are talking about. The Central Bank has to reduce its exposure to the government by selling these bonds in the open market. But given the low interest rate structure in the economy, that will be a Herculean task. Either interest rates will have to be allowed to go up or the Bank has to carry this burden endangering its inflation control measures.
Aseni: But Grandpa, according to this breakaway group of economists who call themselves Modern Monetary Theorists, there is no risk of printing money by a government and spending on people. They say that it will protect the class that consumes and creates a demand for the output produced by a country at a time when it has suffered from a massive unemployment. They say that is the way for the country to maintain its growth momentum undiminished. Apparently, the Sri Lanka’s Government and its central bank are now following this Modern Monetary Theory or MMT. Specially, when the country is in an economic recession, the saviour comes in the form of printing money and spending on people.
Sarath: MMT will work, again subject to a limitation, in countries whose currencies are reserve currencies. Those countries can print money and spend without causing inflation. That is because after the first use in the domestic economy, the bulk of that money is being used by people outside as a reserve currency. Hence, it does not create demand in the domestic economy and hence its impact on inflation is minimal.
During February to December, US Federal Reserve Bank has printed $ 3 trillion to support COVID-19 affected economy to make a turnaround. But its inflation rate is just 1.2% since about 40% of dollars issued is circulated outside USA. Sri Lanka does not have this luxury and its inflation rate is around 5-6% even with the control of some essential food prices. So, MMT should be used by Sri Lanka’s policy makers cautiously.
Aseni: So, we enter Economy.21 with a very bad signal. How bad is it? Isn’t there a way out?
Sarath: It is pretty bad. If a country with no power to issue a global reserve currency has to print money continuously to meet its Government expenditure, that country is, in a technical sense, bankrupt. That is because its Government cannot get a sufficient real resource transfer from the private sector by way of taxation to finance all the wishful mega projects it has. You can compare it to a private company which becomes bankrupt when its assets are less than the liabilities it has to outsiders. We call it a state of negative net worth.
In terms of law, such a company cannot continue its business, because it is not a going concern. Therefore, it has to be compulsorily closed down, a process known as liquidation. But we cannot close a government, though it is unable to raise revenue by imposing taxes on people. In ancient times when the king cannot tax people and his treasury runs dry, he becomes a very weak ruler. His reign becomes short-lived because anyone can topple him. So, Sri Lanka is also one big company – called Sri Lanka Incorporated or Sri Lanka Inc. It enters 2021 with a technical bankruptcy behind it.
Aseni: But you did not answer my second question. Isn’t there a way out?
Sarath: Yes, there is. We can draw parallels from a private company. When a private company is bankrupt, the way to bring it back to business is to get outside support or make internal restructuring or doing both. The outside support will help the company to turn its negative net worth to a positive one. It can either get money from outside by way of equity or long-term borrowings. Equity is better because that money is permanent and does not involve repayment or compulsory dividend payments. Loans are for a fixed time, have to be repaid and, above all, compulsory annual interest payments have to be made. Internal restructuring involves making a strategic move by eliminating unnecessary costs, waste, and inefficient practices. Some units which cannot compete in the market due to inefficiency are closed.
This was done by Jack Welch when General Electric became bankrupt in early 1980s due its inability to compete with cheap Japanese electrical appliances. Welch closed all these lines of business, made a strategic move to sectors that cannot be competed out and made a turnaround in the company within a few years. So, this is the way out for bankrupt Sri Lanka.Inc also.
Aseni: So, Gota has a way out and that is promising. But what are the implications?
Sarath: One is that Sri Lanka Inc. is a privately held company with shareholders numbering 22 million. Private companies are dead against getting money via equity because it dilutes their ownership rights. Hence, they always go for loans. Sri Lankans also have the same mentality. For generations, they have been cushioned to think that getting foreigners to invest in Sri Lanka’s assets is a sell-out of the country. That is why they make life-and-death objections to handing Hambantota Harbour or a part of the Colombo Harbour to foreigners. This sometimes goes to an extreme.
The funding of digitising of presently paper-based land titles under a grant from the Millennium Challenge Corporation was misinterpreted as giving out a strip of land from Colombo to Trincomalee to Americans. Even the most educated professionals in the country had bought this crazy idea because they had been cushioned to believe it. Gota’s Viyath Maga was a contributory factor for developing this mentality among Sri Lankans. But now it has been the main hurdle for Gota to turnaround this bankrupt Sri Lanka Inc. It has practically reduced the options available to him.
So, what is left out for Sri Lanka Inc. is borrowing. But, because of the recent downgrade of its credit rating, that possibility is moving away from us. So, eventually we have no choice but to make that painful internal restructuring. That requires all Sri Lankans to make the maximum sacrifice to rescue Economy.21. What it means is that if we are having three meals a day now, we must settle for one meal and pass the saved two meals for investment in producing more meals for the nation. That is the challenge we have in the new year to rescue ailing Economy.21.
Aseni: Thanks, Grandpa. I now know where we have gone wrong and what we must do exactly to make a turnaround of the economy.
*The writer, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at email@example.com