By Hema Senanayake –
We have a corporate sector. And a few of corporate leaders recently had spoken to Sri Lanka Daily News about the new government. One of them made a comment and a request for which I paid a little more attention. This article is about it. In fact the article is not about his particular comment or request, instead this article is about an economic principle on which the government should establish an important national policy in regard to his request. I believe his request merits in establishing such a national policy.
So, recently, Dr. Rohan Karunaratne, President of Ceylon Institute of Builders had commented as follows;
“… with the change of presidency in January some of the on going development projects were halted due to various reasons. “We hope that the government would look at to any irregularities if any and re-commence these projects as the industry is facing problems due to this.” “We also request the new government that they give priority to local constructors when awarding future projects” (Daily News).
Construction is an important sector in the economy. Even though I do not know the exact percentage of the contribution of this sector to GDP, I imagine the figure could be well over 20%. Hence, this sector in the economy is so important in creation of the nation’s wealth and a lot of direct and indirect employments. This sector will remain so in the next five years too. Now, on behalf of the people who have direct business or employment interest in this sector, Dr. Karunaratne requests that, “the new government gives priority to local constructors when awarding future (development) projects.”
It seems his request is reasonable. His request seems more appropriate since the setting up of the giant “megapolis” project has been mentioned as the flagship development project in the UNP manifesto. Under the Megapolis project, it has been proposed to develop the region stretching from Negombo to Beruwela with the city of Colombo as the core. The Daily News has reported that Megapolis plan will convert the hitherto unplanned Western Province into a major megapolis by 2030 with an estimated population of 8.4 million. This means a lot of constructions will involve in this project itself.
The construction of Mattala Airport was given to Chinese firm. So was the construction of Hambantota Harbor. A billion dollar project of Port City would be again awarded to a Chinese firm even under the government of Prime Minister Ranil Wickremesinghe. The list of development projects which had already been awarded in the past and which would be awarded in the future to foreign companies would be much longer. Why does any government do favor foreign development companies than local developers?
If we ignore all concerns about corruption and technical expertise such as designing capabilities, engineering know-how and acquisition of essential machineries etc. the simple answer to the above mentioned question is the concern about Balance of Payment (BoP) in the country. I will explain later as to how the issue of BoP involves in determining how many development projects should go to local constructors and how many projects be awarded to foreign companies. Before that, from the above answer we could make another simple conclusion in regard to the basic rule on developing a possible national policy in awarding contracts. What is it?
It is that, we must award all development projects to local constructors, if such awards shall not affect the country’s BoP situation badly. This is an important rule. Also, this rule implies that, if any project is anticipated to change the BoP situation badly, then, still the local developer might be able to win the contract award if that company could help in stabilizing BoP. When these two basic ideas are incorporated into the national policy of awarding construction contracts, the local bidders understand that they are partly obligated in stabilizing the country’s BoP, so that the bidders or their local bankers can come up with a suitable financial plan which helps removing the negative effects that can possibly occur if the project is fully funded with domestic funds/currency.
Some people believe that there are no sufficient funds in the domestic financial system in order to finance certain mega projects and as a result we need to offer those projects to foreign firms. This notion is not accurate. The problem is not the insufficiency of funds; instead the problem is about the stabilizing of BoP. Under the current banking system which is known as fractional reserve banking which we practice today, we have literarily unlimited amount of funds but the limit is set by the BoP situation.
When any country increases consumption or investment or both, then, that primarily affects the country’s current account. If the country is running a current account deficit already which is the case for Sri Lanka, the deficit will increase when the country increases consumption and investment. This appears as bad. But if the negative impact can be balanced out by the funds recorded in the country’s financial account then the country’s BoP would be stabilized. That is why I mentioned above that the limit of local funds has nothing to do with insufficiency rather the limit of local funds is determined by the BoP situation.
Therefore, giving priority to local constructors is not a simple decision. But it is also not a difficult decision, if all stake holders get together to facilitate the process. The important stake holders I have in my mind would be the Central Bank, the Treasury, the local constructors/ tentative bidders and the local commercial banks. Under this process, the bidders have to submit a financial plan too. That is exactly what the Chinese firms do in securing a development project. For example, they submit the bid and Exim Bank of China submit the financial proposal.
Now, under the new process I mentioned above, the constructor would submit the bid and their banker would submit as to how much they mobilize in local funds and how much they want in foreign funds so as to neutralize the effects of BoP in carrying out the project. Instead of paying to Exim Bank in China, now the government would pay to local bank which financed the project which is an additional advantage.
Also, the above mentioned policy setting will do another important thing which is that the government will put more projects in “investment mode” than “consumption mode.” These two “modes” relate to the fund flows in the economy. The government can hire a contractor to do a particular project. When the project is done the government would pay the contractor in full. Even though this type of infrastructure or any other development project is called as an “investment” by the government, in fact such projects must truly be defined as “consumption” when considered the fund flows in the economy. When a bank finances the project, it will become an investment. It might be strange, but that is how it works in the economy.
Since the Ministry of Finance has now requested the public and private sector institutions and the general public to submit their proposals to be included in the proposed budget for the year 2016, I submit the above view. I wish if the Ministry of Finance pay its due attention on this matter.