By W.A Wijewardena –

Dr. W.A. Wijewardena

The emerging China, Japan and Modi Nexus: Should Sri Lanka jump onto Modi’s bandwagon?

Sri Lanka’s choice: whether or not to jump onto Modi’s bandwagon

Dr Ganeshan Wignaraja, Director of Research at Tokyo based ADB Institute, made a presentation on an apt topic to a selected crowd at a seminar at the Institute of Policy Studies or IPS recently. The main title of his topic was “Will South Asia benefit from Pan-Asia Integration?” Implying that the answer to his question was in the affirmative, he went onto analysing a newly emerging aspect of the issue under a subtitle “The Challenges for the Modi Government”. The Modi Government has declared its intention to get connected to the rest of the world effectively in order to push up India’s decelerating growth rate through increased exports, services and capital flows. Modi will definitely go along with his declared policy throwing challenges not for India but for its neighbour to the south, Sri Lanka. Therefore, the subtitle of Wignaraja’s presentation needs re-titling appropriately: “Should Sri Lanka jump onto Modi’s bandwagon?”

A scholar on Pan-Asia Integration

Wignaraja has done research in this area quite for some time and his latest research on the subject has been published as a working paper issued by the ADB Institute in February 2014 under the title “Experience of South Asia-East Asian Integration and India’s Role” (available at: http://www.adbi.org/working-paper/2014/02/25/6180.experience.south.asia.east.asia.integration.india/  ). Recently, he has presented his views on the subject in a short article published in the East Asia Forum – an online publication by the Crawford School of Public Policy of the Australian National University – under the title “India looks east to RCEP (Regional Comprehensive Economic Partnership) for economic growth” (available at: http://www.eastasiaforum.org/2014/07/07/india-looks-east-to-rcep-for-economic-growth/ ). His presentation at IPS was principally based on these two publications.

Asia at large is integrating

In his presentation, Wignaraja said that the whole of Asia is integrating into an informal economic block – a development known as ‘Pan-Asia Integration’ – through both bilateral trade and foreign direct investment flows. Two leaders in this integration process from South Asia have been India and Pakistan which have gone into a number of bilateral trade agreements with more developed nations in East Asia. The other countries in South Asia have been laggards in the process. This observation by Wignaraja is specifically true for Sri Lanka which has gone into a ‘domestically boosting economic growth strategy’ relegating even its large neighbour to the north to an unwanted position by keeping on postponing the signing of an already agreed comprehensive economic partnership with that country since 2004.

Bottlenecks for integration

In order to make the Pan-Asia Integration a reality, there are some bottlenecks that have to be removed, Wignaraja stressed. Among Asian nations, the current state of infrastructure developments has been uneven with some countries like China and India moving pretty fast while countries like Bangladesh, Myanmar and Cambodia moving slowly. The failure to connect these countries through modern land routes has slowed the integration of Asia as one large economic block. A number of countries have entered into free trade agreements or FTAs but they have not been used effectively to develop trade or business networks. Another bottleneck has been the trade barriers that have been erected by these countries to protect their domestic businesses thereby preventing the development of trade on the required scale. To make the matters worse, these countries are saddled with cumbersome business regulations impeding start-up innovative businesses to take root in the respective economies. All countries have placed barriers for services to be traded freely across the borders. The outcome of this last bottleneck has been that even if these countries get integrated through visible goods, such integration is incomplete unless invisible services are also traded freely across the borders.

Quantifying the gains and losses of Asia-wide integration

Wignaraja based his argument on the results of a Computable General Equilibrium or CGE model that has incorporated different countries in the region for its quantitative analysis. A general equilibrium in economics is a situation where all types of demands and supplies across different markets in an economy tend to be equal to each other without excess demand or excess supply at a given set of prices. Once an economy reaches this equilibrium level it has no incentive to move out unless it is disturbed by some external factor such as a war or an increase in the international price of a major input say, the price of petroleum products. However, once disturbed, the economy is said to be reaching a new equilibrium level at a new set of prices and new set of quantities. A CGE model is a model where the researchers will use actual economic data to quantify the equilibrium situation. Thus, these models are also called ‘Applied General Equilibrium’ models.

Computable General Equilibrium Models

CGE models use relationships between inputs and outputs across an economy, a system first proposed by the Russian-American Nobel Laureate Wassily Leontief based on the work he did for the US government in 1940s but formally presented in a publication ‘Input-Output Economics’ in 1966. They assume that an economy can be presented in a linear relationship implying that what is observed in the past will continue to prevail in the same manner without change into an infinite future. This is different from the observed non-linear characteristic of all natural systems. For instance, an economy can be disturbed by any unexpected non-linear event which will derail it from the assumed linear path making the predictions of the model less reliable. To this extent, they are far from the reality. In the computation of CGE models, the researchers have to use elaborate input-output tables which may not be available accurately for all the countries. Wignaraja has warned of these two limitations underlying his study in the Working Paper referred to above but the results, he says, can be used to draw broad conclusions.

Integration will make everyone richer

These broad conclusions reached by Wignaraja and his associates who had worked with him on CGE models take the following form. First, India will gain more in the form of sustained higher economic growth if it enters into Free Trade Agreements or FTAs with large economies in East Asia like China or Japan than its FTAs with USA or Europe. This is intuitively understandable because the current technology and market competition prevailing in India will not permit it to supply goods competitively to the rich Western world. Second, if Asia gets itself integrated broadly with South Asia, all the participating countries will have significant gains with minimal losses for those countries which do not participate in the ‘Pan-Asia Integration’ initiative. Thus, India definitely stands to gain by being a member of such an initiative.

India to gain more if it joins an Asia-wide integration

Suppose that FTAs are arranged among the countries in the Association of South East Asian Nations or ASEAN and the three big economies to the north, namely, China, Japan and South Korea, known as ASEAN+Three or APT. Then, those within the group will gain significantly while those outside in South Asia, including India, stand to lose. If India is included in an FTA with APT – an arrangement of APT plus India or APTPI – both India and APT countries will make gains. These are exclusive gains only for member countries. However, Wignaraja and associates have concluded that India’s gains will be much more if it gets all other South Asian neighbours too into the club of APTPI which could be categorised as ‘ASEAN Plus Three Plus South Asia’ or APTPSA.

Sri Lanka’s choice

This is where Sri Lanka has to make a crucial choice today. That is, whether it chooses to jump onto the bandwagon of Modi who is planning to join APT or chooses to play the game solo by having more relationships with countries like China thereby sidelining the Modi Government completely.

China has been a friend of Sri Lanka all throughout

Sri Lanka is politically aligned to China today more than to India because of the support the Sri Lankan government gets from China in its disputes with the Western world led by USA. At the same time, in terms of economic relations too, China has entered Sri Lanka in a significant way in the recent past. China has been a friend of Sri Lanka from early 1950s when the two countries signed an agreement to enter into a bilateral trade relationship, known as the Rubber-Rice Pact, in which Sri Lanka supplied rubber to China and China made available rice to Sri Lanka. Both countries were desperate in having the two commodities, China for stepping up its production and Sri Lanka for meeting its consumption needs. This pact continued till late 1970s to the advantage of both countries. China also gifted Sri Lanka its only international conference hall – Bandaranaike Memorial International Conference Hall – in 1976 to enable Sri Lanka to host the Non-aligned Summit in the following year. This was followed by another gift of that nature – the construction of Sirimawo Bandaranaike International Convention Hall – at the same premises. More recently, it also gifted a theatre to Sri Lanka – The Nelum Pokuna Theatre – to enable Sri Lankan artistes to present performances of international calibre.

But China is now a commercial lender

However, the recent economic support given by China to Sri Lanka has all been on commercial terms. China has had a balance of payments surplus continuously and therefore was in a position to make investments abroad. China had earned its foreign exchange in the hard way and therefore desired to earn a return on its foreign lending at market rates. Hence, naturally, China’s support to Sri Lanka has not been on concessionary terms as it had been in 1970s. Though it had entered African and Latin American economies by offering them with foreign direct investments or FDIs, it has so far kept Sri Lanka away, except its involvement in the Colombo South harbour Development project, when choosing destinations for its FDIs. This is evident from its apathetic approach when Sri Lanka offered an exclusive Export Processing Zone to China at Mirigama in 2007. The 120 acre land earmarked for this had remained unused even as late as 2013 prompting the Sri Lankan authorities to lease it out to University of Central Lancashire to set up a branch campus in Sri Lanka (available at: http://www.sundaytimes.lk/130908/business-times/british-university-branch-replaces-chinese-special-economic-zone-in-mirigama-60598.html ). Thus, China has a shown a lacklustre attitude toward making FDIs in Sri Lanka. However, this is not a general Chinese policy since, according to UN data, it has invested around US $ 19 billion in the form of FDIs globally in 2013 (UN FDI Report 2014, p 5).

Commercial lenders are worried about country exposure limits

China is a commercial lender and every commercial lender is supposed to follow a prudential risk assessment system to cover its exposure to a country. It is freely lending Sri Lanka today because what it has lent so far is minutescule compared to its total global lending. As at end of 2013, Sri Lanka had an outstanding loan balance of US$ 516 million, up from US$ 50 million in 2006, and an undisbursed balance of US$ 1693 million on account of China making it a total amount of US$ 2.2 billion. This is nothing compared to China’s international investments of about US$ 3000 billion as at that date. However, Sri Lanka, a small economy of less than US$ 70 billion in total output, will pretty soon exceed the country exposure limit which China may have in prudential lending to other countries. The associated high risk may be covered by China either through a higher interest premium or limiting its lending to the country. Whatever it maybe, Sri Lanka cannot expect the Chinese aid to continue on the same scale which it is receiving today. This will force Sri Lanka to have a different strategy in its connectivity to the fast-growing economies in East Asia.

Modi will seek support even from the ‘Devil’s Land’

The Modi government has come to power by making ambitious promises to the electorate and it now has to deliver its promises. Its first budget presented to Lok Sabha last week by the Minister of Finance, Arun Gaitley, was an apology to the Indians that it has no enough money to provide any more concessions to people. Thus, to generate revenue, Gaitley had to increase taxes even on ‘Paan Masala’, the chew of betel, the popular pastime of India’s common man. Hence, to deliver the promised high economic growth, it has to increase investments and to increase investments, it has to attract prospective investors even from the ‘Devil’s Land’. Accordingly, Modi is approaching both China and Japan as prospective development partners. Both these partners are expected to come to India not as lenders but as direct investors in strategic industries. The Japanese car industry has already shown interest in setting up manufacturing plants in Chennai in Tamil Nadu making that city the Detroit of Asia in time to come. To pave way for that, Modi government is opening up sectors which had hitherto been closed for foreign investors. The defence and insurance which were opened to foreign investors up to 49% in the recent budget are two such cases in point.

China’s miracle has been through a well-developed East Asian supply chain

China has been the world’s assembling plant for multinational corporations in the West. But, it is being served by a well-established supply chain that constantly keeps its factories fed with inputs. The chain includes a large number of countries in East Asia covering Malaysia, Thailand, Indonesia, the Philippines and Taiwan. What this means is that not a single country can produce a final product alone to the world market today but it is a joint product by many countries that have teamed up in the enterprise. This is a lesson for Sri Lanka. When India boosts its economic growth by connecting itself to East Asia, Sri Lanka could join it as a development partner by being in its supply chain. It will also enable Sri Lanka to productively utilise the facilities already built around Hambantota Harbour and Mattala Airport to produce essential inputs for booming Indian industries and become the hub of a new supply chain.

Sri Lanka’s choice: Jump onto Modi’s bandwagon

Sri Lanka’s choice is therefore clear. It has to jump onto Modi’s bandwagon before other South Asian countries will grab that opportunity.

*W.A Wijewardena, a former Deputy Governor of the Central Bank of Sri Lanka, could be reached at waw1949@gmail.com