By W.A. Wijewardena –

Dr. W.A. Wijewardena

Sri Lanka’s impressive performance since the end of the war

Since the end of the disastrous war conclusively three years ago, Sri Lanka was poised for a rapid take-off filling everyone with hopes of a bright future ahead. As a herald of these hopes, several macroeconomic indicators recorded impressive performance in the first two years of the new era. The overall real economic growth rate which amounted, on average, to less than 5 per cent per annum in the whole of the post-independence period shot up to 8 per cent in 2010 and 8.3 per cent in 2011. The unemployment rate which was above 10 per cent of the labour force in 1990s started to fall sharply, finally settling at low 4.2 per cent by mid 2011. Given the normal unemployment in an economy due to people leaving jobs in search of better jobs and people waiting for acquiring the necessary skills to get themselves employed, this rate of unemployment denoting employment at 96 per cent connotes more or less a state of full employment of the country’s work force. The poverty level as measured by the number of people below poverty as a percentage of total population fell from above 15 per cent a few years ago to below 9 per cent by end-2011. Inflation which had been eroding the real welfare of people at the rate of 23 per cent per annum in 2008 was tamed and contained at an annual average of 5 per cent in the subsequent three year period. The Sri Lanka rupee which was exchanged at the rate of closer to Rs 115 per US dollar in 2009 was strengthened to reach a level of Rs 110 per US dollar by mid 2011. Though Sri Lanka’s trade deficit expanded phenomenally, its exports continued to rise at an unprecedented rate of over 20 per cent per annum in 2010 and 2011. The confidence which the investors had about the future health of the Sri Lanka’s economy was amply demonstrated by an unprecedented improvement in the indices of the Colombo Stock Exchange in 2010 making it one of the best performing markets in the world.

All these indicators of reported good performance contributed to raise the high hopes which everyone – politicians, policy makers and the general public – had about the Sri Lanka’s future. Encouraged by the super performance of the country’s economy in the first two years of ending the war, the country’s top policy makers set on a mission of projecting this high growth into indefinite future by having such goals as ‘doubling the per capita income of the people in US dollar terms, within 6 years and thereby making Sri Lanka a nation to be awed, respected and emulated by others in Asia. The development tagline, ‘Sri Lanka: The Emerging Wonder of Asia’, was coined in order to market this highly ambitious goal of the nation.

But 2012 started to see a reversal of all these achievements which Sri Lanka had made in the previous two years.

The gloomy outcome in 2012

Economic growth started to slip away from the high growth trajectory forcing the policy authorities in late September to revise downward the high growth target of 8.5 per cent set for the year to a level of 6.8 per cent. Given the current prolonged drought conditions and the gloomy global economic performance, the authorities may have to make a further downward revision of the growth rate by the end of the year. The inflation which was tamed below 5 per cent per annum started to accelerate gradually by mid-2012 making it necessary for tightening the monetary policies by way of increasing the interest rates, raising the statutory reserve requirement and introducing quantitative ceilings on the private sector credit growth. The rupee fell freely in the foreign exchange market from Rs 110 per dollar in mid 2011 to Rs 132 by September 2012. With the depreciation of the rupee, imports started to contract as expected, but the gloomy global economy imposed a heavy penalty on the country’s exports. In fact, during the first seven months of 2012, exports fell by 4 per cent and the current indications are that it would generate a trade deficit as big as the deficit in 2011. The government budget came under pressure overshooting its current expenditure and underperforming its revenue as against the budgetary projections for 2012. Accordingly, the government’s revenue shortfall over its consumption expenditure, known as the revenue account deficit, ballooned from a target level of Rs 2 billion for the whole of 2012 to Rs 75 billion or 1 per cent of the country’s Gross Domestic Product or GDP during the first half of the year. When annualised at this rate, it amounts to a deficit of 2 per cent of GDP for 2012. The overall budget deficit which had been targeted at Rs 489 billion or 6.5 per cent of GDP amounted to Rs 311 billion or 4.1 per cent of GDP during the first half of the year. If the government’s expenditure is not kept in check, this level of overall deficit in the budget will end the year with a much larger deficit of over 8 per cent of GDP frustrating the country’s attempts at disciplining its budgetary operations.

Budget may be disciplined by cutting capital expenditure  

The gravity of the country’s budgetary problem is seen by the recent announcement by the country’s top policy administrator, Dr P.B Jayasundera, that the Treasury would prune the government’s expenditure to keep the budget numbers within the targets set for the year. Since the government’s consumption expenditure consisting of salaries, pensions, interest payments and subsidies  cannot be curtailed, the essential expenditure cuts are expected to come from a cut or a postponement of the government’s capital expenditure programmes.

Sri Lanka’s economy is not in good shape

Accordingly, contrary to the belief of many, Sri Lanka’s economy is not in good shape. Its macroeconomic health has deteriorated with growing problems on every front. The growth is faltering, inflationary pressures are building, external sector is deteriorating and the budget is slipping. The ultimate casualty of these maladies is the high hopes which people have formed about the future; if the situation is not arrested promptly, it is inevitable that people’s dreams are to be evaporated into thin air.

The country’s future economic challenges   

Thus, Sri Lanka’s economy is currently facing two challenges: To sustain the high economic growth it started since the end of the war and to regain the needed macroeconomic health to create the conditions conducive for such economic growth.

Since the government has to rely very much on the private sector participation in economic activities, it is necessary to create the suitable ground conditions for the private sector to invest its moneys in business enterprises that would create wealth for the nation. As this writer has been arguing in the previous articles in this series, the most essential ground condition is the protection of property rights.

The protection of property rights a must

In every modern economy, people have two types of property – material property such as land, buildings, businesses, and so on and human property such as labour, knowledge, skills and talents. An individual who owns this property must be able to sell this property in a voluntary transaction in the market for his personal gain. If for some reason, the government or a group affiliated to the government can expropriate this property from him through coercion, in the first place, he has no incentive to develop this property. It also gives a bad example to others and they are also discouraged, in the second place, to develop their property. Societies have created wealth and brought prosperity to their members through the development of both the material property and the human property belonging to such members. If this process is halted, it is inevitable for such society to revert to poverty.

Zimbabwean example not to be followed

The physical property is expropriated by governments in many countries by using the majority power they have in the respective legislatures. For instance, the government of Zimbabwe took over the farms which had been developed by its minority white population and handed them over to the black majority who did not have competence to develop them as had been done by their previous owners. The result was the deterioration of farms leading to a decline in the agricultural output. This made Zimbabwe, once a net exporter of meat and grains, a net importer of such products. When the country did not earn enough foreign exchange to import such essential products, there were chronic shortages in the market putting upward pressure on prices. When the country’s central bank, Reserve Bank of Zimbabwe, printed local currency in massive amounts to promote the farm outputs, the inflation became uncontrollable and accelerated to even one million per cent per annum at one stage. Hence, a government should think twice before it decides to take over private material property however much such take over could be justified on political grounds.

Illegal killing of people too is a violation of property rights

Since slavery has been outlawed in all countries today, human property cannot be expropriated by a government or any other person. However, governments can deny right to life directly or indirectly. Directly, it can use its armed forces to kill people indiscriminately as is reported to be happening in Syria today. Indirectly, it can get government-sponsored para-military groups to kill targeted people as it has happened in many Latin American countries in 1970s. Or it can simply overlook the killing of people by individuals connected to high places in the government by not applying the laws of the country impartially. Whatever the way a government uses to deny the right of people to life, it reduces the human capital stock and dampens an economy’s ability to create wealth and prosperity on a sustainable basis.

Requirements to ensure the protection of property rights

To protect the property rights, there are three basic conditions to be created by a democratic government. The first is the maintenance of law and order and observance of the Rule of Law. The second is the promotion of good governance practices at all levels of the government including the handling of the public finances. The third is the restoration of the judicial system to its due place by guaranteeing its independence and impartiality. Almost all the Latin American countries which were among the developed countries in early 20^th century could mot maintain that status for long because they failed to create these basic ground conditions needed for a nation to continue to prosper and sustain its growth. This historical lesson is a good eye-opener for Sri Lanka when it decides on its future economic policies.

Budgetary reforms are a top priority

Sri Lanka needs to undertake budgetary reforms on a priority basis if it is to provide a permanent cure for its macroeconomic maladies. This is because all its ensuing macroeconomic problems – rising inflation, sick external sector and inability to sustain economic growth – are all have their roots to the imbalances in the budgets pursued by Sri Lanka’s successive governments in the whole post-independence period. The reform programme requires Sri Lanka to put a stop to government sector expansion, consolidate its revenue generation efforts, curtail consumption expenditure to manageable levels, properly screen its capital expenditure programmes for potential benefits over costs and, above all, restructure its leading state enterprises which have now become a severe burden to the tax payers. In fact, all these prescriptions, though presented in a different language, have been identified by the Ministry of Finance and Planning as outlined in its Annual Report for 2011.

Stop bailing out loss making state enterprises

Restructuring the state sector enterprises to make them financially self-sufficient is a top priority in the country today. When these enterprises incur losses year after year, due to inefficiency or otherwise, their capital base gets eroded resulting in a negative networth. If it were a private sector company, it has to be wound up in terms of the Companies Act since it is classified as not being a ‘going concern’. But what has happened in the past has been to clean their balance sheets by providing them with free grants of immense magnitude thereby transferring their losses to tax payers. Such transfers give wrong signals to them as well as other state enterprises: That is, there is nothing wrong in their making losses because eventually the tax payers are ready to bail them out. Two good examples are the Treasury bonds issued to Sri Lankan Airlines and Mihin Air recently to wipe out their losses and enable them to show clean balance sheets to potential creditors. According to information now in public domain, Mihin Air has been provided with grants to a value of nearly Rs 6 billion from time to time and Sri Lankan Airline, Treasury bonds to a value of Rs 15 billion in a single payment. To settle the debt owed by the state enterprises, mainly CEB, to CPC, Treasury bonds to a value of Rs 55 billion were issued by the government to CPC early in 2012. The sum total of these cash grants by the Treasury amounts to Rs 76 billion or little over 1 percent of the country’s GDP. Put in other words, that is the amount of funding required to run 12 state sector universities for five years.

This practice which is not transparent and contributory to the perpetuation of inefficiency in state enterprises has to be stopped. To do so, state enterprises should be restructured and run as if they are profit making private enterprises, a suggestion made by IMF too in its seventh review of the just concluded Stand-by Arrangement with Sri Lanka.

Lure FDIs to convert Sri Lanka to a complex economy

Sri Lanka should also bring about a transformation in its economic structure from the simple type of products it produces at present to complex products to sustain its export markets. Since Sri Lanka does not possess technology to do so, it has to acquire the needed technology from abroad as is being done by both India and China today. Such acquisition of technology can be done by opening the country to foreign direct investments involving high technology. This was the strategy adopted by both Singapore and Malaysia in their initial transformation from a poor country to middle income country and in the case of Singapore, from a middle income country to high income country. To facilitate Sri Lanka to receive high technology from abroad, its work force should be developed by equipping it with ‘productive knowledge’, the type of knowledge that is applied in the market place to generate new income and create wealth on a sustainable basis.

Therefore, the challenges which Sri Lanka faces in sustaining its initial growth momentum after the end of the war three years ago are not simple but daunting. It requires Sri Lanka’s policy authorities to reassess the government-centred growth model they are currently pursuing and design a new growth strategy to take Sri Lanka out of the growth hampering maladies from which it is suffering.

*Writer is a former Deputy Governor – Central Bank of Sri Lanka and teaches Development Economics at the University of Sri Jayewardenepura. This article first appeared in Daily FT  – W.A. Wijewardena can be reached at waw1949@gmail.com