By W.A. Wijewardena –
Sri Lanka’s Linear Growth Projections to Prosperity in a Non-linear world: The challenge of tackling unexpected derailments
Now the issue is beyond $ 4000 mark
Having accepted that Sri Lanka’s average income per head, also known as per capita Gross Domestic Product or GDP, will reach the US $ 4000 mark one year before the previously targeted year of 2016, the Central Bank Annual Report for 2012 has now concentrated on how to take that impressive economic growth beyond that level.
Linear models in non-linear worlds
Table 1.5 of the Annual Report has given the Bank’s projections of economic growth till 2016 based on an accelerating linear economic growth during this period. Accordingly, the real economic growth which fell from 8.2 percent in 2011 to 6.4 percent in 2012, a significant decline from the previously projected growth rate of 9 percent set for that year, is projected to accelerate to new highs after 2013. The numbers are very impressive: starting from an economic recovery at 7.5 percent in 2013, it is projected to accelerate to 8.5 percent by 2016 with marginal increments in the growth rate in each of the intervening years. The Table also presents all the other relevant macroeconomic numbers that will support Sri Lanka to attain these linear targets, again assuming linear growth in these supportive numbers as well.
Foreign borrowings to finance BOP: Have a cautionary approach
But a well-crafted box article in the Annual Report titled “Bridging the Savings-Investment Gap to Sustain High Economic Growth in Sri Lanka” (Box 1) has recommended a cautionary approach to filling this gap by using external funding. The article has noted that the national savings – that is, savings made by all Sri Lankans irrespective of whether they live here or abroad – have increased as a ratio of GDP during 2000-12. Since there has not been an impressive increase in the savings made by Sri Lankans living within the country, known as domestic savings, the increase in national savings has been mainly due to the increased net flow of remittances which the country has received during this period. This has helped Sri Lanka, according to the article, to finance a larger portion of the investments it had made during this period. This is good news because to that extent, it has reduced the need for the country to look for foreign funding – both loans and private investments – to fill the savings investment gap. But there is still a huge gap to be filled – about 4 percent of GDP now and 8 percent of GDP if the country is to increase its investments to more than 30 percent of GDP to attain and maintain a high economic growth.
Don’t sacrifice tomorrow for today’s comforts
The box article, like a knowledgeable physician who prescribes medicine to his patients balancing both the positive and negative side-effects of the drugs concerned, has sought to balance the side-effects of various measures which the country has adopted to fill the gap in the past. For instance, it has argued that the use of excessive foreign borrowings and unsustainable short term flows like investments in the share market or in government securities may make the country vulnerable to unexpected derailments from outside – known as external shocks in economists’ language. Hence, it has cautioned against the use of this tactic. There is nothing like using domestic savings for investments and to promote domestic savings, the article has argued that the interest rates have to be kept at appropriate levels in real terms and the country’s output has to be increased by increasing its productivity. It has a final warning for using foreign funding to finance the savings investment gap because “larger inflows of external financing could partly bridge the savings-investment gap, although, such inflows may lead to an appreciation of the domestic currency, eroding external competitiveness, thereby, constraining growth over the medium to long-run” (p 6). So, the country may have temporary comfort today, but it will have to sacrifice the future if it continues to borrow from foreign commercial markets and getting the private sector, including the state and private banks, to borrow abroad to finance their investments.
Revisit the past expenditure programmes
This strong message delivered by the Central Bank deserves attention by policy makers at all levels in the country. In my view, consideration should be given to it at two levels.
At the first level, all the development decisions taken and strategies adopted in the past should be revisited by the country in order to ascertain whether it is just a short term comfort involving the sacrifice of the future. If the findings are in the affirmative, immediate re-fix of the economy should be made however much it is politically unpalatable. This includes the reexamination of the unproductive capital expenditure programmes which have become a burden to taxpayers in view of both economic and financial non-viability of those projects. These capital expenditure programmes have increased current growth rates, but since they are not viable, they are to eat up the future economic growth. The list is long but it is necessary to reexamine each one of them.
Cheap global money maybe a curse
At the second level, with respect to the tactics currently being employed and the ones to be adopted in the future, the same question should be raised before they are implemented. They may increase wealth temporarily, but if they bring about a cut in the growth in the future, then the economic growth becomes unsustainable. There are many such gray areas as pointed out in the box article under reference. Encouraging the private sector to borrow abroad and invest locally may free them temporarily from the high interest rates charged by banks because moneys are available in foreign markets at relatively cheaper interest rates. But unless those moneys are invested in businesses that generate a higher rate of return to them and foreign exchange earnings to the country, the repayment of the loans and making annual interest payments will become a critical factor. Many countries have got into trouble simply by overusing such cheap money for less remunerative businesses. The list is long, but Argentina, Cyprus and Greece have been in the forefront in the recent past.
Sri Lanka to lend abroad in 2016
This good message which the Central Bank has delivered in the box article under reference does not appear to have been reckoned when its medium tern macroeconomic framework had been prepared. As mentioned above, it has projected everything to become better – good things to increase and bad things to decline – in a linear fashion. For instance, investments are to increase from 31 percent of GDP in 2012 to 33 per cent in 2016, domestic savings from 17 to 28 percent and national savings from 24 to 34 percent. With a projected surplus in the current account of the balance of payments in 2016, the country’s national savings are higher than the investments, making Sri Lanka a net lender nation in that year. Since the annual trade deficit has been projected to be at around $ 10 billion in each of the years to come, this miracle will happen due mainly to the increased gross flow of remittances from $ 6 billion in 2012 to $ 9 billion in 2016 and net sale of services to foreigners such as tourism services, educational and health services, information technology services and aviation and shipping services from negligible $ 1.3 billion to $ 5.4 billion.
More foreign jobs means a labour shortage
For Sri Lanka to have this increased remittances flow unabated, either Sri Lanka should send more people for foreign employment or they should send more money back home or both. But as the Annual Report has commented elsewhere, the country’s unemployment rate has fallen continuously from around 16 percent in 1990 to 4.2 percent by the end of 2012. This rate of unemployment is practically considered as equal to near full employment because the businesses are unable to hire new workers unless they lure those who are already employed elsewhere by paying higher wages. Against this background, if more people are sent abroad for foreign employment, there will be a severe shortage in the local labour market especially in skilled categories. The shortage of workers has already been felt in the hospitality industry: according to industry sources, the higher level managers are even now being hired from abroad. Sri Lanka will not have a sufficient number of low level workers to serve the 2.5 million tourists who are to be lured to the country by 2016. Hence, Sri Lanka cannot send more people abroad without compromising its growth targets. If the country is desirous of maintaining its growth momentum unabated, it will have to impose an embargo on foreign employments. But then, that move will not enable the country to have a linearly growing remittances flow and increase its national savings as projected. Thus, economics is always a choice between two alternatives.
Bad things are to decline in a linear fashion too
The bad things – the revenue or current account deficit in the budget, its overall deficit and public debt as a percentage of GDP are projected to decline over the time. There is no plan by the government to reduce its size, but it has been projected that the revenue account deficit will completely vanish in 2013 generating a small saving. Thereafter, the surplus is projected to rise to 1.7 percent of GDP in 2016, surpassing even the deficit of 1.4 percent experienced in 2012. This is again a hard to achieve target without a comprehensive reform in the public sector. It includes a complete overhaul of the loss making public corporations, freeing them completely from political interferences and putting them on viable business plans, a moratorium on further recruitment to the government sector, reducing the size of the Cabinet and stopping wasteful government expenditure programmes, making it compulsory for the infrastructure projects to come up with viable business plans and setting up of a mechanism to control the government’s consumption expenditure effectively. There is no sign of introducing these reform measures by the government; nor has the Central Bank emphasised them in strong words in its Annual Report.
Government should reform itself
The overall deficit of the budget – another malaise from which the country has been suffering since independence – has been projected to decline to a historically low level of 4.6 percent by 2016. In 2012, it stood at 6.4 percent according to the numbers reported by the Central Bank. The examination of the projections reveals that this feat is to be accomplished by a combined effort: improving revenue and curtailing expenditure marginally. These are not difficult tasks provided the government has placed itself on a comprehensive reform programme. The objective of such a reform programme is to make the public service more efficient – a higher output for each rupee it spends – and more effective – its facilitation helps the private sector to create more wealth. Then only the government can legitimately tax people and raise revenue to maintain itself. Otherwise, the private sector sacrifices, the government sector wastes and the nation loses. Hence, to attain the linear reduction in the overall budget deficit over this period, it is necessary that the government makes a firm commitment to set itself on a comprehensive reform programme.
Low debt ratio maybe a statistical artifact
The public debt is to be reduced from the current 79 percent of GDP to 64 percent of GDP by 2016. Since the budget is to have an overall deficit, it is not possible to retire any of the existing public debt of the country. Hence, the public debt will continue to grow which is not a healthy sign when its contribution to GDP does not grow at the same rate in view of the low efficiency of the public expenditure. Thus, the reduction in the debt to GDP ratio is to come purely from the higher increase in the nominal GDP which includes the inflation rate that has been built into these numbers. According to the Central Bank projections, the inflation rate – here represented by the GDP Deflator which is the rate at which the money value of the real goods and services will increase due to price changes – has been estimated to be 5 percent plus on average every year. Hence, the reduction in the public debt to GDP ratio is not an achievement by itself but a number that has been thrown out by a faster increase in the nominal GDP. One could give credit to the government and the Central Bank could appreciate such action if at least a part of the maturing public debt is repaid by the government out of its existing revenue without reissuing the same to repay old loans and pay interest on them.
Global connectivity key to progress
So, the linear growth projected by the Central Bank for the next four years is subject to ‘high downside risks’ if one uses the terminology used by the Bank itself. The Annual Report in another box article titled “Challenges to Increasing Per Capita Income Beyond US dollars 4,000” has pointed out what the country should do to take this $ 4000 mark forward (Box 2). The reference in the box article has been how to avoid the middle income country trap once Sri Lanka reaches this $ 4000 mark. It is reported in this box article that South Korea had managed to avoid this trap “through improving connectivity and linkages, higher productivity, stable macroeconomic conditions with export promotion and complementary polices in the area of education and financing with high concentration on research and development” (p 12). This means that Sri Lanka should move away from the current inward-looking import substitution economic policy to an outward oriented globally-linked economic policy. The report has further highlighted the need for introducing modern technology, reforming the agriculture sector in order to release its underemployed labour to other sectors and attracting foreign investment with high technology to start with. Given the emerging technology base of high performers consisting of the use of nano technology in almost all economic activities, 3D printing technology in manufacturing, distributed intelligence in ICT, genetic engineering and research in agriculture, health and curative medicine and corning technology in new generation computers etc, these are indeed dreams which have to be put into reality through conscious efforts.
These recommendations in the two box articles in the Annual Report should be put into action forthwith if Sri Lanka is to avoid derailment of its linear projections made for the next four years.
W.A Wijewardena can be reached at firstname.lastname@example.org