While much has and continues to be made of Sri Lanka’s economic growing pains, Central Bank Governor Dr. Indrajit Coomaraswamy, argued last Friday at the YMCA Forum that the country is now in the midst of the most favorable set of economic circumstances it has encountered in 50-60 years.
Coomaraswamy delivered a lecture entitled ‘The Economic Challenges of the Country’ that was more an explanation of a series of best-case scenarios for economic growth. The solutions, he reasoned, lie in broad macroeconomic adjustments and increased exports and foreign-direct investment.
In order to show how advantageous the current moment is, Coomarawamy reviewed the developmental and economic obstacles Sri Lanka has faced since the late 1950s.
“If you look back, there was a dramatic decline in the country’s trade in the late 1950s. From the late 1950s to early 1980s, the prices of tea, rubber, and coconut declined on a continuous basis,” he said.
During this period, the population increased rapidly, and the combination of a stagnating economy and a surging population combined to slow development.
 A section of participants at the YMCA Forum |
Furthermore, the 1960s and 1970s saw the country adopt inward-looking economic policies. For a country of 14-15 million, relying on the domestic economy is unsustainable and not properly suited for promoting sustained development. These policies did not yield good outcomes.
After the economy was liberalized between 1977-1978, the war broke out, and until 2009, the prospects for development were dim.
Though the nation has had a tortured recent economic history, Coomarswamy noted that the aforementioned issues are now no more.
“Today, no such restraints are compromising the country. We are located in Asia, the most dynamic region in world, and we occupy a strategic location within the region,” he said.
But how should the government orient the country’s economic policies in order to take advantage of these opportunities?
His answer was that the government is in the process of putting in place a private sector-based growth model. The Governor was quick to point out, however, that he is not ideologically opposed to an approach featuring public-based investment. But the government, in his estimation, does not have the fiscal capacity to drive development processes at this time.
The state’s inability to foster growth through public spending is due to the previous government’s economic model, which relied heavily on public investment in infrastructure financed by foreign commercial borrowing.
“The recent construction and transportation development depended on government spending, but this has now run out of steam due to the fiscal deficit and public debt. We have basically maxed out on our credit card,” he said.
According to Coomaraswamy, the private sector will now have to take the reins of the economy, and it must feature increased exports and foreign direct investment (FDI). He noted that, without a large jump in exports, it would be impossible for Sri Lanka to maintain a rate of 6-7 percent growth per annum over a decade, a benchmark which many other Asian countries have achieved. “Our exports, as percentage of GDP, are between 16-17 percent. For countries like Malaysia and Thailand, the numbers are closer to 60-70 percent. We are way behind. Unless we increase exports, we will not get out of our debt problem, and we will not achieve sustained 6-7 percent growth,” he said.
Coomaraswamy did not delve as deeply into the need for FDI, but noted that it has played a key role in fostering development in countries throughout the world.
Macroeconomic Adjustments
Though the government cannot directly drive economic growth and development as it did between 2010 and 2014, it still has a central role to play in creating an advantageous environment for private sector players.
Coomaraswamy noted that the state is busy making three large-scale macroecnomic adjustments, the first of which is the inauguration of a fiscal sustainability project that manages the budget deficit. “Ever since 1978, a main source of economic instability has been the budget deficit. This pumps excess demand into the economy, which brings about high inflation. High inflation brings with it high nominal interest rates, so the cost of capital is high.”
“For the past forty years, the Sri Lankan economic situation has featured a high budget deficit, high inflation, high interest rates, and an overvalued exchange rate.
These features are diametrically opposed to those of economically successful countries in South and Southeast Asia,” Coomaraswamy said.Of utmost importance, then, is to contain the budget deficit. The Governor noted that the government is conducting fiscal consolidation and revenue enhancement projects in order to drive the budget deficit down to 3.5 percent of GDP. Right now, the number is closer to 4.6 percent, but decreasing this would remove a source of economic instability.
The second piece of macroeconomic policy undertaken by the government is to set an inflation target of 4-6 percent. Coomaraswamy noted that interest rates recently shot up by 25 basis points because inflation was up around 8.1 percent.
“The economy was not overheating, but we thought the Central Bank should send a signal that it would not tolerate inflation outside the 4-6 percent range. With this inflation target, there would be little wage pressure, and businesses could take advantage of a stable environment knowing that the Central Bank would take action when necessary,” he noted.
The third piece of policy is to let the exchange rate fall to its natural level. He noted that the government has usually aimed to keep the exchange rate at an artificially high level. But this policy is extremely expensive, and the government has often had to spend massive amounts of its reserves to keep the rate high.
“You cannot defend the exchange rate, but we keep doing it. In 2015, this government spent $2 billion to defend the rate, and then had to depreciate it anyway. Successive governments have done this, and it does not make sense to me. There is no choice but to devalue the currency,” hesaid.
He added that the best method of keeping pressure off of the exchange rate is to increase foreign exchange earnings through exports.
These macroeconomic adjustments should, in Coomaraswamy’s view, lead businesses to formulate robust growth plans.
Investment Climate and Trade Agreements
The government is also working to make it easier to conduct business in the country. Sri Lanka currently ranks 110th globally on the World Bank’s ease of doing business index, and Coomarswamy noted that the government has formed task forces focused on decreasing the difficulty of investing in the country.
“If you now have to take six steps to acquire a construction permit, we are trying to reduce that number to four or three steps. The process of improving the investment climate will go through deregulation and technological upgrades,” he said.
He also shared that the Board of Investment (BOI) has focused on six sectors wherein the country has competitive advantages. It is working to attract key companies to come and invest in these sectors, but he did not divulge the identities of these six.
He did, however, give examples of countries that have done well after massive investments from large multinational corporations. He noted how Samsung invested in Vietnam and at one point accounted for 40 percent of the country’s exports.
“Vietnam and Sri Lanka had similar export numbers in 1995, but today Vietnam’s exports are around $166 billion. They have left us far behind.”
“If you target the right sector and get global players to invest, you can transform your export economy,” he said.
He added that customs is being overhauled and will soon conduct its operations online. The government is also working on anti-dumping legislation that will make it illegal for country’s to dump imports into the economy.
“We are also working on a trade adjustment package to foster trade liberalization and assist our own companies and workers to get training so that they can be more competitive,” he said.
Finally, perhaps the most important plan that Coomaraswamy shared is the formulation of trade agreements with regional economic powers.
In particular, the government is looking to make important trade deals with China, India, Pakistan, and Singapore. He also noted that the country should receive GSP+ status in May. If Sri Lanka is able to lock up these deals by the end of the year, it would have preferential access to combined markets of over 3 billion people.
The country already has a bilateral trade agreement with India, which it hopes to widen, and if it secures a similar deal with China, it would be the second country to have preferential access to both of these markets.
“The government is trying to leverage the nexus between trade and investment to promote economic growth and development. These deals are potentially transformative, but we must improve education and training so that the labour force has the skillset to take advantage of the opportunities that are likely to come,” he said.
Coomaraswamy also touched on the Hambantota issue, saying that it was important to look at the lease agreement in a holistic way. Though the port’s lease would bring more business, the Governor was more excited about the lease payment.
“The $1.1 billion that will come as the payment would be tremendously helpful in terms of meeting our foreign debt obligations. This is a non-debt creating inflow,” he said.
Furthermore, he noted that the people of Monragala and Uva would benefit from China’s plans to develop the area. He claimed that China is planning to invest about $5 billion in and around Hambantota, and this would create jobs and raise the average wage to around $500 a month, or Rs. 75,000.
“Here is an opportunity to help the people of this area,” he said.
Coomaraswamy touched on the master plan for Trincomalee, where Japan, India, and Singapore are expected to help with investment. He also briefly reviewed other development projects, such as the Megapolis and the rehabilitation of Palali airport and Kankesanthurai port, but noted that it will take between 18 months and two years before the country starts to see the results of these projects.
Over the next 18 months, however, the private sector will be the main economic driver, he said.
Though he is optimistic about the current moment, he did note that these policies and goals are easier formulated than achieved.
“In my view the plans are good. The real challenge will be execution. We have three priorities: execution, execution, and execution. Even if we do half of what I talked about, the country will be transformed. We need to come together to seize the opportunity,” he said.
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