Road to recovery: Lankan economists grapple with way forward

By Nizla Naizer

Economists from all sectors in Sri Lanka convened at the Galle Face Hotel last week to discuss the future of the country in a post-recessionary world. The rules have changed across the globe, as global economies collapsed and the concepts of demand and supply were affected by the intervention of Governments to save their economies with trillion dollar bail out packages.
The Sri Lanka Economic Association’s (SLEA) annual sessions were full of stimulating insights to the world of the economist and attempted to bring both sides of the story with private sector participation. Most were of the opinion that it was time to strategise and convert policies into actions while Chief Guest World Bank Chief Economist for the Africa Region Dr. Shantanayan Devarajan explained, “The world maybe looking for new concepts of economics but in Sri Lanka, the Washington version of economics is very much alive.” The Bottom Line takes a look at the key issues discussed at the meeting of economic minds at the SLEA Annual sessions titled “The way forward to recovery from the fallout of the global recession.”

Using monetary policy to deal with the global recession
*Flexible exchange rate saved Sri Lanka from crisis
*Tightened monetary policy till 2008, now eased
*CBSL focussed on communicating decisions effectively
How important is monetary policy in the context of a global recession? How must exchange rate policies and interest rate policies be changed or formulated in order to lead a country away from a crisis? These were the questions addressed by the experts speaking at the first session of the day.
The Central Bank is either part of the problem or part of the solution in an economic crisis, Central Bank Assistant Governor H. N. Thenuwara said speaking on the importance of the exchange rates in an economy. “Sometimes the Central Bank steps in with measures to remedy the situation created by its own policies and sometimes it steps in with measures to curb a situation beyond its control.”
He added that the exchange rate policy is used solely as a policy in some countries or as the residual effect of decisions taken by some others. He informed that monetary policy and the exchange rate must be compatible.
“Conventional wisdom dictates that the Central Bank must employ monetary policy solely to maintain price stability, but with the global crisis, Central Banks intervened with large bail out packages with little thought for future inflation. With high budget deficits resulting from this, there is suddenly a rethinking of objectives across the board.”
Explaining that various lessons could be learnt from crises in the past, Thenuwara pointed out the 1929 Great Depression in the US. “The US Federal Reserve tightened monetary policy and worsened the crisis, so in 2008 it learnt from that error and expanded its monetary policy.” In Japan where the country experienced a lost decade in the 1990s the Government intervened and established heavy protectionist policies for which the country is still paying the price. “Here the exchange rate policy was not used as a tool and we see the yen Vs dollar progressively declining.”
He pointed out that in Europe too the Governments decided to implement a managed exchange rate system with currencies pegged down in the 1970-1990 but eventually resorted to a single currency to combat the dollar. “The developing world can learn from the lessons of the developed world. An expansion policy is what is needed in times of crises.”
He said that in many cases, such as the Latin American crisis where a few countries like Mexico saw a shrinking economy, it was a localized problem so they could expect assistance from the better off regions. However in the current crisis, there is nowhere to run so you need a different approach. “Sri Lanka has never had a crisis because since 2001 we have allowed a free floating exchange rate system and our underlying policy has been to let it be at that.”
Speaking on the importance of interest rates Central Bank Sri Lanka (CBSL) Chief Economist Nandalal Weerasinghe said that the Central Bank signals it’s stance on monetary policy through its policy interest rates. “The Central Bank can ease the monetary policy by reducing Repurchase and Reverse Repurchase Rates and it can tighten it by increasing these rates,” he explained.
The CBSL tightened monetary policy from 2004 to mid 2008 to contain high inflation which had been driven by the lagged effect of excessive monetary expansion, he informed and which was aggravated by the supply side as well as external shocks. “The Central Bank relied on high interest rates, which was raised by as much as 350 basis points till early 2007 and aggressive Open Market Operations (OMO) to siphon of liquidity from the banking system. This was done with the intention of directly restricting the credit creating capacity of banks.”
However, he explained that the direction of the monetary policy changed towards the end of 2008 as inflation began to decelerate and the need for releasing liquidity to the domestic market in the wake of the global financial crisis. “And in 2009 too we saw that the decelerating rate of inflation in 2009, at a faster rate than expected has confirmed that the Central Bank’s strategy of focusing more on quantitative targets was more effective in a high inflation environment,” he explained, “With inflation expected to stabilize at single digit and manageable rates for the rest of the year the Central Bank has been able to reestablish the policy rate corridor formed by the Repurchase and Reverse Repurchase Rates more effectively in its monetary policy.”
Weerasinghe added that the Central Bank has a Monetary Policy Committee that gives recommendations with regular statements issued on decisions make. “We now have a better communication policy to keep the market and the general public informed about the decisions we take and since 2007 we have had a Road Map for each year drawn up at the beginning of every year. We publish inflation forecasts and we obtain feedback from the academia,” he informed, “And since there was no appropriate inflation index, we encouraged the Census and Statistics Department to produce core inflation research.”

Realities of fiscal policy
*Current expenses guzzling government revenue
*Country facing Debt Induced Displacement
*Encourage Corporate Debt
The biggest challenge facing the Government now is to tackle the budget deficit as revenue continues to fall and expenditure increases with the required bail out packages to the economy, Institute of Policy Studies Executive Director Dr. Saman Kelegama explained. “The Government is experiencing a fall in revenue and the management of the budget has become a challenge. The bulk of our response to the crisis has come through the monetary policy side and structural adjustments but the question now is how does the Government intend to stick to the IMF Standby Agreement’s condition?”
The biggest guzzler of revenue come from current expenditure in the form of debt interest, wages, transfers and subsidies, he informed, and although the President has appointed a taxation commission, it is a daunting task to bridge the gap. He pointed out that BOI incentives to investors alone amounted to 1% of the GDP which was high in comparison to Thailand at 0,4% of GDP and Vietnam at 0.6%. According to the World Trade Organisation Policy Reviews, he pointed out that a further 70% of our imports entered the country duty free and that these regulations must change for the deficit to narrow.
Echoing this observation Sri Lanka Economic Association Vice President R.M.B. Senanayake said that the fiscal stability or balanced public finance is a useful indicator of the macroeconomic health of a country. “High budgetary deficits are considered to be the cause of macroeconomic problems including high levels of inflation, current account deficits, highly indebted economy and slow growth.”
He alleged that in Sri Lanka’s current scenario the banking system has been affected by the global crisis, a fact which the Central Bank attempts to conceal. “The level of Non Performing Loans in commercial banks has increased from 5 to 9%,” he declared, “And the Central Bank is not disclosing this fact while continuing to generate FOREX reserves through capital sources.”
He said that the country is experiencing a Debt Induced Displacement where although interest rates and inflation is down, the commodity prices have not decreased and the debt burden of the borrowers has also increased.
This is aggravated by the cycle where state owned enterprises are delaying their payments to private entities and causing them to experience working capital crises, he informed. “The Real Interest Rate has risen and in fact it is easier to for companies to repay their debt when inflation is high.”
Painting a dire picture, he said that unless the interest rates are less than the inflation rates the private sector cannot be saved adding that even though recent claims indicate that the Stock Market is performing well, foreign investors pulled out more than they brought in.
He added that the Government is funding it’s deficit with loans from abroad but it is only a matter of time before the Central Bank funds the Government’s requirements. “Why is the Government continuing to attract foreign funds with rupee denominated bonds at high interest rates when they should be encouraging corporate debt? There is no corporate bond market in the country and the commercial paper market has collapsed.”
He said that since our banks are risk averse, there is low leverage rates and greater scope to develop the corporate debt market. He added that the country’s inflated adjusted budget deficit is more important than a mere percentage of GDP stating that the public must understand that the Current Account Deficit is the most concerning element and that borrowing money to finance it is a pressing issue.
Senanayake’s remarks were echoed by former Ceylon Chamber of Commerce Chairman Chandra Jayaratna who said that the Bond Issue is an offer waiting to be taken brutal advantage of by foreign investors just as lack of regulators are creating oligopolies within the country.
Speaking on the role of taxes and subsidies, Sri Jayawardene University, Senior Economics Lecturer T.N.Herath explained that a decrease in marginal taxes and an increased supervision on the use of subsidies is now called for. He explained that supply-side economics is more efficient that demand side and there fore a tax cut policy, corporate tax, sales tax and payroll tax can be used to stabilize the function. “Tax policy is more reliable that subsidies,” he said, “So focus on cutting down on subsidies and restructuring taxes.”

The importance of sectoral economic adjustments
*Improve productivity and differentiation
*Government must practice better governance
*Exchange rates and a lukewarm policy crippling exports
Improving productivity is vital if the country wants to move out of the after effects of the global recession, but Strategy Development Consultant Lloyd Yapa warned that it is not enough. “Any one of your competitors can emerge as productive as you, so the trick is to create a differentiation to your operations,” he informed.
Speaking on the impact caused by the recession on the Sri Lankan economy, he said that the effects had been twofold. The private sector firstly saw job losses of over 96000 in the first quarter of the year alone while exports dropped by 18.9% till May 2009 compared to 2008. The Government’s budget deficit is expected to increase to 10% at the end of the year as revenue dropped and expenditure increased just as the growth projected for the country is at 3%. However, the ailing public sector has also been affected. “It maybe more advantageous to partly privatize some of the larger loss making public sector enterprises including the CEB, CPC and Mihin Air which is eating into Government revenue.”
He discussed internal techniques to improve productivity which included realizing economies of scale with large scale production, corporate bodies among SMEs, orchestration, subcontracting and Research and Development. He also listed some external recommendations which included the Government’s role in supporting businesses improve productivity.
“The Government must simplify its bureaucratic procedures and red tape, they must develop the tertiary education with a focus on knowledge economy, develop infrastructure especially the neglected road network and ensure an increased level of governance,” he informed. He said that the Government must reduce the amount of protection and raise levels of responsibility within the institution while at the same time the politicization of the constitution must be abandoned. “I believe it is important to implement the 13th and 17th Amendments and establish independent commissions to ensure better governance.”
Providing a private sector take on the matter former Hayleys Chairman N.G.Wickramaratne said that adjustment strategies based on productivity and competitiveness only work in a competitive environment. “I’m always under the suspicion that we as a country don’t seem to feel the need to be globally competitive,” he said, “and there is an export bias where the focus on exports has decreased in the last 10 years.”
He pointed out that the policy bias has given less importance to the private sector with external orientation and that in many parts of the world, it is high export orientation that has spurred growth. He added that the dependence on domestic demand was unsustainable to local businesses but with an over valued exchange rate, high trade deficits and a tendency to depend on remittances, the lukewarm policy of the state is not letting Sri Lanka reach its potential.
“I hate remittances,” Wickramaratne declared, “We have over 1.9 million Sri Lankans away from their families sending USD 2 billion each year. That is Rs. 175000 per person per year while merely by adding value; they could earn Rs. 500000 a year.” He said that it is time to create the jobs here in Sri Lanka.
Ceylon Chamber of Commerce Chairman Anura Ekanayake recommended that the economists, private sector representatives and the Government reach a consensus on future policies together. “The economists know the way things ought to be, but it is the business people who feel the consequences on the ground level,” he explained.
He pointed out that the while productivity is driven by labour, the labour laws in the country enforce inefficiency by making it impossible to let people go. In the meantime, even the stimulus package announced for exporters propagates inefficiency and improper use of resources as the condition to earn the rebate is that an exporter retains the same level of exports as the previous year with no lay off of employees.
“Stop focusing on incentives because the Government does not have the fiscal space to have any,” he continued, “But focus more on removing disincentives. And we must emerge out of this mindset that the Government must handle everything. Let the private sector get more involved in infrastructure development.”

The good governance challenge
*Public Governance playing second fiddle to Corporate Governance
*Appoint permanent Budgetary Committee
*Being too nice in the Boardroom must be changed
Focusing on the importance of public governance as well as corporate governance to carry a country through a global recession, economists agreed that there must be commitment from the higher authorities to combat corruption with a regulated system in place.
Nithya Partners, Precedent Partner, Arittha Wikramanayake pointed out that in recent times public governance has played second fiddle to corporate governance, but is just as important to take the country forward. “In corporate governance, there are always stakeholders in the form of shareholders who agitate to ensure corruption does not take place, but In public governance there is rarely a party to be accountable to. This has led to a steady decline in transparency.”
He explained that although it maybe perceived to be an internal issue, the lack of good public governance also contributes to the country’s low rankings in several international indices including the Ease of Doing Business Index by the World Bank where Sri Lanka is ranked 105 out of 181 countries and the Economic Freedom Index where Sri Lanka ranks 111 out of 183 countries. “These indices are studied by international investors when they attempt to make a decision on whether to invest or not,” he explained, “So unless we have good public governance we cannot improve are standings.”
He said that the biggest failing in Sri Lanka has been the lack of advocacy within civil society. “As a society we accept the lack of accountability. We need to advocate to form a regulatory framework to over look these areas just as we need a more effective COPE, judiciary and media.” He explained that the failure of some of the measures such as COPE to monitor and enforce good practice in public governance has resulted in a sense of cynicism and apathy among the people, a mindset that needs to be urgently changed,
This view was endorsed by Transparency International Sri Lanka Executive Director J C Weliamuna who said that COPE had no effectiveness, capacity or relevance. “We do not even have a permanent budget committee which is essential if you wish to have realistic budget projections. Most of the time, the budget projections are mythical and we do not question its integrity or authenticity.”
He said that even as professionals, they fail to connect governance to their work, a trend that must change.
In the arena of corporate governance too, many issues were highlighted by KPMG, Ford, Rhodes, Thornton and Co, Advisory Services Head Riyaz Mihular. “The principal players in corporate governance are the shareholders, management and the Board of Directors,” he explained, “and it is governed by the principles of right and equitable treatment of shareholders with no conflict of interest, protecting the interest of the shareholders, the role and responsibility of the Board of Directors and integrity and ethical behaviour.”
He said that in recent times, the role of the non-executive director has become an interesting phenomenon. Although they provide expertise and direction, several large companies failed in the past despite having many experienced non-executive directors on board. “In Sri Lanka too, there is a custom where people are too nice to each other. Even on the Board, you abstain from speaking up because you are afraid to hurt someone else. This mindset must change, if you are in a position to speak, you must be firm in your stance. You can disagree without being disagreeable.” He added that professionalism is key to ensuring that good governance is promoted within the organization.
Mihular also stated that disclosure and transparency has become a topic of debate in recent times. “Many say that Fair Value accounting brought on the global economic crisis. I disagree, Fair Value Accounting ensured that the crisis was revealed faster before it got worse and that is why the IAS backs it.”
He commented that the auditor’s role is vital now more than ever and an auditor must not only declare its independence but must be perceived to be independent through its actions and disclosures. He added that corporate entities must also review their compensation arrangements. “Many organizations pay large amounts of compensation without realizing the damage they are doing to the future of their organization.”
Former Ceylon Chamber of Commerce Chairman Chandra Jayaratna pointed out that many questions must emerge from the public on the matters of good governance. Speaking on the role played by the economists he recommended that SLEA members must create a Economic Policy Planning and Development Sub- Committee to meet monthly to review and make appropriate submissions through the SLEA to the relevant stakeholders of society on the areas of Policy Reform options enhancing Socio-Economic Value Enhancement, macro-economic development opportunities and issues with implications for economic policy while addressing issues of macro-economic importance and presenting views and recommendations and evaluation and critique on proposed or planned significant resource allocations for socio-economic national development initiatives.
He added that the committee must conduct Economic Post Audit based evaluations and recommendations on significant public spends in both capital and revenue and must analyze any issue, economic or otherwise, referred to it by SLEA.
He also recommended the creation of a representative sub committee of members of SLEA called “Public Governance Facilitation Support Sub- Committee” to meet monthly to review and make appropriate submissions through the SLEA to the relevant stakeholders of society on areas including Integrity, Transparency, Completeness and Professionalism of Public Information and Data Releases, Technology and Best Practice transfer options enhancing public governance responsibility and accountability for the management and control of public resources and delivery of programmes and services while also studying the reported or purported cases of violation of public governance responsibility and accountability for the management and control of public resources and delivery of programmes and services.