The keynote address delivered by Dr. Kalpana Kochar, the World Bank’s Chief Economist for South Asia, at the recently concluded CCC Economic Summit highlighted three fundamental flaws in Sri Lanka’s growth model. It will not be possible to achieve sustained growth of 8% without addressing these effectively.
Considerable controversy has arisen regarding Employment Provident Fund (EPF) investment in the Colombo Stock Exchange (CSE). There have even been calls to stop all such investments. It is important, however, to remember that there are positive arguments in favour of such investments. However, it is necessary to create the appropriate enabling environment to avoid criticism based on conflicts of interest, a lack of transparency and an erosion of investor confidence.
The balance of probability is that growth will decelerate sharply by the fourth quarter of this year to about 5% (this was the average recorded during the 30 years of the conflict) and inflation will be at a double digit level. There is an urgent need for a mix of policies that not only curtail aggregate demand but also create the impetus for a robust supply response.
With the end of the war, there was a desire throughout the country for a peace dividend. Over the 30 years of the conflict, pent-up demand had built up both for consumption and investment expenditure. The authorities were under intense political pressure to create an environment that was conducive to finance imports of consumption goods, as well as intermediate and capital goods to boost investment and business activity.
The government of Sri Lanka introduced a number of bold macroeconomic stabilization measures in February/March 2012. These were necessary as the country was on a trajectory to a very destructive balance of payments crisis. It is still too early to determine whether enough has been done to stabilize the balance of payments, particularly the trade deficit. As the Pathfinder Foundation has pointed out in several previous articles, the trade deficit doubled last year, despite a 22% increase in exports. The current account deficit deteriorated from 2.8% of GDP in 2010 to 6.8% in 2011. The overall balance of payments was in deficit to the tune of $1 billion. The deterioration in the external account led to pressure on the currency and a hemorrhaging of reserves.
Global and domestic economic developments call for vigilant and cautious policy-making at this time. The Eurozone crisis; the fragile recovery in the US; the economic slowdown in China; the twin deficits (budget and current account) and a lack of economic reform in India; the political turmoil in the Arab world; and sanctions against Iran mean that the external economic environment is characterized by elevated uncertainty and risks. These negative factors are mitigated to some extent by a softening of oil prices as a result of a slowing of global economic activity. However, policy-making needs to take cognizance of the very real risk of the slow-down in Sri Lanka’s key export and tourism markets outweighing the benefits of lower oil prices. Consequently, the authorities’ forecasts of a trade deficit of $9.2 billion and an overall balance of payments surplus of $1.2 billion this year could well come under considerable pressure. It is also important to recognize that it is highly risky to count on borrowing oneself out of trouble.
Tourism has emerged as an extremely important sector in the economy from a number of perspectives in post-conflict Sri Lanka. It is important as a potential source of growth, employment and foreign exchange. The sector has seen impressive recovery since the end of the conflict. Arrivals have increased from 447,890 in 2009 to 855,975 in 2011. In addition, earnings from tourism have risen from $350 Mn to $850 Mn during this period.
Last week saw both the exchange and interest rates come under some pressure, despite the courageous reforms introduced by the Authorities in early February 2012. It is important, however, to learn from the policy mistakes of the recent past and to resist imminent pressure to manipulate these two key economic prices.
Sri Lanka now a middle-income country has to operate within a new paradigm, particularly in raising finances for the country’s development program. In this context the Pathfinder Foundation wishes to draw the attention of policy makers and the leadership to study the feasibility of raising low cost, long-term financing through a new innovative mechanism, technically known as introducing an innovative, low cost and long-term ‘Asset Backed Securitization of Future Flow of Receivables’ such as remittances. Securitization is a form of secured borrowing involving the transfer of assets to a Special Purpose Vehicle (SPV) that finances the assets with securities backed by the value of the assets.
The Pathfinder Foundation (PF) welcomes the measures adopted by the Authorities in recent weeks. PF has consistently advocated the use of the exchange rate, interest rate and fiscal measures in a flexible and pragmatic manner to achieve macroeconomic stabilization. It is encouraging that the measures taken so far have arrested the hemorrhaging of the country’s foreign reserves and placed the economy on a path towards stabilization.
From its very inception there have been serious concerns about the financial viability of the national carrier (Air Lanka/Sri Lankan Airlines). These become more intensified each time the need for fleet renewal comes-up. That situation has arisen again. It is important, therefore, to consider very carefully the options available. The way forward should attach priority to ensuring that an undue burden is not cast on the already over-stretched budget and balance of payments of the country. The risks associated with Sri Lanka’s budget/balance of payments deficits and debt profile are already elevated.