The Challenge: Macroeconomic Stability and Strategic Action
There has been an improvement in macroeconomic conditions since the introduction of the stabilization measures introduced in Feb/March 2012. Inflation has abated and the balance of payments has improved. However, though the growth momentum has picked up in 2H 2012, the balance of probability is that it has been well below the targeted 8%. More fundamentally, the current economic model, where consumption is very dependent on remittances and growth is disproportionately funded by borrowing, including increasing amounts of foreign commercial debt cannot be the basis for placing Sri Lanka on a higher path of sustained growth and development for a decade or more, particularly as international interest rates will rise in the future as the major global central banks unwind their extraordinary liquidity infusion. Despite this, the opportunity now exists to emulate the achievements of the successful countries of East and South East Asia which recorded rapid growth for 10 – 20 years. However, Sri Lanka cannot achieve such success without maintaining macroeconomic stability and taking some key strategic action
The recently concluded Commonwealth Summit issued four statements reflecting the outcomes of their deliberations: the Colombo Declaration on Sustainable, Inclusive and Equitable Development; the Kotte Statement on International Trade and Investment; the CHOGM 2013 Communiqué; and the Magampura Commitment to Young People.
Some commentators have raised the prospect of India facing a repeat of the balance of payments crisis that shook the country in 1991. Fears have been expressed that after years of 8% - 9% expansion, growth could fall to as low as 3% - it was 4.4% in 2Q 2013. The Indian Rupee depreciated about 18% and there has been an outflow of portfolio capital from stock markets. However, Prime Minister Manmohan Singh, who piloted the reforms of 1991 that placed the economy on a higher growth trajectory, has dismissed fears of a balance of payments crisis.
Overheating to Cooling-off
The growth momentum in the economy has slowed sharply, since 3Q 2012. As mentioned in previous Pathfinder Foundation (PF) articles, this is reflected in reduced government revenue, imports, electricity sales and company profits. Such a slowdown in growth has been an inevitable consequence of the stabilization measures introduced in Feb/March 2012. These became necessary to address the overheating of the economy, which was reflected in elevated inflation and balance of payments imbalances which exerted pressure on the currency/reserves.
The promise of accelerated growth
The end of the conflict has raised expectations regarding the growth prospects of the country. However, a lesson to be drawn from the experience of 2010 and 2011 is that a sustained accelerated growth trajectory cannot be achieved by demand management policies alone ie adjustments to monetary, fiscal and exchange rate policies. The structural constraints that have persisted for several decades have invariably triggered an over-heating of the economy whenever growth accelerates. This experience was repeated again and resulted in the introduction of the stabilization measures of February/March 2012. Growth slowed down sharply since then.
The Shared Experience
Both Japan’s post-World War II recovery and China’s resurgence over the last three decades were export-driven. Manufacturing, based on low-cost labour, was the key determinant of the initial transformation process in both instances. Both countries also used under-valued currencies to provide exporters with the competitive advantage. Japan and China promoted exports at the expense of domestic demand (household income and consumption). Both countries were able to attain very high levels of domestically financed investment. Both generated extremely large trade surpluses which were invested abroad, particularly in US securities. This enabled them to achieve the twin objectives of avoiding upward pressure on their exchange rates and of helping the US and others to purchase their exports.
Sri Lanka’s Low Productivity/Growth Syndrome
The 35 years since liberalization of the economy has seen repeated cycles of the economy overheating once growth exceeds 6%. Growth of 8% or more is necessary over a sustained period to achieve economic transformation similar to that achieved by a number of countries in East and South East Asia. The causality for Sri Lanka’s inability to sustain accelerated growth (as seen again after 3Q 2012) is complex. An unstable macroeconomic framework, with an unsustainable budget deficit, is an important explanatory factor. Low productivity is another as it limits the capacity of the economy to achieve non-inflationary growth. In addition, it results in Sri Lanka not being able to produce goods and services the rest of the world needs in sufficient quantities at competitive prices i.e. to earn adequate foreign exchange to support the level of imports necessary to sustain an 8% growth rate without running into balance of payments difficulties. Low productivity also reduces the scope for a non-inflationary rise in incomes.
Implications for Emerging Markets
Currently, there is much debate regarding the future of the massive Quantitative Easing (QE) program of key Central Banks, particularly the US Federal Reserves (FED); the European Central Bank (ECB); the Bank of England (BOE); and the Bank of Japan (BOJ). Of these, recent attention has been focused, particularly on whether the FED is considering a ‘tapering’ of its purchases of bonds and mortgages. ‘Tapering’ is the term used to describe a possible slowing down of the FED’s asset purchases which currently amount to $85 billion per month. This has led to selling by bond-holders thereby driving up interest rates and causing volatility in stock markets. The nervousness has not been confined to the US and has spread around the world. There has even been talk of an emerging market sell-off. If the mere possibility of the FED ‘tapering’ its bond purchases can cause such volatility, the prospect of it actually happening requires careful consideration. It would be useful, therefore, to examine some of the issues involved regarding the FED’s future action on its massive QE program. Any such analysis is complicated by two very different narratives that make it difficult to separate the good news from the bad.
The Negative Narrative
Sri Lanka’s exports have declined from 33% of GDP in 2000 to 16% in 2012. In addition, Sri Lanka’s share of global exports have also declined (this reflects clearly a decline in competitiveness). Exports have declined in absolute terms in 1Q 2013.Furthermore, in 1980, export complexity in Sri Lanka and Thailand was similar. Today, Thailand’s exports structure reflects a far more diverse and complex mix of goods and services. This disappointing performance is a function of both an anti-export bias in the policy framework that has tended to persist since 1980 and a lack of competitiveness/low-productivity. Challenges exist for both policymakers and business to affect a decisive turnaround. This is crucial as Sri Lanka with a very small domestic market cannot achieve an accelerated growth path on a sustained basis without significantly better export performance. It is a cause for concern that remittances are the only non-debt creating source of foreign exchange that is not underperforming in relation to government targets.
Emerging Political and Diplomatic Tensions
The ongoing sessions of the UN Human Rights Council (UNHRC) have raised a number of issues regarding the conduct of Sri Lanka’s international relations. The Pathfinder Foundation (PF) does not wish to get involved in areas of politics, diplomacy or human rights. However, the course of the country’s international relations will have a crucial bearing on its economic prospects. There are serious concerns that have arisen about the policies and actions of the US, Europe and India, as well as some other countries that are likely to support the US sponsored Resolution. Sri Lanka already has advantageous economic relations with a number of these countries, or has the potential to do so in the future. Therefore, political, diplomatic or human rights issues need to be addressed in a pragmatic manner that best serves Sri Lanka’s national economic interests, in a context of mutual respect. It is important not to let them have a negative impact on the economic arena in a manner that fundamentally compromises the country’s future prospects.
Responding to a Changing World
The global landscape is changing more quickly than at any time in human history. Geopolitics, technology, lifestyles and even the climate are all posing new opportunities and challenges. In geopolitics we are seeing the crystallizing of a new multi-polar world. Within that, the economic centre of gravity is shifting from West to East with the re-emergence of Asia as a dominant player. This is, of course, nothing new. China and India accounted for well over half of global GDP on their own, before the Industrial Revolution.
From ancient history to present day
Since ancient times, Sri Lankans have engaged in international trade. Our rulers were open to international traders and visitors, such as Fa-Hsien. In addition, Ptolomy, a Greek, depicted Sri Lanka in a world map many centuries ago which indicates that Sri Lanka was on the trade routes of that time. Gems, spices, elephants, ceramics and pottery items were among the products that were exchanged. Though colonial rule and subsequent developments brought about a different economic structure and trading pattern, Sri Lankans continued to capture opportunities arising from the colonial economic exploitation process. That is how the emergence of a local entrepreneurial class took shape. This development is well and vividly presented in Dr. Kumari Jayawardena’s “Nobodies to Somebodies.”