Comments /7380 Views / Tuesday, 27 December 2016 00:05
The year 2017 dawns with two anniversaries. One is the sixth anniversary of this series analysing economic and related issues. The other is the second anniversary of the good governance government that came to power in 2015 in a silent revolution. The first anniversary is to be celebrated by looking at some of the economic analyses done during the past six-year period. However, with respect to the second anniversary, a grand celebration is being planned by the victors of the silent revolution.
Any celebration by government leaders involves the spending of scarce public money for a purpose not directly productive according to economists. Yet, the leaders of developing countries are known for their desire to make a show-off of their successes by using taxpayers’ money. In Sri Lanka’s present case, it is more agonising for two reasons. One is that it is not only the taxpayers’ money that is being used; it is borrowed money which is being wasted since the Government has to borrow even to meet its day to day operations due to shortfalls in revenue. The other, is that it is being done while Sri Lanka is sitting on an economic volcano which is to erupt at any moment, destroying everything in the vicinity.
The economic volcano is the deep economic crisis which the country has been going through since around 2012. The symptoms of the onset of the crisis were visible from many fronts though they were conveniently ignored by the policy makers at that time. The symptoms took the form of a worsening external sector, unusual growth in money and credit, suppressed inflation, slow-down of economic growth and an undisciplined budget causing the accumulation of public debt. Independent analysts, including this writer, drew the attention of the policy makers at that time to the need for taking urgent corrective action to arrest the oncoming catastrophe. But the only response to such constructive criticism was a flat denial, rebuff, name-calling and personal attacks. On top of this, there was a deliberate attempt at massaging the main economic numbers painting a rosy picture about a fast-growing vibrant economy.
The external sector crisis began to manifest itself when exports started to fall both as a share of the Gross Domestic Product or GDP and the world exports from around 2005. It led to a growing trade deficit and a major part of the deficit was funded by using the remittances made by Sri Lankans working abroad. Those remittances provided a temporary relief to the authorities and they were supposed to use that breathing space to take measures to fix the external sector ailment permanently. But what was done was to borrow money from commercial sources and use the loan proceeds to meet the market demand for foreign exchange so that the rupee could be prevented from falling against other currencies. The attention of the policy makers to this insane strategy was drawn in an article published in this series in November 2011 under the title ‘External value of the rupee: Market driven or Central Bank driven?’ (Available at: http://www.ft.lk/article/58156/External-value-of-the-rupee--Market-driven-or-Central-Bank-driven-). Yet, the policymakers continued to follow the same policy by making ever increasing commercial borrowings from abroad. Then, the foreign borrowing numbers were cooked and published in a special debt report by the Central Bank to show a rosy picture. This stand of the Central Bank was challenged in another article in the series published in May 2014 under the title ‘Sri Lanka’s external debt sustainability: Complacency based on incomplete analysis may be the worst enemy’ (available at: http://www.ft.lk/article/297680/Sri-Lanka-s-external-debt-sustainability--Complacency-based-on-incomplete-analysis-may-be-the-worst-enemy). The Central Bank vehemently reacted, even going to the extent of personally attacking this writer but the problem did not go away and its results are now being faced by the present government.
Economic data too was manipulated by the government that was in power, starting from growth numbers and then poverty and unemployment numbers. Growth was shown as a super achievement but the actual growth was pretty much lower than what was publicised. Attempts were made by the Government to drive growth arbitrarily above what the economy could have achieved based on its capacity for growing, known as the country’s potential growth. The result was to overheat the economy, leading to both inflation and depreciation of the currency. This was brought to the notice of the Central Bank in an article published in this series in March 2014 (available at: http://www.ft.lk/article/268250/Potential-output-of-Sri-Lanka--It-is-dangerous-to-speed-the-car-beyond-installed-engine-capacity). The Central Bank once again rebuffed it as irrelevant but the subsequent events proved that the country was heading for disaster on both the inflation and exchange rate fronts. The inflated growth numbers were visible when they were significantly higher than the household income numbers gathered through field surveys even after making an allowance for the incomes of companies which are not included in household incomes but in the GDP numbers. This anomaly in growth numbers was again highlighted in an article published in February, 2014 (available at: http://www.ft.lk/article/258408/Average-income-of-a-Sri-Lankan--When-numbers-gathered-from-top-and-bottom-do-not-tally-). But the Central Bank instead of advising the Government on the adoption of relevant corrective policies, took issue with this writer. Then, it was revealed that the growth numbers had been massaged by the top economic policymakers to suit their petty objectives. This was the subject matter of an article published in the series in December, 2013 (available at: http://www.ft.lk/article/233962/Alleged-massaging-of-growth-numbers--Should-a-credibility-restoration-exercise-be-launched-for-Sri-Lanka-s-statistics-agency-). The poverty of the poverty numbers was also brought to the notice of the authorities in an article published in May, 2014 (available at: http://www.ft.lk/article/292226/Sri-Lanka-s-growth-paradox--When-poverty-yields--income-gap-holds-stubbornly).
Thus, when the new government came to power in January 2015, it was a sick economy which it had inherited from the previous administration. The top priority of the new government was, therefore, to take a quick stock of the economy, make a diagnostic and a prescriptive study and introduce urgent corrective measures. Since the economic volcano was showing all the signs of eruption without warning, there was no time to be wasted. The Central Bank, as advisor to the Government, was to apprise the new government of the real economic situation and the need for urgent corrective measures but the Annual Report of the Monetary Board for 2014, prepared after the new government came into power and released in April 2015, was silent on any economic crisis being faced by the country. It had reconfirmed the doubtful economic data issued by the previous administration thereby removing any statistical ground for blaming it for the prevailing economic ills. Even the Annual Report of the Ministry of Finance, released in June 2015, had taken the same stand: The country does not suffer from any economic ailment that needs quick fixing. Consequently, it is the present government which is now being blamed for the ills in the economy.
Had the leaders of the new government gone through the State of the Economy 2014 report issued by the Institute of Policy Studies or IPS in October 2014, instead of relying on the Central Bank, their reaction to the issue would have been different. In this report, the first chapter on policy perspectives and the second chapter on macroeconomic performance outlined the basic economic issue faced by the country. The report said that the source of growth in recent years had been largely dominated by the domestic non-tradable sector, meaning that the growth had not generated sufficient volume of exports (p 2). In fact, if this message had been read correctly, any policymaker would have known the reasons for the chronic and acute external sector crisis in the country. The Government cash flow had been managed by delaying payments to suppliers which was not a viable solution. The viable solution was to raise revenue and curb wasteful expenditures. The report had stressed that the Government should have moved away from consumption type taxes which are unreliable and based on the performance of imports and economic growth. If both do falter, so does the tax revenue. For a more sustainable increase in tax revenues, it was necessary to go for fundamental reforms in tax policy and tax administration (p 3). This was not addressed to either in the interim budget or the two permanent budgets that followed.
IPS had correctly identified that it was not prudent for Sri Lanka to go for mega projects undertaken out of foreign commercial borrowings backed by sovereign guarantees since they increased the Government’s payment liabilities, on one hand, and make the country vulnerable to adverse developments elsewhere, on the other (p 4). The report had advised that Sri Lanka should identify key urban areas into which industries and foreign direct investments can be channelled and build the energy, housing and environmental management infrastructure around it (p 13). This piece of advice aiming at inclusive growth everywhere is more prudent than embarking on a single province-based Megapolis, being undertaken by the Government. It has also opined that Sri Lanka, being a small developing economy, should consider the demand for its products from outside Sri Lanka as critical for sustained long-term high growth, absorbing the surplus labour and raising productivity (p 19). Hence, export of goods and services should be promoted at any cost and budgetary provisions should have been made for achieving that goal. The implication of the government-led economic growth in the post-2009 period, according to the report, is the driving of the private sector to lesser economic engagement with unintended consequences for long term economic growth (p 33).
It took about 11 months for the Government to recognise these important requirements as revealed by the Economic Policy Statement presented by Prime Minister Ranil Wickremesinghe to Parliament in November, 2015. It was too late by that time. Then, it is still too late now since two years have now elapsed without any concrete action by the Government to come out of the economic crisis in which it is now deeply immersed. The Government is walking into 2017 totally unprepared it seems, for the pitfalls that lie ahead.
Prime Minister Ranil Wickremesinghe presented a second economic policy statement in October, 2016 in Parliament. However, this second statement had no connection to the first statement he presented in Parliament nearly a year ago. It was a completely different statement from the first one, without any evaluation of the attainments made with respect to the goals of the first statement. Hence, two years have now elapsed without a concrete economic policy package for rescuing the country.
In the second policy statement, the Prime Minister had emphasised the need for maintaining a minimum annual economic growth rate of 7% by Sri Lanka. The growth target of 7% is for the country to double its income in every 10-year period based on compound growth rates. Then, in a 30-year period by 2047, Sri Lanka’s income would increase by about eight times from what it had in 2016, elevating the country to the status of a rich country. It is a noble ambition but without a concrete plan, it appears that the target has become elusive.
Sri Lanka’s annual average growth rate during the post-independence period has been at about 4.7%, well below the desired growth rate of 7% announced by the Prime Minister. In 2016, the Minister of Finance has expected the economy to grow by about 6%. But the indications today are that the country’s growth rate in this year would be around 4%.
The country has already experienced a downfall of the output of paddy and tea, causing a negative impact on the growth targets for 2017. The best economic growth the country could attain in 2017 would be about 4.5%, despite the high economic growth expectations made by both the Central Bank and the Minister of Finance.
What it would mean is that the economy should grow faster than 7% in the next 30-year period, if it is to realise its target of becoming a rich country by 2047. This is difficult but not impossible, provided Sri Lanka follows a consistent economic policy toward that goal during the remaining 29-year period.
The external sector is fragile today with mounting pressure for the rupee to depreciate against the dollar in 2017. On one side, the country has lost a significant amount of its foreign exchange reserves in its attempt at defending the exchange rate. The free foreign exchange reserves by the end of the year would be around $ 4 billion, well below the amount it has to set aside for servicing the Government’s foreign debt during the next 12-month period.
The option available to the country is to borrow more foreign funds from commercial sources. However, the US Federal Reserve is planning to increase interest rates in order to avoid another economic and financial crisis in that country. With this expectation, US interest rates have started to go up causing capital outflows from EU and elsewhere. Thus, the Euro has already fallen close to parity with the US dollar. Sri Lanka, without sufficient foreign exchange reserves, cannot avoid a massive depreciation of the rupee in 2017.
This makes it important for Sri Lanka to finalise the deal on Hambantota Harbour and the Mattala Airport within the next three-month period.
The year 2017 and beyond is not rosy for Sri Lanka. With the mounting economic crisis which has engulfed the economy, Sri Lanka cannot waste money on anniversary celebrations. It would be like the Roman Emperor Nero, as the popular saying goes, fiddling while Rome was burning.
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