Gota’s economic war: Ferocity of the enemy makes the challenge frightening

The country’s external debt overhang is looming frighteningly over Gota’s administration

The sick economy

President Gotabaya Rajapaksa – now fondly called Gota by everyone – inherited an underperforming economy. It was just like the economy which the previous administration had inherited from his brother some five years ago. As I had presented in this column repeatedly, the economy was turning from bad to worse since around 2013 and it was the job of the previous administration to put it on the right growth path. They were successful somewhat in constitutional reforms, but regarding the economy, their performance record had been far from the desired. Hence, the economy today is characterised by sad stories all around. Gota’s immediate challenge has been to convert them into pleasant and promising stories. 

What are those sad stories that confront him?

Falling growth rate 

Three weeks ago, the Department of Census and Statistics, Sri Lanka’s official statistical bureau responsible for assessing the size of the economy and its growth rate, came up with the first piece of sad news. The growth rate in the third quarter of 2019 has been 2.7%, a little up above the previous quarter’s rate of 1.6% but pretty much less than the growth of 3.5% recorded in the corresponding quarter of the previous year. Thus, in the first three quarters of 2019, the real economic growth has been at a dismal 2.7%.  

Accordingly, the year is likely to end up in a rate of less than 3% as has been predicted by international agencies. What is important for Gota is the predicted economic growth rate for the next three years which if no action is taken, would settle between 3 and 3.5%. If he is to meet the targets set in his manifesto, the growth rate should practically double to 6.5%. This is indeed a Herculean task for any economic planner.

The fragile external sector

The supporting drivers of economic growth have also been very weak. Exports in the first 10 months of 2019 have been virtually stagnant, recording a growth of only 0.8%. In the services sector, the main driver of growth – tourism – has not recovered from the depth to which it had fallen after the Easter bombings. In fact, its earnings have fallen by 21% in the first 10 months. Remittances which had been the single-most important relief for the country’s fragile external sector in the past have declined by 6% during the same period. 

Both agriculture and services have been at a very low level of performance. The industrial performance has been a little better, but it cannot single-handedly rescue the economy. Hence, Gota must adopt a multi-pronged approach to expand agriculture, services, tourism exports, and remittances simultaneously if the economy is to remain on course with the planned targets.

The external debt overhang

The country’s external debt overhang is looming frighteningly over Gota’s administration. That has been the cumulative effect of the original sin committed by Sri Lanka ever since it had gained independence from the British. That sin was to borrow abroad to finance local investments in the absence of adequate local savings and invest in sectors that have contributed poorly to the country’s foreign exchange earnings.  

As far as economic rebuilding is concerned, the next four months will be a write-off for Gota since his government has to fight a Parliamentary Election to secure majority. If the voting pattern at the recently concluded Presidential Election is repeated, his government has a good chance of securing a simple majority in Parliament. But what is being fought for now is not just the simple majority but a two-third majority. The latter is needed by him to amend the Constitution and revert to the governance structure that prevailed prior to 2015. 

To attain that goal, his government has to postpone all the unpopular economic reforms that are necessary to come out of the present economic malaise. Hence, the economic war has to be temporarily kept aside until the conclusion of the scheduled Parliamentary Elections. Since Sri Lanka has no time to waste, that temporary recess will surely be fatal to the country’s economic rebuilding exercise

As revealed by the Central Bank statistics, in the next 12-month period, the total foreign debt servicing commitments comprising both the repayment of the principal and the payment of interest will amount to $ 6 billion. This is made up of the government’s commitments amounting to $ 4.8 billion and those of the private sector by about $ 1.2 billion. The country’s liquid foreign exchange balances after taking out the illiquid gold reserves at end-November 2019 had been some $ 6.5 billion and if it is used for debt payments, its foreign exchange reserves would fall to a critically low level. Thus, Gota’s problem is slightly different from those of the private sector borrowers. 

The latter may be having rupee funds to meet its commitments and its problem is lack dollars in the country. Gota’s problem is that he has neither rupees nor dollars to do so. Hence, he has no alternative but to borrow abroad to fill his coffers and use those proceeds to repay his loan commitments. This strategy, known as loan recycling and used by all the previous successive governments, would provide only a temporary solution to the country. It adds to Gota’s, woes and, if continued unabated, those of any future administration to come to power as well. 

The need for using scarce money prudently 

But, just like the previous administration had been preoccupied by constitutional reforms and a hurry to bring the alleged corrupt deals of their predecessors to justice, Gota is also preoccupied by considerations other than the economy. He has to seek Parliamentary majority in a general election in a few months’ time. Hence, all governmental resources are now being diverted to attaining that goal at the expense of sound economic policies. 

Accordingly, at a time when the Treasury was limping with a huge cash shortage, he has offered a costly tax cut to citizens and jobs for 100,000 Samurdhi kids. The first would drain the Treasury of a promised revenue flow of about Rs. 600 billion and the latter would impose an unexpected cost of Rs. 42 billion on his already fragile budget numbers. That latter amount is a lot of money equal to the annual administration budgets of some 14 state universities. 

This is a serious choice to be made by a government which is planning to increase the university admissions by about a quarter by establishing 300 odd university colleges. The government does not have money for this and, hence, the available moneys will have to be spent prudently.

A ‘write-off-four months’ ahead 

As far as economic rebuilding is concerned, the next four months will be a write-off for Gota since his government has to fight a Parliamentary Election to secure majority. If the voting pattern at the recently concluded Presidential Election is repeated, his government has a good chance of securing a simple majority in Parliament. But what is being fought for now is not just the simple majority but a two-third majority. The latter is needed by him to amend the Constitution and revert to the governance structure that prevailed prior to 2015. 

To attain that goal, his government has to postpone all the unpopular economic reforms that are necessary to come out of the present economic malaise. Hence, the economic war has to be temporarily kept aside until the conclusion of the scheduled Parliamentary Elections. Since Sri Lanka has no time to waste, that temporary recess will surely be fatal to the country’s economic rebuilding exercise.

Inadequate capacity for developing technology

Sri Lanka has a limited scope for creating economic prosperity for its people through historically prominent growth drivers like subsistence agriculture, three tree crops comprising tea, rubber and coconut, apparels and telecommunication services. All these sectors have now reached their saturation point with the available technology. Hence, any further development leading to increased additional wealth creation known as value addition in these sectors requires the adoption of advanced technologies. 

Given Sri Lanka’s inadequate capacity for developing such advanced technologies in-house, the attainment of this goal is necessarily a medium to long term objective. Hence, in the initial stage of economic development, Sri Lanka needs to use technologies developed elsewhere. This was the strategy adopted by the four Asian tigers, namely, Singapore, Taiwan, South Korea and Hong Kong. That was done by attracting foreign direct investments or FDIs with high technologies on one side and forcing local universities to get affiliated to world’s reputed universities to develop its own technology, on the other.  

Sri Lanka has a limited scope for creating economic prosperity for its people through historically prominent growth drivers like subsistence agriculture, three tree crops comprising tea, rubber and coconut, apparels and telecommunication services. All these sectors have now reached their saturation point with the available technology. Hence, any further development leading to increased additional wealth creation known as value addition in these sectors requires the adoption of advanced technologies

Gota’s problem is that Sri Lanka is still in the Second Industrial Revolution or Industry 2.0 or 2IR in which production processes are only partly mechanised. He has to make a leapfrogging from Industry 2.0 to Industry 4.0 bypassing Industry 3.0 or 3IR. This is challenging, but not impossible provided he adopts an appropriate policy package to wean the local businesses to the use of emerging technologies. Vietnam has begun this process by introducing a road map covering 2020 through 2030 in which all sectors in the economy, including education and healthcare, would go for new technologies

A good example in the present era is Sri Lanka’s competitor in most respects, Vietnam. That country which was nowhere in the global trade map some 30 years ago is the home for large technology-based manufacturers like Nike, Samsung, IBM, Intel, Fujitsu, and HP today. According to the World Bank data, Vietnam’s high-tech exports in 2017 had been 41% of its manufactured exports. The comparable figure for Sri Lanka had been just 1% implying that it has a long way to go. 

To attract high technology in the initial period of economic expansion, the strategy adopted by both South Korea and Singapore could serve as guidance to Sri Lanka. 

South Korea’s technology policy

South Korea’s strongman President Park Chung-hee who held the post from 1963 till 1979 had a separate technology policy side by side with his industrial policy to acquire or develop new technologies and make them available to all sectors concerned to improve productivity and go for new areas of production. In this respect, technology had been recognised as a public good to be necessarily produced by the state. 

It consisted of two aspects: one was to develop new technology through research and development and improve the technologies adapted from other countries. The other was to facilitate the use of technology for going for new products and improving the existing production practices. To develop technology in-house, new research institutes were setup, while encouraging the existing universities to undertake new research and development programs. 

One of the institutes so setup was the Korea Institute of Science and Technology, popularly known as KIST, with the joint participation of both the Korean and US governments. This institute was later amalgamated with the Korea Institute of Science and is presently known as Korea Advanced Institute of Science and Technology or KAIST. Its success is gauged by the number of global patents it has got and its ranking within the top 50 universities in the world and at the 6th place among Asian universities. South Korea is a technology driven economy and its high-tech exports in 2018 had amounted to 36% of manufactured exports, according to the World Bank data.

Singapore’s going for a Western Oasis

In Singapore, Prime Minister Lee Kuan Yew forced all Singaporean universities to get affiliated with universities of repute in USA and improve curricula and research capability based on such collaboration. As a result, the National University of Singapore which was relatively unknown in early 1960s got itself elevated to the 22nd position in global ranking by 2018. In addition to developing in-house capacity for technological advancement, Lee adopted a policy of attracting FDIs with high technology to the country. 

To enable the expatriates from the Western world to come and work in Singapore, a conscious policy to convert the country to a Western Oasis was adopted. In this policy, Singapore improved its environment, healthcare facilities, education and transport to be on par with any developed country so that the expatriates felt as if they were working in their own countries. This was a miraculous development and today, Singapore’s high-tech exports amount to about 52% of the manufactured exports, according to the World Bank data.

Industry 4.0

Both South Korea and Singapore are presently going through the Fourth Industrial Revolution, also known as Industry 4.0 or 4IR. This is a term coined by the founder and Chairman of the Davos based World Economic Forum – Klaus Schwab – to distinguish the modern wave of high technology based global production model from the existing model of production using electronics and computers. 

Gota’s problem is that Sri Lanka is still in the Second Industrial Revolution or Industry 2.0 or 2IR in which production processes are only partly mechanised. He has to make a leapfrogging from Industry 2.0 to Industry 4.0 bypassing Industry 3.0 or 3IR. This is challenging, but not impossible provided he adopts an appropriate policy package to wean the local businesses to the use of emerging technologies. Vietnam has begun this process by introducing a road map covering 2020 through 2030 in which all sectors in the economy, including education and healthcare, would go for new technologies.

Wake up and fight the war

I have discussed how Sri Lanka should go for Industry 4.0 in a previous article in this series under the title ‘Presidential Aspirants and Voters: Read IPS’s SOE 2019 before you make your next move’ (available at: http://www.ft.lk/columns/Presidential-aspirants-and-voters-Read-IPS-s-SOE-2019-before-you-make-your-next-move/4-688892). The following para from the article aptly describes the challenge before Gota: “In this context, State of the Economy 2019 (by the Institute of Policy Studies) makes the following remark: ‘It can be argued that Sri Lanka is yet to even come to terms with technologies of the third industrial revolution – electronics and information technology – leave alone those of 4IR. The reality though is the pace of change, or the quantum leap of technology from one revolution to another is so swift, that countries can no longer be complacent’. 

What this means is that the world is waking up every morning with news of ‘next big thing’ hitting the market. A sleeper will find himself being overtaken by all others who are continuously awake and vigilant on the developments in new technologies”.  

So, Gota should wake up and fight his economic war to a conclusion as he did in the case of his other wars. 

(The writer, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at [email protected].)