Quo Vadis Sri Lanka’s economy? An appeal to President Rajapaksa

President Gotabaya Rajapaksa

Thrift is that habit of character that prompts one to work for what he gets, to earn what is paid him, to invest a part of his earnings, to spend wisely and well, to save, but not hoard – Arthur Chamberlain

‘Quo vadis?’ is a Latin phrase meaning ‘Where are you going?’ It is perhaps opportune now to ask this question about the Sri Lankan economy. It is perhaps also the time to move away from the many shields that have been used by successive governments to disguise the state of the economy, and arrive at some consensus as to how the true state of the economy can be presented to the public and give them a more believable plan how it can be managed from now on.

Some relevant information prior to the COVID pandemic are noted here. Before things get any better, they are expected to get worse.

How bad is worse going to be for Sri Lanka?

Government debt to GDP in Sri Lanka is expected to reach 92.50% by the end of 2020, according to Trading Economics global macro models and analysts’ expectations.

Generally, government debt as a percent of GDP is used by investors to measure a country ability to make future payments on its debt, thus affecting the country borrowing costs and government bond yields.

The recent request by the Secretary to the President Dr. P.B. Jayasundera for all Government workers to forego their salary for the month of May signifies that Sri Lanka’s economy is in a perilous state. His financial position perhaps would not cause a dent to his needs and those of his family by foregoing a month’s salary. However, it would, to a vast number of Government workers and their families.

Dr. Jayasundera makes the point that this sacrifice is needed to demonstrate to the outside world who are trying to help us, that we are making a sacrifice as well.  If the intention of his appeal was for this purpose, then, such an appeal should have come from the President or the Prime Minister and not a Government official. When this official who was the Secretary to the Minister of Finance during the previous Mahinda Rajapaksa Government, makes such an appeal, it signifies it is an economic decision and he is looking for that proverbial raft in turbulent waters.

It is time the President laid bare the bare cupboard of the Sri Lankan economy. No doubt the COVID catastrophe has made matters worse for the country, but in truth, it appears Sri Lanka was in dire economic straits even before COVID-19 hit us. 

It needs to be understood at this point that the present state of the economy is due to an accumulation of mismanagement by successive governments and not due to the policies and practices of any particular government. So, a blame game is the last thing the country needs at this time.

As the writer has no expertise in economics, this article is written from a prism of relative ignorance of economics. It is written to highlight a few points that might be relevant to the millions of ordinary people of the country, like the writer, who do not understand the jargon that is dished out and who are perplexed and confused with opinions offered by economic experts. 

This is why an appeal is made here for the President, who is the only person elected by the people of Sri Lanka at present, to take the people of the country to his confidence and share the actual state of the economy with them in language that they can understand, and articulate some contributory reasons for the state of the economy and articulate some fundamental futuristic principles that are needed to improve it.

External debt in Sri Lanka was $ 55,157.27 million in the third quarter of 2019

Firstly, such an explanation should begin with the admission that all governments since independence has contributed to the perilous state we are in, and what we see today is the result of an accumulated mismanagement over seven decades.

Very fundamentally, there has to be an admission and an acceptance that we have been living beyond our means. At the level of a household, it has been like living on credit cards, borrowing from one card to pay what is due on another card.

No doubt there has been several laudable development activities, and we have had to endure a costly war and other challenges. The costly war also arose perhaps due to our inability to have recognised some challenges, political, economic and social and not taking action to nip things in the bud as it were, and avoid escalation of conflicts through discussion and compromise. 

However, it does appear we have not operated within a sound economic structural framework.

What is this framework? Leaving aside a myriad of measures and indicators, there are two fundamental accounting operations to consider

(a) A rupee account and (b) a foreign currency account

The traditional terminology used to describe and manage these accounts are many. This article takes a different approach and attempts to present these in more fundamental down to earth terms, with the hope that this approach will lead to a better understanding of the complex but at the same time, basic task of economic management. Hopefully, we’ll hear from economic experts soon who are qualified to do so rather than from pseudo economists experts who end up in Parliament due to the misguided votes cast by unsuspecting voters. As someone quipped recently after watching and hearing a State minister on a television program, some of these economic experts in Parliament were people who would even fail to run a street corner tea boutique with any success!

Since the Sri Lankan Rupee is not a free floating convertible currency, the two accounts mentioned have to be managed as if they were in separate cupboards although each has an impact on the other.

The rupee account of the country has two components, the current account and the capital account. The current account has an expenditure side and an income side. In a healthy economic situation, these two sides balance, and in a healthier situation, there will be a surplus in the income side.

To the best of the writer’s knowledge, the country has not been able balance the current account, except perhaps during the very early days of independence when the healthy financial legacy left behind by the British colonialists allowed us to do so, and over time squandering that healthy economic legacy.

The main expenditure items in the rupee current account are broadly speaking, a huge component comprising of salaries of Government officials, both in Government offices and Government owned undertakings (hence Dr. Jayasundera’s appeal), rupee interest payments on rupee borrowings and other recurrent expenditure which is not regarded as capital expenditure.

The income side of this account comes from personal income tax receipts, corporate tax reports, GST proceeds and other rupee income streams. It needs to be noted that this income stream does not bring much income as Government officials do not pay tax, and private sector employees pay tax if they are above an income threshold. It is likely that local rupee loans in the form of rupee treasury bills and borrowings from commercial and State Banks are also credited to this account as income. This does not seem correct as such borrowings cannot be considered income. One is not sure how the capital component of these borrowings are treated if such borrowings are not for capital projects but to meet recurrent expenditure.

A confusion caused by a structural deficiency here is that most likely, the rupee income derived from capital projects which is funded not by rupees but with foreign currency loans is also included as income in the rupee current account. An example would be road toll income. The sole if not primary source of funding for all the highways subject to tolls have been funded with foreign loans where the capital and interest of such loans are payable in foreign currency. This is of course subject to correction if these receipts are treated differently.

The two white elephants that swallow a large component of Sri Lanka’s meagre resources is Sri Lankan Airlines and the Ceylon Petroleum Corporation. It is likely, although not certain, that rupee income from these two are also credited to the current account as income although both are funded almost in its entirety with foreign borrowings. This deficiency may be addressed partly by crediting such rupee income to the rupee capital account so that such income may be used to fund other capital projects. The question as to how such overseas borrowings for capital projects are handled is something that needs to be addressed.

The rupee component also has a capital account where rupees generated as income from any capital expenditure projects funded with rupees, should be credited to this account as income. In Sri Lanka, it is very likely that no significant capital projects, or very few of them, have been undertaken with rupee funding from this account. It is possible, and it should be the case that capital projects such as hospitals, schools, roads which are not regarded as national roads, bridges, etc. are funded through this account. It should be, if it’s not. Sri Lanka should strive towards funding rupee projects with income generated form rupee capital projects and not through rupee borrowings at least in the longer term unless deemed absolutely necessary. It is agreed that in the immediate term, capital projects may have to be funded by domestic borrowings. These are however debts, and have to be treated as such and not income.

The foreign currency account perhaps is the most mismanaged account. It is common knowledge that we have been borrowing large amounts to fund development projects perhaps without adequate thought given to how such borrowings and the interest on such borrowings are to be repaid. Hiding behind various international economic monitoring measures and indicators and justifying borrowings on the basis of such mechanisms has probably cost the country dearly.

A gross simplification from the point of view of economic pundits, but probably a common sense approach from the perspective of the simple minded majority of the country of the country might be the principle that:

a. Foreign currency borrowings should be for capital projects that cannot be funded with rupees as there aren’t sufficient rupee funds to do so, or only to fund a component of the project that requires importation of machinery or equipment or foreign expertise. All such projects however should have a return on investment (ROI) computation in order to ascertain and decide on priorities as the country needs to make such choices. 

b. If revenue from such projects is confined to a rupee revenue, the government should factor in the ability to repay such borrowings and interest payments in foreign currency that it earns from exports and other foreign currency earnings. 

If the Government resorts to additional foreign currency borrowings in order to repay an existing borrowing, it would be akin to a credit card borrowing strategy where one gets deeper and deeper into a debt quagmire. It is certain that successive governments have resorted to multiple credit card borrowing strategies judging by the current perilous state of the economy. In times of low interest rate borrowings, one could make a judicious decision to borrow at low interest payments and favourable long term repayment conditions for specific projects which have a social responsibility bearing and which have a long gestation period , but this has to be accompanied by the building up of the country’s own foreign exchange reserves with its export earnings and other foreign currency revenue streams so that the country would have enough savings to tide over unfavourable economic conditions as we are experiencing at present due to the impact of COVID. 

Perhaps a difficult to implement policy although many would be in agreement it has to be done, is to take away the responsibility for managing the economy of the country from Parliamentarians who have demonstrated that they have failed the country since independence. The politicians in general have passed their use by date, and collectively, they have all failed the nation. If the nation is to be saved from its economic morass, it needs to be saved from politicians who are not fit to run even a way side boutique let alone the economy of the country.

The independence of the Central Bank has to be restored in order for them to be able to make monetary decisions independent of the whims and fancies of any governing party. We simply cannot have a Governor of the Central Bank who had no credentials to hold such a vital position, including the citizenship of the country and a family member closely associated with key operational aspects of the bank, nor a Governor who also functioned as an Adviser to the President of the country.

In summary, it is opportune to discuss whether we travel down the same failed path and fall into the abyss below us or whether we look at fundamentals that might help us to save ourselves from the abyss below us. 

In lay person’s terms, these fundamentals may be listed as follows:

1. Balancing the Rupee Current Account

Develop a policy setting, a road map and a target to achieve a balanced rupee current account say within 5 years. Ensure that this current account is to meet only recurrent expenditure as described earlier, and the income side of this account is from local, non-capital revenue raising measures such as income taxes, corporate taxes, land taxes, GST revenue etc. It should not include any revenue such as earnings from road tolls or from any other capital project funded by foreign or local loans. During the five-year period, in order to balance this account, some unpalatable decisions will have to be made to reduce expenditure and to increase income. These will include reducing the Government’s salary bill, which means reducing the numbers employed by the State, including a phased reduction of Armed Forces personnel, and reintroducing income tax to Government officials, and widening the GST coverage and enforcement mechanisms. 

Such a plan should also be accompanied by a five-year development plan that must be based on the growth of the private sector which would have employment opportunities for those lost in the government service. Besides these, all government undertakings should be given targets to breakeven and start showing profits within five years or run the risk of closure or privatisation.

2. Balancing the Rupee Capital Account 

Achieving this will be different to balancing the current account, as expenditure items here will have longer investment yield periods, and some projects like building hospitals, school buildings, etc., will not yield a conventional rupee return. Balancing this account may need to be over planning period horizons such as five-year plans, 10 year plans, etc. 

However, the principle that should underpin such planning horizons should be that one should not spend more than what is earmarked for the planning period, and income streams to meet this expenditure should equal the planned expenditure during that period. If rupee loans are obtained for some capital projects, the repayment of the loans obtained and interest on such loans should be factored into the account. 

3. Managing the Foreign Debt Account 

Foreign borrowings should be made only to fund capital projects that have a significant foreign currency component and where borrowings are justified from a ROI perspective. As proceeds from such projects are not realised in foreign currency, the ROI computation may have to be done in rupees in equivalent terms to the prevailing currency conversion rates. A project such as a toll road which has a social bearing besides a commercial one, may need a longer gestation period when computing the ROI. 

However, the principle that should underpin foreign borrowings must be the ROI. If a government uses foreign borrowings say to pay salaries of Government officials, it defeats this principle. Enterprises like SriLankan Airlines which have borrowed heavily to fund its airplane acquisitions and leasing, have been haemorrhaging so much, if it were a human life, the life support system would have been turned off by now. It is difficult to guess whether there is enough guts amongst politicians to either wind up SriLankan Airlines or drastically reduce its services, and hence its capital requirement. The COVID-19 aftermath would be an ideal time to make a strategic decision about the airline. 

The Petroleum Corporation is a Government undertaking that sees no end to the bottom of its depth in debt. Over a five-year planning horizon, the Government will have to make a necessary but unpopular decision. In five years, the CPC should be given a target to balance its income/expenditure account and commence yielding a profit to the government coffers. 

If the CPC is unable to provide such a plan and work towards achieving the Government’s compulsory objective, the option of privatising the CPC should be considered. Either way, there will be an impact on transportation of goods and human beings and on the cost of goods, hence the cost of living when the true cost of all petroleum products are passed down to products and services.   

4. Managing the Foreign Currency Current Account

The income in this account will include export earnings, foreign exchange remittances and income streams in foreign currency like tourism and the hospitality sector. This account should not include any foreign borrowings as income. The key expenditure items would be repayment of foreign currency borrowings and interest payments. A surplus in this account would signify funds that are available to augment the country’s foreign exchange reserves. 

The necessity of doing so will be paramount as that would be the cushioning needed to weather any future storms like the COVID-19 attack, a tsunami, or a global financial crisis. The criticality of exporting more in order to increase earnings, moving away from exporting low paid unskilled workers and increasing the export of better paid skilled labour, developing the country as an education and health hub for foreign nationals are some measures that would create increases in income streams. 

Lowering expenditure on some items such as motor vehicle imports, plus non-essential imports would be avenues to move towards building surpluses in this account, and thereby increasing the country’s foreign currency reserves.

Following is submitted for consideration as the principles that should underpin this simplistic model:

a. Foreign debt should only be incurred to fund capital projects that delivers a ROI. Such debt repayments should be made from the Foreign Currency Current Account. 

b. Foreign Currency Current Account should have a target to achieve a surplus that increases the country’s foreign currency reserves adequate to fund at least 12 months’ imports.

c. Rupee proceeds from foreign currency-funded projects that have demonstrated acceptable ROI returns should be credited to the Rupee Capital Account. 

d. Rupee Capital Account should be used to fund domestic capital projects 

e. The Rupee Current Account should be balanced within five years, and all Government official’s salaries and the entirety of the Government’s recurrent expenditure should be met through this account. 

f. All Government owned undertakings, including SriLankan Airlines and the Ceylon Petroleum Corporation that do not breakeven and start showing profits in five years should be either privatised or closed.

Hopefully, more and more Sri Lankans will focus on fundamentals and begin questioning the expert opinions presented to them by economic experts. The silence on our part has led these experts and the pseudo experts in Parliament to bring the country to near bankruptcy.

President Rajapaksa, many would say it is time to cut the crap presented to you by various officials and politicians and begin a new chapter in taking the country away from the abyss we see ahead of us. It may be well to remember the words of US President Herbert Hoover who said: “Economic depression cannot be cured by legislative action or executive pronouncements. Economic wounds must be healed by the action of the cells of the economic body, the producers and the consumers themselves.”

The road ahead is full of mine fields, perhaps even deadlier than what was on the ground during the war. As was done then, an efficient, loyal team will be needed to take the country forward and get the fundamentals of the economy on a sustainable footing. However, as Bernard Baruch said, unfortunately, we tend to learn little from the experience of the past.

An economist must know, besides his subject, ethics, logic, philosophy, the humanities and sociology, in fact everything that is part of how we live and react to one another. This is certainly not confined to an economist. It applies to the President of the country as well.