Contemporary thrust of Sri Lanka’s development strategy: Part I

Wednesday, 16 April 2014 02:17 -     - {{hitsCtrl.values.hits}}

Following is Part I of the Dr. W M Tilakaratna Memorial Lecture delivered by Treasury Secretary Dr. P. B. Jayasundera. Part II will be published in tomorrow’s Daily FT Honourable Sarath Amunugama, Senior Minister of International Monetary Corporation and Deputy Minister of Finance and Planning, Honourable Basil Rajapaksa, Minister of Economic Development, Ajith Nivard Cabraal, Governor Central Bank, family members and friends of Dr. Tilakaratna, Secretary to the Cabinet, Country Directors of the World Bank and JICA, invitees, friends and colleagues. My speech is in two parts. Part I, is more about Dr. Tilakaratna’s career and on selected economic issues relevant to his times. Part II, is about the thrust placed by the present Government towards an all inclusive development. It is very likely that this speech will take about an hour and I request your patient hearing. At the outset itself, I seek apologies for any shortcoming. Dr. W.M. Tilakaratna Dr. W.M. Tilakaratna was the Senior Deputy Governor of the Central Bank, at the time when I was interested in joining that prestigious institution way back in 1975. I remember feeling pretty nervous, when I saw Dr. Tilakaratna for the first time in person at the Central Bank interview. The Interview Panel was full of serious economists and Central Bankers such as Dr. Tilakaratna himself, late Dr. H.N.S. Karunatilake, then Director, Economic Research and T.G. Punchiappuhamy, then Director Establishment, ready to grill me. However, my first impression of Dr. Tilakaratna was very positive. He was chubby and was with a smiling face. He was very kind and truly charming. What is remarkable is that, these characteristics that I saw in him when I first met him, remained unchanged throughout the years until his demise last year. I found him to be a remarkable person throughout the 38 years I knew him as a Senior. Hence, I consider the opportunity I got to deliver this lecture in his memory as a rare privilege and a great honour. Dr. W.M. Tilakaratna who graduated from the University of Ceylon with B.A (Ceylon) degree in 1949, joined the Income Tax Department immediately thereafter and served till 1952. He joined the Central Bank of Ceylon in 1953, the year in which N.U. Jayawardena was appointed as the first Sri Lankan Governor to succeed Mr. John Exter, the eminent American economist of the Federal Reserve System who served as the founder Governor of the Central Bank from 1950. Hence Dr. Tilakaratna was fortunate to develop his early professional carrier in the Central Bank, modelled by John Exter with relatively strong characteristics of an independent Central Bank under the leadership of well respected seniors at the time, such as Sir Arther Ranasinghe, D.W. Rajapathirana, W. Tennakoon, all of whom rose to the position of Governor subsequently, and Dr. B.B. Das Gupta, the first Director of Economic Research. Having joined the Central Bank as a young economist, Dr. Tilakaratna pursued his post-graduate studies at the London School of Economics, having been financed by the British Government under Colombo Plan Technical Assistance Scheme and the Central Bank. Dr. Tilakaratna presented a thesis titled “Agricultural Credit In A Developing Economy – Ceylon” in part fulfilment of the requirements to be awarded a Doctor of Philosophy degree by the University of London in November 1957, that reflected the economic conditions that prevailed at the time in a predominantly primary agrarian economy. Let me quote his views on agricultural credit from his thesis, for you to get a perspective of the rural economy at the time which had not seen modern solutions, either from the demand side or from the supply side. “Agricultural credit is a vital aspect of the problems of development in a primarily agrarian economy like that of Ceylon. Yet it is a subject, which had received very little consideration in Ceylon. Although, the Government appointed two committees, once in 1909 and the other in 1919, to consider the question of banks for agriculturists, those reports did not consider the problems comprehensively. The Banking Commission of 1934 devoted only a single chapter to the problems of agricultural finance. The legal handicaps preventing the free flow of credit in the economy have also been studied from time to time. These have all been attempts to examine mainly the supply side of the problem, but none of them were comprehensive studies even of the problems of supply. The demand side of the problem has never been studied. Moreover, the question has not been looked at from an economist’s point of view as such. Data on rural indebtedness have been available in recent years, but no attempts has been made to analyse them with a view to studying the problem of indebtedness itself, or gleaning some knowledge of the nature of demand for agricultural credit. It has always been assumed that the small farmer is oppressed by a heavy burden of chronic indebtedness and that the moneylender is necessarily a Shylock.” Such views also demonstrate that the Sri Lankan economy has not had a development model capable of transforming the country into an integrated modern economy based on its comparative advantage. Until recognition was given by the post-independent Government, irrigation systems, agricultural marketing and the supply chain, industrialisation, banking research and technology was not in the development agenda. The demand side of the economy was linked very much to imports. On the positive side were some initiatives towards broadening the frontiers of education and health, thanks to free service delivery mechanism engineered during State Council days. Transition to independence As we all know, the country was in a transition to independence during a period of 1946-49, at the time when Dr. Tilakaratna was in the University. In the early years of post independence, the mid 20th Century leaders were struggling for independence and were flexing their muscles for economic freedom to make political freedom more meaningful. By the time he joined the Central Bank, the excitement of independence had been replaced with economic challenges encountered with the collapse of the Korean War economic boom. In 1950, country’s critical economic problem was rising money supply and inflation due to the exceptionally good rubber prices that led to the accumulation of international reserves. Policies adopted with very distortionary price subsidies in 1951 helped dampening price inflation during the boom but then by 1952, the deflationary adjustments to the collapse of the Korean boom in the presence of higher import prices made political instability and offered hard and complex choices for the country to follow. The exchange control was tightened under Finance Regulation and in 1953 the new Exchange Control Act came into force. In other words, Dr. Tilakaratna’s career at the Central Bank began in a period in which post independent policy makers were confronted with serious economic challenges due to the loss of external assets that were very comfortably generated prior to 1951, with underlying structural issues in the economy were sidetracked without being addressed. The Central Bank Annual Report of 1952 described this as “Ceylon lived far beyond its means”. The Annual Report articulated that the underlying difficulty in 1952 was that the country as a whole had become accustomed during the Korean War boom, to a level and pattern of expenditure that it could not afford to maintain after the boom subsided. The 1952 experience underscored that the budget deficit ran well beyond safe limits and deficit financing was used to finance present consumption at the expense of development and public investments that the country needed. The most important element of Government consumption expenditure was food subsidies maintained through imports. The economy also reflected structural weaknesses. The well-known plantation economy created by colonial super power had produced a modern urban economy leaving the rural economy behind. The entire Asia was poor except Japan. In 1948, our per capita income was $ 120, the share of agriculture, predominantly plantation as a primary commodity export was 35% and the urban service sector essentially catering to the plantation needs of banking, port and logistics, transport, etc. was 44%. 62% of the labour force was in agriculture. The total investment was 8% of GDP and Government ran a fiscal surplus thanks to export taxation, which was almost 5% of GDP – out of 16% tax revenue. In the external side, the Balance of Payments was in surplus, a little over a year of International Reserves and an Exchange Rate of Rs. 3.32. The entire real economy was built on a primary commodity export structure and the Korean War boom, hence the associated fiscal strategies in a way nurtured the crisis. New development regime The political swing in the 1956 General Elections and the popular trend towards state-run economies in the third world countries at that time, placed Sri Lanka on a new development regime which included nationalisation of foreign and domestic private enterprises, import substitution-led industrialisation and the regulation of production, consumption and distribution. Centre-left politics and Centre-right politics travelled along this road with adjustments mostly compromised due to political pressure. Dr. Tilakaratna’s experience during this period included working as the Commercial Manager of Ceylon Petroleum Corporation in 1963, General Manager of Ceylon Transport Board in 1964 – both of which could be seen as results of nationalisation policies of the post 1956 regime. He was back again at the Central Bank as the Director, Economic Research from 1965-68, then Assistant Governor from 1969-71 and later represented the country as the Alternate Executive Director of the IMF 1972-74 and was the Deputy Governor to Governor William Tennakoon and Governor Hector Tennakoon during 1975-78. So his exposure prior to 1978 was full of State-run activities, Central Banking in a closed economy and a spell at the IMF in a fixed exchange rate regime. My generation of Central Bankers joined the bank during the tail-end of the closed economy after having spent economically and politically painful early 1970s in the Universities. I remember that even the university life was not exciting, since we did not get to eat rice two days of the week. During my short period of work at the Industrial Board soon after my graduation under the Chairmanship of B.C. Perera, I saw how various raw materials were given to industrialists through permits and over regulations, thereby causing great difficulties to entrepreneurial initiatives. During the junior days of my career at the Central Bank, I saw a drama being managed by Dr. Tilakaratna as the Senior Deputy Governor, when the then Finance Minister late Felix Dias Bandaranaike revalued the Exchange Rate in 1976 on the advice of Director of Economic Affairs of the Treasury Dr. Narapalasingham. Dr. Karunatilaka, the then Director of Economic Research, publicly criticised this move instigated by the Ministry of Finance and Dr. Tilakaratna managed this conflict. We did not know exactly how serious this situation was, but we all knew that Dr. Karunatilaka was transferred to the Employees Provident Fund, as its Superintendent. We also saw during our orientation program how powerful the Department of Exchange Control was under Kanagasabapathy, the then Controller of Exchange and how people came in queues to obtain even less than $ 5 from the powerful controllers. Regulatory functions were carried out by the Monetary Board through the Bank Supervision Department, essentially supervising the large state banks and the few domestic private banks. Banking development The establishment of the People’s Bank in 1961 and the National Savings Bank in 1971 were flagship developments which took place at that time, and marked the beginning of changes relating to banking development. All these are among important areas that Dr. Tilakaratna has drawn attention in his thesis, which had been associated in the management of the relationship between the Central Bank and the Treasury in a closed economy, also being regulatory responsibilities of the Central Bank connected with exchange control and commercial banking. The Central Bank was managing the Employees Provident Fund by putting all its money in non-traded Rupee Securities and in a wide range of development activities through credit guaranteeing and refinance schemes, which I am sure Dr. Tilakaratna would have taken a keen interest since he developed his thesis on agricultural credit. The 1977 General Elections, once again like the 1956 Elections, was held in the backdrop of a 20 years State-run economic model within a highly regulated environment and poor growth rates, which were common features in all third world countries. The South Asian growth rates of around 3% against a population growth of 2.5 to 3% per year were branded as Hindu Growth rates. Further, very few countries that were exceptions, such as Singapore, Hong Kong, South Korea and Taiwan, did not adopt the popular third world development strategies in the 1960s and 1970s and instead followed an export oriented path. They ended up being high performing Tiger Economies, bypassing us rapidly. Transition time The economy was liberalised in 1977, and the initial team that worked with Ronnie De Mel, the Minister of Finance in the Government of President J.R. Jayawardena, included Dr. Lal Jayawardena – Secretary to the Treasury, G.V.P. Samarasinghe – Cabinet Secretary, Dr. Wickrama Weerasooriya – Secretary, Plan Implementation, Hector Tennakoon – Governor, Dr. Tilakaratna – Senior Deputy Governor and other senior economists of the Central Bank. On the recommendation of the IMF and the World Bank, the Development Secretaries Forum was set up under G.V.P. Samarasinghe co-chaired by Dr. Tilakaratna, to coordinate Government development programs particularly since public investments got out of control in 1979 and economy witnessed a destabilising macroeconomic environment. Dr. Tilakaratna lived through the transition from an opened- economy in the early 1950s to a closed economy in the mid 1950s through the late 1970s, and also through the opening of the economy in 1977, in various capacities. He retired from the Central Bank in March 1978 to take up the appointment as Secretary to the Ministry of Finance, and became the ex-officio member of the Monetary Board of the Central Bank, replacing Dr. Lal Jayawardena. During this critical period, during which the Sri Lankan economy went through a transition from a closed economy to an opened economy, further changes took place in the Central Bank when Governor Hector Tennakoon died in January 1979 and Dr. W. Rasaputra who was the Alternate Executive Director of the IMF became the Governor. Dr. Tilakaratna served as the Secretary to the Treasury till 1986 and had a strong team to support him, in the calibre of C. Chanmugam and thereafter G. Coomaratunga, being Deputy Secretaries to the Treasury. Central Bank was led by Dr. W. Rasaputram as Governor, whose support team included Dr. H.N.S. Karunatilake as the Senior Deputy Governor and A.S Jayawardena as the Director, Economic Research. The Bank was quite generous to release a number of Central Bank officials to work in the Treasury and in the two State Banks. In 1986 he joined the International Monetary Fund as Senior Advisor. In 1987 Ronnie De Mel resigned from the Government having served 10 years in office. C. Chanmugam, who served as Secretary to Treasury and Dr. Rasaputram who served a long tenure as the Governor, Central Bank also left in 1988. In a way, the era of the first 10-year post 1977 reform team of senior policy makers, came to an end by this time. State of the economy Let me now briefly describe what the economy was by the time this senior team ended their responsibilities. The reason I thought of doing this is since one could assume that Sri Lanka with a strong political leadership, backed by a highly qualified team of experienced technocrats and free market policies, the first 10 years of post 1977 reforms, should be a period of sustained high growth. In fact, Ronnie de Mel, in his first Budget Speech expressed this view quite strongly: “The massive majority that the people have given us has for the first time since 1956 laid a sure foundation of political stability without which no Government ever hope to go forward. The significance of our majority cannot be under estimated. It is a majority secured by one party under one leader speaking with one voice and with a clear cut policy and program, and determined to pull the country out of its present economic mess. This is really the first Government in Sri Lanka after 1956, which is not in some way or another a Coalition Government, composed of persons of diverse parties or diverse political views and opinions pulling in different directions. On this sure foundation of political stability, this Government is now engaged in the even more important tasks of laying the foundation for economic and financial stability which has also been sadly absent in this country for almost 20 years.” However, it is evident that the outcome of the first 10 years of post 1977 reforms did not live up to expectations. The momentum of post 1977 reforms and the public investment drive was lost by 1980 with the fiscal deficit rising to near 20% of GDP. Accelerated Mahaweli Development initiative was scaled-down with many projects being abandoned. Monetary conditions and prices were unstable with a rapid expansion in the Money Supply and Inflation. Poverty and Unemployment were high and economic growth systematically slowed down from the peak of 8.2% in 1978 to 6.3% in 1979, 5% in 1983, 4.3% in 1985 and 2.7% in 1988. We all know that this was a period of political uncertainty, particularly since the 1983 riots. The country was in the midst of a terrorist threat in the North, which was countered by even the Indian Peace Keeping Force (IPKF), insurgency in the South and with a transition to Provincial Councils that were setup in terms of the 13th Amendment to the Constitution. I would argue that despite there being political stability the way a Finance Minister would desire, there being ample competent technocrats available, and there also being support from international financial institutions with external resources being available, the country could not manage the intended reforms and development programs, partly due to economic reasons and largely due to the LTTE led terrorism that saw a beginning of a period of nearly 30 year presence – commencing with the 1983 riots. Among the economic reasons, ill-sequenced public investments and expenditure plans beyond what resources permitted, the inability to ensure effective public financial management by accommodating too many independent Spending Agencies and the creation of various funds outside the Consolidated Fund, the absence of reforms towards deregulation parallel to trade and payments liberalisation which required the reorientation of exports and imports, appears to be the significant failures. Following the 1988 presidential elections, a new management team in the Government and the Central Bank took charge, substantial reforms with respect to privatisation were implemented and poverty reduction and taking industries to rural areas were given priority. A number of Fund/Bank supported programs were carried out during this period. The acceptance of Article VIII Status of the IMF that from restrictions on current account transactions was a major milestone reached in the continued foreign exchange liberalisation that was started in 1977. However, it was also a period associated with a high number of terrorist incidents and an increased number of assassinations of political leaders, activists and security personnel. The 1994 General Elections saw a new Government committed to restore peace and change the economic policies implemented since 1977. This period ended in 2001 and the 2002-04 Government attempted to end terrorism through a peace approach having eventually got involved with the international community, but saw no lasting progress towards peace. During this period privatisation of a large number of manufacturing and plantation companies, that were spillovers of previous Governments, were completed. The deregulation and the relaxation of entry barriers in the telecommunication industry saw a rapid expansion in these services. The signing of a Free Trade Agreement with India in 1999 marked country’s trade liberalisation efforts. Another milestone was realised in 2000 with the free-float – in the exchange rate regime, but once again the absence of corresponding domestic reforms placed the entire burden on the monetary and foreign exchange markets. However, the country was lagging behind in terms of public investments in infrastructure and in keeping the fiscal deficit, inflation and interest rates, under check. The 2005 presidential elections took place in this background and the Government of President Rajapaksa got the mandate on an alternate platform.