CB Governor outlines new trade policy developments, way forward on FTAs

The Government has formulated a Trade Policy Framework, Anti-Dumping Bill and a Trade Adjustment Package for local industrialists to upgrade their businesses and grab the new business opportunities which will facilitate the successful negotiation of Free Trade Agreements, said Central Bank Governor Dr. Indrajit Coomaraswamy, delivering his address as the Chief Guest at the 20th anniversary celebrations of the Trade Finance Association of Bankers held at The Kingsbury recently. The address made by the Governor is as follows:

First let me congratulate the association on this landmark which is your 20th anniversary and thank you very much for inviting me to be part of the celebrations. I understand that there was a very vigorously-contested quiz that took place earlier this evening and let me in advance congratulate whoever has won it. 

What I am going to do this evening if I may is first to share some general observations about the economy and what is being done in terms of policy and programs, I am going to elaborate quickly, because I can see people in the audience who would have heard what I have had to say before. I would like to skip through that if I may, then to say a little bit about the prospects for trade in this country, in terms of whether or not we can be confident that trade volumes are going to increase, that your business is going to increase and I like to try to make the case that there is good prospects that the international trading sector could increase in this country provided we do some things and get them right. 

About the economy, if one had to describe it in one sentence one would say that there is steady stabilisation of the macro-economic fundamentals and some of the policy reforms are beginning to come into place, but I think we need to be more vigorous in the way we implement them and we need to move faster. That I think is kind of one line description of where we are at the moment. The direction of travel is positive, we need to go faster. That’s really the message one would want to give. 

Macro-economic fundamentals 

Let me start with macro-economic fundamentals and what is done by the Government and Central Bank to strengthen those macro-economic fundamentals. There are three frameworks that have been put in place. I think all of you know that there is now a fiscal consolidation process which is revenue enhancement driven and the objective is to bring the budget deficit down to 3.5% of GDP by 2020. Last year there was over performance, the deficit came out at 5.4% of GDP against a target of 5.7%. This year I think with the floods and drought there may be some slippage but overall there is a reasonable chance of hitting the target of 3.5% of GDP.

On the Central Bank side, in terms of monetary policy we are putting in place what may be termed a flexible inflation targeting regime. I am not going to go into the technicalities of it, those of you who are interested can find the technical details in the in the Central Bank’s Road Map which was published early this year. It is up on our website. The idea essentially is to have a much more proactive forward-looking monetary policy and to adjust interest rates early rather than too little too late, which was what we have done in the past. If one is able to be proactive then you will find the volatility in the interest rates gets smoothed out.

Definition of a Central Banker has traditionally been that it is the person who takes away the punch bowl as the party gets going. That is something we have not done very well in the past. We have allowed the economy to overheat and then have been playing catch up. We want to move away from that and be more proactive and to be more forward looking and flexible inflation targeting regime that we are introducing will help us to do that.

On the exchange rate you would probably know that we are now trying to manage it more flexibly. In the past we tried often to defend a particular rate against the dollar and have even gone as far as using our scarce resources, often borrowed resources to try to defend the Rupee. That is something that we want to move well away from. So we want to manage it flexibly to have a competitive exchange rate. Where the real effective exchange rate is 100, it will take us a bit of time to get there, but we will go there very gradually. We will certainly intervene to stop sharp volatility in the exchange rate market. Other than that we want to have a flexible exchange rate and to keep it at a competitive rate so that exports and imports substitutes remain competitive, the local producer is given a competitive exchange rate. People often don’t understand that when we have an overvalued exchange rate you are actually subsidising the foreign producer against our local producer. This is something we want to get away from. That’s in terms of the macro-economic framework. 

Growth model

In terms of the growth model as you know in the years after the end of the conflict main impetus for growth came from foreign commercial borrowing led public investment in infrastructure. That gave us quite a lot of growth but that model does not have any head room anymore simply because of debt and deficit dynamics of the Government. We just do not have the fiscal space to run that model anymore. The debt situation does not allow it. So the private sector has to drive it. 

The growth model essentially has to be essentially private sector driven, the government of course has to give supportive policies, it has to do some infrastructure and find the money to do that. But primarily it has to be the private sector, domestic and foreign investment that has to drive the growth process and within that approach with the private sector being the locomotive, I think exports and FDI will have to play a key role. If you look around the world whether a country as large as China or small as Singapore, often you see exports and FDI being key pillars of the growth process. 

This is not rocket science, other countries have done it. Some people say is this wise to go down this route at a time when the global economy is more subdued than it has been in previous decades. By that I mean, the growth in the global economy, sluggishness in the international trade etc. are headwinds that are not conducive for this export led growth model that the Government is trying to introduce. 

There the answer is that while the global situation is improving it is improving for the first time since the global financial crisis, we now have actual growth in the US, Europe and Japan, but it is still subdued. Sri Lanka has some special advantages and which in my view, will enable it to trump any sluggishness in the global economy. Those advantages are clearly our location. We are 20 miles from the fastest growing large economy in the world which is India. We are smack in the middle of China’s Maritime Silk routes and that is one of the two arteries down which China is willing to pump billions of dollars investment and we are very strategically located on that maritime silk route. 

In addition we have excellent relations with the capital surplus countries of East and South East Asia, Japan and Korea, all countries which are willing to help us. As you know in those countries if the government to government relations are good then the governments can through nod and a wink get their companies to come and invest here, provided create the stability and the enabling conditions to absorb that investment. In my view, despite more muted conditions in the global economy Sri Lanka has some special advantages which it can leverage to have this private sector driven export and FDI led growth model.

Of course there need to be enabling conditions for this growth model to work. And there the government has recently launched a program to improve the investment climate. There have been task forces set up on the different pillars of the World Bank’s Doing Business Index there is a clearly laid out Road Map as to how to improve performance on each of those pillars. The trick now is to implement that and the Government launched it last month and now need to set about implementing it. 

Equally the Board of Investment is being revamped and there is going to be a different and more focused approach in terms of investment and facilitation. In the past they sat back and waited for applications and did approvals. The idea now is to identify sub-sectors where the country has a potential comparative dynamic advantage and then and pursue investors, anchor investors in those sub-sectors. 

For instance, in Vietnam, Samsung in their early stages of their transformation accounted for forty percent of their exports. In Costa Rica Intel accounted for eighty percent of their exports. So if you get four five big anchor investors they can really trigger a transformation of the exports performance of the country. One needs a much more focused attempt to work out what are the sectors we want to promote and within those sectors target some key anchor industries. So that is the approach we are moving into now. Trade facilitation, you know better than I do, the single electronic window. It’s there and it’s not there, we need to do a little bit more to make it work as well as it should, but I think progress is being made.      

Trade policy and FTAs

An interesting and I would say an important narrative is trade policy. I am going to take a little bit of time because this relevant to you in terms of assessing prospects for the volumes of trade one can expect in the future. 

On trade policy, firstly, the Government has formulated a Trade Policy Framework. It’s a 20-page document, in my view it is very well written and for the first time we have a kind of coherent story as to what our Trade Policy is. Secondly, the Government has an Anti-Dumping Bill. I think it’s in Parliament already, if not it’s on its way. 

Clearly, if one is going to negotiate trade agreements and there is going to be some liberalisation in the economy you got to have an Anti-Dumping Bill in place and that is on the way. On top of that the Government is also formulating a Trade Adjustment Package. That package will have two components. It is working with the World Bank and the International Trade Centre in Geneva to formulate it. That package will have two components; one is to assist companies to become more competitive in sectors which are being opened-up. The second thing would be to provide training, re-training for workers who need that if they are in affected sectors. These are kinds of enabling bits of policy that has been put in place to clear the way for these Trade Agreements which I am next going to get to work more effectively. 

I don’t need to tell you, you already know, the Government is working on three big Trade Agreements, one with India, the existing bi-lateral Free Trade Agreement in goods is to be deepened and widened and then services, investment, technology, training are going to be added on. A similar agreement is being negotiated with China as well as Singapore. Quite naturally there are many concerns, as to how a relatively small country like Sri Lanka can negotiate a constructive, useful, favourable Trade Agreement with countries like China and India. Here, there is a track record of other countries which have done this, small countries negotiating with larger partners. 

First thing is it must be negotiated on the principles of 1) Non-reciprocity. The larger country has to do much more than the smaller country. 2) On special and differential treatment that for in certain sectors in terms of the negative lists the positive lists etc. that smaller country must get special and differential treatment. Both China and India has accepted those two principles and these agreements will be signed on the basis of those two principles in that they would have to do much more than we would. 

We need to negotiate very carefully as to what our negative list should be, what we want in terms of positive lists in terms of services, we have to have safeguards. This is also a tried and tested methodology. Where you are building safeguards against import surges, for example if there is a sudden 10% increase in imports over a specified period of time, then you are allowed to put in place tariffs. These are all mechanisms that are well tried and tested and going on, and of course to have a good dispute resolution mechanism. These are that have to be put in place to make sure that these Trade Agreements work to our advantage and our negotiators know this very well and hopefully we will get agreements which will be of benefit to the country. 

We already have a bilateral agreement in goods with Pakistan and the idea is try to invigorate that and GSP+ with the EU, as you know, has been restored. If you take all these together, as long as the Trade Agreements are successfully negotiated and our interests are pursued vigorously in those negotiations, as GSP+ begins to gain traction, I think opportunities for trade to increase is going to be significant. Clearly that is something of relevance and importance to everybody in this room. In fact one of the biggest indictments of the overall policy framework over the last 10 to 15 years has been the fact that the tradable goods sector, that is, imports and exports as a percentage of GDP declined from about 80% to 45%. Basically your business has basically shrunk by half simply because we have the wrong policy framework. 

The framework that was focused on the non-tradable sectors like construction, transport all of which are important but if you create a policy framework that tilts away from the tradable goods sector and you are a small open economy, clearly you run out of road very quickly. We need to address that and that has been done and we will have a much more trade friendly policy framework going forward which clearly has a significant importance to all of you in this room because there is every prospect that trade should increase if these Trade Agreements are negotiated successfully and as the GSP+ kicks in. That’s really the demand side. On the demand side with these Trade Agreements and GSP+ etc. there is clearly going to be a significant increase in demand. 

We need to look at the supply side and all of you in the room come into play because we need to have the structures, structured products, instruments etc. to be able to respond to this significant increase in trade which would well take place going forward. Try to understand what has happened, we need to see the most dynamic component of the international trading system over the last 15 to 20 years. 

If you look at that issue the most dynamic component has been intra-firm trade in Asia. That is all the value chain stuff that has been going on particularly in East and South East Asia. That has been the most dynamic component. We in Sri Lanka have almost a negligible presence in the regional and international value chains. That is really the challenge before us. To get private investment in domestic and foreign into sectors which enable us to plug in to this regional and global value chains. 

In these modern production sharing networks, no one produces a car in one country, often in three or four countries with each country producing parts of it. We need to get into those supply chains producing niche products. In these modern types of sharing kinds of networks which are the most dynamic part of the trading system, the distinction between exports and imports get very blurred because in that production network you have to bring the stuff in do your part and send it out. 

Often we make big distinction between imports and exports and we have a whole lot of para-tariffs. One of the things that the Government has said it would do is to clean up the para-tariffs, because if you have these high effective protection rates you cannot get into these value chains, because you cannot bring the stuff in and send it out which is what you have to do to participate effectively in the value chains. These are all significant quality changes which we have to effect and all of you in this room have to be important parts of brining about this change where while we create the financing to support these structural changes that need to take place in our trading patterns. That’s the demand side and supply side of the story.

The Central Bank has continuously tried to improve access to trade finance through direction, rules and regulations in order to facilitate international trade. These include the following: Allowing outward remittance in respect of payment of interest for the credit facilities offered by the supplier of such goods to an importer of goods resident in Sri Lanka, facilitating requests for imports and exports of goods for the entrepot trade, allowing granting of loans in foreign currency from their domestic banking units to foreign exchange earners’ accounts for any purpose as may decided by the authorised dealers as a part of their normal business. 

These are some of the things that the Central Bank has done to facilitate your business and we would want to work very closely with you as these changes take place. If we are successful in getting international trade going, that if we are able to get into international value chains and both imports and exports increase significantly, ideally of course we want to increase exports much more than imports and as that happens and clearly if we are to achieve the 6% to 7% growth annually which we want this has to happen. Because you cannot drive 6% to 7% growth over a sustained period of five to 10 years by selling to a domestic market of 20 million people. We have to get our exports going.

We would like to work very closely with your association in the Central Bank, and anything that we need to do to enable you to position yourself to support this transformation that the country is trying to achieve in terms of international trade we would very much want to support that. Please work with us, please advise us as to how best we can support you in bringing about these changes. 

With that let me conclude by again congratulating your Association, clearly over the last 20 years an important role has been played in terms of building capacity in terms of maintaining standards in this very important segment of the financial services sector  and I hope I have been able to give you the message that this is a component of the financial services sector which is going to become more and more important as the country tries to achieve this growth model that we are trying to put in place.

Central Bank Governor Dr. Indrajit Coomaraswamy addresses the 20th anniversary celebrations of the Trade Finance Association of Bankers