International financial institutions and development in Asia

By Cassandra Mascarenhas

Addressing a topical subject which is of crucial significance to Sri Lanka in the context of the current drive towards achieving GDP growth of over eight percent per annum in the next five years, the Postgraduate Institute of Management hosted a lecture-discussion on ‘International Financial Institutions and Development in Asia’ earlier this week, at which the keynote speaker was Asian Institute of Management Professor Nihal Amerasinghe.

Drawing from his vast experience, particularly at the ADB, Professor Amerasinghe made a presentation taking examples from his latest book on the same subject and published by The Asian Institute of Management.

Development in Asia

Commencing his presentation with some insights about development in Asia, the Professor noted that the last 40 years has seen unprecedented economic and social development in Asia whereas in the Western world, it took them 200 years to move into a stage that we would refer to as development.

He pointed out that some countries have surged forward while others have simply stagnated over the last 60 years of development. Taking the example of the Republic of Korea and the Philippines, Korea was virtually rubble at the end of the Korean War in 1953.

“At this point, Korea looked to the Philippines to learn how to do their own planning as at the time, the Philippines had many beautiful plans drawn up. Yet, where is the Republic of Korea today and where is the Philippines? The Philippines is very good at planning but do not implement and Sri Lanka too needs to plan but also needs to focus on the implementation,” Amerasinghe cautioned.

However, even with the phenomenal growth we have seen in Asia, there is still phenomenal poverty and growing disparity of income, he stated. Environmental climate change has become an issue and these are all challenges that need to be addressed. GDP has quadrupled in East Asia, tripled in South East Asia and doubled in South Asia but there is so much more to do. Life expectancy has improved and deaths from infectious diseases have dropped but there is so much to do, reaching out to the other half.

Amongst the problems we face, quality of life is one, which is restrained by access to medical services, water and sanitation – 60 to 70 per cent of the region still does not have good access to the latter. The need for functional literacy is yet another major problem, along with key demographic issues such as international migration, aging populations and rapid urbanisation.

“One thing that must be highlighted is the fact that agriculture has been the cornerstone of development of many developed economies. Thailand and Indonesia moving forward with the paradigm of agriculture to industrial development to service. Governments have neglected agriculture and as a result food issues have become a problem once again. 15 to 20 years of neglect in agriculture is beginning to be seen now in Sri Lanka. What happens to the agriculture sector?” the Professor questioned.

Taking a look at countries that got it right, they had several key factors in place in order to do so. Amerasinghe then went on to list some of these out which includes essential macroeconomic stability with low and stable inflation, political stability, policy consistency and with it goes good governance as well, emphasis on universal primary education and literacy and openness to trade.

Countries that have exported and opened up have moved forward. Taking the example of India, he noted that up to 1991 they were a closed economy but since then they have reformed and moved forward rapidly.

Another factor is continued agricultural productivity and exports – agriculture was never neglected by these countries. During the 1997 financial crisis when you saw countries like Thailand and Indonesia having made great strides, grappling with their financial provisions, it was their agricultural sector that helped them greatly.

Policies that encourage savings and investments is yet another important factor. All countries in advanced stages in Asia have high savings rates of more than 35 per cent of savings.

“Physical infrastructure advancements this is something Sri Lanka forgot with so much focus on social development at the expense of our economic infrastructure and now we are back again at looking at our physical infrastructure,” he said.  “A major constraint in India is the lack of physical infrastructure. The key areas we have seen in successful trade oriented investment are roads, ports, telecommunication, energy and physical infrastructure together with trade orientation and export oriented perspective.”

Financing development in Asia

Moving onto the topic of financing development in Asia, Amerasinghe stated that sources of finance traditionally looked at public finance, government finance along with official development assistance, which must have at least 25 per cent of a grant element else it is not official developmental assistance. However, private capital has become very important for development over the last 15 to 20 years.

“What is interesting to look at is the statistics over a period of time. From 1997 to 2010, ODA has gone from $50 billion for the whole world to $110 billion. The war in Iraq amounted to $900 billion. That’s nine years of development assistance to all the countries. Private capital has increased $294 million to $590 billion so the action is now clearly in the private capital area while ODA has more or less remained static,” he elucidated.

Hence there is a need to focus more on how to attract private capital. Analysing what drives private capital, the Professor noted that capital market liberalisation has been espoused by the IMF. Supporting infrastructure has also helped, such as telecommunication electronic transcripts and the banking service which has improved so much over the past 20 years. Regulatory changes have taken place in governments supporting this as well.

“How the international media is so negative about Sri Lanka hurts. Perceptions are very important and I hope the government makes a bigger effort to try and clear the air on our image,” Amerasinghe said.

On the topic of FDIs, he stated that this has been captured by China with 42 per cent, Hong Kong with 18 per cent, India with 10 per cent, Japan with seven per cent, Singapore with five per cent and the balance spread out amongst the rest of Asia. There is $590 million floating around and they are very clearly moving to very specific countries.

The advantages of FDIs include that it promotes technology transfer, encourages more efficient business practices and provides cheaper and valuable source of equity. At the same time there are many disadvantages such as the sudden reversal flows of capital, particularly with portfolio investments, crowding out SMEs – large conglomerates get in and small businesses are quickly absorbed by the larger companies or completely eradicated. They also come in only for the purpose of cheap labour with no value addition to the country.

This can be seen in the Philippines with their motor industry – companies bring in all their material and only use local labour – therefore Sri Lanka has got to be careful about what it is trying to do with attracting MNCs.

The Professor also noted that Sri Lanka is very keen on PPPs. “This is funny because we don’t have the resources for development. How are you going to attract this private capital? To bridge the savings investment gap, with a GDI 27.8 per cent of GDP and gross domestic savings at 17.7 per cent, clearly there is a gap and we need to have private capital and ODA to help us with the required capital to move into our eight per cent growth,” he said.

Amerasinghe acknowledged that remittances from workers overseas have been a new phenomenon generating four billion dollars in Sri Lanka and generates $18 billion in the Philippines.

He urged banks to organise themselves to be better use this and added that the Government should encourage the utilisation of this money for developmental purposes. In the Philippines, all the remittances went into consumption and then the housing industry which is now being funded by these sources. The Government therefore needs to look at ways of channelling these remittances.

Remittances don’t go everywhere, the Professor noted and one reason is size of market. India and China are sitting pretty, with Indonesia poised to take off in the next five years. Another reason is resources – does Sri Lanka have resources that are attractive?

This requires a business environment that is friendly. Singapore is rated number one in the world as one can start up a business in a week in the country. He stated that this is a major constraint that Sri Lanka needs to address – the private sector has so many places to go to therefore we need to be able to offer something special. Consistency, predictability, cost of doing business and the required infrastructure are some aspects that are necessary for this.  

The Business Competitive index takes into account all these features; people in the private sector constantly look at this and the importance of image plays a role here and he cautioned that Sri Lanka needs to be careful about perceptions and images.

“In fact huge amounts of capital are required. The ADB prepared a study strategy for 2020 and it showed that the cost of infrastructure alone for the next 10 years is $4.7 trillion. Furthermore new capacity amounts to $3.1 trillion, $1.6 trillion for capacity replacement, $197 billion for the financial sector, $30 billion for renewable energy, $28 for the adaptation to climate change, $20 billion on environmental improvements, $8 billion on water resources and $7 per year for education,” he listed out. “Where will this money come from?”

Amerasinghe added that it is interesting to note that some years ago, the advanced countries made a commitment at the UN that they would provide 0.7 per cent of their GNI for developmental purposes. To date, only four countries meet that target – Norway, Denmark Finland and the Netherlands and all the others are way below. He noted that unfortunately, the world has major problems with their own budgets and so we cannot expect there to be huge amounts of funds coming in which puts further emphasis on private investment.

Emerging Asia

Asia has two faces, Amerasinghe stated, one being growth and development and the other, poverty and destitution, an aspect that is covered in a chapter in his latest book.

Regional challenges include poverty, income and non-income disparity, demographic shifts, environmental stress, infrastructure deficit, inadequate region co-operation and integration, and higher education and technology, which is very important.

“If we don’t have higher education and technology, we will get caught in the middle income trap. In these initial stages of development, you can work with unskilled labour but beyond that to continue to earn foreign exchange; you need to move into a different sphere. What is new? We need to be innovative. We are comfortable now but if you want to move ahead, education and skill is very important and that doesn’t come overnight. We need to put in the money for this,” he emphasised.

Sustaining the investment climate, addressing social concerns, microfinance, conditional cash transfers are some other aspects that need to be looked into, he added. The Professor on a side note said that personally he does not think that conditional cash transfers is solving the problem – if there are problems or lack of skills, he said that these need to be countered and not be dealt with by merely transferring some money.

On preserving the environment, Amerasinghe felt that Asia has failed to find the correct mix of market-driven policies with institutions and they have therefore failed when it comes to the environment.

Combating corruption is another major problem in Asia and in Pakistan alone, $50 million is lost each day as a result of this.  Decentralisation has had great expectations in combating corruption with policies introduced in Indonesia and Philippines along these lines but it has led to even more corruption. “Do we have a governance model that would help us to minimise the money that is lost?” he questioned.

IMF, World Bank and ADB

Taking the IMF into consideration, Amerasinghe noted that a lot of criticisms have been directed towards the agency in recent times. People are very unhappy about the quotas which is a critical factor. It also amounts to a country’s voting power at the IMF and unfortunately the five big countries have the biggest quotas – US, Germany, France, UK and Japan. They dominate the voting which was fine when the IMF was started 65 years ago but the world has changed. More countries are so much more important in terms of economic importance and these developing emerging countries are asking for a larger share – that’s a major issue.

Conditionality is another aspect that countries dislike, the Professor noted.

“We have to understand that big amounts of money are given so that countries can reform and the IMF is the lender of the last resort. Sri Lanka and Afghanistan are the only countries with IMF programmes. We forced into that because after the war, reserves were down and we needed a capital injection. Personally, I think it was a good thing for the IMF to help the Government to restore some sanity in the fiscal and monetary matters,” he said.

Moving onto the World Bank, Amerasinghe felt that Sri Lanka is not doing enough with the World Bank at the moment with only one loan for $100 million for 2012. He acknowledged that the ADB has become a bigger player than the World Bank in Sri Lanka.

“What is wrong, why isn’t Sri Lanka taking more from the World Bank? The Government needs to cultivate this. Attitudes must change with senior officials and they must know how to deal with these organisations to work with them. How important is the World Bank to Sri Lanka and how should Sri Lanka engage the bank more?”

The World Bank too has gone through some rough patches and have faced major criticisms but are now very keen on building capacity, strengthening governments, creating infrastructure, creating judicial and legal environments, developing financial systems and combating corruption amongst several other factors.

Small countries in the region were neglected by the World Bank because earlier they used to only look at the larger countries and there was a need for a bank that would take care of the smaller countries with a focus on regional cooperation – this is the rationale for ADB operations, explained Amerasinghe.

The organisation has got its weaknesses and the Professor pointed out that one of its biggest criticisms is that it is Japanese funded and run.  

“I think change will come about because China and other countries are beginning to assert themselves.

The ADB should be different from the World Bank. It is focusing on finer areas such as finance, infrastructure, regional cooperation, education and environment. It will be interesting to see how the Government works with them effectively. Sri Lanka’s portfolio performance has to improve. The Southern expressway took 14 years to finally come into being when the country requires much infrastructure so we need to see to that,” he noted.

“We need a 36 per cent investment which is a big improvement on our historical figures, from 28 per cent today. From where are we going to get this? The Government can’t produce this domestically. This has to come from external sources. The ultimate analysis I can see is how do you attract FDI?” Amerasinghe concluded.

Pix by Upul Abeyasekara