IMF is not the only option but it will carry some positive results because it comes with around three or four billion dollars of financial assistance with a program so that we have a commitment to follow it although we have a history of honouring those IMF programs.
There is an improvement in international perception about the Sri Lankan economy and its future. Positive things are coming with the IMF program. The Sunday Observer spoke to Prof. Sirimal Abeyratne of the Department of Economics at the Colombo University about his views on the present economic crisis in Sri Lanka.
Excerpts:
Q: Some say that we should have approached the IMF two years ago. What is your view?
A: I too believe that we should have done that because we could have avoided a lot of downfalls we have experienced so far.
Even if we go to the IMF, it will not provide a comprehensive 100 percent answer to our problem. We have a big part to play at home which will not come out of the IMF. This is especially regarding export promotion and investment promotion. It is our duty to focus on these two areas. The IMF will basically bring about fundamental problems with our physical management.
Q: Some say that even if we approach the IMF, we will not be able to attract international investors for our international sovereign bonds as we have been declared as an international bankrupt country.
A: When you declare bankruptcy and the default ratings by the credit rating agencies, there are a lot of bitter consequences that we need to expect. The international community investors have negative trust on our ability to honour borrowings as well as about our businesses. They mistrust the situation of the country and the banking system here. That is why we are facing problems like them not wanting to trade with Sri Lanka.
It is not only that we postponed the matter but we declared that we cannot pay the loans or have to postpone the payment of loans. This carries a lot of damage to international relations for the economy.
Q: Is the IMF the only option available for Sri Lanka?
A: IMF is not the only option but it will carry some positive results because it comes with around three or four billion dollars of financial assistance with a program so that we have a commitment to follow it although we have a history of honouring those IMF programs. There is an improvement in international perception about the Sri Lankan economy and its future. Positive things are coming with the IMF program.
However the major part of the work that we need to do is to come out of the economic crisis and to move beyond and above the crisis. Otherwise we will head back to the 2019 situation which is not a good position to be in. All these things are in our hands, not in the hands of the IMF. Our Government and people need to do a lot of cleaning work at home. The IMF will only serve as a support for this.
Q: As an economist, what is your opinion about the present situation of the Sri Lankan economy?
A: Sri Lankan economy is in an unprecedented crisis. This situation did not happen overnight. We knew that the country was going in that direction. Crises build up slowly but the collapse is instant. It is different from the crises that developed countries face because they make adjustments from time to time.
This is also a man-made crisis. So our policy errors in the past have brought us to this situation. There were some triggering factors in 2019 and 2020 and the collapse started with those factors.
Q: The Government is introducing many reforms. How long do you think it will take for the country to recover from the present situation?
A: It is questionable if the reforms are comprehensive enough. The way that I see it the reforms are basically not enough aiming at macroeconomic stability. This is only one side of the crisis. It has to do with raising Government revenue, cutting down the expenditure, reforming the State-owned enterprises as well as targeting the welfare programs and reducing corruption vulnerability.
Those are the major elements of the recovery process. However, when we look at the other end of the crisis, the dollar crisis is what stands out for me. Until we have a long-term program to generate foreign exchange, earnings through export growth require foreign investment because domestic investors alone cannot cope with the situation.
Therefore, we need not worry about investment funds today. We cannot save more as a developing country today because there is no shortage in the global savings which should be available as foreign investment. As long as we do not address this fundamental issue we will not enter the sustainable growth part.
Q: Why isn’t Sri Lanka attracting foreign investors?
A: Before the end of terrorism, everybody thought that it was terrorism which prevented foreign investors from coming to Sri Lanka. However, even after terrorism we do not possess a good record of foreign investments. In the midst of the Covid-19 pandemic India received 64 billion dollars of foreign investment. Singapore received 92 billion. Sri Lanka received only less than half a billion. Therefore, we can see how poor we are in terms of receiving foreign investors. Even Vietnam and Thailand received around 10 or 15 billion dollars per year.
Throughout our 40-year period, our accumulated foreign investment stock is not more than 13 billion.
There are three reasons why foreign investors do not come here even after the terrorist era. Our policies are not geared towards export growth. We actually have a policy which is biased towards export promotion. One element of that is that Sri Lanka is not an open economy as suggested. We have very lengthy bureaucratic procedures and complicated regulator systems that have not been reformed for many years.
This is very cumbersome for investors. Our policy and political environment is not predictable.
We need to show a consistent policy direction for the country. The corruption in the country affects genuine foreign investors too as they look at the corruption records through international records. Therefore, they know Sri Lanka is not a good place to invest in. Unless we resolve these problems, it is difficult for us to expect substantial increase in foreign investment.
Q: What are the macroeconomic fundamentals we need to correct to attract investment?
A: Investors look at macroeconomic fundamentals which are related to our monetary policy and fiscal policy. So the Government budgetary management has to be manageable with sound revenue acts and productive expenditure patterns so that our debt levels can be manageable. The monetary policy had to be geared towards achieving the Central Bank objectives like price stability and the financial sector stability. During the last two and half years the Central Bank has to support the Treasury by providing the necessary funds because it lost physical budgetary management. This is not a wise way of using the Central Bank instruments to sustain Government spending.
Q: Inflation has gone up to around 70 percent. However the savings rates are around 20 percent. How will this affect the banking sector?
A: If savers withdraw deposits due to the high inflation, the banking system will collapse. The road to that kind of calamity is actually having due to high inflation. Sri Lanka has the highest inflation among the Asian countries. Inflation is good for borrowings but bad for savings. So depositors are naturally encouraged not to save in this situation. Therefore, they exchange their deposits to some other asserts.
If this continues to the future, obliviously we will face challenges in banking and finance sectors. We need to manage it and reduce the pressure on inflation with the use of monetary policy.
Q: Some economists say that the current predicament is due to the negative balance of trade which occurred after introducing the open economic system in 1977.
A: If that is so, it should be applied not only to Sri Lanka but all the other countries in the world like Singapore, Hong Kong, South Korea, Malaysia, Vietnam, Thailand and China. However we have not seen them take on similar routes.
Sri Lanka is not an open economic country. True, we opened it in 1977 but we did not address the fundamental requirements for the open economy like the public sector reforms or reform the public enterprises. We adopted liberalisation programs and reversed it. We did not address corruption and rule of law.
One of the most important aspects of having an open economy is having a liberal international trade. Sri Lanka’s total tax revenue from the taxes on international trade has a percentage of the Government’s total tax revenue which expands to around 18 percent. This was in 2019 before the Corona virus pandemic. In India it is four and half percent while in Singapore it is almost zero percent. In most of the developing countries in Asia it is three to four percent. This means Sri Lanka is far behind all these countries in having an open economy.
Q: Although we tried our best to increase export revenue since 1977, we could not make a sound export-oriented economy due to high cost of production and administrative red tapes. Do you think we can promote Sri Lanka as an export-oriented country?
A: I do think Sri Lanka can be a successful export-oriented economy. For that we need to adopt a comprehensive reform program. We need to reform our trade policies which are not in favour of exports, our regulator mechanisms which are not in favour of export and investment and other elements. We have given up our reforms over the last 25 years. Sri Lanka needs to go back to the reform process.
We need to convince the international investors with those reforms. Hence, there will be more investment in this country as well as exports generated within the country. One of the major low hanging fruits is the Port City project. It is free from all these anti-export policies and regulatory mechanisms. It is a good opportunity to generate foreign investments and export revenue for the country if we adopt the investments promotion schemes now. Even the country can have a good export promotion record because Sri Lanka has all the necessary fundamental conditions to do so.
Q: Due to the tax cut done by the former President Gotabaya Rajapaksa’s Government, the Government lost around Rs. 600 billion annually. How can the Government increase its revenue without it affecting the people who are already suffering from high inflation?
A: You need higher income to reach Government revenue and you need higher Government revenue to reach income. When we look at our tax revenue as a percentage of GDP, it has been declining over the years. It has been declining because we haven’t been focusing on our tradable production growth. It was basically about Government spending on our infrastructure and providing Government jobs with small salaries to all the unemployed people. It looked like our economy was moving with all these projects. We improved our per capita income but in reality our tax revenue was declining even before 2019. We would have recognised this problem and made the corrections then and there long ago.
The second part of the issue is that within the tax system there is a major part of the problem because a small share of direct taxes is as a percentage of total tax revenue and is about 20 to 25 percent. The balance 70 to 80 percent comes from the complicated commodity taxes. This is not the correct method of direct and indirect taxes. According to Sri Lankan standards income taxes should be around 50 percent. Therefore around half of our taxes should come directly. Direct taxes are low because many people are not paying taxes.
The Government or the tax authorities do not know people’s income levels. We haven’t established a proper system to get information about people’s income and wealth. Such a system many would find it difficult to explain their income and wealth and that might be the reason why there is no such system. Due to this the Government cannot raise direct access and as a result of this the Government resorted to more and more to indirect taxes.