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In a shrinking economy with no local fund support, the Government will have to rely wholly on foreign funding
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Praising Sri Lankans with sugar-coated phrases to win their hearts
The IMF team that visited Sri Lanka to conduct the first review of the EFF of March 2023 – a bailout package extended to Sri Lanka – has praised the ‘people of Sri Lanka for showing remarkable resilience’ in the face of the economic catastrophe that engulfed them in 2022. Though people or the economy has not shown resilience in the present crisis, it seems that the IMF team has used this sugar-coated phrase as the entry point to make its mission in Sri Lanka acceptable to people. This is because hostility toward IMF type reforms is growing day by day due to the hardships undergone by people not easing immediately. IMF is not to be blamed for this, but the consensus of the people is that IMF is responsible for their predicament.
The Government is also contributing to the proliferation of this anti-IMF view among people by pointing at IMF when unpopular policies are adopted. For instance, when the professionals agitated for relief from unaffordable income tax rates that have been imposed on arbitrarily chosen tax slabs at low-income levels, the Government leaders were quick to divert their hostility toward IMF claiming that any relief could be provided only after it has consulted the Fund team when they would make the first review of the bailout package. The professionals who believed in political leaders were to have a crude shock when they were told by the Fund team that taxes are solely decided by Sri Lanka and not by IMF.
But by that time, IMF’s culpability for the hard economic policies being implemented has been well established and the damage done could not be reversed. In several countries where IMF type policies have been adopted, namely, Argentina, Costa Rica, Egypt, and South Africa, popular uprisings have sprung up against those policies and economists now call them ‘IMF riots’, because they have occurred after the implementation of IMF led policies. IMF is blamed for them because these policies have aimed at unnecessary ends, or they could have been achieved through less painful means. In these circumstances, it is natural that IMF may not risk public outcry against its policies at this stage. Hence, the reason for seeking an entry point to people via a sugar-coated phrase.
Is Sri Lankan economy resilient?
It seems the term resilience has been used by IMF out of context here. In laymen’s language, resilience means the ability of a person to stand on his own feet without external support if he has been knocked down by an outside force. For example, suppose the roof of your house has been flown by a storm which is an outside force. If you have past savings to finance the repair or have enough time, energy, and skills to do it yourself or have the needed materials within easy reach, you do not have to seek outside support to do the job. In that case, you are resilient. But if you cannot do it without outside support, you are not resilient. In the case of an economy which is made up of millions of such individuals, resilience comes from the presence of a critical mass – enough number to correctly influence the direction of the economy – of such resilient individuals.
In the case of Robinson Crusoe’s lonely island where there are only two people, the correctly influencing critical mass is just Crusoe himself. But in a large economy which has a few large enterprises surrounded by many micro, small, and medium entrepreneurs, the critical mass that can correctly influence the course of the economy is also large. What is needed is that all these people should be able to rise again through their own efforts and not out of support given by some external force. In the case of present Sri Lanka, it is hard to judge that it is blessed with such a critical mass. Hence, to say that Sri Lankans and its economy are resilient is far from the truth. It serves only as an entry point to win their support for the unpopular policies that are being implemented to resuscitate the economy.
Government is not resilient
Look at, for instance, the Government. Its revenue has fallen short of the budgeted targets despite the increase in taxes and tax rates. As the IMF review team has revealed, in 2023, the actual revenue of the Government may fall short by 15% of the targeted revenue of Rs. 3.2 trillion. What this means is that the revenue realisation at most will be around Rs. 2.7 trillion, 9% of GDP instead of the target of 10.7% set for the year. Given the inflexibility of its revenue cut plans, the only available source for funding the Government in 2023 is to get a sizeable amount of foreign financing, a method of relying on outsiders, thereby losing resilience.
This has been further aggravated by the negative real economic growth which Sri Lanka will attain in 2023. During the first half of the year, the economy has shrunk by 5% and the whole year is projected to experience a reduction in the size of the economy by about 3%. In a shrinking economy with no local fund support, the Government will have to rely wholly on foreign funding. That is why the on-time receipt of the second tranche of the bailout package which can be used for financing the budget in terms of the conditions is vital for Sri Lanka. However, given the massive shortfall in revenue, the expected amount from IMF amounting to about Rs. 115 billion will be only 0.4% of GDP and it will not rescue the budget.
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External sector too is not resilient
The external sector is also not resilient. During the first eight months of 2023, exports have declined by 10% in comparison to the first eight months of 2022. Sri Lanka is expected to record an export earnings of about $ 12 billion in 2023, same as its performance in 2019. This is not the sign of a resilient economy. The deficit in the trade account has eased not because of the performance of exports but because of the massive shrunk of imports by 14% so far.
The shrinkage in imports has been mainly due to the reduction in the import of intermediate goods by 16% and investment goods by 22%, further dampening the prospect for improving the resilience of the real economy. When the import restrictions are removed as planned, it will have direct impact on the stability of the exchange rate. Without a massive inflow of foreign support, a sign of a non-resilient economy, Sri Lanka will not be able to maintain the exchange rate at the current levels.
SMEs, driving force of economy are also not resilient
The biggest casualty of the non-resilient economy is the micro, small, and medium enterprise sector of the country. According to an ADB study in 2018, the small and medium enterprise sector, without the micro sector, contributes 52% to Sri Lanka’s GDP. It is made up of 75% of all active enterprises, while providing livelihood for 45% of the workforce. This is 3.7 million individuals supporting 15 million or a two third of the population. When the micro sector made up of a large number of farmers and self-employed persons in the transport sector like three wheel and cab operators are also added, though no estimate has been made, the whole of the micro, small, and medium enterprise sector is the real driver of the economy.
And if it is handicapped and cannot revert to original position without support from an external source, surely it is not resilient and therefore, the economy is also not resilient. But someone might argue that the large enterprise sector which also contributes about a half to the GDP together with the Government sector might, through its backward linkages, provide life support to the micro, small, and medium enterprises. These backward linkages essentially mean having an effective supply chain within the economy.
The broken supply chains
Let’s take an example. Suppose there is a large fruit juice manufacturing company. It needs the basic raw materials, namely, fruits, cultivated by farmers scattered throughout the country. When those farmers harvest their fruits, assuming that they are of good quality acceptable to the fruit juice manufacturer, they should be supplied on a regular basis to the manufacturer. That is the supply chain between the manufacturer and the farmer and is mainly provided by truck owners. If the truck owners do not have trucks and fuel to carry on their business, due to banning of importation of trucks or non-availability of spare parts, the supply chain is broken. But not all truck owners get busted, and a few will still remain in business. But the monopoly power which they now enjoy gives fertile ground to raise the charges which should be borne by the farmers who do not have bargaining power to insist on a fair price based on the cost of production for their products. The loss of income by farmers is also a breakdown of the supply chain because they cannot ensure the supply of those fruits in the next season.
Then, there is a backward supply chain for farmers in the form of supplying inputs and extension services. Inputs consist of land preparation services, seeds, fertilisers, chemicals such as insecticides, weedicides, and pesticides, and extension services from those who are knowledgeable of the subjects under reference. If this supply chain breaks down, farmers cannot cultivate the fruits and it affects the large manufacturer as well. He can keep his supply uninterrupted by importing fruits from abroad, but it becomes a costly affair due to the scarcity of foreign exchange to pay for them. It is not advisable to import the needed fruits permanently, because it will simply kill the farmers, on one side, and increase unemployment among them, on the other.
Sri Lanka Government is noted for adopting such unsound policies in the case of paddy farmers and poultry farmers. Paddy farmers who have already been beaten by the breakdown of both backward and forward supply chains cannot get a price based on the cost of production due to government’s manipulation of prices. Poultry farmers who have also been hit by the breakdown of backward supply chains have been hit again by the Government’s decision to import eggs to supply to a market short of eggs.
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Large enterprises too are not resilient
It is not only the micro, small, and medium enterprises which have been hit by the broken supply chains. Large enterprises have also been affected by a breakdown of supply chains by way of difficulties to acquire the needed raw materials, spare parts for vehicles, machinery, and other capital installations, and the breakdown of distribution channels in external markets.
I know the plight of a leading vehicle assembler who had earlier assembled motor cars and luxury buses maintaining a domestic value addition of 40%. He has a factory capacity to put out a car a day and had earlier employed more than 1,300 workers of all categories. When I visited his factory recently, I found that the production of both these lines has ceased, workforce has been reduced to less than 300, salaries are paid out of past savings of the entrepreneur and not out of the income of the business and he has resorted to import an electric vehicle just to keep the factory running. Surely, he cannot continue like this. When I asked him whether he would see the light at the end of the tunnel, his quip was there should be a tunnel to see the light. ‘How can you see the light if there is no tunnel’ he questioned me.
I also recently visited a large-scale printing press who had been supplying printed materials to BOI companies and other corporate bodies. He had imported three modern 4-color printing machines from Japan and provided employment to more than 300 workers who had worked round the clock to complete the orders. Now he does not get those printing orders and all the three machines remain idle. Just to attend to occasional small orders he gets, he has kept 6 people on the payroll and works only when there is an order in hand. He is now pondering the idea of selling two of the machines to Indians who have a big demand for those Japanese machines in their country.
I also met a leading chocolate manufacturer who had been supplying his products to both local and foreign markets. Faced with the breakdown of the supply chain, he has shifted a part of his chocolate manufacturing facility to Ghana where there is no shortage of raw cocoa powder.
The worst case has been the fabric knitter who had been supplying the canvass for the Nike shoes that are finally manufactured in a factory in Vietnam. This knitter had invested a massive amount in sophisticated machinery, trained more than 4,000 people in the operation of these machines, and run a very lucrative business. However, two years ago, the buyer had cut the supply chain leaving this fabric knitter in the wilderness. He is now trying to make a new beginning by changing into a new product line that could supply a new form of knitted fabric that can be used as wearable medical outfits.
These are only a few examples and if you speak to any large entrepreneur, he will tell you a similar story.
Restore supply chains to deliver prosperity
It is necessary to make Sri Lankan people and the economy resilient by reestablishing both the forward and the backward supply chains if we want to deliver prosperity to people. There are bottlenecks in the present supply chain. Top priority should be given by the Government to remove those bottlenecks. In the initial relaxation of import controls which the Government is planning to do, attention should be paid to relax controls on equipment, spares, and raw materials needed for industry. It will keep the economic activities going and contribute to the delivery of prosperity to people. Without doing this, just praising people with sugar-coated phrases which are non-existent will not do the job.
(The writer, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at [email protected].)
It is necessary to make Sri Lankan people and the economy resilient by reestablishing both the forward and the backward supply chains if we want to deliver prosperity to people. There are bottlenecks in the present supply chain. Top priority should be given by the Government to remove those bottlenecks. In the initial relaxation of import controls which the Government is planning to do, attention should be paid to relax controls on equipment, spares, and raw materials needed for industry. It will keep the economic activities going and contribute to the delivery of prosperity to people. Without doing this, just praising people with sugar-coated phrases which are non-existent will not do the job