Want to uplift the economy? Follow the 7 wisdoms of Koshy Mathai

In concluding the late K. Sivagananathan Memorial Oration 2011 in Colombo last week, Koshy Mathai, the highly-respected and much-sought-after IMF Resident Rep in Sri Lanka left the audience with seven points of his wisdom to ponder if Sri Lanka is to sustain its current euphoric growth experience.

This writer finds a very close kinship between these seven points and what he has been talking about all this time as the appropriate policy mix for the country.

Of course, Koshy, who had a limited time allocation, was very brief in his presentation and just outlined the seven points of his wisdom. There has not been a detailed analysis of pros and cons of his wisdom by him or by anyone else at that forum. It is up to others, specifically the top policy makers, to do so by subjecting them to open debate and drop what is impracticable and agree on what is workable for implementation.

IMF’s polite public façade

The IMF and its staff have a remarkable skill in using a specially articulated polite language when it comes to addressing a host country’s general public. This is understandable because the IMF is a guest in a host country and should not overtly or covertly rouse popular sentiments or add to the fears of people by speaking the wrong language and be an embarrassment to its host.

Hence, it does not use the scathing language which the local critics or the opposition political parties sometimes use when unveiling the weaknesses of the policies of a government. But, to the credit of IMF, it delivers very strong messages without compromising its polite public façade which others have to understand by reading between the lines or scrutinising closely the words used in the messages.

Accordingly, when the IMF says that it has identified “some risk factors,” the host country should take serious notice of this message and act swiftly and resolutely. It is like a physician advising a patient that he needs “emergency treatment” meaning that the curative process can no longer be delayed. If the patient chooses to disregard the fine advice, he would do so to his own peril.

This is exactly what Koshy did when he unveiled the seven points of his wisdom.

First, optimism about the achievements

Koshy, at the beginning of his oration, expressed optimism about the direction and the measure of the policy framework being followed by Sri Lanka’s Government. The revenue targets and the budget deficit are on track, public debt as a ratio of the total output or the Gross Domestic Product is on the decline and the Government has reiterated its commitment to put the needed reforms in place.

The Central Bank has done a better job by reining in inflation, building up foreign reserves up to the required levels and maintaining the stability in the exchange rate despite the mounting pressure for the Sri Lanka Rupee to appreciate.

It should also be credited for maintaining an interest rate regime conducive for economic recovery and not overreacting to short term price increases due to floods or global price increases.

The economic growth has accelerated from low three and a half percent in 2009 to well above seven per cent in 2010 and is set to achieve a still higher growth rate in 2011. By and large, the macroeconomic scenario being created in the country tallies with what the government has agreed with IMF.

So, there is all the reason to keep on smiling so far.

Risk factors need urgent attention

Koshy did not say it explicitly, but he implied that the achievements so far are not adequate for sustaining the growth momentum in the medium to long run. He coated it nicely saying that there are “risk factors” facing the economy and they need be addressed urgently and permanently.

In my view, his implication was that the longer Sri Lanka would delay action, the worse would be the results it will have to reap. It is like a cancer patient refusing stubbornly to take medication in time and one fine day finding the cancer invading his vital systems.

To overcome these risk factors and place the economy in a sustainable growth path, he suggested a course of action that embodied the seven points of his wisdom.

First Wisdom:

Discipline the budget

The first wisdom is relating to the need for maintaining the overall budgetary discipline, meaning that the Government should live within its means in the long run. Koshy did not elaborate on this point, but I could reason it out as follows:

No one, whether it is an individual, a company or a government, can continue to live above its income forever. For a year or two, it may be possible to do so by borrowing from others, but, unless one is going to default his loan repayments, one would face the serious issue of having to allocate more and more of his income for the repayment of the past loans.

With an ever-declining leftover income, he will now have to use less and less income for his present wellbeing by reducing his consumption or for his future development by curtailing his investments. The corollary of this unsavoury practice is obvious: a person loses both his present and the future.

This universal rule which is valid for a person or a company is valid for a country as well. One may think that a government is big, has the capacity to borrow from its own citizens or from abroad or just print money and finance the rising expenditure programmes. Therefore, a government is safe and insulated from the catastrophic disasters that may befall on others who are heavily into debt. But history abounds numerous episodes of governments falling into trouble due to their inability to repay debt to foreigners or getting caught in hyperinflation, forcing everyone in the society to sacrifice their hard-earned achievements.

In the early 1990s, the Russian Government could neither borrow anymore nor print new money to finance its expenditure, so it had to default even the payment of pensions. More recently, both Greece and Ireland fell into this trap and had to be rescued by other friendly nations, but not before everyone in the respective countries lost a significant amount of previously enjoyed welfare.

In my view, though Sri Lanka’s budget is on track as per the agreement with IMF for the stand-by facility, it does not mean that it is in proper shape. One should not forget that the IMF benchmarks are too liberal and were revised upward when it found that it was the only way to save the stand-by arrangement.

Its budget deficit at seven per cent and debt level at 80 per cent, both of GDP, are unsustainable. Therefore, in the long run, there is no alternative but to discipline the budget, as now identified by Koshy too.

Second Wisdom:

Look toward Asia

Given the gloomy performance of the global economy, the countries which had traditionally sourced their growth to the lucrative West cannot continue to do so any more. Hence, according to Koshy, it is of paramount importance to tie up economic growth of emerging economies to their own domestic markets.

Both China and India in this region, because of their large domestic markets, can profit immensely from this strategy. A small country like Sri Lanka should piggyback on India and China which are set to achieving super economic growth in the next decade. In this connection, Koshy reasoned that Sri Lanka should seriously consider reviving its shelved Comprehensive Economic Partnership Agreement or CEPA with India early.

Sri Lanka has a very small domestic market both in terms of population and income level. Hence, exports are its lifeline. Traditionally, its major export markets have been North America and Europe. According to Koshy, Sri Lanka should now develop its export markets not in the West, but in the East.

Similar advice had been given to Lee Kuan Yew when he mapped out Singapore’s early development strategies. In the second volume of his autobiography, ‘From Third World to First,’ he says that his colleagues assessed the risk factor involved in relying on neighbours who had no prospect of technological advancement or proper management of their economies.

Consequently, Singapore decided to leapfrog the poor neighbours to the more advanced Western countries. This was a strategy which permitted Singapore to look everywhere instead of just its neighbours.

It is true that both India and China are set to achieving super economic growth in the coming decade. But as far as Sri Lanka’s current export products are concerned, both these countries are simply rivals and not potential absorbers of its exports.

While Sri Lanka should promote its trade with neighbours, that should not be done to the exclusion of the lucrative West. This is because the Western markets are stable compared to the unstable markets in the region. Hence, in my view, Sri Lanka should have a policy of looking north and east first, as advised by Koshy, and then looking everywhere to benefit from the growing world trade.

Third Wisdom: Promote FDIs

To accelerate economic growth, a country has to invest a higher proportion of income and to invest a higher proportion, it has to save a higher proportion too. This is where Sri Lanka has faltered in the past. Its savings have been dismally low with the Government making, year after year, dis-savings by spending more than its income on consumption. Hence, in the current context, Sri Lanka has to rely on savings made by others.

Since its debt ratio is at a critically high level, it is not advisable for the country to contract more foreign debt. In the circumstances, the only way for Sri Lanka to obtain foreign savings is by promoting Foreign Direct Investment (FDIs), which is a non-debt source of funding. They will help Sri Lanka to access foreign markets, obtain advanced technology and improve production techniques and quality.

With the war ending in mid 2009, expectations were running high about mobilising FDIs. But the actual results have been dismal; even less than half a billion dollars per annum, compared to much higher levels achieved by comparable countries like Vietnam. This need not be the case.  

So, Sri Lanka should create a situation conducive for FDIs to flow in by making it easy for doing business, removal of existing barriers for owning lands, etc.

However, in my view, the most important factors are the maintenance of law and order and observation of the rule of law which are more relevant for the protection of the investor rights than the cheap and literate labour which Sri Lanka has been claiming to possess in abundance.

Fourth Wisdom: Have smart infrastructure facilities

Sri Lanka’s physical infrastructure facilities are outdated, dilapidated and worn out. Therefore, Sri Lanka’s current challenge is twofold: replace the existing stock and then augment it with smart facilities.

While the current attempts at adding to the infrastructure facilities are laudable, in my view, it is necessary to prepare a priority list in order to avoid wastage and getting into low yielding projects prompted by non-economic considerations.

Sri Lanka should learn from the bad experiences of some of the Latin American and African countries that were caught in “wasteful capital project traps” by trying to develop infrastructure without proper assessment or combining with the overall development plans.

Ports built in Mexico in 1970s out of low cost funds raised from the international markets with no adequate number of ships calling on them to sustain them financially and highways built in African countries to enable the ruling dictators to visit their birth places are some of the examples of bad investments.

Hence, in my view, Sri Lanka should invest in infrastructure to be compatible with its overall development strategy after making a careful assessment of their feasibility and cost effectiveness.

Fifth Wisdom: Invest in human capital and the knowledge base

Human capital and the knowledge base have become more important contributors to economic advancement of nations today than physical capital. This is because human capital and the knowledge base help a country to introduce innovations in increasing numbers and raise its competitive advantage vis-à-vis the rival nations. It also helps a country to expand its service base, which is again a significant wealth creator in the modern world.

In this context, according to Koshy, the Government’s recognition of the need for developing five hubs in Sri Lanka is an important step taken toward the modernisation of the country’s economy.

While all hubs will help Sri Lanka to expand its services sector and sell services to the rest of the world, the knowledge hub will develop Sri Lanka’s human capital base. The early signing of CEPA with India will help Sri Lanka to develop its knowledge base by establishing higher academic institutions in the style of reputed Indian institutes of Technology with Indian partnership.

In my view, knowledge is necessary but for knowledge to serve its purpose, it should be relevant and used productively in production.

Sixth Wisdom:

Reform the financial sector

Sri Lanka can boast of having a fairly well-developed financial sector compared to other countries in the region such as Vietnam or Cambodia. Yet its financial institutions are inward looking in scope and outdated in using modern technologies. The heavy reliance on interest-based income and high interest margins are some of the burning issues facing the country’s financial institutions.

The low level of financial inclusion is also a serious problem in Sri Lanka. The country’s domestic payment system at the retail level is much to be desired. Microfinance is provided by adventure type institutions without proper regulation or supervision. The available facilities for credit counselling and loan resolution are to be improved.

The low acceptance rate of popular technologies such as mobile phone banking for reducing the inconvenience and the transaction costs has also been a stumbling block in the country’s move toward inclusive banking. All in all, the development of a customer friendly financial system has been the prime challenge of the authorities in the country.

But it is a must if Sri Lanka is to accelerate its growth momentum on a sustainable basis.

Seventh Wisdom: Make it a participatory development process

For long, development has been a top down process in which the ideas and plans stemmed from the top leaders or policy makers. Now it is recognised that, to have the highest effectiveness, development processes should be linked in all direction to the entire population of a country. This calls for the introduction of a participatory development management process.

Koshy drove this truth home by quoting Henry Kissinger, US Secretary of State during President Richard Nixon’s time that, ideas created in a few great minds will not be useful unless they are absorbed by many hearts. When applied to development, the development strategies can be formulated by a few geniuses, but they would not be successful unless their implementation is broad – based and all citizens are enlisted to implement them as if their own creations.

So, the most important requirement of a sustainable development programme is the widespread ownership of the development work by all and sundry in a society.

What next?

The seven wisdoms of Koshy Mathai are not just casual remarks made by an intellectual to satisfy his audience at a public lecture. In my view, they have been developed after careful thought and analysis.

Sri Lanka is currently in a euphoric phase of growth. But the historical experience is that the initial high growth momentums gained by countries lose their steam pretty soon unless they are built on firm foundations. Koshy’s message is that Sri Lanka’s foundation is not solid enough and need be strengthened by addressing the key risk factors.

Hence, if Sri Lanka is to move up to a sustainable growth path, it behoves the country to give careful consideration to the seven points of Koshy Mathai’s wisdom.

(Wijewardena can be reached on [email protected].)