Responses to Chandra Jayaratne’s ‘Important issues’ to ponder over

Following are some responses from three economists to the guest column by Chandra Jayaratne titled ‘Important issues’ for Sri Lankan legislators, the Executive, policymakers, Central Bankers, economists and thought leaders to ponder over published on 2 February

1) I disagree with the Stiglitz-Krugman line. My diagnosis is that Europe is in this mess for two reasons: a basically flawed Euro; and living beyond its means – over-spending and over-borrowing. The two have come together in a toxic cocktail after the GFC. So countries have to put their houses in order, which means several years of pain. This is what the US and UK did in the ’80s, as did many now-successful developing countries.

Taking on more debt to boost aggregate demand is like giving extra shots of heroine to a hard addict. The problem is the euro. Countries in the Eurozone don’t have the cushion to adjust via a devalued currency, which makes the currency difficult to maintain in the long-term.

Lessons for Sri Lanka

What lessons for Sri Lanka? Hard infrastructure is usually good for development, and we should see some positive effects in Sri Lanka, despite “waste and leakage”. But it is happening in fairytale land. It should happen in the context of macroeconomic stability and prudent management of public finances; instead of which the Government is perpetuating chronic macroeconomic instability and fiscal incontinence. So a macroeconomic crisis is always around the corner. That is not a price worth paying for gleaming new roads, ports and airports.

The comparison with Malaysia is instructive: big spending on infrastructure is part of its relative success, but it had conservative fiscal and monetary policy.

On trade policy, the issue is both exports and imports, coupled with FDI. Sri Lanka needs all three. A basic rule of trade economics is that a “tax on imports is a tax on exports”. De-liberalisation on imports translates into a tax on tradable sectors, including exports. Even P.B. Jayasundera is bone-headed about this. I once heard him say that SL needs to double exports by 2015 and reduce imports at the same time. That is analytical diarrhoea.

2) I am not au fait with the details on sanctions against Iran. But it seems to me to be folly for Sri Lanka to become too dependent on Iranian oil, and to rely on it through friendship with the Chinese and Russians.

Sri Lanka has enough international pressure on the human rights front; this would expose it to even more sanctions pressure – which it might or might not avoid – I just don’t know. But the more sensible policy is surely to diversify sources of oil supply through more reliance on the open market and less reliance on backroom deals with dodgy allies.

China vs. India

3) The last question is a big one and I cannot do it proper justice in a short paragraph. I will say the following, though. Yes, for next decade or so, we will see China opening a wider gap with India. Living standards were at par in 1990; now Chinese living standards are close to three times the level in India.

Why is that? Chinese market reforms have gone further than in India (contrary to the “command economy” explanation), and China started almost 15 years earlier than India. China has also enjoyed a bigger demographic dividend.

A centralised, authoritarian state has managed to mobilise investment in a way that a “soft,” decentralised and democratic Indian state cannot do. Finally, India’s growth dividend for the poor has been hampered by the lack of reforms in crucial areas, notably labour markets. It has not had the Industrial Revolution China is having.

But let’s look at the other side of the coin. Chinese growth is going to slow down over the next decade and even more in the following decade. It is partly because so much investment, especially in the public sector, is wasteful and yields diminishing returns.

Needed reforms have stalled and are politically more difficult. The demographic dividend will be over in about a decade. And – the trillion dollar question – will the political system survive long-term given the increasing contradictions between it and a globalised market economy?

India’s insurance policy against a systemic crash, in contrast, is its relatively stable democracy and open society. And it is going to enjoy a demographic dividend while China’s declines. But to take advantage of it requires a new wave of reforms. That, most likely, will happen in gradual, piecemeal fashion, and in some states much more than others.

Growth and employment

I agree with Stiglitz that a focus only on austerity is not the answer for Europe. Growth and employment have to come into the equation. This requires external financing support which Germany, in particular, is reluctant or unwilling to provide in sufficient amounts. At a minimum, it should allow the ECB to print money i.e. issue Eurobonds.

On infrastructure, the emphasis should be on delivering efficient economic services and not just on building assets. This would address the rate of return issue and also draw attention to maintenance and regulation – all of which are important.

Addressing the infrastructure backlog is important.  The current 6.5-7% limit on public investment seems okay. Going forward the momentum can only be maintained through increased recourse to public-private partnerships e.g. Colombo Port development.

The fiscal challenge should be addressed by increasing revenue from the current low level of 15% of GDP and addressing the poor performance of SOEs and the untargeted/inefficient Samurdhi payments (while structuring a robust safety net for those who need it). It is difficult to sustain that a country with a poverty head-count of 8.9% and per capita income of $ 2,800 needs a safety net for 40% of its people! Useful vote machine, but unaffordable.

Anti-export bias

 Sri Lanka has had an anti-export bias in its policy framework almost continuously over the last 50 years or more. This is one of the main reasons why we have gone from 2nd in Asia, in 1948, to nowhere in Asia during the intervening 64 years.

On Iran sanctions, it is unlikely it would possible to negotiate a complete waiver. The strategy should be to negotiate in good faith and argue for the best possible deal in terms of demonstrating some decline in our trade with Iran. The US has some leverage as it accounts for about 25% of our exports. On this matter, India, given its good relations with the US, may be a good ally in terms of negotiating the best possible deal, particularly as they too are in the same situation.

A breach of the sanctions is unlikely to be a good option. A positive approach on this issue, while seeking to protect Sri Lanka’s interests as best as possible, could yield some dividends at the UNHRC sessions as well. Understand a US Treasury official is due in the country. More details may emerge regarding room to manoeuvre for Sri Lanka.

Confucian work ethic

 On China/India: The Confucian work ethic certainly gives an advantage over the more individualistic and chaotic culture of South Asia. The historical tradition of highly efficient Mandarins in the bureaucracy is also a factor – the Bapu culture in South Asia has been a drag on development.

Regarding development models, successful outcomes have been achieved through a range of approaches – with different mixes of liberal and command economics. The Economist of 21/1 has an interesting piece comparing state and liberal capitalism. The overall conclusion seems to be that the command economy is better at infrastructure but less competitive in consumer goods (innovation and creativity) – one needs to remember the Economist has its own line.

 Economic policy

Stiglitz believes that the austerity plans in the EU nations, especially by the debt-ridden poorer nations of the group, is akin to a collective suicide pact and is an act of madness promoted and enforced by the more powerful nations of the Group.

In the above context and environment, do Sri Lankan legislators, the Executive, policymakers, Central Bankers, economists and thought leaders hold similar or divergent views:

On the prescription for Greece, Portugal, Italy and Spain?

Believe the economic policy continued in Sri Lanka in enhancing foreign borrowings and investing in infrastructure and other projects some of which may have no real or competitive sustainable socio economic returns is a valid policy prescription?

Accept that running high budget deficits in the name of development and full employment and allocating national resources and spends to projects/activities that fail to conform to internationally bench marks on economy, efficiency and effectiveness is an acceptable prescription in the longer term for Sri Lanka to dream of becoming the next ‘Wonder of Asia’?

Accept that Sri Lanka whilst exposing itself to widening trade deficits adopting a trade policy, tariff structures and  exchange rate policy conflicting with the expansion of exports is in the longer term interests of sustainable growth in Sri Lanka?

Trade sanctions

In the face of trade sanctions imposed on Iran by the EU and the US, with  Sri Lanka as a nation dependent on crude oil imports mainly from Iran (80%) and the local refinery tuned to process the Iranian type high density crude, what options does Sri Lanka have?

Will Sri Lanka qualify to and be able to get a special waiver from these sanctions?

If Sri Lanka is able to win some concessions from trade sanctions, as an import and export dependent nation, at what lower level of transactions with Iran can Sri Lanka survive -say can it live with a 10%, 25%, 33% or 50% reduction in present levels?

Are there ways around the sanctions, especially in making settlements say in gold etc not involving bank linked settlements?

Can barter with tea be an option of settlement?

Will long term credit until sanctions are lifted be a possibility?

Can India, Russia and China help Sri Lanka to effectively get round the sanctions?

If any Sri Lankan banks are listed for having effectively violated sanctions by EU and US controlled banks, will these foreign banks impose penalties, retentions or holdovers of a part share of transaction proceeds, even involving trade done through such local banks by Sri Lankan businesses with countries other than Iran?

Finally, if Sri Lanka breaks sanctions in some way, what further international repercussions and negative head winds will come our way?

Can India catch up?

Dr. Amithya Sen believes India can never catch up with the positive comparative social indicators of China, even in the longer run even with higher than annual growth contributions over China,

Can this be attributed to the lead China now has over India to be so large to give it an unassailable position?

Or can some political economists believe and interpret it as that it as a reflection of;

Command economy vs. open economy natural outcomes?

Centralised state led autocratic governance vs. democratic governance led outcomes?

Capability, skills, technology and values and attitude differences between India and China?

What lessons can Sri Lankan policy draw from these interpretations in compiling policy prescriptions for Sri Lanka?

Eurozone fiscal policies

Stiglitz believes that the austerity plans in the EU nations, especially by the debt-ridden poorer nations of the group is akin to a collective suicide pact and is an act of madness promoted and enforced by the more powerful nations of the Group.

Yes, in the short term but the fact is that the excessive debt has made these countries insolvent. So some debt has to be written off for there is no way such foreign debt can be repaid to the bankers as they fall due.

In any case if these debt-ridden governments want to continue their growth they have to borrow more. But international bankers will not lend without some guarantee from the international lending institutions to the bankers like the European Central Bank and IMF.

So what the European Central Bank has done is to give very low interest loans to the banks affected by the Greek crisis and other Eurozone countries. These banks have taken a 50% haircut on their loans to the Eurozone insolvent debtors and now re-lend to the Eurozone debtor nations. This will allow their governments to continue their expansionary policies in the short term.

But as a long-term solution Germany wants to tighten Eurozone fiscal policies of individual countries. There cannot be a sustainable monetary union (Euro) without central control of government borrowings. So if a close knit Eurozone is formed it will be a curtailment of the borrowing powers of individual Eurozone countries.

In the above context and environment do Sri Lankan legislators, the Executive, policy makers, Central Bankers, economists and thought leaders:

Hold similar or divergent views on the prescription for Greece, Portugal, Italy and Spain?

Believe the economic policy continued in Sri Lanka in enhancing foreign borrowings and investing in infrastructure and other projects some of which may have no real or competitive sustainable socio economic returns is a valid policy prescription?

Foreign debt

The question of how sustainable our foreign debt is the subject of disagreement. The debt/GDP ratio is being cited by the Government and they point out that this ratio is coming down. But it is coming down not because of less borrowing or repayments but because the growth in the GDP is higher. But this ratio is not an absolute standard and I have pointed this out to the Governor at an MPCC meeting. But he is not convinced.

What is valid is that the debt/GDP ratio cannot keep on rising and this is not happening owing to the increase in GDP. So if the growth is sustainable we may not have a problem. But economic theory says growth is dependent on several factors including

According to Roubini: “The inter temporal solvency constraints imposes excessively mild restrictions on the paths of trade balances, current account balance, primary fiscal balances, foreign debt and public debt that are consistent with a country or a government being solvent.”

Economics is not a precise science like physics. My view is that we should go by the net foreign reserves after deducting the foreign debt falling for repayment in the year since it is no longer possible to rollover such foreign debt by fresh borrowing in the present global financial scene But I can’t ascertain the amount of foreign debt repayment falling due.

There is short-term trade debt like the Iranian oil bills falling due for repayment. There are the bilateral foreign debts. The IMF includes the short-term foreign portfolio investments which amount to $ 2 billion dollars on government bonds and another two billion in the stock market. Foreign investors in the stock market continue to take away from the stock market.

But foreign bond holders have not shown such a tendency because our interest rates are comparatively high with world markets paying only 1%-2%. So they prefer to hold the bonds until maturity. But if there is a threat of exchange rate depreciation, then there is a distinct possibility that there will be a flight from the bond market as well. If you tot up all these as the IMF does, then we run a high risk of liquidity failure if not solvency failure.

Accept that running high budget deficits in the name of development and full employment and allocating national resources and spends to projects/activities that fail to conform to international benchmarks on economy, efficiency and effectiveness is an acceptable prescription in the longer term for Sri Lanka to dream of becoming the next ‘Wonder of Asia’?

It is difficult to be dogmatic on this issue but in the long term you are right.

Accept Sri Lanka whilst exposing itself to widening trade deficits adopting a trade policy, tariff structures and exchange rate policy conflicting with the expansion of exports is in the longer term interests of sustainable growth in Sri Lanka?

Exports are of paramount importance for if we lose our markets it is difficult to get them back and other countries have depreciated including India by over 15%.