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Economists concerned over perils to sustained growth
View(s):Economists are concerned that the current economic policies would be a serious constraint to sustained economic growth. The annual sessions of the Sri Lanka Economic Association (SLEA) on October 25 and 26 brought this out clearly. Delivering the presidential address on the theme “Way Forward for Sustained Growth”, Prof. A.D.V. de S. Indraratna, noted that Sri Lanka was able to reverse its low economic growth, not by investing domestic savings, but by borrowing from abroad to finance development. The higher rate of growth achieved by borrowing, he pointed out, boosts growth initially but causes the current account deficit to expand further, increases imports and the trade deficit.
Growth achieved in this manner becomes unsustainable, as already demonstrated by the high economic growth of 8 per cent achieved in 2010 and 2011, falling to 6.4 per cent in 2012.
Indraratna’s prescription for sustainable growth was the cutting down of consumption expenditure by reducing “waste, corruption, and ostentation of the public sector” and “improvement in the management and the productive efficiency of the public sector institutions” and encouraging non-debt foreign direct investments.
Indraratna contends that peace is not sufficient to attract FDIs. There should be good governance, rule of law, right to information, efficient, honest and independent public sector institutions, enlightened free media and simple rules and procedures in customs and immigration.
Perils to sustained growth
Dr. G. Usvatte-aratchi, a Cambridge economist, who served the United Nations, in his keynote address titled ‘Perils to Sustained Growth’, pointed out that the perils of economic growth were earlier known as business or trade cycles, but today they are called ‘economic crises’.
Carmen Reinhart and Kenneth Rogoff’s 2011 book, ‘This Time is Different: Eight Centuries of Financial Folly’ have linked the merry borrowing and spending by governments and corporations to eventual debt default and economic crises. The crises begin when borrowers go on rolling over short-term debt without gaining capacity for repayment and lenders losing confidence in the borrowers. Accordingly, lenders disappear from the scene creating liquidity problems and the crisis hits the borrowing country. Thus, economic crises today are man-made rather than arising from economic systems, as presumed earlier.
Since the experience of borrowing that we have been indulging in Sri Lanka resembles this, we are on the road to an economic crisis. When governments and corporations borrow and spend, growth becomes less because the bubbles they create burst sooner or later to lead to economic crises, because cheap money available in plenty, as in the case of stimulus packages and central bank sponsored lending schemes, are spent on less important areas without rigorous screening and assessment processes. The outcome was loss of economic efficiency and creation of white elephants, as evidenced in many developing countries, including Sri Lanka.
Vital lessons for Sri Lanka
The disappearance of lenders, Usvatte-aratchi said happens at the speed of light as funds could be transferred electronically from one place to another even to gain a small advantage in interest rate differences. Countries with borrowed foreign reserves — borrowed from the short term money markets — should be careful about handling their economic matters.
Usvatte-aratchi compared the case of India and Sri Lanka. India has a huge foreign exchange reserve of some US$ 285 billion, but when the Indian rupee came under pressure for depreciation, the Reserve Bank of India did not think it prudent to spend those foreign reserves to prevent the rupee from falling.
In contrast, Sri Lanka has only a reserve of US$ 7 billion and even if only a fraction of that leaves the country in search of higher interest rates, the country will be in trouble due to the loss of foreign reserves. Therefore Sri Lanka should avoid relying on borrowed funds.
Prerequisites for attracting FDIs
Sri Lanka is notorious for spending more than it earns. This generates a gap in the combined trade, services and income accounts of the balance of payments and therefore incurs new foreign debt. That gap is partly closed through remittances and partly by borrowing abroad that increases the gap further because foreign exchange resources are needed to pay interest.
Sri Lanka’s track record of attracting FDIs has not been encouraging due to three most important reasons: Poor law and order situation, faulty dispute settlement mechanisms and lack of quality manpower at middle levels. While the first two can be tackled within a short period, the third requires long-term attention.
Competitor country inflation
Usvatte-aratchi contended that due to the Government’s failure to keep inflation rate low in line with foreign inflation rates, (inflation rates in the US and EU have been at 1.5 per cent in August 2013), the Government has been depending on short term foreign funding to finance its expenditure, since foreign interest rates are lower than those in the domestic market. This is the reason for getting short-term foreign hot money for investment in Treasury bills and bonds.
Dr. Usvatte-aratchi urged not to make domestic economic policy a ransom to foreign investors as this strategy is fraught with serious risks. Even a slight increase in foreign interest rates could result in a massive outflow of foreign funds creating a serious situation within the domestic economy just like the recent experience of India.
The need for urgent economic reforms
Usvatte-aratchi called for proper economic reforms to cover a wide range of areas to avoid such a situation, even though such reforms are unpopular. It is essential to raise revenue before increasing expenditure. The current policy has been to increase expenditure without looking at its adverse repercussions and then borrow from external commercial markets either directly or through government entities.
These populist policies, Usvatte-aratchi says is what makes, “the long-term growth a hostage of short-term stability”. When governments borrow heavily from commercial markets and countries that lend on commercial terms like China, a ransom is paid to foreigners.
Step-motherly treatment of education
Usvattearatchi argued that there has been a marked shift of government expenditure away from education recently and “a woeful neglect of education at all levels, much of it reversible with far more money spent on them.” He has reservations on the quality of private sector educational institutions compared to public sector institutions which should set the benchmarks and standards which the private sector institutions should follow.
These perils to sustainable growth in Sri Lanka must be removed to ensure that the economy’s growth momentum is sustained and the quality and sources of growth enriched.
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