Financial Times

Sound governance central to reconstruction efforts

By Muttukrishna Sarvananthan, International Centre for Ethnic Studies

Despite the fact that there were hardly any domestic political developments that affected the Sri Lankan economy during the first-quarter 2003, the impending American-led war on Iraq did negatively impact on the Sri Lankan economy because of declining tea exports to Iraq and garments exports to the USA due to depressed market conditions.

In the agriculture sector tea and coconut output declined while rubber output increased during the first-quarter. The international price of tea declined in the first-quarter primarily due to the anticipated war on Iraq. In the industrial sector both the private sector industrial production index and the public sector industrial production index improved during the quarter. However, industrial exports declined considerably during the quarter under review primarily due to lack of demand from America (the major market for Sri Lanka's industrial exports) as a result of depressed market conditions in anticipation of the war on Iraq.

The interest rates generally were on a downward trend during the first-quarter of this year in comparison to the preceding quarter. However, the prime lending rate rose in March and the Treasury Bill rate rose in February and March. The repo and reverse repo rates dropped in January and remained unchanged throughout the quarter. The cost of living dropped during the quarter both in terms of the CCPI and the new SLCPI. The public debt of Sri Lanka increased marginally by three percent during the quarter under review.

The net private remittances dropped in comparison to the preceding quarter but were higher than the quarterly remittances received during the first nine months of last year. The tourist arrivals and income from tourism were upbeat during the first three months of the present year. The number of tourist arrivals and tourism earnings during the first-quarter of this year were the best quarterly performance in the past three years.

The capital market indices were on the downside. The pause-in-conflict economy of the North and East Province was picking up with the rise in crop cultivation as a result of the return of Internally Displaced Persons to their places of origin, commencement of infrastructure rehabilitation works and one major private foreign investment.

There were no significant political developments locally during the first-quarter of this year. However, the run up to the war on Iraq (which started in mid-March) did have a negative impact on the Sri Lankan economy because Iraq is a major market for Ceylon tea. Besides the general uncertainty generated globally by the anticipated war on Iraq did have its ripple effect on the Sri Lankan economy as well.

Tea production dropped to 72 million kgs during the first-quarter of this year compared to 83 million kgs during the last quarter of 2002. However, the 1st quarter tea output this year was almost the same as the 1st quarter output of last year. The monthly tea output during the quarter under review was lower than the monthly output during the previous three months.

The international tea auction price increased marginally in January 2003 to US$ 1.60 per kg in comparison to US$ 1.54 per kg in December 2002. However, subsequently the auction price of tea dropped to US$ 1.51 per kg and US$ 1.48 per kg in February and March respectively. The auction price of tea in each month of the 1st quarter was considerably lower than the corresponding months last year. The war on Iraq, which commenced in March, was the main factor behind declining tea auction price during the quarter because Iraq is a major market for Ceylon tea.

The private sector industrial production index (base year 1997) increased during the quarter under review. The private sector IPI increased from 123 in December to 130 in January and 132 in February, but declined in March to 128. The public sector IPI more than doubled in January and February compared to the previous three months, but dropped significantly in March. The public sector IPI shot up to 171 in January from just 71 in December. However since then it dropped consistently to 155 in February and 92 in March.

Industrial exports declined considerably to US$293 million in January from US$410 million in December; almost a 30 percent drop. Nevertheless it picked up in February and March to US$304 million and US$320 million respectively. The quarterly industrial exports worth US$918 million in the 1st quarter 2003 were lower than the last two quarters of 2002. The sluggish industrial exports during the quarter under review was also primarily due to the anticipated war on Iraq and its negative impact on consumer demand in the United States, because USA is the largest market for Sri Lanka's industrial exports.

The movement of interest rates during the first-quarter was not consistent. For example, the prime lending rate dropped from 12.24 percent during the last week of December to 11.25 percent during the last week of January and remained at the same level during the last week of February but increased to 11.77 percent during the last week of March. Likewise the 12-month Treasury Bill rate declined from 9.56 percent during the last week of December to 8.85 percent during the last week of January and then increased to 9.11 percent during the last week of February and 9.18 percent during the last week of March.

The repo rate and the reverse repo rate declined during January and remained at the same level in February and March as well. The repo rate declined from 9.75 percent in December to 9.00 percent in January and the reverse repo rate declined from 11.75 percent in December to 11.00 percent in January.

However, the lowering of the repo and reverse repo rates by the Central Bank has not been reciprocated by lowering of lending rates by the commercial banks. The primary objective of lowering repo and reverse repo rates is to boost investment by reducing the borrowing cost of investors. However, this objective was not realized during the first quarter because of the reluctance of commercial banks to reduce lending rates.

The gross official foreign exchange reserves increased marginally from US$ 1,700 million by end-December to US$ 1,716 million by end-January and further to US$ 1,772 million by end-February but declined marginally to US$ 1,725 million by end-March. The drop in the official foreign exchange reserves in March was due to the dramatic decline in foreign aid received during that month.

Overall the gross official foreign exchange reserves increased only marginally to US$ 1,725 million by end of the first quarter compared to US$ 1,700 million by end of the previous quarter. Despite the considerable drop in the trade deficit during the quarter under review (compared to the preceding quarter) there was no corresponding rise in the gross official foreign exchange reserves because of a considerable drop in foreign aid and net private remittances received during the quarter in comparison to the preceding quarter.

The pause-in-conflict economy in the North and East Province is defined as the transitory economy from a conflict economy to a post-conflict economy.

Due to the resettlement of these IDPs agricultural production received impetus. Paddy, cereals, chilli, onion and tobacco cultivation increased throughout the North and East Province.

The infrastructure rehabilitation and reconstruction activities gathered momentum during the quarter under review. The Asian Development Bank funded rehabilitation of the A9 highway commenced in January 2003. However, due to a variety of factors the pace of the A9 rehabilitation project is very slow. Power supply to the Jaffna peninsula and the LTTE-held areas of the Batticaloa district has been increased during the first-quarter. The telecommunication services of the Sri Lanka Telecom have been extended to the LTTE-held areas in the Vanni as well as in the East. Besides, cellular phone companies such as Dialog GSM and Mobitel have expanded their coverage to Ampara, Batticaloa, Jaffna, Trincomalee and Vavuniya districts.

The Indian Oil Company made the first major foreign private investment in the North and East after the ceasfire. The Lanka Indian Oil Company took over the oil tank farm in China Bay in Trincomalee from the Ceylon Petroleum Corporation on a 35-year lease.

Multilateral organisations such as the United Nations (UN), World Bank (WB) and the Asian Development Bank (ADB) jointly prepared an Assessment of Needs in the Conflict Affected Areas of the North-East in April 2003 to be presented at the Sri Lanka Donor Forum in Tokyo.

There was a fundamental problem in the process of preparing this document. This exercise was meant to assess the needs of the people of the North and East in a pause-in-conflict situation, but there was hardly any consultation with the people themselves. Of course it is not practical to consult each and every person in the region. Nevertheless some focus group meetings at the district level (at least) could have been arranged. Further, in a democracy the elected members of parliament and local government could be reasonable proxies for the people. Hence, the needs assessment exercise should have consulted the elected representatives in the region as well.

Instead, the consultation process involved meetings with the LTTE, central government representatives in the province (Government Agents and Kachcheri staff), North and East provincial administrative staff, local government staff, representatives of Non-Governmental Organisations (NGOs - local, national and international), academics and representatives of local businesses. Many local NGOs and trade associations in the North and East are politically manipulated, and therefore cannot be regarded as independent and objective. The need assessors bent over backwards to accommodate the needs of the LTTE that is unrepresentative. Although most of those consulted may have expressed the needs of the local people the consultation process is not complete without meeting the people themselves and their elected representatives. This is a major drawback of the needs assessment exercise.

As regards the contents of the needs assessment document there are two elements. One is the identification of needs and the other is the costing of the identified needs. The needs identified in the document are by and large real. However, there are some key missing components. For example, originally the United Nations Development Programme was expected to identify needs on the issue of governance in the North and East. Governance transcends human rights that have been covered in the needs assessment. We understand that due to the objection raised by the LTTE the proposed needs assessment on governance was left out. This is an instance where the needs of the people were sacrificed in order to appease the LTTE. This is very unhealthy because sound governance is a prerequisite for reconstruction of a region/country in the aftermath of conflict.

Capacity building is obviously the overarching need in the North and East, which is clearly acknowledged in the needs assessment report. For capacity building to take place sound governance is sine qua non. Even a year after the signing of the ceasefire MoU qualified professionals, administrators, managerial/finance personnel, et al are hesitant to work in the North and East primarily due to poor governance in those areas, especially in LTTE-held areas. Capacity building cannot be implanted from outside; it has to indigenously develop within the region by retaining human capital. Retention of human capital is not possible without a dramatic improvement in governance throughout the region particularly in LTTE-held areas. Therefore, sound governance is central to reconstruction efforts, which is unfortunately not covered in the document.

The costing of the identified needs is at best guess-estimates. It is simply impractical to do a proper costing in just two months. More time could not be given for the exercise because the people expect tangible benefits on the ground in the shortest possible time. The original cost estimation was more than double that presented in the document. We understand that this is because the government wanted the original estimation to be slashed by half for reasons best known to it. First of all, there is no guarantee that the donors will pledge whatever is asked for. Secondly, there is no guarantee that whatever is pledged at the Tokyo Donor Forum will be actually paid. Most of the foreign aid pledged at a similar Tokyo Donor Forum for the reconstruction of Afghanistan in early-2002 has still not materialised for a variety of reasons. Under these circumstances the decision to downsize the original cost estimation was a blunder.

Economic infrastructures (roads, railways, ports, telecommunications, power, irrigation, water and sanitation) are expected to consume 46 percent and social infrastructures (education and health) 12 percent of the total reconstruction cost. Therefore, almost 60 percent of the total reconstruction costs are apportioned for economic and social infrastructures. In a region emerging out of two decades of conflict it would be prudent to use labour-based technologies (as opposed to heavy machinery-based) as much as possible (in so far as there is no trade-off on time taken to complete the work and the quality of such work) for rehabilitation and reconstruction of economic and social infrastructures so that maximum employment opportunities could be created. For example, these labour-based technologies have been quite successful in the post-conflict reconstruction of Cambodia. Perhaps the cost of infrastructure rehabilitation / reconstruction could be considerably reduced if more emphasis is placed on labour-based technologies.

The second largest component (after economic infrastructures) of the total cost of needs is for housing, which is 18 percent. There is a dearth of data on damage to and destruction of houses in the region. Hence the data presented on housing needs should be treated cautiously.

The assessment of needs in the agriculture sector (including livestock, fishery and forestry), the primary economic activity in the region, is very disappointing to say the least. Further, the assessment of needs in the industrial sector is submerged in the Small and Medium Enterprise Development part of the 'livelihoods' section, which is a serious lacuna in the needs assessment document. Industrial development should have been given greater prominence.

It is amusing to note that 'livelihoods' have been identified as a separate sector in the needs assessment document. Livelihood is a crosscutting theme and therefore cannot logically form a separate sector. Furthermore, the section on 'protection and resettlement' has partly covered livelihood issues. This is a demonstration of donor-driven character of this document.

It is a pity that the section on management of donor funds, which is of immense importance, is not made available for public scrutiny. The Sri Lankan experience of management and utilisation of foreign aid has been rather poor. Now in the present context of the reconstruction of the region the management of donor funds would acquire greater significance because of the anticipated flow of foreign aid to a region that is largely unaccountable and non-transparent.