Financial Times

Under IMF-imposed policies, Sri Lanka has witnessed dramatic deterioration of many local industries.

Sri Lanka sold off its profitable public sector enterprises such as the Tyre Corporation, Sugar Corporation, Milk-food Corporation, Air Lanka (used to be the Sri Lanka’s national airline), Ceylon Transport Board, and textile factories at Tulhiriya and Veyangoda, etc.

There is some rationale to sell state owned-enterprises which are highly subsidized and/or losing money; but none what-so-ever to sell profitable assets such as the national airline. Lending from the IMF and World Bank to developing countries usually curtails self-sufficiency and makes developing countries even poorer in the long run.

It also makes it difficult to sell goods produced in developing countries to the industrialized countries. These policies unfortunately have resulted in increased debt, decreased local production, increased prices and higher inflation, increase unemployment, and a reduction in the value of the local currency.

For example, under the IMF Structural Adjustment Policy, the Sri Lankan rupee had been devalued many times starting from Rs 16 per one pound sterling in 1977, to over Rs 190 in 2006; a 1,200% devaluation (similarly, Rs. 10.00 per $1 to Rs 100/dollar during the same period). It is time to break away from this vicious circle of no growth, stagnation and mounting international debt.

Having stated the above facts, it could be added that open economies imposed by the World Bank and IMF have been beneficial to a handful of developing countries such as Singapore, Hong Kong and Ireland. However the majority of developing countries have not been able to come out of poverty.

On the other extreme, a closed economy such as North Korea and Russia are obvious self-inflicted disasters. However, the vast majority of the developing countries, including Sri Lanka fall in between and continue to have problems in lifting their heads above water. Sri Lanka must develop methods to attract FDIC and have plans to pay off and get rid of loans speedily (rather than accepting additional loans with further accumulation of interest payments), aiming to get out of the loan trap.

Adopting outward looking policies

Without economic success, Sri Lanka will not be able to maintain peace, harmony, unity, dignity, and prosperity, or for that matter national security. Irrespective of political settlements/interferences, most of the inherent social unrest and political disturbances will significantly improve with economic and social advancement of the country. Once the economy improves and people are not starving, social unrest will gradually disappear.

Therefore, this is yet another reason for the government to improve the economy of the country. It should do everything to assist, but not necessarily subsidize individuals or the business community to become prosperous. With an improved economy and job opportunities, increased revenue will be generated by individuals and firms for the government. These inevitably would lead to overall economic and social advancement of the country.

The profit margin in most of the current industries in Sri Lanka is small, in comparison to the rapidly developing neighbouring countries. Rather than increasing price of products, which will eventually phase one out of the market, firms should consider decreasing its cost of goods sold (i.e., the overall production costs by improving the process and minimizing or eliminating non-value chains).

It is necessary to prioritise most important areas of development and achieve these goals before moving into less important or less demanding areas. In contrast to China and India, the market within Sri Lanka is much smaller; therefore, the strategic focus should be to produce high quality goods, in particular branded products, for export to Asia and other foreign markets.

A broader macro-economic vision along with large-scale incentives, tax cuts and tax holidays could attract foreign investments to Sri Lanka. This is exactly what Ireland successfully did a few years ago with their supply-side policies.

They became the ‘Celtic tiger’ very quickly because substantial tax cuts for foreign investments led to a massive influx of foreign direct investment. These examples once again illustrate the importance of FDIC in development of a country, rather than dependence on international loans. On the contrary, political uncertainty, weakening and unstable local currency, lack of infrastructure development, unchallenged environmental pollution, and on-going corruptions are discouraging foreign countries and firms from investing in Sri Lanka.

Most of these problems can be contained in a relatively short time with honest, forward-looking and a dedicated strong leadership that is willing to take bold, honest and extra-ordinary measures. Therefore, FDIC will go hand in hand with the honesty of a government; a lack of which has been the root problem in many instances.

One must keep in mind that foreign investors have no particular interest in developing Sri Lanka or any developing country. Business enterprises and investors will come only to take advantage of tax breaks, cheap labour, perhaps weaker labour laws and ineffective environmental protection laws (truth of capitalism). But the government should harness its strength and efficiency to capitalize on these short-term investments to tie-up into Sri Lanka’s long-term development plan, while proactively minimizing potentially negative influences.

What could be done

It is important to attract FDIC and not depend on loans or handouts to develop the Sri Lankan economy. Following the tsunami disaster, the government of Sri Lanka had the golden opportunity to appeal to the West for cancellation of its existing loans (dbt forgiveness, or at least debt moratorium); but it lost this golden opportunity.

Instead of requesting loans, the government should negotiate to decrease or eliminate trade barriers and acquire favourable export status and obtain preferential market access in industrialized countries.

Even though these may not have an immediate impact on debt relief, the gains from the increase trade to Sri Lanka would be substantial and sustainable in the long run. This is more beneficial than depending or begging for loans and handouts.

The state must provide a ‘safe capital' environment, an honest government, enforceable contracts, honour intellectual property rights, and provide incentives to foreign companies to invest in Sri Lanka.

It must relentlessly market its new economic policies to the world (selling a country and its products are like selling soap). All politicians, especially the President, Finance Minister and Central Bank governors, must be proactively engaged to provide wide international publicity for the country’s new economic plan. The government should offer incentives to attract business, the same way Ms. Ruth Richardson, the former Finance Minister of New Zealand, successfully did at every visit to a foreign country. We need to learn from these examples and act appropriately. Every Sri Lankan politician or diplomat on each foreign trip must make at least one favourable trade deal for the country; otherwise they should not be allowed to engage in a similar trip in the future representing Sri Lanka.

Most countries use VAT when only value is added to a product, but in Sri Lanka retail sales function attracts VAT up to 20%, even when there is no value added to a product or to the consumer. These taxes are in addition to the CIF and governmental stamp duties. These forms of taxation add another 30%-40% increase of price of basic commodities used by the consumers; most of them are prevailing below the poverty line.

In addition to the recently discovered massive VAT scandals in Sri Lanka, which drains the treasury funds away from its intended developmental activities; one of the major deficiencies in the system is that only a small fraction of individuals actually pay personal taxes.

The current tax-exempt earning capacity is Rs 25,000 month. However, there are a large number of Sri Lankans who earn much more than this, but do not pay any income tax due to loopholes in the current tax laws.

This should be rectified. Improvement of the efficiency of the Inland Revenue Department is critical for improvement of government’s revenue collection by fair taxation across the board.

Ironically, the Sri Lankan government hinders free trade because it gets most of its revenue from import tariffs. Gasoline (petrol) is one such example. The high cost of gasoline, which is currently about Rs 450 ($4.50) per gallon (Rs 90 per litre), is mostly due to governmental taxes. Therefore, this excessive tax has proven not to be a deterrent to reduce gasoline consumption. Instead, it adds a significant financial burden to all, who now have to pay higher prices for everything, which many cannot afford to.

Subsidy of diesel fuel across the board for example, has only incentivised rich folks to use high consumption vehicles. Ninety percent of these high-consumption vehicles belong to the government, NGOs, and companies. Government must take the leadership by converting (getting grid of) these high consumption vehicles to low cost, low consumption vehicles. There must be an absolute ban on importing high-consumption vehicles (with very few exemptions such as for military vehicles and in healthcare sector such as ambulances).

As a result of ever increasing gasoline prices, the cost of living has sky rocketed over the past 15 years, and continues to increase exponentially. In these situations, high taxes and import tariffs are in fact counter-productive for the economic growth of the country.

Even with these high taxes imposed on gasoline; government seems to subsidizing this commodity leading to further loss of governmental revenues. In this scenario, instead of further raising gasoline taxes, the government should ‘invest’ in decreasing energy consumption in all sectors (e.g., introducing low energy consuming technologies, incentives to decrease energy use, etc.), thereby conserving foreign exchange.

Subsidies and negative effects on the economy

In 2005 alone the fuel subsidy for Sri Lanka's to the Ceylon Petroleum Corporation was estimated to be about Rs.22 billion, while the Ceylon Electricity Board lost about Rs.19 billion. These two alone amounted to more than 2.0 percent of the GDP.

This is about the same amount of money the government spent on healthcare or education. The government must gradually trim these wasted subsidies, and use that savings on job creation programs especially in the periphery and also for further development of agriculture and the infrastructure.

Sri Lanka's government abandoned the automatic fuel price adjustments and adopted a policy to print additional money equivalent of 3 percent of GDP in 2004, to subsidize a range of imported commodities in particular oil (gasoline) and fertilizer under a new economic policy presumably aimed at insulating the country from world market prices.

Not surprisingly, excess borrowing and printing money only accelerated the inflationary cycle. Indeed this led to an increase in inflation to 18 percent further plunging the country into a crisis that involved a balance of payments.
The government must resist its temptation of monitorization in the future. It is ironical that 75% of the government subsidies go to high-income earners, who certainly can do without any of these subsidies. If this be the case, why not consider giving subsidies directly to those who desperately need assistance, rather than subsidizing the rich? Subsidizing a commodity such as diesel fuel of which the rich use 70% is not the way to help the poor and the needy, or the country.

The long-term effects of these inappropriate subsidies include bad price signals, and prevent conserving energy, or seeking out alternate energy sources (e.g., generating energy from ethanol, wind power, biogas, desalination, etc.).

One would imagine that the government could also direct a portion of these subsidies as incentives to use alternative energy sources, with a view to decreasing the import of gasoline, and to invest on energy conservation.

For example, instead of losing over seven million rupees a day, the electricity board should consider using a part of these losses to embark on programmes such as distributing energy saving items such as fluorescence light bulbs (at a highly subsidized prices) to the consumer, and give incentives to industries to conserve energy.

Agricultural base

Within the long-term national economic development plan, it is important not to alienate the countryside and the villages from their traditional nature, culture, and economic bases. For example, the agricultural base and the tank-based irrigation systems for agriculture present in Sri Lanka for the past thousands of years must not be neglected.

Instead of subsidies, the government should use that wasted revenue and continuous earmarked investments to revamp these irrigations systems, so that crops such as paddy will be grown in two seasons per year with a rotation for a third crop, while generating year-round job opportunities. Following are some key points if followed, will lead to future success of Sri Lanka:

* Eradication of terrorism, and directing the savings to infrastructure and other development projects.
* Minimize adverse effects of globalization by educating, re-training, and empowering its citizens, thereby strengthening social measures, including expansion of skills training and employment such as the Samurdhi programs.
In addition, enhancing small-scale industries throughout the country would resist penetration of negative frontiers of globalization, while enhancing employment and capturing the benefits of new technology and development.
* Sri Lanka should not shy away from shifting its economic base from Colombo to elsewhere if this is applicable. For example, with the expansions of the Asian markets, it is logical to expand the Trincomalee harbour, which is one of the best natural harbours in the world.
This would lead to easier access to four Asian Tiger markets as well as Chinese, Japanese and Malaysian markets, which are more lucrative than the difficult and costly North American markets.
Perhaps, the Indian project of creating a deeper canal for shipping, Sethu Samudram (if materialized for commercial shipping purposes, instead of solely military purposes of India) may also indirectly benefit the expansion of the Trincomalee harbor-expanding better shipping options in the area.
* Sri Lanka must ignore inappropriate foreign and NGO influences and proactively give the highest priority to the national interests, sovereignty, and to national security leading to political stability.
* Restrict foreign company-based economic development to certain controlled areas such as the Sri Lanka Development Zones, as seen in the Shanghai model. This would enable Sri Lanka to enjoy the economic and commercial success, while minimizing its negative consequences of globalization in the countryside and villages.
* In theory, open trade will improve the economy of Sri Lanka.
However, in the short-term, if these policies are rushed without allowing for natural adjustments, there will be significant displacements and negative, societal impact as the economy adjusts.
Government must try to alleviate these problems via a balanced policy, education, and re-training.
(This is the final installment of this 3-part series)