Is the Sri Lankan economy on the threshold of an economic boom? This is the question in the minds of many. The prospect of a sharp revival in the economy is very much in the minds of the government, the business community and foreign observers. Three developments have boosted such expectations. First and foremost is the dawn of peace. Second is the consequent confidence that has been re-established in the country and the prospect of foreign investment, enhanced tourism and uninterrupted economic activity as a consequence of peace. Third is the buoyancy generated by the dramatic improvement in the foreign exchange reserve position that has changed from a crisis situation to one of abundant reserves in the space of a few weeks.
Peace and the containment of terrorism is the single most important factor that gives rise to great expectations on the economic front. There is the prospect of an economic revival in parts of the country and several economic sectors that were seriously impaired and in some cases even devastated by the war. This is especially so in the East where the initial revival has begun. Increased fishing in the North and East, restoration of agriculture, tourism in the East coast are some of these revived activities. What is anticipated is not merely a revival but enhanced and diversified economic activities in these areas that have been throttled for three decades. The economic revival of the North will no doubt take time till the rebuilding and restoration of its infrastructure. Commerce between the region and the rest of the country that has already begun to some extent is one that would be of benefit for the country as a whole.
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The peace dividend is however not restricted to the mere revival of economic activity in these areas. It is the larger and more important impact on the economy through the investment confidence that would matter. It is generally accepted that a rapid take off of the economy requires considerable foreign investment as the country’s own savings are limited. Apart from this savings-investment gap, foreign investments would bring in state-of-the-art technology and international marketing channels and skills. Thus far foreign investment has been nothing more than a trickle.
The security situation was the foremost reason for the limited foreign investment though other factors also inhibited a free flow of foreign investment. In actual fact we have already lost much foreign investment to other countries owing to the security situation. This is particularly so with respect to large manufacturing plants. Japanese investors have in particular been wary of investing in Sri Lanka owing to this. The consequence of this has been that foreign investors have turned to other countries like India, Malaysia, Vietnam and even Bangladesh.
With the advent of peace there would be a need to entice a larger amount of foreign investments, particularly those industries that would have advantageous backward and forward linkages and the local value added component is significant. It would however be foolish to think that peace alone would be a sufficient condition for foreign investment to flow in. While peace is a necessary condition it is not a sufficient condition for foreign investment inflows. A number of other conditions require to be fulfilled. These include the improvement of economic infrastructure such as roads, electricity, ports and economic services. There is also a need to revise labour legislation that is a sore point in the country’s investment climate. A less recognised and yet important factor is the level of bribery and corruption. It is well known that foreign investors are diffident of dealing with countries with a high level of bribery and corruption. Unfortunately the country has a poor reputation in this.
A special effort is definitely required to eradicate corruption especially in institutions that are relevant to foreign investors for obtaining permission.
Considerable confidence and optimism have been generated by the dramatic improvement in the foreign reserves of the country. Foremost among the reasons for this improvement has been the obtaining of the IMF stand-by facility and the first injection of US$ 326 million. This was the starting point that led to the accumulation of foreign funds. At the time of writing foreign exchange reserves had reached US$ 4 billion. This is indeed a sharp reversal in the reserve position that was witnessed only a few months ago. By March this year reserves had dropped to US$ 1.2 billion a level that would have been adequate to finance only a little more than a month’s imports. In reality the foreign reserve situation was much worse with impending loan repayments. The country had reached a low level in its reserves that were described by economists as net negative reserves. In has now increased more than threefold to US $ 4 billion a more than adequate amount of reserves.
The latest infusion of US$ 250 million from the IMF has been the most recent boost to the reserves. This amount is not a part of the approved IMF stand-by facility of US $ 2.6 billion. It is in addition to it. It is a new IMF facility to boost member countries’ reserves through a one-time allocation of special drawing rights. (SDRs are the IMF's internal accounting unit, based on a basket of currencies that are convertible to hard money). Sri Lanka's share of the US$ 475 billion allocated for this purpose was US$ 250 million. This was separate from the US$ 2.6 billion IMF loan approved in July. The replenishment of the foreign reserves has enhanced investor confidence and the Central Bank expects a steady increase in foreign exchange inflows to strengthen the reserves further. In fact, a US. fund last week bought up $875 million in government securities.
The biggest obstacle to economic development has been eliminated. Yet to think that this alone would bring about rapid economic growth would be a flight of fantasy. The precondition of peace must be augmented by a number of conditions to ensure its full economic and social benefits. A speedy reconstruction of the war torn areas and resettlement of people is vital. The development of infrastructure in these areas and improvement of economic infrastructure are important for economic investments. There is a need to improve the incentives and legislation to be competitive with other investment hungry countries so as to attract foreign investors.
The elimination of corruption is vital. Above all the country requires to get its economic fundamentals straightened out and among them fiscal consolidation is foremost. With it must be a realistic foreign exchange rate policy that does not erode the country’s competitiveness of its exports in international markets. There has to be a realisation that in as much as the high foreign exchange reserves are an important confidence booster that most of these have not been earned. A substantial portion of the foreign reserves are borrowings that have to be returned.
The reserves must be used to strengthen the economy and increase foreign exchange reserves. Whether the country would achieve rapid growth in its economy would depend on meeting these preconditions. Peaceful conditions would generate a growth momentum that must be accelerated through other policy measures. |
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