Fiscal expansion vs. trade expansion
View(s):In total, there were 296 companies listed on the CSE in the same year. This means that, interestingly, most of the public limited companies in Sri Lanka are “domestic market-oriented” catering to the local customers. My figure quoted above refers only to the manufacturing companies which focus primarily on export markets.
Gems and jewellery are valuable export items for Sri Lanka.
Big questions
The finding looks strange to me and raises some important questions as well. First and foremost, why are most of the listed manufacturing firms catering to the domestic market, instead of export markets? Are these exporting companies “too small” to become public limited companies? If not, are they not interested in raising capital in the stock market for their expansion?
There are valid economic reasons for a company located in a small country like Sri Lanka to focus on export markets. Unlike India or China, the local market of Sri Lanka with 22 million people is, anyway, too small to allow companies to grow and reap benefits of the economies of scale. Even for countries such as India and China, the local market is too small.
Export market is the key to industry expansion beyond the local boundaries, to exploit the benefit of economies of scale and scope, and to become more innovative and competitive constantly. Well, for someone all these advantages can become disadvantages too. It depends on how you treat them either as opportunities or challenges, because you can also take all of them as challenges instead of opportunities.
If you examine some other stock markets in the region such as those in Singapore, Malaysia, Thailand and Vietnam, the picture is quite different from what you observe in Sri Lanka. There are a significant number of exporting firms that are listed on their respective stock markets.
Advantages
In general, the advantages of becoming a listed company are not limited to the ability to raise capital by selling shares to the public. It improves the company’s prestige and brand name which is important for expanding the customer base as well as attracting strategic partners.
Accordingly, listed companies enjoy market trust and credibility among customers and investors. This could be constantly monitored by the management, by keeping an eye on share price movements in the stock market. As listed companies must comply with regulatory and reporting requirements as well as modern corporate governance practices, inevitably they must keep improving their corporate governance.
In spite of many of the proven benefits of listing on the stock exchange, I cannot say that Sri Lankan companies are not interested in becoming listed companies; in fact, there are nearly 300 companies listed on the stock exchange!
My observation is about “exporting firms” and there are only a handful of exporting firms listed on the Colombo Stock Exchange. It looks like more about the policy environment than the interest of businesses, while the incentive
structure defined by the policy environment creates the type of business outlook and performance.
Trade expansion
Growth performance across the Asian region illustrates two distinctive episodes as one based on ‘trade expansion’ and the other on ‘fiscal expansion’. Under the first episode, we can list out a group of countries which have focused aggressively on export growth. In these countries, increased export growth has become the main growth driver so that their growth and economic performance were sustainable.
Let me explain: When a country focuses on trade expansion, it must promote exports and for that matter they must allow imports too. There is no export growth without import growth, although some may think otherwise. Accordingly, these countries keep improving their exports and foreign exchange inflows.
Export growth originates basically from private investment, not public investment. Therefore, the source of income growth, job creation and poverty alleviation take place through the promotion of private investment. Business environment should be conducive to private investment, while it should be established and improved through policy and regulatory reforms.
Growth that is based on export expansion is sustainable. It has enabled these countries to achieve both better trade performance and sound budgetary operations through higher tax revenue. This has been the story of successful export-oriented economies in East and Southeast Asian countries.
Fiscal expansion
In contrast, the other story is about a group of countries which promoted fiscal expansion or, in other words, government spending, perhaps aggressively. It also generates growth as long as government spending continues. But the problem is that the government cannot continue with unlimited spending without creating a budget deficit and public debt. Budget deficit and public debt cannot grow limitlessly.
When the government keeps spending beyond limits, it can also become an obstacle to private investment rather than a facilitation – that is due to “crowding out” of private spending. Accordingly, too much spending by the government imposes limits on private sector-led growth. Therefore, income growth, job creation and poverty alleviation all depend on “government expansion” rather than private sector expansion.
Growth that depends on fiscal expansion becomes unsustainable. It requires repeated increase in government spending which usually comes from credit financing and not tax financing. Tax collection without private investment expansion is anyway limited, while most of government projects are exempted from taxes.
As private investment is constrained by fiscal expansion, there is little impact on export growth. Therefore, continuous increase in government spending caused not only a widening budget deficit but also a widening trade deficit due to foreign exchange shortage.
Classic example
Sri Lanka, among the Asian countries, provides a classic example of the second type – a country with growth performance based on fiscal expansion, which is anyway, temporary. The signs of increased public sector expansion over private investment were already visible over a long period of time, but its overwhelming episode became prominent during the past two decades.
If we examine the sources of growth carefully, we may understand that economic activities such as construction, power and energy, telecommunication, banking and finance, transport, and public administration have become the main growth drivers. The role of government in these sectors is overwhelming.
As trade expansion through private investment is limited, it is the fiscal expansion with credit financing that could keep the country’s aggregate demand, job creation and poverty reduction all in the hands of the government. Accordingly, growth was sustained temporarily, until the economy collapsed with an unsustainable debt burden.
Challenge, unavoidable
There are only a few more days to go for the Presidential election, which is likely to be followed by Parliamentary elections soon. Sri Lanka is under an IMF programme, that will be effective for three more years under the new administration too. By that time, Sri Lankans must be ready to start repaying their external debt comfortably.
Under these circumstances “unlocking the country’s growth potential” by shifting towards sustainable growth momentum through “trade expansion” must be effective. There is no more fiscal space available for old-fashioned public sector expansion.
The new growth strategy must be one that creates an incentive structure for private investment promotion, aimed at export markets. After all, Sri Lanka must generate foreign exchange inflows to meet external debt obligations without which “rupee incomes cannot be converted to dollar payments”.
When the incentive structure favours exporting firms over those catering merely to the domestic markets, there will be many export firms growing and listing on the stock exchange too. Unlocking the country’s export-oriented growth potential is a major challenge that cannot be overlooked by the new administration.
(The writer is Emeritus Professor of Economics at the University of Colombo and can be reached at sirimal@econ.cmb.ac.lk and follow on Twitter @SirimalAshoka).
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