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Sunday, 27 February 2011





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Sri Lanka's macroeconomy sound

The Macroeconomic situation in Sri Lanka is basically sound said the President of the Sri Lanka Economics Association (SLEA) Professor A D V de S. Indraratna in an exclusive interview with the Sunday Observer. However, he warned that it would be better if some key fundamentals, particularly in the external sector function better. Excerpts of the interview:

A D V de S. Indraratna

The Year 2009 was not a good year for Sri Lanka due to many reasons; internally, in the first half of the year, the country was facing the most intensified final stage of the terrorist war and externally, it was the year that the second round of the global recession impacted heavily on the real sector of the Sri Lankan economy.

Macro economic indicators were not sound with the country experiencing a huge budget deficit of 9.9 percent of the GDP, high inflation and high interest rates, an alarmingly low level of external reserves and falling FDI and a large external debt with a heavy debt servicing burden.

Fortunately, the situation changed for the better in 2010 and inflation started coming down until about the latter part of the year, remaining at a single digit right throughout. However, until the end of the year we have not seen a substantial increase in the credit to the private sector and private investment has not increased as expected.

External sector

Even though in 2010 the average growth rate has risen to a respectable level of 8 percent and is expected to grow even further to 8.5 percent in the current year (the IMF estimates are 1 percentage point less than these respectively), the external sector has not fared well. Our trade deficit have been widening as imports have been increasing faster than our exports.

Even though the adverse impact on the current account deficit has been cushioned somewhat by the increasing worker remittances, we cannot reckon this as a fundamentally strong position. Our foreign reserves have been rising (now adequate for nearly seven month's of imports at current level) but they are relatively more of a short-term nature rather than arising from FDI (Our FDI in 2010 was expected to be around 2009 level but it was below 2008 level).

The appreciation of the rupee due to this inflow of short-term capital has been contained somewhat by the intervention of the Central Bank. The trade weighted exchange rate should be lower helping our exports.

Another unhealthy feature in the external sector is the rising external debt burden even though not at an alarming rate. In order to alleviate this situation several measures would be needed. Our exports have to be increased by diversification as well as by increased value addition in both agriculture and manufacturing.

Increased productivity is crucial in the context of an appreciating rupee, both in export agriculture and manufacturing. The import bill in food has to be curtailed by a vigorous drive in domestic agriculture including fisheries, livestock, dairy and poultry farming and ensuring food security. As I said before, both in export agriculture and manufacturing, value addition, branding and seeking new and niche markets should play a big role. A surplus in the current account of the balance of payments would be vital to reduce the budget deficit as well. An enabling environment has to be created to attract more and more FDI.

These measures also would help to reduce the debt burden. Our external debt has been rising from around 85 percent of GDP to more than 86 percent. Our debt servicing expenditure is higher than the current revenue.

Even though the economy overall may not be worrying with single digit inflation (around 6 percent), estimated unemployment slightly above 5 percent and market interest rates of 7 percent- 8percent and an estimated poverty level of around 7 percent, there cannot be any complacency as long as the external fundamentals are not sound.

In my view, by the end of the mid term (by 2016) or so, we would have to have the budget deficit, unemployment and inflation, all brought down to a tolerable level of 3 percent with poverty below 5 percent with a sustained growth rate of more than 10 percent with inclusive development (which I have explained elsewhere and I have no time to elaborate now). These are not 'magic' numbers just quoted offhand but what would be realistic with the achievement of targets of Mahinda Chintana Future Vision.

I generally agree with the economic policy framework of the government Mahinda Chintana: Vision for the Future. One important feature I particularly agree with the policy on agriculture, the pride of place given to it in the Chintana. I am one who has been strongly recommending such policy since the late sixties, because I strongly believe in the critical need of food security as a weapon for a country like ours in the sustainability of its development. It provides a cushion against vulnerability in escalating food prices in the international market.

It contains domestic inflation; it helps to have inclusive development and reduce poverty and so on. I have already referred to increase productivity and value addition in this sector. And there is great potential for rapid development in this sector including fisheries, livestock and dairy farming.

Infrastructure and FDI

Heavy investment in infrastructure is necessary for increasing the rate of growth as envisaged by us. This is crucial for Sri Lanka to be an upper middle income country, like some of her Asian neighbours, Malaysia and Singapore. Initiatives already taken by the government in this direction are welcome. For it is the government which should be the provider of the basic infrastructure as one cannot expect the private sector to provide public goods and heavy, lumpy investment whose private costs are high relatively to private returns.. These are also essential to improve the productivity of the economy. We see the government investing, as it should be, in power, harbours, airports, roads and bridges.

The Government is also paying a great deal of attention to ICT. These are necessary to make the knowledge economy grow and the economy becoming competitive in the highly integrated world.

It may be because of the inadequacy still of the infrastructure and the lack of an enabling environment that we are not fully realising the dividend of peace.

I have already mentioned about the sluggish inflow of FDI which is vital for achieving a sustained growth rate as high as 10 percent or more. There is a big gap between our present rate of domestic investment (of 24-28 percent of GDP) and the domestic savings of (15 percent-18 percent)-I am quoting these figures from memory.

This gap has been largely met by domestic and foreign borrowing and we cannot go on doing this without falling into a debt trap. Already we are near it, as I mentioned before. The only solution for this is to increase the FDI inflow to the country. If a country like Vietnam can do it why can't we?

The Government is fully aware of this problem and according to my information, has been taking measures to create an enabling environment, alongside building the infrastructure I have already mentioned about the active role being played by the Government in regard to the former. As regards the latter, the Government has still to do a lot. It is not a difficult task to have good governance. After all, what is good governance? It is simply the management of the limited resources without waste and corruption, but with transparency and accountability. There also should be 'flexible' labour laws which are not heavily weighted in favour of one side, ensuring industrial peace and work ethics and norms, the law and order in the country.

There should be simple rules, regulations and procedures for investors to comply with, and efficient and honest government institutions which the investors have to go through. These may be the secrets of countries such as China and Vietnam and India in their success in attracting FDI. The decision to re-structure BOI is a good move by our Government in this direction. Similar moves in other areas, which I have mentioned, are necessary.

The Future

The country has a vision for economic development as spelt out in Mahinda Chintana Vision for the Future. It should be inclusive development, the benefits of which shall be shared by all equitably. A large segment of the people of our country has so far not got their due share of the development that has taken place.

As far as I can gather from media reports, the trade chambers have accepted the strategy spelt out in the Mahinda Chintana This augurs well for the future. My question is: Is the private sector doing enough? To attain the sustained high growth, the private sector must be the engine of growth. It should come forward to make four to five times the investment the Government is undertaking, as a provider of facilities. If the Government is failing, it must tell the Government where and why it is failing, and wherever possible and feasible, it must engage in public private sector partnership.

To increase the economic growth rate to 10 percent or more, as envisaged, our investment has to be increased to around 40 percent of GDP unless we increase our productivity substantially by being able to improve the capital- output ratio, say from around 4:1 today to 3:1. Even if it were brought down to 3:1 we still need 30 percent GDP for investment to achieve 10 percent growth.

The Government may not be able to invest more than 6 percent to 7 percent if it has to contain the budget deficit and the debt burden. The difference has to come from the private sector. Here, the critical role of the private sector and FDI must be highlighted in sustained growth and development.

Global economy

Sri Lanka also cannot overlook or disregard the prevailing global economic situation. The world of nations is highly integrated and no one country can stand in isolation in achieving its goal or vision. We have experienced this as recently as 2009 and early 2010. We learnt some bitter lessons during and after the global financial and economic crisis.

Since we had a sufficient domestic food supply we did not feel the bitterness of the global food crisis as much as many others. But we were seriously hit by the oil crisis. Of the total import bill during the oil crisis, a staggering portion went into oil. Recession in USA and EU affected our exports badly. Although there is recovery in these economies now, it is slow and still not sufficient to give a significant boost to countries like ours.

Moreover, we have been also affected by the denial of the preferential access to their markets we had enjoyed until recently. Therefore, we in Sri Lanka have to plan our development so as to cushion the economy as much as possible from the impact of any adverse global trends. That is why we have been advocating food security as a strategic weapon in our development armour.

We also can look for alternative markets. In contrast to what has been happening in the West, Asia has been growing fast, opening new opportunities. China has become the world's second largest economy growing faster than any other country except Singapore.

India too is growing very fast though not at double digit. East Asian economies too are maintaining respectable growth rates. It is opportune for us to shift our focus from the West to the East and look for new and niche markets in Asia, without of course, turning away from USA and EU.

Today most of Sri Lanka's foreign investments come from Asia- China, India and Japan. To remain competitive in these markets she has to improve productivity all round, maintaining at the same time a realistic exchange rate, and go in for more value added and branded products and optimise the opportunities opened by bilateral trade agreements.



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