Emerging economies need tight policies

If we look at the Sri Lankan economy in the context of the global economy, I have a few observations on where Sri Lanka is right now. After the crisis, global recovery continues. However, growth rates differ across countries.

Developed countries are growing at an average of 2.5 percent while emerging countries are growing at an average of 6.5 percent. Asia is leading the global economic recovery and the growth in China and India is remarkable.

Dr. Koshy Mathai

In the USA the unemployment rate is still high. The housing market has not recovered fully and banks are not willing to extend credit.

Advanced economies are recovering slowly. Due to this multi-speed recovery policies recommended for each economy differ.

Tight policies are recommended for emerging and developing countries while extending or not pulling back stimulus packages are also recommended.

Emerging economies need tight policies because with high growth rate there will be overheating and inflation. For instance India is increasing policy rates and planning how to deal with fiscal problems.

Today, capital flows from developed countries to emerging and developing countries as a result of interest rate differences and growing growth prospects in these economies. This is an advantage for emerging and developing countries because they are in need of capital from outside.

However, capital flow should not come in like tsunami.

There are lots of problems the country has to deal with.

Re-balancing global demand

Re-balancing global demand altering the present trend is the key. Over long years China has been the net exporter and America has been the net buyer.

This cannot continue. The savings ratio in the US is increasing while the consumption ratio in US and EU is declining.

Therefore, China and other Asian countries have to find new paths. What needs to be done is to increase demand in Asian countries, especially in China. Domestic demand in Asia needs to be boosted as domestic demand in US and EU are declining.

Re-balancing demand does not apply in the same way to all countries.

In Sri Lanka, the domestic demand is healthy. During the past few years the key problem in Sri Lanka was the external pressure on the exchange rate.

The external sector was weak due to high oil prices, drop in remittance due to the global crisis, low capital inflow as a result of weak investor appetite and government's heavy borrowing from abroad.

There was a risk and IMF supplied dollars and the Central Bank was successful in stabilising the rupee. The oil price dropped, remittance increased and investor appetite recovered.

In Sri Lanka there is something special, and investor interest boosted after the end of the conflict. Everything is changing and today the external situation is strong and stable.

Today what we worry about is the exchange rate regime flexibility.

Today the external sector is stable. On the monetory front inflation has increased again to 7.8. In Sri Lanka the inflation was at double digits always and it has reduced to a single digit.

This recent increase is due to the supply shock and it has now started to come down.

Since the increase is due to supply shocks, the Central Bank can do nothing to control it.

What the Central Bank can do is raise interest rates to slow down economic activities which cannot be recommended. However, the risk of this situation is that it will create inflation expectations, the second round effect, and therefore it should be watched very carefully. Inflation expectations will create a demand for a wage hike which will make everything go out of control.

Real economy

Economic growth as well as sectoral growth is strong in Sri Lanka. Credit is increasing and it will be inflationary. However, Credit/GDP ratio is not a major concern now as it is declining.

Fiscal position in Sri Lanka has been weak over a long period of time and Debt/GDP is over 100 percent and this poses a risk to the economy.

Today the budget deficit is maintained at below 10 percent. Steps have been taken to reform taxes, reform the BOI and reform loss-making State institutions.

These measures are important to improve the fiscal position. Sri Lanka is a unique country and maintained a 5-6 percent growth rate even during the conflict. Keep the fiscal deficit under control, re-balance demand, especially boost domestic demand is that Sri Lanka's exports have declined from 0.08 percent of the global trade to 0.06 percent. Sri Lanka should find markets somewhere to send this 0.02 percent exports it lost.

Over 60 percent of Sri Lanka's exports go to US and EU. Only 4 percent of Sri Lankan exports go to India.

China and India are growing at 10 percent and there is a huge export market within the region.

Focusing on eastern markets is very important and the Mahinda Chinthana vision on this is sound.

The comprehensive Economic Partnership Agreement between India and Sri Lanka is sound.

If India grows at 8-10 percent you should take advantage of it. Regional integration is one important part of the policy.

Intra regional trade in South Asia is low at 5 percent and in East Asia region it is 25-30 percent. Exporting value added and branded products are also important instead of raw, bulk products.

While Sri Lanka has a reputed Ceylon Tea brand, exporting bulk tea is a crime.

Boosting FDI Development of infrastructure and improving the doing business indicators are key to attract FDI.

It is not easy to start a business in Colombo as there are so many procedures and licences to be obtained.

Infrastructure development has been slow and it is a shame to hear that the rail track has not extended an inch from where the British stopped.

Lack of technical skills is another issue in attracting FDI. Not only the high level engineering skills, low and middle level technical skills are also in short supply.

The corporate debt market in Sri Lanka has not grown. It is less than 2 percent of the GDP. This is also the same in many other Asian countries.

However, in Malaysia the corporate debt market is well developed and Sri Lanka can learn from her.

The above are excerpts from the speech by the Country Representative of the IMF Dr.Koshy Mathai at the Key Person's Forum organised by Federation of Chambers of Commerce and Industries Sri Lanka (FCCISL) in Colombo recently.