Direct foreign investment will raise investment ratio - Economist

Sri Lanka's economy is growing and the government expects the per capita income to double by 2016. The consumption pattern and demand for goods and services are changing. People are ready to pay extra for quality goods and services. Private higher educational institutions the luxury metro bus service, the increasing taxi service and import of cars and other vehicles indicate this change in the consumption pattern.

In an exclusive interview with the Sunday Observer, Economist and Senior Lecturer of the University of Colombo, Dr. Sirimal Abeyrathne explained the transformation in the Sri Lankan economy and its challenges.

Q: Sri Lanka is now considered a middle-income country and according to government estimates, the per capita income is increasing and is expected to double by 2016. What is the identity of a middle-income country in comparison to a lower-income country?

A: The World Bank classifies its member countries according to their per capita income levels, while these income levels are revised frequently. According to the present criteria, countries with per capita incomes of $ 1006 - 3975 are considered lower-middle income countries and those with per capita incomes of $ 3976 - 12275 as upper-middle income countries. Given this classification, Sri Lanka with its per capita income, amounting to $ 2240 in 2010 is a lower-middle income country. Japan and Singapore in the Asian region have the highest per capita income of over $ 40,000.

Q: Does this represent the true picture of the economy or how should we look at our poverty statistics?

A: Many say that this does not reflect the distribution of income.

True enough, by observing an apple you can't say "it does not look like an orange".

The per capita income indicator is not meant to show the distribution of income. We need to use a different indicator. But this is the widely used simple indicator which shows the economic status and economic progress of a country.

It can also be used for comparison, but we should understand that it is a 'moving indicator'. Whether a country is progressing depends on how fast that country is increasing its per capita income level, because all countries improve their per capita income levels annually.

Q: How does the demand for goods and services change when an economy transforms from a low-income country to a middle-income country?

A: If the per capita income is growing, that country is improving its ability to reduce poverty and to increase people's incomes. As a number, the per capita income does not mean a thing to a poor or an average citizen, unless it is translated into his or her household income. Therefore, the poor as well as other income earners should have improved incomes.

When the per capita income has doubled in five years, it is fair for people to expect a substantial increase in their salaries.

According to official statistics, the share of the poor as a percentage of population has also declined from 22.7 percent in 2002 to 15.2 percent in 2006/07 and 8.9 percent in 2009/10.

But we should consider socio-economic statistics with caution, as they do not indicate the whole truth and can be interpreted differently.

I would say that, the decline in Sri Lanka's poverty ratio is a result of both policies and numbers.

We all know that, under the present government there has been policy emphasis on the rural sector and on poverty.

As the poverty line is based on consumer prices, recent changes in the consumer price indices, administrated prices and exchange rate policies have influenced poverty ratios to drop.

Even the per capita income is only a digit - it can show the real growth of the economy or the growth of just a digit without any real change. In that instance it would be difficult to see a reduction in actual poverty or an increase in salaries and other incomes.

For instance, the per capita income is a nominal value on the one hand and, its conversion to USD is based on the current exchange rate on the other.

The nominal value gets inflated in response to the movement of the inflation rate. Exchange rate movements, unless it is controlled, respond to inflation as well as trade deficits and balance of payments performance.

Q: Do you think that the private sector and state agencies have recognised these structural changes and the changing demand pattern?

A: When a country enters into a lower-middle income stage due to expansion in economic activities, it could be considered as the take-off stage of the economy.

The country begins to record exponential growth, as each year the real output multiplies at an increasing rate. In fact, the increase in per capita income grows, as the middle-income countries are alive in terms of economic activity.

The private consumer demand is rising and private investment is also on the increase.

Q: How should we cater to this changing demand in goods and services?

A: At the take-off stage of per capita income, according to experience in different countries, private consumer demand is due to the rise in specific goods and services: food and beverages, clothing and jewellery, beauty care, travel and tourism are some of the sectors that are in high demand. That is why we see an expansion in economic activity at the initial stages of achieving a middle-income status.

Q: Do you think that government policies are in the right direction to cater to this demand?

A: The policy document of the government states the vision of the government: achieving medium-term economic prosperity.

The government has also conceptualised that this achievement would be based on entrepreneurship development to reach international markets and the transformation of the economy into a global dynamic hub catering to world demand.

Both aspects recognise the importance of an open economy as having greater connectivity and global competitiveness being the essential elements of this strategy.

As a small country, Sri Lanka does not have any other option. This requires a policy and a regulatory reform process.

The policy document also states that Sri Lanka has to maintain on average eight percent economic growth, not just for a few years, but for many years. As high-performing countries have confirmed, this requires an increase in investment from the current level of 28 percent of GDP to around 35-40 percent of GDP and should be sustained in the long-term.

The government has a limited capacity to contribute more than what it is doing today to raise the investment ratio.

In fact, further increase in government expenditure is neither feasible nor desirable.

The private sector, is still too small to take a massive leap forward in raising their current investments around 20-22 percent of the GDP to 30-32 percent of the GDP.

All this means that, at the initial stage, direct foreign investment has a major role to play in raising Sri Lanka's investment ratio, as it has done in many other countries.

An increase in the investment ratio depends on the establishment of a better investment climate, even in this case, policy and regulatory reform process matters.

GW