Plotting a Web of Structural Reforms

Four economists discussing structural reforms highlighted the government’s failure - nearly two years after taking office – to present a detailed long-term plan for the economy. They said the 2017 budget offers an opportunity to correct the last two years’ blunders, consolidate the budget deficit and set the tone for economic reforms

Sri Lankans expect an economic transformation, and they want it fast. more than any other country, Singapore is held up as a benchmark by many Sri Lankans. Getting there won’t be easy, as it requires a business-like approach to governance, openness and difficult structural reforms. While there are pitfalls in blindly following Singapore’s example, Sri Lanka can certainly draw many examples of small, easy steps that can lead to big wins, four economists say, ahead of the 2017 budget. Among the many obstacles in the way of realising Sri Lanka’ economic aspirations, the most imposing, the four argue, are low investor confidence, weak governance and a meek entrepreneurial spirit among established businesses.

Sirimal Abeyratne, Professor of Economics at the University of Colombo; Dushni Weerakoon, Deputy Director of the Institute of Policy Studies, a think tank; Deshal De Mel, Senior Economist and Head of Business Development at listed firm Hayleys; and Anushka Wijesinha, Chief Economist at the Ceylon Chamber of Commerce are optimistic that Sri Lanka is slowly moving in the right direction. Investors are still interested in Sri Lanka, voters are becoming more discerning and demanding, and new businesses are emerging with the right attitude to succeed in a global economy. Excerpts of the interview are as follows:

What are your expectations for the 2017 budget?

Sirimal Abeyratne: I don’t expect miracles. The 2017 budget will reflect economic realities, unlike the last one. The government tried moving in a completely different direction with the previous budget, ignoring the economic realities we live in. This resulted in several changes to its revenue and expenditure proposals, and as a consequence, we are navigating troubled waters, the likes of which we’ve never seen before. The 2017 budget should be a hard one, and it should reflect some long-term policy. It’s unlikely to be a populist budget, or at least it shouldn’t be.

I would expect the 2017 budget to clarify some of the half-implemented tax reforms and confusing revenue proposals of the previous budget. We could expect to see new taxes because VAT and other limited adjustments to tax rates are not going to take us very far in terms meeting revenue targets.
– Dushni Weerakoon

Dushni Weerakoon: My expectations are factored on one important missing, or elusive, element: A comprehensive long-term economic policy document. Hopefully, we will get this soon – before, during or immediately after the 2017 budget is presented. So far, we’ve heard the government’s long-term policy direction in broad terms in the form of a statement by the prime minister, but we haven’t yet seen a detailed policy document. If that policy document, which I believe is in the making, is part of the 2017 budget-making process, then my expectations are high that the budget would be much more comprehensive, starting with fiscal consolidation focusing on the revenue side and how expenditure will be allocated to important areas like education, healthcare and social protection. The budget will also not just focus on volumes of spending, but on improving targeting and efficiency.

However, if the 2017 budget is presented without a long-term policy document like last year, then I would moderate my expectations for a no-frills budget that covers the basics, addressing fiscal consolidation focusing essentially on the revenue side. I would expect the 2017 budget to also clarify some of the half-implemented tax reforms and confusing revenue proposals of the previous budget.  We could expect to see new taxes because VAT and other limited adjustments to tax rates are not going to take us very far in terms meeting revenue targets.

Deshal De Mel: We have an excellent opportunity to set up a three-year economic policy framework coinciding with the IMF’s Extended Fund Facility programme for the same duration. This should be the priority because a three-year framework for fiscal consolidation will give much-needed clarity and confidence to markets and all Sri Lankan economic actors.

Deshal De Mel Senior Economist and Head of Business Development – Hayleys

It will be a bonus if we can shift away from some of the negative factors we saw in the previous budget like price controls, domestic protection and heavy indirect taxation. Price controls distort markets in areas like energy and fuel. There is an opportunity now to move into market-based pricing mechanisms, particularly when global prices are still favourable. But these prices are not likely to last at these levels forever. We have a short, narrow window to change our pricing policy. We also saw price controls imposed on tea and other commodities in the previous budget; these should be removed.

We should also move away from domestic protection and go towards export orientation of the economy. This is what the government has said all along, but not what has been taking place. We need clarity on the balance between direct taxes and indirect taxes. Last year, the prime minister’s economic policy statement indicated a 60:40 balance between direct and indirect taxes, but what we saw instead in the previous budget was a strong focus on the indirect side and less on the direct side. If we can address all these issues with the 2017 budget, it will give the right direction going forward.

Anushka Wijesinha: I expect the government to reset its fiscal policy with the 2017 budget because this year is a write-off in terms of policy consistency. There are proposals made in the previous budget that are not implemented today, like the 17.5% tax rate, the capital gains tax and several changes to VAT. On a basic level, the 2017 budget must flatten all confusions of the 2016 budget. On top of that, a bonus would be if, for instance, a tax policy is announced for a three-year period or an extended period beyond one year.

Right now, given the many changes to the previous budget, investors are looking for an increased level of comfort. We risk sending bad signals if we fail to deliver fiscal consolidation by focusing more on collecting direct taxes, implementing measures to widen the tax base, rationalising tax incentive structures and plugging loopholes. The adoption of the Revenue Administration Management Information System (RAMIS) will help in all this. Investors got a degree of comfort because of the IMF programme, so if we fail to deliver on fiscal consolidation, we risk sending them the wrong signals that we are deviating from the IMF programme because we cannot see the fiscal reforms through. However, I am optimistic this won’t happen.

I also expect the government to be realistic. I would not want big bang reforms, particularly more tightening of taxes or expenditure, because in early 2017, we have the referendum on the new constitution and local government elections, so we don’t want these to be referendums on the government’s economic policy. If the people see too much tightening, too much austerity or too much liberalisation, the government will set itself up for a political fallout. At the very basic level, we should reset the tax policy and get some indication of fiscal consolidation, clarity and consistency on many of these areas, and leave other reforms outside the budget.

Three groups of people are desperate to have the budget linked with a long-term economic policy framework: citizens, businesses and the public sector. They all want to know. We shouldn’t have another year where the budget deviates from a plan. Public officials don’t have a reference document to work with. Taking decisions, approving private sector projects or even taking initiatives within their ministries is difficult without an anchor document. Another bonus for me would be the tightening of public investments with public funds and a move towards more public-private partnerships. I do see movement towards this right now, so it will be great to see it strengthened. If the government can plug loopholes on the spending side, which are not controversial and ones the people support, it will make a big difference.

We need one main target and everything else should be geared towards achieving this one main target. Investor confidence, for me, is that target. Policymakers should try to identify the underlying factors as to why investors are reluctant to come here. Slow growth, structural reforms, export orientation and everything else is secondary.
– Sirimal Abeyratne

People expect an economic transformation, and fast. For years, many have been talking about Sri Lanka aiming to be another Singapore, but what can we do to take us there?

Abeyratne: We need one main target; everything else should be geared towards achieving this one main target. Investor confidence, for me, is that target. Policymakers should try to identify the underlying factors that make investors reluctant to come here. Slow growth, structural reforms, export orientation and everything else are secondary.

Investors are reluctant to come here because they don’t see policy direction. Having read the economic policy history of this country, we know the economy is market oriented, but investors need much more than that to feel comfortable. We have consistently failed to articulate the economic policy direction of this country. Even after two years, the current government has made little progress in this regard. Inconsistency and unpredictability in economic policy is a big problem for investors. If you look at the whole of last year and this year, many things have been done in an ad hoc manner. Revenue and expenditure proposals have changed several times over petty issues, and these have had big impacts on businesses. Policy direction has to be clear, and at the same time, policy consistency and predictability have to be clear. Those are the things that are necessary, after which comes the reform process.

We’ve not had major reforms since the early 1990s. One crucial area is trade reforms. If we have an open economic policy and start liberalising trade, it will help us integrate with the world, and then getting into bilateral trade agreements will become easier. We shouldn’t start with bilateral agreements. Fiscal consolidation and external financing of the deficit, which has gone out of control, need to be rationalised. The other crucial area is reforming state-owned enterprises. These reforms are not easy for a populist government, but they are crucial steps we need to take.

Weerakoon: Singapore is always held up as an example for Sri Lanka, and there is always this assumption that we can replicate Singapore here. Indeed, Singapore is an exceptional performer and holds examples not just for developing countries like Sri Lanka but even for developed countries in terms of how it manages its reforms, bureaucracy and political economy. But when we look at Singapore and its structural transformation, I am very hesitant to draw lessons for Sri Lanka on how we can replicate Singapore’s journey to a very industrialised, services-oriented, open economy. One needs to understand Singapore’s history to understand why I say this.

dushni-weerakoon

Dushni Weerakoon Deputy Director – Institute of Policy Studies

From the early 1960s to the 1980s, industrialisation was driven by multinationals, before the services sector opened up. At the time industrialisation took off, with lower tariffs and opening up to foreign investment, Singapore, a city state, had no agriculture sector to speak of and a population of around three million. So when we try to draw lessons for Sri Lanka, which has a large agrarian rural economy, I just don’t get the logic of how we can replicate Singapore in terms of opening up the economy. That’s the first point.

The second is that our politics are so different. Singapore has had a single party ruling since 1965. They are not prone to the same kind of competitive populism in countries with two-party systems that change every five or six years like Sri Lanka or India. So Singapore does not have a welfare state like we do. Unlike us, Singapore always manages to ensure that their fiscal positions are strong while they open up. So the lessons from Singapore on broader structural transformation on the macro level are non-starters. But Sri Lanka can draw lessons from Singapore’s bureaucracy, which is a tight, lean and highly competent technocracy. They pay their bureaucrats top salaries so they attract the best people. Then look at how Singapore managed the limited amount of welfare they have distributed through their pension system, similar to our EPF. They linked the pension system with housing, where workers contributed to several funds in housing, healthcare and investment. The system has provided housing for 90% of Singaporeans.

Their welfare system is not financed through budgets, so Singapore avoids the kind of difficulties we are talking about in Sri Lanka. Another example we can draw from Singapore is its education system. They were always ahead of the curve, putting money into the right areas of study and encouraging students to get into sciences and engineering. We talk of Singapore being an open economy, but their biggest businesses in banking, logistics or even leisure are all state-linked though the Temasek model, which we are closely studying now. Even their flagship brand Singapore Airlines is state-linked. Singapore is not a free-market, hands-off development model, its government plays a critical role.  So when we talk about institutional reforms, there is a lot we can learn from Singapore.

De Mel: Let me touch on four things that are doable, which can have significant outcomes. First, we have a large public sector of over 1.3 million people, and cutting back is politically difficult. But what we can do is bring a lot more accountability to service delivery and performance. We can look at things like citizen report cards for service-oriented sectors, where people are able to give feedback on performance, which can be linked to key performance indicators (KPIs) and in turn linked to remuneration or reward schemes. These things can be done, but we need to create the right kind of incentive structures to do this. Even if we are stuck with the same number of people in the public service, we will still see improvements in performance and efficiencies in functions.

The second concerns a huge problem for all companies in Sri Lanka across sectors: Access to skilled labour in terms of volume and skills. The initial reaction to this problem is starting to think of bringing in labour from outside the country, and I agree that we must look at this option fairly soon and it’s already happening. But before looking outside, we need to look at the volume of labour locked up in unproductive sectors of the economy or not utilised at all. For example, female labour participation is very low at 35%. This can be improved with fairly simple fixes like the government proactively pushing for flexible working hours and subsidising maternity leave like in many other countries. There is a huge amount of labour locked up in agriculture, an unproductive sector; here again, over time, we can look at ways to encourage people to move into sectors likely to drive the future, like exports, leisure and logistics.

The third area is around FDI. We’ve taken a very reactionary approach to FDI, attracting around $1 billion a year, which is below par. We need to take a more proactive approach and target companies that have potential to invest in Sri Lanka. We need to go to them with a strong case, showing why it makes sense to set up in Sri Lanka – to benefit from faster lead times and competitive cost differentials. We can showcase the success stories of investors already here to convince them. There are many companies in Southern India who could be approached to do certain parts of their manufacturing in Sri Lanka.

Finally, on trade, there is a huge resource we don’t use – the Sri Lankan population living overseas. We often look at the Diaspora in terms of getting their expertise or investments, but the biggest advantage is the networks they have with big multinationals around the world. We don’t use these connections at all. Australia, on the other hand, does this quite well, where they link local businesses with the Diaspora. This is something we can look at as a big boost in terms of driving our exports and expanding market access. So these four areas – the public sector, skills, FDI and trade – present uncontroversial reforms that will have significant positive impacts on the economy.

Wijesinha: It gets tricky when we try to look at how Singapore got to where it is today because it becomes harder to compare and replicate. What we should do is look at what Singapore is today, and probe into those characteristics that make us Sri Lankans say ‘Hey! We like to be like that.’ When we look at some of these things, we realise there are some things Sri Lanka can do.

An example of this is Singapore’s public sector. It’s lean, proactive and highly competent. Let me give you anecdotal evidence of this. Before visiting Colombo for trade negotiations, Singaporean trade officials had asked companies what they would like the trade delegation to discuss in Sri Lanka on their behalf, even before preliminary negotiations began, sectors identified for opening or agreements drafted. The Singaporean delegation arrived here with a business focus. They flew in for meetings that took up the entire day, met key people at an official dinner and flew back the same night—no unnecessary time wasting, no jaunts. This indicated their level of focus.

Singapore has an outfit called International Enterprise Singapore, which proactively reaches out to countries that may not have a strategic importance to them today, to send out feelers. They don’t wait for Singaporean investments to talk to these countries, but offer services their public sector can provide. Another example is the Monetary Authority of Singapore (MAS). When a company applies for a license to set up a financial services business there, an official specialising in regulations sits together with an official in the promotions unit vying for the new business. The regulations official comprehensively covers the regulatory challenges before the aspiring entrant and the promotions official takes over to present what Singapore has to offer. That is the kind of proactive public service Singapore has.

Another characteristic we see and like about Singapore is the use of its geographic location as a logistics and financial hub for the region, creating a city-state that people like to live and work in. Sri Lanka has much to learn from Singapore about developing a smart city and financial hub. We can have several Singapores around the country, not just Colombo.

Singapore is open. We keep talking about wanting to be another Singapore or a regional hub, but we’ve forgotten how to be open. We come short even in the little things like issuing business and spousal visas for talented people. We need to be smarter if we want to attract the best talent here. I’m struggling to understand how we can be open when we are so fearful of a fairly basic trade agreement that is not anything close to the deeper integration that is being discussed today. We are still not open to foreign companies investing here. We are suspicious. Sri Lanka needs to be more open, and this requires a shift in mindsets.

Another lesson we can draw is nimble policymaking. With Singapore, you see a lot of nimble policymaking that understands businesses. They are always on the look-out for what is over the horizon, and not just stuck in what happened yesterday. Sri Lanka, on the other hand, is reactionary. In April, we had a restrictive policy on repatriation of export proceeds. That did not sound like we were going towards openness at all, nor did it sound like it catered to Sri Lanka becoming a trading or investment hub. It was a reactionary move lacking in understanding of the realities. Businesses got stuck with that rule and there was uncertainty for months. Finally, Singapore did a lot of reforms that had catalytic impacts, and some of these are not politically difficult for Sri Lanka, like everything Singapore did to cut red tape and improve the ease of doing business. That is what we should focus on to attract investments from overseas and unlock dynamism from within.

We need to walk before we can run. We want to be a financial hub, but in Sri Lanka, we cannot even do a forex hedge for one year. We don’t have derivatives. Liquidity in our equities market is terribly thin and foreign investors who come have possibly just two companies to look at.
– Deshal De Mel

Weerakoon: We need to be mindful that, although Singapore is a free economy in every respect, it also has one of the highest rates of inequality in the world. Its model is not replicable across the world. I don’t get why everybody talks about Singapore as a role model to get through Sri Lanka’s structural transformation. Malaysia, on the other hand, is a better example.

Wijesinha: Malaysia’s structural transformation, including its political economy, holds some good examples for Sri Lanka. Some may argue that Malaysia is stuck in a middle-income trap. We need to look at why these countries are successful and attractive, and figure out what we need to do. In many of these areas, I don’t think it’s impossible or untenable. There are many things we can do if we have the focus. We have an advantage. Sri Lanka is such a latecomer in many of these things that we can look at the experiments and experiences of Singapore, Malaysia, Thailand or any country.

De Mel: We need to walk before we can run. We want to be a financial hub, but in Sri Lanka we cannot even do a forex hedge for one year. We don’t have derivatives. Liquidity in our equities market is terribly thin and foreign investors who come have possibly just two companies to look at. We don’t even have the basics of a well-functioning, sophisticated financial market domestically, but we are talking about being an international financial hub. We should not get carried away with the successes of Dubai or Singapore, but get our house in order and do our homework. We must get the basics right. It’s good to have a vision, but we need to be sensible about how we go about it. This financial hub is a great example. We have several shortcomings, like not having a secondary market for corporate bonds, and that is an absolute basic need. We don’t have a proper trading platform for the secondary market in government securities either.

sirimal-abeyratne

Sirimal Abeyratne Professor of Economics – University of Colombo

We’ve been talking about structural reforms for years. What’s holding us back?

Abeyratne: I think the reason behind the lack of progress is that the ministries don’t have a vision or mission. They don’t have a plan, and no short-term or long-term goals to achieve.

Wijesinha: We need to take more than one crucial big step, and each requires a hundred smaller steps that can be done. What is holding us back is the lack of a businesslike approach to everything; this does not mean the ruthless pursuit of profits, caring little for inequality or poverty, but seeing what can be done and doing it. If our vision is to create the Colombo International Financial Centre, and we cannot get it done one way, we need to do it in another. If we cannot provide 50 different financial services, we must be ruthlessly focused to still achieve this goal by providing two services so well that we become the leader in the region for just these two services. Let’s look at what skill areas can set Sri Lanka apart for the next 10 to 15 years like data sciences, and invest heavily in a few public or private universities. Let’s get things done. The businesslike focus can be applied to welfare transfers as well, which are a big problem for Sri Lanka today. What can be done to improve things without having to overhaul the entire system? India, being a very big country, rolled out a massive national identity card project from their biggest cities to a village of just 10 people to improve welfare targeting.

De Mel: One important factor is accountability. If we can create accountability, this will be a much bigger incentive to get things done. That is why businesses are successful, because if you don’t get things done, your job is on the line. We don’t see this same level of accountability in the state sector.

Weerakoon: There are so many things that need to get done. If we open up the economy, we’ll find a labour shortage, and this comes back to education. We have a weak bureaucracy, which comes back to public sector reforms; so all these reforms come together. So why aren’t we reforming? It’s not only Sri Lanka, it’s India, Pakistan and Bangladesh; it’s a South Asian problem. The last time any of these countries went through reforms was in the 90s. Much has been written about why South Asia could not reform, while East Asia was so successful at it. For me, it comes down to one thing: governance.

Take Singapore’s example. How can one party stay in office, elected every four years, for 50 years? They did not prevent any other party from contesting; it’s because they delivered. There is no disenchantment because of the level of governance and accountability in Singapore. Look at our institutional governance structures. There is no institutional building. Governments operate in closed circles outside these institutions or they create new ones. Decision making is done within a small group, and there is no authority and responsibility going down the line to ministry levels. This is not going to get us anywhere. This is why we haven’t managed to do anything when it comes to reforms.

We need to take more than one crucial big step, and each requires a hundred smaller steps that can be done. What is holding us back is the lack of a businesslike approach to everything—and this does not mean the ruthless pursuit of profits, caring little for inequality or poverty—but its seeing what can be done and doing it.
– Anushka Wijesinha

Wijesinha: There is so much focus on policy making and so little focus on implementation. Implementation has always been our Achilles’ heel. We need to get far more strategic with that. Let’s take all our constraints—the political economy, the government that doesn’t command the popularity of the country, trade unions and the lack of money to solve problems; despite all of these, a clever implementation strategy can identify what can be achieved in the short term, what needs to be done in the long term and what needs to be avoided. We can identify all these things and get them done. But if you look at the last one and a half years, or even further back, implementation has been bad. We talk about wanting to be like Singapore and all the hubs we want to set up here, but we don’t do the hundreds of doable things that can help us get there.

Taking risks and getting things done embodies the entrepreneurial spirit. So given where we are in the reforms agenda, can the private sector deliver?

De Mel: The ability to ‘think big’ is really missing in Sri Lanka. Companies that do ‘think big’ tend to be in a few sectors like garments or property development. There are many factors for this. Many established companies have developed a defensive mindset of just holding their ground to survive the next year, instead of ‘thinking big’ about the next 10 years or how they can be four times bigger than they are now. That mindset won’t change overnight, but some companies that have emerged over the last few years are thinking big. For example, Softlogic Holdings has the mindset to think big, although I may not agree with everything they get themselves into. Established companies still have that defensive approach, but this should change when new businesses come in.

What I would really love to see is openness – much more openness to investment and talent. We have to attract talent into the country. Right now, we are bleeding talent, but everything we do is blocking it. A foreigner wants to come in, but his wife cannot work here; so who will want to come? We need to change our mindsets. Sri Lanka two thousand years ago used to be a completely open economy. We had everything and everybody was here. We’ve entirely changed that focus.

anushka-wijesinghe

Anushka Wijesinha Chief Economist – Ceylon Chamber of Commerce

Wijesinha: A big litmus test will come if and when we open up, then you will see the separation of the wheat from the chaff. Once we start liberalising, and we know we have slipped back substantially from liberalisation, we will see which companies take on the challenges and run with the new economy, and which ones fail. You can already see from those opposing liberalisation and trade agreements which companies or sectors are more vulnerable to that kind of change. There are young companies or parts of the older ones taking on the risks of an open economy, just not in Sri Lanka, they are investing overseas.

What are you most optimistic about for Sri Lanka’s economic prospects over the next five years?

Wijesinha: I am optimistic because we have so many things going for us at this moment in time, including a government that believes in a reforms agenda that the private sector buys. Of course implementation is an issue, but I am positive, otherwise it’s a non-starter. The second thing I am optimistic about is the resetting of foreign policy. If Sri Lanka is an outcast, nothing can get done. These two are good enough bases to build on. I am not expecting miracles, but these can take us to the next level.

De Mel: Export-oriented investment is where the change is going to come. You still see a lot of interest in Sri Lanka. Investors come here and stumble over a number of issues. But those can be fixed with policy or better implementation. We still have their interest. People love the location, and they like to live and work in Sri Lanka. That gives us a huge amount of potential. If we can convert this interest into action, which is not too far away in terms of getting things done, we can be in such a great place. We are so far behind from where we could be compared to Singapore, Malaysia or Thailand. We should stop comparing ourselves to the rest of South Asia. We should compare ourselves with East Asia, and the bridge is not so far to jump. We know what needs to be done, it’s just doing it.

There is another reason to be optimistic. Eventually, policymakers respond to voters in a democracy. One thing that was very exciting for me was how voters pushed for change in governance in January and August 2015, and policymakers responded. We got the 19th Amendment to the Constitution and Right To Information – those things would not have been thought of five or ten years ago. The political class delivered on voter demands, and if voters can demand economic structural changes in the economy the same way, policymakers will respond. An aspect of any reform process is communication. It is essential that the government effectively communicates with voters, and more immediately, the stakeholders directly affected by the reforms. Failure to do so will result in the failure of the entire reforms agenda. Like implementation, communication has been an Achilles’ heel for this government.