IS SRI LANKA’S ECONOMY DOOMED?

A REVIEW: MANAGING DOMESTIC AND INTERNATIONAL CHALLENGES AND OPPORTUNITIES IN POST-CONFLICT DEVELOPMENT-LESSONS FROM SRI LANKA, FROM THE IPS

TEN YEARS have passed since the end of the conflict with the LTTE. In Sri Lanka’s troubled post-independence history, ten years is a long time. Th at’s enough time to assess the performance of the economy, post-war, and refl ect on some questions of politics. A new publication “Managing Domestic and International Challenges and Opportunities in Post-conflict Development-Lessons from Sri Lanka” contains papers that throw some light on these issues.

“In May 2009, Sri Lanka’s nearly three-decade-long separatist war ended when government forces crushed the separatist insurgency and annihilated its leadership. A war-weary population hoped and expected that this would usher in a period of peace and national reconciliation, political stability, and sustained economic growth. But a decade after the end of the war, those hopes and expectations have faded as the country once again faces the reality of political instability, a struggling economy and sharpening ethnic, religious and social tensions.”

What went wrong? “Successful and sustainable post-conflict recovery and growth required a combination of economic and political measures.

(a) to lay the basis for national reconciliation by sensitively addressing the root causes of minority grievances, ethnic and regional inequalities and perceptions of discrimination in particular;

(b) to provide a quick peace dividend to the population as a whole through employment and income growth and reductions in poverty and income inequality; and

(c) to set in place a sound medium-term macroeconomic framework for growth with stability to underpin a strategy for long term economic development”.
The table of economic indicators sets out the bare facts. (see Table)

The ceasefire broke down in 2006 and fighting resumed. During the war years (2006-09) growth averaged 6% helped by the rapid expansion of the global economy (2006-2008), higher levels of public investment (average close to 6% of GDP) and improved connectivity associated with rapid progress in infrastructure: road development, telecom and electricity sectors.

In the immediate aftermath of the war, the global economy slowed (due to the financial crisis), but Sri Lanka’s growth accelerated to 8.5%. The spurt lasted three years (2010-2012) and was driven by government spending, particularly on infrastructure and increased consumption.

“The government implemented a large-scale infrastructure development programme and some current consumption-oriented spending initiatives. An infrastructure programme certainly had a strong economic rationale: after three decades of a destructive war, the rebuilding of infrastructure had to be a core component of any recovery and rebuilding effort. The other spending initiatives also had appealed to a population that had gone through years of economic restraints and difficulties”.

POST-CONFLICT COUNTRIES EXPECT TO EXPERIENCE A SUSTAINED “PEACE DIVIDEND”

Growth then slumped to an average of 4.2%, where it has remained since. Post-conflict countries expect to experience a sustained “peace dividend”, but in Sri Lanka, this was puzzlingly short.“These initial economic successes were deceptive. On closer examination, the indicators of economic performance were not nearly as robust as they seemed at first glance. The economic boom itself was built on shaky foundations.” Rapid growth post-2009 was driven by:

a)The under-utilised productive capacity of the North and East coming into production. Once utilisation reaches normalcy, growth slows.

b)Post-conflict construction and reconstruction.

c) Consumption-caused by reductions in import taxes, post-war consumer confidence, a favourable exchange rate and increased government spending. The limitations of (a) and (b) are apparent. Domestic consumption is limited by market size and spending power.

As the report notes: “The nature of growth was heavily biased towards non-tradeables, with 70% of GDP growth in non-tradeable sectors (construction, transport, utilities, trade and other services), reflecting the dominant role of infrastructure development and construction projects. Manufacturing growth was primarily home-market-oriented (rather than export-oriented) sectors and quite sluggish; its share in GDP declined from 18.5% during 2000–2004 to 16.5% during 2005–2013. Unemployment did decline, but this was largely due to increased public sector employment (10.4% in 2004 to 14% in 2012) and emigration of workers (mostly) to Middle Eastern countries; overseas employment reached 23% of the total labour force in 2011 (Arunatilake et al. 2011). In the major conflict zones of Eastern and Northern provinces, poverty remained high despite several large infrastructure projects (Sarvanathan 2015).”

“FDI inflows did increase somewhat, but went primarily into the construction and services sectors. Manufacturing attracted only just over 30% of FDI during 2010–2013. While some FDI went to the recovering tourism sector, the closing down of a large number of export-oriented foreign firms was a signal that the country’s international competitiveness was eroding…. Exports of goods and services as a share of GDP fell sharply from an average of 25.6% during 2004–2009 to 16.8% during 2010–2013.”

With the principal drivers exhausted growth slumped. Worse, much of the infrastructure and government spending, which drove the boom, was fueled by debt, particularly foreign debt. A debt-funded infrastructure drive became an attractive option in the wake of the global financial crisis of 2009 (which brought interest rates to record lows) with the emergence of China as a major lender. “Both sources provided ‘easy’ money with few questions asked and no conditions attached.”

Financing infrastructure with debt is not itself a problem, but to be viable in the longer term, it must meet several conditions. “First, the debt must be used for efficient and productive investments. Second, long-term investments must be financed by long-term debt; otherwise, debt repayments will fall due before returns from the investment are available.”

Regrettably, too many projects failed to generate a return (Mattala Airport, Hambantota port), while the returns on others may not have matched the loan profile; the project takes much longer to pay back than the loan that financed it. The low returns eventually led to the current problems with repayment: instead of being self-funding, it required further taxes and new debt. Unluckily, the recovery of global markets meant the foreign debt being rolled over now carries a much higher interest rate than before, worsening the existing burden.

The new government that was elected in 2015 inherited a misfiring economy but proceeded to make matters worse with populist spending on public sector salary increases and fuel price reductions that took a toll on already weak public finances. While some steps were taken to improve export performance (eliminating para tariffs and enhancing market access to export markets), little fundamental reforms took place. Divisions within the coalition meant policy became more erratic and corruption less predictable, which affected business confidence and investment.

“The spectre of the looming economic crisis forced the government to sign a Stand-By Agreement with the International Monetary Fund (IMF) in mid-2016. The focus of economic policies shifted to stabilization, rather than growth and development. But stabilization measures to help contain the fallout from a debt-financed spending binge are not conducive to accelerating economic activity and growth.”

Ravi-Economy-Doomed-Chart

Instead of tackling spending, the government opted to raise taxes, burdening consumers who were already feeling the impact of a sharp currency depreciation. The incompetence and unpopularity of the current regime has obscured a discussion of the underlying problems in the economy. Economic growth has remained sluggish for five years since 2013. Despite much talk, there has been little reform, and the economic structure has hardly changed from the Mahinda era.

SUSTAINABLE GROWTH IS BUILT ON TRADE (EXPORTS) AND BASED ON PRODUCTIVITY

We cannot hope to return to a debt-financed infrastructure driven model because debt is now more expensive and public finances weaker. Privately financed construction, particularly the Port City and Hambantota, will cause reported GDP to jump from 2020 onwards, but since these are heavily reliant on Chinese workers, spill-overs to the local economy will be limited. GDP will expand, but most people will not experience an improvement in living standards. Therefore, while a change of regime may improve the policy environment unless structural problems in the economy are addressed, people will not see better living standards.

Sustainable growth is built on trade, particularly exports, and based on productivity. This means reorienting the economy to exports, to create more productive jobs. It means improving logistics facilitation (reduce the per container cost of exports), setting up FTZ’s to ease access to land (and address infrastructure shortcomings), simplifying regulations (for investment, taxes, business), and welcoming migrants to address skill and labour
shortages (which also facilitates knowledge transfer). The government debt and fiscal metrics preclude a state-led push. Investment needs to be driven by the private sector with the state playing the facilitator. The macro-environment must be stable (interest rates, inflation and exchange rate), which means bringing the budget deficit under control (cutting waste/corruption, closing unviable state enterprises, selling assets) and running tight monetary policy. This is just to address the problems in the economy. As the report observes:

“Extremist violence did not end with the military victory in 2009. Extreme forms of Sinhala Buddhist organizations emerged and appeared to have been given free rein to engage in campaigns that targeted not only Tamils but also other major ethnic and religious minorities, Christians and Muslims.”

“A decade after the end of the war, Sri Lanka finds itself in unchartered waters having to cope with deeply entrenched economic problems, unprecedented levels of political uncertainty and institutional stresses.”