The process of Sri Lankan policy reforms of liberalisation since 1977 has been predominantly unilateral. These reforms were undertaken in a global context of multilateral trade and tariff reforms under the guidance of international organizations like GATT and WTO. In addition, Sri Lanka joined in the efforts of liberalisation at regional level, e.g. the South Asia Free Trade Agreement (SAFTA) under SAARC initiatives. Multilateral and even regional trade negotiations however, have proved very slow and cumbersome. Bilateral and preferential trade agreements have become attractive globally, as well as in Sri Lanka.
The first experience of post-independence Sri Lanka in bilateral trade agreements was the well-known Rubber-Rice Pact of 1951 between Sri Lanka (then Ceylon) and the People’s Republic of China. It was a simple bilateral bartering agreement which provided a win-win solution to the two participating countries. The recent Sri Lankan interest in pursuing bilateral and preferential trade agreements can be traced to the 1990s. Three FTAs have been signed and implemented since then. The India-Sri Lanka Free Trade Agreement (ISFTA) was signed in 1998 and entered into force in March 2000. The Pakistan-Sri Lanka Free Trade Agreement (PSLFTA) came into force in June 2005. The Sri Lanka Singapore Free Trade Agreement (SLSFTA) was signed and made effective in 2018.
The ISFTA and PSLFTA are simple agreements covering the trade of goods between the respective partner countries. The SLSFTA in contrast, is a comprehensive agreement covering trade in goods, sanitary and phy-to-sanitary measures, and technical barriers to trade, customs procedures and trade facilitation, trade in services, telecommunications, E-commerce, government procurement, foreign investment, competition, intellectual property rights, transparency rules and matters of economic and technical cooperation. Sri Lanka may choose to negotiate its future FTAs in the same format as that of the SLSFTA. The new FTAs would then be comprehensive/deep agreements. Such ‘deep’ FTAs influence border-related policies as well as beyond-the-border policies. Liberalization through bilateral FTAs is being given priority with multiple objectives.
Several issues must be raised on this declared approach of expanding the policy scope of FTAs. A fundamental issue is that FTAs, particularly comprehensive FTAs, restrict the policy autonomy of the government to a significant extent. In today’s global institutional and organizational structure the policy autonomy of a small country is no doubt extremely limited. It may be for good reasons that the policy makers in Sri Lanka opt to get their policy autonomy further constrained by a series of FTAs. Here the opinion makers in the country seem to demand the following. The reasons for signing an FTA ought to be transparently shared with the public. Adequate research ought to be conducted to establish that any envisaged FTA would generate net positive benefits to Sri Lanka. Further the feasibility of the envisaged FTA should be carefully examined without rushing into signing. The planned FTAs are to be signed with countries with greater experience and equipped with better institutions. If adequate care is not taken, the signing of an FTA could produce extensive adverse effects on the country’s development efforts.
”From an overall point of view, Sri Lanka, as it stands today, is in an extremely weak competitive position in the global economic set up”
There are many needed domestic economic reforms. Some of these could lead to further liberalization. At the same time, there could also be critical intervention by the state in some fields. Before envisaging any more FTAs, priority must be accorded to domestic policy reforms based on a coherent national development framework and a widely-accepted national foreign trade policy.
There is another danger in the current declared policy of moving toward two more FTAs and a comprehensive agreement with India, in addition to the three FTAs currently in force. FTAs are not the best way to improve Sri Lanka’s competitiveness or productivity which is constrained by various structural and institutional factors. None of these factors can be resolved by entering into FTAs. In addition, operating a number of FTAs with different countries, involving multiple Rules of Origin, can make the foreign trade system extremely complicated, distorted and cumbersome.
Sri Lanka does not yet have a firmly established institutionalised procedure within which international trade agreements, particularly those so-called comprehensive agreements, can be negotiated and implemented. Strong legal, regulatory and institutional frameworks are needed if the national interest is to be safeguarded in the process of negotiation and implementation of bilateral preferential FTAs. Entered into without due care, bilateral trade agreements could turn out to be, in the long run, contractual traps with obligations, without worthwhile advantages to gain.
Secretary to the President Dr. P.B. Jayasundera remains supremely confident in the country’s push towards self-sufficiency. However, despite the government having charted the country’s post-pandemic path to prosperity in its ‘Saubhagyaye Dekma’ (Vistas of Prosperity and Splendor) Economic Development Strategy, questions still remain over what this entails exactly. With that, Sri Lanka’s most high profile public servant sits down with Biznomics to outline not only how, but why the country is capable of achieving what some believe are quite lofty goals.
What does the alternative development model of the government entail?
I believe that the “Saubhagyaye Dekma” Economic Development Strategy of the Government has been vastly misread. The Government has a visionary approach in defining an alternative development model, taking new dynamics in the changing comparative advantage in the global economy. Particularly with technology and innovation being the force in production whether it is for import replacement or exports. So the Government’s Economic model is to reach market needs through exports and import-competing sectors. Just think about big-ticket items in the import composition in Sri Lanka. The import cost of fuel and fertiliser is one-fourth of total imports. The country’s dependency on these alone is $5 billion a year. Now in the past, oil exploration was the only option and was a costly option. Today, solar, wind and other renewable energy sources have become feasible simply because of technology. The same is true for bio-fertiliser in place of chemicals. It’s not just a change in supply source. Even the public’s preference is increasingly in favour of clean and renewable energy and biofertiliser. On a similar note, the apparel industry was the industry for the global market. It has certain links to import-competing opportunities for fabrics, packaging, branding etc. Now, IT has become a billion-dollar export business, with a huge local supply chain that makes import competition in IT and enabling industries viable businesses. Many startups, whether in agro-business, manufacturing, or services, are linked to technology. So instead of thinking only of apparel or tea factories, the time has come to go beyond. The “Techno Parks” proposal in the 2021 Budget is such an initiative to break down the thinking process in economic progress. It’s an aspirational change.
When you think about even primary agriculture. Classic import replacements like rice, maize, black gram, green gram, soya, big onions, potatoes, dry fish, canned fish, dairy, sugar etc. The market size of this sector is around $2-3 billion in annual imports. High tech agriculture, land use, sensible trade and industry policy, incentive structure, infrastructure, particularly electricity and communication, and vocational education are the critical building blocks in putting all of this in one; that is a national production base for exports with a diversified supply chain to replace some imports. That is the space creation in the external account to accommodate imports that Sri Lanka needs to be in the global economy i.e. technology, advanced machinery, and equipment, medical and scientific innovation.
“Instead of thinking only of apparel or tea factories, the time has come to go beyond.”
Some have questioned the numbers put forth in the budget 2021. How do you rationalise them?
Here again, there is a big difference between the statistical approach versus the development approach. If one approaches from statistical sense, the last 5 years average growth is around 3 percent, and before that 6 percent. So statistically you can get 3-4 percent growth, depending on how you calculate the average figure. As you know, growth is an outcome of many behavioural activities in production and consumption.
Think of what has been taking place. Plantation companies have not been a growth sector. Agriculture was lagging behind. Apparel depends on global markets. There has been no diversity in exports for years. Domestic market needs have been met from imports. The trade deficit has been debt financed. There is a need for alternatives to change the behaviour of farms and households to move out of this path. Investments and consumption demand, earnings and savings options etc., need new horizons. So the government has sets a growth of 5.5 percent for 2021, and placed the economy on a path of 6 percent inclusive growth reflecting those behavioral changes in the economy and lifestyles.
“The government has sets a growth of 5.5% for 2021, and placed the economy on a path of 6% inclusive growth reflecting those behavioural changes in the economy and lifestyles.”
It is to generate from what I discussed early, exports and diversified supply chain for import competition. Sri Lanka should, in my view, look at a $10 billion annual export figure, and a $20 billion import figure, and work out as to how this $30 billion trade is raised with a different export-import mix, and global commodity exports and supply chain activity, to raise the size of the economy. Think of an overseas employment market of $6.5 billion, with low skill supply of labour versus the scope for transformation to middle and high end skill supply such as diversified vocational skills, IT, nursing and health care, business outsourcing activities, overseas, and make it into a $10 billion earning source.
Similarly, “Saubhagyaye Dekma” means to move the high end tourism market to generate $10 billion tourism sector, with much more diversified products and linked to local supply chain. IT and pharmaceuticals are new drivers in the emerging economy set up. So both the private and public sector need to work in these areas to generate growth. The provision of enabling environments through changes in the legal system, finance, taxes, and the decision making process are very important.
The budget is another set of numbers people are debating heavily on statistical grounds rather than behavioral grounds. Some feel the revenue/GDP ratio of 11 percent is not adequate to keep the fiscal deficit in check. However, if one looks at the source of the revenue, 50 percent is from selected excise/commodity taxes, and 80 percent is from 20 percent of large tax payers. If there is optimum and efficient collection, that may be fine, but we all know leakages, irregularities, malpractices, weak administration and enforcement capacities, policy ambiguity etc. are all over.
So although the revenue/GDP ratio may be 11 to 12 percent, the tax compliance and transaction cost could be another 5-6 percent of GDP to the tax paying community. So reforms in these institutions are unavailable to increase tax efforts, rather than introducing further complex taxes through discretionary actions.
Secondly all taxes, whether they are from wage income, interest income, property, rent or businesses, come from the economy that is GDP. So the economy has to grow in a manner where all sources of income are growing to create taxable income and expenditure. So growth has to be broad-based. The Deregulation Commission has been tasked to simplify systems and procedures, and the ICTA has been assigned to popularise IT solutions.
Thirdly, deficit management involves public expenditure management to ensure that the least is spent to get a most desired outcome. Choices between long gestation of expensive debt financing projects and programs, versus quick yielding low cost debt and investment financing strategies must be desired on the basis of cost benefit analysis. So the budget must be read in this context. In a debt heavy environment, particularly in the external sense, the sensible approach is to contain new borrowings from expensive and high risk sources. Moreover, debt finance activities too must have high domestic content so that it brings foreign inflows rather than simply financing imports. These are difficult, but we are encouraged as large multilateral development agencies have moved along this wave length. Bilateral lenders are encouraged to invest in commercial projects besides looking at private sector debt and equity market as well. So private sector and banking and financial institutions will have to work out new business models.
What is your perspective of “Saubhagyaye Dekma”?
It is new economic architecture for Sri Lanka. “Saubhagyaye Dekma” is a business model for the entire corporate world as well as for SMEs, residential household economies, the public sector, and for the Central Bank and the financial sector to support the real economy. It is a strategic view as to how Sri Lanka is positioned in the emerging global economic landscape. It is a mindset change and an alternative path to development. It is a fulfilment of Sri Lankan aspirations for which his Excellency the President got a resounding mandate. It has fundamentally three pillars. Namely, (a) National Security, Law & Order (b) Nationally Centric Production Economy linking exports and competitive import replacement and (c) Corruption Free People Centric Public Service delivery.
These pillars are designed to support a platform for gainful opportunities for all Sri Lankan with secure and predictable environments for doing business and for them to live with aspirational goals. It is a challenge for those who are bogged down with what they are used to and those who are reluctant to change. Resistance and criticism are unavoidable from that group. Resistance to these changes is resistance to progress. There are many openings for those who are hungry for progress. The Techno Park is a place where investors will not waste time in construction but start with plug and play from day one of IT and supply chain activities.
“Saubhagyaye Dekma’ is based on 03 pillars: (a) National Security, Law & Order (b) Nationally Centric Production Economy and (c) Corruption Free People-Centric Public Service delivery.”
Take 30,000 mini market outlets for Samurdhi women entrepreneurs, they just lease them and operate village centric mini supermarkets. Take energy secured for low income households through solar based electricity connectivity. Think of 250,000 students of which 200,000 are from the Government’s new city universities and vocational educational establishments, acquiring marketable skills to engage in gainful employment and with ambitions of engaging in a business of their choices with startup capital. So these are a few avenues, just to highlight what this new economic architecture is all about.
The investment capacity is high. Every country with investable funds are looking for countries with political stability, policy continuity, investment protection etc. Growth prospects in various sectors such as tourism, IT, renewable energy, advanced agriculture, manufacturing with global supply chains, are strong. Sri Lanka has leverage with them. The Port City is a new economic zone open to all. The government is encouraging large nations in Asia; India, China and Japan, against where Sri Lanka runs trade deficits, to provide market access. This means they will be encouraged to increase investments here or open markets for others to invest here. So the strong economic positions of India and China encourage other countries to look at Sri Lanka as an investment destination. We have investors from U.S., Europe, the Far East, and South Asia already in Sri Lanka and they have been driving many export industries.
The IMF, the World Bank, and the ADB all project China as the only country reporting a positive growth in GDP in 2020. So China has edged forward in the background of all other nations having seen negative growth. With the setback suffered by the U.S. due to the Covid-19 pandemic, there are indications that China will overtake the U.S. before 2030. If so, we are in a decade that will witness the transfer of economic super power status form the West to East. So it is a phase of West-East economic balancing.
This does not mean the U.S. and China, or for that matter China and other advance countries are identical. They will have their own strengths, and Sri Lanka is an investment and business destination for all. This is why His Excellency is very explicit on “neutrality” in the country’s foreign policy approach. The government has tested our missions overseas to focus on economic diplomacy as that is more relevant to us.
Can the country continue to rely on China for investment in the long term?
We don’t rely only on China. This nation has a much more diversified foreign investor preference. As you know, investors come from domestic and foreign sources. In Sri Lanka, to date, in terms of domestic investments private investment is very large. Foreign Direct Investment has been not large and has not exceeded 2 percent of GDP. Public investments, largely in infrastructure, has been around 5 percent of GDP in recent times. So the balance is private, which is around 23 percent. However, a noteworthy feature is that foreign investments continue to come into the country through several channels like manufacturing, ports, energy, telecommunication, and banking etc., which has expanded in the country with significant value addition.
The present government encourages Foreign Direct Investments from all countries, provided they fall in line with the national development strategy of looking for exports, technology, external markets and supply chain import competition
In fact, compared to the past governments, this government encourages foreign investments instead of foreign loans. That itself is a shift.
“Sri Lanka’s import based trading community needs to continue their trade based on domestic supply.”
The UK and EU have a new trade deal after Brexit, improving European prospects for recovery rapidly.
Disinvestments will also be a part of the post COVID global recovery. Bankable restructuring of businesses may be a priority in many advanced countries as well. Some companies may also look at new opportunities elsewhere, and Sri Lanka could be one of such attractions. So all depends on how each economy evolves in the post COVID recovery process.
How will the imports rationalization policy work?
The Government of President Rajapaksa is deeply committed to alleviate poverty in order to create a poverty-free advanced middle income country. As you know, 70-80 percent of agricultural land ownership is with small holders, below 5 acres. Small farm agriculture has huge potential to make the country go beyond self-sufficiency targets to create an export surplus. This requires farm agriculture linkage to processing through agro industrialisation. So import of agricultural commodities that are being produced locally have been put under a Negative List in our benchmark free trade agreements with India and Pakistan. So this Negative List is part of the Government’s agricultural development strategy.
Agricultural commodities such as maize, green grams, soya beans, black gram etc., are smallholder farm activities. The small agriculture sector has remained poor as these commodities have been liberally imported. Giving them a support to grow is a step towards alleviating poverty as they have a market to supply. Agricultural farms in advanced countries do not belong to the poorest sectors but they are subsidised. The value of imports of these easily cultivable commodities is around $500 million. Imagine the impact if this money is transferred to farm agriculture through import rationalizing.
So Sri Lanka’s import based trading community needs to continue their trade based on domestic supply. Processing options are huge, human and animal feed processing, coconut, soya oil and many consumables out of such materials must be encouraged. The world is also shifting to natural products rapidly and Sri Lanka should capitalize on it.
Fruits, vegetables, poultry, eggs, dairy, and aquaculture are other huge supply chains that require investments. Then the next big ticket items like cosmetics, milk powder, pharmaceutical drugs, sugar, and wheat flour, of which combined imports are worth nearly $2 billion per annum. The government is encouraging large import dependent business operations in Sri Lanka with multinational experience to convert them to export industries using Sri Lanka’s locational advantage. This process involves our farmers in the supply chain of global trade.
Then the large import bill with fuel and fertiliser imports annually costing $5 billion. Renewable energy provides a huge scope for import replacement of oil and help us to work out an economically viable energy mix. Imagine the value impact of 50 percent savings from energy in the total import cost of oil on the balance of payments. His Excellency has advised the reduction of the application of chemical fertiliser each year to find a proper fertiliser mix to provide sustainable fertiliser solutions to address agriculture, health and biodiversity concerns. Even big market economy like China is looking for local solutions through joint ventures to transfer manufacturing technology of the Airbus 320 to the Chinese market.
So Sri Lanka has prospects in the manufacture/assembly of motor vehicles for the local market on a similar basis. Technology, skills, and digital governance are key.
Motor vehicle import is the least value added sector with huge foreign currency outflows and currency mismatches in import cost and domestic sales. The compression of such imports are necessary considering the country’s foreign debt service obligations. However, importation of spare parts and components that are not available here to maintain vehicle fleets in the country will be. Export diversification is unavoidable as Sri Lanka cannot rely only on apparel and predominantly bulk tea exports.
Critics argue that the savings-investment gap cannot be met. Does the government have the savings to finance its investment goals?
This is a National Account identity which has extended to very sophisticated open macroeconomic models like the financial programming model of the IMF which largely applies in fund supported programs. They are good, useful and relevant to blend with country specific development models. There are country specific development models like the Japanese growth model. Malaysia, India, China etc., all have rich growth experiences through country specific programs. All these countries raised domestic savings to finance investments, in addition to foreign savings mobilised by way of investments.
The Budget has proposed several incentives to raised savings such as Samurdhi Savings Accounts, additional exchange rate-based incentives for remittances from overseas employment, extension of retirement age to raise life cycle savings of working populations, ratifying payments for insurance, housing, and capital markets to the tax paying community, and incentives to multinationals to invest dividend payouts are some noteworthy measures. The Government has also kept the door open for foreign investments in commercial infrastructure.
There is no single recipe for development. So, the Government has to overhaul the entire system to get its alternative development path right. It may be seen initially as difficult, but once the going gets tough, the tough get going. Technology, skills, and digital governance, are key to galvanising this process.
Sri Lanka raised USD 2.0 billion international sovereign bonds on the strength that IMF has endorsed the country’s economic performance, while the bonds having been rated by international rating agencies as “Non-Investment” grade. In fact Moodys attached “B2” rating while Standard and Poor’s and Fitch assigned “B” rating. The USD 500 million face value bond with 5-year maturity was raised at a semi-annual coupon rate of 6.35 percent while USD 1,500 million with 10-year maturity was raised with a semi-annual coupon rate of 7.55 percent. The Bonds were subscribed by 91 percent fund managers while 5 percent came from insurance and pension funds.
Sri Lanka entered in to the international bond market in 2007 and the June 2019 issue was the 14th USD benchmark offering. This was also the country’s second sovereign bond transaction this year. The Government of Si Lanka raised USD 1 billion 5-year bond at a semi-annual coupon rate of 6.85 percent and a 10-year bond at a semi-annual coupon rate of 7.85 percent in March 2019.
Sri Lanka has USD 17 billion ISBs as of June 2019 and account for nearly 50 percent of Government external debt.