ECONOMYNEXT – Sri Lanka needs structural reforms for sustained growth, and monetary policy has to play a stabilization role to allow private businesses to invest aggressively, Central Bank Governor Indrajith Coomaraswamy said.
Sri Lanka saw growth spikes of up to 8 percent of gross domestic product (the system of national accounts have since been revised to make the GDP number even bigger) after 2009, but it could not be sustained, he said.
"In the period immediately after the war we had a set of unsustainable macro-economic policies which created a sugar high," Coomaraswamy told an economic forum organized by the Ceylon Chamber of Commerce.
"We got 8 percent plus growth for two years but from day one it was unsustainable."
After recovering from a crisis in 2008, in 2011 the central bank triggered another classic soft-pegged balance of payments crisis by printing money and failing to allow interest rates to move up when the credit cycle turned positive. A similar pattern was seen in 2015, analysts have showed.
Structural Reforms
"Why hasn’t the economy (growth) got back up to 7 and 8 percent?," Coomaraswamy asked. "While we have done the stabilization in 2012, we haven’t done enough structural reforms to strengthen the growth framework.
"That really is the key message for us. You can create a sugar high and create 8 percent. But if you want to sustain in you’ve got to have strengthen the growth framework with structural reforms."
He said Prime Minister Ranil Wickremesinghe is expected to present a five year plan outlining a direction which private investors use as foundation to increase their investments.
"The country seems to be making some headway towards putting in place conditions for sustained growth and development," Coomaraswamy said.
"Not grasping for quick fixes and sugar highs, boom and bust cycles, of the sort we have seen in the past, but trying to create a strong foundation – strong macro-economic fundamentals – a clear plan to go ahead."
Fiscal Consolidation
President Maithripala Sirisena and Finance Minister Ravi Karunanayake had both underlined the need to reduce budget deficits, which was encouraging, he said.
"Both his excellency the President and the honourable finance minister stated very clearly that they recognize that fiscal consolidation has to be of the highest priority.
"If you look back at the last 30-years that has been the main sources of instability, if we are able to crack that we can create the kind of foundation that is necessary for the private sector to invest, create jobs and thrive."
"The second part of the story is that in the next few weeks, the Prime Minister is expected to set out his five year plan.
"So a combination of sound macro-economic management with fiscal consolidation having to be at the heart of it, and clear direction, which I am fairly confident that would be set out by the Prime Minister, those of you in the private sector will have a framework to re-calibrate your risk appetite to commit yourself to investing in the future of this country."
In addition to standard business risks faced by businesses in most countries, Sri Lankan businesses have to face ad hoc tax changes, retrospective taxation, expropriation, a currency depreciation-high inflation-high interest rates matrix, which comes in the wake of balance of payments crises.
Sri Lanka has also tried to promote self-sufficiency – justified by foreign exchange shortages coming from a money printing central bank that accommodate budget deficit with debt monetization.
Planning vs Liberalization
Though any liberalization – freedoms given to either businesses to invest or consumers to buy goods through trade liberalization- will boost growth, boost economic activity and living standards, ‘five year plans’ could also constrain countries and blunt initiative.
A government could and should have a plan for itself, including a budget and other rules to limit its negative impact on the community, and a reform agenda to given freedom for citizens to flourish, but if the government tries to ‘plan’ for private business, with a limited bureaucratic understanding, disaster at worst or mediocre performance at best is the result, analysts say.
India was de-stabilized by a series of five year plans styled after Soviet ‘Gosplans’ and relegated to ‘Hindu’ rate of growth until 1991. India’s Planning Commission was finally shut down by the Modi administration. USSR shut down the Gosplan agency in 1991.
Planning was abandoned in 1991 following a severe balance of payments crisis, and the central bank reformed by cutting out the Treasury from rate setting and the country has flourished since then. Planning was abandoned.
Such five year plans can make businesses more dependent on state initiatives, and drive investments into less productive areas than would have happened if they were allowed to invest in areas giving the best returns (which signals there is the most need).
Malaysia has lagged behind and fallen into a Middle Income trap, while countries like Korea which largely abandoned planning gave full economic and civil freedoms to citizens have forged far ahead.
Idris Jala, an advisor to Malaysian Prime Minister suggested having an 8 -week workshop where businessmen and government officials were shut up in a conference room and ordered to come out with investment plans.
It is not clear how much real growth such an investment ‘sugar high’ will deliver and whether there will capital mis-allocation with bad loans to foloow later in Malaysia.
Razeen Sally Chairman of Sri Lanka’s Institute of Policy Studies said liberalizing investments in shipping – which was now controlled – and opening up tea imports would add to growth and contribute to making Sri Lanka an economic hub.
Monetary Instability
At the time of independence Sri Lanka was second only to Japan in Asia on most indicators, Coomaraswamy said.
"We have fallen well behind several countries since then," he said. "We need to ask ourselves why that has happened."
Until independence Sri Lanka had a currency board, like Hong Kong and Singapore, which did not have an active policy rate to print money and de-stabilize the economy through firing credit bubbles.
Analysts have pointed out that in 1951 Sri Lanka created a money printing central bank, which led to foreign exchange shortages, balance of payments crises, exchange controls, currency collapses, high inflation, which then led to price controls and trade controls.
Analysts and economists have called for the central bank to be abolished and a currency board to be re-established, so that it cannot accommodate high budget deficits from the Finance Ministry to generate economic instability. (Colombo/Aug08/2016)