ECONOMYNEXT – The three fetters that shackle Sri Lanka’s economic growth, peace and general happiness; monetary instability, regime uncertainty and dehumanizing nationalism have converged to slam into the country during the Coronavirus pandemic.
The economy is not some mysterious amorphous mass that only ‘economists’ understand. It is the actions that individuals and firms take in their journey to produce, earn profit or salaries and consume and invest.
If bureaucrats try to control this behaviour, many of which can be seen in markets, based on their ideologies and beliefs and desires to impose their will through coercive means individuals will have to spend time and waste resources in circumventing such actions as well as the inevitable unexpected fallouts.
As a result, the entire country will ‘miss the buses’ that other countries are seemingly getting on effortlessly. Some countries not only get on buses but aircraft.
Leg Shackle No 01 – Monetary Instability
Though there have been several records about monetary instability and currency debasement in Sri Lanka’s history, from the ancient to the more recent history, nothing may compare with what has happened after 1950.
It was not an occasional bubble that hit the country, but a continuous, debasement through REER targeting, currency collapses and import restrictions that sapped the life out of the resident of what used to be called a resplendent isle.
The British printed Rix dollars and undermined what was a strong, silver pegged money, trading above its specie value against the Madras Star Pagoda. The 1848 uprising was fired amidst the economic hardships and higher taxes and burst commodity bubble that came in the wake of the credit boom known as the British railway bubble.
The collapse of Oriental Bank Corporation in 1884 (a note-issuing free bank which issued silver-backed Ceylon Rupees), amid burst commodity bubble silver and gold price changes, led to the creation of a currency board and the government took over the function.
But in 1950 a central bank was set up with the assistance of an expert from the Fed, John Exter. Since then the currency had fallen from 4.70 to 185 to the dollar.
All the central banks set up by the ‘experts’ of the Latin American unit of the Fed after the Great Depression, brought disastrous results.
Bank of Korea had the Hwan collapsing from 60 to 1350 to the dollar, and per capita gross domestic product collapsing to almost nothing. Ecuador set up by another expert is now dollarized. Cuba went to the communists.
Philippines central bank went bankrupt and it went to strongmen. The list goes on.
Open Market Operations, which moved central banks out of a market determined two-way discount rate followed by the Bank of England for centuries, which had allowed it to keep a gold peg was invented almost by accident at the Fed during when Benjamin Strong headed the New York Fed.
So were ‘operation twists’, both of which also so effectively helped trigger currency crises in Sri Lanka after the end of a 30-year civil war.
Open Market Operations helped trigger that roaring 20s bubble, which then led to the Great Depression. In a little over 20 years since its creation, the dollar collapsed from 22 to 35 dollars an ounce. Less than 40 years later the Gold Standard was dead. The Bank of England had kept it for over three centuries.
If Sri Lanka had a policy corridor and more restrained central bank which did not target a call money rate and recklessly inject liquidity the country’s sovereign bonds would not be trading at steep discounts.
The question has been asked what if the central bank had not printed money in March and April as cash demand grew? Nobody asked central bank not to accommodate a cash demand, what they are saying is not to generate excess liquidity to manipulate interest rates artificially?
Sri Lanka bonds would not be trading at steep discounts.
Sri Lanka would be like Vietnam, where there is a two-way cash auction with a wide policy corridor to protect the currency. The 2024 international bond would be trading at an 11 cent premium on the dollar.
If no money is printed and dollar bonds are trading at a premium, a country can borrow abroad for stimulus, or bite the bullet and see it through. When the US prints money, pegged nations with monetary stability can use it. Or if there are reserves they can be used directly.
This is what the New York Federal Reserve did to Sri Lanka. The same department sent a mission to South Vietnam. South Vietnam is history now.
Far from promoting demand, Sri Lanka’s economy is now in a trade lockdown killing even the normal economic activity.
Leg Shackle 02: Regime Uncertainty
The second leg shackle on the economy is regime uncertainty, sudden policy reversals and explicit and implicit expropriation of citizens, non-citizens and businesses.
2020 started with tax cuts, reversing two years of hard-fought value added tax reforms. The income tax hikes was a mistake that was better corrected. High direct taxes kill jobs and growth. Indirect taxes are the way to raise money.
The US has high direct taxes but hardly any sales taxes or import duties. Sri Lanka has value added taxes and high import duties and to raise income taxes to high levels was wrong. Income tax should be kept at 15-17 percent. To depend too much on income taxes is also bad, since direct taxes are highly susceptible to economic cycles.
Regime Uncertainty worsened with a vengeance during the crisis. Tinned fish and dhal disappeared as the Consumer Affairs Authority slammed price controls.
Regime uncertainty is also closely linked to monetary instability. The high taxes that come during IMF programs are also due to currency collapses, which bring the IMF program in. The UNP regime whatever its faults, passed them all through the parliament with adequate notice to the public.
The destructive import controls also come from money printing. So does price controls. The Import and Export Control Law along with the Department should be abolished. The midnight gazette makes taxes a fluid comedy. They should all be abolished to restore the rule of law. The price control authority of the CAA should also be taken out and junked.
Leg Shackle 03: Nationalism
Monetary instability not only triggers import controls but also import substitution.
Little wonder Raul Prebisch the architect of Argentina’ central bank was a supporter of import substitution. Sri Lanka is paying the supreme price today by being slaves to such illiberal nationalist ideas.
Some of the central banks in Latin America was set up with Prebish’s help.
In fact, at least one ‘expert’ of the LatAm department who went around setting up disastrous central banks had expressed his admiration for Prebisch, whose destructive ideas brought misery to millions and kept countries in the third world and worse.
Nationalism also came in other ways. The bodies of Muslims who died from Coronavirus were cremated. This is despite the Director General of Health Services initially saying they can be buried under certain rules according to World Health Organization guidelines followed by other countries.
India, the Hindu bastian from where cremation spread to many countries with Indianized cultures, allowed burials.
Sri Lanka does not have a public sector that treats everyone equally, there is no just rule of law. Selective political directions rule. The independent public service with permanent secretaries was an institution of liberty. But many institutions of liberty were dismantled after self-determination from the British and arbitrary rule promoted.
The British brought the birth certificate which made it impossible for people to switch their ethnic origins as had happened during the time of ancient kings.
Tamil (so-called) mercenaries became Sinhalese, persons of Kalinga origin became ‘Sinhala Kings’. Sinhala king married Tamil wives. They also married Muslim wives according to the latest story that is now doing the rounds.
But after Western rule, birth certificates cast people’s names and origin in stone or at least in paper. The registrar general’s documents were copied in two places, at the district register and in Colombo. The citizenship was another western appendage fully embraced by the indigenous ruling class after self-determination.
The immigration law was enacted in 1949 in a parliament set up by colonial rulers.
It stopped naturalization – which was a basic phenomenon under all Sinhala kings – perhaps for the first time in the long history of the island and people who came to work in the plantations were deported despite being born in this country. The same immigration law and its visa regime are now keeping the country from gaining knowledge and moving to new sectors.
But Sinhala kings (also Tamil kings for that matter), allowed kinds of agricultural workers to come and stay and inter-marry and work, ranging from toddy tappers to cinnamon workers to elephant trappers to fishermen.
The central bank law came in 1950. The Sinhala only law came a few years later.
Chauvinism exists, especially among the religious in all countries but it is nationalism in practice when laws are enacted based on their ideas through a parliament inherited from Colonial rulers. It is the popular vote (illiberal democracy) that gives the incentive to mistreat minorities. Kings, who did not identify directly with commoners, had no such incentive.
The people of Sri Lanka are still being fed revisionist history, based on dehumanizing nationalism, just like it happened in Eastern Europe. When economic hardships worsen minorities in many countries – who happen to be trading communities – are targeted for being rich. Monetary instability is rife, sovereign default is looming which is not good for minorities.
A hopeful sign is that there is broad agreement that default is wrong, which is as good as a law. In Sri Lanka expropriation happens because there is no knowledge that it damages investment. In fact, politicians who passed the expropriation law were laughing in parliament as they spoke in favour of it.
If Sri Lanka has to progress, the country has to be freed from the grip of these three shackles.
Sound money should replace monetary instability, which will bring back free trade and prosperity and stop rent-seeking import substitution, rent-seeking businesses from exploiting consumers poor or otherwise.
The greed of the import substituting, domestic producer Mercantilists, the blood profits of food producing landowners, who trade on the hunger of the poor, will end as they will not have a leg to stand on if the rupee stops depreciating.
Regime uncertainty should be eliminated, expropriated firms returned, and taxes fixed for long periods, preferably for a decade or more.
If there is monetary stability frequent tax changes would not be necessary. If the central bank is reformed Sri Lanka would not have to go to the IMF for balance of payments support and become a top customer.
IMF also helps with default workouts. It is possible to default with even dollarization.
It has happened to countless US firms, and also Panama. Greece which a Euro nation also went into a debt crisis. If markets lose confidence it can happen.
While nothing much works without monetary stability (Stability may not be everything, but without stability everything is nothing as Federal Republic Economy Minister Karl Schiller once said) the reverse is not true.
If the policy framework is bad, with import substitution, putting tax money into loss-making state enterprises, sudden tax hikes, policy changes, re-nationalization and a large public sector, growth will stall, which is bad for a country with 50 percent or more foreign debt.
A recovery from default may be more prolonged than a currency crisis. The sooner these three shackles are junked the better for everyone’s money.
This column is based on ‘The Price Signal by Bellwether‘ published in the August 2020 issue of the Echelon Magazine. To read Bellwether columns as soon as they are published, subscribe to Echelon Magazine at this link. The i-tunes app can be downloaded from here. (Colombo/Aug26/2020)