Situation Report: Our Balance of Payments

Sri Lanka has seen better days. Having exhausted nearly every possible alternative, it is turning to big players in the region to help meet its debt obligations and resolve a severe balance of payments crisis. The Reserve Bank of India has offered a USD 400 currency swap to the Central Bank, while the Bank of China, it is reported, has offered a USD 300 million loan.

Both institutions, according to the Central Bank Governor Indrajit Coomaraswamy, were considering scaling up their offers to USD 1 billion each. Whatever the amount is that will be doled out to the Bank, it will mask a fundamental problem: the international bond market is no longer a dependable source of funding and debt servicing.

Of loans and debt bondage

Several months ago, the government paid back a huge USD 1 billion international sovereign bond by resorting to foreign exchange reserves, once it failed to raise funds from the bond market. By the end of 2019, it will have to meet a further USD 5.9 billion debt, and by the end of 2022, it will have to meet loans estimated to mature up to USD 20.9 billion.

The January repayment, however, had the effect of boosting investor confidence, which is why the rupee, which had depreciated to an all time low of 183 per USD on January 3, appreciated by 2.4% by the end of the month. But this may not continue: Fitch revised its forecast for the rupee from 177 per USD this year and 183 per USD next year to 186 and 192.

Given these reduced circumstances, the country has no option but to look for help from regional players in the form of currency swaps, loans, and trade agreements. A USD 87 billion economy, Sri Lanka carries an unenviable public debt to GDP ratio of 78%. While countries as developed as Japan (238%), Singapore (112.85%), and the United States (106.14%) have bigger ratios, the point is not the proportion but the ability to meet the debt obligations. Most of Japan’s debts, for instance, are internal, while Singapore’s debts arose from its activities as one of the biggest and most successful entrepôt trading centres in the region.

Not that it’s all gloom and doom. The Economic Intelligence Unit of the Ceylon Chamber of Commerce expects the economy to grow by 3.5%-4%, although improving prospects thanks to stronger consumption and increased rainfall will probably be negated by upcoming elections and external challenges. Moreover, in its Report the Unit notes rather cautiously that growth will come from big projects such as the Hambantota Port and Port City which have been aided by the State. The Unit calls for stronger private sector investment instead, a shift away from such State-aided “big ticket items” established through bilateral relations.

Sri Lanka, in this context, faces a dreary future thanks to a worsening balance of payments. As an economy still dependent on exports of agricultural products, it faced an onslaught early on this year thanks to what Reuters refers to as probably “the worst pest infestation” in its history, in the form of crop-eating fall armyworms, which are estimated have destroyed more than half of the country’s maize and its rice and vegetable output. Predictably, it has led to an upsurge in imports on the one hand and increased government outlays through compensation for farmers on the other. The balance of payments, given that, took a hit.

Sri Lanka has almost always faced a balance of payments deficit. Its current account plus capital account deficit, for instance, rose by 34% from 2016 to 2017, representing not just an increase in imports but a decrease in the usual income sources the country has relied on, especially worker remittances. But while economists have pointed these out and have diagnosed the issue correctly, they offer solutions which fall short of what needs to be done and combated. Much of those solutions follow the same prescription: promote exports and free trade.

Because of electoral pressures the government has so far not implemented the more radical of these solutions, which involve liberalising the public sector, reforming immigration policies to open the economy up to brains from across the sea, entering into more trade agreements, and eliminating trade controls. Still, officials are reconsidering these proposals: the Central Bank Governor, to give just one example, recently lamented the fact that South Asia remains “the least integrated region in the world”, with inter-regional trade amounting to just 5% of trade as opposed to 50% in East Asia and 22% in Sub-Saharan Africa.

With an IMF delegation scheduled to meet officials this month, it would do well to check some of these proposals against the actual issues which have ailed our balance of payments.

Too much consumption, too little industrialisation?

To start off, does consumption benefit the economy, as the Chamber of Commerce Report implies it does? Former Central Bank Deputy Governor W. A. Wijewardena set the record straight: “increased incomes through expanded government expenditure programs… end up as incomes of people in other countries.”

Wijewardena had once asked some MBA students what they would do if they had LKR 10 million. The replies were symptomatic of consumption patterns among the young in the country: “they would buy a car or travel abroad or spend that money to buy various electronic equipment that have become the fashion of the day.” This writer can attest to these findings, the bottom line being that stronger consumption has led to higher imports through expenditures on items that have propped up the import and re-export/buying and reselling “Pettah industry.”

However, while pundits and economists have put a finger on and identified the issue, the solutions they tend to prescribe don’t really go around resolving it. Wijewardena contends that the answer is to sign and enter into free trade agreements with the more developed economies in the region. Such diagnoses assume that Sri Lanka should become an entrepôt centre by dint of its location: basically, that is should turn into a trading post where products are imported, stored, and re-exported. This is a retread of the “Sri Lanka should turn into another Singapore” mantra economists have been spouting thanks to the “urban myth” that Lee Kuan Yew looked to Ceylon in the mid-1950s when he was restructuring Singapore’s economy.

On that basis, it has also been implied that Sri Lanka doesn’t really need to develop a manufacturing sector. Speaking at the H. A. de S. Gunasekara Oration last December, W. A. Wijewardena argued that the 1972–1976 Plan of the Sirimavo Bandaranaike government was drawn to combat a balance of payments crisis, when the issue went deeper: it was to shift the country to the industrial sector. The failure of the government to facilitate such a transformation had to do with its limited impact. S. B. D. de Silva, in The Political Economy of Underdevelopment, noted that import substitution became the paradigm because export-led industrialisation had “expose[d] the economy to foreign competition” resulting “in [the] enervation and emasculation of indigenous industrial enterprises.”

The policy failed, however, because it merely enriched a rent-seeking class; what de Silva refers to as the “industrial bourgeoisie”, who would enrich themselves more in the J. R. Jayewardena era. As he said in an interview in 2017, “J. R. enabled [these merchants] to do legally, what they were doing underground.” Given this, even an institution like the Gem Corporation, set up to encourage the export of gems, became “a license for people to enrich themselves”, leading to a “scarcity economy” which, in the eyes of economists today, was a failure not of the rent-seeking merchants, but of the same policies which (ironically) were implemented to curtail those rent-seekers. It’s a case of not seeing the wood for the trees, simply put.

The issue goes even deeper, incidentally: as one writer put it, we have failed to industrialise to such an extent that while Ray Wijewardene developed the technology for two-wheeled tractors and J. C. V. Chinappa developed solar-powered refrigeration technology, Sri Lanka has not made use of either. The private sector has not lived up to what has been expected from it, not even in the garment sector, where we don’t manufacture a single needle.

Consider that this, the most pressing issue we have now, has been the subject of controversy since Sri Lanka became a colonial enclave, right down to the two decades before independence. In an article in the Ceylon Economist in 1956, Henry Oliver, the then Professor of Economics at the University of Ceylon, traced this problem through the debates in the State Council between those who wanted the economy to industrialise quickly, those who wanted the peasant sector to industrialise first, and those who felt the country was not ready for industrialisation. Oliver points at two State Council members in particular: George de Silva and N. M. Perera, the latter of whom accused the powers at the time of being opposed to industrialisation because of their plantation interests.

K. M. de Silva also notes this when he observes that the balance of payments, which had recorded “a handsome surplus” in 1945, fell down to a heavy deficit in 1947 in the absence of a manufacturing sector “independent of the processing of tea, rubber, and coconut.” From the lip service paid to industrialisation which never went beyond “some state-sponsored industrial ventures” emerged other problems, widening a rift between the needs of the economy, the solutions marketed to resolve them, and the measures taken to implement those solutions.

Clamping down on consumerism

The solution to meet the balance of payments deficit is three-fold: reduce imports, make better use of available resources, and ease traffic. Before the Finance Ministry clamped down on them through a set of taxes, one of the biggest reasons for the deficit was the fuel bill through the hike in vehicle imports, natural given that motor vehicle imports rose 117% to USD 121.5 million in February 2018 from a year before, representing a rise of 77.9% to USD 208.8 million in the first two months alone. Again, this paints a picture of local consumption patterns: everyone wants to have the same product to look better than those around them.

A report in the Daily Mirror makes this very clear:

“During the 10 months [of 2018], Sri Lankans spent a mind boggling USD 1, 391 million on personal motorcar imports. Sri Lanka’s public transport system remains at a pathetic state and the capital city Colombo has one of the worse traffic jams in the whole of Asia. Meanwhile, Sri Lanka spent USD 266 million on fuel imports — USD 62 million on crude oil and USD 201 million on refined petroleum in October, which together [is] up by 12.3% over the same month in 2017.”

This has led to an annual rise of 8.5% in the number of motor vehicles and an average of more than seven or eight million trips a day in Colombo. The emergence of application based taxi cab services, such as Uber, has fuelled this rise in private transportation even more. That has been buttressed by to another related dilemma: the lack of quality, diversity, and continuity in public transport. An efficient transport network, after all, can ease the burden of congestion that gets built up in peripheral areas like Borella and Nugegoda, and can check a recent disturbing trend: population growth being superseded by vehicle population growth. (Source: the Urban Transport Master Plan, the Japan International Cooperation Agency, 2014.)

It has been pointed out that the government should focus on a Bus Rapid Transport (BRT) system over a light rail scheme, since such a system would entail fewer debts, get faster off the ground, be implemented widely, and encourage people to use buses and trains more often.

The JICA Master Plan, shelved after the government changed, made a telling observation about the state of public transport: a rising suburban population has not been met with a rise in quality in transport services in the suburbs. Given that the middle class more or less has moved and is moving to these suburbs (Nawala, Rajagiriya, Maharagama, Piliyandala) and given that they have a great propensity to spend on transport to the city, a BRT system might just be what the doctor ordered for the deficit.

At the end of the day, whatever the solution, it will be the more consumerist sections of the population on whose shoulders will fall the responsibility of resolving that deficit. Worker remittances are, as was pointed out, stagnating, averaging around USD 5 billion a year.

Exports of primary products are also stagnating, especially since last year’s bumper harvest was negatively checked by the fall armyworm. The industrial sector, especially in areas like construction, is on the other hand facing a two-pronged issue: massive unemployment and also massive worker shortages. Part of the solution might be to “advertise” these sectors over the service-led growth model the government, since the end of the war, seems to have privileged. A whole bunch of reforms, extending even to our education system, will have to be implemented.

Meanwhile a set of taxes and a depreciating currency have managed to keep back the tide of rising imports, particularly vehicle imports (with registrations falling by 20% from November to December 2018), for the time being, though for how long one can’t say.

The ultimatum is only too clear, though: unless the BOP crisis is resolved and averted, the government will find it difficult to meet its debt obligations it already has, and the new obligations it will have to accumulate to meet older obligations. This will only worsen if the Fitch Report forecast turns out to be correct, and the rupee drops to 200 per USD.

The writer can be reached at udakdev1@gmail.com

Sri Lankan. History fanatic. Movie addict. Book lover.