COULD SRI LANKA BECOME A COMPETITIVE ECONOMY IN ASIA PART 2
Posted on February 13th, 2022

BY EDWARD THEOPHILUS

Bulky ownership of the banking market of Sri Lanka is in the government hand. This includes as Bank of Ceylon, Peoples Bank, National Savings Bank and several development banks, investment banks and long-term financial institutions such as mortgage and national development banks. As the government is not in a position to provide capital for state banks, they are in a difficult situation to profitably manage and provide investment support to the private sector and public enterprises. There are few banks under private ownership with a small capacity to finance the development thrust of the country, but they are also depending on the government business services subject to direct or indirect control measures of the government. The existing competition within the banking market appears to be like in house conflict between family members with many regulations. It is also observed that banks are working as a secret cartel when referring to decisions making process of interest rate and bank charges, application of procedures and many other matters. In this environment, the banking market in Sri Lanka restrains attracting foreign investments to compete and provide greater benefits to customers. The efficient operations with the ability to provide financial services for domestic investments and foreign investors in expanding export market.

Recently, I have examined annual reports of government banks and found that profit figures of these banks comprise  Rs Billions of exchange revenue, which automatically made of declining the foreign value of Sri Lanka rupee. This automatic process is quite easier because of a weak economy in the country, the foreign value of domestic currency declines every day generating rupee profits from existing foreign assets.  This exchange profit is not a result of the quality of management stewardship of banks. 

The billions of risk assets of banks were funded by borrowing from either domestic or foreign sources, issuing debt instruments at a higher rate of interest.  As the government guarantee ensures the safe return of funds to investors and debt instruments mark at a higher rate of interest, foreign and domestic investors will subscribe to them. The bank management indulges this situation as a higher achievement covering actual truth to the government and customers. In this situation why Sri Lanka’s government is reluctant to consider alternative options for capitalizing banks.

The technique of banks generating liquidity for lending business has become a serious repercussion for indebtedness of the country. It has already created structural issues in the economy with a possibility of austerity measures to be insisted by international financial institutions when they support the country. The other serious issue of the banking system is that it has not made realistic credit lost provisions after successful risk asset reviews, which is the global strategic technique that is used to realistically estimate the required volume of specific and general provisions for total credit portfolios.

When examining credit portfolios of banks, obviously they are comprising a large volume of non-performing credits, in which the pace of bad debt is possibly over 15% but the bank management calculates interest earning for these non-performing credits adding it into the banks’ revenue component as provided paper profits. If there are 15% non-performing credits in the aggregate lending portfolio of a bank, it means that the bank is not making profits from its lending business. 

When these interest revenue and exchange profits are transferred to the treasury, they will use for government spending. That means paper money will be added to the country increasing inflation. There are several reasons to increase non-forming credits in the banking system of Sri Lanka, but I do not know to explain them in this article as it has limited space.

The other visible issue in the government bank imperatives is that many subsidiaries are attached to individual banks and these subsidiaries eat a considerable portion of bank profits.  Why did these subsidiaries created is a hard question to answer, sometimes ago it was a pattern of the management of government banks that when a top banker retires from the service, he or she creates a subsidiary using bank funds as initial capital?  The purpose of the subsidiary was to continue in the service by the retired person indirectly enjoying banks’ facilities. Before creating subsidiaries, banks never evaluated the viability of subsidiaries from a different point of view.  The government banking system also promoted opening branches overseas or creating subsidiary branches overseas purely for management indulgence purposes rather than profitability or investment diversification purposes.  Sometimes, the purpose of creating subsidiaries appears to be contained undisclosed dishonest elements to a certain extent.  This type of management is not successfully supervised or controlled by the top management of banks. It is quite possible to assume that politicians or regulators have no clear understanding of this type of risky manipulation in the government banking system.

Sri Lanka needs to maintain strong domestic and international confidence in its payment system.  During the last several years there has been a major news item in international media about the financial crisis and the public confidence in the payment system of various countries. Although it was not a serious issue, bad debt in the banking system created distress in many countries. If such a situation incurs in Sri Lanka, it is difficult to imagine what would be the probable results in the country.  There had been several financial failures in the country since the beginning of the 1980s.  Some people, who were badly affected by failures, are still cursing to some organizations and their management as they lost the savings of a lifetime.  The style of the management of financial institutions needs to reflect how they support to secure the payment system of the country.

Although the investment regulations in the country indicate that investors are allowed to borrow working capital from the domestic banking system, the current banking system is unable to provide the required volume of credits to investors as they expect at a competitive rate.  The capacity of domestic banks to provide lending support for foreign investors is highly confined to a lower level than investors expected in the country.  In this connection, Sri Lanka’s trading banks cannot ignore BIS regulations, which insist on the capital requirement base on risk-weighted assets.   In this background, how could Sri Lanka become competitive in the financial market to attract foreign investments for expanding export earnings?

The answer to these vital issues would be dependent on the strengthening of Sri Lanka’s banking system with a portion of foreign capital injections and gradually privatizing the government banks for broadening the ownership as it was done in Australia for government banks under the microeconomic reforms in the 1990s. The banking system of Sri Lanka is in a serious distressful situation because the government and domestic industries look for finance from banks rather than using other alternative sources. Sri Lanka needs to consider how Asian countries resolved problems promoting the Asian Bond Market.  The distress of banks in Sri Lanka could be reduced by 50% by promoting an effective domestic bond market among industries and provincial governments. To be succeeding the bond market, it needs support from the government or regulatory authority by offering the guarantee for bond investment.

The superannuation market of Sri Lanka remains in the government hand which controls entire operations of the market such as basic administration, investments, regulation and all other related activities. This market is comprised of employee’s provident fund, employee’s trust fund and pension fund while several small funds related to finance and insurance institutions’ employees prevail under the control of individual institutions.  The operative controls and the management of funds are performed by the Central Bank of Sri Lanka, which is the regulatory authority and it is playing the role of market operations.  No country allows the regulator to play market operations as the role of the regulator is to fundamentally regulate the market for efficient and effective operations and to maintain its stability, integrity and confidence of investors.  The management of the superannuation market in the modern era becomes a highly risky task as the volatility in investment markets such as investment in stocks or many other lending-related activities are subject to contain a high risk. The decline in oil prices has badly affected investment returns of super funds.  In this situation, the government might have thought that superfunds must be on its hand rather than allowing it too risky players.

The entire superannuation system of Sri Lanka has become an investment source for treasury and Central Bank bonds, which are sources for government spending.  In other words, the government of Sri Lanka indirectly uses the superannuation market to finance the budget deficit and payment for foreign debts. Generally, the superannuation systems in developed and emerging market economies use to promote private investments through the stock market.  It does not mean that the investments of the superannuation market should be direct only to risky investments in stocks, the investment managers need to set a diversified portfolio in which a reasonable component could be given to investment in government bonds.  The problem in the current system is that money generated by the government of Sri Lanka from issuing bonds seems to be spent for recurrent expenditures to maintain loss-making public enterprises or corrupt spending in provincial governments and expensive government services that are not essential to the country.

Sri Lanka desperately needs an average of 10% of annual economic growth, which supports double the economy within less than seven years.  The current expenditure pattern of the government would not support strong fiscal stability to the government unless it is focused to have a balanced budget or an excess budget over the expending. The government of Sri Lanka provides too many services to the community, which is addicted to government services at free of charge, or a subsidized price rather than paying for the value or user-pay price like payments for quality services.  The traditional left politics has created a false consciousness among the members of the community on private services.  There is no comparative logic in left political ideology against private sector services.

Public investment management is under the hand of government henchmen, who have no either qualifications or skills or experience in managing such organizations.  They do not know to review the operational capability, efficiency and efficacy of organizations management and make a productive policy structure to the organizations.  This situation has been in Sri Lanka since the so-called socialist revolution in 1956 and no elected government has been taken successful action to solve the problem, but all political parties were using the issue like a beggar’s wound to gain power but the system is allowed to continue creating problems in the economy without nationhood attitudes. 

The trade union system of Sri Lanka is an invisible hand of left politics, which had supported certain individuals to be a part of the elected parliament without an intention to take over the power to fix the problems.  The broad objectives of the trade union systems of the world are expanding focus on broader areas such as generating productivity in the workplace, safeguarding workers’ rights as well as industrial democracy and equal opportunity, strengthening employees’ capacity, knowledge and skills and so on.  In this situation, it is essential to educate trade union officials on the government policy and the possible positive impact of the government policy on members of trade unions.  The best example for this situation is the proposed reforms on the superannuation market, which focuses to establish a strong independent organization to manage superfund’s removing from the current status, which is a hostage of the regulatory authority. However, the effort of the government was dead in the labour room as the government did not educate trade unions on the policy matters before presenting them to the parliament.

Sri Lanka may be a country with higher basic literacy, but the financial literacy of people is weaker compared to Western countries and the ability of citizens to comprehend financial transactions and constructively participate in the economic and financial decision-making process is limited to a tiny extent.  In this situation educating the general public, workplace employees, as well as politicians are key aspects to the success of developing the competitive economic environment in the country.  Newspaper reporting in Sinhala, Tamil and English media demonstrate that politicians always talk rubbish on political platforms, which are reported to the public by newspapers without considering the negative impact to the community.  The role of politicians should be comprised of educating the public on government’s policy matters for a successful implementation of policies rather than making attention to drawing stories on political platforms.          

International competitiveness is a circuitous notion that involved a variety of factors but product quality, cost of production and cost leadership are major contributing factors to maintaining international competitiveness.  In many instances, the product quality and the other factors are not compromising because when the product quality is higher, the cost of production should be lower.  Concerning the quality aspect, many Western countries believe that they could maintain a competitive leadership in the world as the product quality of Western countries assumes to be higher.  Despite this notion, China and other Asian countries were able to achieve competitive leadership defeating the Western world using the natural ability of Asian countries to make products at a lower cost using fairly cheap labour.  It can be observed that China maintains international competitiveness using a group of factors rather than sticking to a single factor.  In this connection, Sri Lanka needs to learn a lot and also needs to select areas where the country could be competitive when compared to other countries in Asia.

Attracting foreign investment to Sri Lanka using factors that are competitive with other countries is vital and in this sense, it is necessary to align to service industry rather than industrial productions which consume more capital or high-quality labour.  Under the economic diversification programs since 1965, Sri Lanka identified several subsectors of the economy such as tourism, foreign employment and many others. It appears that the government policy has not much focused on the service sector.  For example development of port services, tourism, real estate services, and leisure activities would be in a highly competitive environment unfortunately Sri Lanka is losing this opportunity due to international politics under the present government, which got away from the Chinese alliance which can make a positive impact on the development of competitive services.

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