The dollar crisis
Posted on July 12th, 2022
Sugath Kulatunga
In early March this year the Sri Lanka rupee was devalued by about 15% against the dollar. Since then, we have had a fuel and gas crisis and the escalation of all prices of essential commodities. The economic crisis led to Cabinet reshuffles several times and the resignation of the Prime Minister in early May after the island wide arson and the murder of one MP. Meanwhile from early April a youth protest called Aragalaya with a cry of Gota go home had camped out in Galle face.
During the last four months from the time of the devaluation the Parliament has met many times. Parliament has been preoccupied with finding a political solution to the crisis through an Amendment to the Constitution while the economic crisis has worsened with an empty Central Bank foreign exchange reserve. At the same time economic wizards who are responsible for the catastrophe are busy firefighting with their monetary arsenal. None of these bodies or their minions have the honesty and courage to say MEA culpa and own up their doctrinaire blunders and profligate borrowing habit in the past.
Meanwhile people are dying in fuel and gas queues. Children are starving in homes. Media is not in short supply of their variety of high-octane fuel which they are gleefully add fuel to the fire. There is a severe escalation in all prices. Inflation is running at over 50 percent. Out of desperation the youth led by university students came out in an island wide mass protest on July 9 in which they have occupied the President House, Presidential secretariat and the Temple Trees. The social upheaval of this catastrophic proportion was in the making. The economic crisis has now become an acute political crisis and made all the Constitutional amendments proposed irrelevant. Media was adding fuel to the fire. Nary a word on the real problem and how it can be solved. The time they spend on showing the misery of the people was as long as the queues for fuel. (There was a rare exception on Derana last Wednesday where a professional panel discussed the vast opportunities to earn dollars from our maritime assets).
The present economic debacle of dollar deficit is the result of irresponsible short-term policies of political leaders and delinquent behavior of economic wizards in the Central Bank monastery. The simple explanation that the persistent economic crisis of the country of chronic adverse balance of payments has been lost on politicians and many policy makers. In the pre-Corvid period, the remittances from foreign employment and income from tourism mitigated this predicament. But the vulnerability of these two sources was soon demonstrated with the strike of the Corvid pandemic The only solution was and continue to be is to ensure a positive trade balance. The proven path is in industrialization and not in subsistence agriculture of paddy farming which is practiced in Sri Lanka. With all the attention and investment in paddy farming over half a century we have to import wheat flour to achieve food self-sufficiency. The plantation sector which has been the mainstay of our foreign exchange earnings is beset with adverse terms of trade. The country has a high density of population, and the land man ratio is high. In modern agriculture the introduction of new technologies results in less workers employed in agriculture. It is only with industrialization that there can be full employment. But Sri Lanka has given some attention to import substitution industries which have a limited potential due to our modest domestic market. But we did not give priority to export led industrialization.
At independence Sri Lanka (Ceylon) had a stable democracy, a sound economy, and an efficient public service. Our external assets were equal to 100 percent of annual import value. Ceylon was second only to Japan in almost all social indicators and above South Korea at as late as the mid-sixties. Per capita income of Singapore was just a little bit higher than that of Sri Lanka at the time. It is now over USD 64,000 whereas ours is only USD 3845. The oft repeated question is why Sri Lanka with better physical resources failed to advance like Singapore.
What went wrong? Did we have the correct policy mix? What were the unforeseen events which impacted on the destiny of the country?
This note is impressionistic but unbiased. It tries to focus on turning points in the political trajectory of the country and the consequential policy determinations.
In 1944, the State Council resolved to launch a State Project of Industrialization in Ceylon. In the same year there was the – Industrial Corporation Bill. The concept of socialist industrialization was keenly advocated by the Marxist parties which believed that full employment could be achieved only through industrialization. In the same year J.R. Jayawardene (JR) moved a motion in the State Council for the preparation of a complete plan for industrialization. There was a firm bipartisan consensus on industrialization with a different emphasis on ownership. D.S. Senanayake (DS) was a prime mover of the plan for industrialization. This was also the time that Anagarika Dharmapala was haranguing the nation to industrialize. The following paragraphs highlight in a chronological order the performance in industrialization of different regimes in Sri Lanka.
At the general election of 1947 the UNP fell short of a majority and had to form a government in coalition with the All Ceylon Tamil Congress. The success of the left parties at the 1947 election alarmed DS who was an astute politician. He was aware that the left could build a mass base with industrialization. DS had a staunch commitment to the development of agriculture through colonization. He also had the motive to create a pool of peasant farmers who would be a strong base for the UNP. The project had both a nationalistic and political flavor and was vigorously pursued in the face of criticism from the left parties. But for the political bias, DS could have steered a two-pronged strategy for the development of the country leading to food security and full employment through industrialization. We had the funds, physical and human resources, and the infrastructure to venture into manufacture. But politics prevailed and we missed the most important opportunity for an early start of a manufacture-based economy with export orientation.
DS denied SWRD Bandaranayake (SWRD), who was at the time the leader of the House, his due place, and maneuvered to get his son Dudley Senanyake to succeed him as Prime Minister. This resulted in SWRD creating a new party resulting in both positive and negative consequences. The split created divisive politics based on ideology and ethnicity. This was the dawn of the era of chauvinistic and emotional politics.
This maneuver also kept JR, the best brain in the party, out in the cold. If JR succeeded DS, he who believed in planned industrialization could have introduced industries with modern technology with the help of the Japanese who were under obligation to him for his open support to Japan, at the war reparation conference at San Francisco in 1951,where he rejected reparations and quoted the Buddhist saying Nahi verena verani.
With the Korean Boom’” in 1949 Sri Lanka had a trade surplus and the plantation sector was strong and bringing in sufficient foreign exchange. This background may have made the policy makers of the time complacent on the performance of the economy and other than a few import substitution industries, industrialization on a larger scale was not contemplated
Dudley S who inherited the leadership was a perfect gentleman but a weak leader. He followed the policies of DS giving priority to agriculture. He resigned in the face of a civil disobedience campaign (Hartal) organized by left parties. With his resignation, Sir John the strong man in the UNP became the Prime Minister. Sir John took over the leadership at a moment of history in politics in Sri Lanka when there was a tempest of opposition to the policies of the UNP. It also coincided with a socio-cultural groundswell spurred by the Buddhist Commission Report. The flamboyant style of Sir John was not helpful in resisting the forces against the UNP.
The MEP led by SWRD swept into power in 1956 on a wave of religious and cultural renaissance. But SWRD also believed in planning and development based on nationalism and state ownership. He established a Planning Secretariat which formulated a 10 year plan in consultation with renowned development economists such as Gunnar Myrdal, Joan Robinson, Kenneth Galbraith and Nicholas Kaldor. It is reported that Myrdal recommended the invitation of foreign investors on a Build Operate and Transfer basis. The period of foreign operation was to be limited to 20 years. (The Prima investment during the time of JR was on this basis). The ascent of SWRD was supported by the Pancha Bala Vegaya led by leading Buddhist clergy some of which acted as kingmakers. The assassination of SWRD by the same kingmakers terminated the planned development in the country. The proposals and the 10-year plan of SWRD were not implemented by subsequent governments. If we had FDI on a BOT basis we would have had access to both markets and technology which would have had a spread effect. In1957 Industrial Corporation Act No 40 was enacted. But the industries established under this Act were for import substitution which to some extent relieved the pressure on the trade balance.
On the assassination of SWRD, Philp Gunawardhane, the most dynamic and experienced minister in the MEP government was denied the Prime Minister’s position. That prevented the continuation of the 10-year plan.
During the regime of Mrs. Sirimavo Bandaranayake between 1960 to 1965 she followed in the footsteps of her husband SWRD. She reveled in international relations and supported the Non-Aligned Movement. Mrs Bandaranaike became a founding member of the Movement along with great world leaders like Nehru, Tito, Sukarno, Nasser and Nkrumah.
During this time certain industries were confined to the State sector which hampered private sector led industrialization. Sri Lanka had introduced a dual rate of foreign currency was introduced in order to reflect the real value of LKR.
As the Central Bank annual report of 1964 reveals that the focus was to continue and even intensify efforts to step up the production of her staple exports”
CBSL considered that in the long run Ceylon could also add to her export ear
nings through the sale abroad of industrial products. Indeed, the establishment
of export capacity in the industrial sector is, in view of domestic market
limitations, a necessary condition for both large scale industrialisation in Ceylon
and for a long-term solution of her external payments problem.” However, CBSL envisaged constraints such as Industrial exports on a large scale might also be dependent
on arrangements for regional co-operation in Asia which would help to improve
access to regional markets. Moreover, the successful establishment of large scale
industrial capacity in Ceylon would itself involve increased imports of machinery,
equipment and raw materials.”
The conclusion is that as far back as 1964 there was realization that SL should resort to industrial exports to generate foreign exchange to increase imports, but the approach was lukewarm and there was no policy at political level to implement an export-oriented industrialization program.
Duringthe time of the return of the UNP government under Dudley from 1965 to 1970 therewas again an emphasis on Agriculture. This too was on paddy farming where the green revolution of the introduction of hybrid varieties of rice like H4 increased paddy yields significantly. But not much impact was made in areas like horticulture and floriculture where countries like Thailand have made them high foreign exchange earners.
The coalition government of 1970-1977 had high expectations of development with the participation of the intellectuals of the left. But it was plagued with serious constraints such as the JVP insurgency of 1971, a marked decline in the terms of trade, increase of the price of oil from an index of 147 in 1972 to 826 in 1975 (1969=100), global financial crisis and severe drought affecting food production. Above all these there was the ideological difference between the two coalition partners which finally led to the breakup of the coalition. 1970 -77 government was more firefighting than concentrating on long term development.
The 1977 JR regime missed many opportunities under fortuitous circumstances and also made more self-inflicted blunders and evaded emerging opportunities. The 1977 regime established new institutions like GCEC and EDB for investment and export development (which had their origins in the previous regime) but introduced a wide-ranging package of neoliberal policies. The government removed all import controls and opened the floodgates to imports. These free-market policies destroyed many nascent domestic and import substituting industries and also had a severe adverse effect on domestic agriculture. The import liberalization diverted most of human and financial resources into import related activities. Although the government was keen to encourage exports the sector was starved of finance which went to meet the incessant demand for import and construction activities that carried minimal risk. The Banks were more than happy to finance these activities which involved low risks. Import finance was recoverable in a short time. Finance for investments exports and investments in export projects carried interest rates as high as 25 percent. The 1977-regime went into a frenzy of unwarranted and unplanned privatization of state enterprises. This was contrary to the successful development model of Singapore, which adhered to the basic principles of a free market economy, but never shied away from state planning or state ownership where deemed important‚.
The JR regime did not focus on economic restructuring other than dismantling existing institutions like the Marketing Department and the Paddy Marketing Board which were the connecting links between the producers and consumers of food products. The adverse impact of this policy is felt even today. Unlike Sri Lanka, in 1979, the Singapore Government started a program of economic restructuring. This was achieved by modifying education policies, expanding technology and computer education, offering financial incentives to industrial enterprises and launching a productivity campaign‚. Sri Lanka Government had no innovative policies. Even today the education system in SL is not producing the manpower to fit the needs of skills and knowledge for now and the future.
The American Business-Higher Education Forum said in 2005 that ; Increased global competition, lackluster performance in mathematics and science education, and a lack of national focus on renewing its science and technology infrastructure have created a new economic and technological vulnerability as serious as any military or terrorist threat.” This is more relevant to Sri Lanka.
Under the government of Prime Minister Ranil Wickremesinghe, his magnum opus was Regaining Sri Lanka” with emphasis on poverty alleviation where he identified Four Challenges Facing Sri Lanka i.e.
I. Increasing Employment – Creating 2 Million New Jobs
II. Overcoming The Public Debt Crisis
III. Resources For Reconstruction
IV. Increasing Income Levels – Higher Productivity & Increased
Investment
It also had a divided power centers with the President and Prime Minister in two opposing parties. Ranil was also preoccupied with a dubious peace move with the LTTE.
The challenge of the adverse balance of trade was not even mentioned under the Regaining project. Export led development was not even envisaged.
President Chandrika Bandaranayake claimed that her economic strategy was market driven but geared to achieve human development and prosperity at the grass roots level. Her policy was to channel development efforts and resources to domestic capacity builders at the village level who are the pillars of the national economy.
Her Government’s stated policy was free market economy with a human face”designed to give access to the benefits of development to all sections of the population.
This again was a populist policy evading the real problem of the trade gap and debt. There was no policy on industrialization, only privatization of existing SOEs some of which were making substantial profits.
The next regime of Mahinda Rajapaksa came out with an elaborate and ambitious pollical manifesto called the Mahinda Chinthanaya with the objective to transform Sri Lanka into a strategically important economic centre of the world. The thrust was to develop the country as a Naval, Aviation, Commercial, Energy and Knowledge hub. Closing the trade gap and industrialization did not come into the picture. MR concentrated on developing infrastructure. The supreme contribution of MR was the ending of the separatist war which cost the country 200 billion dollars.
But the Chinthanaya had no thoughts on the development of exports and closing the gap in the balance of trade.
The Yahapalanaya government of Maithripala and Ranil were bent on penalizing leaders of previous regimes. The Maithripala political manifesto promised to achieve for the country ten times the development that occurred during the past six years only by preventing mega corruption that existed in the country. There was no serious attention on long term issues like the trade balance and debt. To begin with, the attention was on amending the Constitution to transfer powers from the President to the Prime Minister. Thae government was involved in major scams like the Central Bank bond issue. In the latter stages the rivalry between the President led to divert focus on serious economic issues. Finally, the Easter bomb blast put back the country by many years.
The government of President Gotabaya Rajapaksa presented a comprehensive manifesto titled Vistas of Prosperity and Splendour” with 10 Key Policies i.e.,
1. Priority to National Security
2. Friendly, Non-aligned, Foreign Policy
3. An Administration Free from Corruption
4. New Constitution that fulfils the people’s wishes
5. Productive Citizenry and a vibrant Human resource
6. People Centric Economic Development
7. Technology Based Society
8. Development of Physical Resources
9. Sustainable Environmental Management
10. Disciplined, Law Abiding and values based society
Gotabhaya (GR) government started with an abundance of good will and expectations. Within a few months of the new government the Corvid 19 pandemic battered the country and the full attention of the government had to be diverted to the management of the pandemic. When the country was coming out of the health crisis the President on the hair-brained advice of dubious experts made a serious blunders of rushing into banning chemical fertilizer which generated intense reaction from the farmer community. The financial wizards of the Central Bank and the Treasury totally mismanaged the scarcity of dollars. The President was ill advised on the financial crisis and did not take timely action at least to soften the impact.
In early March this year the government resorted to devaluation which has not helped in a solution to the problem and has resulted in price escalations in essential commodities and their scarcity. Cost of living has become unbearable to the vast majority of the people who finally has said enough is enough.
One of the grave mistakes of all governments was the neglect of the chronic problem of the trade gap and not increasing industrial exports. Industrial export venture would also have generated productive employment. Educated employment was a recurring problem for which all governments had the facile solution of absorbing them to already over staffed public service and SOEs which made the public service a burden on the government. Over staffing of public enterprises made them loss making white elephants.
While political leadership were blind to the critical problem of the adverse balance of trade they made prejudicial decisions which affected export development and the economy of the country. A turning point was the decision taken by the first Prime minister DS to focus on paddy cultivation in the dry zone to the exclusion of industrial development. This was in spite of DS ardently supporting In the State Council in 1944 to launch a State Project of Industrialization in Ceylon and the Industrial Corporation Bill.
Later, when in South Korea President Park directed the leading business houses to venture into high tech industries, president Premadasa forced leading business houses in Sri Lanka to invest in low tech garments industry in rural areas to generate employment. While South Korea through industrialization developed into a leading industrial powerhouse in the world, Sri Lanka continues to excel as a superior tailoring shop.
Even in the 1977 regime the GCEC was keener to fill up the Zone rather than attracting technology. The result was GCEC became a haven for apparel quota seekers.
In 1983 the Black July resulted in Sri Lanka losing high tech investments by firms like Samsung and Motorola. Samsung went to Vietnam and now their investment in Vietnam has exceeded 17 billion US dollars mainly in high-tech industries.
Rather than export led development and aim at a healthy balance of trade and payments and provide productive employment, all governments resorted to devaluation and prolific borrowing as the remedy. The outcome of many devaluations and IMF prescriptions has been negative as far as the trade balance is concerned. The LKR which was 8.83 in 1976 declined 15.56 to a US dollar after the 1977 devaluation and slumped to 100 per $ in 2005 and was 135 to a $ in 2015 and today it is frozen at 365 per one USD.
In 1977 before devaluation there was a positive balance of 41 million US dollars which became a minus 680 $ in 1978, minus 3656 in 2007 and rocketed to 10343$ million in 2018.
The panacea adopted to solve the trade deficit was to devalue the currency with a view to discourage imports and induce exports. Devaluation has been a futile exercise in Sri Lanka where at the time of independence in 1948 the US dollar was only 3 rupees and now it is over 350 rupees. We continue to chase the dollar without focusing on the real problem of poor export performance.
The two-fold objective of a devaluation is to stimulate exports and reduce imports. What have we done to stimulate exports? Have we diversified our supply base? Have we introduced new technology? Have we made full use of our human resources and physical resources in minerals, marine products and horticulture or in the scope for adding value to existing products? What incentives are there for innovations and their commercializing?
Now with the massive devaluation of the currency there is an excellent opportunity to push for a concerted export development drive. It appears that the political leaders have now got into their thick heads that the only solution to get out of the dollar crisis is to produce for export and export more. In the 1980s when the EDB went into operation it had a slogan export or Perish” Our decision makers have now trying to an economy which has perished. Had the policies and objectives of the EDB were implemented Sri Lanka would have ‘Exported and Prospered’.
Exports cannot be increased overnight. It is necessary to have both short term and long term programs. In the short term we could concentrate on adding value to existing products and making the best use of our existing physical and human resources. But in the long run the country has to improve its export supporting services and industries.
Taiwan is an Island smaller than Sri Lanka with a similar population. It was a predominantly an agricultural economy. Today it is a high tech powerhouse leading the world in a number of high tech industries. It has a per capita income of 36, 000 dollars. At the beginning of the 1980s, Taiwan increased the ratio for senior vocational schools and general high school to 7:3. By 2012 there were 155 senior vocational schools, 14 junior colleges, and 77 universities/colleges of science & technology, totaling 246. It is the education system that has sustained the significant development of this small nation. Our education policy must be revamped if we are to progress in technology and expand high valued exports. Far back in 1944, the Kannangara education reforms proposed practical schools (vocational) but this aspect of reform has not been implemented seriously. The private sector should be encouraged to conduct Technical and Vocational training. It could be useful to request India to establish a branch of their IIT in Sri Lanka.
If the government is serious about giving priority to export development the export cess should be made available in full and directly to the EDB. The EDB should use these funds on export incentives and for venture capital investments in pioneering projects. Export and investment promotion should be made the primary function of our representatives in foreign countries who should be given targets for FDI and market access. Business leaders should be encouraged with incentives as done in South Korea to venture into selected high-tech industries. One effective incentive would be to give them import quotas which could be resold. EDB should again be made a lead project of the government.
For the first time, two natural gas discoveries were made in two wells out of the three wells drilled in Block M2 by Cairn in 2011.
A few more fau pas. :- Sri Lanka’s Petroleum Resources Development Secretariat (PRDS) with the assistance of regional experts estimated that the Mannar basin alone could have the potential to generate over two billion barrels of oil and over nine trillion cubic feet of natural gas(9 TCF), which would be sufficient to fulfil a substantial portion of Sri Lanka’s energy needs for the next 60 years.
https://www.news.lk/fetures/item/27867-oil-and-gas-in-sri-lanka-are-we-on-track
It took another 10 years to enact Petroleum Resources Act, No. 21 of 2021 to provide for the establishment of the petroleum development authority of sri lanka; the formulation of a national policy on upstream petroleum industry and regulation and management structure capturing the maximum economic value of domestic petroleum resources.
The present estimate of the Mannar Bay oil and gas resources is claimed at US$ 267 billion. Cabinet approved the proposal of the then Minister of Energy to invite investors to exploit the resources on a fifty/ fifty basis. He was planning to present the proposal to a forum of oil explorers on the 15th of March 2022 but before that the Minister was sacked.
It is noted that the government policy and action on oil exploration was entirely erratic. The last act of preventing the presentation of the present proposals to the international oil interests at this moment when oil prizes at their peak is criminal.
We should have offered one well in 2011 to an investor for 20 years on a Build Operate and Transfer basis. This was the formula for FDI that Gunnar Myrdal suggested to SWRD in 1957. When this well was in operation other investors could have been invited on our terms.
So, the present crisis is a result of all governments from 1960 onwards for lack of a vision and inability to exploit a proven resource. While we were dilly dallying Ghana attracted investors, such as China Development Bank Corp, which lent $1 billion to Ghana for developing its natural gas infrastructure and resources. In 1990 a US dollar was 246 cedis but today a dollar is only 8 cedis.
Another failure in the determination of development priorities was on the Sapugaskanda Oil Refinery built in 1969 with a capacity of 35,000 bbl/d. This was expanded thereafter to a processing capacity of 50,000 bbl/d to meet the domestic requirement of Petroleum fuel. Singapore which does not produce a drop of crude oil developed a refinery capacity of 1.51 million bpd by 2018. Our vision was to build a refinery capacity to meet only the domestic demand whereas Singapore went into the export of refined products.
Sapugaskanda refinery also had a facility for the production of urea.It had a capacity for an annual production of over 294,000 tons of granulated urea valued at US $ 79 million. This facility was sold to an Indian buyer and it is mentioned that there is no information in the public domain as to how much this urea plant was sold by the Sri Lankan Government to the Indian company. (https://www.ft.lk/Agriculture/The-saga-of-the-fertiliser-industry-in-Sri-Lanka/31-700789)
If all the refined petroleum products could be produced in our own refinery we would have cheaper products and avoid anxiously the arrival of a refined products ship.
On the management of resources Sri Lanka had a golden opportunity of holding a reserve of crude oil which even USA does, using the Trincomalee oil Farm which we got for a pittance from the British. While Sri Lanka did not realize the vital importance of the Oil Farm India was so cognizant that in the subterfuge of the Exchange of Letters in the Indo Sri Lanka Accord It was included at item three as -III) The work of restoring and operating the Trincomalee Oil Tank will be undertaken as a joint operation between India and Sri Lanka. Yahapalanaya gave the Oil Farm to India on a platter.
A government with a vision could have made use of these tanks to stock oil when the prices were down.
During the last few years fuel consumption has swelled rapidly due to the surge in the import of vehicles mainly high-powered gas guzzling vehicles. It is known that more vehicles were allowed to be imported to collect a higher amount of customs duty. The surge of imports and the over concentration of economic activities in the city has led to a severe traffic congestion. It was estimated in 2005 that the average speed on Colombo roads falls below 15 kms per hour. It must be very much lower today. At such speeds, fuel consumption doubles, consequently increasing air pollution as well. In addition to the direct cost of fuel there is also the opportunity cost to the commuter of the time lost on the roads.
Colombo roads have been widened as much as possible and it is impracticable to widen the present roads any further. There are several actions that could be taken to ease the traffic congestion marginally. These include introducing flexi hours in officers thus smoothing the traffic peak. In many countries heavy goods vehicles are kept away from the center during peak hours. Charging a fee on single passenger vehicle induces passengers to use vehicle pools. Another method is the use of park and use of public transport is being presently tried out. The improvement of public transport is perhaps the best way to wean away commuters from using private vehicles.
When all countries in the world were encouraging the use of electric vehicles, Sri Lanka in the 2015 interim budget’ imposed a prohibitive tax on hybrid vehicles of 92 per cent of the total value of the vehicle. One wondered whether it was a scam to induce the import of petrol vehicles of Indian makes. It is estimated that if all vehicles in Sri Lanka were to move to hybrid, we could save 25% (or more) on the total import value of fuel for motor vehicles.
It is truly a tragic tale with self-imposed blunders. One cannot imagine that the politicians and the advisers were not aware of the dire consequences. All of them deserve to be ‘sent home’.
Sugath Kulatunga
PS. The tragedy of the EDB will be dealt with in another article.