Editors note: Read the original article by the Governor of the Central Bank of Sri Lanka on Forbes.com or as a PDF here. Photo by Dinuka Liyanawatte/REUTERS, courtesy the Curionimist.
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A Rejoinder to the Governor of the Central Bank of Sri Lanka
The Governor of the Central Bank of Sri Lanka (CBSL) has penned a compelling article entitled “Practical, not Conventional, Wisdom has driven Sri Lanka’s Rebuilding and Reconciliation” which was posted on the official website of the CBSL on Thursday 3rd April 2014 and abruptly removed on Monday 7th April 2014 for reasons best known to CBSL. However, this author has downloaded the Governor’s article which is available on request. The objective of this rejoinder is to demystify the theory of “practical wisdom” postulated by the Governor from what he claims to be the “conventional wisdom” in economic science.
Macroeconomic theories are formed on the basis of long-term real-time practical experiences of numerous countries in various stages of economic development in various time periods of human history. Similarly, microeconomic theories (aka theory of the firm) are formed on the basis of long-term real-time practical experiences of numerous firms in various sectors of the economy in various time periods of human history. Hence, we would argue that what is conventional economic wisdom is in fact practical economic wisdom and therefore there is no difference or contradiction between the two. What is posited in this rejoinder is the illusory economy championed by the Governor versus the real economy of Sri Lanka.
The Governor claims that “a staggering US$ 3.2 billion” has been spent over the last four years (2010-13) against the conventional wisdom, which has resulted in rapid clearance of landmines, speedy resettlement of IDPs, and all around economic revival in the Northern Province though he does not provide any statistics of such economic revival. Such practical wisdom, so he claims, has resulted in a peaceful country with economic growth all around the country and dramatic decline in levels of poverty.
It is a fact that no other post-independence government has poured such a colossal amount of public money/investments into the North (especially in the Vanni mainland) than the incumbent government. However, what the Governor has failed to acknowledge is that three-times more than the money spent on economic development in the North has been spent on Defence in the past four years (>US$ 2 billion annually), which has been rising every year since the end of the civil war in May 2009. What is the practical wisdom that necessitates defence expenditures to continue rising even five years after the end of the civil war? If such a colossal amount of expenditure on defence is necessary to maintain peace, how can the Governor claim that it is the US$ 3.2 billion spent on economic revival that has ensured peace? Besides, what the Governor fails to understand or overlooks is that absence of “terror” is not necessarily ushering of peace.
Further, the Governor has failed to acknowledge that official poverty levels in the eastern and northern districts are significantly higher than in most other districts in the country; official unemployment and underemployment rates in the north are more than double that of the national average. Many economists, including this author, claim that official statistics on inflation, poverty and unemployment are gross underestimations. For example, according to this author’s estimation while the countrywide unemployment rate was 18.0% in 2011 (though the official rate was just 4.2% in 2011), it was 32.8% in the Northern Province in the same year.
The Governor highlights the average 7.5% rate of growth of the GDP in the past four years (2010-13) after the end of the civil war compared to the average 5.0% growth rate during the course of the civil war. Is this 50% increase in the annual economic growth rate an optimal achievement? The sources of economic growth are more important than the growth itself; recent higher economic growth in Sri Lanka is not much earned growth (for e.g. through rise in productivity or employment generation), rather significantly borrowed growth (fuelled by growth in public expenditure largely through external commercial borrowings).
The Governor also self-congratulates for going against the grain, which has resulted in sustained single digit inflation, low interest rates, declining budget deficit to GDP ratio and public debt to GDP ratio, and rising gross official foreign exchange reserves.
The single digit inflation was attained partly by changing the methodology by which the consumer price indices are compiled by the Department of Census and Statistics whereby commodities that significantly contribute to inflation (such as alcohol and tobacco) were taken-off the basket of consumption goods taken into account in the compilation of consumer price indices. Inflation was also contained partly by resorting to greater external commercial borrowings in lieu of domestic borrowings thereby making the economy vulnerable to external shocks. Of course low inflation resulted in low interest rates but that did not result in higher private sector borrowings because “excessive monetary expansion was contained through unconventional monetary policies such as tight quantitative tightening” according to the Governor.
The declining budget deficit to GDP ratio and public debt to GDP ratio was achieved NOT through any deceleration in public expenditures or public borrowings. There is an “innovative” (albeit high risk) trend of coercing the state-owned and private commercial and specialised banks and state-owned enterprises to borrow in the international capital markets at the behest of the government; while this “innovative” practice of public finance may have reduced the budget deficit to GDP ratio and public debt to GDP ratio, it has also increased the probability of insolvency of many state-owned financial and non-financial enterprises. Moreover, there is a growing trend of government purchasing shares in private commercial banks thereby gaining a foothold in these financial institutions in order to coerce these private financial institutions to borrow in international capital markets and then lend to the government. Furthermore, payment of utility bills to the state-owned Ceylon Electricity Board (CEB) and Ceylon Petroleum Corporation (CPC) by government departments and institutions, and state-owned enterprises such as the Sri Lankan Airlines are deliberately deferred in order to artificially curtail recurrent expenditures of the government thereby jeopardising the financial stability of CEB and CPC. The losses incurred by state-owned financial and non-financial institutions runs into over US$ 2 billion per annum which are contingent liabilities of the government but not shown in the public financial accounts and thereby manipulatively lowering the budget deficit to GDP ratio and the public debt to GDP ratio.
In yet another “innovative practical wisdom” the foreign currency reserves in Sri Lanka are bolstered not through greater earnings of foreign currency (by way of growth in exports and lower trade deficits) but through greater external borrowings, especially in international capital markets at exorbitant price. The value of Sri Lankan rupee is maintained artificially high by the Central Bank through interventions in the foreign exchange market in order to minimise the cost of repayment of short-term external loans borrowed from international capital markets at high cost thereby eroding the competitiveness of Sri Lanka’s exports. The sale of foreign currency denominated treasury bills and bonds and floating of sovereign bonds such as Sri Lanka Development Bonds have significantly bolstered the gross official reserves of the country in recent years; but such short-term external borrowings may not be able to sustain the current level of gross official reserves for long, thereby making the gross official reserves vulnerable to external shocks as happened in late 2008.
The so-called “innovative practical wisdoms” highlighted by the Central Bank Governor reveal the invisible hand of dubious public financial accounting practices and politically induced statistical manipulations, as opposed to the invisible hand of the markets, at play in the Sri Lankan economy. Are these dubious “innovative practical wisdoms” transforming the vicious cycle of the Sri Lankan economy into a virtuous cycle?
Muttukrishna Sarvananthan (Ph.D. Wales) is the Principal Researcher of the Point Pedro Institute of Development, Point Pedro, Northern Province, and could be contacted at [email protected]