Dr. PB recaps recent economic achievements and future challenges

The person – Dr. P.B. Jayasundera or the post he holds – Secretary to Ministry of Finance and Planning – are not very popular in many circles. However, he has been one of the longest-serving Treasury secretaries. He had served under three Finance Ministers and two Executive Presidents after a long career at the Central Bank. Critics would pin the blame on Finance and Planning Secretary for macroeconomic ills and policy slips. Likewise, he should be credited if things are improving or have been good. Jayasundera has been passionate about the role he has played so far in fiscal and economic policy as well as monetary policy, being an Ex-Officio member of the Monetary Board. The Daily FT met with
Dr. Jayasundera recently to get his views on the recent success on the macroeconomic front, the challenges faced, various criticism levelled against the Treasury and what issues beset a better way forward. Following are excerpts:

 

 

By Nisthar Cassim
Q: Of late many questions have been raised about credibility of data and doubts whether there has been real high economic growth. How would you respond?
A: I would cite four factors to confirm that there has been real and high economic growth during the past few years. One is the investment growth in relation to GDP is on the rise. The second is the efficiency gains that will keep the growth going. The third point is that the share of growth sectors – services, agriculture and industry. And the fourth one is the investment climate. All these four factors confirm robustness and growth.

 
The economy and the investments have diversified considerably and much broader. In the past as opposed to apparel in recent years we have seen investments in tourism, port and airport, property development and IT. Existing industries are also getting into a very competitive environment like apparel, or shipbuilding, or ship breaking, as well as value addition in agriculture.
With regard to efficiency though it is still not the ideal, the tax regime is much better, the tariff regime is much better, the trade regime is much more liberal, the banking and capital markets transactions are much better. From non-economic aspects the law and order is much better as well. The economy is in the hands of the private sector other than the critical infrastructure or utilities. So that should explain the underlying efficiency that we see in the economy. The country has also progressed rapidly in different indices compiled by independent global institutions.

 
As far the structure of the sectoral economy is concerned, the primary agriculture is now only 10% but we see dynamism and higher value addition in livestock, fisheries and expansion in irrigation, etc., as opposed to five years ago. This sector is also reaping benefits of the peace dividend. The overall agriculture sector has remained resilient despite regular bouts of drought or floods. The industry and services sectors are also doing well and at times compensating for any setbacks in the agriculture sector. We have seen tremendous improvement in the ICT sector, which will be one of the growth drivers in the future. We have also seen far greater diversification in the financial services sector.
I am quite encouraged by the manufacturing sector as well and exports have bounced back. The exchange rate depreciation and other structural adjustments we made some time back are proving beneficial. Our markets overseas though challenging are also going through considerable structural reforms. Further improvement in our competitiveness will help exports. Finally, the kind of infrastructure development and sustainability that is evident at present will grow with macroeconomic adjustment the country has done so far.

 
We have managed to keep the fiscal deficit down and people are for the first time beginning to believe it that we are serious when we commit to lowering the deficit. This has been consistent as opposed to one-off achievements in the past. Today there is a five-year consistent direction in fiscal policy reduction and keeping expenditure in check. The stability extended by prudent monetary policy has helped too.
So when you take these factors into consideration along with the Government’s fairly consistent policy towards exploring viable import substitution activities such as poultry, sugar, grain production, etc., the setting has been positive. So in a nutshell, I feel that we are much more diversified in our investment levels as well as in our efficiency gains supported with a fairly decent macroeconomic environment. All this explains our growth story.
Given existing challenges, going forward the next wave of growth will come from further consolidation of the macro-economy and reforms as well as improving competitiveness through productivity and technology.

 

 

Q: Based on the third quarter, are we in line with the GDP growth projections for 2014?
A: Given the economy’s performance in the first half and third quarter in spite of the adverse weather impact, I can’t see that the fourth quarter is going to be less than the same rate of growth in 3Q. But more or less GDP growth in 2014 will be around 7.8% or 7.9%.

 

 

Q: So you feel that 7.8% growth in a post-war situation is fairly commendable?
A: It is commendable in this sense because somebody can argue that Sri Lanka should have doubled its GDP growth by now since the difficulties are over. But in my view, the growth – the acceptability of a recent growth rate – depends on two things. One is per capita income, because we don’t have the kind of population growth that other countries are having – where they have two plus, we have one less (the replacement rate). So in that case 8% growth in some countries technically speaking is equivalent to 16% here.

 
The second thing is that to grow faster we need to have much stronger macro adjustment to keep the inflation rate down. So nobody should forget the fact that we were not only having a war, we were also having 30 years of a double digit deficit, 30 years of double digit inflation, 30 years of structural problems. So we only cleared one major hassle. So removing structural constraints, addressing inflation and getting macro and monetary and fiscal policy right, getting the exchange regime working, and getting the capital market working aren’t easy. It requires public sector reforms, efficiency in public service delivery, improvement in doing business, etc.

 
So the growth that we have achieved for the last five years and the predicted growth of 8% for the next 10-year period is in a way a durable growth because it has kept the inflation down. Earlier we also had this rate of nominal growth but it was basically inflation driven. My argument is that we have now reversed it – the inflation to what the growth was and the growth to what the inflation was.

 
But the country should think of moving much faster with growth for a couple of reasons, one of which is that this is quite conducive for that – without creating inflation in the country, you have to create growth. The second thing is that if we can maintain 8% growth plus 4% inflation, all together let’s say 13% nominal growth, then we can bring the fiscal deficit down to 3%, public debt down to 65% of GDP and in that whole character you are raising exports to $ 20 billion, which then means, if it is exports, that you must grow at a rate way over 8-9% per annum.
The only way of sustaining the remittance to $10 billion and the tourism to $4 million is by diversifying into export and into IT and much more of the high value industrial exports and services, then I think Sri Lanka can get much more viable external and internal balance. So that’s how I look at it. The key is to maintain sustainability in the coming months.

 

 
Q: So then you don’t think we will hit a double digit situation at all?
A: It might by about 2020. This is not an impossible task but at the same time we should not hit double digit growth at the risk of inflation and at the risk of the balance of payments. Unless our exports become very buoyant and tourism and various other services generate robust earnings, double digit growth has its own risks. And we should go slow for this side of 2020. But maintaining 8% growth is comfortable.
The real underlying challenge is with old processes. The growth that Sri Lanka wants to generate, in this case the 8% (GDP growth) plus 4% (inflation) kind of scenario has to be driven by three things. One is skills – we are now not talking about labour in quantities, we need quality. So from education reform onwards we have to address this. In the immediate run, you cannot depend on this for a solution. The second thing is productivity. Productivity requires technology and research oriented investment. That’s the area for our industries that we will have to look at.
We have to go for a much more energy efficient environment type of compliance because these kinds of costs are very high and even in the next 10 years, banking systems will be upgraded all over the world to maintain a very high standard of requirements because the financial sector is learning from its disaster.

 
So those are the abilities we will need to have to go through this adjustment. Institutions will need to have to ensure that IT-related services are not only happening here but also elsewhere so that kind of helps. So in the case of Sri Lanka, one advantage we have is that we are fairly progressive on human resource development and upliftment of rural sites may be much easier to do here to keep the country on a much more sustainable inclusive growth structure.

 
Q: So it is skills, productivity, technology leverage – that’s what we need?
A: We need to sustain the speed. And then of course that’s a huge managerial challenge. There is a human resource problem in the country.

 

 

Q: How can you go towards this double digit growth, at least on the exports side?
A: One is to expand the market scope because we have been basically creating our exports based on given markets and we have diversified quite well. In the apparel industry, in addition to earlier markets, we now have new markets including China under a FTA in the future. So we have a huge advantage there. Then there is the high value of production because our exporters will have to. From what I have seen in the last five to six years, there is a massive expansion in the margins not through quantity but through quality and product innovation. That’s one way.

 
The second is getting the country to go in for much more manufactured industries and that is like shipbuilding, ship breaking, boats manufacturing and heavy industries, etc. I also feel the country has a huge potential in Asia to become a net food exporter, which is a fundamental change. And then of course in the medium term, Sri Lanka may have a huge potential to expand its IT and professional services and then there are the aviation and shipping kind of activities and diagnostic type of export activities far beyond what is produced here, which will also come into our export picture.

 

 

Q: Whilst the Government is talking of high growth, there is some reservation citing the very low credit growth. How would you respond?
A: The credit of course if you analyse it seriously with an aggregated credit growth was more consumption-related credit. Take for example the whole imports, other than oil, the next biggest item was motor vehicles. If you take these two out, the rest largely came from the buyers’ credit or non-credit. In the oil industry, I have not seen much of a borrowing in that sense when it comes to these operations.
The third point is that some of the growing sectors became cash rich, such as tourism. What I see is that this excessive credit force is consumption focused and inflationary focused. In the meantime, many sectors became cash rich including tourism with the assisting investment. Past and existing investment are having a windfall gain now. The tourism industry which dealt with 400,000 tourists with $ 200 million once is today basically enjoying $ 2 billion in income with 1.5 million tourists. And that’s probably income coming here. There’s probably income elsewhere.

 
Then the construction industry’s financing has come from the public investment type of funding and though overall private sector credit was low, the phase of growth that we went through is essentially public investment driven in structure. And foreign funded or domestic funded, it’s essentially public investment and that also kept the construction industry moving.
So I am not very worried about the direct relationship with the numbers that we see because the numbers are somewhat distorted. Even now I asked whether the credit growth is picking up with the motor vehicles and if that is the case then we need to have some balancing of the motor vehicle kind of imports. Now of course we have a little space because imports of milk powder and food grains have declined but it may have probably picked up again from the rice imports during the last four to five months. So again to me it is not growth.

 
There is lot of saving in the corporate and financial services industry as well with lower finance cost. Many leading companies are also borrowing abroad because borrowing was cheaper until very recently and so they don’t need this domestic private sector credit. I was told that a firm was borrowing overseas because there is no foreign exchange here in the market. In John Keells Holdings’ Waterfront project, the bulk of the investment and financing is sourced from overseas so it is not reflected in the credit growth.
So these sorts of complexities have come into the picture from many, as you have said, including Government. We had extraordinarily high credit growth once, so some correction is warranted in some sectors. We also had the effect of the collapse of the gold market prices. Still it has not recovered even though we have attempted to revive it. That industry has basically compromised Rs. 300 billion of credit. So I am a little bit concerned about these distorted numbers and statistical bases.

 
But by and large, if someone can adjust the numbers properly, you will see the credit to growth relationship because ultimately what you have to look at other than credit growth is growth and its financing. How much from the stock market, for example. A lot of debentures have gone in and how much export borrowing and with exporters in the country that’s roughly $ 10 billion dollars of export activity and largely export financing. We have permitted them to borrow foreign currency loans and settle it. Taxes have come down so all these things must be raising their cash levels while I still have a problem of maintaining a decent revenue GDP ratio; this money is then with somebody.

 

 

Q: Regarding the public debt controversy, people are getting very excited about it. I know it has come down as a percentage. I know you were talking about 65% (public debt as a percentage of GDP) in the medium term. The concern is about the above-average rise in the foreign commercial component and then this story about the Government having transferred the whole liability to banks. Can you comment?
A: It’s like this. The way I look at it, one is the total of Sri Lanka’s debt. I mean whether private or public, ultimately the Central Bank will eventually have to manage the country’s balance of payments and that money and debt servicing will become part of the balance of payments. There at least in terms of our management policy we have opened it up for external borrowing for many domestic companies subject to a proportional limit and also to export companies. So to that extent it is a more risk-free kind of activity. What people forget is that many countries that have got into debt crisis are not necessarily through government, it’s in totality because you can open a capital account and you can get hammered.

 
Secondly, in the Government’s case, what we have done is that the amount of money that the Government used to borrow till almost 2000 was confined to the ADB, World Bank and so on. That picture then got wider because China and India appeared. I mean within a matter of nine years India goes from zero to $ 2-3 billion and China from zero to $ 5 billion has been a huge capital formation. But now it is increasing but at a decreasing rate and they are more or less 15 to 20 year debt at more low cost ones. Now when you get into World Bank, ADB, Japanese, China, India, Saudi funds, in all these countries there is nothing called a 100% foreign-financed project. Most of this credit is at the minimum, upfront and domestic. Even with India, China, Korea, anybody, the mobilisation advance goes from here and that has to be done because only then will the loan be activated.

 
Given our fiscal outlook, we are still borrowing. So no project is 100% foreign. Now that part – the choice we have is to borrow locally and pre-empt it or bring that amount from the market. That’s why we went to the capital markets. Secondly, it is roughly, even with the World Bank and ADB, that kind of past loan, there is a debt servicing amounting to a billion dollars now at least. Now that billion dollar neutrality can be maintained if we have a market and so that’s why we went to the market and that’s how we have a quite diversified portfolio and then the World Bank and the ADB also have increased their portion of the outcome – so in a $4-500 million range. That’s their amount though the capacity is higher, the investment needs are higher. So what we have is kind of a middle income country debt structure, not the low income country debt structure. The low income country debt structure is essentially the World Bank, the ADB and foreign money and a kind of repayment and things like that.

 
From that when we cross from $ 1,000 per capita to the current $ 4,000 per capita and going forward we will eventually see a situation where your external debt will be not 40 years but maybe 20 years. And not 0% in terms of interest rate but maybe 2-2.5% interest rate kind of thing. Because one third is commercial and will be whatever the market rate is, ADB and World Bank will be at the lower end which is also about a third. The bilaterals will be in between.

 
What I am looking at is that annual average weighted debt servicing capacity. That is how we look at this and within that – that is why we are also now shifting some of the project selection if the domestic content is high and since petroleum, electricity, water imports and balance sheets have improved there is no reason to go for Government finance. They can look for their own debt equity balance because since they can generate profit, that can be their equity; they have also contributed to their capital and they can start. Two or three things, though. One is that they will be examined by lenders, not by the Government – here you know, annual borrowing programs, water projects, here you take it. They are not looking at the project balance sheets just yet and project sequencing. At least these five agencies will be gradually growing.
I have succeeded about 50% but still I have pressure because some of the borrowing from bilaterals is essentially to promote their exports. So in that sense we have to decide on the compatibilities that their exports have with our imports. If it is clearly locally-generated imports, then go for local finance, that’s the criteria.

 
We have a foreign exchange external resource management policy framework where we look at the import content because there is an advantage because it is like a balance of payments system support in that sense. The British give us $ 150 million for a bridge construction project which is a balance of payments support in a way. So it is neutral because there is no pressure. So we have also got the local financing and also to see graduation to an exit bank strategy where local contractors show the strength. He can go to Hatton National Bank and borrow and ask if they will accept the kind of strategies that he is using. In way what we have done this year is put a full stop to any organisations like the Water Board, the CEB, the port, the airport, where the Government doesn’t borrow.

 
Now even from JICA and places like that you go and do your business. To that extent we reduce our borrowing. That’s why when we say we are reducing our debt level below 65%, we will make sure that that has a provision for Government guarantees so a new instrument is coming. Instead of the Government directly borrowing and giving it to them, the Government will now facilitate them through guaranteed status so only the contingent liability part will be reflected in the Budget. So it is a fairly big reform. And then of course these enterprises will be compelled to look at their own tariff on the project selections, etc., so project selections are better.

 
In fact we adopted a policy last year, the Central Bank and the Government, that we no longer want to entertain projects below $ 50 million because they are costly projects. The other criteria is that for education and health kind of things, irrigation and environmental projects we prefer more World Bank and ADB type projects. When we talk of public debt we also needs to be mindful of the avenues for investment for long-term funds such as the EPF, ETF and institutions like NSB.
Critics of public debt are right, provided we are not on a path of deficit reduction. Provided we are not on a path of maintaining a proper mix of bilateral, multilateral and commercial, provided we are not maintaining the maturity structures from the short, medium and long term, and the proper yield curve and the kind of risks with the private sector. But these factors are not looked at.

 

 

Q: So you feel that the public debt levels are comfortable and servicing can be sustainable?
A: Yes, because what they don’t understand is – let’s start from the Mahaweli phase. Now the Mahaweli phase debts are disappearing because 40 years is over so technically speaking that accumulated debt has gone out and then new debt has come in and if you look at our debt profile, within the next five years another set will be over and then decreasing again. So essentially it is a replacement.
What we have to keep in mind is, replacing at what cost? Because some are expensive ones so we may have a chance of replacing them at a low cost. Some are at medium term maturity and then can be replaced over a longer term. It is kind of a debt profile restructuring challenge that we have. I don’t see that Sri Lanka is continuously on a debt increasing path because many of them are going away.

 
In fact, the expansion in the CEB has reduced its demand for borrowed funds so the debt to equity ratio is getting better. Now with the completion of nonrevenue water in the Water Board and the expansion, its revenue base has expanded. The Port is basically commercial. In the meantime the Government eventually expanding its tax base will bring a kind of bonus revenue structure so then of course exports earnings, tourism revenue should bring the foreign debt service much lower. We can maintain it steady as I mentioned earlier, the growth rate at 8% with no change to goods and services content – I can’t see a challenge there.
Our challenge now is to work towards a reserve level in the country that should be equal to the commercial short term debt. The commercial debt, the Treasury bond and Treasury bill and that includes actually when we classify some of this debt sustainability issues now say a 40-year World Bank loan, if it is in the 39th year then that one is clear.

 

 

Q: The reserves are about $ 8 billion but our commercial debt right now must be slightly more? You want to get to that point where you match it?
A: The commercial debt including petroleum, liabilities and all must be about $ 10-11 billion? So what we are trying to do is that $ 10-11 billion can be reduced. And the reserves can go up. So that’s the structural change that we have to do. Right now we are about 71-75% or somewhere around that. So if we can raise this – that’s why the next round of the bonds issue should not necessarily be to borrow and raise the reserve on the one hand and liquidity here but to borrow and pay off all the short-term loans so that we are debt neutral but the exposure level will get eased. And of course along with that the changes to get more exports and to get more productivity, growth, etc. to be there.
The country has also been maintaining a satisfactory debt servicing to export ratio. In the ESCAP analysis, we are not in that crisis mode. So those are the indicators that experts are using – I mean people can have different views.

 

 

Q: So there is no relevance in someone flagging off a debt crisis, etc.?
A: No relevance. If that is the case, that flagging will come from the lenders. Critically, this is the borrowing side to the story. Ideally you can say borrowing is bad and go for privatisation because this is an asset so you privatise and the private sector will raise the capital and all. That’s one but still its capital formation and it will continue to be an issue because you have to have debt in the system.
The next one is the further contraction in the deficit – that is the Budget. If people don’t go to borrow they must explicitly recognise that no borrowing means no debt financing. So fiscals apply.

 
That debate should be there – that’s what I am also saying. Okay, why don’t the people insist that we should go for 2% with the deficit? This means a massive adjustment. And to remove all together say remove the public service scale and raise revenue and pension reforms, etc. have to be there. So that’s the degree of the adjustment and this is why I am preaching that somehow now that we have come to a 5% deficit this year and then we have targeted 4.5%. We must target that in the next three years we will be below 3% with the fiscal deficit. That is the crux. In my view that’s a credible one. If someone can figure out how to get it to a zero deficit, then so much the better. So debts are rising at a decreasing rate. So that’s number one.

 
Number two – in a middle income country, debt profile analysis is done by the IMF, the World Bank and then the rating agencies and the financial agencies, etc. One particular advantage that we have is that we still have two-thirds as bilateral or multilateral so you have the space to deal with non-commercial organisations. So it’s only one-third that is commercial debt and that needs to be managed in the kind of direction I mentioned before. Instead of the country traditionally looking at the number of reserves and number of months of imports, the country has now come to the stage where it’s fine to import any amount on a Letter of Credit but make sure that your reserve amount gives the full debt amount clearly.

 

 

Q: When do you think you will get to that level?
A: What we are thinking is that it should be 2015-16 to target and the number actually that we should monitor is whether 70 becomes 80 and 90 and 100 and nothing else. Now even if for the sake of it we keep arguing that the reserve is $ 8 billion – it makes no sense if you have short term debt. So make it $ 9 billion.
Because given the sophisticated development in the world there is no reason to have boats about 12 months in port, six months in port – that’s all additional. You know what is important – whether countries are in the investment ratings grade and we are still not.

 

 

Q: There is concern that the interest rates are under pressure to go up?
A: It’s like this. I won’t describe whether the interest rates are under pressure. It is all dependent on the global macro correlations. Now if you take these limited narrowly-focused indicators, now look our interest and inflation rate is a 4.5% on average for this year. If it is 4.5% then we have a positive interest rate. Should it be? So that means tight monetary policy. So that’s number one.
Number two – should this level be maintained or should it be further down because the lending rates at this rate still mean double digits? The rest of the commercial loans will still be 10-12% depending on the risk. And so is it the kind of lending rates a double digits growing Asian country should have? So that’s why these banking and finance sector reforms are very important and we may not have 16-18% credit growth in the future.

 
Now to go to single digit credit growth, what are the instruments that we are going to use? Is it tight monetary policy operations or much stronger banking systems where the banks are compelled to build capital and things like that? So that’s an issue.
Then there is the exchange rate. Are we going to, if it is export buyers, then look at the rest of the exchanges across the world and decide what the rate should be? So I am not saying we have come to an equilibrium – there could be plus or minus deviations but I can’t see from the current macroeconomic foundations that the country has got that we have the equipment to move further down on the fiscal deficit. The manner of fiscal management has improved in terms of management controls, in terms of public investment management, in terms of public enterprises being more sensitive to balance sheets. I can’t see huge pressure on the credit side.

 
Then at the same time the kind of excess losses, the country suffered for years in running – petroleum losses of over Rs. 200 billion, CEB running at $ 100 million and the whole large estate enterprises running at that scale is no longer the character in Sri Lanka. Now this is my living experience. Now for a newcomer this in itself is scary, but for me, we have come through a crisis to a manageable viewpoint so therefore I don’t think interest rates or exchange rates or any other things are under pressure simply because of macroeconomic challenges.
But I want the country to know also that if at all those changes reflect the underlying structural changes that the country still needs to do – the banking and financial sector reform, the structural reforms which are taking place slowly, the base is expanding, the rate remains stable, enforcement will be high, group holds will be closed, so tax levels or the tax to the GDP ratio will move up.

 
And with the numbers I have managed I cannot see pressure on interest rates but then I mean you must also remember that within an open economy whether this interest rate is compatible with this exchange rate. Because this exchange rate if it is a slightly lower interest rate and a slightly higher exchange rate, then we may be more export friendly. Those sorts of changes may happen. But not big ones. Because I can’t say, at least in terms of what I have gone through in recent times, I cannot say that the exchange rate depreciation is beyond 2-3% or the interest rate moving beyond 0.5% or the diesel price getting adjusted by Rs. 30. That way despite all the rhetoric I am more comfortable with the Government than the previous successive governments during election times.

 
I mean nobody asked me, even the price reduction we did recently, if I didn’t suggest it – they were not even looking at it. But the President said, “No, make sure the dividend is kept.” I said, “No sir, we must also reflect the direction” and I reminded how we did it with the exchange rate. And I said: “To move on to that kind of flexibility is too much at once so let’s see six or seven rupees.” What I want is for kerosene to be targeted and anyway kerosene demand is not a big issue in the future.

 

 

Q: How do you think overall macroeconomic management has been?
A: There has been clarity, consistency, and continuity overall. There have been some bold and farsighted measures. Prudent macroeconomic management has fuelled economic growth and helped the much-needed infrastructure push and other improvements. There has been a disciplined effort on a consistent basis to reduce the Budget deficit, which is unprecedented. This is arising out of an appreciation of benefits from a low deficit regime. In the past our biggest frustration in the macro-economic world was running a high deficit. Governments have thought spending and keeping the deficit high would solve problems. We inherited a high deficit setting and encouraged by success, there is greater zeal to further reduce the figure to 3% in the medium term. The Government is also thinking about debt sequencing strategies.

 
The country and the private sector has got more decent growth, a consistent taxation strategy. The Government even during the election is articulating consistency and continuity. The Government is focussed on building institutions with best practices, accountability, transparency and good governance kind of structures and middle income countries are talking about it. In a disciplined society, all these things are good. So to that extent, continuity, clarity, deepening and recognising the next level of priorities is important as Sri Lanka braces to become progressive.