EASL AGM - Speech by Dr. Koshy Mathai, Resident Representative in Sri Lanka & Maldives, International Monetary Fund (IMF),
Thank you for that very kind introduction. And all of you ladies and gentlemen thank you for giving me this opportunity to be with you here this evening.
As Mrs. Austin said, I do get invited to speak at many events and it is no great tribute to me that I accept. I am constantly amazed that people want to hear what I have to say. I think I’d better take advantage of that opportunity while it lasts. Just two weeks ago, as Harin said to me as we walked in. We were here in the same room, same podium, speaking for the import sector of the Ceylon Chamber. And if you can imagine a group of people who are not happy at the way how the economy has been managed, has performed over the last two years, it would surely be the import community. Because after all there has been very major changes in the policies that we have seen in the economy and as Mrs Austen said these clearly were necessary changes. And my main message two years ago was that these actually are good times for the economy. Good times, not bad times. I think one of the newspapers quoted me saying ‘we all should be jumping up and down given that these are such good times’. May be that is carrying things too far. But I think the message that I was trying to convey was that we should be happy that the right policy frame work is in place now right now. You see last year we were all very happy. The economy had been growing very fast, It has grown at more than 8% for a couple of years. We had inflation coming down, exports were doing marvelously. We’ve had 2 years of 20+% growth.
The long term decline in export share both relative to GDP and relative to world trade that the EDB chairman mentioned, was arrested and seemed to turn around a little bit. Everything was looking very good but of course underneath the surface there were problems that were building up. The main problem was on the import side. You see countries often go in to cycles of overheating. And our judgment was that Sri Lanka was never that Sri Lanka was overheating. Because we did not see the typical indicators of overheating in the economy. We didn’t see inflation being very high. Either headline or core inflation. We did not see huge wage pressure. Yes they were starting to build up but not like in countries which really were running at full stealth and running a little too fast. We were not seeing property price bubbles of the nature that we have seen in many countries in Asia. We were not seeing material shortages in sector after sector after sector. Another indicator of an economy running too fast that need to be.
We were seeing credit growing very fast of course credit grew at about 34% last year. But we noticed that came from a very low pay. Remember that 207/2009 banks were not at all lending to the private sector. There was a restriction of credit extension. And from that low bay that seemed like a reasonable thing for a growing economy. And what we did also note was that government authorities noted was an increase in imports. That increase in imports, in retrospect proved to be quiet remarkable. Because imports went from 13 billon dollars in 2012 to 20 billion as we all know.
An increase of 50% more than 50%. In just one year. And even though exports were performing very well and even though a remaining a major source of foreign exchange to the economy. And also doing very well last year. It could not keep up to the imports. And we had an excess demand for dollars in the market and what was the response. The response was that well we know there is a pipe line of money coming in to the economy in the future.
We know that well the government is issuing euro bonds we know that the banks are borrowing tier2 capital overseas, we know that the foreign investors want to come into the stock market, we know that foreign direct investors have many deals that they are looking at and that they are going to bring FDI into the country. And for all these reasons we know that there are dollars coming into the economy. Therefore, even though there is a temporary shortage of dollars in the economy, we as government policy makers were thinking, would not like to see the rupee weakening because it would only have to strengthen later. And rather than using that policy let us use the reserves that we have now to smooth the situation out. That is what reserves are for. I remember Governor Cabraal saying, reserves are not there to sit on a shelf thank you very much.
Reserves are there to be used in a time of need. And that of course is a very sensible thing to say. But I think the point comes that the issue at hand is how much reserves you use to what extent do you use them before you start to question the policy fundamentals that are in front of you. You see if there is a short term shortage of dollars for a week, or two, a month, may be even two months, it would be okay. But if we see the situation persisting for 6 months or 8 months, which is what we saw last year, a decline in dollars from 8 billion dollars to 6 billion within just 6 months time. If we see a loss of reserves at that scale.
Well then it is probably necessary to take a step back and realize that it is not okay, since we have a current account deficit and price finances. What we need to do is take steps to moderate the prices of the current account deficit itself. To reduce the size of the trade deficit so that we don’t need commercial amping and so that we don’t need to rely on capitals of the country in the future.
That is exactly what the government did. After a delay, admittedly. After a delay. We took very bold, very tough steps in order to bring current account deficit back under control. To boost exports and bring imports under control. Now bringing imports under control is a key part of the story and of course the import section of the Ceylon Chamber would not like any policies directed towards that end. But as I said that day imports have to be financeable, however imports are, whether they are petroleum imports, raw materials of other kinds, capital goods, even consumption imports which Sri Lankan people may not have enjoyed enough during the war years.
Even if these imports have a very good motivation and are productive to the economy at the end of the day we have to be able to finance them. And what was happening in 2011 was we were headed on a path that was not good. And what we did in 2012 was a very clear and a very meritorious recognition on the part of the authority that they need to adjust the current account deficit. Those are the good policies that we have seen. We have seen the government allowing the exchange rate to be flexible. We have seen that the government has tightened market policy and fiscal policy in order to bring the current account deficit to control.
Now this of course had bad effects in the short term, growth comes down and inflation goes up but in terms of the long term health of the economy it is an undoubted positive. That there is no doubt in my mind, no doubt in any economists mind that the steps taken this year were the right ones. (08.45) And it is in that sense that I say these are absolutely good times.
These are not times that we are having a party as the underlying foundations of the economy are getting weaker. These are the times when we are taking a little bit of pain upfront but we are strengthening the economy and allowing the economy to grow further and faster in the future. The Governor was quoted I think today saying that sometimes you have to slowdown a little bit in order to speed up later on. I think that is exactly what we are seeing right now.
Now all that is well and good, no doubt importers would be unhappy. I was surprised to see that Mrs Austen’s address was nearly as gloomy maybe even more gloomy than the address of the chairman of the imports sector. That is truly remarkable. No doubt you all have been hit by uncertainties in interest rates, uncertainties in, you know, increased financial cost and ahh….excuse me..increased fuel cost. There is no doubt that you have been hit by an unhelpful global environment. Which both previously have mentioned. But surely let’s be frank about it, the depreciation cannot have done anything but improved your bottom line by a substantial amount. I refuse to believe in this room without an admission from all of you that the depreciation has been massively helpful to your bottom line ,and I can understand that is not a short term effect. In economics we always talk about a so called J-curve where a trade balance response only with some delay. Imports may come down quickly because imports become expensive when a exchange rate weakens. But for exports to suddenly grow, it’s not just a matter of saying, “oh! We get more rupees for the dollar suddenly we can sell more”. Yeah, you may be at full capacity. It may take some time in order to build up new capacity.
So I’m not saying that you are going to be in clover immediately but I think you will in medium term. May be not years and years, may be within the next year, you should be taking advantage of the depreciation that you have got in front of you , taking the opportunity to build new capacity, so that you can export more in the future. So I would say that for exporters, relative to other groups in the economy ,I refuse to accept that the policy adjustments we have seen have not been at least more beneficial than they were for other groups.
Now looking a little bit more at medium term fixture ,as I said and as Janaka_said before, we have had good export performance in these last two years but that is against a background of fifteen years of export decline. Now, janka doesn’t like it when I say this, we were together at the export development for the exporter awards I think may be a year ago. And I think he got a little angry with me although he was too much of a gentleman to say, he got angry with me because I was emphasizing this point that exports have decline ,declined, declined. And Mr Rathnayake always like to say “well you can’t compare it to GDP, you can’t compare it to global trade, because those things are growing, so why should we also grow?”. I don’t think that is logical, Janaka with all due respect. If these other parts in the economy are growing fast, then we also need to grow fast, if we are not growing fast, well we have to question why is it that we are not able to grow as fast as other sectors of the economy. Why is it, we,in Sri Lanka as exporters are not able to grow our exports as fast as exporters in other countries have been able to do it. There may be some reason. I’m not saying it’s your fault, I’m not saying it’s the governments fault but there must be some complex agreements out there related to currency exchange rates, maybe electricity cost, maybe it’s labour conditions, may be many of these aspects of the ease of doing business that Mrs. Austen referred to earlier. For whatever reason ,export growth has not been up to the standard that it needs to be for this economy to go forward.
Because as was mentioned earlier, this is a small economy and it is only going to grow not based on satisfying domestic demand but based on satisfying the demands of the rest of the world. Exports are a key ingredient to Sri Lanka’s economic success. And we are not going to have economic sustained economic success if we are going to have exports declining relative to the size of the economy. It is only with economic growth that Sri Lanka’s economy is going to go forward.
I am not saying this because I am standing in front of a room of exporters but because this is absolutely clear to anybody looking into the situation that a country of 20 million people must look to the outside world. How do you do it? This is where an economist should humbly and will humbly say it is up to you to say how to do it. How can you develop your export market better? How can you develop product range better? It strikes me as a lay person looking at it there is much to be in terms of improved value addition. Now certainly you are seeing it in many sectors.
In rubber we have gift products, we have tyres as was mentioned earlier. In tea of course there is this big debate going on but probably there is a need for increased value addition, increased branding of ceylon tea while at the same time perhaps allowing for this tea hub concept to be there at the same time. I am not an expert in tea but it strikes me that producers in different markets have a variety of goods to offer and as long as you have the mechanism to make sure that teas of certain qualities don’t go and reduce people’s faith in the quality of the other teas that are being sold as long as you can set up that sort of mechanism which may be a very difficult thing to do.
Well then it should be possible to market both kinds. well value addition is one part of the story but I think the other the more important part of the story is regional integration. And this was also brought in by Mrs Austen and Mr Ratnayake. Why is it that Sri Lanka export only 5% of its exports to India? Now I am an Indian American and I have made this comment in the past, people have said that aha! we know why he made that. But frankly it has nothing to do with my background.
It has nothing to do with any Indian interest in trade with Sri Lanka. I think Sri Lanka is too small to have any material impact on India’s trade value. The point is somebody, may I point our who is married to a Sri Lankan and have Sri Lankan children. How is it somebody interested in Sri Lanka, how is it somebody interested in Sri Lanka, how is it that this country can go forward.
Well we have this massive market depth in all. Which is growing extremely fast. And as Indrajith Koomarswamy points out, Not only is India growing very fast but the Southern Indian states must have been growing extremely fast. Probably at double digit rates if Indian national growth rates are so high. Because some of the Northern Indian states are not nearly as dynamic.
So we have got this huge population not very far away from our shores at all which is growing fast and should be able to absorb a lot of our exports. China, China only absorbs only 1% of Sri Lankan exports and that also is an amazing thing. Now, Sri Lanka is blessed with amazing geography and I would say not just amazing geography but also amazing economic geography. Your geography has always been the same but what is happening in around the world, what is happening around the economic world around us has changed dramatically in our lifetime. India and China were not the power houses of the global economy several years ago. And now they are and that means that it was okay not to take advantage of those economies earlier but failing to take advantages provided by the economic progress of those areas today would be a shame.
Would definitely be giving up on an opportunity for Sri Lanka to go forward. Now an argument that I often hear is that well these countries are like us, how is it that we are going to sell goods to these countries. And again I would say that is for you all to figure out. That is for smart businessmen to look at their individual sectors and see how is it that we can sell in to these countries. I can only give you a general economic theory point which is that of comparative advantage.
I am sure you all are familiar with comparative advantage this theory going back hundreds of years basically said that if there is a country, if there is a trail of countries and one is better at doing everything than the other country is, they can still benefit from trading with one another.
By having the country that is relatively good at one product specializing in that and the country that is not so bad in the other product can specialize in that. And in doing the production in that way they are able to maximize their joint production and enjoy higher work levels for everybody. Now this is very academic and theoretical sounding but the bottom line is that Sri Lanka will have an opportunity in India and in China and in ... there not just in terms of goods but in terms of services as well which is why I think it so important to expand the existing free trade areas in goods in to services as well in order to have better economic integration with the region. Exports really are the key to this country’s economic success. And I wish you all the best in the years ahead.