COVID-19 would undoubtedly be a turning point Interview with CB Governor W.D. Lakshman

Pic by Pradeep Pathirana

Inevitably the global economy will come to experience conditions of recession, the worst after the Great Depression of the 1930s

Will China take the leadership and make necessary resource contributions to take the rest of the world out of COVID-19 crisis?

Daily Mirror discussed the impact of COVID-19 on the national economy with Central Bank Governor and former Vice Chancellor of the Colombo University Deshmanya Prof. W.D. Lakshman
Excerpts:

Q Early this year the ADB forecast a GDP growth of 2.2% for this year and 3.5% next year, the inflation rate to remain at 5% in 2020 and 4.8% in 2021. In this backdrop of the Central Bank has already indicated a lower GDP growth of 1.5% in 2020. How do you see the challenge of rebuilding the national economy in the aftermath of the COVID-19 pandemic?
The annual growth rate of an economy, in the past is calculated using (i) Gross Domestic Product (GDP) estimates for any two years, (ii) expressed “at constant prices” i.e. after removing inflation effect. These GDP numbers are what an average educated person refers to as “real” GDP estimates. The comparison of real GDP of two years gives us the widely used economic growth rate.

In Sri Lanka the official agency that is responsible for producing these GDP data and price index numbers are the Department of Census and Statistics (DCS). It is these numbers that the Central Bank also uses in its analytical work and its publications.  Due to slight differences in definitions and statistical practices, the growth rate number published even for a given year in different publications may not always be uniform.

What you have asked me is about a growth rate number, presented as a forecast for a future period – for whole of 2020 and for 2021. These numbers may vary from one publication to another even more than growth rate numbers for past periods. This is because the forecasting frameworks and assumptions used vary from one computation to another. This explains the difference between ADB and CBSL forecasts of Sri Lanka’s expected growth rates for 2020 and 2021. Indeed, the estimates presented by the IMF and the World Bank, although you have not mentioned these, indicate even lower growth prospects for these two years. The Central Bank, having made its computations with greater familiarity with domestic socio-economic and political conditions, believes that its forecast is likely to be closer to expected reality in overall 2020 and trusts also that 2021 growth would be higher at 4.5%, still a little less than the ADB forecast of 4.8%.

Q The industrial sector, tourist industry, small and medium enterprises, rural and domestic industries are the most affected from COVID-19. How do you suggest these vital segments of the economy could be revived in the shortest possible time period?
It is true that the Small and Medium Enterprises (SME) in agricultural, industrial and service sectors, cottage industries, micro enterprises and self-employed and casually employed people are the most affected by the spread of COVID-19. Viewed from a humanitarian angle, the plight of low-income families in these groups appears particularly distressing. The large enterprises, particularly those employing large numbers of workers, are also badly affected. Therefore, the large enterprises might be able to tide over the financial difficulties of the lockdown period and workers in those enterprises would have been provided with a living wage even when the industries were locked down.

The lasting solution to revive these affected segments of the society and their livelihoods is obviously the recommencement of economic activities kept under locked down conditions for several weeks. As a prerequisite for this, the health authorities must gain the confidence to recommend to authorities that the further spread of COVID-19 would remain subdued. The government would then begin the gradual and selective lifting of restrictions on social movements, thus permitting people to commence their normal economic activities.

Although nationally the spread of COVID-19 is under control, its global spread has not yet reached that stage. Inevitably the global economy will come to experience conditions of recession, the worst after the Great Depression of the 1930s. The post-coronavirus world economy, particularly the countries of the West, will take quite some more time to turn around. The time when the process of unlocking would begin in earnest in the rest of the world is yet unclear and unknown. The best example to highlight these difficulties is the export-oriented garments and apparel industry. The spread of COVID-19 led to a drop of about 40% (in 2020) in the demand for its products from overseas market. 

The other activity area closely linked to the rest of the world is the tourism sector. The best approximate estimate of total employment in tourism was around 450,000, about 5% of total Sri Lankan employment. Of this number, 180,000 are directly in tourism industry and 270,000 (55% of the total) indirectly so. Another classification is that of total employment (direct and indirect) about 60% are in the “informal” sector.

That the 21st century would be the Asian Century was a prognosis heard over many years. In the same way as the USA was a catalyst for the recovery of Europe and countries like Japan, during the post WWII era, China and India are likely to play an important role during the Asian Century. Post-COVID-19 Sri Lanka is bound to gain from these regional developments, growing with the surrounding Asian economies.

A point to be noted in passing is the recent use of digital technology to carry out delayed tea auctions. This shows that export related problems have technological solutions as well.

Q The largest contributions to Sri Lanka’s foreign exchange earnings come from remittances sent by expatriate workers, garments and apparel exports, fish exports and the exports of tea and rubber. At a time when all the export revenue has dropped to a drip, what incentives can the government offer to rekindle these sectors?
Your question brings out certain concerns that are being raised by most analysts of our foreign income flows during and in the aftermath of the corona virus. These judgments have a certain element of partial thinking. In apparel related cash flows, for example, there are both inflows and outflows of foreign exchange to consider, as a large proportion of required raw materials and intermediate inputs for apparel industry are imported. Drop in immigrant worker remittances (expected to be around 15% for the whole of 2020) would be compensated somewhat by the benefit of the sharp decline in expenditures on petroleum imports. In the whole full year of 2020, the drop in tourist earnings is estimated to be around 53% without any major restructuring of sources of incoming tourists. Against this also there will be a substantial drop in import expenditures.

The world is now almost totally closed to inter-country migration for jobs. If banks take up the financing of projects people connected to them will be developing. This highlights the long term need for a well-funded and well-functioning development bank in the country.

The COVID-19 would undoubtedly be a turning point. There will a gradual transformation in the country’s industrial structure as between pre- and post-COVID-19. There will be the development of export activities through initially domestic market-oriented production activities, under proper incentive schemes. The COVID-19 experience can certainly be made a turning point in Sri Lanka’s development experience. 

Q One of the biggest challenges before Sri Lanka is to meet its foreign debt obligations this year. By October, Sri Lanka will have to pay US$ 4.8 billion as the loan installment, plus interests and the total debt obligation of the country is Rs 2.1 trillion in 2020. US$ 2.8 billion is needed to service loan obligations in the first half of this year. How does the government expect to surmount this uphill task?
The numbers in your question are not totally clear to me. Foreign debt obligations i.e. obligations to non-nationals, falling due from May to December 2020, amount to US$ 3,420 million and for 2021, US$ 4,310 million. Whatever the numbers, we have this year and the next, a formidable foreign debt service obligation. Numbers referred to include both re-payment of capital and interest costs. International Sovereign Bonds (ISBs) and some other debts to foreigners, amounting to several billions of dollars come up for settlement this year. These debt service obligations were known for quite some time and are not directly related to COVID-19. What COVID-19 has done, by cutting down our foreign exchange inflows, is to make the outstanding debt service obligations appear daunting.

At the beginning of this year, the plans were to finance these foreign currency debt obligations by raising required funds using market-based instruments, ISBs and syndicate loans. In the prevailing conditions, however, raising funds from dollar denominated ISBs is likely to be challenging. However, the settlement of debt obligations this year and the next is very much manageable given the contingency plans we have had to raise required funds. Alternative methods and sources have been planned for raising required funds. Negotiations are currently on-going between the Government of Sri Lanka and several lending agencies - the ADB, World Bank, AFD and China Development Bank - to raise required funds to meet debt obligations. Access to IMF’s Rapid Financing Instrument (RFI) also is being sought. The Central Bank is seeking currency swaps with RBI (India) and PBC (China) as well. All these arrangements will provide loan funds exceeding the amounts needed to roll over the debts falling due in the rest of 2020.

Q Who are the most vulnerable sections in the country that should be given priority in the government’s recovery programme?
COVID-19 is perhaps the first time Sri Lanka is experiencing and handling the impact of a major global pandemic. Preventive health measures, primarily measures to bring about social distancing, were taken from very early stages in the spread of the virus in order to bring its spread under control. This saved lives and the country could begin to plan the return to normalcy within a short period of about two months. This happened through loss of production, trade, investment and business in many activity areas. The impact on informal sector employees, and particularly on daily-wage earners, has been the most widely felt, in an economy in which close to 60% of total employment comes from the informal sector. About 24% of the informal sector are estimated to constitute daily wage earners. It has been estimated that in the four ‘high-risk’ districts of Colombo, Kalutara, Gampaha and Puttalam alone, as many as 660,000 have lost their sources of income.

In addition, families depending on remittances of the country’s large migrant workforce have been badly affected by the spread of COVID-19. Workers’ remittances which amounted to US$ 6,717 million in 2019 are projected to decline by about 15% to US$ 5,713 million this year. Because of lockdowns introduced by majority of foreign employment destination countries, Sri Lankan migrant workers are facing employability issues. Some of these workers have been compelled to return while those who remain in employment abroad are undergoing difficulties of sending money to family members here.

Let me briefly talk of two concerns: questions of poverty and food security. It is known that there is significant clustering of families around what we consider as the poverty line. The poverty headcount ratio, i.e. % of numbers below poverty line, was around 5 percent under pre-COVID-19 circumstances. COVID-19, by reducing incomes of the vulnerable, would have increased the poverty percentage, by pushing down the incomes of large numbers who were earlier clustered above the poverty line.

Threats to food security coming from this decline in consumption were aggravated by COVID-19 related disruptions to channels connecting farmers with markets and closure of food supply sources from overseas. A valuable lesson learned in this regard is how risky it is for a country to depend heavily on imports for food.

Q Are there any tax reforms in the pipeline to increase state revenue in the aftermath of the pandemic as the tax cuts late last year cost the government an estimated Rs. 500 billion? What measures are being taken to address issues related to this revenue drop?
Tax reforms announced in December 2019, were aimed at simplifying the tax system and to stimulate growth of the economy by increasing disposable incomes of taxpayers. That there would be some initial fall in government revenues following these tax cuts was expected. But the income growth following the tax cuts was expected to widen the tax base and to soften the possible fall in government revenue. The number you have mentioned has been widely referred to as the revenue decline due to end-2019 tax cuts. The reality, however, is that no reliable estimate has been made of the revenue implications of these tax cuts on rigorous methodological premises.

The intervention of COVID-19 has further complicated the revenue implications of these tax cuts. As the Secretary to the Treasury once mentioned, this was the first time during his association with policy making, that no new vehicles have been purchased after an election. This statement is perhaps intended to symbolically express the government’s expenditure reduction efforts.

Q Do you think COVID-19 has devastated almost the entire global community much more severely than the 1930s Great Depression?
The comparison to be made to answer your question is between an economically and socially devastating condition we are currently living through and a similar condition in historical memory. There is descriptive and pictorial, as well as an analytical material about the Great Depression of the 1930s. The humanitarian disasters of the Great Depression were due to the collapse of economic and commercial activities, brought about by failures of market forces. Impacts of this economic collapse prevailed over several years in late 1920s and early 1930s destroying employment and livelihoods. Market forces operated freely producing these impacts, with little or no restrictions and restraints imposed by the state. COVID-19 impacts on humanity have been felt despite the wide range of governmental interventions and relief measures, implemented at the cost of tremendous human effort and enormous volumes of financial resources. There were deaths in the Great Depression but those were caused by hunger due to livelihoods being disrupted which resulted from economic systemic failures. COVID-19 deaths, most probably larger in number than those in the 1930s, resulted from health systems failing to prevent virus-caused deaths. 

Q To minimise the negative economic and financial impacts of WWII, the World Bank and the IMF were established to help Europe in particular and other nations at large as a follow up to the Bretton Woods Monetary Conference in 1944. The US launched the ‘Marshall Plan’ as a Recovery Programme of Western Europe. Does the world community need such a mechanism to recover from this unprecedented and unexpected disaster?
There was the relatively less devastated US after WWII to give leadership to postwar reconstruction efforts. The US had indeed used these conditions to establish its own postwar global leadership. One does not see any large country emerging unscathed from COVID-19 with the US currently going through an experience appearing to be the worst among the affected advanced countries. As the second largest country in the world today, China has gone through the experience and is re-emerging as a powerful and rich country. Will China take the leadership to develop institutions and to make necessary resource contributions to take the rest of the world out of COVID-19 crisis? Would the majority of the other countries be willing to accept its leadership? There were discussions during the last couple of decades about the epicentre of the world economy moving out of the West and into the East. In terms of humanitarian impact, COVID-19 has produced a less impact on Asia than on the West. Will that help the Asian region to take leadership in the global post-COVID 19 reconstruction? As you could see, I could, in response to your question, go on raising many questions without necessarily being able to provide clear answers.

Q Finally, don’t you think many of the economic theories in the Capitalist and Marxist domain have collapsed with all countries confronting economic challenges as a result of the viral infection as the export and import based economies, including in Sri Lanka, are the most affected? Your comments?
My perspective is that COVID-19 and its extensive impact have begun to pose a significant challenge to the dominant world view of the pre-COVID-19 era. As it evolved since the late 1970s or early 1980s, particularly strongly so since the 1990s, the pre-coronavirus world view was one of neoliberalism. Globalization has been the constantly repeated mantra in discussions of economic policy and management over the last four decades.

Indispensability of Foreign Direct Investment (FDI) for rapid economic growth has been constantly highlighted. Import replacing domestic industry has been shown as ineffective and inefficient and export oriented economic activities shown as the sine qua non of rapid economic development. Finding and locating the country in international value chains within global production networks and liberalization of international trade processes have been seen as the secret of success in export-oriented production and economic growth. Two other avenues of globalization have been promoted for economic success of Sri Lanka, namely international tourism and worker migration for overseas employment. COVID-19 and related developments are raising issues about the accuracy of these neoliberal policy positions.

To be sustainable, the growth process requires to be based on innovative thinking moving away from the failed neo-liberal paradigm of the last four decades. Although signs of change are visible, there are still strong elements aiming to go back to the old world. An environment surrounded by conflict of opinion would remain in respect of policy thinking and practice. There are some changes, associated with the corona virus, appearing to be globally significant. Could these become more permanent? How could these changes be made more long-lasting so that corona virus becomes a blessing in disguise?