Economic activity is on an accelerated path since the end of war in 2009. The island is bullish about its tourism prospects and is encouraging the export of labor to boost forex earnings.
However a top international economist with deep roots in Sri Lanka says tourism and remittances is not the way forward for the country.
Dr Howard Nicholas, a co-founder of the Institute of Policy Studies in Colombo was in the island recently. LBR caught up with the expert, known for his early warnings on major changes in the world economy for an interview.
LBR started by asking his opinion on Sri Lanka’s economic direction.
A: I am very optimistic about what has happened in terms of infrastructure. This is something that successive governments in Sri Lanka have not paid any real serious attention to. I have told a lot of my friends that one of the striking things, coming from the Katunayake Airport is to see the streets clean and well organized. I have been told that the new highway from Colombo to Galle is marvelous and there is another one planned. This is far overdue for a country aspiring to develop like Sri Lanka. You cannot develop without good infrastructure. I think the government has moved in the right direction.
However I see a problem and it is a very fundamental problem. I still have not seen any country that has developed on the back of tourism, migrant remittances and services, which are two of the biggest areas for Sri Lanka. Many people keep telling that maybe Sri Lanka will show the world to become the first but I do not believe in that.
There is a fundamental that you need diversification for development and only manufacturing gets you there. It is impossible to significantly diversify services. Eventually if you don’t do that and keep splurging on infrastructure you will get in to Balance of Payment problems like Latin America did. In the end you will start accumulating debt like Latin America which did not go down the export oriented way but rather internal industrialization. Sri Lanka cannot even claim that it is industrializing behind tariff barriers.
I do not see the possibility of that for a country as big as Sri Lanka, unlike the Maldives which can survive on the basis of tourism. Tourism is a bonus but it is not going to create the sort of dynamism that would take Sri Lanka to the level of Singapore or Malaysia.
There is one real big mistake Sri Lanka made which I think should be soon re-addressed – giving up state development banking. No successful Asian country has developed without a State development bank. I have said it many times that external forces conspired to force Sri Lanka to privatize the country’s two excellent development banks which then became commercial banks. So we lost long term low cost loans for innovative manufacturing sectors.
If Sri Lanka is really serious about developing the manufacturing industry then I think development banking is one of the policies the country has to bring back.
LBR: Sri Lanka’s economic growth forecast has been downgraded from 8.3 percent to 8.0 percent. How do you think this is going to impact investments?
A: My concern is where does the growth come from? If you look at the numbers it is fundamentally from two sources; construction and services. That is projected to grow at 22 percent and 12 percent respectively. Again, what you really see in all the successful countries like Singapore, Malaysia, Korea or Japan is that you have to have the manufacturing dynamism. Unless you see export oriented manufacturing really taking off the numbers will not mean very much because we could always grow very rapidly with a huge infrastructure program because it is not sustainable. Then you come back to the old problem of having growth for two-three years and then hitting a balance of Payment brick-wall because you are not earning enough foreign exchange to sustain the process.
I am optimistic about Sri Lanka much more than I was in the 1990’s and it is because Sri Lanka seem to have a good foundation. Now the country has to unleash the private sector, give them the tools to expand and develop to become an Asian power house. I can see Sri Lanka growing easily at 10 percent for a decade or more. But there is only one way for that which is manufacturing and allowing more and more diversification from one to another sector and a lot of State support to the private sector.
LBR: inflation is rising in Asia which is a worrying factor. What do you think governments can do to curtail inflation?
A: I am not that worried about inflation. Whenever countries grow rapidly they invariably have inflation accompanying that growth. The trick is not to allow it to get out of hand and make sure that competitiveness is not damaged. There is obviously an issue with the currency here because when the country is inflating very rapidly, in order to maintain competitiveness it frequently has to depreciate the currency. I know there is a big debate in Sri Lanka about the currency. In the 1990’s I was involved in a debate where we were recommending that the government looked carefully at relative inflation and adjust the currency to make sure that our exporters will not lose out.
My take on this is that you have to be careful when you do not have export dynamism and when you are also facing a global recessionary environment where if you depreciate could you significantly boost exports? On the other hand if you have lost a lot of competitiveness as a result of inflationary differentials then sooner or later you are going to have to adjust. So, the pain will come and the longer you delay greater the pain. It is very difficult for policy makers. I could understand and appreciate if they wanted to delay because it may be the current conjuncture is not the right moment given huge import bill to pay for the huge infrastructure.
LBR: During the last two years over 40 percent of global economic growth came from the Asian region and the trend is likely to continue. What is your growth projection for the region?
A: It is very positive. But I am not sure if India and China will maintain the same growth rates it has had in the past and nor should they because now they are really big economies and they cannot sustain the growth rates. I expect China to come down and India to continue for a while long but eventually to come down. The important thing is what are the next generation power houses? I see Indonesia as having a great future with a population is around 200 million people, massive natural resources and a very young population, dynamic and increasingly educated good links to the Middle East due to common religion. I see a number of new countries emerging in Asia.
LBR: The European economy is definitely in bad shape and is affecting investment decisions in Asia. How would you advice investors to optimize their returns in a turbulent market like this?
A: They have to be cautious and look at the facts. I am not so negative about the situation in Europe, not in the long term. One thing that seems to be happening in Europe is they are using the turbulence to accelerate integration. That integration creates synergies. The last time we saw this kind of integration is when the United States integrated creating a 30-40 year very rapid growth period. They then overtook the UK and came to be the dominant power. I think the Europeans have similar ambitions. Certainly the Germans have used every opportunity for integration. So on that score I think the way Asians should look at it is not to be fearful of a disintegrating situation but of a rival economic power. I think Europe is trying to create a block which will rival the power and growth of Asia. I do believe they fear Asia in some ways.