October 13, 2012, 5:16 pm
By R.M.B Senanayake
In 2010 and 2011 we had high growth rates of 8% or so. But this year the government was forced to orchestrate a lower growth rate because of the crisis in the balance of payments last year due to a huge trade deficit leading to loss of Foreign Reserves under a regime of fixed exchange rates. In February 2012 the Central Bank allowed the rupee to float and the rupee promptly fell by almost 18-20%. The Government panicked and the authorities tried to talk the rupee up to Rs 125 to the dollar. But talk alone would not do unless there are foreign capital inflows or the Central Bank intervenes.
The Central Bank knows that if it reverts to a fixed exchange rate regime the prospects for a correction in the adverse balance of payments will recede, harming exports and also cause loss of Foreign Reserves which have been borrowed through the Sovereign Bond issues, the IMF and from bilateral borrowings from China and other countries. This occurrence -where growth is periodically checked by crises in the balance of payments, is an old pattern. It has happened before even where the exchange rate was depreciated each year by 7-8% because of excessive budget deficits funded by money printing rather than the savings of the people which requires higher and higher rates of interest.
Instead the present government has resorted to foreign borrowings which are comparatively cheaper and saves the day for the private sector. But there is a danger of over-borrowing from foreign sources making debt repayment dependent on roll-over. But no country can depend on perpetual roll—over. Greece depended like us on such roll-over until the bond markets demanded higher and higher yields and the world ultimately refused to buy their bonds at all. A completely free floating exchange rate will conserve Foreign Reserves but it may push up prices of imported goods- no bad thing except that it increases the cost of living since we are still dependent on food imports. We have built up a false economy over the years through subsidies and administrative prices instead of market prices.
Our comparative advantage
We have achieved near self-sufficiency in rice (although at an excessive investment). But our land is fertile and concentration on agriculture is no bad thing. It not only gives us food security it also enables us to cut down on imports and strengthen the balance of payments. In the past when we depended a lot on the export of primary products like tea, rubber and coconut, economists used to argue that there is a long term decline in the relative prices of agricultural goods vis-a-vis industrial or manufactured goods. But this argument has not always held. Right now world commodity prices are rising and prices for tea are holding up well. Rubber too is not faring too badly. In the case of coconuts our exportable surplus has practically disappeared. We hardly export any coconut oil now.
I think we do have a comparative advantage in agriculture and we should pay more attention to agriculture. We import a lot of subsidiary foodstuffs from India but her exportable surplus is likely to decline as per capita incomes rise there. We will have no difficulty in exporting our agricultural products to India in the long run. In fact we could export much more fruits and vegetables and even rice if we can standardize and improve the quality of our rice. We have successfully cultivated maize and have become almost self sufficient. But we have used protectionist measures which should be gradually reduced.
We have built up a successful chicken farming industry for both for eggs as well as for meat. Erratic government policy has been a problem for most farmers. Recently the farmers of onions complained that their crop could not be sold because the government had permitted imports - the policy of trying to protect both the producer and the consumer is not workable. If we want to protect the farmers (we need to do so because we have had a high inflation economy for the last 50 years) then we should ban the imports completely instead of regulating imports to coincide with the harvesting season for local agricultural products.
The bane of our country is erratic government policies. The economy has been prone to high inflation which was made possible by huge and increasing budget deficits funded more and more by money printing. The result is higher wages and cost structure in the domestic economy relative to other countries. This situation can be corrected through the depreciation of the rupee but such depreciation should not be offset by wage increases – a difficult task indeed.
Our agriculture marketing needs new investment by the private sector. For the last 50 years we have depended on government institutions to buy the local agricultural products. There was the Marketing Department which used to buy subsidiary foodstuffs and vegetables. But it was a failure. The farmers themselves organized their producer co-operatives like the Udapaltha Co-operative Society and the Jaffna Producers Co-operatives. But the politicians interfered and gave them the kiss of death. Then we had the CWE and the Paddy Marketing Board. All these models have failed.
We find that the large private sector organizations like Cargills have been buying produce directly from the farmers and giving them a fair price. We need to develop this model. We need more such organizations. I heard that the maize crop is sold under forward contracts to large buyers. We need to encourage such buyers from the private sector. One problem they will have is the lack of stores to hold the produce until it is transported to the markets. The government has many large stores in the districts constructed in the past by the Food Commissioner’s Department and the Agrarian Services Department. The government should make these stores available on rent to private sector organizations to buy and store produce from farmers. The farmers should be encouraged to sell their produce forward.
But Minister Johnston Fernando is a threat to forward planning for the purchase of agricultural produce. Price controls and imports of these products should be banned until we bring our domestic cost structure in line with the global economy. India has recently relaxed restrictions on multinationals entering the domestic retail market. Why? Because they will develop their supply chains by entering the producer areas and buying directly from producers. We still have restrictions on foreign investment in the retail sector. It is time to remove the restriction.
There is something more which strikes me as desirable. That is to allow foreign investors to come into the business of buying farm produce and allow them complete freedom to export the produce. Our agriculture like the agriculture in the SAARC region is seasonal. Perhaps if the foreign buyers can export part of our produce during the harvesting season it may be possible to pay higher prices to local farmers. At least they will not find themselves without any buyers because the government buying organizations are not able to buy because of lack of storage or money.
There is another reason why we should concentrate on agriculture. In a globalized environment the domestic economy fluctuates with the business cycle in the developed countries. We saw this during the financial meltdown in 2008/2009. If we can ring fence our agriculture then the domestic economy will be protected from such fluctuations to some degree. We would then be less exposed to balance of payments crises due to fall out from the global business cycle.
Tourism and Services
Another sector we can concentrate on is tourism. We have the infrastructure in place and we have the variety that tourists would like to enjoy. Here too we run the risk of pricing ourselves out of the market because of high inflation and an over-valued exchange rate. We may need some minimum price but let us limit it to the five star hotels in the city and exempt the resort hotels from such minimum price controls. We have the expertise in running hotels and catering to tourists. After the cessation of the war the number of tourists have increased. We expected 1.5 million according to the Mahinda Chinthanaya but it has fallen short by nearly half a million. But we can increase the numbers if we keep the rupee from getting over-valued.
It is best to allow the rupee’s value to be determined by the market rather than being fixed by the Central Bank. In my opinion if the interest rates are allowed to rise, there will be much larger inflows of foreign capital to the stock and bond markets. Foreign investors should have the confidence that the authorities are not fixing the rupee ignoring the economic fundamentals. Of course foreign investors would like a fixed exchange rate. But we can allow them free access to the forward market in exchange so that they cover the exchange risk.
New financial instruments like derivatives need to come in. We have been talking about them for too long. We should demutualize the Stock Exchange so that it can be run by persons who understand and have experience in markets. If a foreign party is given control of the Stock Exchange we can promote meaningfully the newer financial instruments. The answer to price manipulation upwards is to allow short selling so that some investors can bet against those who push up the market through manipulation. We need to liberalize and introduce structural reforms. As Indonesia did we should outsource our Customs department to General Superintendence Co for it is a huge drag on modernization.