Sri Lanka: Transcript of Press Conference on the IMF Article IV Report
May 2, 2013Koshy Mathai
2 May 2013
Colombo, Sri Lanka
Mr. Mathai: Thank you all very much for coming. As you probably know, Article IV of the IMF’s Articles of Agreement specifies that member countries on a regular basis—usually once a year, or once every two years—should have broad-ranging discussions with IMF staff about economic developments, prospects, and policies.
A team led by John Nelmes came here a couple of months ago and had those discussions with the government and the central bank. They went back to Washington and wrote up a report which they submitted to our Executive Board, consisting of representatives of the various governments of the world. The Board had a discussion of that Article IV report yesterday, and in line with my practice over the past few years that I’ve been here, I thought I would call this press conference today to answer any questions that you have about what the Board discussed and what our views are on the Sri Lankan economy.
Maybe before I throw it open for questions, I can give you an overview of the main findings and the main views which were expressed and which the Board endorsed yesterday. The basic finding, I would say, is that the economy has made a lot of progress, but there are still challenges, and there are still risks.
The economy grew at 6.4 percent last year, and we see something similar—maybe slightly slower, around 6¼ percent—for this year, 2013. Now these figures are lower than what we had in 2010 and 2011, but it’s important to remember that they’re still higher than the average for emerging and developing economies across the world.
As for inflation, it has come down quite a bit. There was a very recent release of the April data, showing that inflation is down to 6.4 percent, year-on-year. But we expect that figure to rise once again, as the impact of the electricity tariff hike is fully reflected, and generally we remain cautious in terms of inflation. Sri Lanka, after all, has had a long history of high inflation, and while it’s excellent and commendable that we’ve now had more than four years of single-digit inflation, I think we would all agree that single-digit inflation is not the final goal. We can’t rest on our laurels; we need to reduce inflation further for the good of the economy. And as a result, we continue to think that monetary policy should remain on hold, as it has for quite some time now, and shouldn’t be changed prematurely.
The current account deficit of the balance of payments has improved. As you know, there was a very strong policy package that the authorities introduced about a year ago, in early 2012. And that package worked. It involved exchange rate liberalization, monetary tightening, and fiscal tightening in the form of increases in administered prices for fuel and electricity. Even though the global economy was still pretty weak last year, causing exports to decline, we still had an improvement in the trade balance and a narrowing of the current account deficit. This allowed the overall balance of payments—measuring all the flows of money in and out of Sri Lanka—to move into a small surplus. And we’re expecting that to continue to improve this year.
We thus see the exchange rate flexibility that the Central Bank introduced last year to be a very useful thing—a very helpful feature of the economy that we hope will remain in place. It has helped to safeguard reserves, and it has helped to stabilize the economy. Reserves have stopped declining in the way they were before the exchange rate was made flexible, but reserves do need to be boosted further, in our view. And foreign direct investment, as we all know, remains a challenge for the economy.
The package of measures that helped the balance of payments did have an adverse impact on the fiscal accounts—imports were restrained, and the revenues collected on those imports naturally declined; and at the same time, with interest rates rising, the interest bill of the government went up. But despite those pressures, the fiscal deficit remained all right last year. We had a cash deficit of 6.4 percent of GDP, slightly higher than targeted, but an improvement from the previous year. I say “cash” deficit, because there were some payments that were delayed, so if you look at the underlying spending, the deficit may have been roughly unchanged from 2011 to 2012, but that itself is an achievement, I would say, given the strong policies that were taken to address the external position of the country.
The deficit thus continues to be on a good trajectory, but clearly the debt ratio is still too high. We’ve still got a debt-to-GDP ratio of about 80 percent, and that is too high, and it needs to be reduced. So, fiscal adjustment needs to continue. And the main issue that we’re seeing here is not that expenditures are too high—though, of course, in any country’s budget one can find spending that can be trimmed—but rather that revenues are too low. Tax revenues last year were about 11½ percent of GDP, which is one of the lowest figures in all of Asia. And because it’s so low, it means that the government is not able to do the type of productive spending that it would like to be able to do.
In China, for example, public investment amounts to 18 percent of GDP. In Malaysia, the figure is around 10 percent, and in India, 8 percent. In Sri Lanka, however, we’re in the 6 percent range. Raising investment is very important to boost growth, but we won’t have the space to do it if we aren’t collecting the revenues needed to finance it. So boosting revenues seems an important priority to us, and here we’re talking not about rate increases, but rather about base-broadening measures—getting rid of some of the exemptions in the system, so that more people are paying taxes and contributing to government’s revenues—and also improving administration…there are problems with VAT refunds, with the collections of direct taxes, etc., and all of that also has to be improved.
The fiscal issue is not restricted to the central government alone. As we all know, large losses are being accumulated at some of the public enterprises, in particular the Ceylon Electricity Board (CEB) and the Ceylon Petroleum Corporation (CPC). And one natural implication of this is that price adjustments need to be made, in order to help recover some of those costs. We were not involved in the recent tariff increases, or the particular structure of those increases across the different consumption brackets, but we were always strong proponents, both publicly and privately, of moving toward pricing that would allow the enterprises to recover more of their costs, so that they would not run big losses.
And why is that? It’s not because we have some undue concern for financial results per se. We’re not just looking at numbers on the page. It’s actually a very real economic issue, because if these enterprises run huge losses—last year, CEB and CPC alone ran a combined loss of more than Rs 150 billion—well, then they have to be financed somehow, and typically this has happened through the state banks, the Bank of Ceylon and People’s Bank. When those banks are forced to lend such huge amounts, they have correspondingly less money that can be lent to the rest of the economy, and interest rates for the whole economy become very high, as businesses are seeing now. And when those interest rates are high, investment is curtailed, growth falls, and jobs are lost. So when the general public has to face increased tariffs, it’s not because policymakers are just trying to make some income statements look nice, but rather it’s actually done to ensure that the economy remains healthy and continues to create jobs.
We were happy to see electricity prices adjusted, but at the same time it’s very important to shield the poor. Transfer programs to shield the poorest people are a very big priority. And over the longer term, as the Pathfinder Foundation and others have said very correctly, it’s not just a matter of pricing. We can’t simply pass on high costs and inefficiencies to the consumer; we need to implement structural reforms to address those inefficiencies and reduce the costs in the first place. Now, I’m no expert on state enterprises, but it seems clear to me, and probably to everyone in this room, that there are serious changes that need to be made at those enterprises in order to reduce their costs, so that prices to the consumer can come down. And that is a key priority for the medium term and long term. Certainly the government is keen on this, and we’re looking forward to seeing more in that area.
I’d also like to say one thing further on pricing. We’ve been talking for a while about the importance of having an automatic pricing formula, so that, at least for petroleum, movements in international prices are passed on in a smooth way to the domestic economy. Rather than having large, discrete jumps in prices that are made on a discretionary basis by the government, let’s have this happen in an automatic way that will be easier for people and firms in the economy to absorb. That’s been the practice in many other countries, and they’ve had a lot of success with that.
Let me end by looking to the longer term. I started off by talking about growth and saying that it’s higher than the emerging-market average. But still, it’s clearly less than what the government and most of us would like to see for the economy—the 8+ percent growth rates that people talk about. We don’t see those rates as being achievable on current policies. But with some policy changes, we think Sri Lanka could get there. And what are those changes?
I’d start with continued investment in physical infrastructure, and hopefully with more private-sector involvement as well. More investment in education is also important—Sri Lankans talk a lot about high literacy rates, but it’s well acknowledged now that university education, vocational training, English skills, and IT skills are all areas for improvement. Financial market development—something the Central Bank has emphasized a lot recently—and in particular, developing the corporate debt market, so that there’s a source of long-term finance for companies. And the last thing I would mention is trade—Sri Lanka’s exports have declined relative to GDP for the past 10 or 15 years, and there’s a need to reverse that. Sri Lanka is a small economy, and like any small economy, it needs to look to the outside world to power its growth. We still have more than half of our exports going to the US and Europe, when those economies are growing very slowly, whereas only 5 percent of exports go to India and only 1 percent to China. There’s a need for a geographical reorientation of trade. Part of the onus lies on the private sector, which must explore these new markets, but there are also things that the government can do, such as signing new trade agreements and, we would also say, taking a strategic look at the overall tariff structure. Some recent reports done by the World Bank and the World Trade Organization have highlighted the fact that rates of protection have actually increased in the last few years, and this kind of domestic protection is not helpful for an export-oriented economy.
So these are some of the issues that we see. Maybe I should stop here and take any questions that you have.
Questioner: You talked of broadening the tax base. If I remember right, the Central Bank in their recent report said that the wholesale and retail sector grew by just 3½ percent this year. So do you think there is space to broaden the tax base, under those circumstances?
Mr. Mathai: Well, I think that that sector may have grown slowly this year, but this was an exceptional year, because of these policy measures that were brought in. And I don’t think that a tax structure is going to be able to keep up with the collections that it needs to deliver if the wholesale and retail sectors are exempted. We thought it was a very good thing that they extended the VAT to the large retailers, and I think going forward, maybe there’s a case for expanding that further.
Questioner: You mentioned the importance of shielding the poor when these price hikes happen. Now yesterday, the President in his May Day speech announced some measures to shield the lowest consumers of electricity. What’s your comment regarding this situation and the overall picture?
Mr. Mathai: We don’t have the details, but from what I understand, the cost of implementing the change announced yesterday—partially reversing the tariff hike—is not very large, and it seems to do something to shield the poor, as you were saying. So we can understand that logic; it makes a lot of sense.
But some burden still lies on the higher-consuming customers, because there’s a need to do something about those losses that the enterprises are accumulating—as I said, those losses are a real drag on the economy. It’s easy to put those losses aside, because we don’t see them in the central government budget—there’s no line item there. They are hidden somewhere on the balance sheets of the Bank of Ceylon and People’s Bank, which most normal people—and even abnormal people like economists!—don’t look at. The losses are hidden there, but they have a very real impact on every single person in the sense that they boost interest rates in the economy and ultimately destroy jobs. So that’s a key thing that has to be addressed, going forward.
Questioner: You talked about protection that has, as per a WTO report, increased, and that has also affected exports. Can you elaborate?
Mr. Mathai: Economists have this concept of “effective rates of protection.” If you’re producing something, you have inputs and outputs, and in order to assess the overall impact of the tariff regime on your sector, you have to consider the tariffs not only on your outputs, but also on your inputs, some of which may be imported. It’s not always straightforward. If you do the calculations, you’ll see that there has been some increase in effective rates of protection, in the last few years, even as the tariff structure has been simplified. When you have an increase in protection, then naturally there’s more incentive to produce for the domestic market, and this diminishes the incentive for capital, labor, and the other factors of production to move into export-oriented sectors.
Questioner: Our foreign debt component is supposed to be something like $1.9 billion per annum between 2013 and 2015. Given that large amount of money that’s going to deplete our foreign reserves over time, how well prepared do you think we are in terms of our reserve position? And given that this is going to happen, what is the likelihood of another SBA arrangement from the IMF?
Mr. Mathai: We don’t think that there’s anything wrong with the reserves position—it’s about 3½ months of imports or close to $7 billion—but certainly there’s scope to boost it further. As for the likelihood of another arrangement, my office is here and we remain in close contact with the authorities, and anytime they feel like discussing this issue with us, we would be ready to talk. But ultimately, of course, that’s a decision for the government to make, as to whether they want to get back into a program relationship with us.
Questioner: Where are we with this talk about going for a new program?
Mr. Mathai: So, yes, this is just the point I’m trying to make. Right now there are no discussions going on. The team that was here doing the Article IV discussions was, as you know, also talking about the possibility of a new program. Those talks didn’t move forward beyond that point. So right now we’re not in an active negotiation phase, but we’re always open to helping however we can. That option is always there.
Questioner: Regarding the deficit, you said it’s “cash.” Is the spending on an accrual basis? Is it recorded in the budget numbers that we have? And also, if we have cash for the deficit this year, is it usually accounted for in the following year?
Mr. Mathai: There is always spillover from one year to the next. Our understanding—and I don’t have a lot of detail on it—is that there was a larger-than-usual spillover this year. So you have to make some adjustment when you look at the headline figures.
Questioner: How does it work out? I remember the previous year, there was a Rs 50 billion payment made to CPC, in the first quarter of 2012. That kind of stuff—in which year’s budget does it appear?
Mr. Mathai: The CPC payment is a different issue, and I’m not sure of its treatment. But what I’m saying is that for ordinary payments to any vendor or supplier to government, there’s always a spillover, say from December to January, but last year, given the fiscal pressures, the spillover was bigger than normal. In 2012, we had a 6.4 percent deficit in cash terms, but the actual deficit may have been somewhat larger than that. Exactly how much larger, I’m not sure.
But the basic point that I do want to emphasize is that despite those needed policy measures that, as expected, unfortunately dampened revenues and raised the interest bill, we did not see a wholesale reversal of the progress we’ve had in the fiscal sector. In fact, that fiscal consolidation has continued. The deficit has continued to decline, and the debt ratio was hurt by the depreciation but is still basically around the same level as it was a few years back. Now clearly that’s too high, and moving forward, it will remain very important to continue reducing the deficit, to bring the debt down.
Questioner: How do you view our standards of data preparation and disclosure? Do they conform to IMF standards? Are we going to move onto GDDS?
Mr. Mathai: I need to check on the GDDS issue and can’t give you a precise answer right now. We have data that comes from the government on a regular basis. Most observers comment that the central bank website is among the best in the region, in terms of availability of data. There are certainly issues on some other data fronts, but all in all they have not risen to the level where we feel they have impeded our ability to analyze the economy.
Questioner: When you talk of other data, are you referring to the census department?
Mr. Mathai: Well, general data outside the central bank. One comment that I’ve definitely heard is that the central bank website compares very favorably to other central bank websites in the region. I don’t know if that’s true about DCS versus other census departments.
Questioner: You were talking about Sri Lanka’s dependence on exports to the west. In the trade figures that were released this morning, we see a 2½ percent decline in overall exports in the first two months. But garments have reportedly increased by almost 9 percent. Considering that Sri Lanka’s main markets are in serious trouble, do you tend to believe that there is actually an increase as shown in these numbers?
Mr. Mathai: I haven’t gone through those figures yet. But I do think it’s not so simple as saying that Europe is down and therefore it can’t be that garments exports are up. There are many other reasons—for instance, there could be supply disruptions elsewhere, as happened in the past with Bangladesh, which benefited Sri Lanka for a while.
The general point—looking at the data from the last few years, and not just the last few months—is that we do have a very high export dependence on a certain few regions of the world. And there are some large firms here that say that that’s OK, because even if those markets are growing slowly, we have a very small market share and can still do good business by increasing that share. Other firms, however, make the argument that I was trying to advance earlier, which is that if the pie is not growing very fast, perhaps it behooves you to look at other markets that are growing faster. Probably you need a mix of both strategies—deepening your exposure to existing markets while broadening your exposure across markets. But I’m an economist, not a businessman, so I can’t give you more of an answer than that!
Questioner: Do you feel that the authorities’ being quite conservative in giving tax holidays has impeded the growth of FDI?
Mr. Mathai: There has been probably 40 years of studies, across the world, on the impact of tax policy on FDI. And that literature has shown very consistently that tax considerations are far down the list of considerations for most investors. They will be looking at the fundamental business sense of a project, the general environment, labor quality, infrastructure, and other things like that. At the end, if there are two regions that are similar in all these respects, then taxes may play a role, but it’s certainly not a primary driver.
Questioner: There’s a phenomenon called “jobless growth” in Sri Lanka that a few people have been talking about. The number of jobs in Sri Lanka has remained static between 2006 and 2012. Given that statistic along with historic low unemployment, what do you feel is actually going on?
Mr. Mathai: I’ve read a little bit about this, and yes, with low unemployment, I have a hard time wrapping my head around the jobs data you cited. People have talked about jobless growth in recoveries in the US and elsewhere, but there we had high unemployment rates. Here, though, we have historically low unemployment rates and labor shortages in many sectors, so it’s very hard for me to think about this growth as being “jobless.” Now, there are always questions about the composition of jobs, what types of jobs they are, the need to develop higher-skilled jobs, etc. Those issues may still be there, but the quantum of jobs doesn’t seem to be a problem.
Questioner: Energy costs have been high, and they’re growing. The lack of manufactured exports may be a failure, or it may be a good thing. A lot of domestic capital has gone into tourism, which seems to be kind of a low-hanging fruit. Should we worry too much about the fact that, as our energy costs are still high, we don’t have a lot of energy-intensive, manufactured exports, but we do have affordable things like services that we can export?
Mr. Mathai: That’s quite a deep question. I think that in any country, you’d not like to see the industries that you currently have being hindered. Just this morning, there was a news report on a major glass company in Sri Lanka that was complaining that the electricity price hike would have a serious impact on its bottom line. It’s very important for businesses to have reasonable energy costs, and that’s why we and the government, of course, realize the importance of bringing in cheaper generation sources and implementing structural reforms over the longer term. Of course some of the considerations that you’re talking about also may play a role over that longer term. Countries have to look at their comparative advantage and focus on sectors that make sense given their particular endowments. But since every sector depends on energy to a greater or lesser degree, it will remain critically important to implement reforms to improve the operations of the utilities companies.
Questioner: There is a strong correlation between FDI and exports in some countries. Our FDI is quite low. Could that be a reason for poor export growth?
Mr. Mathai: I’m not sure, but certainly boosting FDI is a major priority, both in terms of financing the current account deficit without increasing indebtedness, and also in terms of the technology-transfer and other benefits to the real economy that FDI can bring.
Questioner: Since the last visit of the IMF delegation, in February, what are the changes you have seen in the macroeconomic numbers, especially in terms of growth? You came up with certain risks and potential risks. Have you seen any sort of improvement since then?
Mr. Mathai: I don’t think our assessment has changed fundamentally in the last few months. It’s only been two months, really, since Mr. Nelmes was sitting here and briefing you on the mission’s findings, and there’s been no dramatic change in our views since then.
Questioner: When you say you expect inflation to rise, can you share any numbers?
Mr. Mathai: I can’t give you any firm estimates now, but the rise would probably be on the order of 1 to 1½ percentage points. We need to analyze this a little bit more.
Questioner: Are you all satisfied with the inflation data from the Census and Statistics department?
Mr. Mathai: Well, this is an issue that has come up many times. It’s hard for me to give an answer, because we are here with just two economists in the Colombo office, and it’s not our job, nor is it within our ability, really to investigate numbers like this. All we can do is to work with the numbers in front of us. Some have made claims that inflation is dramatically higher than reported, but as a resident of the city myself for a few years, my personal observations don’t match those claims. Again, I can’t give you a very good answer here, because ultimately we are economists and not statisticians.
Questioner: During the Central Bank Annual Report release, Dr. Jayasundera made it clear that there is room for a rate cut, and for interest rates to come down in May or June, and the Central Bank has also given that sort of direction regarding market and tbill rates. How do you see it? Do you think there is room for a policy rate cut?
Mr. Mathai: We would stay on hold for now.
Questioner: For how long?
Mr. Mathai: It’s hard to say, but that’s why the Central Bank has frequent Monetary Board meetings—so they can assess conditions as they are changing, on a rapid basis. But right now we would certainly stay on hold.
Questioner: Is it because you feel that the 6.4 percent inflation is too high and doesn’t warrant a rate cut?
Mr. Mathai: As I said, we think that inflation continues to be an issue in the country and that we should be very cautious about giving the impression that we are trying to look only at growth and not paying attention to inflation. Preserving inflation expectations is key. We’ve had this very good history of the past four years, and building on that success is a very important thing. That’s why we would recommend staying on hold for the time being.
Questioner: There was a study that was carried out that said that inflation for urban, middle-income families was 20 percent. Given such a huge discrepancy…
Second questioner: It has fallen dramatically now.
Questioner: It has fallen dramatically, but at the time…
Mr. Mathai: What is the figure now, according to the authors of that study?
Second questioner: 7½ percent.
Mr. Mathai: 7½ percent, against the official figure of 6½ percent.
Questioner: At the time the study came out, the figure was 20 percent against a government statistic of 9.8 percent. So there was a large discrepancy. Do you give it any weight?
Mr. Mathai: Well, as I said, it’s very hard for us to be able to judge. You can’t make bricks without straw, and similarly we need the raw ingredients to do an economic analysis. We’re not able to come up with those raw ingredients ourselves; all we can do is to use the numbers in front of us. We try to cross-check numbers as much as possible. For instance, when we analyze fiscal performance—not just in Sri Lanka, but in any country—we don’t just look at the numbers coming from the Ministry of Finance, but we also look at the financing data, to see if they match. But for a basic piece of information like inflation, it’s very difficult to do any cross-checking, absent a major exercise to gather the raw data and duplicate the efforts of the statistical agency. Even for things like growth, we as economists can compare reported statistics against indicators like electricity generation or cement consumption. But inflation is trickier. Certainly it’s something that we think about and ask people about. I guess it’s comforting that the discrepancy is now quite small.
Questioner: When did you have your last Article IV consultation?
Mr. Mathai: The last Article IV was two years ago, 2011. Usually it’s an annual exercise, but when a country is in a program relationship with the IMF and is anyway going to the Board on a regular basis for disbursement of funds, some leeway is given on the timing of the Article IV.
Questioner: I understand that the IMF releases a Public Information Notice after Board meetings?
Mr. Mathai: Yes, that should be coming out relatively soon on our website. If you go to www.imf.org/srilanka, you should see it pretty soon.
Questioner: Was it released for your previous consultation?
Mr. Mathai: Yes it was. You’ll find it at the same address.
Questioner: Our defense budget hasn’t really shrunk since the days of the war, four years ago. Is this something that you look at?
Mr. Mathai: This is an area that’s difficult to comment on, not because of the sensitivity of the issue, but because of the data. As you know, the Defence Ministry now includes the Urban Development Authority, so there are other functions being carried out aside from the pure defense function. So I don’t think I’ll be able to comment very well.
Certainly over time, there’s a reorientation of the economy that will happen naturally. I was struck by a comment that Dr. Nalaka Godahewa made a couple of years ago, when he was at the Tourism Board—he said that in order to reach the country’s goal of attracting 2.5 million tourists here within a few years, the sector would need an additional 400,000 workers. Now at the time, the entire pool of unemployed labor in the labor force amounted to just 400,000 people, so either every single one of them would need to get a job in hotel, or some of the people who are currently in other sorts of jobs—maybe they’re migrating overseas, or they’re working in the forces or the public service more generally—would shift to the sector as the economy develops and wage levels rise. So over time, this sort of thing will happen naturally.
Questioner: How do you see our remittance picture? Is there scope for further growth?
Mr. Mathai: I think remittances continue to be very strong, and they are a major contributor to the balance of payments, as you know. That’s a good thing, and I think it will continue for the time being. Of course, over the very long term, an economy would like not to rely on remittances but rather to generate those sorts of high-quality jobs domestically so that people stay and make their contributions directly here. But it’s a perfectly respectable economic model to have remittances coming into your economy, and that may be with Sri Lanka for some time to come.
Mr. Mathai: Are there any other questions? Well, if not, then thank you for your attention, and I appreciate your coming here today.