The Hindu Business Line : `Sri Lanka not living up to its potential'

"The private sector has factored-in the war situation and is not shying away but is also not investing in long-term projects." — Mr SAMAN KALEGAMA, EXECUTIVE DIRECTOR, INSTITUTE OF POLICY STUDIES OF SRI LANKA

recently in Colombo

Though the private sector in Sri Lanka has shown resilience and factored in the uncertainties arising from the ethnic conflict in the island nation "to a very large extent, as was proved by last year's 6 per cent GDP growth rate," the country can do much better, said Mr Saman Kelegama, Executive Director, Institute of Policy Studies of Sri Lanka, in an interview to Business Line.

Excerpts from the interview:

How is the recent outbreak of military hostilities in Trincomalee district impacting the economy?

As far as the economy is concerned, the private sector has mostly factored in the situation. It knows that the CFA (Ceasefire Agreement) is just on paper and for the international community, but in practice it is almost dead. Last year the economy grew at 6 per cent, and that was thanks to good agricultural growth and the construction activity with tsunami aid. Though 2005 was not a smooth year vis-à-vis the peace process, the economy showed some resilience, and the last quarter saw a growth of 8 per cent, proving that the private sector has factored in the uncertainty to a great extent. Also, 50 per cent of GDP is concentrated in the Western Province alone, where the economic activity has not been disturbed much by the war.

But Sri Lanka is not living up to its potential. Now it attracts about 1 per cent of its GDP as indirect investment. It can attract about 3-4 per cent as FDI, which it is not doing thanks to the uncertain environment. The private sector is not putting in money in high-risk, long-term projects. Most of the money is put on medium-term, low-risk projects. The potential is not reached even though the private sector has not shied away. At the same time due to the escalation in the war the defence expenditure will go up.

Had it come down in the last few years?

Yes, a little bit, especially during the ceasefire time when we did not resort to rapid upgrading of the defence equipment and this resulted in reduction of defence expenditure by 1-2 per cent of GDP. This over and above the high subsidy cost - close to 3 per cent of GDP - for petroleum and fertiliser, as also the recruitment of university graduates in the public sector as assured employment.

Along with this high subsidy cost, there is another cost — the high interest payments, because our public debt-to-GDP is about 95 per cent. The interest payment alone accounts for about 31 per cent of overall government expenditure. The remaining 70 per cent goes on wages, subsidies, poverty alleviation programmes, transfers, pensions etc.

The budgetary situation is very tight and in 2006 we expect a budget deficit of about 9-9.2 per cent and it may even go up to 10 per cent. Last year it was 8.5 per cent. Inflation is at about 11 per cent and may go up further, as petroleum prices were hiked on August 1.

So it's a worrisome situation...

Yes. Though we got an 8 per cent growth rate in the first quarter, we have an unsustainable macro-economic situation. Tsunami related aid and the aid coming to the North and the East saved the country from a foreign exchange crisis. We now have sufficient foreign exchange for three and a half months, but the situation could have been worse.

In this positive growth but negative macro-economic situation, one good feature is that big infrastructure projects are moving. Despite the problem in Trincomalee, the oil power plant with Indian investment is moving, as also the coal power project with Chinese bilateral aid. The southern highway, the airport highway, etc., with various multilateral and bilateral donations, are moving.

But have economic reforms slowed down?

Yes, economic reforms in key areas such as the Ceylon Electricity Board (CEB), Ceylon Petroleum Corporation, Sri Lankan Railways, which are great burdens on the budget, have slowed down. Nevertheless, the infrastructure projects are moving, mainly with bilateral aid, where India and China are key players; India is assisting with our railways.

Do you think the previous Ranil Wickremesinghe government could have pushed in serious economic reforms, had it survived?

He might have been able to do it but he was implementing economic policies under uneasy cohabitation. So he didn't have the full authority to do what he wanted; his hands were tied. Some of the reforms got diluted as he launched these on an ambitious scale with a grand reform type of implementation and without focus on any particular area. That was one the shortcoming of the Ranil government.

Do you see a sort of disenchantment with the present government as the cost of living has risen sharply?

People are worried about the cost of living going up, but at the same time they know there is a very, very uncertain situation where the government has to manage a mini-war with the LTTE and at the same time face international challenges such as crude oil prices going up.

Do you think Sri Lanka has failed to leverage the booming economy of its large neighbour - India?

We were trying our best to get the Indo-Lanka Comprehensive Economic Partnership Agreement (CEPA) - the bilateral trade agreement - where liberalisation of investment, trade and services are considered, implemented by March 2004. Our intention was to further integrate with the Indian economy and benefit from India's growth from the IT revolution and other booming economic activities, particularly in the south.

But around March 2004, when the CEPA was supposed to come into force, both Sri Lanka and India saw change in government, in April and May of 2004. The new government on both sides wanted time to study this agreement, as neither had an ownership to it. During the whole of 2005, we've been having negotiations.

The stumbling block is copper and vanaspati, particularly vanasapti exports, which increased very rapidly in 2005 affecting Indian small and medium industries. Consequently, India put a quota on vanaspati exports from Sri Lanka and brought its purchase under a government authority. This sent wrong signals to the vanaspati factories in Sri Lanka, most of which are operated by Indian entrepreneurs. This is acting as an impediment for further progress in CEPA. But for this, deeper integration with India was something we were looking forward to.

Is there a growing problem of educated unemployed in Sri Lanka?

Our graduates are not readily employable by the growing private sector of Sri Lanka due to their lack of knowledge of the English language and suitable skills. That is why the present government had to absorb about 40,000 graduates in the public sector in February 2005.

Were they required?

They were becoming very revolutionary; they were the ones who joined the JVP in 1971 and gave the stimulus for the youth uprising. So their concerns have to be addressed.

How does the future look on the economy front?

It is a country with enormous potential but it has been highly shaken by the domestic Southern policies and the war. The Government has to implement economic reforms particularly in the areas that are cracking up, like the CEB, whose accumulated debt of about $800 million is almost equivalent to the annual foreign aid inflow into Sri Lanka. Power and petrol prices have to go up. The Government could go slow on diesel and kerosene because these affect the common man the most, but petrol is used by upper middle class and the rich.

What is the sentiment here vis-à-vis the recent problem Lanka IOC had with the Sri Lankan Government? Is there a feeling in some quarters that if you let Indians come in, this is what happens?

Lanka IOC is a big Indian investment in Sri Lanka and we shouldn't give any negative signals on that front, as we are particularly keen on getting more Indian investment. After all over 50 per cent of Indian investment in the SAARC region is in Sri Lanka. When the Maoist rebellion started in Nepal, a lot of Indian investment in areas such as vanaspati came to Sri Lanka.