Investor sentiment showing improvment

By Dr. S. Colombage

The current wisdom based on free-market principles is that developing countries should get on to the bandwagon in the grand parade towards globalisation and boost their exports. Several developing countries that are successfully integrated into the global economy have achieved higher income growth, longer life expectancy and better education, according to a recent World Bank report on globalisation. But many countries, particularly the poorest, have not been successful in this parade. As a result they get marginalised and left behind. In order to achieve greater integration, the report emphasises, inter alia, the need to implement measure like improving the investment climate, good economic governance, combating corruption and better-functioning bureaucracies. All these are very relevant to Sri Lanka in the current context.

The country depends heavily on a few exports. Garments, which have become the leading export product after trade liberalisation, account for one-half of total export earnings. The garment industry is considered Sri Lanka's flagship industry. Tea, the traditional export leader, accounts for about 13 percent of total export earnings. Thus, these two products alone generate two-thirds of export earnings, reflecting the limited impact of the export diversification drives that have been adopted so far. Other industrial exports contribute about one-fifth of total export earnings. The bulk of them consists of primary type exports such as food and beverages, leather products, tableware, and bunker oil and aviation fuels. Most of these products depend on imported inputs, and therefore, the value-added accrued to the domestic economy is low. For instance, about two-thirds of the inputs for the garment industry are imported. Supporting industries such as fabrics and accessories have not been developed. Thus, there is hardly any development of such backward-linkage industries.

There is a danger in depending too heavily on the garment sector, particularly in view of the phasing out of textile quotas in 2005. Sri Lanka has benefited significantly from these quotas by way of attracting foreign investment and creating jobs. With the abolition of quotas, a ready market for our garment exports will not be available. Our producers will have to compete with other suppliers in foreign markets. This will be tough unless they produce quality goods at competitive prices. Export competitiveness is crucial in trade expansion. The competitive edge can be sustained to a large extent by having a lower domestic inflation, compared with other supplying countries. Exporters are now losing their competitiveness rapidly due to the acceleration of inflation to 15 percent this year. The competitive edge gained by exporters from the rupee float that was introduced early this year is being nullified by high inflation.

The export downturn is putting severe pressure on the balance of payments. According to the now defunct standby arrangement with the IMF, the export target for this year was $5,977 million. But the actual amount for the year is unlikely to exceed $5,000 million in view of the low export turnover of $3,729 million in the first nine months. The export downturn has resulted in a fast depletion of foreign reserves. Official foreign reserves are barely sufficient to finance about two months' imports.

Against the backdrop of the current world recession exacerbated by the terrorist attacks in the US, developing countries are likely to face a 10 percentage point drop in the growth of demand for their exports. However, it is expected that there would be a recovery in mid-2002 with a resulting world trade growth of 2.6 percent next year. Thus, we can expect a rise in demand for our exports. The export sector should be geared to meet this demand. Also, domestic market conditions should be conducive to export growth. The trade and industry chambers are urging the new government to restore political stability and disciplined governance soon to enable them to do business smoothly. The post-election bullish trend on the sharemarket already signals an improvement in investor sentiments. Consolidation of this trend is essential to attract capital flows for production and export growth.

Underutilisation of foreign aid

Foreign aid has been important in Sri Lanka's development, especially since the 1977 liberalisation, as a major source of development finance and an element in closing the foreign exchange gap. At a time of low foreign exchange reserves and a fiscally constrained government cutting down on capital and social expenditure, the role for aid is even greater. However, in the last couple of years there has been a significant downward trend in aid inflows. In fact, interest and amortisation payments have exceeded these annual aid inflows. Yet, in this context, there remains over US$ 2,500 million of unutilised aid. This article investigates why so much aid is underutilised, and explores means of enhancing the effectiveness and utilisation of aid.

The issue of aid gained increased awareness since the Paris Development Forum in December 2000 and the IMF stand-by arrangement for Sri Lanka in April 2001. At the Development Forum, the donors expressed concern about Sri Lanka's performance with regard to the non-implementation of the Public Service Commission, increased election irregularities and election related violence, the Prevention of Terrorism Act, politicisation of the Samurdhi movement and the inadequate supply of food and medicine to the Wanni area. The Forum continued to push for structural adjustments, public sector reforms, institutional controls, accountability and transparency, more privatisation, reforms relating to tertiary education and devaluation of the currency. 

The devaluation of the rupee against the US dollar on the eve of the Paris Forum was seen as a goodwill signal on the part of the government. Additionally, major changes are in tertiary education that will eventually lead to the withdrawal of the government from this sector. Notably, none of the donors got down to consider the quantum of aid pledged individually or collectively.

However, Sri Lanka successfully negotiated a 14-month stand-by credit of US $253 million (with $131 million immediately available) to tide over an immediate reserves crisis. This was a new development amidst the country's continuing negotiations regarding a more long term, larger (albeit with more conditions) Poverty Reduction and Growth Facility (PRGF).

Profile of aid in Sri Lanka

Commitments of loans and grants

The three major donors, namely the Asian Development Bank (ADB), Japan and Germany accounted for 54 percent of all the aid commitments.

Disbursements of loans and grants

The aid received by Sri Lanka can be classified into project, programme, commodity, food and other aid. Project aid has been significantly higher than other forms of aid throughout the period under consideration, though disbursement of programme aid increased sharply in the early 1990s with the embarking of structural adjustment programmes.

There has been a significant decline in foreign aid in 1999 and 2000. This decline could be partly attributed to the negative economic and political factors in the domestic and international environment. In the domestic front, the increased security threat and consequent rise in military expenditure affect aid in three ways:

• provides less opportunities for initiating aid projects,
• leaves less resources available to provide counterpart funds for development projects, and
• detracts the government's attention from such projects.

•  Economic recession and budget pressures in donor countries.
• The end of the cold war created a new set of recipients in Eastern Europe, in particular Russia, to share a declining poll of funds.
• The donor community appears to have focused their efforts on Africa and the least developed countries.
• The upgrading of Sri Lanka to "lower middle-income" status in 1998 (from "low income" country) according to World Bank classifications, makes Sri Lanka a lower priority recipient country.

Aid utilisation problem

The level of aid utilisation is calculated by using the disbursement ratio, which captures the disbursed aid as a share of the cumulative undisbursed aid for a given period. A high ratio signifies high utilisation of aid. As revealed in Table 4 the overall utilisation is quite low with an average utilisation of 28 percent for grants and an average of 15 percent for loans for the 1996-2000 period. The utilisation of grants declined by a dramatic 39 percent in 2000.

In the utilisation rates by the composition of aid, food loans recorded a disbursement ratio of 100 over 1996-2000 (except in 1999 where there were no disbursements), and high disbursement ratios were also recorded in commodity grants (except for 2000 when there was a significant drop).

A sector-wise analysis of aid utilisation reveals that the highest utilisation in 2001 so far was in the balance of payments (BOP), the cultural sector, private sector development and finance and banking with disbursement ratios of 92.3 percent, 35.7 percent, 28.7 percent and 25 percent, respectively. All other sectors recorded a utilisation rate below 10 percent; which indicates serious under-utilisation of aid. 

From 1996-2001, utilisation of aid in the BOP sector recorded the highest disbursement ratio. Average disbursement ratios were significantly lower since 1999, declining from 25 percent in 1998 to 14 percent in 1999, 19 percent in 2000 and 10 percent in 2001.

Factors limiting the utilisation of aid

To capture the elements inhibiting better utilisation of aid in Sri Lanka, a survey was undertaken by the Institute of Policy Studies, to ascertain the main issues from the perspective of the donor community. Of the fourteen donors contacted, five multilateral donors and four bilateral donors responded to the survey. Although the sample size is too small for a formal statistical analysis, the survey remains a useful exercise in bringing attention to the main issues inhibiting better utilisation of aid in the country.

The survey results indicate that political interference with regard to planning, implementation and allocation of funds affects aid under-utilisation most, with seven out of nine respondents giving it a score of eight or higher on the level of importance scale. The donors also felt the commitment by the Sri Lankan government with regard to foreign aided projects is crucial for better aid utilisation, as was appointing project staff in a timely manner.

Beyond the issues mentioned in the survey, other important issues identified by donors relate to the following issues:

Staffing:

• Selection of poor quality staff for project management.
• High turnover of project management staff.
• Promotions and salary increments of key project staff are not related to overall performance and delivery of outcomes.
• Lack of authority given to Project Directors to implement projects.
• Lack of motivation and incentives for quality staff to serve in the under-served areas of the country.
• Misuse of funds and ineffective management of government counterpart funds particularly with regard to staff development, and misuse of vehicles and other facilities by politicians.

Implementation

•  Long procedures for land acquisition, resettlement and payment of compensation for infrastructure projects.
• Delayed contract awards due to cumbersome government tender procedures.
• Inordinate delays in procurement and a lack of understanding of the procurement processes and inadequate capacity for procurement management.
• Poor performance of some local contractors.

Monitoring, evaluation and overall management

• Unfocused monitoring of project progress (inclusive of financial progress) at the ministry and departmental levels.
• Inadequate evaluation procedures within the government. Much of the evaluation processes is donor driven, hence taking on a donor perspective and not in the overall national context.
• No full involvement of the government/national counterparts at both operations and policy level in planning and formulating project documents.
• Poor coordination between the centre and province and between departmental staff and Project Management Unit (PMU).

Conclusions

This would also prevent fragmentation of assistance given to a particular sector and give the government a better position from which to make concrete requests from the donor community to support efforts at poverty alleviation and overall development of the country.

Table 2

Year 1994 1995 1996 1997 1998 1999 2000 

Loans 522 369 846 628 694 640 350 

Grants 175 155 139 141 134 66 90 

Total 697 524 985 769 828 706 440 

Source: External Resources Department of Sri Lanka 

Table 3

1994-2000 (US$ mln) 

Year 1994 1995 1996 1997 1998 1999 2000 

Loans 416 505 455 418 590 342 378 

Grants 177 182 143 125 88 95 54 

Total 593 687 598 543 678 437 433 

Source: External Resources Department of Sri Lanka

Table 1

Country ODA (dollars per capita) % of GNP 

1990 1998 1990 1998 

South Asia 

Sri Lanka 43 26 9.3 3.2 

Bangladesh 19 10 6.9 2.7 

India 2 2 0.4 0.4 

Pakistan 10 8 2.9 1.6 

Nepal 23 18 11.5 8.3 

Other LDCs 

Bolivia 83 79 11.8 7.5 

Botswana 115 68 4.0 2.3 

Cambodia 5 29 3.7 11.9 

Ethiopia 20 11 15.0 10.0 

Ghana 38 38 9.7 9.6 

Jordan 280 89 23.3 5.7 

Namibia 90 108 5.1 5.8 

Papua N. Guinea 107 78 13.3 10.4 

Senegal 112 56 14.9 10.8 

Lao PDR 37 57 17.3 23.0 

Malawi 59 41 28.6 24.4 

Mozambique 71 61 42.4 28.2 

Nicaragua 87 117 33.7 28.1 

Source: Compiled using World Development Report 2000/01

Table 4

Type of Aid 1996 1997 1998 1999 2000

Total Grants 30.18 30.75 26.65 33.07 19.99

Total Loans 15.36 15.18 19.00 10.92 12.49