Columns - The Sunday Times Economic Analysis

Financing economic infrastructure for Lanka’s development

By Nimal Sanderatne

The development of economic and social infrastructure is vital for rapid economic development. Inadequate infrastructure has been a serious bottleneck for the country’s economic development. This was made dramatically clear when the country’s economy was seriously jeopardised by the energy crisis in the mid nineties. The energy crisis affected industrial production adversely to such an extent that the country’s economic growth was negative.

The setback to economic development owing to poor infrastructure in other areas is less apparent, though no less debilitating. Unsatisfactory road conditions, congestion of traffic, long hours to traverse relatively short distances are among the impediments to rapid development. The development of highways, ports, bridges, public transport, railways, telecommunications and irrigation are important for an economy’s development.

These constitute essential economic infrastructure whose development is vital to support investment. The efficiency of investment is determined by the state of a country’s infrastructure. The significant contribution of social infrastructure to economic development though less perceptible is no less important. Education and health make significant contributions to support economic development and higher levels of economic achievement are inconceivable without higher skills in science, technology and management.

Underdeveloped infrastructure

The country’s infrastructure has been underdeveloped in many areas to support a high rate of economic growth. Comparisons with less developed countries have often led us to complacency in the need to focus on infrastructure development. Financial constraints have restricted the capacity of governments to invest as much as is needed for the development of infrastructure. In fact government finances have been so limiting that in many years financial difficulties have resulted in cutting back of even voted capital expenditure. In many past years there have been cuts in capital expenditure owing to inadequate finances.

It is to the credit of the government that infrastructure development has been an important focus in the country’s development strategy. This is particularly so with respect to developing the country’s energy capacity, development of roads and irrigation. However there are many areas of infrastructure that require to be addressed. This is especially so with respect to the state of education and health. The economics of infrastructure development, especially the methods of financing, require serious evaluation.

Financing infrastructure

While the importance of infrastructure development is undeniable and the recent progress in the development of infrastructure commendable, the means of financing large investments in infrastructure have important economic repercussions. Two characteristics of economic infrastructure investment are that they are large and their economic returns take a long period of time. In many cases it is even difficult to determine precise benefits of infrastructure investment. Therefore the manner of financing infrastructure investment is a significant issue.

However beneficial investments in infrastructure are, if they lead to large fiscal deficits these would lead to inflationary pressures. Further, as there is a large import content in many infrastructure investment projects, such investment would increase import expenditure and strain the trade balance and balance of payments. Foreign financing is a means of avoiding these pitfalls, but large foreign borrowing too would result in high foreign debt servicing costs.

For these reasons the phasing out of infrastructure investment is needed. Even more important is the need to ensure that there is a prioritization of investment in infrastructure and to ensure that infrastructure projects lead to higher export earnings or reduce import expenditure. Investment in energy would no doubt increase the production capacity of the country and help export industries. In the case of roads and bridges, some highways would be economically more beneficial than others.

Similarly, the development of ports and other transport infrastructure has a range of cost: benefit ratios. Therefore the prioritization of infrastructure on the basis of costs and benefits is important. Import costs, export earnings and the impact of financing on the public finances and debt servicing costs should be considerations in infrastructure investment.

The Institute of Policy Studies State of the Economy 2010 report has discussed some of these issues. It is of the view that the additional expenditure on infrastructure investment must be found by reducing public expenditure in non productive areas and through public sector reforms. It states: "The priority for fiscal policy is to release financing for infrastructure investment and reconstruction spending. This entails that a mix of far reaching economic, institutional and policy reforms accompany a re-orientation of public finances.”

The IPS observes, “In the absence of such reforms, Sri Lanka will falter in putting its public finances in order - that is, cutting back on recurrent spending to support capital investment. Without such flexibility, a heavy infrastructure-led development drive will inevitably rely on borrowed funds. This will not only lead to an accumulation of the country's stock of public debt, and associated risks for macroeconomic stability, but will also mean that Sri Lanka's development priorities do not have the financing that is needed on a predictable basis.” The underlying principle is that the much needed increase in infrastructure should come from reduced government expenditure rather than through foreign borrowing.

The government’s current infrastructure investment is heavily financed by foreign borrowing. Foreign funded large infrastructure projects should have potential for increasing foreign exchange earnings or reducing import expenditure or else it would be a burden on the balance of payments. Further, there is need for prioritization of infrastructure investment on the basis of cost benefit analyses and the gestation period of such investment. All infrastructure investments are not of high benefit.

Summing up

One of the achievements of the government has been the improvement of the country’s economic infrastructure. This is especially so with respect to the enhancement of energy that was a serious constraint to economic development. Many obstacles and challenges were overcome to develop new power plants. Some may still argue that these power plants have adverse environmental impacts, ARE DAMAGING TO THE ENVIRONMENT. Nevertheless there is no denying the fact that they have augmented the country’s power supply at reduced costs through additional thermal power generation. Energy costs are high. Therefore the development of new sources of cheaper energy is vital. Efficient administration of public utilities too has a bearing on energy costs.

On the other hand, there are concerns that some economic infrastructure developments may not be cost effective. The methods of financing including large foreign financing of infrastructure projects have been questioned. Financing additional expenditure through savings from other expenditure has been suggested to reduce the inflationary impact of infrastructure investment. There has also been little attention to public-private partnerships for infrastructure investment.

However important infrastructure development is for the country, expenditure on infrastructure investment should consider the costs and benefits of such investment and how they are financed. All infrastructure investments are not equally valuable to the country’s economic and social development. In view of the largeness of infrastructure investment there should be a prioritization of infrastructure investment. The government should consider these aspects in the continuation of its infrastructure development programmes of the future.

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