Dr. Nimal Sanderatne, in his regular column in The Sunday Times of 4th May 2014 has dealt with the economic consequences and challenges of the Geneva resolution, last week. Sadly, that article appears to be based on incorrect facts and figures, while the technical analysis too seems to be quite unsound, biased, and illogical. In [...]

The Sundaytimes Sri Lanka

Rapid increase in FDI flows in recent years

Response to Dr. Nimal Sanderatne’s recent economic analysis

Dr. Nimal Sanderatne, in his regular column in The Sunday Times of 4th May 2014 has dealt with the economic consequences and challenges of the Geneva resolution, last week. Sadly, that article appears to be based on incorrect facts and figures, while the technical analysis too seems to be quite unsound, biased, and illogical.

In his article, Dr. Sanderatne refers to Central Bank Deputy Governor Dr. Weerasinghe’s contention at the recent LBR/LBO forum that the Geneva resolution had no impact on international investors’ confidence on Sri Lanka. Dr. Weerasinghe’s argument was based on several factors, one of which was that the Sri Lankan Sovereign bond issued after the resolution was oversubscribed many times more than the pre-resolution bond issued in January 2014,while also being priced at 87.5 basis points lower. Dr. Sanderatne has disputed this claim by stating that the tightening of yields in the sovereign bond was not due to improved international investor confidence for the Sri Lankan bonds, but due to a drop in borrowing costs of emerging markets to a record low in the backdrop of heightened appetite of international investors to diversify their asset portfolios. Dr. Sanderatne has also argued that the interest of 5.2 per cent paid for the April 2014 sovereign bond was one of the highest rates of interest paid by any country.

In this regard, it may be useful to look at the actual facts and figures in order to make a proper comparison of the sovereign bond performance vis-à-vis Sri Lanka’s peers in international markets to ascertain whether there is merit in Dr. Sanderatne’s arguments.
As is well known all over the world, the fundamental barometer in assessing the tightening of yield rates in financial markets is to assess the issuance spread over its benchmark of similar US Government Treasury instruments. In this connection, it would be noted that the issuance spread of Sri Lanka’s Sovereign bond in January 2014 stood at 431 basis points, while the issuance spread had declined substantially to 347 basis points by April 2014. This reduction clearly indicates that there has been a preference of international investors for Sri Lankan paper, despite the Geneva resolution. Further, when Sri Lanka is compared with similar rated countries, it would be observed that the borrowing costs of similar rated economies either recorded increases in their borrowing costs or maintained the levels of costs as reflected in their secondary market trading yields. This too indicates that the appetite for the Sri Lankan paper had enhanced, and not diminished, after the resolution. In fact, it would be noted that the Sri Lankan Sovereign bond issuances on 6th January and 7th April 2014, have continued to trade at a premium price in international markets, with the April 2014 Sovereign bond issued at 5.12 per cent currently trading around 4.92 per cent, while the January 2014 Sovereign bond issued at 6.00 per cent is currently trading around 4.87 per cent.

The above facts and figures clearly confirm that Dr. Sanderatne’s arguments are without foundation, and completely contrary to the actual situation.

Dr. Sanderatne goes further and also contends that trade would decline due to possible economic sanctions, and attempts to support such statement by stating that “Following the suspension of GSP plus in 2010, there was a dip in Sri Lanka’s exports to EU markets in 2011 and 2012. …”

As is widely known, the GSP plus was introduced in July 2005 and was withdrawn in December 2009. After the GSP plus withdrawal, contrary to Dr. Sanderatne’s comment, Sri Lanka’s exports to EU market increased from US$ 2,727 million in 2009 to $2,875 million in 2010 and $3,576 million in 2011. In 2012, however, in sympathy with the slow-down in world economic activity and the prolonged recession in the Euro area Sri Lanka’s exports to the EU marginally declined to $3,228 million (just like many other emerging market exports). Even so, the levels of exports in 2012 were still well above the pre-GSP plus levels. In 2013 onwards, Sri Lanka’s exports to the EU market have continued to increase further, and that trend is continuing in 2014 as well. The facts therefore are directly opposite to the unsubstantiated claim of a “dip” as claimed by Dr. Sanderatne.

Dr. Sanderatne has further argued that Sri Lanka’s share in total apparel exports to the EU markets have declined continuously over the past three years, in contrast to the significant increases in the market shares of Bangladesh and India. This statement is also factually incorrect. In actual fact, only Bangladesh has increased its share, while the shares of both India and Sri Lanka have declined since 2009, although in absolute terms all three countries have increased their value of apparel imports to the EU region at varying rates. In this regard, Dr. Sanderatne’s economic analysis is obviously incomplete since Sri Lanka has reached close to its existing capacity in volumes of apparel exports while for India and Bangladesh there is still excess capacity and comparative advantage.Further, reading Dr. Sanderatne’s article, a person may also observe that Dr. Sanderatne has not been able to appreciate the fact that the Sri Lankan garment industry is now competing on the basis of diversifying products into high-end of the value chain and diversifying markets. In that background, any assessment that Sri Lanka should strive to increase its global market share in a particular product only, would be contrary to the current dynamics of the economic factors which enhance the overall export of goods and services of any country. A well known fact is that Sri Lanka is now implementing a strategy of diversifying its exports of goods while intensifying the export of its services, such as tourism, port and aviation services, IT/BPO services, etc. Therefore, a proper and unbiased analysis should take into consideration, Sri Lanka’s changing structure of exports both merchandise and services, and its diversification into a varied range of products and services, as well. If such a proper analysis is done, it will clearly show that Sri Lanka’s export strategy is working well and moving in the desired direction, both in terms of volume and market share. Unfortunately, Dr. Sanderatne seems to be still under an illusion of a by-gone era when Sri Lanka only exported tea, rubber, coconut and basic garments. In fact, his regular articles on the“trade deficit” also reveal such faulty reasoning and outdated analysis, ignoring today’s progressive conditions and circumstances.

Dr. Sanderatne makes another erroneous statement that Sri Lanka’s net reserves (gross reserves net of short-term debt repayment obligations) are much lower today. Sadly, the standards applied in his computation of net official reserves seems to be quite different to the standards adopted by the international agencies such as the IMF, though Dr. Sanderatne cites the IMF methodology to stake his claim. The IMF standards specify that net reserves must be calculated by deducting the reserve related liabilities from gross official reserves. On that basis, when calculating the net reserves of Sri Lanka, the net official reserves are on an increasing trend over the past several years. Even more importantly, the current net reserves of Sri Lanka are at a healthy position, in direct contrast to Dr. Sanderatne’s claim, which is probably because Dr. Sanderatne has not factored that Sri Lanka is now receiving a higher inflow of foreign funds, rather than short-term debt obligations, and as a result, the reserves net of short-term debt obligations are rising rapidly.

Dr. Sanderatne has also attempted to ring alarm bells by claiming that there could be a sudden reversal of the foreign investments in government securities of $3.7 billion. Here too, it has to be mentioned that this would be a highly unlikely possibility in today’s global and local financial conditions, particularly since Sri Lanka has already fared exceptionally well, recording a net inflow of foreign investments to the government securities market with the exchange rate also remaining steady, at the time when the US Federal Reserve started tapering of its bond buying programme. Of course, several Asian economies experienced a sharp reversal of foreign investments, which exerted pressure on their currencies particularly during the second half of 2013, but Sri Lanka did not suffer from such a fate, because of the country’s prudent external sector policies which were well understood and appreciated by savvy foreign investors. When considering the maturity profile of foreign investments in government securities too, it would be observed that a large part of the foreign investment is inlong-term bonds, compared to relatively volatile short-term treasury bills. Such long-term investments by foreigners have taken place even during the period when increasing yields were observed in advanced economies and while various allegations on human rights were levelled against Sri Lanka by various persons. Hence, Dr. Sanderatne’s assertion that there is a possibility of a capital flight due to “accumulated volatile capital” also seems to be not in keeping with the ground reality.

The following statement has also been made by Dr. Sanderatne, “Even if the UNHRC resolution has no impact on Sri Lanka’s borrowing ability, if they are invested in activities that have lower rates of return, such as infrastructure and in the non-tradable sectors, then repayment would become difficult.” To suggest that borrowed funds if invested in infrastructure and non-tradable sector, per se would lead to difficulties in repayment reflects very narrow thinking. It is true that investments in infrastructure would take a longer period to deliver direct benefits. However, all economists know that infrastructure investments on roads, ports, airports, hotels, power and energy have many spill-over effects on both non-tradable and tradable sectors.Therefore, it is a well-recognised principle that infrastructure investments lead to improved productivity of the country, expands the potential of the economy, and more importantly, bolsters investor confidence. The persistent reluctance of Dr. Sanderatne to recognise these benefits seems to be puzzling.

Dr. Sanderatne also ignores the ground reality when he suggests that the Central Bank is keeping the exchange rates fixed as much as possible, discouraging e- exports that are needed to pay the bond at the end of five years! To claim that the Sri Lanka’s current exchange rate is “fixed” suggests a scant understanding of the current external sector conditions, when even the IMF has categorised Sri Lanka’s exchange rate regime as ‘flexible’. This flexibility is also reflected in the movements in the LKR/USD rate during 2013 as well. At the same time, it must be appreciated that Central Banks all over the world are keen that the country’s exchange rate is stable, but that desire must not be interpreted as an attempt to keep the exchange rate “fixed”. Any person who has studied about Sri Lanka’s foreign exchange market would probably know that, if at all the Central Bank has intervened, in recent times it had been to stop the exchange rate from unduly appreciating, thereby placing exporters in adisadvantageous position. In that background, it is important that an eminent economist like Dr. Sanderatne did not seem to appreciate the obvious position.

Dr. Sanderatne also states as follows: “Foreign direct investment according to the 2013 Central Bank Annual Report is falling, the debt to GDP ratio of 78.3 percent and the fiscal deficit of 5.9 percent are above the safety threshold. The low revenue to GDP ratio with revenue being inadequate to even meet current expenditure is alarming.” With regard to foreign direct investment, Dr. Sanderatne somehow seems to have missed the fact that the FDI flows have been on a rapidly increasing trend over the past several years.Further, Dr. Sanderatne does not appropriately acknowledge that the debt/GDP ratio has been constantly falling over the years, i.e., from 90.6 per cent in 2005 to 78.3 per cent in 2013. Similarly, when commenting on fiscal deficit of 5.9 per cent, he also surprisingly fails to see the continuous improvements since 2009, i.e., from 9.9 per cent in 2009 to 5.9 per cent in 2013. Hopefully, in future analysis with an expanded horizon would provide a more unbiased comprehensive picture of the state of the Sri Lankan economy.

In any event, Dr. Sanderatne must be thanked for expressing his views regularly in the Sunday Times which provides the opportunity for other economists too, to explain another dimension of Sri Lanka’s economic situation to the general public in greater detail.
(The writer is an economist and Deputy Superintendent, Public Debt Department, Central Bank. Prior to his present engagement, he was attached to the Economic Research Department as a Deputy Director. Views expressed in the article are that of the writer nd not the institution he is attached to).

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