Dr. Mohamed Z. M. Aazim’s response to my recent economic analysis of May 4th under the title “Rapid inrease in FDI flows in recent years ” has given me another opportunity to dispel inaccurate, if not erroneous, views on the Sri Lankan economy. Readers may be reminded that my Sunday Times column of May 4th [...]

The Sundaytimes Sri Lanka

“Rapid increase in FDI flows in recent years”

(Reply to Dr. Mohamed Z. M. Aazim, Deputy Superintendent of Public Debt of the Central Bank in his Business Times article on May 11th)

Dr. Mohamed Z. M. Aazim’s response to my recent economic analysis of May 4th under the title “Rapid inrease in FDI flows in recent years ” has given me another opportunity to dispel inaccurate, if not erroneous, views on the Sri Lankan economy. Readers may be reminded that my Sunday Times column of May 4th was an analysis of the recent LBR/LBO-CEO Forum on the challenges faced by Sri Lanka on account of the UNHRC resolution in Geneva in March this year.

Dr. Aazim’s response deals with the performance of foreign direct investment, the borrowing costs of the sovereign bonds before and after the resolution, the management of the exchange rate and the extent and burden of debt. I have dealt with the burden of public debt in my regular column in the main section of today’s Sunday Times, while the other issues raised by him are addressed here.
Foreign Direct Investment

I am surprised that Dr, Aazim, who repeatedly states that my facts are wrong, has not got his facts right. He says “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.” The figures of FDI inflows from the Central Bank itself given below show that they have decreased by nearly 46 per cent in the last three years.

2010-2013 US$ millions
2010 435
2011 896
2012 877
2013 855

Is this “a rapidly increasing trend”? In fact the Central Bank’s own statement in the 2013 Annual Report stated quite clearly that FDI had fallen by 5.6 per cent in 2013. He disputes my quoting this figure without checking the Central Bank’s data and makes the horrendous error of claiming that FDI has been increasing rapidly.

I am averse to quibbling on such figures as they miss the bigger picture.

The more important issue than whether FDI increased a little or decreased a little, is whether the magnitude of FDI is adequate;whether the kinds of FDI make a significant impact on the economy; whether FDI has contributed to the country’s economic growth and especially exports; and whether the type of FDI the country received has resulted in the transfer of technology and management skills. Most of the recent FDI has been for the purchase of property for the construction of hotels and recreational facilities that have proved highly controversial too.

At the recent LBR/LBO-CEO Forum that my column discussed, the inadequacy of foreign investment was bought out very emphatically. The Chairman of the Ceylon Chamber of Commerce, Suresh Shah pointed out that foreign investments are inadequate and only a fraction of what countries like Myanmar and Vietnam are attracting. Dr. Nishan de Mel, Head of Verite Research, made the terse statement that foreign investments were not high and even if they were to fall, there is not much to fall!

Apart from the factual inaccuracy of saying that FDI is on an increasing trend, when it is decisively not, the inflow of FDI has been far below the government target of US$2 billion. Why has the government target of US$2 billion of FDI in 2013 not been achieved? One can hardly be content with the inflow of FDI when only about 40 per cent of the target has been achieved.

The plain truth is that we have been unable to attract adequate amounts of FDI of the right types to transform the country’s economy. Dr. Aazim’s position on FDI reflects a perilous complacency and satisfaction with the poor performance in attracting FDI. What economists like Dr. Aazim should point out, is that while FDI is not only inadequate, the country is not receiving the types of FDI that would transform the economy into an industrial state by the transference of technology, marketing and management skills. A good economist must ask the question why, despite five years after the end of the war, the country has been unable to attract higher volumes of FDI of the right type. These are the critical issues that good economists must address rather than split hairs about a little data.

Borrowing costs

Dr. Aazim has taken issue with my argument that Dr. Nandalal Weerasinghe’s contention at the LBO Forum that the Geneva resolution had no impact based on the lower interest rate of the Sovereign Bond after the Geneva Resolution than before was both faulty logic and bad economics. As to whether the Geneva resolution had any impact on borrowing costs is a matter of conjecture and I am quite willing to concede that it may not have had a significant impact. My contention was that the lower interest rate was not a sound argument that it did not have an impact. By the same logic, the Central Bank and its economists could contend that the Geneva resolution had improved the credit rating of the country! This shows the false and spurious reasoning of this argument. This argument was also bad financial economics and ignored changes in global financial conditions. It completely overlooked recent developments in global financial markets.

The quintessence of what I said was that interest rates of borrowing depended on a host of factors, some of which Dr. Aazim himself has mentioned. The pertinent point is that the drop in the interest rate is not an indication of the Geneva resolution having no impact, but the factors determining international interest rates on such borrowing are complex. As I pointed out the US$1 billion sovereign bond issue at a coupon rate of 6 per cent took place at a time of growing worries in financial markets as the US Federal Reserve rolled back its easy monetary policy stance. Over the past few months borrowing costs of emerging market economies have dropped to a record low level against the backdrop of heightened appetite of international investors to diversify their asset portfolios.

What is relevant is that Sri Lanka has borrowed at very high rates of interest both before and after the resolution. As I pointed out both the 6 per cent and the 5.2 per cent paid for the sovereign bonds were one of the highest rates of interest paid by any country and was the highest interest rate paid by an Asian country recently, with the sole exception of the 7.25 per cent coupon rate of the recent US$ 2 billion bond issue by Pakistan, according to ADB data.

Use of loans

Interestingly, Dr. Aazim disagrees with my contention that if borrowed funds are invested in activities that have lower rates of return, such as infrastructure, and in the non-tradable sectors, then repayment would become difficult. His point of view is that investment in infrastructure though it may take time to generate returns is necessarily good investments. One could agree that some of the infrastructure, though having a long gestation period, would contribute to growth in the fullness of time. But the weakness of this argument is that all infrastructure, merely because they are infrastructure, would generate benefits.

His argument is all the more spurious because huge infrastructure investments have been made with little or no cost-benefit analysis. While the costs of several large infrastructure projects are very costly, their benefits are uncertain. There is a need to invest in a mix of infrastructure development that would lighten the costs and increase the benefits.

Furthermore much of the infrastructure is very costly as they were not undertaken after competitive bidding that would have ensured lower costs.

And some large infrastructure projects may bring very little direct or indirect benefits to the economy. The examples of such costly low benefit infrastructure are too well known to mention.

Management of the exchange rate

On the matter of the exchange rate one has to make a distinction between the exchange rate system that a country is said to follow and the actual practice. Although Sri Lanka has declared that the country has followed a “flexible exchange rate policy”, this has not been the case in actual practice. For instance, when the Central Bank allowed the exchange rate to depreciate to Rs. 126.75 in 2012, it was because the rate had appreciated by close to 11 per cent between 2009 and 2012. It was good that this adjustment was made to keep the economy competitive. However, it is no secret that this was done to avert a balance of payments crisis on the advice of the IMF.

Since exporters operate with very small margins even a 2-3 per cent appreciation makes a big difference to the profitability of exports and Sri Lanka’s share in the world export market. A decline in this share, as has happened, is an indication that one factor needed to maintain competiveness has been absent. There is no problem with day-to-day fluctuations of the exchange rate or Central Bank interventions by leaning on the state owned banks to keep the dollar from appreciating, but there is concern with the time trend.

While the Central Bank has been exhorting exporters to become more competitive, through increases in productivity, even at the height of the great success of East Asian countries they were not able to raise productivity by 10 to 11 per cent in a three year period.Also, to say that Sri Lankan exports have increased, one has to look at the time trend between about a 5-year period. All the evidence seem to show that Sri Lanka’s share in world exports has been declining for its major exports rather than increasing and Sri Lanka’s exports are only about one half of her imports. A policy of keeping the exchange rates fixed as much as possible would discourage exports needed to pay off the bond at the end of five years.


Foreign direct investment has been falling in recent years despite the claim to the contrary. In any case, FDI of less than $1 billion is a pittance and the right types of FDI flows are not coming. The costs of international borrowing have been among the highest irrespective of whether the Geneva resolution had any impact. Some of the infrastructure development would benefit the country, but their costs are high and could be a burden for repayment. Heavy expenditure on infrastructure projects that are doubtful of bringing in returns in the foreseeable future increases the debt burden.

Although the country is said to have a flexible exchange rate, its management has led to an appreciation of the rate in the three years to 2012. Sri Lanka’s share in world exports has been declining for its major exports rather than increasing and Sri Lanka’s exports are only about one half of its imports.

Those who have a genuine interest in the economy must not be lulled into complacency. Economists should address the fundamental problems of the economy rather than dabble in figures to advance the view that the economy is on a sound footing.

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