12th December 1999

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Promises..promises ...sans resources

Sri Lanka's electoral politics has been characterised by extrava gant promises. The food subsidy was the most conspicuous of promises for a long time till its abolition through the ingenious introduction of a diminishing food stamps scheme. While the food subsidy lasted, there was political bidding at elections till a free rice ration was given. While much of this can be described in Sir Ivor Jennings words as " truckling to the multitude," there is little doubt that some benefits have also accrued to our society. Improved nutrition and basic food security to poor households are among the benefits.

More recent promises have taken the shape of the Janasaviya promise to give Rs 2500 per month to households and bread at Rs 3.50. Neither of these promises were kept as originally announced. In fact most promises which have had a high financial cost have not been kept.There are two reasons for this. First is the fact that when promises are made the sole objective is to obtain votes and the financial implications of the promise is not considered at all. The voters too are fairly gullible as most of them have no appreciation of the financial burdens of the promises and capacity of governments to implement the promises. Besides this, even when the promise is blatantly impractical the expected beneficiaries think it too good to miss. This is what happened with respect to the promise of the Janitorial, which most people realised, was too good to be possible but too good to miss too.

Some promises not only do not consider the financial burdens but do not look at the broader implications of the promise. The promise at the last election to reduce the price of bread to Rs. 3.50 was not only costly financially but had an adverse effect on rice prices and paddy farmers. Thus quite apart from the cost of the measure the reduced and subsidised price was in effect an incentive and inducement for people to shift their consumption from locally grown rice to imported wheat. One can even call it a subsidy to the American farmer. Since the number of paddy farmers and those dependent on rice farming directly or indirectly was a large number, this measure was not even good politics, leave aside good economics. Yet a political party made it an important promise because it was popular among the urban voters. Rural voters took some time to realise its adverse effects. In the event it turned out to be a very short lived promise.

At this election voters must weigh each promise carefully. First of all they must consider whether a promise is financially realistic. Then they must look at what the cost of the promise would be in financial terms and see whether there are ways by which it could be financed. And third, and perhaps most important, is to see whether the manner in which it is financed has any long term harmful impacts on the economy.

In considering election promises it is well to remember Milton Friedman's well known words that "There is no such thing as a free lunch". By this he meant that if the government gives something free ,then someone has to pay for it. And often those who pay are those who receive the benefits. This aspect is not appreciated adequately partly due to the lack of understanding of public finances, but perhaps also due to the fact that direct tax payers in this country are a very small number. Most government revenue is derived from indirect taxes. This makes it less apparent to the large number of indirect tax payers that they are bearing the cost of various subsidies and free goods given by the government. In many mature democracies politicians who make promises of concessions and benefits are expected to indicate how they would finance the new measures. Without such supporting facts the electorate would reject the promised benefit. This is a practice we should adopt in order to make our politicians more accountable.

In our political experience the list of unfulfilled promises should make the people view promises as mere political rhetoric and make their choice of rulers on the track record rather than extravagant promises sans resources. The other fact to remember is that extravagant promises without consideration of economic consequences, if implemented could have disastrous consequences.

Promises sans resources are empty promises.

Govi Sahanaya Scheme

Forward markets for agri-produce

A major problem fac- ing farmers is the sharp change in prices of their produce owing to weaknesses in markets. Farmers get ridiculously low prices when their crop produce come to the market, sometimes even ten times lower than in other times. These low seasonal prices are hardly adequate to meet cost of production, compelling default in loan repayments, and leaves nothing for the farmer and his family to live on. The farmer is totally discouraged. He does not know what to grow next. Even if he knows, he will be reluctant to use fertilizer and new technology which costs money because there is the risk of making a bigger loss in a volatile market.

The banks which have gone out of their normal routine to lend to farmers to grow specific crops now are unable to recover their loans. Sometimes, these defaults are offset from profits made elsewhere. But where the amounts are so large that the banks are unable to provide for losses, governments have to intervene and meet these losses. The money from the government actually comes from the taxpayer. Thus, the whole nation pays for the failure in agricultural marketing.

Given the uncertainty regarding prices and supplies, buyers and processors of agricultural produce are unable to plan ahead. If they had some assurances in this regard, they would be willing to set up cold stores, warehouses and processing plants which can help create a stable market with assured supplies. It is the uncertainty that make our agricultural producers import tomato pulp etc. for sauces and jams even at times when there is a local glut with lower prices. Thus, this uncertainty retards the growth of an efficient local agro-processing industry.

We have the potential for developing an export-oriented agricultural processing industry, but this is discouraged by the lack of assured supplies, which foreign buyers insist on. The uncertainty along the entire chain from production, transport to processing, discourages investment and activity.

When farm prices collapse due to seasonal gluts, the traditional local remedy has been to get government trading organisations and co-operatives to move in to buy produce at remunerative prices; but these organisations are not very efficient in doing this and also, do not know how to market the produce efficiently. Recently one read about large quantities of onions bought by government agencies rotting in stores.

This is not a problem unique to Sri Lanka. In many other countries, this problem is being efficiently solved by "FORWARD MARKETS" which enable farmers to sell their produce in advance at a remunerative contracted price. This contract is known as a "FORWARD CONTRACT". For instance, a farmer who grows chillies or tomatoes costing Rs. 30 or Rs. 20 per kilo can at the time of planting, contract to sell his produce at a reasonable price retaining a 50% profit at Rs. 45 or Rs. 30 per kilo when the crop is harvested 3 months later. Although the buyer now pays a price higher than in the glut season, it is yet lower than the off-season price and he is assured of supply. Prices will thus be stabilised around the forward contract price.

A Bank can facilitate this contract by getting the farmer and buyer together to sign a legal contract. Banks are best suited to find buyers, from among their clients. The buyers could be a trader from the area or a proccessor in the city. The farmer can insure the crop for a nominal sum of about 1% of contract value against loss by drought etc. Now, the bank will be able to lend to the farmer to cultivate and to the buyer to buy and market the produce with a greater sense of security. With the buyer, the bank can facilitate the supply of inputs such as quality seed, fertilizer and pesticides and even technical knowhow. When markets become more efficient in this manner, there will be assurances of supplies and this will encourage buyers to invest in storage and processing of farm produce, such as cold rooms, extraction plants and efficient transport systems, which will reduce wastage.

Banks will now earn more by lending to these activities. Finally, the farmers will receive assured incomes and market supplies will become regular and prices will become stable. With stable market conditions, processing industries will invest and plan their operations better and even export markets become realisable. When markets expand thus, giving greater certainty to farming activity, farmers will be iduced to raise their productivity, which will bring down costs and prices to international levels.

This will assure the consumers of agricultural produce with stable and lower prices with quality. Producers will become competitive against imports and hence will not need to seek excessive protection from imports by means of high import duties or import restrictions. The eternal clash between consumers seeking lower prices and farmers seeking higher prices will get moderated.

The forward contract price will be fixed by negotiation between the farmer and the buyer for a standard defined product in the presence of the bank manager acting as facilitator. The price should be at lest 50% above cost of production to encourage the farmer, but below the off-season price. The buyer must make a similar profit in selling to another market. As chillies, tomatoes etc. are not of standard size and quality, the contract will define the quality according to the Sri Lanka standard and in terms of number of berries/fruits per kilo. An agreed percentage deviation from the standard (plus or minus 5%) could be allowed in the contract price. Decisions on this can be made by the facilitating banker if the two parties cannot agree.

Based on the forward contracts, the buyers in turn can sell their contracted produce to agricultural markets and processors in advance by using a similar contract. A standard valid legal forward contract document has been prepared and is available at most branches of lending banks.

Initially, there will be teething problems in taking off, because of unfamiliarity with the idea. This calls for education. The farmers organisations - GOVI KENDRAYA - could assist farmers to enter into contract and to organise production. They could assist the banks to settle disputes.

The contract price will have to be reasonable. It should be at least 50% higher than farmer's cost, and provide a similar reasonable return to the buyer to market his purchases at a profit. As the success of the scheme depends on the fairness of price fixing and the interest of the seller and the buyer to honour the contract, market prices and supply information is vital for this scheme, especially for farmers to decide on what to grow at what expected price, for buyers to organise marketing and storage and for agricultural processors to plan their production.

This information will be provided over all media by the Central Bank, Ministry of Agriculture and all related organisations. Govi Kendras will furnish supply and potential supply information. Government institutions will not import similar produce if adequate supplies are expected soon. All agricultural producers will be protected from import competition by levying the maximum import duty. Forward markets are not unkown in Sri Lanka. In tabacco cultivation, farmers grow crops on the assurance of sale at a pre-determined price. Smiliar practices prevail in growing export crops such as gherkins. Also, it is common for farmers to sell the yield of perennial trees such as jak, breadfruit and cloves seasonally in advance. Govi Sahanaya spreads the practice wider, gets banks involved and provides a legal basis for the transactions. Thereby it raises farm productivity by stabilising the prices which farmers get. Incidentally it helps the growth of the agro processing industry with assured supplies.

What would happen if the contracts are not honoured? This will not happen in the case of tabacco because there is only one buyer. What if the farmer reneges on the contract because he can get a better price? This is unlikely because seasonal prices are low and the risk of being made ineligible for future contract trading. What if the buyer defaults on some pretext or another. He too faces the same risks and is unlikely to jeopardise his long-term business interest. The processor also will have an interest in playing by the rules because he will have assured supplies at a stable price and hence will be able to plan his production. So will the bank which now gets better security for lending and more profits. Thus, the scheme must work because all parties gain. Neverthelses, if defaults take place, there is a legal remedy, the forward contract being a legal contract under the Sale of Goods Ordinance.

In other countries, there are thriving forward markets in agricultural commodities such as wheat, rice, cotton and sugar, even for port bellies! These markets have now developed into "FUTURES MARKETS" which trade in contract paper even without a supply backing. There is a lot of speculative activity in such markets, which is said to further stabilize prices globally. These markets are organised by giant Commodities Exchanges which guarantee contracts for a fee. What is suggested now is a simple FORWARD MARKET with the backing of supplies - a straight forward deal, with the bank acting as the facilitator. At this stage, it is premature to consider futures markets. We should work forward markets well. Who knows? We may even have futures markets soon.

The backwardness of our agriculture, especially farmer subsistence agriculture, has been a perennial problem. Successive governments have spent large sums in providing water, seeds, chemicals, technical knowhow and credit to improve production. When it came to marketing the produce, which everyone ignored, all the governments could do was to bring in government's trading and co-operative machinery to buy the produce, which had not helped to create an efficient self sustaining market. Govi Sahanaya forward contract system is likely to be the best method of meeting the marketing problems of our farmers, which will stablilize prices at remunerative levels. Incidentally, this system could be adopted in other sectors as well, such as fisheries.

Calling international markets

NTT DoCoMo, the Japanese mobile telecommunications group, recently agreed to pay $410m for 19 per cent of Hutchison Telephone, Hong Kong's dominant mobile telephone company controlled by Li Ka-shing, a local property tycoon.

The move is the latest in a string of foreign investments by DoCoMo, Japan's biggest company by market capitalisation, which is keen to expand overseas as the Japanese market is almost saturated. In particular, it wants to use minority stakes in international mobile groups to promote its third generation wide-band Code Division Multiple Access (W-CDMA) technology.

NTT recently said it also had reached a memorandum of understanding (MoU) to take a possible stake in Telekom Malaysia Berhad. The announcement did not specify the size of the planned investment but it comes amid speculation in Malaysia that NTT is planning to buy up to 30 percent of the Malaysian state telecommunications firm.

A Telekom Malaysia Bhd release said that persuant to the Khazanah Nasional Berhad and NTT Communications Corporation and NTT Mobile Communications Network's MoU, evaluation on Telekom and discussions on the terms and conditions of the proposed acquisition by NTT will commence soon. Telekom Malaysia has a market capitalisation of 10 billion dollars, according to the NTT statement which came on the same day as the Japanese firm announced a pre-tax profit jump in the six months to September.

The industry speculation is that since Telekom Malaysia has a stake in MTN Dialog and in some way NTT, if it acquires a stake, will have a leg in Dialogs operation. In addition NTT will have a stake in Hutchison's 100% equity stake in Lanka Cellular Services (Pvt) Limited, a local cellular operator providing national services to the country.

However, Shiro Tsuda, DoCoMo's managing director, said the company was looking for opportunities to invest in European mobile telephony and was watching the outcome of Vodafone AirTouch's hostile bid for Mannesmann, the German engineering group, carefully.

However, Mr. Tsuda refused to be drawn on whether the group was interested in purchasing Orange, the UK mobile provider owned by Mannesmann that would be back on sale if Vodafone's bid is successful.

Mr Tsuda said the company was also studying the possibility of a New York listing, but meeting the requirements of the US Securities and Exchange Commission was onerous.

Analysts said NTT, the fixed-line telecoms group that still owns 67 per cent of DoCoMo, does not want to see its stake in DoCoMo diluted. However, if DoCoMo wanted to make a large acquisition in the US or Europe it would need to issue additional shares, reducing NTT's holding.

DoCoMo's purchase gives Hutchison Telephone an enterprise value of $2.6bn, which includes $560m shareholders' loans that can be converted into equity. This is four times the HK$5bn ($644m) investment the Hong Kong unit has incurred since it was formed in 1985.

International Telecom Usage Minutes soaring

A report published in the United States says that international call volumes are soaring, far faster than long distance traffic in most parts of the world.

The annual report - the 11th in a series from TeleGeography - says that international call volumes reached 93.0 billion minutes in 1998, up from 82.5 billion in 1997.

The report says that new entrants to the international telecoms market gained significant market share in 1998, carrying a record 12 billion minutes in 1998, compared to 8 billion minutes the year before.

TeleGeography says that, over the last four years, the world's telecommunications marketplace has seen the arrival of more than 1,400 new international carriers around the world.

The research firm says that newcomers to its list of the Top 40 international carriers include Facilicom, Star Telecom, and Teleglobe USA, a subsidiary of Canada's former overseas monopoly.

The report says that the newcomers' gains have come at the expense of larger, older carriers. For the first time, it says, AT&T and MCI WorldCom saw a fall-off in the number of international minutes carried on their own networks.

In Europe, new competitors hit Deutsche Telekom the hardest, grabbing a 14 percent market share after only one year of German competition. The company says that, even where call volumes increased, former monopolies often experienced falling profits, as price cuts outpaced customer demand.

Gregory Staple, the editor of the report, which is published in a yearbook format, said that, in Europe, thanks to the recent opening of markets, the company has seen some significant price declines and call volume growth, especially in the UK, German, and French markets.

"The threat of competition in Latin America drove established carriers to realign tariffs, boosting Latin America's traffic by 20 percent - the highest growth of any region," he said.

Staple said that the US still accounts for one quarter of the world's international telecommunications traffic, though its global market share decreased slightly from 1997.

"The growing squeeze on international telcos' margins is likely to continue to drive industry mergers," he said, citing an example of Telecom New Zealand, where lower tariffs stimulated a 45 percent increase in the carrier's outbound call minutes in 1998/1999, although the carrier's actual revenues on these calls dropped 24 percent.

Lanka Bell untangles twisted wires

Lanka Bell will shortly conclude the debt restructuring deal with its suppliers Nortel and GTE. The company also said that they have stopped scouting for an investment partner, however their major shareholder has indicated willingness to sell out if an interesting proposition comes their way, a top company official said last week.

The company accumulated losses worth Rs. 441 mn during its initial start up period and owed US$ 34 mn to its equipment suppliers Nortel and GTE.

Lanka Bell chief Vijay Watson said major shareholder Transmarco has committed to invest US$ 30 mn to fund their network expansion programme. But the monies would come in once the two creditors approve the debt restructuring plan.

Watson said, Lanka Bell has made a remarkable turnaround in its business during the last seven months. He said, the company is now showing a positive monthly Earnings Before Interest Tax Depreciation and Amortisation (EBITDA) which was Rs. 14 mn as compared to the loss of Rs. 50 mn experienced last November. Telecommunication companies world wide use EBITDA to measure profitability.

Lanka Bell is expected to report its first positive EBITDA of around Rs. 70 mn for the financial year ending March 2000.

"This is a vast improvement and a most spectacular turnaround of our operations, particularly when compared to our performance for the corresponding period when we reported a Rs. 441 mn loss," a beaming Watson told the media last week.

As part of their restructuring process, the management decided to localise its operation shedding 35 expatriate workers who were on a GTE management contract.

Since November 1998, the monthly recurring revenue of the business saw a 41 percent increase, while monthly operating expenditure decreased by 58 percent in the same period.

Meanwhile, Transmarco announced in Singapore on December 3, that they were making a full provision of 16 mn Singapore dollars for their investment in Lanka Bell. Watson said the provisioning was more to do with prudential accounting practices. Transmarco which is quoted on the Singapore stock exchange is involved in trading activities. Lanka Bell is also their biggest investment and the poor financial results were dragging the rest of Transmarco's results down.

Lanka Bell's accounts will not be consolidated as part of the group's accounts which barring any unforeseen circumstances is expected to be positive.

Being one of Sri Lanka's largest operating BOI companies with a US$ 150 mn investment, Lanka Bell ran into difficulties during its initial start up period and ran up debts worth US$ 34 mn. Watson says this is not unusual for a telecommunication company. Many other regional telecommunication companies also underwent similar difficulties during the Asian financial crisis, where their debts are being re-structured into long term loans.

TRC eases the rules

The Telecommunications Regulatory Commission (TRC) said last week that it had eased the rules a little so that the two Wireless Local Loop operators could achieve their 100,000 connections by 2000. On the recommendations of the TRC the Ministry had approved that every connection given outside Municipal and Urban councils would be regarded as ten connections. Officials believe that this will help the WLL operators achieve their targets. An official from one of the WLL operators just days before the decision was made said that they were pushing for an extension of their deadline for connecting 100,000 lines before 2000.

However, if each operator serves less than 40,000 subscribers by the set period, a penal licence fee of Rs. 100 million will be levied.

At present the Suntel customer base has topped 58,000 customers while Lanka Bell serves approximately 35,000 customers.


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