2016’s biggest risk: Absurd budget assumptions

In early 2015, markets were feeling reassured that their year ahead was going to be spectacular. Neither elections nor uncertainty of a coalition government was going to stop Sri Lankan consumers from spending, firms from exporting and Sri Lanka from making giant strides to becoming a services hub.

Phew… was that not off the mark!

Earnings of listed firms were flat in 2015. Fixed income fared better because inflation was low.

Asset allocation is about to get a little trickier in 2016. Few expect corporate profits to rebound this year, so pickings are thin. Inflation will make a comeback, fixed income narrowing real returns. Holding cash, which was a sensible enough thing to do last year, won’t continue to work in 2016 because of inflation, which is already at 4.5% and rising fast. To allocate assets a macroeconomic view will be more important than in the past years because these uncertainties are both altered and elevated compared to the last few years.

The government’s budget seems to be making absurd assumptions about income, spending and how the deficit is going to be bridged without causing widespread mayhem.

There is little that can be usefully said about the 2016 outlook for the market except that short-term fixed-income instruments are the surest bet. But asset managers and investors won’t be judged on how safe their bests were, but by how much they exceed benchmarks. To achieve this, they should keep a keen eye on macro developments. That’s what will matter the most.

Wood for the Trees:  income taxes and civil disobedience

Of course, we are all against corrupt governments, coddled and ineffectual bureaucracies and sinister business interests. Then why pay taxes to support this system? Most may envy Thoreau for his frugal and toiling, tranquil and deeply satisfying lifestyle in the great woods on Walden’s shores, nod our heads off to his critique of big, corrupt government and business interests, and applaud him for spending a night in jail for not paying his taxes.
His arguments On the Duty of Civil Disobedience resonate with us today, in an age and continent far removed from his own. However, he also believed in paying taxes (yes, really!) and waxed eloquently about commercial railroad companies and commerce and industry. He called the hypocrisy of officials employed by the state, suggesting there was no point noisily protesting corruption without vacating their jobs positions. Private citizens opposing taxes, Thoreau argues, are dutybound to express disobedience, but only by giving themselves up to be jailed. 
Wood for the trees, we say, and that brings us to Bellwether, our long-suffering columnist. We hope you enjoy the Bellwether column in this edition. While he does make a valid point about the dangers of progressive taxation, missing the nuances could lead to misleading conclusions. 
We quote Hayek, a venerated economist in our pantheon. He begins an impressive laborious censure of progressive taxation in his treatise The Constitution of Liberty with these words: Individual taxes, and especially the income tax, may be graduated for a good reason—that is, to compensate for the tendency of many indirect taxes to place a proportionally heavier burden on the smaller incomes, (and that) is the only valid argument in favour of progression. It applies, however, only to particular taxes as part of a given tax structure and cannot extend to the tax system as a whole. 

DDR: Handle with Care

According to a December 2021 IMF blog post co-authored by Peter Breuer, the current IMF Senior Mission Chief for Sri Lanka and the Maldives, and two other IMF staffers, restructuring domestic debt is like surgery: You only do it if you must, and you avoid it if it might do more harm than good!
Emerging markets have seen domestic debt increase from 31% of the total sovereign debt to 46% over the past 20 years; that means restructuring domestic debt is often an inescapable, or inevitable, eventuality for a country mired in a debt crisis. Restructuring external debt (altering the terms, such as the amount or repayment period) requires deft negotiation skills. Negotiations could last several years, denying access to international capital markets for the duration.  
On the other hand, domestic debt restructuring (or DDR) is very different. It is far easier because a government can alter the terms by changing domestic laws. By doing so, they can avoid far costlier consequences of external restructuring, like losing access to international capital markets. However, the downside is that domestic debt tends to be held by local creditors - banks and superannuation funds like the EPF - and the sovereign malaise spreads to the rest of the economy.
DDR can surely help negotiations with external creditors, but securing the stability of the domestic economy and its financial system remains the state's prerogative, argue the IMF staffers. In other words, DDR may be necessary, but not if it causes more problems. The Sri Lankan government recently called for voluntary domestic debt optimization.

Local government elections and the endgame

we need timely elections: to defend our collective idea of what a democracy should be and place in power a group of people we believe to be credible, who we can trust to eradicate corruption and revive the economy. 
Some people are overly offended by the blatant delaying of local government elections as an erosion of our democratic rights in defence of a corrupt cabal that pushed this country to the brink. They anxiously wait, in rapt suspense, to vote for the change they so desire. 
What happens once the local government elections return a near-unanimous decision? Would the victorious politicians, and their ground troops, agitate for an expeditious general election? Very likely. Should the general election return a similar outcome, what then? 
How would the next government approach economic reforms: by continuing with the present reforms programme, turning back the clock, or setting the timer? 
While the upcoming elections are about voting for change, does that include economic reforms? If so, what do we mean by economic reforms? Would it be market economics, social market economics, communism, or socialism? There is an ideological rift to consider and breakaway radical groups that honed their skills during the Aragalaya. How would the different factions of the Aragalaya (those who started it and those who hijacked it) respond if their party leaders (or preferred party leaders) do not find a majority? Or worse, they are in power but assume a reform programme contrary to their expectations? How would decent manifest itself and be dealt with? As a species, we are prone to jack-boot idealogical decent.

Women without Rights

While we are preoccupied with securing our democratic right to hold provincial council elections - so we can sooner reset the economy, fast-track the debt-restructuring process, and decisively  overhaul the ineffectual public while restoring law and order and governance) -  blessed by Koalemos forever and ever, amen, and touched by his divine hands, we are perpetually comatose to far more vital matters. For instance:
Sri Lankan women put up with tremendous injustices. They have fewer rights than men. They have fewer rights than women in Rwanda, Liberia, Tanzania, Zambia, Saudi Arabia, Angola,
Congo (Dem. Rep.), Ethiopia, Uganda, Sierra Leone and South Sudan, and more than 126 other countries, the World Bank's Women, Business and the Law (WBL) Index 2022 reveals. 
The annual index analyses legal and regulatory differences between women and men in 190 countries across eight economic indicators: mobility, workplace, pay, marriage, parenthood, entrepreneurship, assets, and pensions. Sri Lanka has an overall score of 67.5, which means a Sri Lankan woman has less than 70% of a man's rights. 
She stands on level ground in mobility and marriage, but in the workplace, she has 75% of the rights of a man. She does not have three-quarters of a man's rights around pay and half the rights to a pension. She finds only limitations and restrictions to building a career after having children because laws deny her 80% of the parental rights available to men. She has fewer rights than a man to hold assets (80/100) or start a business (75/100), the WBL Index shows, and this is just the tip of the iceberg (and mind, the wisdom is in the simile!).

We are all complicit!

For decades (some) economists have been exhaustive in their prescient warnings about the twin deficit problem. However, their prophesies about this economic crisis went unheeded, as if they were under an Apollonian curse.
There was never an urgency to deal with the problem, and today Sri Lanka is a defaulter with a junk credit score that cannot manage its affairs. In this, we are all complicit.
After all, the zeitgeist has only recently manifested its reprehension of politicians and their ilk, corruption, nepotism, cronyism, and waste. Have not the citizens let themselves be held to ransom by a bloated, coddled, and egregiously inefficient public sector? The gradual reversal of trade reforms of the late 70s ruined our prospects for FDI and export growth. Instead of striving to lift all the boats, have we not pursued policies that only sank Sri Lanka deeper into serfdom (in a profoundly Hayekian sense)? We produce several graphs (please see pages 22 to 26) that tell an important-yet-banal story people are tired of hearing. However, looking at these graphs, at which point should we have launched an Aragalaya to get off the aimless and senseless economic ride post-independence? What do you think?
Even as we mark the 75th year of independence, we are worse off because of our individual choices, as the economists featured in this edition point out. 

In the 30 months from the onset of the Covid pandemic to the end of 2022, Sri Lanka printed almost Rs2.5 trillion. Between February 2020 and September 2022, Sri Lanka’s domestic debt stock (t-bills, bonds) increased by 96% to Rs13.3 trillion. Some of the increase was due to Sri Lanka’s inability to access the foreign commercial market resulting in rupee-denominated debt replacing maturing foreign currency-denominated loans. Total debt (including all foreign currency debt) also increased by 89% to Rs25 trillion. Because the currency collapsed by 80% in the second quarter of 2022, the rupee value of the foreign debt increased by an equal amount. 
It takes incredible incompetence and/or arrogance to oversee the near-doubling of a country’s public debt in 30 months without anything to show for it. Surely, no public servant went without a salary in that time, and people paid less tax, but with devastating consequences now.
Impacts of the debt orgy on asset prices pale in comparison to the pain and lost hope. But the debt, combined with lower interest rates, remains a primary reason for the run-up in prices of equity and debt. After several years we have a climate without easy money, and in this Investor’s Guide, we discuss how to navigate portfolios through this crisis.

Grand corruption, the theft of Sri Lanka’s national wealth by kleptocratic leaders and their cronies is again in the public eye following the elevated civic consciousness after the aragalaya that overthrew a government. The amounts pilfered by politicians and their cronies is anyone's guess given that most of this wealth is stashed away overseas. 

However in the last decade or more attitudes have changed with the growing view of corruption as one of the main causes of poverty. Global institutions including NGOs that offer practical help to track down the loot have emerged. Most notable among them is the joint UN-World Bank project, the Stolen Asset Recovery Initiative. 

National legal regimes too are evolving. Even within a country  a criminal prosecution must prove beyond reasonable doubt before action for asset recovery can commence. This is a difficult task. However several countries have introduced a system called non conviction based recovery where you go after the property, and not the perpetrator. Anyone unable to provide a plausible explanation risks having the assets confiscated for good after an investigation. 
In our December issue a panel of experts discuss the future of corruption and how Sri Lanka should get about recovering stolen assets in the country and overseas.

What’s special about special economic zones

The history of special economic zones (SEZ) isn’t all runaway successes. On paper, they create within an area with physical boundaries, a zone where everything that’s investor unfriendly is suspended or blunted. Often such areas will include better infrastructure, lower taxes and tariff and regulatory incentives unavailable in the rest of the county. Two types of SEZs exist, those oriented towards manufacturing and the second type geared toward services. Sri Lanka’s Free Trade Zones were designed to host manufacturing firms whereas its Colombo Port City is an SEZ designed for services. SEZs offer an opportunity to experiment with a new regime and tweak it before rolling out its best parts to the rest of the country. 

China’s creation in 1980 of its Shenzhen SEZ is the poster boy for potential after its success in transforming a landscape of small fishing villages into one of the world's most dynamic economies. However, not all SEZs are Shenzhen-type successes. In the shadows of the runaway successes including the United Arab Emirates, Malaysia, South Korea and now the Philippines, two other categories of SEZs exist. They are a large number of marginally positive zones and the vast number of outright failures.

Sri Lanka’s Free Trade Zones are only marginally successful. The tariff and other FTZ benefits are available across the county. Most new manufacturing ventures don’t find an attractive investment environment in the zones. 

Colombo Port City’s designers aim for its international financial centre, to attract global businesses to establish their regional offices here due to the ease with which they can operate and transact. To avoid the mediocrity of Sri Lanka’s FTZs, the designers of the Port City face several challenges. For our cover story, we brought together a panel of experts to discuss these.

The hype cycle in wearables

Around 2013/14, the hype around wearable technology reached a crescendo. People who purchased the first-generation products were universally disappointed due to their lack of utility, clunkiness and unreliability.

Several factors prevent the widespread adoption of wearable tech devices besides being relatively expensive. There are three reasons often cited, the exception being the smartwatch which does much more than tell the time.    
First, many wearable devices are unable to function without a nearby smartphone. Second, they are far from cool for mass appeal. Today’s wearables are generally clunky, can unexpectedly malfunction and are often considered a fashion faux pas. Third, they don’t yet have the ‘killer app’, for instance, like in a smartphone which is a great tool to connect with people far away. 

Now that the hype is over, clear-eyed investors are chasing narrower opportunities. Today they have the benefits of a decade of tech development, manifested in far faster internet, miniaturized computer chips and mechanical devices and powerful smartphones that can wirelessly connect to wearable tech.

Our cover story features the successes of Twinery, the innovation unit of MAS Holdings, one of Sri Lanka’s largest apparel manufacturers.

Justice in Sri Lanka is notoriously slow, and its reform equally so 

The rule of law depends not just on judges, but on an entire ecosystem including police, lawyers and prisons. Updated laws and regulations for civil, criminal and commercial are also required for justice to be done. Of course, trials are getting fairer and the basic rights of defendants, like the presumption of innocence and provision of a defence lawyer, have been tenets of the justice system for a long time.  

However, the chronic delays and outdated laws, are reasons for the inability of the justice system to keep up with the demands of a modern economy and a transforming society.

Sri Lanka’s fight against corruption has also faltered, due in part to its inability to bring to justice those responsible. Politicians, even when they are brought to trial for corruption, remain untouchable by the justice system. The weakness of the rule of law has a direct consequence on the country’s investment climate too. Serious investors, the type who will fund world-class firms, overwhelmingly prefer the rule of law, efficient judicial infrastructure and up-to-date laws suitable for modern commerce. Sri Lanka's judicial system is a discussion of a roundtable titled ‘Future-proofing Sri Lanka’s legal system’ starting on page 88.

Governments’ fondness for interventionism and its consequences

Data compiled by three economists tracking 30 European countries listed 1,160 privatizations in Europe compared to only 61 nationalizations in the decade ending in 2016. Productivity gains from previously poorly managed resources are a source of economic growth in Europe and other countries. 

A case in point is Romania. In 2005, it established Fondul Proprietatea, a closed-ended fund, to take over 90 state-owned ventures, including its hydroelectricity and coal power plants. In the years since, Fondul, and its private sector asset managers, have been successful at generating a steady stream of returns through dividends and asset sales for the government. The Romanian state's ownership of the fund has dwindled to 6%. Romanian pension funds and portfolio investors are now the fund's largest shareholders. 

Dividend and divestment income has funded Romanian public spending and welfare.   

Expanding the welfare state without targeting benefits was a major weakness in Sri Lanka’s public finances. Packaging subsidies with commercial operations of state ventures are fraught with conflicts of interest. 
States intervening in multiple areas of the economy, monopolistic control, and crowding out funding rarely serves the long-term interest of taxpayers who fund these. Sri Lankan managers of state ventures have demonstrated a general lack of capacity, alignment with objectives and poor governance, which can indeed lead to disaster. 

Many states have unravelled the state's interest in the need to run commercial ventures successfully during the last three decades. Romania is just one example. Sri Lanka is not short of examples to follow.

Modern monetary theory: Keynesianism in another name

In a public lecture, W.D Lakshman, the then governor of the central bank appointed to the role in November 2019, said he doesn't see any relationship between money and inflation. Facing a large budget deficit due to a sweeping tax cut in early 2020 followed by a slowing economy due to Covid, Sri Lanka resorted to printing money. Since the then governor of the central bank no longer believed printing money would lead to inflation, the printing presses worked over time.

Its proponents, including governor Lakshman, suggested that modern monetary theory (MMT) was the magic bullet to fund infrastructure, provide social safety nets and usher in a new era of prosperity. MMT is another way to describe printing money, eschewed by classical economists due to its inflationary impact. MMT was Keynesianism in different drab.   

Sri Lanka’s inflation has now spiralled out of control. After the departure of governor Lakshman, the central bank increased interest rates to record levels. Economists who were part of Echelon’s Reboot Everything Festival suggest that taming inflation and navigating the economy to growth won’t be as straightforward as raising interest rates. 

Indefensible spending

The United Kingdom is a military power and maintains defence forces for security, to protect its interest overseas and project power on the global stage. Its armed forces are backed by modern nuclear weapons. The British Navy has two brand new aircraft carriers, its own air wing and nuclear-powered submarines. Its airforce is over 800 aircraft.

Sri Lanka has no nuclear capability, has no submarines or aircraft carriers and its airforce has three combat aircraft. However, Sri Lanka’s standing armed forces (army, navy and airforce) are approximately the same number of active service personnel as the UK. A legacy of the war, perhaps?  

Thirteen years after the conflict with the LTTE ended, Sri Lanka maintains a defence force costing around Rs400 billion annually and similar in size to those of the UK. Defence spending had outpaced government spending and almost quadrupled since 2009 after the conflict with the LTTE ended. Defence and the police account for half the government’s salary bill although the combined personnel in these forces is far less than half the total 1.5 million in state jobs. Bloated defence spending is just one of Sri Lanka’s public finance challenges, and one that few want to discuss. However, the economic crisis has brought into sharp focus Sri Lanka’s real and persistent challenges. In June Echelon begins to explore the challenges facing Sri Lanka’s economy in series titled Reboot Everything.

The stability of a predictable and rule-based system 

Predictability and its rule-based nature are two attractions of currency boards. For several reasons, an emerging economy may find these particularly attractive. 

That a currency will depreciate is seen as inevitable in most emerging economies. However, the handful of countries that have currency boards, most notably Singapore and Hong Kong, have fixed exchange rates. Fixed exchange rates, due to their predictability and stability, promote trade and investment. 

Currency boards are fixed exchange regimes. The strict discipline of a currency board prevents government profligacy. A government cannot use the central bank’s printing press to bridge the budget deficit unless it can provide the currency board with an equal amount of the anchor currency as reserves. Most currency boards have adopted the US dollar as their reserve currency. To make the commitment to convert to the reserve currency credible, a currency board holds reserves of foreign currency at least equal to the domestic currency in issue.   

Ceylon had a currency board for about 70 years from 1884 until 1950 when the anchor currency was the Indian silver rupee. Professor Steve Hanke of Johns Hopkins University, known for his work as a currency reformer in emerging-market countries, features in our cover arguing for a currency board.

When the river runs dry

Stampeding crowds have featured in various incarnations. Stampeding crowds have protested, demanding the political leadership, now clearly inept at managing the economy, step down. When someone, in this case, protestors, shouts ‘fire’ the resulting flight risks being trampled by falling prices, margin calls and vanishing capital in the markets. 

Sri Lanka’s market for listed equities saw a dash to exit. The stock index, now weighted to reflect the volume of trades, has declined over 35% from its January 2022 peak. 

The draining liquidity is not just a feature in the stock market but in the economy as a whole. Sri Lanka, which is subsidising many services where the government is a monopoly or oligopoly, is now unable to meet the demand. It also has no credible plan, so far, to navigate out of the issue. The state is both illiquid and insolvent. But that's not the end. It now faces several other crises, more fundamental, including poor leadership and a governance crisis. In this issue, we discuss how to address the liquidity crisis, and what to expect of asset markets as this crisis unfolds.

Women, the workforce and the pandemic

There is still a lot to be untangled about the impact the pandemic has had on the workforce and in particular women. But a few things are obvious. The past two years have altered the course of women's careers. While downturns generally tend to reduce inequality, Covid may have been different. There is no Sri Lanka-specific data about Covid’s impact on work, but many of the trends seen in other developing countries will hold true here. 

The uneven impact of the pandemic on women globally is due to females more likely working in service jobs that require interacting with other people. Schools and pre-schools were also closed leading to women stopping work or reducing work to look after children. Women are more likely to be holding informal jobs, the kind that falls out of the workforce when the economy takes a hit.

The hit is greater in the so-called ‘pink’ sectors. In Sri Lanka, women hold most of these jobs in the plantation sector. Migrant labour, a ‘pink’ sector for its household income impact in Sri Lanka, is mostly female but not part of the country’s employment statistics. 

Of course, for women holding jobs in large companies the pandemic has offered the ability for flexibility in where they work from. Since the sort of jobs that can offer this are, only a small fraction of the workforce, few can will benefit from this. However, for female workers, this may be one of the few silver linings of the pandemic.

The battele for brainpower

Winston Churchill, admired for his visionary zeal and ability to compress in to simple language great insights, suggested in a speech at Harvard University in 1943 that “the empires of the future will be empires of the mind.” 

For millennia people and kingdoms have fought over natural resources, precious mettles, fertile farmland and serfs to tax and exploit. Some of these battles, like the ones for natural resources, are still with us. However one that has emerged and overtaken everything else is the global battle for talent. For the most efficient economies, this battle has been won by immigration policies that welcocmes the braniest and most enterprising. Weaker economies that are failing to keep pace, have been losers. For the brightest, to move to a competitive economy, vastly improves their chances. 

Technology has helped level some of the disadvantages for countries. For instance, India exported over $160 billion in knowledge services in 2021. For comparision, Sri Lanka’s knowledge services exports the same year were less than $2 billion. India isn’t winning the battle for brainpower but its knowledge services industry has somewhat stalled the brandrain by creating jobs at home, often serving global clients. 

A unit of the global managment consultancy Stax is doing just that in Sri Lanka. It isn’t the only knowledge services firm, but perhaps the only one in managment consulting. They are featured in Echelon’s cover this month.

Lurking danger of the herd instinct

Humans are herd animals more than we care to admit. That instinct has kept us safe for generations when the lurking dangers were natural disasters and tribal wars. Now that very instinct, for collective thinking that has kept us safe, may also hinder us as investors. Those investors will act along with the herd, but will often buy when others are done buying and remain skittishly on the sidelines when prices fall.  

Even for late bloomers, 2021 was a phenomenal year to be investing in a select group of stocks. Despite the pandemic, many companies managed costs and pivoted to maintain profit margins. Several firms did remarkably well. One analysis suggested 12-month trailing earnings were up 88% by the end of 2021. The stock market gained 80% during 2021 with much of the rise due to the performance of a dozen or so listed companies. 

Analysts expect earnings to grow only marginally in 2022 except for those companies in shipping. 

Equity was the asset class for success in 2021, although only a few companies saw profits and share price increase. Now as Sri Lanka faces an economic crisis, due partly to its access to international debt markets being shut, investors are wondering what asset class to bet on. In this guide to investment in 2022, we discuss how investors may go about crafting a strategy for the new year.

Tinkering around the edges
Sri Lanka’s approach to its foreign bondholders is less impressive than it appears

At first sight, it was a triumph. Despite the pandemic, Sri Lanka maintained its spotless debt servicing record over the two years to 2021. It was a triumph because the country’s sliding credit rating had all but locked it out of global credit markets. In this century, countries that cannot roll over their debt have had little choice but to restructure those obligations. 

Since the 1970s, governments have restructured their foreign currency debt to banks and bondholders at least on 100 occasions. It is feared that the pandemic’s impact on public finances in some countries will challenge many more countries. Sri Lanka’s own foreign debt sustainability is questionable. Vanity, the cultural shame of a deadbeat debtor and the fear of being shut out of capital markets in the future, are driving politicians and bureaucrats to maintain a spotless debt service record. 

It has been rare for a county to get a haircut on its debt without defaulting. Announcing a moratorium on debt repayments (a default) is one approach. Another is a pre-emptive restructuring; of early negotiations with creditors before the inevitable. Pre-emptive restructuring could lead to reprofiling of debt, a relatively gentle form of restructuring, in which the maturity of bonds is extended but the amount owed and the interest rate remain unchanged.  

By expending its few resources to pay bondholders in full now, Sri Lanka will have to enforce deeper cuts on other creditors in the future. The economic pain of a later adjustment will also be greater. It’s time to end the tinkering around the edges.

In a time of upheaval, how should Sri Lanka approach supply chains?

Despite the challenges, Sri Lankan apparel manufacturing and export supply chains have shown significant resilience. Of Sri Lanka’s exports, apparel is the largest. While they have been challenged, apparel supply chains have remained intact compared to, for instance, those for semiconductor chips.

However, the Coronavirus pandemic has exposed a major risk of globalisation, which is that it concentrates production and eliminates buffer stocks. For several decades now, supply chains have been tuned for maximum speed and efficiency. Companies, like Sri Lankan apparel producers, have specialised to concentrate expertise and scale. Now, however, there are growing worries that these fast and efficient supply chains are a source of vulnerability. Self-reliance is a new mantra in some industries. 

However, it would be a mistake to consider supply chins a source of vulnerability. For years, private sector firms have been apt at adapting to long term threats including geopolitical tensions, shifting economies of scale, and even the risks posed by pandemics. Just like trade promotes openness, protectionism spreads from one country to another. 

Sri Lankan businesses including MAS will be considering how to shore up the resilience of their supply chains including moving their geography closer to customers. As manufacturing automates, some production may also move onshore to the main markets for apparel. In response to disruptions, private companies are acting to build more resilient supply chain models. Without any untoward government meddling, they will succeed in adjusting the global supply chains to new vulnerabilities.

Innovation needn’t be a tech thing

For decades a flank on the debate about who is the better catalyst for innovation focused on large organisations versus small ones. In the last couple of decades, however, as the internet spread and tech adoption accelerated, some small companies became giant killers. Unshackled by legacy business models, they were freer to reinvent how things were done. These tech-led disruptors tilted towards smaller companies with the ability to be innovative in ways that disrupted commerce. 

But large firms have fought back by ‘routinising’ innovation. They have been helped along by their abundant resources and the carnage they have witnessed in some industries. For the most successful large companies, innovation is a more regular and sometimes predictable activity. More than small companies, large firms are also successful at ‘open innovation’: the realisation that the greatest value creation comes from partnering with suppliers, customers, and sometimes even with competitors.   

This issue features a conversation with some of Sri Lanka’s top proponents of the open innovation model. They each have vastly different backgrounds but a common approach to making companies more innovative: being open to collaborate with stakeholders.


The reality of Sri Lanka’s debt

Moody’s, Fitch and S&P all cut Sri Lanka’s credit rating by a notch in December 2018 when a political coup installed a second Prime Minister. Since then the three rating agencies have cut Sri Lanka’s credit ratings twice, essentially locking the country out of the global credit markets. 

The problem is that the refinancing option occasionally proves to be fragile. Sometimes, like in Sri Lanka’s case, it is the country’s own economic management that causes markets to turn skittish. At other times, its causes are quite outside the ability of the sovereign debtor to effect. An unexpected geopolitical crisis, a Lehman moment, interest rates in the developed world rising, can all trigger markets. 

When the signs were ominous, Sri Lanka should have suspended debt service payments. The credit rating downgrades following the Covid pandemic’s spread should have been the cue. By then it was evident the country could not refinance its debt. 

If there is a constant theme in sovereign debt crises over the last 40 years, it is that countries have put off the decision to restructure their debt for as long as possible. Putting off the decision creates what is called a subordination problem. 

In October 2020 and July 2021 Sri Lanka repaid, using its reserves, two maturing sovereign bonds of a billion dollars each. It also repaid other dollar debt and interest of at least 900 million dollars in the last year. By paying in full some creditors, it will now have to force far deeper haircuts on the debt it cannot fully service in the future. By its not facing reality, Sri Lanka is forcing narrower and starker choices upon itself.

Social entrepreneurship as a transformative force

A popular approach to social entrepreneurship is to see it as applying business management skills to achieve social ends. Nothing wrong with that. Many social minded ventures could benefit from sharp management common in successful private sector firms. But social entrepreneurs can be transformative forces too: people with new ideas to solve society's most stubborn problems. Like leaders have to be, social entrepreneurs too must be relentless in the pursuit of their vision.

Since its founding in the 1950s’ the Sarvodaya Shramadana Movement has been a force for change in rural Sri Lanka, empowering the most marginalised and rural communities to figure out how to address their own needs. For Sarvodaya, micro credit has been a tool for village regeneration and local activism. It’s also a third way between state provision of public services and full-on privatisation. Government is resource-constrained and private capital is weary of low returns in rural investments.

Organising disadvantaged communities to address their own needs matters. However, the advent of technology, global supply chains, and the advantage that scale confers, mean that entrepreneurs can no longer ignore the impact these have had on consumer expectations. 

Village entrepreneurs may stay local but they cannot ignore product development, marketing and supply chain. Sarvodaya Development Finance, a firm controlled by the movement, is taking an innovative and transformative approach to village regeneration and entrepreneurship. They are featured on the cover this month.

Who will build the banks of tomorrow?

Sri Lankan banks are in a position of strength - or so it appears. No big bank has failed and as a result they are trusted more than fintechs who wish to compete with them. Most people also don’t know what to make of fintechs or how to use them. However banks are also failing to harness the opportunity that digital technology now presents.

Many bankers seem convinced that onerous regulations would protect them from the challenge and that regulators, fearful of competition destabilising the sector, will make it difficult for fintechs to gain significant market share. This has left Sri Lankan retail banks behind in innovation compared to ones in parts of Asia and Europe where regulators have allowed fintechs and tech giants to compete. 

Bankers fear competition and regulators its destabilising effect, because incumbent banks will lose their footing on customer data and relationships. Once their sole possession and advantage, customer data and relationships will become fair game for fintechs and big tech firms which, unlike banks, will operate a balance-sheet-light business model, earning revenue not by recycling deposits into new loans, but by offering services. Fintechs and bigtech will spend heavily on data analytics to understand customer spending to cross-sell more effectively.

Few would have bet on state controlled People’s Bank emerging as a leader in digital banking. Nothing about People’s Bank’s position today suggests that it has won out on innovation, but a product's success is adoption and People’s Bank’s apps and online banking are successful by this measure. 

Banks in the future will create more value from data. People’s Bank, one of the country’s oldest, is surprisingly up to the challenge.


Exports cannot deliver what trade reforms can

We began 2021 on a low, with a 3.5% GDP contraction the previous year, the sovereign rating falling deeper into junk status, and with $3.5 billion worth of foreign currency loans to repay during the year - and a massive $23 billion by 2025! In January, official forex reserves stood at $4.15 billion and recovered to $4.5 billion in April before falling to $4.02 billion in May 2021. Things are dire. 

Everyone agrees that exports can solve most of our problems (if not all). For decades, we have tried to boost exports while liberally curtailing imports. From being among the first to liberalise its economy in the region, we have regressed to a protectionist state, and worse (please see the Bellwether column on page 22). Yet, we are incapable of unlocking the export potential. According to the World Bank, exports as a share of GDP almost halved from nearly 40% in 2000 to 23% in 2019.

To understand why, we interviewed well-known economist Anushka Wijesinha for this edition of Echelon (please see page 84). He argues that without trade reforms, we will not grow exports. In turn, we will fail to attract FDIs that will add real economic value, create better jobs and uplift living standards—important things investments to build apartments will not do. The more we delay reforms, the harder it will be to do reforms. The economy will fall deeper into debt with frequent currency and balance of payments crises. Worryingly, most do not even recognise the need for trade reforms! 
However, there is some comfort. Building consensus on trade reforms is not impossible. 

Special Economic Zones and distortions within economies

In 1978, the establishment of the Greater Colombo Economic Commission (GCEC), the precursor to the BOI, didn’t attract widespread ire perhaps because it didn’t involve a giant Chinese corporation and the development of a landmass reclaimed from the sea the size of Monaco. Some of the controversy with the proposed Port City bill has been about its alleged inconsistency with the constitution. The Supreme Court will deal with such matters.  
However, the GCEC and the Port City Colombo have similar objectives for the special economic zones they established or propose to. Special economic zones cover a broad range of facilities and generally offer investors a geographically defined area, lower taxes and regulatory incentives than the rest of the country. 
For a country, establishing SEZs have two main types of benefits, which explain their popularity. The first are economic benefits such as jobs, export growth and increased government revenue due to expansion in economic activity. The second are more dynamic economic benefits such as innovation, economic diversification, higher productivity of local firms due to competition, technology transfer and skills upgrading. 
Some of the opposition to the Port City is due to its conferring tax, tariff and regulatory incentives unavailable to businesses elsewhere in the country. This may create distortions if Port City businesses offer products and services in the rest of the country. However, like the businesses in the first SEZs, which were enclaves for manufacturing, investors in the Port City will be attracted by the global service hub potential and not by serving the tiny Sri Lankan market. Like the SEZs under the GCEC and subsequently BOI transformed Sri Lanka’s manufacturing export sector, Port City can do the same for creating a globally competitive services sector in the county.

Leadership, charisma and narcissism

Beginning this April and for several months to follow, Echelon is celebrating leadership: a phenomenon that is widely studied but little understood. To prosper economically, Sri Lanka will require, more than anything else, great leadership with vision to set the course for the future. Businesses will also rely on these leaders to build globally competitive companies, and create jobs and prosperity in the process. 

In our discussions we explored three areas; the nature and behaviour of leaders, of those who are led and the structure of the organisation in which the leading takes place. Our conversations revealed that leaders had unique approaches but overall their values and principles were similar. 

Often, people confuse competence, with confidence, charisma and narcissism. On the contrary it became evident, to us, that successful business leaders had sufficient empathy to understand the concerns of others. Things do go wrong, as they did during the Coronavirus pandemic, and great leaders showed the flexibility to adjust their strategy. 

Successful leaders also pay attention to the goings on, they will determine what strategic action needs to be taken, set a new direction and concentrate the attention of everyone in the company on it. We called the special series of articles featuring these conversations ‘Daring CEOs’.

Why it’s hard to reduce informality in the labour market

Informal workers get a bad deal. They earn no pensions and get paid half as much as public sector employees do in Sri Lanka. As we discuss in our cover story, wages are low because informal sector firms are less productive than formal ones. They are also smaller, don’t have access to capital as easily, and stay on the sidelines to avoid catching the eye of officialdom.

Simplifying taxes itself is not known to attract informal firms out of the shadows. If regulations are burdensome, particularly if a small company must pay high pension contributions and severance costs should it run into financial trouble in the future, a small business owner may decide to employ fewer people.
 
In Sri Lanka, 70% of jobs are in the informal sector. Besides employment, this has wide implications for the economy too. A large informal sector is associated with low growth, low pay and poor-quality jobs. Informal firms pay measly wages and the jobs are tenuous. They also dodge both income and sales taxes.
 
What has been missing is political ambition. To reduce informality and allow small businesses to flourish requires a more equal deployment of public resources (including for social protection when people lose their job), flexible labour laws, and simpler tax and business regulations.


Modern monetary theory, essential or hogwash?

Sri Lanka’s central bank and economic policymakers are convinced that modern monetary theory (MMT) can steer the country away from the abyss it confronts. Since the onset of the pandemic, the economic theories of John Maynard Keynes are seeing a revival. Several variants of Keynes’ theories, now called post-Keynesianism, an eclectic mix of ideas that remained in the fringes are now creeping into the mainstream. One of the most popular of such post-Keynesianism concepts is modern monetary theory.   

That inflation has kept low even with low-interest rates in some parts of the world has caused some to question Milton Friedman’s theories that inflation is a monetary phenomenon. 

Recently, two of Sri Lanka’s top economists, former Central Bank Deputy Governor W A Wijeywardena and think tank Verite’s, Research Director Deshal De Mel joined us to dissect what MMT is and how it may play out in Sri Lanka.

MMT theorists are not averse to inflation or deny its impact. They agree inflation could trigger at some point, and that trigger point will vary from country to country. They argue that once high employment or a level of economic activity is reached, or demand grows to generate inflation, governments can, at that point, raise taxes and pull excess cash out of the system.

The economist on our panel suggested, not in the same words, but that’s a load of hogwash to suggest that excess liquidity will play out that way in Sri Lanka’s due to its weak public finances and large foreign debt payments. Read that discussion starting on page 110.


The beast awakens

The Coronavirus pandemic is forcing a rethink about how we live, how we work, and how to run an economy. When governments chose to shut down businesses and limit people’s movement to contain the spread of the deadly pandemic, they also had to contend with lower tax revenues, businesses going bust, and people losing their jobs. 

Now, in the wreckage left behind by the pandemic, governments are scrambling to introduce stimulus packages to get companies back into businesses, to create jobs, and restore tax income. However, funding the stimulus has led to a record amount of debt being added. 

Global debt across all sectors rose by over $10 trillion in 2019 topping $255 trillion. This includes debt outstanding by governments, businesses and households. At over 322% of GDP, global debt is now 40% higher than at the onset of the 2008 great recession. 

For Sri Lanka, with its large foreign debt to repay in the next few years, the choices have been stark. Compared to about four billion rupees of net money printing in 2019, Sri Lanka’s central bank unleashed a flood of about 800 billion in printed money in 2020. All this liquidity may not be without consequences in countries like Sri Lanka, running large budget deficits financed by printed money, and also converting existing debt rollovers, unsold at the auction, to printed money.  

For those believing in orthodoxy, in which governments must eventually pay for their spending through higher taxes or the population must be willing to put up with inflation (another form of tax), apprehensions will now abound.


June 2023

May 2023

April 2023

March 2023

February 2023

January 2023

December 2022

November 2022

October 2022

September 2022

August 2022

July 2022

June 2022

May 2022

April 2022

March 2022

Intelligent Storytelling

The one thing that will define the Echelon magazine will be the quality of the storytelling. Echelon,published monthly, will cover in depth Sri Lanka’s most successful businesses, examine their winning strategiesand profile their leaders in immersive stories. Great stories are also never limited to words, and our approach includes rich photography, bold graphics and leading edge design which together will make for a compelling read.

But business doesn’t start and end in a boardroom;it extends to the golf club greens, to international travel and to pursuits that blurthe lines between commercial venture and sheer passion. The Echelon team will present the best in business and lifestyle coverage that will appeal to an exclusive and affluent readership: an otherwise hard to reach demographic.

Content will be developed by one of the most experienced and proven teams of editors, financial journalists, photographers and designers in the country.This team has already raised the bar for powerful and expertly crafted business news. Shamindra Kulamannage, will lead the editorial team.

The reputation of Echelon is being built on the separation between editorial and advertising. However we are also looking for the most creative and impactful new formats that can be applied in our magazines, iPad app as well as website to help our clients reach our audience. We are flexible and creative and we will have a solution for every single advertiser who wants to reach our audience.

We are passionate about creative results and about working with our advertisers to help them create bespoke multi platform creative solutions with our in house creative team and of course our sales team.

Echelon will be a great place to show off the products and capabilities of our clients because they will be surrounded by an editorial product that is expertly crafted, full of integrity and intelligence.

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Echelon Magazine - January 2016

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