Sri Lanka: Effects Of The Global Economic Wobble – Analysis

By Dr. Kumar David

The impact of the global economy on small countries can be severe and we are passing through a phase when stocktaking is timely. First, a few paragraphs regarding the beast itself –  the world economy, which, mainly, is the advanced capitalist world. A recession is called V-shaped if recovery is steep and U-shaped if recuperation is slow. When stuck at the bottom for a long time (Japan’s lost decade) the appropriate shape is an L, a double-dip or W is when a second recession follows before recovery from the first. However, none of these terms provide a pictorial handle of the Great Recession (GR) that started in Q3-2008.

At the time I developed a model, the Wobble-U, to deal with the difference and illustrate a hypothesis. The Wobble-U is more complex than a double-dip which lay at the heart of the Great Depression (GD) of the 1930s. It is a seesaw of ups and downs, small recoveries and flops and slumps, depicting a long-duration limping economy. (My case, based on fundamental reasoning, is in Essays on the Global Economic Crisis, published by the Ecumenical Institute, Sri Lanka). In fact it is a depression in its own way, and anyone expecting the next depression to manifest the same symptoms as GD is awaiting the wrong Godot. Capitalism is different now, more globalised with new strategies. A depression manifests itself with different symptoms, the Wobble-U. The new strategies are: a) new tools developed by policy economists, and b) global state-capitalism, that is the coordinated responses of world political leaders and central bankers.

Gloom and doom

This Wobble-U hypothesis has been validated with resounding success over the last three years. America never came out of the doldrums it staggered into in 2008. There has been no economic recovery – 4% GDP growth expectations have been scaled back to below 2%, unemployment is stubbornly high at 9% and stock and currency markets are panicking. Instead of 2% annual growth the US would have had over 5% GDP decline if not for massive fiscal deficit spending; but now it has reached its Congressionally permitted debt limit of $14.3 trillion. Two massive rounds of Quantitative Easing have failed to spur recovery.

Europe has three very sick men – one on deathbed – plus four more cases of debility with no certainty of recovery. Greece is in extremis; it will default on its debt (they call it restructuring and reschedule repayments to make it look as if Greece didn’t go bust). Whether Portugal and Spain will go all way into the abyss remains to be seen. UK, France, Ireland and Iceland are into austerity but with no signs of recovery.

Perhaps the sun shines on Asia and its pin-ups China and India? Relative decoupling from the West did offer a degree of protection at the start of the recession, but there are limits to decoupling. Eventually, the capitalist centre will drag all down; China and India can reduce but cannot eliminate dependence on exports and both are in an inflationary spiral. When recession started Beijing turned to its internal market, potentially gigantic, and unfurled its own stimulus programme that helped it pull through and maintain growth. The inward turn was beneficial for the poor in China (nothing similar in India) since expenditure on health, education and upgrading of the hinterland got a leg up. The limits have now been reached; animated macroeconomics has the same effects everywhere; inflation and a god-almighty property bubble that may wreck the Chinese banking system. The control freaks in Beijing can stamp on the economy and limit harm, but the globe is interconnected, so it will be an exercise in damage control only.

India is the other wunderkind in the emerging block and statistics of growth and wealth resound in the media. The truth however is that an obscene wealth and income gap mocks this shining image. When 220 million survive in abject poverty, unsurprisingly, swathes of territory lie outside government control, insurrections aggravate and Maoists proliferate.
And so to Lanka

The impact of the global debacle on Lanka is double edged. The US and EU are Lanka’s biggest export markets (68% together) but the island makes the tiniest dent in their massive national accounts, so declining general demand may not translate into a decline in imports from Lanka. Price is a different matter; downward pressure will affect everyone. Secondly, trouble in the Middle East may magnify oil prices, but falling demand in the wake of a decline in global production will more than cushion the impact. This is vital since sustained oil prices above $120 per barrel will almost certainly create all round price pressure, and if coincident with high world food prices, spell disaster for the government.

The biggest unknown is the island’s largest foreign currency earner, housemaids in the Middle East – larger in earnings than garments or tea exports. But fortune has smiled; the great majority of Lankan women are in Saudi Arabia and the Gulf region, both of which the Arab Uprising has bypassed for now – but how much longer?

Many perceptive economists have sounded the alarm that the core problem with the Lankan economy is structural; it is too much skewed away from industry and too dependent on the service sector. Neither government strategies, nor the global crisis, offer a way to industrial growth. Then there is a further problem, the service sector is mainly tourism and trade; there is nothing similar the knowledge based economy that has sprung up in, say India, even after, mutatis mutandis, scaling for size.

This is very troubling because, for example, it will be the single most serious reason for the predictable failure of the Hambantota port and airport venture. President Rajapakse has, unwisely, pinned his hopes on this remote southern outpost as a star growth hub simply because it is his home. The strategy will fail due to basic geographic logistics, but there is something deeper. An international port and transhipment point is more than breakwaters and cranes; it has to be a communications, IT and business nerve centre – vide Singapore or Hong Kong. There are near zero trained, educated, business savvy and technology smart cadres within scores of miles of Hambantota, nor will they migrate there from Colombo.

Indeed even in Colombo these skills are not competitive with Bangalore, Bombay, Singapore, Hong Kong, or other established rivals. The decline in English language ability in the half-century after 1956, a consequence of ultra-nationalism, is at the core of the pathetic decline in general knowledge, science & technology, IT and business skills among the young.

One of four pillars on which the government intends to erect its foreign investment plan as outlined in the 2011 budget, is carving out a financial hub. The other three are infrastructure (roads, ports, and power); real estate development; and post-war north-east reconstruction. Infrastructure, except for white elephants like Hambantota, is showing success. Foreign funds are snapping up prime Colombo land. But north-east reconstruction is problematic since it excludes the people of the area (mainly Tamils) from decision making processes. The programme is being executed under military tutelage.

The ambitious plan to expand stock market capitalisation, attract investment and banking institutions and liberalise and internationalise the financial sector will be affected by the ebb and flow of the wobbling global economy. The plan may be stillborn, but it is also possible that serendipitously – matching the island’s ancient Arab name – some interests from global capital may make use of the opening. However, I am not sanguine beyond the short term; it is an undesirable trajectory to hitch Lanka’s economic future given the global wobble. Financial volatility, stock market bubbles and regulatory failures are likely. Global economic uncertainties will magnify financial volatility in a small, newly emergent, hub. While a small filthy-rich financial elite may emerge in Colombo and scams proliferate, a sharp class and privilege gap will surface.

Big picture instability

The post-war foreign direct investment (FDI) picture has been very disappointing. The shared view was that with the end of the war, the subduing of Tamils, the stability exemplified in three quick election victories, the carrot in the budgetary thesis and promise of easy bucks for investors venturing into the north-eastern wastelands, foreign investors will come romping in. Taken one at a time the right incentives were all on offer, and yet foreign investors stayed away. The micro incentives seemed right but there was “big picture uncertainty”. I will explain anon.

First the facts; FDI in 2010 was $350 million while the expectation was over $1 billion; for 2011 the government has lowered its expectation to $1 billion but the IMF has grudgingly said it may get $750 million. Why in pluperfect heaven it expects the figure to more than double (750/350 = 2.14) within a year is not explained. Be that as it may, the response to the proposed September 2011 sovereign bond issue ($1 billion) will show how the wind is blowing.

The hypothesis I offer is that though there is visible calm after the war and apparent Rajapakse regime stability, foreign and local capitalists doubt long-term stability; this in conditions of global ebb of financial confidence is a psychological disincentive. Hot money floods in at times and in other months flows out of the Colombo bourse, but crucially, it’s about commitment for five to ten years that capital has developed cold feet. Volatile cash in the equity market and currency plays do nothing for growth. Development needs investors who stay for several years in productive plants and services; this is what FDI is really about, but only tourism and hotels show robustness.

Why is local and foreign capital suffering from big picture uncertainty? Fear of breakdown of the rule of law, abuse of power, domesticating the judiciary, and politicising the police do not make for a good investment climate per se. Then, the political backlash such trends can provoke exacerbates business fears. Inability, nay unwillingness to settle with the Tamils is also destabilising – the worm may turn sooner than expected. The prospect of war crimes prosecution hangs like a sword above the head; if there is prosecution in any tribunal anywhere in the world, the regime’s cohorts will go berserk! It is all of this, taken together, that undermines the big picture in the eyes of prospective investors.

Corruption and bribing politicians is all in a days work for investors, they have gone along with that all over the world for ages; capital is amoral. But uncertainty in the long-term political scene is problematic; investors risk losing their shirt. This is why FDI isn’t coming Lanka’s way big time, and why local capital too is laid back.