• People in power have no interest in changing status quo
• Last year a crisis of supply, this year a crisis of demand
• An angry population is a precursor to any change
• No point blaming IMF; in Sri Lanka by our invitation
• For every Lee Kuan Yew, there are 50 Robert Mugabes
• Lack of funds for polls is a load of hogwash
• Sceptical about IMF programme happening by March
• Politicians and policymakers have to be held accountable

“Sri Lanka has been run for the benefit of a thousand people. The whole system has to change to a more inclusive political institutional environment, which will then lead to more inclusive economic institutions,” asserted Advocata Institute Chair Murtaza Jafferjee, in an interview with The Sunday Morning.

However, Jafferjee said that he did not see the necessary reforms being enacted, noting that he did not believe the people in power had any interest in changing the status quo.

Commenting on the International Monetary Fund (IMF) programme, he said: “You only go to the IMF when you need it. It always gets bad publicity, but they are here to help us. There is no point blaming them; they come to Sri Lanka by our invitation. We need stabilisation.”

Jafferjee also called for serious thinking about tax incentives, which he said had sometimes been granted under very corrupt conditions. “These agreements are not sacrosanct. When you have defaulted on your creditors, nothing is beyond negotiation,” he emphasised.

In the course of the interview, Jafferjee also spoke about Local Government Polls, democracy in Sri Lanka, the move to reclassify China’s loans, the tax regime, the latest power tariff hike, and the importance of holding politicians and policymakers accountable.

Following are excerpts:

How do you view Sri Lanka’s current economic status and what’s your outlook for the country in the months ahead? 

The Gross Domestic Product (GDP) figures for last year have not come out yet. It is expected that there will be a contraction of about 9%. It is forecast that there will be another contraction of about 2-3% this year.

Since I work in the financial markets, I get the opportunity to speak to a lot of companies and this is what they are saying – in Fast-Moving Consumer Goods (FMCG), they are witnessing a volume contraction of 15-20%; with more discretionary items like restaurants it could be as high as 30-40%. The most impacted sector is construction, which is probably experiencing 40-50% contraction and this will probably increase further. Once some of the half-completed projects are finished, I doubt there will be any big projects that come in.

The green shoots are that we are going to see a steady improvement in tourism. The numbers that are put out – that there are 100,000 arrivals a month – don’t necessarily translate to the same value because these are low-value tourists who are coming, but it is all in the right direction. I believe that even remittances – because so many people left the country and the informal channels are reducing – are going to start increasing.

Last year was a crisis of supply. This year is a crisis of demand. Consumers simply cannot afford it and therefore purchasing power will be impacted. Many of the moratoriums that were outstanding on bank loans will be ending, so you will see more stress in the financial system.

You recently said that rebuilding trust and spurring growth may remain a challenge unless robust economic and governance reforms are enacted. Do you see this happening?

I don’t see it happening. The main reason is that I don’t think the people in power have any interest in changing the status quo. You also have a very angry population, which is a precursor to any change. As Professor Mick Moore who knows Sri Lanka has said before, countries where people pay higher taxes enjoy better governance. For the first time, you are seeing people really venting about having to pay higher taxes and I think there will be a call for greater accountability.

When you look at what has happened to Sri Lanka, you have very extractive political institutions and extractive economic institutions. This country has been run for the benefit of a thousand people. What needs to happen is that the whole system has to change to a more inclusive political institutional environment, which will then lead to more inclusive economic institutions.

What are the key steps that you recommend? What should the Government do at this point?

Obviously, the need of the hour is macro stabilisation. What macro stabilisation means is that prior to this crisis, what led to it is excessive interference with the economy by controlling the prices. Some of the key prices that we held down were the cost of money, interest rates were artificially suppressed, the exchange rate was controlled, and energy prices were not revised for many years. Now those things have been adjusted but it has led to inflation.

Unfortunately the Government’s revenues are not coming through so the Central Bank has had to monetise some of the deficit. The high interest rates are doing the necessary actions, demand is compressing, and the forces of demand and supply are now stabilising.

We will need an IMF programme because you only go to the IMF when you need it. It always gets bad publicity, but they are here to help us. There is no point blaming them; they come to Sri Lanka by our invitation. We need stabilisation. Perhaps 2023 is the year of stabilisation and then the focus of 2024 and 2025 has to be ‘how do we accelerate economic growth?’

 With all the uncertainty over elections, there’s also a democratic crisis unfolding in Sri Lanka. How do you think this will play out?

As I said, the issue was that we had extractive political institutions. Now Sri Lanka, on the face of it, has democracy – we have many elections – but what we have is illiberal democracy. You have these ‘strongman’ kind of rulers who come in because the Executive Presidency has an enormous amount of power.

We would like to have a benevolent dictator; we have been waiting for our equivalent of a Lee Kuan Yew. But for every Lee Kuan Yew, there are 50 Robert Mugabes. The tragedy of Sri Lanka is that, given the electoral system we have, to get into that seat you basically have to go down to the lowest common denominator. The people who get into that seat don’t appeal to higher ideals.

Now what’s happening with the Local Government Elections is that they were supposed to be held last year, so we are already over one year overdue. They are trying to postpone the electoral process by saying that there aren’t sufficient funds, which is a whole load of hogwash.

The total primary expenditure – if you take out interest expenditure – that the Government has forecasted this year is Rs. 3 trillion. It is estimated that the election will cost Rs. 10 billion, which is less than 1% of the total budget, so I don’t buy that there is no money to hold elections.

An obvious concern is that if you do have an election, it will be very clear that the mandate will be against the Government that is currently in power and then that will lead immediately to a call for Parliamentary Elections, which will then eat up more time. The risk is that while the political process is playing itself out, all the necessary economic reforms, stabilisation, etc. will come under threat.

Invariably, Sri Lankan elections are an auction of non-existing resources. We already see that right now. The current tax-free threshold is Rs. 100,000. The Janatha Vimukthi Peramuna (JVP) came out and said it will make it Rs. 200,000. The SJB said it will do one better and increase it to Rs. 250,000. You don’t need that kind of activity while we are trying to stabilise the economy.

Democracy needs elections, but economic stabilisation requires space. The democrat in me says that we need elections. The reformer in me says that if they are postponed, it will give more space for a quicker revival.

How do you view the ongoing negotiations with the IMF? Do you think the March deadline will be realised or will things get dragged further?

There was a news report today (22) or yesterday (21) that the Head of the Asia Pacific Department has said ‘don’t speculate on it,’ when some Indian journalists had questioned about it. That guy is a guy who should know what he is talking about.

Our people are basically talking about how there will be a programme by March. He is saying ‘don’t speculate’ and ‘we would like to have financial assurance from the Chinese’. I would be a little bit sceptical about whether a programme can happen by March.

How do you view the move to reclassify China’s loans to Sri Lanka as bilateral and commercial loans?

The IMF has something called a lending in arrears programme. I think it was constituted sometime in 2015. The majority of bilateral creditors have to agree. Accounting for all outstanding, the Chinese are slightly above 50%.

What they are trying to say is that ‘if we are unwilling to give you the necessary assurance, then if we reduce our share of the bilateral outstanding, you have got assurances from the others and based on that you can go forward’. That is not going to work and will therefore move some of the debt to the commercial side.

Now their expectation is that there will be two different mechanisms of restructuring – that the bilaterals will have to take a longer prolonging of the maturities and the commercial creditors will have another arrangement.

My understanding is that the commercial creditors will probably have to take a haircut on the principal outstanding, which has not been suggested by the bilateral creditors that I know – it is more a maturity extension and an adjustment of the interest. I don’t understand what their motives are, I can only speculate that these are the boundaries of how they can stand to benefit.

China has called for multilateral lenders to restructure loans. Do you see this happening?

If you look at the letter that came from China’s Exim Bank, the last paragraph alludes to it. These multilateral lenders were all Bretton-Woods institutions set up after the Second World War. They were set up because, prior to the Second World War, there were huge economic crises in the world, which led to the war.

They said that they did not want this to happen again and that they would create a safety net – that is why the World Bank was set up as a development agency and the IMF was set up as an agency that comes to the rescue of countries when they are in distress. Then you have regional agencies like the Asian Development Bank, the Inter-American Development Bank, European Bank for Reconstruction and Development, etc., which were focused on the region. 

Generally they have very high credit ratings. For example, the World Bank has a AAA rating. The reason why the World Bank has a AAA rating is that you have the major economic powers in the world underwriting them, plus nobody defaults on them because they are given a very concessional rate of lending. These are loans that are made for development purposes over a very long period of time.

What the Chinese seem to be saying is that these multilateral agencies will also need to take a haircut. They are questioning what the Westerners say is a rules-based order and kind of saying ‘we were never part of this, in drawing it up’ so it’s a fundamental questioning of the premise of this Western-dominated rules-based order. That is where I think they are coming from.

So you don’t see it happening? Is this some kind of power play?

It is. But this is a major deviation, which to my knowledge has never happened. If Sri Lanka is going to deviate – and I don’t think it will ever happen here – this is the message that they are giving.

President Ranil Wickremesinghe on Tuesday (21) described the tax regime as a rescue operation. How do you view the current policies?

There is no doubt that you have an extremely distressed situation. This tax issue is basically now at centre stage. Take my predicament. I am at the highest end of taxation. Most of my income is going at 36%. They have to do that. If you give me the option between the devil and the deep blue sea, I would still take the tax option although it hurts me a lot because I prefer that to money printing. Inflation is an easier tax but it hurts the poor much more and it destroys wealth and economic growth. Higher taxation will also have a risk of contraction.

My contention is that if I am being made to pay 36%, then we have to ensure that everybody else also pays their fair share. Unfortunately, that is not happening, on two counts.

One is the issue of tax policy. There are a large number of companies which are tax exempt, which you can break into two. There are companies under the Strategic Development Act – for example, the West Terminal, which was handed over without competitive bidding with a 25-year tax holiday. I don’t know why you needed to give a 25-year tax holiday when you didn’t even have a competitive bidding process and when this is a completely domestic-based and highly-profitable operation. That is one example, but there are many others.

All the existing Board of Investment (BOI) companies which are under a different tax scheme enjoy concessionary tax for life. There is no sunset. You could have two companies in the same business, one under a BOI concession enjoying, say, 15% tax for life and another company without those BOI concessions paying 30%. You never have that in any other country because there is a principle called horizontal equity, which is not being adhered to.

There has to be some serious thinking, where all these tax incentives going on – sometimes under very corrupt conditions – have to be all sunset because these agreements are not sacrosanct. When you have defaulted on your creditors, nothing is beyond negotiation. My contention is, if I am paying 36%, everybody else has to pay. Otherwise it is unfair.

The second issue is that of tax administration. Mainly for salaried people, where there is a visibility, there is a withholding tax which we call PAYE, which is an advance tax that is deducted. But there are a lot of people who basically work for themselves where the visibility of income is not there – people who probably earn much more than salaried people. There has to be a greater effort to go after these people. Serious effort has to be put into collecting taxes from people who should be paying.

How do you see the power tariff hike playing out? What kind of an impact will it have on industries, exports, and the economy in general?

The power tariff increase was needed. For over 10 years we didn’t increase power tariff rates while the costs were going up. The increase that we had the previous time was an in-between hike, the entirety was not increased.

Having said that, I must declare my interest that I am also in the renewable energy sector and for 13 months we have not been paid. The CEB says ‘we don’t have the cash to pay you because we are using whatever cash flows to buy coal because the monsoon is coming and therefore we have to store it for maybe four months’. They do have a cash flow problem. 

Now the question is, should it be what it is? There is no doubt that the generation mix that they have is sub-optimal. There are cheaper ways to do it, but to fix this problem takes time. You can’t build big power plants, etc. overnight and this whole talk about renewable energy is a whole lot of hogwash – who is going to invest when you are not getting paid?

The power tariff hike was needed and I think the consumers will have to adjust. I have contentions about the system we have in place; electricity is electricity, so why do we have different tariff rates for different people? I don’t understand that. Industrial tariff is lower than residential tariff and lower than what they call commercial tariff. Why should it be lower? In an environment where power is scarce, you are encouraging more energy-intensive industries. It doesn’t make sense to me.

In my opinion, you should have one tariff for everyone and do a cash transfer for low-income households – give them the money and tell them to decide how they want to spend it. They may decide to buy low LED bulbs and save a lot of electricity.

Politicians and public officials are yet to be held accountable for their role in compounding the economic crisis. How should this be addressed? Can faith in the system be restored?

There are two types of people who have to be held accountable – the politicians and the policymakers. The politicians – holding them responsible is obviously through elections. If they did a very poor job, people have a mandate and will vote them out. Those politicians who basically didn’t adhere to the norms of government and if they have violated the law, they have to be held accountable through the legal process.

The second lot of people are the policymakers, some of the technocrats – I call them super secretaries – and some very powerful people in some institutions. They have a duty of public trust. It is very clear that they didn’t operate to that high responsibility. You can’t prosecute people for errors in policy. But did they do this because of ideological reasons or did they consciously do it?

To give an example, for something like two years we continued to service these ISBs at an immense cost to the people. What was the logic of this? We paid off something like $ 2.5 billion. When Covid struck our rating was struck and it was very clear that we couldn’t refinance. They kept on saying ‘this is a liquidity crisis, not a solvency crisis’. 

For two years they dillydallied, compressed imports, and disadvantaged the population, but they kept paying the creditors. Was it due to vanity or were there vested interests at play where they had people connected to them who were buying these instruments in the secondary market and making a killing? 

On the face of it, to me it looks obvious that this is what was going on. I don’t have access to this information and some of this information you will never get – you never know who buys and sells your securities. Even the Government doesn’t know. That is one of the weaknesses of the system. But some kind of evaluation and investigation is warranted.

Do you see it happening?

Unfortunately not. As I said, our institutions are captured. We have extractive political institutions and unless there is a wholesale revolution in this country, I don’t think there is any incentive for a change in the status quo.