It's the Economy Stupid!

| by Shanie

"The toad beneath the harrow knows

exactly where each tooth-point goes;

the butterfly upon the road

preaches contentment to that toad."

Rudyard Kipling (1865-1936)

( February 25, Colombo, Sri Lanka Guardian) Twenty years ago, in the 1992 US Presidential Election, Bill Clinton was challenging the incumbent President, the senior George Bush. Bush had had some successful political triumphs, ending the cold war with the collapse of the Soviet Union, the invasion of Panama and deposing the dictator Noriega and freeing Kuwait after it was overrun by Iraq in the first Gulf War. With those triumphs, he was considered unbeatable. Soon after the Gulf War victory, he had an approval rating of 89% in public opinion polls. But there was also an economic slowdown which affected the lives of people. So, in that 1992 election, the Bush campaign kept focusing on the military triumphs; the Clinton campaign, on the other hand, concentrated on the economic woes of the country. A smart Clinton campaign strategist thought up the catch phrase: ‘It’s the economy, stupid’. The slogan caught on and within weeks, Bush’s approval ratings had dropped by over 25%. When the Election was held in November, Clinton defeated the once-considered invincible Bush by a comfortable margin.

In truth, it was the economy that was the undoing of the Bush Presidency. He and his advisors were firmly confident that the military triumphs in Panama and Kuwait, coupled with the collapse of the Soviet Union, was sufficient to ensure his re-election. They failed to address the problems caused by the economic recession. By the time of the election year, interest and inflation rates were the lowest in years but unemployment was rising and an official Census Bureau survey found that nearly 15% of all US citizens lived in poverty. Bush lost that election to Clinton purely because he was basking in the glory of foreign policy and military triumphs without paying sufficient attention to the economy of the country.

In Sri Lanka today, street protests are continuing and growing at the sudden burdens being heaped on the people. The government cannot ignore these protests simply as being orchestrated by the opposition political parties. It is true that a weak and divided opposition will now clutch at any straw to keep itself afloat. But there is undoubtedly genuine popular anger at the economic burdens they have to bear and the government will dismiss them only at its own peril. It must understand that the euphoria over the military triumphs cannot last for very long. Ultimately, it comes down to economic issues of the people. This is a lesson that President Bush learnt to his cost at his re-election bid in 1992.

Role of the Central Bank

The root of the problem in Sri Lanka is the politicisation of many of our public institutions. It will be disastrous for a democratic country if institutions like the Central Bank, Attorney- General’s Department and the Judiciary are not allowed to function independently or if its heads lack the character to uphold the integrity of their office. The primary function of the Central Bank of any country is to ensure the stability of the country’s banking and financial system by its monetary policies. This means that they have to be able to manage their functions with efficiency and professionalism and also proffer sound independent advice to the government, Despite being mindful of the political repercussions of that advice, it will only be a rash government that ignores sound professional advice. For that advice to come, the Central Bank, the Governor and the Monetary Board need to be apolitical and professional. That is how they have functioned in ealier times. There have been instances in the past where the Governor and the Central Bank officials have had differences with Ministers of Finance and their officials but the differences were ironed out with dignity and professionalism.

The Central Bank of Sri Lanka in its annual report for 2010 released last year said that Sri Lanka had witnessed an encouraging improvement in the overall fiscal position and achieved high growth and maintained a low inflation rate. It spoke about the Central Bank having reduced its policy interest rates, the reduction of import duties on certain consumer items, and the increase in commercial banks’ credit to the private sector reflecting the broad based demand for credit with the recovery in domestic economic activity as well as increased post-conflict capacity expansion. The country had made ‘a fast recovery from the setback suffered in 2009 and moved to a high and sustainable growth path. All key sectors of the economy demonstrated a commendable performance in 2010, underpinned by the peaceful domestic environment, improved investor confidence, favourable macroeconomic conditions and gradual recovery of the global economy from one of the deepest recessions in history.’ But the Bank was unsure if the macroeconomic fundamentals were right and if the bubble would burst sooner than later. So the Bank covered itself by warning that ‘monetary management could be challenging in the period ahead owing to possible continued high growth in domestic credit as well as a possible increase in capital inflows, thus requiring close monitoring of macroeconomic developments and formulating appropriate demand management policies to prevent the build-up of excessive demand pressures.’

But this close monitoring obviously did not take place and the Central Bank did not formulate appropriate policies to prevent the build up of demand pressures. This was due either to the politician in the Governor getting the better of the economic manager in him or to a total misreading of the emerging economic scenario. Our foreign exchange reserves were allowed to deplete in trying to defend an over-valued rupee, the trade deficit was allowed to grow, almost double, with a surge in imports and the country faced a balance of payments crisis. This was a pity because, despite all its self-made political crises, there was economic growth that could have been sustained by better economic management. Politics or trying to boost one’s personal ego cannot go with professional management. The present Governor should have left politics behind. He should not have agreed to head the committee overseeing Sri Lanka’s bid to host the Commonwealth Games, which was totally outside his professional position. In the end, he created a very unfavourable impression upon himself and on his official position as well. None of our previous Governors of the Central Bank would have dabbled in such ventures.

Hard Decisions Needed

But the past is now past. It is now up the Governor and the Central Bank to lift the country out of the economic morass we are in. Leave the politicians to find a way out of the political morass. The rupee has depreciated as a result of the Central Bank not intervening in the forex market to defend the rupee. The rupee is likely to depreciate even further. The Central Bank needs to take some hard decisions on reining in excessive credit growth and the demand for imports. There is no alternative to raising policy interest rates and restricting bank lending to finance imports and consumerism. Banks have been lending liberally to finance imports mainly of consumer durables. Raising interest rates will leave some financial institutions with a sizeable portfolio of non-performing assets. This will have to be carefully managed so that we do not have another huge crisis in this sector. These hard decisions are going to see a rise in the prices of all consumer items. Tinkering with subsidies supposedly to cushion the hardship to the consumer will have little impact on the bulk of the people. The demand for wage hikes will be inevitable and justified; these will only increase the inflationary pressures.

The only way to cushion the unavoidable hardships to the people is by boosting domestic production and our exports. This is a longer term strategy which should have been adopted many months ago. The increase in remittances from expatriate Sri Lankan workers, a rise in export earnings and a reduction in the imports bill will be the only way to manage the rising trade deficit and falling forex reserves. Whether these are achievable will depend on a variety of external factors (rising fuel prices) and our ability to domestically take hard political decisions. The government has only itself to blame for its mismanagement. The government has rightly invested heavily in infra-structural development but this should have gone hand-in-hand with sound economic and financial management. Corruption, profligacy in spending (ministers and public officials frequently travelling abroad with huge retinues and domestically living it up in posh hotels with luxury and travelling in convoys of luxury vehicles) and unviable investments (Hambantota Port, Hambantota Airport, Hambantota Sports Complex, Hambantota Cricket Stadium, Hambantota this that and the other) have been its sad record over the years. Valuable state and temple lands (Colombo, Somawathiya, Soragune) have been virtually sold to foreign parties regardless of environmental and livelihood concerns of the local residents. It appears that considerations other than the national interest are involved here. People will be prepared to tighten their belts and put up with hardships only if the leaders show it by example.

While it is the responsibility of those in charge of economic and monetary affairs to give the proper professional advice, the government must ultimately take the responsibility for economic management. Repeated rhetoric about an LTTE rump and western conspiracies are not going to help the people in their daily struggle to make ends meet and to lead a life of dignity. You cannot preach contentment to those who are battling on a day-to-day basis to avoid the tooth-points of the economic harrow. In the last analysis, the decision-makers must understand: it is the economy, stupid!