Our economy is perhaps a house of cards. It can collapse rather easily. Why do I say that? The Central Bank gave in to the pressure of the exporters and agreed to depreciate the rupee but promised to intervene to reduce volatility. There is no doubt it will have to continue to be the major supplier of foreign exchange to the market whether it supports a particular price or not, for otherwise the market will seize. It has been supplying a significant amount in recent weeks and the market seems to depend on it. But what about the Foreign Reserves and how long will they last? In order to conserve Foreign Reserves a one-off deprciation would have been ideal. Now the CB will perhaps continue to lose Reserves.

What is Mahinda Chinthanaya’s answer for the crisis in the balance-of-payments? A National Economy of Rohana Wijeweera where tea is replanted with manioc? But haven’t we gone through it before in the early 1970s. What would happen in the meanwhile if we run out of Foreign Reserves? Our banks will not be able to open Letters of Credit and imports will have to be curtailed until we build a sufficient supply of foreign exchange. Foreign Exchange budgeting or auctioning? The government will carry on with infrastructure development. But can such work continue without imported inputs? The government could of course print money for its internal expenditure.

The rate of Interest

It too can be brought down if enough money is printed by the Central Bank. In fact it is this over-borrowing by the government spilling over to the balance-of-payments that has brought on the foreign exchange crisis. True, the collapse of the bond market and the stock market are due to the foreigners pulling out their money. Their home countries carried on in the same fashion - over-borrowing at the low rates of interest that Alan Greenspan is now blamed for. 

We have also had a long period of excess debt by the government primarily but also to a lesser extent by the private sector. Anybody who goes through the accounts of our quoted companies cannot but fail to notice the high level of debt in relation to equity. Irving Fisher, an economist of the Great Depression era, is noted for two things- one for his disastrous predictions about the US stock market that its prices would hold permanently and more famously for his debt deflation theory. He pointed out that where there is excess debt and the debtors try to repay debt they bring about a deflation.

Excess Debt + Deflation = Depression

Fisher raised disturbing questions then about the roles of the Fed, Wall Street and Washington. He believed two major factors cause depression - excess debt (based on easy credit and loose lending practices) and deflation, especially in combination. He "saw the Fed coddle the banks. They pumped in billions of dollars. But it was no use. They eventually figured out they were just throwing good money after bad. The real roots of the 1930s bust were in the 1920s boom. That’s when the Fed gave (loads of) cheap money to the banks."

They loaned it to brokers who loaned it to speculators, and a bubble was created and imploded. A five year depression followed. Many banks failed, and unemployment soared to record levels. Many small factories and businesses shut down. Tens of thousands of workers lost jobs, investment money dried up; grain prices fell; inventories piled up in warehouses; massive layoffs followed; railroads failed because of over-building; and prices collapsed ruining thousands of investors.

Our CB also repressed interest rates for a long time by creating money and even today the real rate of interest is heavily negative. So our national savings are low and to fund our investment we need foreign money. Will a similar fate befall us? Some economists talk of fiscal stimulus and reducing interest rates. Both call for printing money which the CB is doing recently in a big way having purchased Rs 120 billion of government securities. What happens when interest rates come down? Will they promote new investment in such a climate? No. People and businesses will prefer to hoard cash instead as credit dries up.

The Bank for International Settlements questions the soundness of near-zero interest rates that may disrupt money markets and "discourage banks from lending to other banks."

We have no scope for fiscal stimulus as we already have a mountain of public debt. We cannot prevent a painful adjustment of our living standards both of the government and of the people. The government may try to shift the burden on to the people through the inflation tax if it fails to collect sufficient tax revenue.

We need to face the main challenges posed by the international global recession. The Mahinda Chinthanaya is based on a ‘national economy’ which seeks self sufficiency and closure to the world economy. We are a highly trade oriented economy and the ratio of import-export trade to the GDP is over 50%.So we need to embark on export growth strategy or at least we cannot de-emphasize export and since exports are closely related to imports and the import content of our industrial exports like garments is very high, we cannot afford to have import controls or excessive tariffs and cesses. We have gone through all this before and Karu Jayasuriya a former businessman has remembered  it. Good for him.

New Strategy needed

 We need a different growth strategy. Sustaining growth is critical but growth for whom: not only building the infrastructure which underpins growth but also bringing up the 20% or so of the poor who live in dire poverty as well as the middle classes. That is 50% of the population.

Providing welfare services for all citizens requires much greater effectiveness of public spending which we don’t have. Our free education, free health care and Samurdhi are said to look after the poor. But do they, given the continual rise in inflation to over 20% and the failures in implementation? How many villages lack drinking water, how many lack electricity and how affordable is electricity to the people at large?  How many villages have proper motorable roads which connect to the markets in the big towns?

The sharply different levels of development both within and between districts require a differentiated approach to meeting the country’s development needs. The focus should be on uplifting them and helping them to achieve the Millennium Development Goals.

Support to the urban and middle-income earners in the Western Province should address the challenges emerging from the global economic downturn. We need to promote micro-finance and provide credit to the small and medium business sector since they are largely neglected and will continue to be neglected now. But these policies cannot be carried out by the Central government. Devolution is so necessary. More money must be allocated to the less developed districts who must be allowed to spend according to their priorities. 

We need institutional changes beginning with the setting up of the Constitutional Council under the 17th Amendment. We need to stop  recruitment to the public service and even to shrink it by retrenchment.  Above all we need to stop the war. No amount of appeals to patriotism will prevent economic calamity. The quality of education has to be improved not by throwing more government money at the government schools but by allowing the setting up of private schools and private universities.

These reforms don’t cost money and if done now could stimulate the economy. What we need is not a government stimulus package but one to stimulate the private sector. This requires shrinking the state and reducing the pre-emption of financial resources by the State. We need privatizations for we cannot afford to carry deadweight SOEs through spending public funds. They can never be run at a profit unless they are monopolies and exploit the public through pricing as does the Petroleum Corporation. But such pricing adversely affects the whole private sector businesses and not only the individual consumers.  

Promoting private sector enterprise and shrinking the public sector should be at the core of the new strategy. We need to create more jobs but not in the over-loaded public sector. We need to promote skills and the management and development of water and power resources by the private sector. The political patronage appointments of the present regime have destroyed the public sector for good.

Working with Private Sector

The International Finance Corporation (IFC), the World Bank’s private sector affiliate, has an extensive program for addressing poverty through investment and advisory work on economic inclusion, regional integration and rural development. The World Bank and IFC are collaborating to bring cutting-edge expertise for Public-Private Partnerships (PPPs) for India. While such support has been most visible in infrastructure - power transmission, roads, irrigation and rural infrastructure - it is being extended to health and education, agribusiness, and renewable energy.