Way Forward of the Sri Lankan Economy: Perspective of Risk and Challenges for Financial Organizations Saman Kelegama Presentation to the Association of Banking Sector Risk Professionals in Sri Lanka, BOC Auditorium, 22 April 2015
Debt-Financed Growth Model is Unsustainable Ever since the war ended Sri Lankan economy has been showing high growth rates (2010 to 2014) Peace, 2009 IMF Package, stable government, all contributed to the high growth rates High growth was driven by the debt financed consumption and investment; in other words, it was mostly a borrowing-led growth Economic model close to the Chinese: State at commanding heights with a partially liberalized economy Debt driven model was running out of steam but was sustained via debt roll over by both sovereign and bilateral borrowing Growth was characterized by the services/construction expansion and diminishing real production sectors By end-2014 there were increasing signs of non-sustainability of this model and need to do some changes
Need for Economic Reforms to Sustain Growth For sustainable growth, there needs economic reforms to have a more agriculture/industry driven growth Flexible factor markets, efficient SOEs, etc. are the key components of economic reforms that will increase the competitiveness and stimulate these sectors Private sector role in the economy will then increase and stimulate export-led industrialization and FDI that will be the key engines of growth East Asian model and many others were based on this model of sustainable growth
Switching of Strategy is Not Clear Switching to such a strategy seems to be taking place in stages during the post-2014 period Previous government s state-led investment strategy is being reviewed and capital expenditure in the Budget was slashed from average 6% of GDP to 4.6% of GDP However, the consumption-led growth strategy is maintained with an additional boost public sector wage hike, fuel price reduction, 13 commodity basket price reduction, almost doubling Samurdhi benefits, pension hike, etc.
Emerging Signs of the Sri Lankan Economy Slow credit growth during 2013 and 2014 is now picking up and its mainly consumption driven Some state investment projects have faced a set back having economy-wide ramifications Low prices for tea and rubber continuing and the guaranteed price scheme is not fully effective Inflation remains low at 3% due to low global inflation and reduction in commodity prices Import volumes are increasing rapidly compared to exports but the current account deficit seems to be expanding despite the low oil prices (25% of overall imports to Sri Lanka are oil)
Emerging Signs of the Sri Lankan Economy Public debt per GDP is at a high level of 88% of GDP (government guarantees close to 5.5 to 6% of GDP) Revenue as % of GDP still at 13.5-14.5% -- not a satisfactory position(tax revenue: 11 12 % GDP) FDI has still not accelerated after the regime change, especially due to populist measures introduced in 2015 budget and the super gains tax 2015 Sri Lanka s economic growth is predicted at 6.9%
Positive Signs on the Economy International good will - postponement of UNHCR Session till September 2015; GSP-Plus revival is a possibility, EU ban on Sri Lankan fisheries exports may be removed, more support from Western countries, etc. More open economic policy making to ensure aspect of better governance is visible Stronger institutions to back better economic governance in the pipeline: 17 th Amendment, Right to Information Act, etc.
Negative Influences on the Economy Unstable coalition with political partners pulling in different directions Populist policies, super gains tax, etc., dampening private sector sentiments reflected both in the stock market and private sector investments Political agenda (19 th amendments, RIA, etc.) getting priority over the economic agenda Post June elections scenario remaining uncertain
Risks to the Economy Low Inflation Trap taking only the inflation level, the government keeps reducing the interest rate to stimulate more credit into the economy (a) the CPI figure is full of doubt, (b) low savings, larger imports, etc., (c) Foreign investment in TBs (LKR 3.5 bn 40% of FOREX reserves) can move out Debt Trap debt roll over was possible as long as the ratings were satisfactory and generous bilateral donors were willing; increased borrowing was seen during the last three months to fulfill election promises; foreign debt in overall debt now exceeds 50% and debt service ratio is above 20% Middle Income Trap --In some Asian countries the economy is squeezed between low-wage producers and high-skilled and rapid innovators. E.g., Sri Lanka squeezed between low cost Bangladesh and more high-skilled/innovative Thailand. Then export-led strategy with FDI does not work to generate the growth needed to come out of the trap
Risks International Economy July-September: US most probably will tighten monetary policy capital flight from Sri Lanka is a possibility and pressure on the LKR to depreciate Depreciation of the Euro could erode the competitiveness of exports to EU which absorbs 30% of Sri Lanka s exports Upward pressure on oil prices (possibility if supply problems emerge from Libya, Venezuela and Nigeria)
Possible Growth Sectors Tourism, Remittances, will be key players as before Construction may pick up gradually when the halted project start once again An immediate transition to an export-led strategy with FDI playing a key role cannot be seen at this juncture due to prevailing uncertainty, political economy factors, others With the same possible growth scenario in the next two years with US$ 3,700 per capita income economy at present, how does the banking sector adjust it self in a growing economy with such characteristics? Assume earlier targets $100,000 bn GDP economy by 2016 target is still valid, then what are the challenges for the banks in this uncertain environment?
Risks and Challenges to Financial Organizations Risks associated with FO consolidation Risks associated with government interference with private banks Meeting the challenges of Financial Inclusion Meeting the challenges of societal changes Meeting the challenges of under-capitalization
Risks of Financial Consolidation Banks should be strong enough to fund the requirements of a large economy of GDP of $ 100,000 bn 5 Commercial Banks (CBs) with an asset base over LKR 1 tr, 1 large Development Bank, and few NBFI were the goals (now 5 CBs have assets above LKR 500 bn and 10 NBFI had asset base over LKR 20 bn) Regulator-driven and not market-driven merger exercise The rationale that CB s should be able to borrow a large amount in the international capital market, most often, on behalf of the government is not a requirement in an economy where debt-financing is diminishing Consolidation was a recipe for destroying good banks Big is better does not imply low risk (US Too big to Fail what happened?) Weerakkody Report argues for voluntary mergers at the comfort level of FO
Risks of Government Interference In some CBs the collective share holdings of the government entities (EPF, ETF, SLIC, etc.) exceeds 30%, this in turn qualifies the government for Board positions Such appointments were made in the most high handed manner and we saw some private banks lending to RDA, UDA, Water Board, etc. For instance, 24% of a private CBs lending is to SOEs risky lending Strict separation of the powers of the Board of Directors and the Management e.g., in one of the CBs the Chairperson was involved in management meetings We have to assume that under good governance regime that this practice will come to an end
Financial Inclusion Challenge Government s objective is to all the people to have a bank account on similar lines to PM Modi s Jan-Dhan Yojana (Scheme for peoples wealth) Banking IT plays a crucial role in any financial inclusion strategy and most banks have taken this factor into account The value of retail transactions as a percentage of the total value of noncash payment share of Credit Cards was 1.3 % in 2009 which marginally increased to 1.4% in 2013 The same share for Debit Cards was 0.2 % in 2009 which marginally increased to 0.5% in 2013 Usage of mobile cash is 0.1 % as a percentage of non-cash payments (Colombage, 2011) E-facilities for financial access exist but the utilization is not satisfactory May indicate that IT expenditure of banks have not kept in line with IT infrastructure utilization What is the role that the banks are playing in improving financial literacy?
Meeting Challenges of Societal Changes Peoples living standards have improved, purchasing power has increased, life styles of changed, leading to an increase of retail banking the new generation does not want to come to the bank, they would like the bank to come to come to them at their hour of need product differentiation, IT-Bank nexus, all become important Above 60 years population will double by 2025 to 22% of the overall population and their needs should also be fulfilled by banks with innovative products These challenges should be met in the coming years
Meeting the Challenge of Under- Capitalization 2015 and 2016 although may be engulfed in uncertainty, the operating environment for the banks will improve with loan growth picking up Since of late foreign currency borrowing and gold backed loans have been rising Although the capital adequacy ratio for many CBs exceeds the regulatory minimum of 5% and 10% set by the CBSL for core CAR and total capital, the former is boosted by absence of capital charges on assets such as foreign currencydominated exposures to the sovereign and gold-backed loans while the latter is low compared to other banking systems in emerging markets Fitch has estimated that the CAR would reduce by 300 bp when higher risks weights are applied to these exposures This fact plus, volatile operating environment, credit concentration, residual provisioning risks are reflected in the rating of major banks which is mostly single B range Sri Lanka has not yet moved toward the implementation of Basel III-recommended reforms, which would act to improve capital ratios over the medium and long term. Under Basel III, the CBSL would be likely to introduce additional capital requirements for banks deemed to be systemically important
Concluding Remarks New issues keep coming : role of foreign banks, money laundering, black money, microfinance legislation, CRIB for the Microfinance sector (India 2011), over-regulation, cost of compliance, etc. There is a need for a Presidential Commission for Banking and Finance to revisit the recommendations of the 1991 report and examine the new issues and challenges facing the banking sector and take suitable policy measures
Thank you