Tackling An ‘F’ and Two T’s in Sri Lanka’s SME Development Drive

Sri Lanka has been talking about SME development for a long time. And trying to do something about it for most of that time too. Yet, the focus is too narrow, and a lot more refinement in the strategy is needed. Since leaving IPS I don’t work on SME issues as much as I used to, but still actively keep up with research and reading on the topic. So, a forum this week gave me the opportunity to link back to some of that work. The Konrad Adenauer Stiftung and the Pathfinder Foundation organized a one-day roundtable on ‘Social Market Economy in South Asia: German Experience and Fostering Small and Medium Enterprises in Sri Lanka’.

In my presentation to the group, I drew on several pieces of published research I was involved with on growth and competitiveness of SMEs and challenges faced. I focussed on 3 main issues – access to finance, taxation, and technology transfer.

My main messages were:

  • Finance: The role of ‘availability’ is overemphasised, while the role of ‘bankability’ is underemphasised. There has been an over reliance on rounds and rounds of concessionary loan schemes refinanced by donors as a ‘magic bullet fix’ for all SME problems. I argued that we need to a) focus more on addressing what I call SMEs’ ‘intrinsic weaknesses’ that hurt their access to finance, and b) improve banks’ SME lending competencies and products

 

  • Taxation: While it is a relatively under explored topic, some issues are becoming clear. Tax compliance among SMEs is low for multiple reasons (explained in the slides). The Government may need to consider revising tax-free threshold or at least make tax registration compulsory. Meanwhile, VAT needs better messaging among SMEs to help them understand the benefits of VAT registration (e.g. input credit). Compliance procedures/costs were found to be  burdensome and need fixing.

 

  • Technology: There is a dire need to support to access technology (primarily tech transfer) for SMEs, even before focussing on R&D (which takes more time and money). In this, both access to an ecosystem and access financing need addressing. I advocated for setting up a ‘clearing house’ for SME technology access like Steinbeis in Germany.

 

View the full slide set below:

Advertisements

Power Structures

thumb_dsc_9188_1024

Visiting Parliament House in Canberra last weekend was revealing. The degree of openness was noticeable. We drove straight into the car park underground, no security manning the gates, and no boom gate operators. There’s usually a crescat-style entry ticket machine, but as it was a Sunday the boom gates were fully open – free parking. Entering the building, we encountered just two armed security guards, went through a thorough X-ray and metal detector check, and then inside in a flash. After that we didn’t see a single security guard at all (Of course I’m sure we were being carefully watched by a network of CCTV cameras, but nothing imposing). We walked all the way to the rooftop – which is clad with a natural garden – and then just two security guards up there.

thumb_dsc_9213_1024

We walked around freely, including going into the senate and house chambers. Of course, it may have been very different if we had visited on a day the Parliament was in session. The philosophy when designing the building was that regular citizens should be able to walk right up to the Parliament, walk on the grass and enjoy it. The instructions given to the architect was that all Parliamentary chambers should be below the level at which the citizens walk – so instead of climbing stairs up to the Chambers, citizens walk right up to the Parliament on the same level as the road, and they stand above it all – the Parliament chambers are below this level.

Cities and productivity

There’s a new McKinsey Global Institute commentary piece titled ‘Inclusive cities are productive cities’ that argues that inclusiveness (including openness to migrants) is important to maximise the productivity gains of urbanisation. This has important ideas for Sri Lanka’s own urbanisation process via the Western Region Megapolis Project. In a previous article on this blog, I highlighted that the earlier urbanisation exercise was re-writing the DNA of entire communities, and we need to better manage the fallout and maximise the gains.

Some of the article’s commentary on openness to migration may appear more relevant to the European case right now, but it is quite relevant to Sri Lanka as well. Migration isn’t only about foreign nationals, but also about internal rural to urban migration, which is inevitable if the Western Region super-agglomeration takes off.

The opening paragraph captures it nicely,

Cities are productivity engines. They create productivity by enhancing the number and frequency of interactions. Higher population density equals higher frequency of interactions, and the more interactions there are, the more you can figure out what you’re good at and what you’re not. Then, we stop doing what’s not good, and we become better at the good. That’s specialization. That’s productivity. Doing that with as many people as you can creates the opportunity for growth.

During the January Sri Lanka Economic Forum organised by the Open Society Foundations and the Harvard Centre for International Development (CID), one of the CID’s scholars highlighted new research by them that showed that workers who moved to urban settings have higher returns to their skills and training than before they moved. This was largely due to the more dynamic interactions that are possible in urban contexts.  Further work by CID showed that mobility of workers helps diffusion of industries and overall economic diversification.

A Volatile Global Economy – Lecture at BIDTI

“2015 was one of the worst years in the century”, remarked Prof. Joseph Stiglitz at the recent Sri Lanka Economic Forum when I asked him for his take on the health of the global economy. He may sound more bleak than a lot of people, but he isn’t far off the reality. The global economy is certainly in a period of alarming volatility.

 One of the original ‘BRIC’ country touted as a growth superstar – Brazil – is now in recession. An unprecedented monetary policy divergence has begun between the US and Europe. China is in the midst of a tricky economic rebalancing and growth moderation, and Chinese authorities appear to be struggling to keep up. Meanwhile, we are yet to see how global markets adjust to a new era of steadily rising US interest rates, outflows from emerging markets, and oil dipping to between $30 and $40 a barrel.

I was invited by Ambassador Pamela Dean, the head of the Bandaranaike International Diplomatic Training Institute (BIDTI), to deliver a guest lecture on these issues to the students of the ‘Diploma in Diplomacy and World Affairs’ programme. I wanted to keep the lecture to a story, capturing – what in my opinion – are the key issues unfolding and the trends to watch moving forward. Given the diversity of backgrounds and expertise in the group, I kept it fairly non-technical. Here are the slides.

Imports Aren’t a Bad Thing

In Sri Lanka, imports often get a bad rep. Very often you hear people talking about how we must “cut down on our imports”, “imports are draining our foreign reserves”, “imports are hurting our balance of payments”. But these views are far too simplistic, and indeed misleading, as they fail to recognise the role that imports play in an economy. Worryingly, this fallacy is repeated by veteran economists as well; for example this article prescribing that to reduce the trade deficit we must “import less, export more”.

It’s a good time to highlight this, though. Next week (24th November) marks the 80th Anniversary of the Imports Section of the Ceylon Chamber of Commerce. To mark this, a colleague of mine in the Economic Intelligence Unit has written a commemorative article on ‘Why Imports Matter for a Trade-Oriented Economy’ – http://nation.lk/online/2015/11/06/why-do-imports-matter-for-a-trade-oriented-economy/. It’s well worth a read.

For Sri Lanka – small open economy dependent on international trade – imports matter as much as exports. In fact, the two are intrinsically linked. But how often I’ve heard top bureaucrats decrying imports. Dr. Razeen Sally captured it candidly at the Sri Lanka Economic Summit in August, when he called out the former Treasury Secretary for his view that Sri Lanka must double its exports while curbing imports at the same time:

“Exports and imports are Siamese twins. They are two sides of the same coin. Not only does it not work, but it’s stupid to say such things”

With the proliferation of global value chains, imports are now a vital element in international trade. Parts and components are imported and exported in countries at a dizzying pace, with the value chain spliced and diced into multiple layers across countries and continents. If East and South East Asian policymakers and economists took the view that imports must be curbed, they wouldn’t be the global value chain powerhouse that they are today. In fact, it would be impossible to imagine Asian value chains sans imports. As I highlighted in a previous blog,

…90% of GVCs are concentrated in just 10 Asian economies; 43% of global intermediate exports and 39% of global imports are from the region; and over 65% of GVC intermediate imports by countries in this region were sourced from each other. 

But admittedly, Sri Lanka does have a problem. Imports of consumer items, in volumes that the economy cannot bear, does affect the balance of payments when it comes alongside sharply declining and low export income. It’s not unusual then that from time to time a government may take some measures to ‘stabilise’ the situation (as seen recently with motor vehicle imports). Yet, this is not a sustainable strategy. The greater focus instead should be on opening up the economy overall, encouraging greater trade, and promote trade-oriented FDI so that the economy benefits from the trade-investment nexus. The focus should be on growing exports and earning more export income, so you have to worry less about the cost of imports in the balance of payments. But the notion that overall ‘curbing of imports’ is a desirable economic policy objective to be pursued is a fallacy. And it must not be propagated.

What’s Changing in the Global Financial Order?

I was at a very interesting session on ‘The New Global Financial Order’ at the UNESCAP Asia Pacific Business Forum last week, and something that one of the speakers said struck me. He remarked,

“This was a financial crisis more than an economic crisis. It should never have happened. Money was originally only a medium of exchange and for accounting that exchange. But…over time, money became a storer of value. Just like gold did in the past, people started keeping money, hoarding money, and money became scarce. People started making money from money. And now we have a huge degree of financialisation in the economy”

During the course of the discussion, we ended up talking about some big trends that are shaping the world of finance.

One is the rise of the Renminbi, the Chinese currency. RMB is now 4th highest traded currency in the world, and China is lobbying for it to be included in the basket of currencies in the IMF’s Special Drawing Rights (SDR). Moreover, China’s new bilateral trade agreements are being linked to RMB, bypassing the USD.

Another trend we talked about is the simultaneous disintermediation and disruption in financial markets today. For one, there is disintermediation away from the US. In some countries disintermediation away from traditional big banks towards smaller ‘local’ banks seen to have customer interests stronger at heart..

Meanwhile, the disruption comes from something that is starting to be at the heart of disruption everywhere – big data. Big data will transform how banks operate; for instance being able to take KYC checks (‘Know Your Customer’) to the next level. Targeting products would also be enhanced. We even talked about how in advanced stages of KYC, a bank could know what type of customer is more likely to have a mistress, and predictive analytics would show how spending patterns would change.

We also talked about the rise of bitcoin and other virtual currencies; the future of electronic and mobile finance, the prospects for Ali Pay (the Alibaba equivalent of PayPal), where FinTech would go next, and whether cashless and careless payments with NFC technology like Apple Pay would truly become mainstream.

One of the issue I brought up was whether regulatory and supervisory agencies, like Central Banks and Financial Services Authorities, would adequately keep up with a rapidly changing landscape. Whether they will understand these products and how they help (and indeed potentially hurt) consumers, and regulate smartly, without snuffing out innovation. There are also concerns of privacy, and indeed equity, which we didn’t get to, but would certainly be interesting to explore.

Will innovation in financial markets make finance more inclusive or more exclusive?

And on the first trend, will the disintermediation away from the US amidst the rise of the RMB simply mean a shift from/and an over-dependence on/dominance of one large country to another large country, or will it truly mean a multipolar financial world?

Cover image: the logo of AliPay.com, the third-party online payment portal by Chinese e-commerce giant Alibaba.

The Government’s New Economic Diplomacy Drive

In recent years, much of our foreign policy has been preoccupied with managing international relations related to the end of the war, human rights and governance issues. But as a country seeking to be a serious regional economic player, attracting foreign investment, and boosting prosperity for its citizens, it was high time we reoriented this. Our foreign policy now must necessarily have a strong trade and investment component with a strategically planned international business agenda.

It’s rather encouraging that this is being tackled as a priority by the Ministry of External Affairs, under the leadership of the Deputy Minister Hon. Dr. Harsha De Silva. There’s a new Joint Task Force on Economic Diplomacy under the Ministry, that is aiming for inter-agency cooperation to push the work forward, and its good to be a part of this effort representing both an economist’s and a private sector perspective.

In its narrowest form, Economic Diplomacy is about using Sri Lanka’s diplomatic assets to advance the country’s economic interests. But I suspect the Deputy Minister is planning on expanding the scope of this, to use a full spectrum of tools to advance our economic interests abroad – to get our exports into more markets, our companies investing in more ventures abroad, and more good investors attracted to opportunities here. I also hope it would encompass diaspora engagement – for investment as well as skills and knowledge transfer.

In August I wrote an op-ed calling for a post-election reform agenda that makes the Sri Lankan economy more open to the world and helping more companies ‘go global’. It’s heartening to see moves already underway to take these forward, under the leadership of the Deputy Foreign Minister.

But of course, it’s a new discourse in Sri Lanka. “Using foreign policy towards achieving economic goals”, “economic diplomacy” … What do these mean for the private sector? How can the private sector latch on, how can it contribute, and what is the role of the state?

A recent LBR LBO forum was the first business gathering to try and unpack this. Some of the videos are up on their Youtube page:

Dr. Harsha De Silva : https://www.youtube.com/watch?v=y8CQXLbhzxY

Alex Lovell : https://www.youtube.com/watch?v=0wiTFBY33gA

Explaining the Bearish Sentiments on China’s Growth Prospects

China’s growth prospects continue to be a hot topic in discussions on the health of the global economy. It’s easy to be caught up in the bearish sentiment on China, given recent events. And especially given the systemic risks to the world economy that a China slowdown poses. But here is my take on what is likely driving this sentiment:

  1. China’s Shanghai and Shenzhen stock market crash that began in July affected more than just the few. Even though some analysts have argued that the stock market isn’t linked too heavily into the broader economy, it is much more linked that is immediately obvious. Chinese authorities had been doing a lot to encourage greater retail investment in stocks, including providing concessionary credit. Yes it was an inevitable bubble, but a bubble that encompassed a lot more people than just the elite wealthy few. So, to be worried about the effects of the crash would be justified. Yes it is the correction of a bubble, but it also has ‘negative wealth effects’ for a wider segment of the population. (Read here for a basic explanation of ‘wealth effects’)
  2. The sudden Yuan depreciation by Peoples Bank of China (PBoC) worried investors and analysts about China’s growth, as it indicated concern on the part of Chinese authorities on the country’s export performance and weaknesses in some key markets in the West. It also came on the back of disappointing factory activity data (manufacturing) in August (Ciaxin Purchasing Managers Index – PMI). This may change with next weeks expected release of the latest PMI data.
  3. The full effect of China’s economic rebalancing is not yet known. China’s government led by Xi Jinxing and Li Keqiang have embarked on a potentially tricky, but essential, rebalancing away from investment-led growth to consumption-led growth. It is unclear whether this would lead to a ‘hard landing’ or whether China can manage it smoothly. See here for something I wrote a couple of years ago on ‘dragon-slaying’ or ‘panda-hugging’. Yet, some recent measures indicate that a nervous Chinese state is not backing away from public investment completely. Local Government Financing Vehicles (LGFVs), which are economic entities established at the local government level to finance public investments, have been direct beneficiaries of the recent round of stimulus measures.
  4. An issue connected to this rebalancing (away from investment and infrastructure-led growth) is the substantial slow down in the real estate industry. Projects have slowed, news constructions have slowed, returns on new projects are lower, and many projects remain unfinished leaving large ‘ghost towns’ of unfinished condominium complexes. But it appears that some of the latest stimulus measures are aimed at stemming this tide – China lowered the mortgage down payment for first time home buyers in order to stimulate the property market.
  5. The clamp down on corruption has slowed somethings down. The current Chinese regime’s singular focus on combating corruption in the government and public-private dealings (some argue some of it is politically motivated, but that is a different story altogether) has been having an impact on infrastructure projects and also interactions between government and business. There is some sense that this is affecting the real economy. Some investments that had been forged before are now taking a wait and see approach. Public officials don’t want to go out of their way facilitating private investment projects either, in some instances, as they become over cautious.

Yet, as I have argued in the past, both here, and here, China’s medium to longer-term prospects appear bright. However, it may be a few years before many of us can be truly convinced of it. In an insightful interview, two Deutsche Bank economists argued that many are too bearish about China, and the current signs are just symptoms of a transitionary phase in China – especially as the Chinese authorities get used to managing an evolved economy.

However, it may be a few years before many of us can be truly convinced of it.

(updated 13th & 15th October. Image courtesy Reuters)