30 Years of Liberation

July 2007 marks the 30th anniversary of the free market in Sri Lanka.

“The United National Party led by Junius Richard Jayewardene (‘JR’) swept to victory over Sirimavo Bandaranaike's Sri Lanka Freedom Party. With JR’s swearing in as Prime Minister on July 23rd 2007 came liberalisation of the economy. The shackles of a closed, state-controlled economy - which witnessed bread queues and foreign exchange shortages - were broken. JR opened the economy to market forces, to which many credit the subsequent growth - but also greater social divisions. The move also destroyed local industry to some extent.”

- Feizal Samath, Business Editor, The ST Financial Times (STFT)

STFT: Has the open economy brought gains to this country?

AM: Yes… The foreign exchange crisis of the 1970s brought home the message that we are living in an interlinked world. We realised, even before other countries did, the need to set our sails according to the new economic winds that had begun to blow across the globe.

STFT: Would we have done any better under a free market if not for the conflict that broke out in the early 1980s?

AM: Yes… The conflict represents a diversion of productive resources for destructive purposes. These could have been better deployed on infrastructure and social development.

STFT: Assuming there had been no conflict, would Sri Lanka have developed to become a successful state like other thriving Asian economies?

AM: Yes… It is estimated that the conflict has trimmed 2 percentage points off our GDP each year. The compounded effect is that our per capita income would have been at least 60% higher than it currently is. Besides, the 'brain drain' phenomenon wouldn't have been as rapid.

STFT: Has local industry been affected by the free market?

AM: Yes… Economic forces have caused some domestic industries to perform and others to perish. With uncompetitive firms having fallen by the wayside, there have been social costs.

WANTED: ‘One-Stop Shop’

The Industrial Association of Sri Lanka (IASL) and Institute of Policy Studies jointly embarked on a process, last year, to cobble together a National Industrial Policy Framework (NIPF). The consultative exercise collated views of key stakeholders in Sri Lanka - including industry, employees and public authorities. The initiative, funded by World Bank, was completed and the report handed over to President Mahinda Rajapakse, also Chairman of the Economic Council, in March 2007.

Key conclusions of the NIPF:
Overall economic stability is essential for growth
Rural development must come from business linkages, not handouts
Industry requires better access to finance and information
Trade remedies are essential for protection of domestic industries

Final policy recommendations, based thereon:
The government must facilitate, by establishing an umbrella organisation/ one-stop shop for industry
Policy should be a consistent, consultative and transparent
All constraints must be addressed fast, within this framework

Addressing the AGM of IASL this week, Dr Anura Ekanayake, Chairman, spoke of the consultative process that had been followed. He was pleasantly surprised to note the degree of understanding and goodwill that emanated from the trade unions. “They are aware of productivity issues and competitiveness concerns,” he remarked.

Drawing on CBSL statistics, Dr Ekanayake expressed concern at the persistent decline in industrial growth, quarter by quarter. After recording 8.3% during 2005, growth had slipped to 7.2% during 2006; Q1 of 2007 has been a matter for real concern, with growth declining further - to 6%. This trend is particularly worrying because the slowdown is happening “despite the economy benefiting from increasing external and domestic demand for factory products”. Intensified global competition in the apparel industry and deceleration of economic activity in the North & East complete the gloomy picture.

Attempting to examine some of the causes of this trend, Dr Ekanayake spoke of higher and more volatile energy prices. Domestic prices are determined by international markets. The higher prices have had serious repercussions on manufacturing industries across the board. Predictably, these implications have been harsher on industries that are energy intensive.

The sharp rise in administered interest rates has raised financing costs. Due to the lower operating margins that they typically command, the “small and medium sector has suffered more than others,” Dr Ekanayake clarified. The deterioration in exchange rates has affected the competitiveness of domestic industries by increasing their cost of imported inputs.

Local industry was further impeded by delays in implementing infrastructure projects. By end-Q1 2007, only 8% of funds had been deployed, against the 25% that it should – on a pro rata basis – have been. Dr Ekanayake urged Kumara Welgama, Minister of Industrial Development - and Chief Guest at the AGM, to ensure that “expenditure be invested rather than diverted for other purposes”.

Welgama asked members to focus on the broader picture of balanced regional development. He urged industrialists to avail of the concessions offered by the government to invest in remote areas.

Sops for Nissan, Kyron & Amby

The government is pulling out all the stops in a bid to attract foreign automobile majors to assemble cars in Sri Lanka. At least two rounds of discussions were scheduled during the week to iron out certain impediments and improve the feasibility of such a move.

Speaking to The Sunday Times FT, Kumara Welgama, Minister of Industrial Development, highlighted one significant change that would attract the motor industry to invest here…

Foreign manufacturers have already rejected the minimum local value addition norms of 30% that had been stipulated. The local auto ancillary industry is at a nascent stage, they say, and components are not available to that extent. They have sought that the norm be relaxed to 15%, which would make investment worth considering because tyres, batteries and upholstery are available locally.

Indicating a refreshing sense of flexibility, Welgama expresses willingness to concede the concession. He says, “We can gradually increase the local value addition to 30% later”, as ancillary industries develop and grow. Another positive fallout of such a move would be the generation of employment at the assembly units that would be set up.

It is expected that, once that is approved, motor companies would seriously consider biting the bait. There are a few companies that are already lining up to set up assembly lines. These include Nissan Motor Company and some Korean carmakers – including SsangYong, which launched the ‘Kyron’ last year.

Hindustan Motors is also in contention. The company’s most visible product is the Ambassador, which has been ruling Indian roads for generations and is a quaint sight on Indian roads even today. Originally based on the Morris Oxford (UK, 1948), its dependability, spaciousness and comfort factor have made it Indians’ most preferred car for generations.

"Down with Trade Unions!"

Causes of Conflict at Workplace
The root cause of conflict at the workplace, where Trade Unions (TUs) are concerned, is that most of them have political agendas. Neville Joseph, Supreme Court Advocate, elaborated on this and other themes in an interview with The Sunday Times FT last weekend. He indicated that the trend was traceable to a slogan that TUs thrived on: “Down with capitalists! Down with employers!” That was a Marxist concept that permeated into our system, was blindly followed by the workers and has now boomeranged on us.

TUs can carry out a very important function in Sri Lanka, he affirms. They should be social partners whose role is to ensure productivity and enhance workers’ standard of living. However – excepting the Mercantile Union and the Bank Employees’ Union (“the educated lot”) – they have become political stooges of the government. As a consequence, even legitimate rights of workers are subjugated for political reasons, to appease the government.

What to Do When Management Is Unreasonable?
The main weapon that workers have is strike action, confirms Joseph. But, it is only as an ultimate resort that workers should strike work.

Before engaging in strike action, responsible TUs must agitate before the Commissioner of Labour for a settlement. There is a conciliatory process where workers can complain to the Commissioner and ask that the matter be referred to arbitration. While arbitration is going on, workers are working and livelihoods are secured.

Adequacy of Labour Legislation in Sri Lanka
Labour law is the most dynamic area of law in the world today because - unlike civil and criminal legislation - labour law affects the entire society through the working class. Being the ‘living law’, it must necessarily be dynamic, not static.

However, our labour legislation, being over fifty years old, is outmoded, opines Joseph. India has a National Labour Commission (NLC) under the stewardship of a retired Chief Justice. The NLC continuously measures changes in global labour standards, based on which it makes amendments and places them before the government for consideration. Hence, labour legislation in India is brought upto the required standard through amendments that are appropriate for the evolving environment.

An NLC on the footing of the Indian model is imperative. Sri Lanka has many erudite scholars, judges and TU leaders who can serve on the commission and evolve a law that is compatible with the changing circumstances.

The high cost of living is a matter for national debate, but a related aspect is the wage structure... Today, we are faced with a market where the buyer calls the shots. Employers say, ‘Paying Rs 6,000 or Rs 12,000 is not a problem, but will the buyer pay us? Or will we lose the market to China and India?’ A National Wages Commission can play a role by examining the problem holistically; establishing such an agency is the onus of the government. Before doing that, the private sector must improve productivity, says Joseph.

Luminaries Speak On Industrial Relations
Three space travellers aboard a rocket to the moon were explaining the reasons for their voyage:
The American astronaut says, “My country intends to dominate outer space.”
The Russian astronaut says, “My country must compete against the Americans.”
The Sri Lankan trade unionist says, “In my country, full moon days are holidays and – on the moon, every day is a full moon day.”

This joke was narrated at a seminar on ‘Conflict Resolution at the Workplace’ last weekend, to indicate the prevailing work ethic of trade unions in our country. The seminar was organised by Knowledge Agent, a company that offers a suite of training inputs through a faculty that includes professors and professionals.

Sri Lanka has witnessed an unprecedented wave of strikes in the public and plantation sectors recently. These highlight the adversarial nature of the relationship between managements and trade unions (TUs), which is a vestige of the country’s colonial past. In this context, the effective and tactful handling of TUs by employers would contribute towards minimising industrial unrest.

G Weerakoon, retired Commissioner of Labour (1982 – 1994), said that a major problem in dealing with TUs is the multiplicity of unions and their political affiliations. In a country with eight million workers, less than 30% of them are organised into unions. Nevertheless, there are as many as 1,600 TUs in operation. Unlike in South Korea and Japan, very few of these are enterprise-based TUs.

Many unions are controlled by outsiders with political connections and most employers would prefer not to deal with - or even recognise - them. This is perfectly legitimate, avers Weerakoon, because present labour laws do not compel employers to recognise TUs. The amendment to Industrial Disputes Act (No 56 of 1999) merely mandates employers to bargain with a TU having membership strength of at least 40% of the workforce.

After a country has ratified any Convention of International Labour Organisation (ILO), there is an obligation for organisations to comply with it. Sri Lanka has ratified ILO Convention 87 on ‘Freedom of Association and Protection of the Right to Organise’. Sharing information with the workforce helps in building up greater rapport between the two sides, observes Weerakoon. This is typically done through in-house bulletins and newsletters, to avoid disinformation and miscommunication.

In an address peppered with humourous anecdotes, Neville Joseph covered a wide range of issues. He identified two challenges confronting human resource management - to maintain harmonious relations and to have a contented workforce.

Thatcher’s Conservative government implemented labour legislation that curbed TU power. A classic example of the hard negotiation stance adopted was the twelve-month Miners’ Strike in 1984/85 that led to the rout of the union. In countries like Switzerland and Germany, public servants cannot strike. Joseph draws a stark contrast with the situation in Sri Lanka where “all strikes are legal.”

Joseph also narrated the case where the Joint Apparel Association Forum obtained a favourable Supreme Court verdict against the Port Trade Unions.

Francesca Victoria (1920 - 2007)

“Grandma described World War II as an unforgettable experience filled with elements of fear and gratitude. The first incident that affected her happened a week after the birth of her first child on December 9th 1940. On the day of the baptism, instructions were received to drape windows, keep house lights off and remain in darkness. This was to prevent houses being visible to enemy planes. Accordingly, the Christening party was celebrated by candlelight.

“For over a year, Japanese attacks were dormant and then - on Easter Sunday - April 5th 1942, they resumed with greater intensity… Grandma had gone for Mass, leaving her 16-month-old baby at home with the nanny. Half an hour after Mass started, sirens went off, warning people to get into air-raid shelters. There was pandemonium at the church. Grandma could think only of her baby and, desperate to get home, she went home via the deserted side-streets when the police weren’t looking. On the way home, Grandma met her British neighbour, Mr James. He told her that he had instructed the nanny to take the baby and get under the wooden table if there was any bombing.

“Grandpa, who was away on business, called and said that he was safe and would return home soon. Not long after he returned, they received the news that Colombo harbour had been bombed. Grandma’s father-in-law wanted them to leave for India. They packed hurriedly and prepared to leave the country. No passports or visas were necessary; only a ticket needed to be purchased over the counter. They left that very night and were safe until the end of the War, when they returned home.”
- Michele Hepponstall

Islamic Banking Explained

Islamic banking (IB) is derived from and governed by Shari’ah principles of Islamic law. These principles prohibit the levying of interest, involvement in unlawful activities, hoarding for profit and other transactions that result in injustice and exploitation.

The concept was explained at a seminar on Islamic Banking and Finance conducted by the First Global Group (FGG) last weekend. Muhammed Ikram Thowfeek, Chairman of FGG Sri Lanka, said, “Islamic banks are not charitable institutions, they are just concerned about protecting society while providing a return to their shareholders.” Indicating that it is a matter of form over substance, he provided the example of two supermarkets retailing chicken, where the one selling halal food would be preferred.

The asset base of the Islamic financial system is estimated at US$ 500 million, small vis-à-vis the conventional system that has had a head-start of over 250 years. However, it has been growing at 15% annually, faster the conventional system. ”We are not attempting to replace conventional banking,” clarifies Sheikh Essam Ishaq, Shari’ah Advisor at Discover Islam, Bahrain, “but provide a vibrant, practical alternative.”

Investor demand for Islamic banking products is high - certainly in the GCC, but elsewhere too. Standard & Poor’s has predicted that, to satisfy this appetite, global demand for Islamic finance will surge to US$ 4 trillion within five years.

The establishment of the Dubai Islamic Bank in 1975 is widely acknowledged as the genesis of Islamic banking. However, it was then perceived as “an eccentric manoeuvre from an eccentric place,” said Ishaq. IB survived the passage of time. Countries like UK, Thailand and Singapore have modified their banking legislation to permit Islamic banking. The Government of Thailand even has a 38% stake in an Islamic bank.

Speakers at the seminar were practitioners in the field and included Dr Mohammed Burhan Arbouna, Shari’ah Board Member of the United International Bank in Bahrain. While attempting to structure products in a Shari’ah-compliant manner, some firms have hoodwinked customers by merely changing the nomenclature from ‘interest’ to ‘profit’. For an existing bank to introduce IB, Dr Arbouna recommends a “firewall for money, accounting and employees”.

Because IB deals with real assets and services, all transactions should be backed by assets. ‘Sukuk’ is the Arabic word for asset-backed bonds, the global market for which is more than US$ 25 billion. Since you are not permitted to sell what is not yours, short-selling is disallowed.

Explaining the concept of ‘murabaha’ – a method of financing, Dr Arbouna explained how it differs from classical lending. The bank buys the asset from the seller and sells it to the buyer at cost plus a disclosed profit margin, with deferred payment terms. Any penalty paid by a defaulting buyer does not swell the coffers of the bank, but is donated to a charitable institution instead.

Six of the world’s top ten global banks are into Islamic finance. HSBC Amanah, for instance, is the global Islamic banking division of the HSBC Group.

How Malaysia Became A Dominant Force…

Speaking at the opening ceremony, Nazirah Hussain, Malaysian High Commissioner, described the strategic measures that her country had taken to become a regional hub of Islamic banking and finance. Malaysia’s aim is to be an investment gateway specializing in Islamic fund and wealth management, and a takaful (insurance) centre.

To accelerate growth, an executive committee comprising of government officials, regulators and industry leaders are working to create a more efficient delivery system.

The Immigration Department has accorded an “executive green lane” to the Malaysian Islamic Financial Centre (MIFC). This will help expedite applications by expatriates for long-term employment passes and, in turn, facilitate movement of expertise in Islamic finance.

Islamic banking, takaful and capital markets have been liberalized to allow the entry of new players. Fund managers of foreign Islamic funds also enjoy tax benefits. Islamic financial institutions are allowed 100% foreign equity ownership. Exemptions on stamp duty and taxation have been granted for foreign currency assets…

As a consequence, total Islamic banking assets have grown to 133 billion Malaysian ringgit (US$ 38 billion), accounting for over 12% of domestic banking assets. Takaful assets have increased to 7 billion ringgit and represent 6% of the insurance market.

Malaysia pioneered sukuk. More than two thirds of sukuk in the global market was issued in Malaysia. Outstanding Islamic private securities constitute 50% of the domestic corporate bond market.

While acknowledging that most Malaysians are Muslims, there could probably be a lesson there for Sri Lanka.

…And a Prescription for Sri Lanka

In conversation with Sunday Times FT, Thowfeek trashes the notion that Islamic finance is the exclusive domain of the Muslim community or that it promotes Islamic culture. He believes that IB can help Sri Lanka follow other Asian and Western economies in tapping the Middle East’s abundant liquidity.

Sri Lanka needs finance for its infrastructure and revenue-generating projects and Thowfeek believes that this can be met through Islamic financing.

After modifications to the Banking Act in March 2005, there is adequate flexibility for conventional banks to start Islamic banking windows and introduce some products. However, attempts to promote Islamic financing and deposit products have been feeble. These have been operated through financial institutions like Amana Investments and Ceylinco Profit Sharing.

What the country probably needs is a full-fledged Islamic bank… To enable that, Thowfeek places the onus squarely on the regulators. They have to perform a due diligence and play a proactive role – as regulatory institutions in other countries have done, he insists.

Although there are no authentic statistics on the IB market in Sri Lanka, Thowfeek guesstimates the figure at LKR 70 – 100 billion. The country has potential to become an IB hub for the entire Asian region, he says. Only if CBSL expresses interest and initiates action can Sri Lanka stand a realistic chance of competing with and overtaking other players. Government organisations, monetary authorities and the private sector must necessarily band together with Islamic banking institutions to make that happen.

Lanka as Finance Hotspot?

Since the 1980s, it has been fashionable to talk about Sri Lanka becoming a financial hub or - to use appropriate terminology - an international finance centre (IFC). There has, however, been little real progress in that direction. An IFC is a location where the entire gamut of financial activities takes place with the active presence of strong international financial institutions. IFCs typically have a well-developed and integrated financial system.

Kicking off a debate at an economic conclave recently, CBSL Governor Nivard Cabraal explained two possible routes to becoming a financial hub. Growth could be organic, as happened with London and Tokyo; alternatively, the hub could be engineered – as in Singapore and Dubai. Cabraal suggests the latter mode as more relevant for Sri Lanka.

One prerequisite for IFC status is that the location should be strategically located, in geographical terms. Proximity to sea routes and easy access to major international markets are desirable. Another essential criterion is that time zones of the hub overlap with those of the major markets and economies that it proposes to serve (in our context, India and the Gulf).

Sri Lanka has all these aspects in its favour. But that’s where the positives end...

An IFC needs support services, legal and regulatory frameworks that provide certainty and effectiveness; we certainly have room for improvement there. The ongoing civil strife casts aspersions on political stability. Infrastructure is poor. Although the financial sector contributes a significant 10% of GDP, we do not have critical mass of international capital flows.

Other hubs have got a head start over Sri Lanka. But have we missed the bus permanently? Probably not, provided we plan ahead...

We could probably take a leaf out of the Securities and Exchange Commission of Sri Lanka’s book. Channa de Silva, Director General, said that the commission has developed a Capital Market Master Plan for Sri Lanka, spanning ten years. The first year will see the introduction of derivative products; other plans include listing upto twenty large companies and rejuvenating the mutual fund industry.

We need to decide on the proposed hub’s end-state and develop intermediate milestones, to assess our performance and effect mid-course corrections. It would be imperative for the government to increase the pace of measured policy reforms too.

Nihal Fonseka, CEO of DFCC Bank, suggested that the private sector should have a greater share of assets and liabilities in the financial sector. He also laid emphasis on good governance and revamping the regulatory framework. The CBSL should promote larger financial institutions by encouraging consolidation among banks, he said. That would give them the courage to allow the entry of global banks.

In these deliberations, what seemed to have been forgotten is the rationale: Will becoming an IFC make us rich? Or famous? Instead of aspiring to become a financial hub, can the associated capital and energy be channeled into more critical areas? A Cost Benefit Analysis would probably throw up some interesting answers…