Lanka’s Economic Journey Will Move Forward With Greater Momentum – Nivard Cabraal

The Governor of Sri Lanka’s Central Bank, Ajith Nivard Cabraal spoke extensively with Faraz Shauketaly on a number of key economic factors and on allegations of the Governor’s qualifications for that position.

Q:  What do you attribute the current Dollar Rate to? The consensus was that this rate was to be gradual. Does this mean that FDI and other inflows like Foreign Remittances has not been as expected?
A: As the Central Bank have clearly announced, our exchange rate policy has been made more flexible over the past four months. Further, we implemented certain policy measures that served to cool the import demand, as well as ensure that future inflationary tendencies would be arrested. What we are seeing today is an over-shoot of the exchange rate, which sometimes happens in an economy, in response to certain policy changes.
However, this effect will gradually reverse, and we expect the exchange rate to settle at a level substantially below the current levels, in the next few months.  Already, we have seen the effect of our policy measures, with imports reducing sharply, and that shows that our policy measures are working as expected.
In the meantime, the other expected external inflows are performing according to projections, with Foreign Direct Investment inflows, inflows into the banks, portfolio investments and inflows of worker remittances, showing good progress. Even so, due to the world conditions being very uncertain, we will need to work hard to ensure that the external flows will remain buoyant, and I can assure you that all relevant parties are committed to delivering the planned outcomes.
Of course, there are some economic ‘hit men’ who attempt to destabilize the economy on a daily basis, using both the international and national media, by frequently claiming that the economy is on the verge of collapse.  But, as has happened so regularly in the past, those efforts will once again come naught, and Sri Lanka’s economic journey will move forward with even greater momentum.

Q: The government has made many investments in infrastructure development.  Some of these are yet to make a contribution in terms of returns.  Why?
A: Large scale infrastructure development projects generally have long gestation periods.  That is natural. In Sri Lanka too, it would be observed that some of our existing infrastructure is centuries old. For example, our present Port of Colombo is more than 700 years old and some of our major roads are over 200 years old.
What we have to understand is, when we build new infrastructure like ports, air-ports, highways, power plants, water projects etc., we cannot and must not expect overnight results. The US Inter-State Highway system was built in 1954, and even today it is contributing immensely to economic development in the US. But at that time, there were many critics who did not think that such a massive project was of value to that country.
Even in Sri Lanka, we have some people who cannot, and do not see the value of some of the massive developments projects undertaken by the Government over the past 6 years. While such a reaction may be reasonably expected from ordinary citizens, it is sometimes disappointing to hear the comments of some so-called intelligentsia who too, seem to be looking for short-term monetary returns only, in relation to certain mega projects.
To my mind, that shows that those persons do not have a vision or an overall understanding of a long term economic journey of a nation. But over time, I am confident the majority of the people will see the economic benefits, particularly, new employment opportunities, greater productivity and efficiency, improved business climate and better distribution of wealth, and then, they will understand what a huge difference the development activities had made to the economic and national landscape.

Q: What do you expect the US Dollar to trade at by the end of year?
A: Our current projections are that the trade deficit which was the main cause for the recent rupee depreciation will reduce substantially this year. With that, our current account deficit will also record a corresponding reduction.  On that basis, we expect a healthy positive balance of payments to be realized this year.  Such a result would naturally support a stronger rupee, and therefore we expect the Sri Lankan rupee to trade at a level which is substantially higher than what it is today.
Since of late, I have noted that more and more unbiased analysts seem to have understood this simple logic, and many research teams of leading investment banks have also started to articulate this view.

Q: There is speculation that the Euro Zone crisis will affect Sri Lanka.  
A: The crisis in the Euro Zone is naturally a matter of concern to all nations.  We too, at the Central Bank, have examined the possible impact of that crisis, from different angles and our research teams have undertaken many studies under simulated scenarios. Although we believe that there are some risks that could impact certain segments of our economy, our considered assessment is that the overall impact would not be serious enough to cause a significant dent in our economy.
This is particularly so, because the countries with whom Sri Lanka has major dealings in trade and investment in the Euro Zone, are nations which seem to be the least affected within the Euro group.  Consequently, we believe we would be in a position to ride through the turbulent period, better than some may expect.  In the meantime, there has also been a gradual shift in the business strategies of many corporates to increase their business links in countries outside the Euro Zones, and therefore, those types of mitigating efforts would also provide some comfort to policymakers.

Q: The government seems to be focusing mainly on tourism.  How realistic is that given the competition and the European recession?  
A: Sri Lanka is a tourist destination which has quite a number of strengths, unlike certain other nations which can only offer “tanning”, as some may say. We have exciting wild life, ancient cities, pageantry, adventure, environment, conferences, sports activities, ayurveda and many other attractions.
I am glad that our tourism marketing agencies are now actively focusing on many of those strengths, and I believe that would be the way forward for the future of tourism in Sri Lanka.  In the meantime, there has also been a consistent upgrading in the tourism plant, with the refurbishing of existing hotel rooms; the construction of hotels in new and existing areas; the additions to the transport fleet and infrastructure; and the upgrading of tourist attractions. All these initiatives would serve to encourage new tourism opportunities, and we are happy to see progress in these fields.
Further, the fact that the conflict is over and there is easy and safe access to all parts of the country by road, rail, sea and air, enhances the opportunities for tourism, and I think our sustained effort to promote tourism will result in greater earnings in foreign exchange, higher employment and better showcasing of our country.

Q: With regard to the EPF investments on the Colombo Stock Exchange, these investments are currently in the doldrums.  Indeed, some have depreciated in value.  How do you view these investments, do you foresee a problem and if not, why?  
A: In the case of any investment, there are risks involved and that is why careful assessments are made when making investments, both in fixed income securities as well as equities.   Long term funds all over the world invest a substantial part of its funds in fixed income securities, and a lesser quantum in equities.  Funds also maintain a small proportion in highly liquid assets in order to be able to settle claims as and when such claims arise.
The EPF too has followed a similar investment pattern, and has invested about 93%of its funds in Government Treasury Bills and Bonds, whilst about 6 – 7% has been invested in the Stock Market.  So, we can see that, the EPF has carefully spread its risk, in order to ensure that even in the case of the market moving into a doldrum, that such decline will not unduly affect their overall earning capacity, or the long term stability of the Fund.
At the same time, being a long term fund which provides for the long term benefit of its members, the EPF has also been consciously investing in long term growth stocks which can provide substantial returns in the medium to longer terms, at a future period when interest rates are lower than what is prevailing today.  When investments are made in that manner, with a long term focus, although there may be short term fluctuations in share values, with short term marked-to-market losses, it will not affect the long term progress and earning capacity of the fund.
In fact, as the EPF has pointed out many times, it had, at one time in the recent past, enjoyed as much as  Rs. 19 billion unrealized capital gains in its portfolio during the upturn of the stock market.  Of course, at that time, the hit men who are shouting today, were deafeningly quiet.
Nevertheless, even at that time, the investment committee of the EPF had been of the view that, in the longer term, the enhancement and gains would be even greater, and that is why they have held on to their portfolio without selling. That shows the true nature of a long term fund, quite unlike a hedge fund, which is mainly based on making quick returns in the short term.
It is now clear that there is a bearish trend in the market, and some politicians are trying to make capital of the situation, by making allegations of mismanagement, fraud etc. simply based on the diminution of value of the stocks, which is a market-wide phenomenon.
I think that type of conduct reflects their desperation to find excuses to attack the Government and the Central Bank in whatever way they can, whenever they can.  In the case of some of these persons, whose dubious track records span a few years with similar outrageous claims in other fields as well, we can also see signs of personal hatred, which is very unfortunate, as rational thinking and sound logic seem to elude them now.
In any event, it must be understood that this down-turn in our stock market, is not going to last forever. In due course, there will be an upturn, and once again the sound, long term investments with intrinsic value, would appreciate in value. Then, those stocks would trade at values that are more in line with their fundamentals, earnings, expectations and future potential.
Therefore, there is no need to unnecessarily panic or anticipate unwarranted problems, because it would be clearly seen that the EPF has so far been able to generate returns that are substantially higher than inflation, and earn higher returns than similar long term funds.

Q: In terms of the share purchases, can you recover the premiums paid even over the long-term? What about the opportunity cost?
 A: Of course that will happen over the longer term. I can say that confidently because, the EPF investments are made as a “pool of investments” and have been made on the basis of certain sound principles. It must also be stated that their record must be essentially judged by the value of the pool of investments over a period of time. That is the way that any long term fund is evaluated, and the evaluation of the EPF should be no different.
Even in the case of a bank, the loan and investment portfolio of the bank is valued on an overall basis, with provisions being made in instances where certain advances may not be performing as originally expected or anticipated. No bank anywhere in the world will be able to have a 100% performing portfolio with every single loan performing as originally expected. That will be true with any long term provident fund as well.
However, what is important is to put in place a system, which will ensure that the overall expected yields of the particular investment portfolio is delivered, even if some investments may not perform as well as originally contemplated. In such instances, the higher than average returns of some investments will compensate any lesser performing investments within the portfolio, and that will serve to even out any losses over the longer term.
That is why in the case of a long term substantial investment portfolio, Investment Managers usually base their investment decisions over a time frame, with expectations of certain growth, capital gains, dividends etc. over such time horizon.
I think if the EPF stock portfolio is assessed on such a scientific and professional basis, it would be seen that the EPF portfolio is well-balanced, and is a Fund that has substantial prospects and potential over the long term.

Q: It is widely speculated that ‘old loans’ are paid off with ‘new loans’. What are the prospects for future generations because it is entirely possible that many of these loans will take a rather long time to repay?       
A:  As long as a country has a fiscal deficit, “old loans” will generally be paid off with “new loans”.  That is true with any country, be it the US, UK, Germany or Japan. In that context, what is important is to ensure that a country’s loans outstanding is not allowed to grow at a rate where it increases the debt pressure a more than affordable rate, over the coming years.
If we look at Sri Lanka’s track record over the past 6 years, our Public Debt to GDP levels have come down substantially, from over 90% to less than 80% during that period. In fact, last year, our Debt to GDP ratio reduced to around 79%, which was the first time in 30 years that Sri Lanka has been able to record a ratio that is under 80%!
At the same time, it must also be appreciated that the present government has made sure that they borrow mainly for tangible infrastructure development projects, and not for consumption.  Even reluctantly, I must mention that in the past, Sri Lanka had borrowed more than 600 million US dollars to import wheat flour, in order that our people could consume bread!  Today, 30 years later, we are still paying those loans, and that too, with a currency that is depreciated a lot more than that at the time of borrowing.
However, today, the borrowing strategy has been to mainly support major infrastructure development projects which have an enduring benefit for the economy and the country. Therefore, while acknowledging that the loan and interest repayments in the future would naturally place a burden on the government budget, we also need to appreciate the fact that the resulting economic activities would provide greater employment opportunities and a better business climate.
Those advantages, in my view, would offset the disadvantage of the loan repayment and interest cost.  Another point that must be mentioned is that in many countries today, the debt to GDP levels are rising significantly, although we in Sri Lanka have been able to maintain our debt at manageable levels, whilst also embarking on a massive public investment programme.
Q: Governor Cabraal, the charge against you – is that you are ‘beyond your depth’ when it comes to being Governor of the Central Bank.  Do you feel you really do have the essential tools like qualifications, experience and expertise to be the Governor of the Central Bank?
A: Thank you for asking me this question, because it gives me an opportunity to reply to some who suggest so, possibly with a view to upset and discourage me.  I think I will answer it in two parts.
First, there is no universal charge as suggested by you, but it is merely an allegation of one or two politically desperate persons who are hell-bent on slinging mud at me.  Every time such people throw insults, I have refused to accept those, so that as Lord Buddha has rightly preached, the mud that has been hurled towards me, will resettle on their own faces.
Second, let me answer, based on the actual outcomes over the past 6 years.  We all know that the Central Bank is entrusted with two major responsibilities, namely, the maintenance of Economic and Price Stability, and the maintenance of Financial System Stability.
Under my watch as the Governor, the Central Bank has been able to deliver single digit inflation for the past 40 months, a feat that has never been achieved since 1977, after the liberalization of the economy.  In fact, the previous longest period that Sri Lanka was able to enjoy single digit inflation before I was appointed as the Governor has been only 23 months, while, during the period from 1977 to 2005, our average inflation had been well over 12%!
With regard to the stability of the financial systems during the past 6 years, we can see that in a period where the world has undergone one of the most turbulent periods in banking history, in Sri Lanka all financial institutions have been safeguarded, and are today functional without failures.
Everyone knows that in the past 5 years, in many advanced countries, hundreds of banks have failed and those governments have had to provide billions of dollars, pounds, euros and yen to bail out their banking institutions.
But, not so, here in Sri Lanka.  During my time, even in extremely trying conditions and very complex times, notwithstanding our humanitarian operations, global oil shock, a serious food shock and a debilitating sub-prime crisis, we have been able to come through without a single banking failure and deliver remarkable financial system stability.  Now, that should tell you something about our delivery of financial system stability!
No one can also deny that, over the past 6 years, our economy had been kept on a growth and stable mode, even while we were fighting a major terrorist enemy, and very few shocks were allowed to be transmitted to the country and the economy. Our country enjoyed an over 6% growth during the humanitarian operation, and an over 8% growth thereafter.  Our reserves which were barely touching 2 billion US dollars before I took over, are today at over 6 billion US dollars.
We have been able to gain the confidence of the IMF and successfully complete a program over 8 reviews, and receive over US$ 2.2 billion so far.  In the past, IMF programmes could not even proceed past the 2nd tranche and review. In addition, our country today enjoys the respect of hundreds of international investors, who have shown a tremendous appetite for Sri Lanka securities by investing over US$ 5 billion.
On the banking side, we have introduced far reaching corporate governance practices for banks, established a deposit insurance scheme, improved our payments and settlements structures and positioned the economy towards a growth momentum to achieve a 4,000 US dollar per capita income by 2015.
The EPF has paid the highest returns ever to its members, and our foreign reserve management has also recorded its highest ever returns.  In the North and East, we have effectively supported economic activities to generate an extraordinary nominal growth of over 22%, and over the past 6 years, the Central Bank has been able to support the massive development effort in the country that has today transformed our country to levels that were hitherto thought not possible.
Personally, I have addressed over a thousand business groups at local and international fora, and interacted with thousands of investors with acceptance and acclaim.  I could go on further, but I think what I have pointed out is sufficient.
Let me also say that my qualifications, expertise and experience is known to everyone in this country and I am proud that my entire education has been in Sri Lanka.  I think I also enjoy the respect of my peers who know me as a former President of the Institute of Chartered Accountants, the South Asian Federation of Accountants, Business Recovery Association and the St. Peters College OBU, among many other positions of leadership, which had allowed me to serve our country in different ways.
I have also held high positions in many other top level corporates.  More than anything else, I have been a proud member of President Mahinda Rajapaksa’s economic team, and during his term of office, I have greatly valued the opportunity and guidance that he has provided me to contribute to all what has been achieved by our country and economy.
Let me also add that different people will have the freedom to make different assessments about my abilities, qualifications and expertise.  I have no problem with that, and would be happy to be judged by the results produced. There is however one aspect that I must state for the record.  That is, in my journey to be the Governor and thereafter, I have never stooped to a low level of insulting and humiliating people, like what one or two who are aspiring for high office today, are practicing.
I am genuinely sad about them, because I know they will be frustrated when they find out for themselves, that their hateful and shameful tactics won’t succeed in the long run, and more and more people will soon see through their double standards and intense jealousy.  To be very frank, I have never wanted to talk about my achievements or about these issues, but I think your question requires a comprehensive response, and therefore I feel I have a duty to do so.

Q: Why do you feel that S&P made that recent statement about Sri Lanka’s financial institutions? Is there any merit or justification?
A: In my view, there is no merit or justification in the controversial statement made by S&P recently. In fact, the Central Bank has issued a very clear statement in response to the S&P statement, refuting many points mentioned in the S&P statement.  Further, when we consider what other rating agencies as well as the IMF have said about the Sri Lankan economy and the banking sector, it would be clear that the actual situation is quite different to what has been stated by S&P.
I could also categorically state that recent investor behavior shows that more investors are inclined to believe the Central Bank version and response, than the recent S&P statement, and the distortions of that statement by some local analysts.  Of course, as is usual, one or two well-known local economic hit men have tried to use some sentences of the S&P statement to further their own personal ulterior agendas, but a large population of the people are now beginning to see that those attacks are without foundation, and are not professional analyses that requires a professional response.

Q: Final question Governor: at what point do the responsibilities of the Treasury and the Central Bank converge?
 A: The Treasury is primarily responsible for the Government’s finances, maintenance of financial discipline, administration of the budget, the public investment programme and the realization of revenues.  The Central Bank is primarily responsible for maintaining economic and price stability as well as financial system stability.
The Central Bank also manages the EPF and is responsible for public debt management.  Further, the Central Bank undertakes the exchange control function on behalf of the Government, and promotes regional development as an agency function of the Government. Further, the Central Bank is responsible for the issue of currency to ensure that economic activity takes place at a required level in the country.
We can therefore see that the Treasury and the Central Bank roles are distinct, although there are many areas where the two institutions need to work closely together to ensure that the country’s goals are realized.