WB accelerating inclusive growth for Sri Lanka to become the Wonder of Asia: WB Managing Director

The World Bank stands ready to collaborate with the Government as they implement the Mahinda Chintana and is willing to increase its lending envelope and scale-up knowledge services to help support the ambitious development plans, says Dr. Ngozi Okonjo-Iweala, Managing Director, The World Bank.

Dr. Ngozi Okonjo-Iweala sounded the WB assistance to Sri Lanka in her address on the occasion of the 60th Anniversary of the Central Bank of Sri Lanka at the John Exter International Conference Hall today (December 17).

The full text:

I. Introduction

1. Governor Cabraal, distinguished guests. It is my great privilege to have the opportunity to speak to you today. I would like to extend my sincere appreciation to Governor Cabraal for inviting me here to commemorate the 60th Anniversary of the Central Bank of Sri Lanka. It is truly an impressive venue. Abraham Lincoln once said, “Don’t worry when you are not recognized, but strive to be worthy of recognition.

2. I think we can all agree that John Exter – the first Governor of the Central Bank of Sri Lanka (1950-53) – and the namesake of the conference hall in which we now sit, is worthy of recognition. As you all well know, prior to becoming Governor John Exter was the official from the U.S. Federal Reserve System who worked with local officials in 1949 to establish a Central Bank in Sri Lanka. The result of this collaboration was a terrific document, with a boring title, “Report on the Establishment of a Central Bank for Ceylon,” and the Central Bank of Sri Lanka was established the following year. Sixty years later we celebrate an institution that has been critical in the drive for economic growth and poverty reduction in Sri Lanka.

3. I raise this bit of well known history with you because, after reading the report, I was struck by the relevance of the lessons that it holds for us sixty-one years after its publication. It is an excellent example of international cooperation that was guided by the international experience of the day, was very practical and focused in its approach, and was carefully attuned to the realities of the newly independent Ceylon. The result of this collaboration was the creation of a vital institution for economic policy making that would foster the well-being of all Sri Lankans as the country charted its ambitious course through the exciting, but choppy, waters of the post-independence period.

4. Sri Lanka finds itself in a similar situation today. It is again designing an ambitious policy course in challenging times, characterized by a post-conflict situation and a post-financial crisis global economy that now consists of multiple growth poles. Sri Lanka has managed to end the conflict and I must congratulate you all. Managing the peace in a balanced, transparent and fair manner will be critical to accelerate economic growth and poverty reduction. The choices that policy makers make today and the collaborative partnerships they form to navigate this new environment is going to shape the economic fortunes of Sri Lankans tomorrow in much the same way the creation of the Central Bank of Sri Lanka did 60 years ago. It is some of these policy choices for accelerating economic growth and poverty reduction and the future collaboration with the World Bank that will be the focus of my remarks today.

Fortune Favors the Bold

5. The Government’s development plan, as described in the Mahinda Chintana is bold and ambitious. It is good to be ambitious, it is the right time for Sri Lanka to think big. President Rajapaksa wants to transform Sri Lanka into the “Wonder of Asia” and is dedicated to seeing per capita income rise well above US $4,000 over the next six years. To make this vision a reality he wants Sri Lanka to transform into a strategically important economic centre of the world, serving as a key link between the East and the West. The Mahinda Chintana also states that a key to making the vision a reality are dynamic entrepreneurs that aim to break into international markets.

6. It is a wonderful vision and is one that the Bank would like to help Sri Lanka realize. But as a famous Japanese proverb nicely reminds us,

“Vision without action is a daydream. Action without vision is a nightmare.”

7. The vision is clear, but what are the actions required to realize a doubling of per capita income within six years? Or, as it has been alternatively stated – How can Sri Lanka reach 8 percent real GDP growth into the medium-term? These are challenging questions for any developing country, as there are no set recipes for accelerating growth. The Mahinda Chintana specifies many actions that aim to accelerate growth and achieve these targets. I would like to compare some of these proposed actions to the common ingredients in the successful growth strategies of developing countries that have been identified by the Commission on Growth and Development led by Nobel Laureate Michael Spence  - a commission of which I was a member.

a. Investment and Growth

8. In looking at successful high-growth economies - 13 economies that have grown at an average rate of 7 percent a year or more for 25 years or longer – we found that one common ingredient was high rates of investment. The Government of Sri Lanka has stated that investment rates must rise by almost 10 percentage points of GDP from about 25 percent of GDP to about 35 percent to reach the goal of 8 percent GDP growth on a sustained basis. With public investment rates already at a relatively high level of 6 percent of GDP, the majority of the increase will likely come from the private sector, both domestic and foreign. But, how to encourage private investment?

9. The Government’s stated goal to improve its place from 102 in the World Bank Group’s overall “Doing Business” rankings will be important in this regard. Some policies have long been considered a drag on private sector investment. One of the policies that has consistently been at the top of the list of constraints to doing business in Sri Lanka is tax policy. The recent actions taken to broaden the tax base and simplify the tax structure in the 2011 budget send a positive signal to the private sector that Sri Lanka is now a better place to do business. Building on this success and tackling some of the other well known constraints to doing business further  – e.g. weak enforcement of contracts and difficulties registering property – will help improve investment levels in Sri Lanka. Clearly the end of the conflict will also help reduce investor uncertainty and spur both domestic and foreign private investment.

10. Before I move on to the next ingredient, let us savor investment a bit longer. At about 25 percent of GDP, investment levels are already quite high given Sri Lanka’s stage of development, which I must say is quite remarkable given the years of conflict. So, adding an additional 10 percentage points of GDP will be a challenge. Alongside policies to improve the level of investment, policies to improve the productivity of those investments will also be important.[1] Such policies can be directed at spurring physical and human capital to work more efficiently together. In other words, how can we do better with what we currently have? This calls for strong innovation policies. That is, policies to promote “imitation” and the discovery of doing new things or doing old things in new ways. This may mean better management practices or simply getting into new areas of production or export. In this regard, innovation is more related to discovering entry points to new markets, searching for the right product, the right technology or services that might have been innovated elsewhere and adapting them so that they generate returns under local conditions. Such policies are at the heart of the President’s drive to make Sri Lanka a knowledge hub of Asia and are recognized by the Growth Commission as another key ingredient in the growth process. Let me now consider more concretely innovation policies for a knowledge-led economy.

b. Innovation and Growth

11. In all cases of sustained, high growth, the economies have rapidly absorbed knowhow, technology, and, more generally knowledge from the rest of the world. These economies did not have to originate much of this knowledge, but they did have to assimilate it at a tremendous pace.[2] But, how can policy makers hurry the process along? Let me provide an example from some innovative recent research in this area done by some of my colleagues at the Bank.[3] They randomly selected a set of textile factories in India to receive complimentary five-month management training and compared the profitability and efficiency of these revamped factories with a control group of factories that continued doing business as usual. It turns out management does matter: productivity was boosted by around 10 percent by improving quality, managing inventory, and speeding up production.

12. It is an example of simple, yet effective changes that can lead to impressive results.

Helping to promote better management practices in the private sector to enhance productivity can come in many forms: funding better business schools, developing the local consulting market, or making it easier for well-managed multinationals to enter the domestic market providing opportunities for local workers to gain experience. Better management practices are but one of a number of actions that can be taken to imitate and assimilate existing knowledge. One well known channel that can help spur a wider transfer of knowledge and innovation is foreign direct investment (FDI). Post-conflict, FDI is bound to improve as a key source of uncertainty for the private sector is gone. However, efforts to improve the business climate must also proceed. Particularly important will be the efforts to rationalize the exemptions and incentives under the Board of Investment. Mauritius – where I have just returned from a trip- provides a nice example of the role that FDI can play in  importing ideas and knowledge from the rest of the world to generate growth and poverty reduction. Indeed, work at the IMF indicates that FDI is a key part of the second “growth miracle” that appears to be taking place in Mauritius.

13. Importing knowledge through more FDI will boost the economy’s productive potential, but it is the global marketplace that will provide the demand necessary to fulfill that potential. As the first country in South Asia to liberalize its economy, Sri Lankans have long been aware of the importance of the global market to their development success. This opening-up helped generate a growing export sector led by garments and tea. Exporting world class services is also making its mark. Here I can cite the accountancy offices in Sri Lanka that are doing financial work for some of the world’s biggest companies, including HSBC. And it is not simply payroll and bookkeeping. The export of these services include derivatives pricing and risk management for money managers and hedge funds, stock research for investment banks and underwriting for insurance companies. There are many other similar success stories in Sri Lanka that are worth emulating. I applaud the Mahinda Chintana for reaffirming this commitment to deepening connections to global markets and highlighting dynamic entrepreneurs as the ones to get it done. Fully exploiting global demand was another ingredient recognized by the Growth Commission as critical to successful growth strategies.

c. The Post-Financial Crisis Global Economy and Growth

14. Re-energizing the export sector for accelerated growth is not going to be easy in a post-crisis world, but it can be done if the multipolarity of growth is used by Sri Lanka to expand into new markets. A key feature of the post-crisis world is the sluggish recovery in developed countries and the faster than expected recovery in developing countries. Many argue that this is more than simply different speeds of post-crisis recovery, but that it represents a more fundamental shift in the global landscape. Developed economies like the United States with large current account deficits will continue to reduce excess domestic demand and seek to raise exports, while surplus countries like China will aim to increase domestic demand raising imports and thereby reducing surpluses. Developing country imports are already higher than their pre-crisis peak in April 2008. In contrast, the imports of high-income countries are still below that 2008 peak. Developing world imports have accounted for more than half of the increase in world import demand since 2000.

15. As World Bank President Zoellick has stated, “We are witnessing a move towards multiple poles of growth as middle classes grow in developing countries, billions of people join the world economy, and new patterns of integration combine regional intensification with global openness.”

16. Consequently, the contribution to global GDP growth of developing countries like China, India and Brazil is rising. By 2020, Asia could become the largest centre of economic activity with its share of world GDP projected to reach close to 35 percent.

17. This transition has important implications for Sri Lanka. It presents challenges, but also many opportunities. On the side of the challenges that will have to be faced, is competing for a share of the U.S.’s and EU’s - its largest trading partners – contracting imports. But on the opportunities side, Sri Lanka, with a few changes that we talked about, is well positioned to compete for the rising imports of China, India, Brazil South Africa, Indonesia, Colombia, Mexico and in the World’s other emerging markets in Asia, Latin America and Africa. There is evidence that this is already happening. Sri Lanka’s exports to India increased from an albeit quite low 1 percent in 2000 to 5 percent in 2009. Sri Lanka sits on India’s doorstep and is strategically located relative to East Asia. The empirical trade literature tells us that location matters a great deal. Geography and the rise of South and East Asia help explain the dramatic change in Sri Lanka’s import shares from the region since 2000  - from 46 percent of total imports to 62 percent in 2009. But, I would encourage you to think beyond the regional geography and explore other large emerging markets and the vast new opportunities that they present. Lastly, it almost goes without saying that Sri Lanka has a ready pool of skilled labor to take up new export opportunities.

18. But, the skills of today may not be the “right” skills for tomorrow, so an emphasis on sustained investments in education and training is a must for Sri Lanka to gain and maintain a competitive edge in global markets. The Mahinda Chintana recognizes the importance of a quality university education, and plans are underway to bolster the university system in Sri Lanka. An important recent development in this regard was the announcement that international institutions of higher learning would be invited to set up campuses in the country. It will be vital for universities to also partner with industry to ensure that they are graduating students with the requisite skills for the labor market. Such partnerships have been cited as one of the keys to the successful South Korean – indeed the East Asian - growth story. In addition to improving university education, technical and vocational training institutes will also play an important role to develop the core skills that workers will require to effectively take advantage of opportunities in both the domestic and global markets.

19. Sri Lanka can think even bigger in this regard and this is where the Mahinda Chintana is right to focus on becoming a knowledge hub in Asia. When we talk of sources of growth we should also be talking about exporting Sri Lanka’s educational services to the rest of Asia and beyond. The Chintana notes how 

Sri Lanka’s Buddhist monasteries were once the seats of learning in Asia. In more recent times we saw that some of the best hotel managers and executive chefs in region were trained in the Sri Lanka Institute of Tourism and Hotel Management (SLITHM) in Colombo. Exporting Sri Lankan services should not only be limited to the education sector. I see opportunities in the health sector and with the health sector linking up with the tourism sector to provide Health and Fitness tourism. The service sector makes up 60 percent of the economy. Going forward, exportable services have potential to be important sources of growth.

20. Dealing effectively with this long term transition in the global marketplace will need to go hand in hand with macroeconomic policy that preserves macroeconomic stability in the face of future exogenous shocks. Sri Lanka has handled the international financial crisis quite well. Real GDP growth slowed from 6 percent in 2008 to 3.5 percent in 2009, but with prudent policy responses of a small fiscal stimulus package and the policy of gradually loosening monetary conditions, the economy has rebounded well. Financial support from the IMF and the post-conflict bounce also helped to reduce the crisis effects, as remittances and other capital flowed into the country. The Sri Lanka stock exchange has been one of the best performing in the world so far in 2010. But it is no time to relax, macroeconomic policy has to continue to work to consolidate post-crisis and post-conflict gains and be ready to respond to the risk of a renewed round of global volatility.

d. Macroeconomic Stability and Growth

21. Macroeconomic stability is another key ingredient in successful growth strategies. The policies suggested above and those found in the Mahinda Chintana will not have a fair chance of working if they are interrupted by slumps, insolvency, and runaway inflation. I don’t think that I would provoke a great deal of controversy if I said that past macroeconomic instability has been holding back growth potential in Sri Lanka. Annual fiscal deficits of 7 percent of GDP and double digit inflation (12 percent) over the last three decades has given rise to questions of sustainability over the years, which has negatively impacted private investment. The fiscal deficit reached almost 10 percent of GDP in 2009. The public debt burden has at various times reached over 100 percent of GDP and the latest available data show it at 86 percent of GDP.

22. Domestic debt in particular has been a worry spot in recent years, with domestic interest costs of almost one-quarter of government expenditures and about 44 percent of the entire tax revenues of the country in 2009. The proceeds of the successful sovereign bond issue ($1 billion) in October will be used to pay down some of the more expensive short-tem domestic debt and represents a prudent debt management operation. Lengthening the maturity profile of domestic debt has also been helpful. But, sound debt management can only be part of the story. Fiscal consolidation must help end the need for building up domestic (and external) debt to worrying levels. The 2011 budget that was delivered on November 22 represents an important step in the drive for fiscal consolidation. Let me take a moment to reflect on the key elements of this important budget.

23. The 2011 budget projects a fiscal deficit of 6.8 percent in 2011, down from the 8 percent expected in 2010. The fiscal consolidation is driven in large measure by expected revenue increases from the tax reforms that aim to simplify the tax system and broaden the tax base – e.g. the income tax was broadened to include public sector workers and the removal of a number of nuisance taxes like the debit tax on bank withdrawals. The measures are expected to reverse the worrying trend decline in the revenue to GDP ratio of recent years – which currently stands at 14.5 percent of GDP (2009). The tax measures are also expected to improve the investment climate and economic growth going forward. 

The commentary from the business community as reported in the local press seems to suggest support for the measures. However, private sector investment can also get a boost from government expenditures when, for example, the private sector gets crowded in through public private partnerships (PPPs). This is particularly relevant in the current context where the “Peace Dividend” which can arise from progressively reducing defense expenditures can open up some fiscal space for productive investments. I think this represents the next important focus on the fiscal policy agenda.

24. Looking ahead with regard to monetary policy, I think there is a tricky balancing act to perform. It will have to be sufficiently accommodative to help underpin growth in an environment of fiscal consolidation, while at the same time guarding against rising price pressures. Inflation has come down to the 6-7 percent level this year, the recent uptick due to rising international commodity prices notwithstanding. This is an important development and the challenge now is to lock in inflation expectations at roughly this level and permanently break from the past of double digit inflation. Fiscal and monetary policy coordination will be key in this regard because credibility will not be easily gained as experience from many other countries shows.

25. When the government changes fiscal policy, it needs to think of how these changes will affect inflation and, consequently, interest rates. Similarly, the Central Bank needs to consider how changes in fiscal policy will affect demand and inflation, and thus its setting of monetary policy. Therefore, it is to the mutual benefit of both parties going forward to enhance co-operation in sharing information and analysis as they adjust their policy settings. This will be essential to demonstrate clearly to the public your resolve to achieve greater fiscal prudence and stable inflation of single digits until credibility is gained.

e. Inclusive Growth

26. Let us pause for a moment to re-cap our ingredients for a successful growth strategy. I’ve spoken about the importance of savings and investment, innovation and knowledge-led growth, redoubling efforts to connect to global markets and macroeconomic stability as a necessary condition for accelerating growth. Suppose with implementation of these and other polices Sri Lanka reaches its destination. What will it look like? One thing we know is that the benefits of accelerating growth are unlikely to be spread evenly across the country, across households, across income levels etc. etc. Unbalanced growth is the norm, not the exception. Another important set of policies will be needed to ensure equality of opportunities across all segments of society.

27. The Growth Commission also recognizes that policies to promote inclusion of all segments of society in the growth process are critical so that no group will seek to derail it. Leadership in this area requires policies that unite the nation so that all move toward common goals. A nationally shared sense of identity is a foundation for making the tough, often painful choices that are required for sustained growth. Factionalism tends to focus the politics on the division of the economic pie rather than on increasing its size. I needn’t emphasize that in a post-conflict situation like we have today in Sri Lanka such polices take on particular importance.

28. Concretely, policies that help improve access to services for all people of Sri Lanka will be critical. For example, providing well-targeted safety nets to the poor and vulnerable, and access to quality education and health services – especially when the demographic dividend is going to begin to decline within a decade. Another example might be putting in place incentives to agriculture and agro-based industry, especially in the North and the East of the country, to amplify market linkages to the rest of the country and internationally. Additionally, improved transparency and accountability of service delivery will help improve service provision. Malaysia provides a good example where transparent mechanisms to monitor and evaluate the linkages between economic growth and distribution where put in place and where possible, were adjusted over time. Another set of inclusive policies that are particularly important in the Sri Lankan context are those that will help improve the female labor force participation rate, currently at 35 percent. There is reason to think that some of the future declining demographic dividend can be offset partially though higher female labor force participation rates. The simple math of the matter states that the higher is the female labor force participation, the higher will be per capita incomes for all Sri Lankans. There is also a need to provide incentives for skilled females to stay in Sri Lanka rather than migrating. With Sri Lanka’s track record in reducing gender based disparities,[7] combined with the measures to improve the investment climate and the drive to enhance skills and education, there is good reason to believe that female labor force participation can indeed increase in the coming years.

II. World Bank - Sri Lanka Collaboration

30. The World Bank is an active partner in supporting Sri Lanka in its transition from a low income country in conflict to a middle income country in peace. We have supported the Government’s efforts with rehabilitation and reconstruction in the North and the East, we have an active portfolio of road infrastructure projects, and have long been a partner in the health and education sectors just to name a few areas of partnership. The post-conflict environment provides us with an opportunity to build on this relationship and become a trusted partner in the Government’s vision to double per capita incomes and firmly establish Sri Lanka’s place in the ranks of fast growing middle income countries.

Let me now highlight some areas where I think the collaboration between the Bank and the Government can work to great effect going forward.

31. First, let me say that a middle income country partnership with the Bank requires more resources. The IDA allocation has been running at below $200 million annually and while I think that amount served the relationship well in the past, the time is right to increase the lending envelope to an amount that better reflects the new development ambitions of the Government. In this regard, I am pleased to be able to announce that the Bank’s recent creditworthiness assessment has been concluded and that 

Sri Lanka is now eligible for IBRD financing – funding from the Bank’s non-concessional window. IDA resources will continue as it is important that Sri Lanka benefit from these highly concessional resources to support its post conflict reconstruction and rehabilitation needs. Together, these financing sources have the potential to significantly increase the amount of resources available on an annual basis. This is an important recognition of the middle income country status of Sri Lanka and signals a different sort of relationship going forward – a relationship that is founded on knowledge sharing that complements the available financing.

32. The constant search for innovative ideas by Sri Lankan policy makers will be a key feature of a successful quest to accelerate growth and improve living standards. Learning from the experiences of their counterparts in other emerging economies will help to swiftly apply practical solutions to problems that others at a similar stage of development have seen before. The Bank can play an important role in facilitating this process by sharing not only our own knowledge, but also the expertise of other emerging economies through South-South exchanges. Indeed, Sri Lanka would also be expected to share its experiences and accumulated expertise with others throughout the South Asia region and beyond, for instance in Africa, and other developing and developed countries. Two recent examples in this connection that are worth highlighting are the Central Bank’s training on open market operations provided to Maldivian counterparts and the impressive knowledge sharing and technology transfer of innovative ICT initiatives to Ghana, Rwanda, and Bangladesh, among others. Indeed, as a recognized leader in this area, Sri Lanka has been elected to chair the United Nations Economic and Social Commission for Asia and the Pacific’s (UNESCAP) Committee for Asia Pacific ICT for consecutive terms (2008-2012). I want to congratulate you on that.

III. Conclusion

33. Let me conclude by emphasizing a few points. Sri Lanka has what it takes to be the Wonder of Asia and decisively tackle issues of poverty reduction and economic growth acceleration. To get there I have mentioned the importance of raising investments and improving the productivity of those investments through innovation policies. I have mentioned the importance of skills development, macroeconomic stability and implementing policies that promote the inclusion of all segments of society in the growth process. I also highlighted some of the challenges and opportunities for deepening connections to global markets. In this, Sri Lanka has to be fast, flexible and agile to be able to exploit ever growing opportunities in a fast changing world. It needs strong partnerships and to nurture a sense of ownership by all Sri Lankans in the growth process.

34. The Bank stands ready to collaborate with Government as they implement the Mahinda Chintana. We are willing to increase our lending envelope and will scale-up our knowledge services to help support your ambitious development plans. Let us find creative ways to work together to help Sri Lanka become the “Wonder of Asia”.

As we say in my language: Onye si naya ge na enu ugwu chiya ekwelu.

Determination is everything. A person who determines that they will reach the mountain top will surely get there because once they agree, their personal spirit will agree and everything will support them.

35. Once again, thank you Governor for inviting me to speak to this distinguished audience today. Thank you all for listening patiently and congratulations to the Governor and his staff on reaching the milestone we celebrate today with such professionalism and dedication.