Tuesday, May 15, 2012

Sri Lanka: The upcoming South Asian miracle

Ruchir Sharma, head of emerging markets at Morgan Stanley Investment Management, explains the promises of an upcoming South Asian miracle, i.e. Sri Lanka. The article below is adapted from Sharma’s article published in The Economic Times. It is based on his new book Breakout Nations: In Pursuit of the Next Economic Miracle.

After decisive end of a bloody civil war, Sri Lanka is on a path of robust growth with investment in infrastructure, readily available human capital, better investment climate, and building up of the prerequisites for high growth rate. The Sri Lankans will definitely enjoy a peace dividend that will be of envy to its regional partners like Nepal.

Why Sri Lanka can be a breakout nation

Ruchir Sharma

I first visited Sri Lanka in 1997, shortly after a rebel bombing of the central bank headquarters had thrown the financial system into chaos. Military checkpoints made travelling around Colombo rather punishing, but the overwhelming impression was of a charming island and talented people trapped inside a seemingly endless civil war.

When I returned in 2011, the civil war had ended with surprising finality, and I took an extra day to see the country, including the huge territory that had been behind the lines of the Tamil rebels.

This should have been easy enough: the Tamil capital at Trincomalee is just 160 miles from Colombo - but the new highways were still being built, and the helicopter on offer was a single-engine job of the kind that routinely crashes in India. My accommodating hosts arranged for the air force to take me up in a twin-engined helicopter.

I've taken helicopters in many emerging markets when the road network is inefficient, normally a bad sign for the economy. But the aerial views of the multiple expressways under construction, the lush green plantations of the interior, and the new resorts facing the turquoise waters that drape the island helped convince me that Sri Lanka is no longer a land in waiting.

In the 1960s, Sri Lanka was billed as the next Asian growth miracle, only to be stymied by a tryst with socialism that played a direct role in igniting the civil war. During the war, Sri Lanka grew half as fast as South Korea and Taiwan and became another country in the long line of emerging-market disappointments.

Today, it seems that Sri Lanka's time has come. The civil war is over, the process of healing is under way, and there is every chance that Sri Lanka will become a breakout nation. Despite slowing sharply during the war years, the economy continued to grow at an average pace of nearly 5% even though it was running on one engine: the prosperous Western province where Colombo is located, and where the well-educated young population was producing strong growth in industries and services.

The North and East Provinces, which account for 30% of Sri Lanka's land and 15% of its population, were largely war zones. With the nation whole again, achieving 7% growth over the next decade should be well within reach.

Since taking office in 2005, President Mahinda Rajapaksa has been consolidating power in ways that critics see as the start of a family dynasty. For now, however, he is deploying his growing powers to ends that suggest he understands the fundamentals of growth, if not of democracy.

Rajapaksa's regime is working to trim the fat left over from the socialist experiments of the 1970s, including high taxes and government debts that still equal 80% of GDP. It is also bringing the vast swaths of formerly rebel-held territory back into play; the government has established vocational training centres and low-interest loan programmes, distributed boats and livestock, and begun building roads and bridges in the former war zone.

Banks are returning, big retail chains are setting up shop, and domestic airlines are flying to Jaffna and Trincomalee again. The flood of state spending drove growth in North and East provinces up to 14% in 2009 and 2010, and they are expected to grow at above 13% for several more years, making them the fastest-growing areas of the country.

The effects reverberate nationwide. On my helicopter trip, I visited some of the newly-renovated resorts, from the retro-chic Chaaya Blu in Trincomalee to the Cinnamon Lodge in Habarana, which lies in the 'cultural triangle' formed by Sri Lanka's three ancient cities.
It wasn't hard to imagine tourists, seduced by the country's raw appeal, coming in droves. While prices are not as dirt cheap as they were at the height of the war, they are still very low - $150 for a high-end hotel room - which means the Sri Lankan currency is still very competitive and attractive to foreign investors.

War-zone insurance rates that had made it too expensive to dock in Sri Lanka have disappeared, leading to a large increase in cargo traffic at the main port in Colombo. The government is pouring money into new terminals there, as well as new ports and harbours in formerly rebel-held regions.

The reintegration of the marginalised Tamils - with their high levels of educational achievement and English fluency - could provide a huge boost to a nation that multiple consulting firms already rank highly as a potential destination for multinationals looking to outsource customer service, IT and other back-office operations.

It would be a mistake to sugarcoat the post-war mood. The final stages of the war were highly controversial: charges of human-rights violations still fly against both sides.
There is evidence that Tamils, embittered by the bloody endgame of the war and suspicious of Rajapaksa, continue to leave the country. But many of those who remain seem determined to put the war memories behind them. I was surprised to see Tamils in Trincomalee working to attract Indian tourists to the 'Ravana trail'.

While to Indians Ravana was the devil incarnate, in Sri Lankan legend, he was one of the most powerful and inspired of ancient kings. The difference of interpretation is of no small magnitude in Sri Lanka, which has long feared domination by its much-larger neighbour.

But in Trincomalee locals say that as long as the 'Ravana trail' is drawing tourists, subjective spins on the myth don't matter.

It's only natural for nations to trade most heavily with their neighbours and, indeed, the success of east Asia has been driven in no small measure by the willingness of China, Japan, Taiwan and South Korea to leave old wars in the past, at least when they are cutting business deals.

In contrast, there is no region in the world with weaker trade among immediate neighbours than south Asia where trade within the region has stagnated at 5% of total trade with the world.

Sri Lanka could be the country to move the region toward a new trade regime. The government is proposing a grand deal that could unlock trade with India and provide a huge boost to the economy. The opposition comes from Sri Lankan businessmen fearful of Indian competition. But India welcomes the deal, in part as an opportunity to balance China's growing interest in Sri Lanka as a linchpin on its supply routes through the Indian Ocean.

Sri Lanka is only too happy to exploit its felicitous location in return for even a small share of China's gargantuan outbound investment; China is investing heavily in the Sri Lankan port at Hambantota, the home base of the Rajapaksa family.

There is some risk that the peace dividend could prove fleeting: a 2009 study by the US Agency for International Development found that 40% of nations that end a civil war will revert to violence within a decade. However, Sri Lanka's peace could well hold because of the decisive end to the war.

There is also a fundamental national consensus that the future should be decided based on what works, not on the ideological debates that retarded Sri Lanka's development for so long. By the late 1990s, even the main left-leaning party, the SLFP, was moving toward a more modern development model built on an open economy and trade liberalisation.

Over the course of its war, Sri Lanka grew its economy slowly but positively, by a total of 206%. The country now has economic and administrative momentum. The government can build prosperity without interruption by suicide bombers.