One day a wealthy Englishman travels to Italy on business. While there he decides to buy a hand-crafted cupboard to furnish his new summer home in Spain. He visits an exclusive store in Rome, which sells furniture sourced from a small carpentry workshop in Morocco. This furniture is fabricated from wood imported from a sustainable wood plantation in Brazil. The Italian store-owner is sipping a cup of fine Sri Lankan tea, which he discovered while visiting a friend in Russia, who imported the tea from a Middle Eastern tea-broker. This broker makes frequent trips to Sri Lanka to purchase the tea from the Colombo auction, and while there, enjoys staying in many of the hotels around the island to take a break from work. His apartment building in Dubai, was built by a multinational construction firm, which employs many Sri Lankan professionals and workers - who in turn remit their hard-earned savings back home to support their families, to provide for both their immediate needs and opportunities for betterment. Some of this money goes into setting up small enterprises, which create local employment, and at the same time, provides valuable foreign exchange to help fund Sri Lankan imports and pay off foreign loans.


The above example shows only a fraction of the ways we are all linked in a complex web of commerce, finance and trade in today’s global economy. Even if we wanted to, we cannot change this fact. Just imagine what would happen if we put up a wall around our country to shield ourselves from the outside world. We would not be able to run our garment, tea, spice, plastics or other factories since we would not be able to purchase the inputs and machinery needed to operate them. Tourism would be limited as we would not be able to provide the modern amenities travelers have come to expect in an increasingly competitive global tourism industry. We would not be able to communicate by telephone, nor maintain our roads, dams, IT and other infrastructure needed to run our country. Moreover, there is ample evidence from around the world – especially East and Southeast Asia – that locally designed integration with the world economy has generated growth and reduced poverty.


Experts unanimously agree that today, we are undergoing an unprecedented financial crisis of proportions not seen since the Great Depression of 1929-31, and that its full dimensions still have not been played out. Due to the complex inter-linkages in finance, trade and commerce, every country in the world has been and will be affected by the present economic crisis. Instead of wishing it away, we must urgently and responsibly face up to this fact, analyze in concrete terms the ramifications the crisis is having and will have on the Sri Lankan economy and find the best defensive measures that can be taken to blunt this impact. At the same time, we must look at how we can best position ourselves for the eventual upturn in the market.


There is potentially some good news. Over the next few months, we can expect the price of oil-related products and food to drop, which should benefit ordinary Sri Lankans and industry to some degree. However, let’s be realistic - at present there is more bad news than good. Moreover, for the first time since the Second World War, international trade and capital flows to developing countries are both shrinking simultaneously for the first time in more than a generation.


In other countries many people are finding that they have less money to spend. They have either lost their jobs, have had their wages cut or are simply frightened to spend. Before the economic crisis they may have increased their spending by borrowing money. The trouble is, people can no longer count on doing this. Furthermore, their concern about their jobs and/or the uncertain future makes them keen on building up their savings rather than spending. In any case, banks themselves are not lending because they are stuck with toxic assets (assets that have fallen sharply in value) that originated from US sub-prime loans. These have seriously damaged their balance sheets. Banks have been reluctant even to lend to each other, resulting in frozen credit markets.


But, you say, the Governments in those countries have been bailing out the banks by giving them money. Yes and no. Governments have been extending money - but only to recapitalize the banks, to enable them to lend once more. However, as banks are not certain how much of their assets are toxic, they are reluctant to lend, and are hoarding money to build up their balance sheets. Furthermore, as businesses have begun to downsize or collapse due to the drop in demand resulting from the drop in the value of assets, this has set off a chain-reaction of events, which make the lending environment even more uncertain. In such a crisis situation, banks will not wish to lend money to any government which fails to pay back loans or does not appear to be a good credit risk.


Not only is there a strong possibility that the supply of foreign borrowing will dry up, in addition, in regions like the Middle East, the fall of oil revenues and the reduced supply of money could have an adverse impact on many Sri Lankans working there. This fall in oil revenues has had a marked effect on the formerly booming real-estate market, and there are already signs of a slow-down in the construction industry. In both cases, this not only means that there will be less money for workers to send to support their families in Sri Lanka, but in broader terms, a significant loss of foreign exchange to Sri Lanka which is used to stimulate the growth of the local economy and repay foreign borrowing by the government.


Globally, people are spending less money as the economic downturn impacts on jobs and incomes, and they will buy fewer clothes, drink less tea and take fewer holidays. This has already begun to adversely impact on Sri Lanka’s airline, tourism, garment, spices and manufactured goods industries.


If that wasn’t bad enough, it is difficult to predict how long this economic crisis will last and its exact dimensions. Some experts say it will take 12-18 months for the recovery to begin; others say it could take as much as five years. However, they all agree that the world will go into recession, banks will continue to struggle and credit will be limited for businesses and people alike.


We could talk doom and gloom all day – let’s face it, we Sri Lankans love to see the bad side of a situation. But we are a clever and resourceful people, and should be looking at how we can turn this to our advantage.


The first thing we must recognize is that we are not immune from the effects of a global downturn and that we cannot swim against the tsunami of economic opinion. There is no golden way out of the problems caused by this crisis for Sri Lanka – or for any other country. Though economics is a well-established science, the crisis took experienced economists and financiers by surprise, and none of them will venture to predict how it will eventually play out. Another thing we must be aware of is that the crisis and the eventual recovery will have a lag effect. We have seen the crisis first spread from the US to European countries and begin to spread to Asia, the Middle East and Latin America. The speed of recovery for each country will be largely dependent on each individual country’s actions or inaction in relation to changing global developments. Though some have argued that Sri Lanka will not be impacted since its economy and financial markets are less integrated into that of the international economy, the signs are there that this is not the case. The saying, "no man is an island" is particularly true in today’s interlinked world.


Having faced up to reality, we then need to sit down and carefully analyze the impact of the crisis on our economy so that we can take policy decisions to protect against its ill effects while at the same time determine which opportunities we can seize when the world economy recovers. We must look at each of our imports and exports and work out what will happen. How will those involved in imports and exports all the way down the supply chain be affected? How will the changes across the world affect our balance of payments? Will we continue to be able to service our debt? What are the policies we can apply which will ease these problems? Who will be the most vulnerable in the immediate future and how can we protect them?
The temptation is to give handouts. In the short term that may be attractive, but where will the money come from to pay for these handouts? Higher taxes perhaps; but someone has to pay those taxes, and in the end, it will be all of us, rich and poor alike. Perhaps we could borrow money? As we have shown above, that may not be so easy today and what we borrow eventually has to be paid back, if not by us, then by the generations that follow us. There is also the issue that higher taxes would diminish the disposable income in the hands of investors and entrepreneurs, and thereby discouraging the very entrepreneurship that would be required in order to recover.


Some support for key industry sectors is necessary. As a humane society we should and must also support the poorest. So, some financial support is necessary, but it should be carefully targeted, monitored and kept to the absolute essentials so that the rest of our people do not become overburdened. The recent stimulus package of assistance put forward by the Government is an encouraging start. More needs to be done. We should also ruthlessly cut non-priority expenditures and waste.


Ultimately, though, the real answer lies in greater competitiveness. We have to step up production of goods which are not only cost-effective, but just as importantly, meet the expectations of the discerning consumer. If our products and services are better than those of our competitors in other countries around the world, then we can take a bigger slice of the shrinking cake. The converse is also true. If we do not become more competitive, we will end up with a much smaller slice. This will inevitably lead to a destruction of jobs and incomes. What we therefore require is a steady improvement in productivity – more output from the same resources or reduced resources.


Government has a central role to play in fostering competitiveness by creating the proper economic policy framework and climate, fiscal discipline and prudence, because the budget deficit is often the main source of instability in the system – as it fuels inflation, increases the cost of funds in the economy and puts pressure on our balance of payments and exchange rates. First and foremost, the Government must maintain macroeconomic stability by means of low inflation and a strong balance of payments position. Without these conditions, we cannot achieve a competitive economy.


High budget deficits have many pernicious effects on economic growth. Firstly, they lead to an increase in prices, as more money chases the same supply of goods and services. Inflation is particularly pernicious because it impacts most adversely on the poor, who do not have the compensating benefit of owning assets whose value increases as prices rise.


Large budget deficits also result in high interest rates, which discourage investment. With no investment, businesses stagnate, which in turn results in fewer jobs, lower productivity and falling incomes. High costs in doing business are not conducive to developing competitive enterprises.


In addition, large budget deficits also put pressure on exchange rates by fuelling inflation. The competitiveness of an economy is eroded if domestic prices are increasing faster than those of competitors and trading partners. This situation has to be overcome by adjusting the exchange rate to address the inflation differential. A strong rupee at the moment is hurting exports and making imports cheaper. That is not helping us to be competitive. A more realistic exchange rate for the rupee against other currencies will give us a competitive advantage at this stage.


Depreciation of the currency does increase inflation and the cost of living. However, the effects of a misaligned exchange rate are much worse. By trying to protect the exchange rate, one utilizes valuable reserves at a time when one needs a healthy cushion to cope with the negative impact of the global downturn. This destroys businesses, jobs and incomes. Furthermore, the global drop in food and fuel prices provides an opportunity for governments to make the necessary adjustments.


Turning to the specific situation in Sri Lanka, there is no doubt that a large part of the macroeconomic pressures that are buffeting our country originate outside our shores and are linked to the adverse global economic environment. However, we cannot get away from the fact that domestic policies are also adding to our travails and making it more difficult to withstand the external developments.


We come back to the problem that unsustainable budget deficits are the root cause of the macroeconomic problems that we face. High interest rates and a non-competitive exchange rate are symptoms of this underlying malaise. We need to take a system-wide view and bring the economy into better balance to restore its growth impetus. This is not a new problem. Large budget deficits have often existed in the past. But in the present situation in which the entire world faces an unprecedented economic crisis, we face a very hostile global environment and this places a higher necessity on good house-keeping.


How do we deal with the crisis? Normally, the first thing to be sacrificed in an economic downturn is skills training. Yet this is the most critical time for us to give our people the skills to be competitive. Rather than cutting back on training, we should be offering as many opportunities, especially in languages such as English, but also in the new market languages of Chinese, Hindi and Arabic.


We can also be better at providing the energy needed to run our factories, keeping the costs of all utilities down, by being more resourceful in exploiting alternative energy opportunities, as well as careful purchasing of fuel oil while world prices are low. This will benefit all of our businesses - micro, small, medium and large. We also need a concerted plan to promote conservation through increased energy efficiency.


There are other things that we can do which today are deemed unfashionable by some in our midst, but if conducted correctly, could give us a competitive advantage. We could and should exploit our geographical position as the gateway to India, as our neighbor has a fast-growing middle class and a massive market. Colombo port has been doing this successfully for years. Another example of this potential is demonstrated in the fact that since "Open Skies" and "Visa on Arrival" policies were extended to India, Indian tourist traffic has increased to become the largest single country source of tourism in Sri Lanka. We need to widen that out to the rest of the economy. Completing and signing the Comprehensive Economic Partnership Agreement (CEPA) would be the most powerful thing we could achieve in this direction during these difficult times.


One other thing we should do which has become quite controversial in recent times, is to aggressively seek international aid which may be more freely accessible, and offer better terms than commercial borrowing. Recently, there has been a trend towards criticizing and demonizing international aid agencies and international NGOs, which is counterproductive to our interests. Now is not the time to be making enemies, now is the time to seek support for locally designed priority programmes and to build alliances. That is why we should be talking to the World Bank, International Monetary Fund and Asian Development Bank and other bilateral and multilateral donors - not in a subservient way, but with dignity and mutual respect. These institutions have assisted us in the past and many of them continue to do so. Given our long relationship with them, they must be treated as partners. Of course, the ultimate decision-making power rests with us.


We should also bear in mind that international NGOs have become increasingly important players in providing funds for development, with the new phenomenon of social entrepreneurs. For example, the Bill and Melinda Gates Foundation has a fund larger than the whole of the USAID budget.


Some in our midst prefer to ignore the importance of the international community in our development. It is back to the wall I described earlier; throw up a wall and you deprive our people of many things they cannot obtain any other way. Some say that we are surrendering to colonial interests, yet look at Vietnam, South Korea, Singapore, Malaysia, Taiwan and yes, even India and China – all of them have actively sought to integrate into the world economy, while successfully maintaining their independence, integrity and identity, have grown into strong economies. We can easily follow these successful examples. Sometimes I wonder if the blindly inward-looking argument is more a reflection of fear and insecurity within ourselves, than anything else - a convenient excuse not to face up to unpleasant realities. More so, at a time when every nation is on high alert, pulling together their best minds to find workable ways to weather this grave crisis as it hits its citizens, we too, must proactively ensure that we are taking responsible steps to safeguard our country from this threat. At this juncture, it is every country for itself, and only the fittest will prevail.


It must be emphasized that the present global economic crisis began with a meltdown in the financial sector - which rapidly spread to other sectors in the real economy. In Sri Lanka, we, too, need to be vigilant to prevent any crisis within our financial sector from triggering a full-blown crisis in the rest of the economy. We need to be careful in handling the problems we are presently facing within this sector and also in the way we handle our relationships with the international banking community.


We should be clear, this crisis was not of our making - but it does affect us all. And, we achieve nothing if we are divided. There are times in the life of any country when national unity becomes paramount. At such times, political differences should be cast aside for the sake of the people. Now, more than ever before, we Sri Lankans need to work together for the betterment of Sri Lanka and our people. The extremes never produce the solutions we need – the middle way does. No doubt the Opposition will want to treat this crisis as an opportunity to undermine the government, but before they do so they should think long and hard. If they were in government could they handle the current situation alone? The answer to that is clearly, no! Equally, the government does not need to be defensive; that can only make matters worse. Do they need the opposition to support them at this difficult time for our country? Yes!


Hank Paulson, the previous US Treasury secretary recently stated that "We are dealing with a historic situation that happens once or twice in 100 years." The eminent Harvard Economic historian Niall Ferguson, in an article for the London Financial Times, opined that, "It is all but inevitable that we shall see serious political and geopolitical upheavals in 2009, as the recession takes its toll..." The vast proportions of the current economic crisis call for us to urgently engage in a comprehensive national discussion on the direction our country should take over the next ten years.