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Business


Energy debate often misses the point

Paradox of huge subsidies and high electricity prices

By Paul Steele
The government has just announced the date in eight weeks time when it will present its 2007 budget. Central to this budget must be resolving the energy crisis. The first tentative steps have been taken, but the underlying causes have yet to be properly addressed. The solution lies in actually implementing the recently proposed energy policy and focusing on the real crisis of energy infrastructure. The country cannot afford to wait. In 2005, government spending on fuel subsidies was estimated to be about Rs 42 billion – although the government clawed back Rs 18 billion in petroleum taxes. This still leaves an enormous subsidy figure of over Rs 24 billion in 2005. This is more than the government’s entire spending on education in the same year.
The energy subsidies
The energy subsidy goes both for petroleum products, and for electricity. The petroleum subsidy goes to the Ceylon Petroleum Corporation (Ceypetco) which along with the Lanka Indian Oil Corporation (LIOC) provides gasoline, diesel and kerosene. The electricity subsidy goes to cover the losses of the Ceylon Electricity Board, which sells electricity to consumers way below the costs of production. In 2006, the subsidies have grown still further. Attempts have been recently made to reduce the subsidies, but they still remain.
Subsidies and higher prices
But does this mean that the only solution is higher prices for the consumer? Strangely not – at least not for electricity. Paradoxically Sri Lanka has some of the highest electricity prices in Asia, and yet electricity prices are still massively subsidized. Sri Lanka’s average electricity price in 2005 was Rs 7.7 per unit, but the average cost of production was Rs 10.35 per unit and had risen to over Rs 12 in 2006. How has this paradox of high prices, despite subsidies, arisen? The explanation lies in the extremely high costs of electricity production in Sri Lanka – and this is at the heart of the real energy crisis.
Distracting battles
While all oil importing countries in the world have been impacted by rocketing oil prices, Sri Lanka’s predicament is particularly dire. The economic damage from high world oil prices is worsened by a series of long run failures in the energy sector. Those with responsibility for the energy sector have been drawn into intense political and economic battles over how to structure the industry. The two major battles have been in the electricity sector over what should happen to the Ceylon Electricity Board (CEB) and in the petroleum sector over the entry of the Lanka Indian Oil Corporation (LIOC) into the Sri Lankan market. The battle over energy policy has drawn in political parties, trade unions, and external agencies – in the form of the Indian authorities in the case of LIOC and in the form of the Asian Development Bank in the case of the CEB. This legacy is recognized in the Government’s Mahinda Chintana which states: “Political and other interferences have created immense problems in our energy sector.”
The real energy crisis
While these battles have been raging over restructuring the energy industry, they have in some ways diverted attention from the real energy crisis. At the root of the crisis has been a glaring failure to invest in any significant electricity production over the last decade. The country has also failed to properly improve on energy conservation and the high losses in electricity transmission. But it is the failure to invest in new electricity supply which has led to the country’s very high costs of electricity production. While demand for energy has been growing rapidly, investments in major hydro power or coal has been non existent. For this failure all political parties must share the blame. They have been assisted by the lack of commitment to solving the country’s national energy needs by many other players from civil society including religious groups and environmentalists who should be more responsible. These groups have consistently lobbied to prevent the building of new coal or hydro power plants.
Lack of a mechanism
The much delayed Upper Kotmale Hydropower plant is one example of how different forces conspired for over a decade to undermine a sensible energy investment. The delays cost the country over Rs 40 billion in lost power. While decisions over the energy mix and power plant locations are controversial and contested in every country, there are mechanisms such as public inquiries, government reviews or parliamentary committees to reach a final consensus. In Sri Lanka, no energy decision ever seems to be final. Just when consensus is reached a new lobby or political force appears to drum up a new cause for delay. Energy investments are also particularly large projects running into millions of dollars so the incentives for corruption and bribery are equally significant. These challenges plague much public investment decisions such as highways and ports. But in these cases, there is often a strong local lobby that sees the benefit of having the investment. For an energy investment which may in the case of hydro power lead to flooding of lands, or lead to localized pollution in the case of coal plants, the benefits of the investment are for the country as a whole. The local residents generally bear only the negative imapcts. So unless there are clear and credible mechanisms to reassure local residents and provide compensation – and enforce a decision once it has been reached – the deadlock over new energy investment that Sri Lanka has faced over the last decade, will continue.
Demand and supply
Surging electricity demand and lagging supply exhibit both the strengths and weaknesses of Sri Lanka’s political structure. The CEB has had major success in its rural electrification programme. In this, the CEB is driven on by local politicians, who are rewarded with political support if they can provide electricity to their constituents. But the same local politicians (through the patronage political system) often fight tooth and nail to prevent an energy supply investment which local residents feel or can be made to feel will create negative impacts.
But how does the failure to invest in major new hydropower or coal plants link to energy subsidies? In the absence of new electricity investments, the fastest growing sources of energy supply are privately operated power units most of which use oil – either heavy furnace oil or auto diesel. These are some of the most expensive and most polluting ways of producing electricity. A staggering 25% of the petroleum imported into Sri Lanka in 2005 was for power generation. The result is that 60% of Sri Lanka’s electricity is produced by petroleum powered plants – using either heavy furnace oil or diesel. Environmentally those who have opposed new energy investments to reduce pollution have been their own worst enemy.
Economically, this high reliance on petroleum for power generation means that the rising world price of oil has sent Sri Lanka’s electricity prices rocketing. Even before the oil price rise, Sri Lanka by not using cheaper hydro or coal had some of the most expensive electricity prices in the region. Subsidies have been introduced to cushion the impact of rising oil prices, but this does not address the real energy crisis of producing electricity with a very expensive technology.
This explains the paradox of how Sri Lanka’s electricity consumers receive huge direct and indirect subsidies and yet still face higher prices than most other countries.
A way forward
The government in August 2006 presented its proposed energy policy, which includes a deliberate restriction on any new oil fired power plants. The government has also restarted work on the Upper Kotmale Hydropower plant, started a coal fired plant at Norochcholai and announced a series of other investments.
The challenge is whether the government, politicians and civil groups can reach consensus to actually complete these projects and overcome the delays of the last 20 years.

***

Need to increase the banking habit and bank accounts

I am devoting this week’s column to the above subject of the need in Sri Lanka to increase the banking habit and the public resort to banks and use of bank accounts. Here, I am quick to foresee a possible public retort such as “why should we encourage our people to use our banking system when the banks themselves are not following the best ethical standards and behaving as good corporate citizens?”. There is indeed a public perception – which is often evidenced by many “Letters to the Editor” in our print media, complaining about some general or individual dereliction of duty or poor or indifferent service to customers by banks.
There is also the public perception that all that the banks have done is to have made enormous profits and put up huge nicely decorated and furnished buildings and that they have done nothing for our people, our economy and our country. So why encourage or help to enlarge the coverage of banking?
People also say that the strong marketing slogans used by banks such as “ we are your partner in progress” or “we are a bank with a heart” make no sense when the customer is in default. Then the bank’s slogan is forgotten.
This public criticism of banks is obviously not limited to Sri Lanka. It’s a global trend. While lawyers are the favourite, bankers are also a popular subject for jokes, anecdotes and criticism – often offensive. For example there are the following. A banker is a fellow who lends his umbrella when the sun is shining and wants it back the minute it begins to rain. (Mark Twain). Banks have done more injury to the religion, morality, tranquility, prosperity and even wealth of the nation than they can have done or ever will do good. (US President John Adams, 1819). Or “If you see a banker jumping out of a window, jump after him for there is sure to be money where he lands”. (Voltaire)
Banking system
While recognising these criticisms of banks, I am afraid I cannot join this chorus of criticism. Having studied and taught banking and banking law for the past over forty five years, I am firmly of the view that to criticize the banking system is like looking up and spitting. The spittle falls on you. Banks have become an integral and important part of our economy and our daily life. We cannot do without them. Especially our business and trade depend on them very heavily and when banks are not open for business on weekends or on public holidays or on special bank holidays, business people are worried and make special arrangements about payments and the movement of cash.
The Banks are also the most important segment of our financial system which is a complex system. To explain in an elementary way, the financial system is an integrated set of financial institutions, financial markets and payment and settlements infrastructure that operate collectively within a regulatory and supervising framework to provide our people a mechanism for payment and settlement of obligations and also providing financial intermediation and sharing of risks. We must thus strengthen our financial institutions which are led by the banks.
Banking is at the centre of financial confidence and economic expectations, and those activities that create and destroy prosperity. Thus bankers are traditionally seen as authority figures in their demand for respect and obedience. This they have long received. To no other business will we hand over money for safekeeping without questions or security. Banks are also the only businesses that are permitted to borrow several times over their net worth.
It is also only banks that can operate cheques and savings accounts. Finance companies can accept public deposits but they cannot issue cheques – which only banks can do. The ability to deal in cheques – pay and collect them – enables banks to “create or manufacture money”. The general public or even an average banker may not agree that “banks create money” but this position is now well-established.
Recently, a leading British banker remarked that banking is a terribly challenging business. You have to be watching what other banks are doing, and watching what’s happening in the financial services industry generally, so that you are not missing out on an opportunity that you should be looking at. It is moving so quickly that you have to move with it. The same British banker (rightly or wrongly) also compared a bank to a bookmaker when assessing risks in lending etc. Both have to measure risk, which is the very stuff of life. Bankers and bookies alike need to assess the runners and back the winners, while accepting that many of their choices will lose, often for reasons outside their control. The bookie calculates the odds, so as to reduce the cost of losing, and the banker does the same. Both use bloodlines, past performance, current conditions and the level of competition in picking whom to back, when, where and at what odds.
Banking Coverage
Currently there are about twenty four commercial banks operating in the country – eleven domestic banks and the balance foreign banks. These banks provide a branch network and other service outlets numbering about two thousand. It is noteworthy that the branch network is mainly provided by the State banks – the Bank of Ceylon, the People’s Bank and the National Savings Bank. Banking services through Automated Teller Machines is also increasing. We how have about 900 ATMs. So also EFTPOs (electronic funds transfer facilities at point of sale) which now number about 7000. The banking density in 2005 was about 7.5. The banking density basically means the number of bank branches per hundred thousand persons in the population. Over twenty years ago in 1986 when our total population was 16.8 million, we had only 700 bank branches and a banking density of less than one percent.
In developed countries (for example, England, Canada, Australia) banking grew rapidly when all wages and salaries had to be paid into the employees’ bank accounts and not by cash to their hand. It was this direct credit of wages and salaries that made banking popular and even necessary. In Sri Lanka, in the majority of work places and offices, wages are yet paid direct to the employees in cash. Until this change occurs, not all adult Sri Lankans will require a bank as in developed countries.
According to information this writer obtained from the Association of Professional Bankers in Sri Lanka, the number of people in the country holding bank accounts has not been reliably ascertained. This is due to the fact that there are persons who hold more than one account either in the same bank or at different banks. It has been estimated that there were sixteen million accounts in Commercial Banks and Regional Rural Development Banks in 2004. In addition, there were approximately ten million deposit accounts with the National Savings Bank of which a certain number were inactive or dormant. These figures would be increasing annually.
Although not authenticated with figurers, some bankers are of the view that the number of persons holding bank accounts in various forms does not exceed 45% of the total population. This is hardly sufficient. For example in Australia which has about the same total population as Sri Lanka (19 million) almost everyone has some sort of bank account – even a savings account. Children’s accounts are marketed in every school and “Piggy Bank” accounts are extremely popular. This is not happening in Sri Lanka. On my return from my stint at Australia’s Monash University I advocated the enactment of a short Act of Parliament called “The Promotion of Banking Act” to make it legally permissible for employers – both public and private sector – to pay their employees’ salaries through bank accounts. Although I submitted these proposals to the Ministry of Finance for inclusion in the Budget proposals they were not implemented.
In the above situation, I was happy to read a media announcement last week that the Minister for Public Administration and Home Affairs, Dr Sarath Amunugama has decided that from May 2007 the salaries of public servants will be paid through the banking system. The decision to pay public servants (currently over 900,000) salaries through the banking systems will be first submitted to the relevant Trade Unions for consideration. It will then be implemented coinciding with the May Day of 2007. The Minister had added that this new proposal will be a novel May Day gift for the working class because it will be a welcome move given the progress of the payment of pensions using the same method which has proved to be a great success. Currently, most pensioners receive their monthly payments through the State Banks.
The Banking sector has witnessed a huge increase in the numbers of bank accounts following this move. The Minister also said that a survey to find out how many public servant maintain bank accounts has been launched by the Census and Statistics Department and the Treasury officials.
Under this new proposal, public service salaries will be automatically credited to bank accounts many of which will have to be opened.
The Ministry of Public Administration has found that currently over 10,000 public management service officers are involved in processing salaries of public employees. This huge effort, time and expenditure can be dispensed with once public sector salaries are paid through bank accounts.
Dr Sarath Amunugama has taken a practical decision which should have been implemented over twenty years ago like in other countries. When a bank account is opened and your salary deposited to it, the banking habit will also be developed. An important side benefit is that the employee’s spouse and family may also enjoy the benefits of the salary which when paid in cash is sometimes spent on drinks and gambling. The private sector should also be enabled to pay salaries of their staff through bank accounts. The type of legislation I had proposed to which I referred to earlier can permit this.