Monday, June 30, 2014

Myanmar: Revival of the Lost Kingdom

Myanmar still requires extensive reform before investors will jump in with both feet, but noticeable progress is underway.

Myanmar is one of Southeast Asia’s poorest economies, with a per capita GDP of $868. Despite its strategic location—sharing a border with India, Bangladesh, China, Laos and Thailand—Myanmar was isolated from the rest of the world until 2011, ruled by a military junta since 1962.

The general election of 2010, a landmark event for the country, was Myanmar’s first step toward the transition from military rule to a “civilian” democracy. But the opposition party led by Aung San Suu Kyi boycotted the elections, citing widespread electoral fraud. Moreover, a parliamentary committee in Myanmar recently rejected a proposal to amend a constitutional clause that prevents the pro-democracy leader from becoming president.

Still, the quasi civilian government, led by reformist leader President Thein Sein, has embarked on a slew of economic and policy reforms since coming to power in 2011. Sanctions by the EU, U.S., Canada and Australia were suspended as a response to the reform movement, after which international investor interest grew, resulting in a surge of foreign direct investment.

Myanmar is considered to be a resource rich country with huge economic potential, but with a narrow base of growth primarily concentrated in the agricultural and energy sectors. Industry, which accounts for 20 percent of the nation’s GDP, is dominated by the electricity, oil and natural gas sectors, which together account for 75 percent of total industry value.

On its face, reform efforts in Myanmar have paid off.

Key economic reforms in Myanmar concerning the easing and simplification of foreign investment restrictions and procedures have moved ahead under the new Myanmar Foreign Investment Law (MFIL) of 2012. The country moved toward a managed floating of its currency, the kyat, which was earlier pegged to the U.S. dollar. This has eased significant complexities faced by investors and traders related to the multiplicity of exchange rates before. The authorities have also shown commitment toward granting more autonomy to the central bank in monetary policy decisions. Budgeted social spending on health and education has also increased.

Apart from these key reforms, the current government has been responsive in inviting private sector participation in telecommunications, awarding two licenses: to Telenor from Norway and Ooredoo from Qatar. As a result, most macroeconomic indicators have shown improvement in the post-reform period. GDP growth has accelerated to an average of more than 7 percent year on year (8.25 percent in 2013/14). Private sector credit has accelerated at a double digit pace as the government allowed the licensing of new banks. Budget allocations for social sector spending were increased from 0.9 percent of GDP to 3.0 percent of GDP. The fiscal deficit has also remained below the authorities’ target of 5 percent of GDP (All indicators are IMF/World Bank estimates as official data in Myanmar is considered to be highly unreliable.)

Foreign direct investment (FDI) has been growing. Total cumulative FDI into Myanmar until 2013 stood at $44 billion, of which electricity, oil, and natural gas accounted for 75 percent. China, Hong Kong, Thailand, Singapore, Korea and the U.K. are the biggest investors. Post-reform inflows have surged, accounting for more than 5 percent of GDP per annum. This reflects the eagerness of foreign investors to develop Myanmar’s natural resources. However, core manufacturing investment has been very low. The IMF remains optimistic about Myanmar’s long-term growth, given broad based reforms continue. It expects real GDP growth to average around 8 percent over the long-term.

Three years of reforms have yielded mixed results. Even though the economy has made progress, implementation of these reforms and further clarity of the law at a broader level remains the government’s key focus before general elections in 2015. Foreign investors are still wary of political instability, policy reversals, corruption (which Transparency International’s Corruption Perception index ranked Myanmar 157 out of 177 in 2013), the problems of unskilled labor and the country’s huge infrastructure deficit.

Apart from large scale economic and policy reforms, Myanmar should work on three major reform areas in order for it to sustain its growth in the long-term.

First, it must address its internal ethnic conflict urgently, as this is a major deterrent for long-term foreign investors. Myanmar is a multicultural state, officially comprising 135 sub-groups in eight major ethnicities, namely Kachin, Kaya, Kayin, Chin, Bamar, Mon, Rakhine and Shan. These ethnic groups occupy the peripheral mountainous areas of Myanmar, which make up 60 percent of the land area, while the majority Bamar ethnic group, which represent two thirds of the population, inhabits the center. Many of Myanmar’s ethnic armed groups have signed individual ceasefire agreements with the government, but the government is aggressively pushing for a “single nationwide ceasefire agreement.” The government’s policy of laying down arms prior to political dialogue hasn’t worked well with ethnic insurgent leaders. Their demands for the federal government to increase its efforts are not getting an adequate response. Stabilizing the periphery remains of the utmost importance to the government.

Second, broad based business reforms are slow. The implementation of all laws, and more clarity on the foreign investment law, will be crucial. Recognizing Myanmar’s effort to reconnect with the global economy, the World Bank and World Economic Forum (WEF) included Myanmar in the Ease of Doing Business and Global Competitiveness Survey (respectively) for the first time. Even though Myanmar ranked 182nd out of 189 countries in the Ease of Doing Business survey, the report shows improvement in areas such as tax reforms. However, starting a business in Myanmar is more difficult than in any of the other countries surveyed. According to the WEF, access to finance, corruption, political instability, a low skilled workforce and insufficient innovation capacity are the major obstacles would-be entrepreneurs face in Myanmar. Business reforms would be the next most crucial area for the Thein Sein government.

Third, investment in education is critical in addressing the problem of unskilled labor in Myanmar. According to the Organisation for Economic Cooperation and Development (OECD), Myanmar’s education sector has been severely neglected under the military regime. Education spending is much lower compared to its regional peers. High primary school drop-out rates and low enrolment rates at secondary schools are the biggest challenges facing the government. Investment in education at this stage is necessary, as demand for skilled labor will rise with massive investment proposals in the pipeline. Sustaining an 8 percent GDP growth rate will thus need adequate investment in the education sector going forward. According to McKinsey, the average productivity of a worker in Myanmar is 70 percent below that of benchmark Asian countries, and the country will need to more than double its labor productivity by 2030 to achieve 8 percent annual GDP growth.

Three years of reform have brought visible change in the perception of the international community toward Myanmar. However, international investors remain cautiously optimistic about the country, and most of them prefer to “wait and watch” until further clarity on policies and the business environment is available.

Prachi Priya is an economist at a top corporate house.

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