Policy contradictions hold back

economic prospects

Wednesday, 7 December 2016

Whilst fiscal adjustments are in disarray, the Central Bank
which is supposed to conduct the countrys monetary
policy independently is being increasingly subject to
political influence, according to recent newspaper reports.
The Central Bank being out of the hands of the Ministry of
Finance makes fiscal-monetary policy coordination even
more difficult
The year 2016, which started with the now forgotten Sri Lanka
Economic Forum well-attended by the likes of George Soros and

Joseph Stiglitz, is going to end up with disturbing economic

fluctuations and continuing policy contradictions. The highranking politicians seem to grab every opportunity to attend such
conferences abroad as well without gaining much benefits to the
nation.

As I predicted in the immediate aftermath of the local

economic forum held in January this year, such glorified events do
not help the country to attract foreign investments or to
accelerate economic growth as long as the macroeconomic
fundamentals remain fragile. The absence of a consistent policy
framework prevents any correction of those disarrays in the
foreseeable future.
Hopes for economic stability fading
Just two weeks after presenting the Budget speech 2017, the very
same parliamentarians, who endorsed the Budget proposals for
raising the taxes on goods and services consumed by the ordinary
people for the sake of fiscal consolidation, are now up in arms to
raise their own perks on the initiative of the Prime Minister
himself. These include various forms of additional allowances and
new vehicles to be given to the MPs. This ridicules the sacrifices
that are being made by the masses in the name of the so-called

fiscal consolidation which, of course, has little meaning to them.

On the external front, exports are down by 4.1% raising the trade
deficit to $ 5.5 billion in the first eight months of this year. Foreign
Direct Investment (FDI) amounted to a meagre $ 336 million
reflecting a decline of 37% from last year. This contrasts with the
massive foreign investment inflows of over $ 8 billion a year
anticipated for the Megapolis project alone. Such mammoth
infrastructure projects will have to be funded by foreign loans on
commercial terms posing severe risks to the already weak
Government Budget and the countrys balance of payments in
time to come.
Meanwhile, the emerging inflationary pressures are likely to
aggravate the macroeconomic imbalances. The year on year
inflation (as measured by the National Consumer Price Index) rose
to 5.0% in last October, compared with 3.0% a year ago.
Tax burden on the poor rising
Retention of the fiscal adjustments that are required to contain
the budget deficit is a formidable challenge faced by the coalition
Government. Most of the proposals in the last years Budget had
to be reversed due to objections raised by certain groups within
the Government and public protests. The recent decision taken by
the President to review the proposed traffic fines is indicative of
the difficulty in maintaining the Budget proposals intact this time
too.

Budget 2017 reflected much enthusiasm

for fiscal consolidation, meaning a reduction in the persistent
budget deficits so as to ease the debt burden. The increases in
the Value Added Tax (VAT) and other indirect taxes are the main
tools adopted by the Government to reduce the budget deficit
whereas there are no immediate plans to raise income taxes or to
curtail extravagant expenditure, as I elaborated in my previous
columns in this newspaper. This exerts considerable burden on
the poor as the goods and services subject to indirect taxes are
levied irrespective of the income level of the consumers.
The Government has been able to fulfil the fiscal consolidation
commitments to a large extent by reducing the budget deficit
from 7.4% of GDP in 2015 to 5.4% of GDP in 2016, as stipulated in
the Extended Fund Facility (EFF) agreement with the IMF. This was
achieved mainly by a 9% increase in indirect tax revenue. The
share of indirect tax revenue increased from 81% in 2015 to 84%
in 2016 reflecting a corresponding decline in the share of income
taxes from 19% to 16%. The total collection of income taxes fell
by 10.3% from Rs. 263 billion in 2015 to Rs. 236 billion in 2016
Higher perks for MPs nullify fiscal adjustments

A supplementary estimate is to be presented to Parliament

seeking approval to purchase 28 cars at a mammoth cost of Rs.
791 million for 27 Ministers, Deputy Ministers, State Ministers and
Opposition Leader. This unbecoming move totally contradicts with
the fiscal consolidation efforts envisaged in the Budget, though
such perks might be politically necessary to minimise any
possible breakups.
The Prime Minister, joining the third reading of the Budget debate,
is reported to have stressed the need to increase the salaries of
parliamentarians so as to strengthen the parliamentary system.
Accordingly, the PM has proposed to pay a monthly allowance of
Rs. 100,000 to each MP to carry out his duties in his electorate,
and to raise the daily allowance to Rs. 2,500 from the present
level of Rs. 500. It was also proposed that air travel facilities
should be made available to MPs in the north and east.
Reportedly, the PM had quipped that his wife, a university
professor, is paid a much higher salary in comparison with the
salary he earns as the Prime Minister of the country. Referring to
these remarks of the PM, a staff writer of a website has this to
say, On an unrelated note, if you are planning on becoming a
career politician, dont do it for the money. Youll end up just as
unlucky as most of us. Maybe youll be better off as an engineer,
a doctor, or a senior lecturer (www.roar.lk).
FDIs diminishing
The success of the Governments infrastructure-led development
programme, which forms the backbone of the current economic
agenda, depends heavily on foreign capital inflows. A whopping $
44 billion of foreign capital within five years is envisaged for the
flagship Megapolis project alone, whereas the actual FDI inflow for
this year is going to be not more than $ 600 million. This is in
spite of the generous tax concessions and various other benefits

given to foreign investors.

Globally, it is evident that foreign investors in making their
investment decisions give high priority to factors such as political
stability, social cohesion, macroeconomic fundamentals, labour
discipline, law and order, ease of doing business and corruptionfree administration. Sri Lanka has had a poor track record in most
of these attributes. In particular, policy inconsistences are a major
constraint to attract foreign investment to this country. The
frequent strikes and public protests too discourage foreign
investors.
Central Bank under siege
Whilst fiscal adjustments are in disarray, the Central Bank which
is supposed to conduct the countrys monetary policy
independently is being increasingly subject to political influence,
according to recent newspaper reports. The Central Bank being
out of the hands of the Ministry of Finance makes fiscal-monetary
policy coordination even more difficult.
The PM and the Finance Minister had reportedly questioned the
officials of the Central Bank last week over their failure to control
the depreciation of the Rupee against the US dollar which had
reached Rs. 150. Needless to say, market-determined exchange
rate and interest rates are crucial in managing an open economy
in the absence of import controls. The suppression of these two
policy instruments at the whims and fancies of the administrators
always leads to destabilise economies, as evident from many
countries including Sri Lanka.
The current depreciation of the rupee is a reflection of the
weakening of the balance of payments which shows a larger trade
deficit and drying-up FDI inflows this year, as mentioned above.
Undoubtedly, prevention of the rupee depreciation will worsen
this precarious situation.

Strangely, the recent Budget contains several directives given to

commercial banks with regard to credit allocation among different
sectors. Arguably, it is a prerogative of the Central Bank. Besides,
the Bank had abandoned such credit directives when the country
transited to a liberalised economy decades ago. Reversal of this
well-tested policy is unwarranted at this stage.
In the meantime, certain functions of the Central Bank are to be
transferred to other agencies. These include the countrys
payments platform, public debt management and Employees
Provident Fund. While such transfers may be necessary from the
viewpoint of financial sector modernisation in the current digital
era, it is critically important to ensure the autonomy of the
Central Bank in making such reforms.
W.A. Wijewardena, a former Deputy Governor of the Central Bank,
has articulated the adverse implications of these reforms in
recent news media pointing out the perils of shifting the national
payments platform to an outside body.
Policy mix-up
The absence of a consistent policy framework is detrimental to
harness Sri Lankas growth potential even at this later stage while
the other emerging market economies in the neighbourhood are
forging ahead rapidly using modern technology and innovations.
The concept of knowledge economy, which is the driving force of
such economies, is reduced to a mere political slogan in this
country without making any headway towards knowledge-driven
economic growth, as reiterated in my previous articles in this
newspaper.
Policy contradictions evident in many spheres drive away
potential foreign investors. As already noted above, FDIs are
essential to carry out the infrastructure projects earmarked by the

Government. The downfall of FDIs this year once again signals the
difficulties in attracting foreign capital. This compels the
Government to draw more and more foreign loans to execute its
infrastructure projects with diminishing opportunities for PublicPrivate Partnerships (PPPs) in the gloomy economic outlook.
Considering the longer gestation periods of such projects and the
widespread concessions given to foreign investors, any significant
economic returns cannot be expected from them in the near
future. Hence, settling the foreign debt commitments linked with
those debt-funded projects in years to come is going to be
extremely difficult, given the already persistent debt sustainability
risks.
(Prof. Sirimevan Colombage, an economist, academic and former
central banker can be contacted at sscolom@gmail.com.)
Posted by Thavam