20 DECEMBER, 2017

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DECEMBER 18, 2017 / AUTHOR: W.A. WIJEWARDENA / 9 COMMENTS

Coomaraswamy Chinthana: The Rationale Of The Country’s Economic

Policy Package

By W A Wijewardena –

The need for demystifying economic policies

Economic policies have always been mysteries to laymen. They have become
mysteries because top economists often present them in a language not
comprehendible by ordinary people. Policy makers design policies after
much labour and thought. Yet, they fail to explain their rationale to people,
leaving them in a state of confusion. This leads to the creation of a trust
Dr. W.A Wijewardena
deficit between the policy makers, on one side, and those who are to benefit
from policies in the long run, on the other. It also gives opportunities for
those who feel being threatened by new policies to put pressure on governments not to go for them by
mobilising people and other forces to serve their cause.

As a result, even the policies which are essential and carry high economic costs if they are not
implemented are abandoned in mid course due to prolonged public protests. Sri Lanka’s past is full of
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such instances. It also explains why Sri Lanka’s economic growth had been low – about 4.4% on
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annually
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the whole
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and why itEDITOR’S
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a laggard compared to
its peers. The present government which has experienced a declining economic growth rate – 4.8% in
2015 and 4.4% in 2016 – has particularly been vulnerable to this ominous development. As the latest
economic data suggest, the performance of the economy in 2017 would be most disappointing for the
government with the growth rate estimated to be slipping even below 4%. This makes the realisation
of the ambitious targets pronounced in Vision 2025 of the government – an increase in the average
income of a Sri Lankan, known as the per capita income, from US $ 4000 in 2017 to US $ 5000 by
2020 – extremely challenging.

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SLEA’s attempt at disseminating economic information

In this background, the Sri Lanka Economic Association or SLEA, the topmost body of economists in
the country, had ventured into the task of generating an open and free discussion of the policy
package being proposed by the present government. This it did by hosting a public forum on the
direction of future economic policies in Colombo last week. In fact, such a discussion would have been
generated by the government itself before SLEA ventured into it. Yet, as the government had done on
previous occasions, it appeared to have thought that its job was over after the documents containing
the policy had been released either in Parliament or in a gala event thrown luxuriously at a public
place.

Government’s lukewarm approach

This writer in a number of articles published in this series attempted to analyse those policies for the
benefit of the public and government policy makers (available here, here, here and here). However,
the response received from the government was a stark silence, probably because an open discussion
or a critical evaluation of its policies by the public would have been considered not to its liking.

The tense situation in the public forum

In the SLEA forum under reference, from the government side, Dr Harsha de Silva, commonly
HOME
referred to NEWS
as Harsha, DeputyOPINION WIKILEAKS
Minister of National VIDEO
Policies EDITOR’S
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Affairs, ංහල
took the podium.
Harsha had come to prominence by being the firebrand critic of the economic management of the
previous administration and, therefore, was the best-qualified to represent the government in the
forum arranged by SLEA. The private sector had been represented by the Chairman of the Sri Lankan
brand, Nature’s Secrets, Mr Samantha Kumarasinghe, equally known for being critical of the present
government’s policies, especially its trade policies. In between Harsha and Samantha was the Central
Bank Governor, Dr Indrajit Coomaraswamy, with the difficult task of presenting a balanced view,
compared to the pro-view by Harsha and the counter-view by Samantha. The audience had been
treated to a tension filled evening with the exchange of arguments followed by counter-arguments. It
is a healthy sign since economic policies should be debated freely before a final agreement is reached.
It should always be remembered that dialogue, though it may be fiery, is always better than enforced
consensus from the nation’s point of view. A detailed report of the tension mounted discussion has
been presented by Daily FT.

High flown economics need be simplified

Governor Coomaraswamy’s presentation at the forum on economic policy (available at:

https://www.youtube.com/watch?v=tmbD_82XReY ) deserves further elaboration. That is because
what Coomaraswamy had presented in high-flown technical terms was totally appropriate for the
audience at hand consisting of the country’s top economists. However, if it is to be conveyed to public
at large, it need be converted to ordinary man’s language to facilitate understanding by them. Such an
exercise is necessary since, as this writer had encountered during the weekend, even the final year
undergraduates or the MBA students of a well known state university could not properly explain the
rationale of the policy package described by Coomaraswamy. Hence, this article aims at taking the
ordinary folk through the policy package, as pronounced by Coomaraswamy, to be implemented by
the government in the next few years.

Sri Lanka Economy: Future Policy Direction

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Relishing on small gains

At the outset, Coomaraswamy brought to the notice of his audience some small gains made by the
country with respect to improving the overall outcome of the budget. Accordingly, the overall budget
deficit, that is, the excess of the total expenditure over the total revenue of the government, which had
been stubbornly as high as about 6% of the country’s total output, known as the Gross Domestic
Product or GDP, had shown signs of coming down. This has been made possible by an increase in the
total revenue of the government, from around 12% of GDP a few years back to around 14% of GDP in
the most recent year.

A surplus in the primary account

At the same time, Sri Lanka is to record a surplus in the primary account of the budget after many
years of having a deficit in that account. The Primary account is simply one component of the budget
generally used by economists to assess its health. In that account, the total consumption expenditure
of the government, also known as the current expenditure or recurrent expenditure, without interest
payments is compared with the total revenue of the government.

If revenue is higher than the current expenditure without interest payments, the primary account
generates a surplus. If revenue is less than such expenditure, then, the primary account records a
deficit. A deficit is a situation where the government has failed to control even its day to day normal
expenditure programmes.

It is like a person who spends more than he earns on day to day living. The result of such lavishness in
spending is that a person or a government will have to live continuously on borrowed money. But,
sooner or later, it would reach the stage where it would not be able to borrow any further. At that
stage, it will have to abandon all its plans for the future for lack of resources.

Desirable fiscal developments

Thus, a surplus in the primary account is considered a desirable achievement. It is not only a sign of
self-discipline but also a mechanism to at least part finance the interest payments out of taxpayers’
money. If the surplus in the primary account is more than the interest payments, then, the budget is
considered to have generated a surplus in its current account. It will not only help the government to
part finance its capital expenditure programmes but also to keep the overall budget deficit in check. A
sound fiscal policy seeks to achieve this status and according to Coomaraswamy, Sri Lanka is now
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moving along NEWS
path. ItsOPINION WIKILEAKS
success has even VIDEO
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by IMF, CHOICE
he noted, ංහල to
when it decided
release the fourth instalment of the Extended Fund Facility Programme which Sri Lanka entered with
the Fund in 2016.

Complacence is the worst enemy

These are of course small gains about which the country could be happy. Yet, Coomaraswamy opined
that it is not a reason to be complacent. In fact, complacence is the worst enemy of any government
since it elevates the government to a false sense of success. What has already been achieved on the
fiscal front has to be continued with consistency, dedication and commitment. By announcing that the
country should not be complacent about its past achievements, he has indirectly warned the
government that it should not even for a moment relax its grip on reforming the budget. This warning
should be seriously taken by the government in general and the Minister of Finance, Mangala
Samaraweera, in particular. Any laxity in these endeavours will amount to sacrificing the hard-earned
gains by the country in the recent past. It is not a risk which Sri Lanka should take at the moment.

Liability management to the rescue

Coomaraswamy drew the attention of the audience to the specific problem faced by the country with
respect to repayment of debt and payment of interest, known as debt servicing, in the next few years.
In fact, the total debt servicing during 2018 through 2020 will be much more than the estimated
revenue of the government due to an undesirable bunching of these debt payments.

A solution available to the government is to elongate the debt service payments by going for specific
borrowings that are not used for financing the budget but for reissuing the debt repayable in lax years
in the future. This is known as liability management since it amounts to changing the structure and
the time schedule of debt liabilities of the government. However, at present, there is no possibility for
the government to do so since the entirety of the borrowings to be made under the Appropriation Act
has to be used for financing the approved expenditure programmes.

Hence, to give this additional supporting power, Coomaraswamy announced that the government will
introduce a special Liability Management Act. This Act will permit the Central Bank to raise funds on
behalf of the government and outside the borrowing limits prescribed in the Appropriation Act to
even out the debt repayment liabilities by shredding the high spikes in debt repayment due to
bunching. It will, therefore, improve the cash flow of the government but it will not be a mechanism to
reduce the overall public debt over the long run. This latter is a must for the government to enforce
discipline on its revenue as well as expenditure programmes.

Monetary fallout of Hambantota Harbour leasing

Coomaraswamy also outlined the special procedure being adopted to handle the extraordinary
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windfall the government would get from leasing the Hambantota Harbour to China’s Merchant Ports
Holding Company. The lease money amounting to about US $ 1 billion will be some extraordinary
revenue being earned by the government by selling an asset, known as asset management. The normal
procedure for handling such foreign exchange receipts is that the Central Bank would buy the dollars
by providing the rupee equivalent to the Treasury, a process commonly known as printing of money.

The Treasury will in turn record it as an income in the budget and spend the rupee proceeds in its
normal expenditure programmes. It will not only boost the government expenditure but also increase
the total expenditure in the economy, known as the aggregate demand or AD directly. If the supply
does not increase, this will overheat the economy causing the inflation to raise its ugly head. Since Sri
Lanka has a free import policy, the new money will move out of the country to meet the import
demand. There is another side effect of this operation. That is, when the Central Bank buys dollars
and issues rupees, it increases its net foreign exchange holdings leading to an increase in the
monetary base – the seed money created by the Central Bank and made available to commercial banks
to create further money – by an equal amount.

Given the large size of the transaction in question, the total monetary base will increase by a huge
amount, estimated to be at around Rs 155 billion. Each rupee issued by way of the monetary base will
help commercial banks to create additional money in the region of about Rs 6.50 over a period of
about 18 to 24 months. Thus, the foreign exchange receipt on account of the leasing of the
Hambantota Harbour will create extraordinary inflation pressures in the economy in the next 2 year
period. To counter this, the Central Bank will have to increase interest rates and cut credit levels. Such
a policy measure, known as a contractionary monetary policy measure, will tame inflation but at the
same time cut down economic growth. This latter outcome is not something which Sri Lanka could
afford at the moment since it has already begun to experience a declining trend in its growth rates.

Neutralising the leasing proceeds

To mitigate these adverse effects, Coomaraswamy revealed that the funds to be received by the
government on account of this transaction will be neutralised in the Central Bank by adopting a
special procedure. Accordingly, two special accounts will be created in the Central Bank, with
government’s approval, to make the entire transaction just a book entry. The dollar component which
is in foreign exchange will be debited to one account; the rupee component will be credited to the
other account.

This would prevent the government from using the proceeds for local expenses directly. At the same
time, it will be neutral on the monetary base since no money would be released by the Central Bank to
the public or the commercial banks. Thus, there will be no additional creation of new money by
commercial banks. Coomaraswamy said that when the debt servicing on account of the loan raised to

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 construct the Hambantota Harbour becomes due, the moneys in both the dollar account and the
rupee account will be used for that purpose.

Accordingly, it will guarantee the debt repayment by the government without affecting its annual
revenue flows. This is similar to creating a sinking fund to facilitate specific foreign debt repayments.
It is indeed a victory for the Central Bank to get the government’s consent to forego the right to use
the leasing proceeds for its ordinary expenditure programmes, specifically at a time when the
government is faced with the problem of raising sufficient revenue to meet its expanding expenditure
programmes.

These are sound policies which the Central Bank is planning to adopt. They will deliver good results to
the public in the long run. Hence, the public support should be extended to the Central Bank to
implement these policies successfully.

*W A Wijewardena, a former Deputy Governor of the Central Bank of Sri Lanka, could be reached
at waw1949@gmail.com

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