A leap forward in economic governance

By Muttukrishna Sarvananthan

The last time the United National Party (UNP) came to power in December 2001, the economy of Sri Lanka was in total disarray after the fall of the Elephant Pass to the LTTE in April 2000 and the attack on the Katunayake International Airport by the LTTE in July 2001.

The huge hike in military expenditures after the fall of the Elephant Pass in April 2000 had drained the foreign exchange reserves, which was exacerbated by the lightening attack on the airport in July 2001 that severely hurt Sri Lanka’s exports.

At that time, Sri Lanka’s total exports amounted to 35% of the Gross Domestic Product (GDP), which has declined to 15% in recent times, and therefore played a dominant role in the economy. In addition, external shocks such as the rise in global oil price and the terrorist attack on the United States in September 11, 2001 contributed to the gloom of the Sri Lankan economy. Perhaps it is important to recall that for the first time in our post-independence history, the Sri Lankan economy experienced negative growth (-1.5%) in 2001.

Under the foregoing gloomy economic conditions, there was significant public support and urge for economic reforms not only from the business and professional classes, but from ordinary citizens as well. In response, the then UNP Government had developed a comprehensive economic policy document named ‘Regaining Sri Lanka’ for reforming the Sri Lankan economy. The economy bounced back in 2002 to record 4.4% growth, followed by 5.9% in 2003.Such public support for economic reforms does not exist in 2015 and in the near future.

Significant changes

Moreover, the composition and nature of the Sri Lankan economy has also undergone significant changes, for the worse in my opinion, during the nine year period from 2006 to 2014.

For example, an exports-led economy developed since 1977 was inverted to a national socialist economy fostered by import substitution policies, subsidies and handouts (such as permits to import vehicles at concessionary import duties) to various interest groups and crony capitalists, encroachment of the State into private businesses (especially in the banking and financial sector) and further entrenchment of the existing State-owned enterprises and expansion of the State-owned enterprises. In short, political nationalism was complemented by economic nationalism between 2006 and 2014.

The present government led by the UNP in coalition with the Sri Lanka Freedom Party (SLFP) has significantly steered away from political nationalism but moving away from economic nationalism seems to be challenging. The government itself is to be blamed for promising inducements in the run up to the Presidential and Parliamentary Elections in January and August 2015 , in order to win the votes of the general public; public servants in particular.

The “Regaining Sri Lanka” of 2002-2003 was replaced with an undefined and anachronistic “Social Market Economy” of 2015 incorporating, for example, pay hike for public servants, subsidised fuel and institution of price controls on certain food items.

Certain public pronouncements about the economic direction/s of this government by the President, Prime Minister, and the Finance Minister and certain proposals in the Budget 2016 are contradictory or ambivalent at best. For example, addressing the Annual Conference of the Sri Lanka Economic Association in October 2015, President Maithripala Sirisena stressed the importance of self-sufficiency in food production, which has been a failed policy in almost all the developing countries in the aftermath of the Second World War and decolonisation.

The Prime Minister in the Economic Policy Statement of this government presented to the Parliament on 5 November 2015, promised far reaching reforms of the public finances (increasing the proportion of the direct taxes to 40%, from the current 20%, of the total government revenue), public enterprises (listing of the public enterprises in the stock market thereby forcing them to comply with commercial laws of the country and sound business practices) and public and private pensions. However, the revenue outlays presented in the Budget 2016 proposes to decrease the proportion of direct taxes to 11% of the total revenue of the government.

Employment generation

Moreover, although the Prime Minister promised to create one million new jobs in the next five years, he did not specify the sectors and sub-sectors in which such employment will be created and by whom. Similarly, 500,000 public houses were promised to be built for public servants, plantations workers and the internally-displaced people in the next five years, but financing of the program was not disclosed.

The proposed listing of the public enterprises in the stock market is a laudable proposal but whether the government can actually do it is questionable, given the strong trade unions in those enterprises (especially in the Ceylon Electricity Board, Ceylon Petroleum Corporation, Sri Lanka Railways and Sri Lanka Transport Board).

The Finance Minister appears to be ignorant of common sense economics. Although there appears to be broad consensus within the government on reviving the exports-led growth model initiated in 1977 (but jettisoned since 2006) – the tariff policy on international trade enunciated in the Budget 2016 does not promote exports-led growth.

During a visit to Japan in October 2015, along with the Prime Minister, the Finance Minister urged that country not to export vehicles to Sri Lanka due to an impending balance of payments crisis. Exports and imports are two sides of the same coin and therefore one cannot promote exports by controlling imports, either by tariff or non-tariff barriers or total prohibition.

Moreover, price controls enunciated in the budget and earlier on cannot control inflation. Fiscal prudence, by curtailing public expenditures and increasing public revenue, is the one and only way to restrain inflation. The expected revenue of the government for 2016 as envisaged in the Budget 2016 is almost impossible to realise.

Although the Finance Minister has been touting the public since August 2015 to expect a “revolutionary budget,” it is hard to find anything revolutionary in the budget. Although the streamlining of the corporate and personal income tax rates is progressive, there is no proposal to broaden the corporate and personal income tax bases in order to net more revenue for the government. The present system of self-assessment of corporate and personal income tax should be replaced with taxation at source through a broader system of Pay as you Earn (PAYE). The PAYE taxes are the norm in middle income countries.

North not a focus

Ironically, there were hardly any proposals in the Budget 2016 to revive the conflict-affected economies in the Eastern and Northern Provinces. Although payment of reparations to civilian victims is the norm in other post-civil war countries such as Colombia and Nepal, in Sri Lanka, to date not a single rupee has been paid to the civilian victims of the civil war anywhere in the country.

The proposed Megapolis project encompassing the entire Western Province and the revival of the Port City Project in the City of Colombo are likely to further marginalise the poorer provinces such as the Eastern, Northern, North Central, and Uva Provinces.

In spite of the widespread recognition that one of the primary causes of the armed youth uprisings in 1971 and 1987-1989 in the central and southern parts of the country and the armed uprising in the eastern and northern parts of the country between 1983 and 2009 is the regional disparity in economic development, it is ironical that successive governments (including the present one) are promoting grandiose development projects centred in the Western Province.

In spite of the gloomy scenario painted above as regards this government’s economic policies, significant improvements in the political and economic governance in the country, restoration of the rule of law, reduction in corruption and improved international relations with the major markets for Sri Lanka’s exports bode well for the Si Lankan economy in the medium and long term through enhanced potential to attract foreign direct investments and increase exports.

The separation of the Ministry of Finance from the Executive President of the country is a leap forward in terms of economic governance.

The very fact that the trade unions were able to freely demonstrate against certain proposals in the budget, the Deputy Governor of the Central Bank was able to publicly claim that the budget deficit in 2016 will be higher than envisaged in the budget, and the Resident Representative of the International Monetary Fund (IMF) was able to publicly criticise certain provisions in the budget were reflections of the restoration of democracy, freedom and rule of law in the country. The foregoing are prerequisites for an open and competitive market economy.