Thinking behind the economic policies of the Government and the Budget
Wednesday, 5 November 2014 00:00
The Government has presented the Budget for the fiscal year 2015 and there is widespread accusation that it is a giveaway budget aiming at anticipated elections in early next year. At the same time, the Budget is praised by the private sector for its economic direction. While appreciating these criticisms, it is appropriate to examine the thinking behind the economic policies of the Government and the Budget.
Previous governments consistently emphasised the point that the private sector was the engine of the growth. This Government, although it has not denied that point, has not emphasised on it either. It appears that the Government would like to control most of the areas of the economy rather than relying on the private sector.
SriLankan Airlines was managed by Emirates and despite the previous continuous losses, Emirates was able to run the airline at a profit. It was taken over by the Government at the end of a contract period when the relationship deteriorated after the CEO of the Airline refused to sacrifice its business interests in order to facilitate the movement of a presidential team. The airline was taken over by the Government and used for foreign trips of VIPs, sacrificing sometimes the business interests of the airline.
In addition to that Mihin Lanka was incorporated and the both airlines together draw out colossal amounts from the national Treasury. In this Budget as well $ 150 million amounting to Rs. 19.5 billion was allocated to the airline to strengthen its capital base. It should be stated that the need of the hour is not these show-off expenses.
There were discussions about the privatisation of the State banks, which proposal was met with considerable opposition. The reason for this suggestion was the high interest rate spread of these colossal two State banks, which was due to operational inefficiencies caused by political influences in recruitment and in granting loans. Private banks have also taken cover under this situation and kept high interest rate spread, which was a hindrance to growth. The Government has not done anything in this line but enjoys the investments in private banks through controlling interest acquired through Government-owned entities and influences the decision-making by appointing nominee directors to the respective boards of directors.
One indirect benefit to the Government of increasing the EPF contributions as a Budget proposal would be to strengthen the EPF and thereby more investments can be made in the stock market to have control of vital companies. Share ownership of the Government in leading banks considering the stake of Government entities Bank of Ceylon, National Savings Bank and Insurance Corporation of Sri Lanka and Government-controlled entities Employeesâ€™ Provident Fund and Employeesâ€™ Trust Fund is given below.
Hatton National Bank: 28.87%
Commercial Bank: 19.17%
DFCC Bank: 20.63%
National Development Bank: 23.58%
Sampath Bank: 12.64%
Seylan Bank: 32.40%
The Government continuously strengthens the public sector where the labour force was more than doubled to 1.4 million from 2005 compared to the total labour force of the country of 8.5 million. Measures were not taken to expand private sector employment and the educated labour force does not have the requirements of the private sector. One intention of the Government is to convert these numbers to votes in an election.
Previously privatised companies were acquired by the Government citing inefficiencies and malpractices and giving different signals in the opposite direction to the market.
The top elite of the Government is keen to have control in their hands. Out of the total allocation of the expenses according to the Appropriation Bill for the Budget 2015, the ministries and the spending units controlled by the President and his brothers excluding Parliament got an allocation of 38% of recurrent expenditure and 59% of capital expenditure.
This thinking is evident in the political arena as well in line with the actions taken against the 43rd Chief Justice and the hindrances created in the operation of the Northern Provincial Council.
In general the emphasis of the Government on industries is very low and in particular the Government adopts an anti-export policy. Efforts of the Government to reduce the budget deficit, interest rates and the inflation rate should be commended and the Government was able to bring down those indicators.
However, as far as export competitiveness is concerned, since the exchange rate was kept constant, the levels at which the interest rate and the inflation rate was brought down is not sufficient. If the interest rate and the inflation rate in Sri Lanka are higher than the competitive countries, then cost of production of Sri Lanka goes up in comparison to other countries, competitors and customers of Sri Lanka.
Exporters can set-off this increase of cost against the depreciation of the rupee, if the rupee is allowed to depreciate in line with the market forces. Since the present Government manipulates the exchange rate artificially, exporters are severely affected. The ratio of export income to Gross Domestic Production (GDP) has gone down from 33% in 2005 to 22% in 2013.
A recent analysis by JB Securities revels that the REER, Real Effective Exchange Rate, which is the weighted average of a countryâ€™s currency relative to an index or basket of other major currencies adjusted for the effects of inflation, is pitching the level of large depreciation in early 2012.
What the Government did in 2012 was to hold the exchange rate as much as possible and then allowed it to depreciate when it could not be held at that level which created a huge impact on the importers and the consumers of imported products. The Government is more concerned about its balance sheet and indicators rather than the impact on export industries.
When the rupee depreciates the Government will have to pay more rupees in repayment of foreign loans taken at high interest rates. The inflated exchange rate can also be used in various indicators such as showing a higher per capita income in US Dollars.
The effect on the exchange rate negates the effects of low corporate tax rate maintained for exporters, which is commendable and the accelerated depreciation facility allowed to them. Main exporters of the country are not effective in the way they communicate this to the policymakers.
There were two instances where the exports of Sri Lanka to Europe were affected. First was the removal of GSP+ concessions to Sri Lanka by the EU. When the EU demanded improvement of human rights which was beneficial to the citizens of the country, the Government did not agree and allowed that concession to be withdrawn. The Government at that point minimised the adverse effects to the exports and the industry of the country. Really speaking the Government did not care.
Recently also when EU warned repeatedly about exporting of illegally captured fish outside the boundaries of Sri Lanka waters, the Government did not take any action and allowed the EU to ban Sri Lankan exports. It looks like the slogan â€˜export or perishâ€™ is history for the Government.
The Government is relying more on foreign remittances rather than export income. Foreign remittances are mainly coming from Middle East countries where a large number of low income groups work. Because of the domestic issues, if they get considerable higher salary in rupees compared to the income in Sri Lanka, they would be comfortable. As a result of the migration of workers, domestic economic development also would be hampered.
Reliance on indirect taxes
The trend for governments to raise more revenues through indirect taxes seems set to continue. Sri Lanka also follows the same path. In the Budget speech there were more reductions on personal taxes. One reason for this is the difficulties of tax collection and administration. The economic reason is the expectation that the tax savings would be supportive of increasing the economic growth rate.
It should be noted that in the past Sri Lanka had experienced higher personal tax rates and administration was not a problem. In Sri Lanka the ratio of direct taxes to indirect taxes is around 20:80. In the other countries in the region the reliance on indirect taxes are not so high. In the case of India it is around 55:45 and in Pakistan it is 40:60. In Thailand it is 50:50 and in Singapore it is 40:60. In Bangladesh the figures are 35:65.
Therefore compared to the other countries in the region, developed and developing, Sri Lanka is relying more on indirect taxes than direct taxes. This means that the contribution of the rich to the national coffer is less and the same by the poor is more in Sri Lanka. This trend goes against the implications of the economic principle that the taxes can be used as redistribution of income in the society. The private sector hails this type of policy and it appears to be that the politicians think that they can convince the masses about the economic implications.
Foreign Direct Investment
FDI is very vital for the development of a country like Sri Lanka. The main reasons for the low FDI and the below-target arrivals of tourists are the foreign policy of the Government and the constant habit of the Government of giving contradictory signals to the market.
Law and order and conditions of human rights have to be improved for investors to come and there should be a precise policy framework. It appears that the Government is of the view that Chinese investors and Chinese tourists would be sufficient for Sri Lanka.
The Budget proposals are by and large a wish-list to keep everyone happy. It was pointed out by many that the allocated amounts may not be sufficient to extend the support as expected. Anticipated revenue includes amounts to be collected from tax defaulters, which shows the weakness of the tax collection process. This most probably is as a result of interference by influential persons. However the direction of the Government continued with the framework laid down in 2010.
In conclusion, it should be stated that the thinking behind the economic policies of the Government and the Budget is detrimental to the economic and social progress of the country. Those who praise as well as those who criticise the Budget should be mindful of the underlying thinking of the Government.
(The writer is a Chartered Accountant by profession and holds a Master of Business Administration degree awarded by the Postgraduate Institute of Management of University of Sri Jayewardenepura.)