Submission for Budget 2019 by an independent group of professionals

Budget 2019 must focus on immediate sharp reduction of imports, increased exports with relevant FDI and improved transparency and governance all round to create the enabling environment – Pic by Shehan Gunasekara

Since early 1950s foreign currency earnings of Sri Lanka have been less than the foreign currency spent1. A clear case of us living beyond our means. The resulting deficit has been bridged initially via concessional borrowings and in recent years with increasing commercial borrowings. As a result, a series of balance of payments crises has been experienced and the currency has steadily depreciated.  

Over the years a complacent and callous attitude2 has developed that even though the currency will depreciate steadily, the rising debt service obligations can be easily rolled over passing the burden to the future generations. Since 1965 Sri Lanka has had 16 episodes of IMF support one way or the other. A sorry state of affairs for an independent sovereign nation. 

However there has been a qualitative change lately. It is not more of the same anymore. The debt service obligations of January 2019 could not be seamlessly rolled over and had to be settled from the meagre reserves. 

A promised Chinese loan failed to materialise in January and now expected only in late February along with possibly a higher interest rate than before. There is talk of another IMF facility even before the end of the current programme which is due to end later this year. The qualitative difference in the situation is that the total foreign indebtedness of the economy has reached 60% of GDP and the sovereign foreign debt will pass 50% of total sovereign debt by the end of this year. 

This is clearly unsustainable given the annual debt service commitments in the near future being in excess of incremental growth of exports, tourism and value addition from FDI. Without immediate action to mitigate the developing scenario3 the foreign debt crisis4 can develop into a disaster5.   

A mix of measures of the following three major categories are required from the Budget 2019 to address the foreign debt crisis. Or else a full-blown disaster with collapsing currency and perhaps a debt default for the first time of Sri Lanka’s history in the near future will be a foregone conclusion. 

a)Reduce non-essential imports: this is the urgent priority and can be achieved via across the board measures as well as targeted specific measures. Allowing the currency to depreciate and permitting the interest rate to rise result in reduced imports across the board. To be effective depreciation must be sharp and over 15-20% or so and interest rate hike must be at least 2-3%. This, however, is detrimental to growth and welfare especially of the poor in the immediate term. Targeted measures on the other hand are of the type imposed recently on the import of non-essentials by way of additional CESS levies, cash margin increases and reduced loan to value ratios and so on. These measures must be retained in the Budget 2019 and possibly enhanced until a degree of stability is achieved. The required legitimacy for such measures must be provided by example by way of significant sacrifices by politicians in terms of new cars, travel overseas and other such perks which contribute to the drain of exchange. At the same time targeted safety nets to support poor and disadvantaged communities are a must. New public capital investments from the Budget 2019 must be limited to projects with low import content, early payback and high RoI. 

b)Increase overseas earnings:  In-spite of all the associated rhetoric, this approach though quite slow to take traction, is the ultimate solution. We were heavily dependent on remittances, apparels and traditional commodities exports in the past. Remittances are already on a downward trend. Large increases cannot be expected in apparels and traditional commodity exports in the immediate future. Tourism is a highly-promising sector with high growth from a relatively modest base. While the recent bout of currency depreciation can be expected to be followed by an increase in exports, the well-known structural rigidities in the economy, along with institutional barriers, widespread corruption and frequent political crises stand in the way of a potential boom in exports. The ongoing initiatives for export development must be relentlessly pursued with greater conviction and vigour. FDIs though considered to be a means of improving the external cash flow of a nation, the net inflow of foreign exchange from FDIs depend on the import content of the investment and the extent of leverage through the domestic banking system which generate more imports. Policy measures are required in the Budget 2019 to address this and give preference to FDI for exports of value-added goods and services. Priority must be given for applied research, technology transfers, enhancement of productivity and quality along with developing the required talent pool. 

c)Improve transparency and governance: increased transparency and greater public awareness of the magnitudes of public debt, total foreign debt (both including contingent liabilities) and debt service obligations should contribute towards a supportive public opinion on tough measures however painful they are. Reducing red tape and complexity, removing informational constraints leveraging on technology and elimination of all forms of corruption are critical aspects of governance. Improved governance must cover the effective control of money laundering, transfer pricing and illegal cross border movement of currency and assets. Thereby can be “re-branded” as a destination for “White” as against “Black” money. The Budget 2019 provides an opportunity for a statement of “intent” and commitment in this regard, and for early upgrading of Sri Lanka’s international sovereign rating.

In conclusion, our recommendation for the Budget 2019 is to focus on immediate sharp reduction of imports, increased exports with relevant FDI and improved transparency and governance all round to create the enabling environment.   

Footnotes

  1 In  other words, populist measures including various subsidies were given precedence over policies promoting productivity and output of tradable goods and services in particular. With hindsight, this should have been the other way around.  

2 Assisted by low transparency, paucity of information in the public domain and ineffective communications. 

3 With possibly large leakage of forex via money laundering, transfer pricing and illegal cross border transfers of foreign currency/gems and precious metals supported by the 2017 decriminalising of exchange offenses.

4 In the three-year period from 2019 the debt service obligations are likely to be of a similar magnitude due to the rising interest rates due to Sovereign rating down grade and rising global interest rates. Yet another spike in debt service obligations is in the horizon say, after a gap three or so years later.

5 With a continuing twin deficit, along with rising domestic household debt due to heavy promotion of loans for vehicles and other imported consumer durables.