Kelegama sheds light on issues and challenges facing economy

By Shabiya Ali Ahlam

A senior economist expressed last week that Sri Lanka clearly showcases “problems of productivity”.

Institute of Policy Studies (IPS) Executive Director Dr. Saman Kelegama at the launch event of the UN-ESACP 2012 Annual Report asserted that despite the country’s investments being a little over 30% of GDP in 2012, the average 6.5% growth indicates the efficiency of the economy.

“If measured by the incremental capital output ratio, this is above 4.5 when it should have been 4,” he said.

Attempting to shed light on the prevailing issues of the economy of the country, he highlighted that having recorded an average growth of 8% in 2010 and 2011, a growth rate of 6.4% was witnessed in 2012 as per the latest Central Bank Annual Report. Dr. Kelegama attributed the slowdown of growth to the stabilisation package which was introduced earlier last year and partly to the sluggish recovery of the global economy.

Structural problems

Noting that that relaxation of the monetary policy and the tightening of the fiscal policy facilitated the growth process for about two years, he stated that it could not be sustained due to structural problems in the economy.

“This growth was accompanied by an expanding deficit in the external account as well as the domestic account. When these deficits expand, it puts pressure on the interest rates and other policy variables and it becomes difficult to sustain the growth rate at a high level,” Kelegama explained.

Meanwhile, the stabilisation package, with a flexible exchange rate and higher interest rates capped by higher tariffs for a number of consumer durables, came in later than expected, Kelegama acknowledged that the policies managed to reduce the current account deficit of the Balance of Payments (BOP) from 7.8% in 2011 to 6.6% in 2012, and the fiscal deficit from 7.5% to 6.4% for the same period.

He added that despite currency depreciation and import tariff enhancement on items such as motor vehicles, the current account deficit did not reduce significantly due to the unsatisfactory performance of exports. With imports and exports having declined by 5.8% and 7.3%, the current account deficit was 6.6% in 2012 regardless of an increased remittance inflow of US$ 6 billion and tourist earnings of US$ 1 billion.

Pointing that the gross reserves of US$ 6.9 billion by end 2012 was composed of borrowed funds and not net earnings, Kelegama opined that there was limited room for relaxing monetary policies.

Stating that this could be achieved by bringing down interest rates which would boost the economy and enhance growth, he said: “It is only by addressing the key structural reforms of the economy that we could bring about manageable imbalances in both the external and the domestic account.”

Speaking on the reforms that need to be implemented, according to Kelegama, Sri Lanka needs to improve competitiveness of export, and increase mainly the productivity of the agriculture and public sector.

Lopsided expenditure

While UNESCAP advises Sri Lanka to have greater emphasis on the quality and composition of public expenditure rather than aggregate budget deficits and public debts, Kelegama highlighted that the nation’s current expenditure is “lopsided,” with interest payments accounting for 5.4% of the DP, and wages and salaries which is of 4.6%, and transfer and subsidies taking up 3.1% of GDP.

Commenting on current expenditure holding 13% of GDP, he pointed out that this is equivalent to the country’s overall revenue in 2012. “Sri Lanka has to borrow for all other current and capital expenditure. This is the reason why the nation has not been able to show a surplus in the current account for the last several years,” he opined.

Stressing that the country’s expenditure needs reprioritisation, Kelegama attempted to justify this by comparing expenditure allocations for education with other countries in the Asian region.

Education

A presentation revealed that in Sri Lanka during 2011 the expenditure on education as a percentage of GDP was 2.3%, compared to 3.2% in Korea, 6.7% in Malaysia, 3.8% in Mauritius, 3.9% in Singapore and 4.2% in Thailand.

With nearly 3% of GDP being allocated to cover the losses of State-owned enterprises, he pointed that Ceylon Petroleum Corporation alone accounts for 1.2% of the GDP, while Ceylon Electricity Board takes up 0.39%, and SriLankan Airlines and Mihin Airlines about 0.39%. “If these losses hadn’t incurred, at least an additional 1% of GDP could have allocated to education, and that puts us on par with Korea,” Kelegama expressed.

He emphasised that the budget deficit from 6.9% GDP in 2011 to 6.4% in 2012 has been brought mainly by cutting capital expenditure which was 5.5% of GDP on 2011 to 4.9% in 2012. “This is not a desirable policy from the long-term growth perspective,” Kelegama said. Taking into account the mentioned scenario, he stressed on the need to allocate more money for capital expenditure and human development.

Sustainable development

UNESACP drawing attention to the development role of macroeconomic policies, particularly the distributive and development role of fiscal policies, emphasised six pillars of sustainable development.

Kelegama read out the mentioned pillars: 100 day job guarantee program for informal sector workers, universal pensions, disability benefits for all disabled, universal health coverage by 2030, universal access to basic schooling by 2030 and universal access to energy services by 2020.

While the report argues that the establishment of the mentioned will cost an average of 5-8% of GDP whereas it could only be found by domestic resource mobilisation, Kelegama stated that the country is close to achieving many of these goals. However, he asserted that the key challenge for Sri Lanka is different compared to what the ESCAP report captures, although funding constraints prevail.

Taxes

Identifying tax as a factor that contributes to the low revenue of the country, Kelegama said that income tax in Sri Lanka was relatively low in comparison to competing countries. While Sri Lanka has had an average individual tax of only 0.6% from 2003-2007, Indonesia had a tax of 1.7%, Korea stood at 3.2%, Malaysia at 2.5%, Thailand at 2% and Vietnam a tax of 0.5%. Noting that Vietnam’s percentage was lower than Sri Lanka’s, he pointed that it makes up for this by having a .7% corporate tax compared to Sri Lanka’s 1.87%.

Stating that in 2011 the income tax GDP declined by 0.1% of GDP in 2012, Kelegama said: “This is because of the adjustment of the tax rate. The adjustment happened without broadening the tax base. On the tax administration side, a lot of work has to be done.”

Bringing to light Sri Lanka’s ratio of direct to indirect tax being close to 20:80, he stated that the ration should instead be 40:60. “As long as the revenue from direct taxation remains low, this ratio will prevail and this in turn means that the bulk of the burden of indirect taxation will be felt by the poor people,” Kelegama asserted.

Social security programs

Acknowledging that Sri Lanka’s social security programs have large coverage and are widespread, Kelegama stated that they are highly fragmented, with several ministries, departments, and provincial councils executing different projects, often leading to duplication and coordination difficulties among the institutions.

“The challenge is to improve targeting in programs like Samurdhi and use the limited available resources for the benefit of the most needy,” he stated.

Kelegama went on to say that rather than finding additional resources for meeting some of the social security areas highlighted in the ESCAP report, the most important aspect with regard to Sri Lanka at this juncture was integrating and consolidating the existing social welfare program.

Highlighting that benefit amounts remain low across all transfer programs and pensions for the informal sector, he said that the sustainability of non-contributory programs such as the Public Sector Pension Scheme is important given rapidly ageing population in Sri Lanka.

“These problems have to be fixed before allocating more financial resources for social security programs. If this is not done, the existing system will not have additional funds, and should that happen, we will not obtain the desired results from these programs,” Kelegama said.

Touching on social security for the informal sector, he shared that the segment comprises of 62% of the labour force of the country. Although many in the sector are not beneficiaries of social security programs and attempts have been made to cover some specific sectors such as farmers and fishermen via insurance schemes, Kelegama noted that the informal sector accounts for a significant contribution to the economy and its strengths and weaknesses should be assessed by a comprehensive study so that its contribution to overall economic growth could be enhanced.

  Pix by Sameera Wijesinghe