Time is running out for President Gotabaya. If early action is not taken, the economy would descend to a further depth. It will certainly deny Sri Lanka the opportunity of attaining the economic glory which is the expectation of all Sri Lankans today
Gotanomics from the new President
I have argued in this column repeatedly that Sri Lanka’s economy was in a dire state, moving from bad to worse on each passing day. It was a warning to economic policy managers that they should take effective measures quickly to arrest the declining trend, turn it around and push it back to the long term potential growth path.
Except the Central Bank which was successful in taming inflation at around 5%, the real sector economic policy makers appeared to be reluctant to hear the bad news. Now, President Gotabaya Rajapaksa, elected to presidency recently, has to do the nasty job by implementing the economic policy package announced in his election manifesto. This package comprising his economic wisdom can be called ‘Gotanomics’.
But, time is running out for President Gotabaya. If early action is not taken, the economy would descend to a further depth. It will certainly deny Sri Lanka the opportunity of attaining the economic glory which is the expectation of all Sri Lankans today.
A pitfall to avoid
In the Manifesto, Gotabaya has just devoted only two pages to bring out the nature of economic ailment from which the country is suffering today. The balance 80 pages have been spent for presenting his policy package which includes Gotanomics too.
This is a good sign because he has not wasted his time for blaming the previous administration. It is in stark contrast with what the leaders of the previous administration did continuously. I can recall one hilarious incident about which I wrote earlier.
A fine lesson from a Malaysian advisor
At the Sri Lanka Economic Summit hosted by Ceylon Chamber of Commerce in August 2016, the then Minister of Finance Ravi Karunanayake castigated the previous regime for all the economic ills which the country had been facing at that time. This he did two years after taking over the administration. Immediately after his speech, it was the special guest at the Summit, Dato Sri Idris Jala, CEO of Permandu Malaysia and Economic Advisor to the Prime Minister who took the podium.
He said amidst loud laughter in the audience: “You guys are extremely lucky because you have a previous regime to blame. We are not lucky because it is the same political party under a different leadership which is in power. Hence, we cannot blame ourselves. Instead, we did a soul-searching exercise to find where we had gone wrong.”
The soul-searching exercise which he recommended to Sri Lanka was taking top bureaucrats and private sector leaders to an economic capsule, diagnose the ailment and prescribe the necessary medication. Once the job was done, both the bureaucracy and the private sector had signed it off taking ownership of the policy. That was how Malaysia had prepared itself for the emerging Fourth Industrial Revolution, code-named Industry 4.0.
Viyathmaga, the think-tank behind Gotanomics
Gotanomics comes from a series of such open consultations done by a think-tank which branded itself ‘Viyathmaga’ or the Path of the Erudite for about two years. Hence, the exercise involving the policy capsule which Malaysia had done has already been completed, saving much time for the President at a time when urgency and swift action have been the critical buzzwords.
However, it is now necessary to reassess the main components of Gotanomics in the light of emerging global as well as local developments. Further, a Manifesto is just a blueprint outlining only the major policies being pursued. Each such policy has to be developed into a detailed work programme eliminating inconsistencies, shedding which are irrelevant today and focusing on the future rather than the present.
In developing these work programmes, it is essential to get the inputs of the Central Bank to prevent Gotanomics from running into conflict with bank’s policies. Once finalised, it is necessary to have it signed off by the bureaucracy, private sector and policy leaders. It is only in that way that Gotanomics can become the policy philosophy of the country.
Modest economic goals in Gotanomics
Gotanomics has some modest economic goals to be achieved during 2020-5, compared to over ambitious goals set by previous governments. Economic growth is to be lifted from the current below 3% to 6.5%. Per capita income which stands at present at $ 4,000 is to be increased to $ 6,500, a midpoint in Sri Lanka’s journey toward a high income country.
Three key macro variables are to be kept below some benchmarks which are not very far from such numbers at present. Unemployment is to be kept below 4% which is the current rate in that number. Inflation will be below 5%, one percentage point above the maximum of this number at present. Budget deficit is targeted to be below 5% of GDP, a drastic reduction from the current 6% plus.
Two difficult if not impossible goals have also been targeted. One relates to lending rates of commercial banks where Gotanomics is planning to bring them below 10%, compared to the current levels between 11% and 20%. The other one relates to the exchange rate. Gotanomics plans to stabilise the exchange rates meaning that it will not fall below the current level of Rs. 182 per US dollar. Both are market determined and therefore are beyond the edicts of a President.
Any attempt at subverting the market would have disastrous consequences for the other goals immediately and the long-term economic growth later. That is why it is necessary to work closely with the Central Bank which is the authority on both policies.
The return of the big government
The main feature of Gotanomics is the central role which the government is going to assume in directing the economy. A National Policy and Planning Commission or NPPC is to be established under the President. Most probably, it will be headed by the veteran economist Dr. P.B. Jayasundera or simply PB, Secretary to the President. As Finance Secretary earlier, he has proved himself to be an able policy manager and an on-time deliveryman.
There were two similar bodies under the previous administration too: A Cabinet Committee on Economic Management or CCEM under the Prime Minister in the first three years and a National Economic Council or NEC under the President in the balance two years.
Both these bodies concentrated on fire-fighting and micro issues relating to the economy and failed to come up with a comprehensive national plan. The proposed NPPC should avoid this pitfall. It already has a fairly comprehensive economic plan covering all the sectors as designed by the think-tank Viyathmaga to begin with. It is a matter for NPPC to reassess it, as I have pointed out above, in consultation with the Central Bank and convert the final product to detailed work programmes to be implemented by different Government agencies.
A full-stop to privatisation
There are several other features embodied in Gotanomics that would strengthen the Government’s role. It has very clearly pronounced that no state enterprise will be privatised and even gone to the extent of proposing the enactment of laws to prohibit it. These are in fact very weak propositions since no one can bind a future Parliament to uphold them. Even with regard to the ones already privatised, the Government is going to issue directions and all private sector stakeholders within those enterprises are required to comply with them.
Since many past privatisation activities have been marred with alleged corruption charges and not been driven by pure efficiency-based changeover plans, there is a political logic behind these three moves. But the political logic has subsumed the economic logic which is based on efficiency requirements and the need for changing business strategies in line with emerging global developments. A management body functioning under a politician is unlikely to act swiftly and with foresight to save an enterprise from an unforeseen external shock.
If the past mistakes are a lesson for future planning, one should examine how the new managers in the nationalised tea plantations in 1970s failed to notice two changes in the tea markets in the Western world and act appropriately. One was the change in tea habits from time-taking tea brewing to instant tea and in the case of instant tea, to Cut, Tear and Curled or CTC tea. The other was the movement of young people from tea to soft drinks. Both were disastrous to Sri Lanka’s tea market and costs are still being borne by the country.
Hiring competent managers
Gotanomics is planning to overcome this issue by introducing two measures. One is a rebellious measure which should be supported by all. In this measure, it is proposed to hand over the management of these enterprises to competent and talented managers who would be paid market salaries and are subject to continuous performance audits. If they fail, like in a private company, they have to quit. This was the model used by Singapore for State enterprises under State ownership.
A likely hindrance to successful implementation of this model is the non-availability of a sufficient number of talented managers to run these enterprises. Singapore overcame this by hiring foreign managers on lucrative salaries but assigning time-bound targets to them. Gotanomics is silent on this possibility and therefore, it is the job of NPPC to assess it and make suitable adjustments.
The other measure is to bring these enterprises under the control of a newly established National Enterprises Authority or NEA to reform them under state ownership to assure their profitability and viability. The target is to free the taxpayers from the responsibility to bail them out if they become bankrupt.
The present model followed by Sri Lanka is to subject these enterprises to continuous evaluation by a team of technocrats housed in the Public Enterprise Department of the Ministry of Finance and assist the Parliamentary Committee on Public Enterprises or COPE to make a final recommendation.
The past COPE reports have over-focused on financial audit to the exclusion of the needed ‘enterprise audit’. In an enterprise audit, what is being looked at is whether a programme carried out by a state enterprise is in accord with its mission to mitigate emerging global and local risks.
When the financial audit focuses on financial irregularities and the media give the widest possible publicity to them, managers in these enterprises will become extra-cautious and refrain themselves from making appropriate decisions. This is the main reason for the wide-spread inefficiency in state enterprises. As such, this possibility also has to be avoided under the proposed NEA system.
Proposal for a simple tax system
Gotanomics has proposed a simple tax system with low rates and a wider tax net to ease the burden on the present taxpayers. Sri Lanka’s present tax system is like the system of Hindu deities. There are reportedly 330 million deities and the number grows every day when a new deity is created to address a new human issue. Since there is no a rational basis for creating new deities, some of them obviously overlap the functions of old ones.
Similarly, a multitude of taxes to generate revenue from every possible tax base has made it a very complex one forcing taxpayers to evade taxes which in turn has resulted in a low tax yield. A salient feature in Gotanomics is therefore to abolish several of offshoot taxes and reduce existing tax rate.
This is a very big gamble which President Gotabaya Rajapaksa is taking as the Head of the State. Both measures will reduce the continuous cash inflow into the Treasury requiring it to raise more liquid cash by way of issuing Treasury bills.
The challenge is to limit this practice to a short period and decide on an exit point. The gamble is if the tax net does not expand as expected and as a result, the cash shortage becomes permanent. Then, the proposed strategy becomes a curse rather than a blessing.
A gamble with high risks
In terms of the strategy in Gotanomics, the corporate income tax is to be reduced from 28% to 18%. The lower taxes are expected to increase the retained profits within the corporate system and plough back the excess income into new investments.
The higher profit base in the corporate sector will increase the total tax revenue despite the lower tax base. However, the reinvestment of excess profits by the corporate sector will depend on many factors over which President Gotabaya Rajapaksa has no control. It will depend on market demand, both local and foreign, competitive edge which the Sri Lankan firms have over their external competitors, new technology they have acquired, the environment for doing business, etc.
If these ground requirements are not conducive, the Government will lose in the gamble creating widened gaps in the budget.
The scrapping of the advance tax collection system
A similar gamble is proposed to be played with respect to personal income taxes as well. The present early tax collection system – Pay-As-You-Earn or PAYE tax – imposed on both private sector and corporation sector employees is to be abolished and the marginal tax rate which is at 24% at present is to be reduced to 15%.
At the same time, the tax-free threshold in the case of the employment income which stands at Rs. 700,000 will be increased providing further relief to employees who file annual tax returns. Similar to the reduction in the corporate income tax, this measure will also reduce the monthly cash inflow to the Treasury.
But, after the abolition of the PAYE tax, all liable employees and others will have to file annual tax returns and pay taxes not only on the employment income but also on the other types of income. If it happens, it will certainly increase the total tax revenue despite the low tax base. If it does not, once again the Government will face a widened budget gap.
Taking out offensive taxes
There are also proposals to abolish or reduce other types of ancillary taxes. The Nation Building Tax or NBT, Economic Service Charge or ESC and Withholding Taxes or WHTs will be abolished. The Value Added Tax or VAT will be reduced from 15% to 8%.
Two other tax proposals aiming at incentivising businesses appear to be non-working. One is the five-year holiday given to agriculture and small and medium enterprises. Since these enterprises are not in the tax net at present, the particular tax holiday is irrelevant for the purpose. The other is the zero-VAT rate given to businesses in the tourism sector provided they use 60% of local inputs when providing their services to tourists. Since it is the worldwide practice that VAT on the sector is passed onto tourists, this particular holiday does not leave a surplus with the cash-strapped tourism sector businesses.
Going for new technology
One important aspect in Gotanomics is the measures to introduce new technology. Though not explicitly expressed, it will prepare the country to the Fourth Industrial Revolution or Industry 4.0. This is a salutary measure since it aims at eliminating fear of technology, on the one hand, and making the people accustomed to new technologies, on the other.
But the full burden of equipping people with capacity has been passed onto the State university system. Since the present cash position of the Government does not allow it to increase the capacity of the State university system immediately, Gotanomics will have to activate the private sector owned higher learning system to meet the demand.
Inviting high-ranked Indian universities to Sri Lanka
In 2004, the Government had an arrangement with the Indian Government to have a few Institutes of Technology on the style of the famous Indian Institutes of Technology or IITs. With the change in the government in that year, this proposal was abandoned midway through. It is now time for Sri Lanka to reopen this path. Hence, Sri Lanka will benefit if President Gotabaya Rajapaksa opens up the abandoned dialogue when he meets Prime Minister Narendra Modi toward the end of this month.
Without quality-minded private sector-owned higher learning institutions, it is unlikely that Sri Lanka could have the needed critical pool of scientists and engineers to help it to attain its main economic goals. Gotabaya’s manifesto is silent on this issue. But the emerging ground realities might compel his administration to review this stance.
Capacity improvement in the Government sector
Gotanomics is a new strategy involving the direction of the economy through central government action. Can it make a turnaround of the country’s ailing economy? It may, as it has worked successfully in Taiwan, Singapore, South Korea and even in post-war Japan.
The secret of success in these countries was the capacity improvement in the central government to act with foresight. Thus, Gotanomics will work if the same Central Government machinery is established in Sri Lanka.
(The writer, a retired Deputy Governor of the Central Bank of Sri Lanka, can be reached at [email protected])