Early signs of stabilisation no assurance of economic recovery and growth

The International Monetary Fund (IMF) review mission concluded that the early signs of stabilisation in the economy were not yet an assurance of economic recovery and growth.

Gist

Although the economy has achieved a degree of stability and moved away from a crisis, there is a long way to go. Promises need to be kept to achieve economic growth. There has been a shortfall in revenue and slow implementation of reforms.

IMF Review

The IMF review mission found that progress on economic reforms was slow and revenue targets had not been met. The progress of the ongoing IMF reform programme was deemed inadequate. The IMF mission concluded that although “Sri Lanka had early signs of stabilisation, full economic recovery is not yet assured.”

Progress

The IMF observed: “Sri Lanka has made commendable progress in implementing difficult but much-needed reforms.” However, there was much more to be done to restructure stateowned enterprises.

Economic recovery

The IMF noted that, despite early signs of stabilisation, full economic recovery was not yet assured. It pointed out that the growth momentum remains subdued, with the second-quarter real GDP contracting by 3.1 percent and high-frequency economic indicators continuing to provide mixed signals.

Mixed achievement

While noting the success in containing inflation, achieving domestic debt restructuring, and early signs of stabilisation, the IMF mission observed that full economic recovery is not yet assured.

Fiscal slippage

The IMF team said the fiscal slippage that had occurred underscored the need to enhance revenue to reduce the fiscal deficit to around 7 percent of GDP.

Revenue

The inability to increase government revenue to reduce the fiscal deficit has been a significant failure. At present, government revenue is only 7 percent, while expenditure is 19 percent of GDP. The fiscal deficit of 12 percent of GDP has to be narrowed to around 7 percent by increasing revenue to 12 percent of GDP.

Taxes

The IMF underscored the need to enhance revenue by strengthening tax administration, removing tax exemptions, and eliminating tax evasion.

Challenging

Reducing the fiscal deficit is a challenging task. It has to be achieved by a two-pronged strategy of reducing public expenditure and raising government revenue.

The IMF prescription, however, is revenue enhancement rather than expenditure reduction. This is based on two reasons. The overall expenditure-to-GDP ratio of 19 percent is not excessive, and there are several areas where public expenditure should be increased. This includes health, education, social security, and welfare.

However, there are several government expenditures that should be drastically reduced. Defence expenditures are a striking example. Similarly, there is excessive expenditure on maintaining unnecessary foreign missions, like in the Seychelles, an over-employed public service, and generous perks to politicians that are not provided even in developed countries.

The reduction of government expenditure is as important as increasing government revenue.

Taxation

As the IMF pointed out, there is much slippage in tax revenue due to an inefficient and corrupt tax administration, large-scale tax avoidance, and tax evasion.

Tax proposals

The IMF tax proposals should be modified to give relief to low-income employees and be realistic in implementation.

Tax system

The country should adopt a tax system that effectively reduces tax avoidance and evasion. Attempting to reform the inefficient, corrupt, and ineffective tax administration is unrealistic and futile. What is needed is a tax system that eliminates tax avoidance and evasion.

Expenditure taxes

This column has repeatedly advocated an expenditure-based tax system. High taxes on property transactions and luxury articles of consumption would rake in revenue from tax evaders.

A wider range of withholding taxes, such as taxes on interest, dividends, and profits, would also ensure higher tax revenues.

Two concerns

Two other concerns are the slow implementation of economic reforms and the impending foreign debt restructuring.

Reforms

The IMF team noted that the government has made commendable progress in implementing difficult but much-needed reforms. However, much more needed to be done.

Opposition

Owing to the unpopularity of privatisation and opposition from political parties to the reform of state-owned enterprises (SOEs), privatisation of SOEs would be difficult. This is especially so with the prospects of elections next year.

This could be a serious constraint to implementing the IMF’s conditions for continuing the IMF facility.

FDR

As far as foreign debt restructuring (FDR) is concerned, one can only hope that the ongoing negotiations will lessen the foreign debt repayment and not be a strain on the country’s foreign reserves.

Elections

The most serious threat to the continuity of the IMF programme arises from the elections next year. Dr. Indrajit Coomaraswamy has captured the risk forcefully:

He emphasised that fiscal discipline should not be lost in the lead-up to any election, as has happened time and again in the past under multiple governments. He pointed out that during some of the previous 16 IMF programmes, progress was made in stabilising the economy, as has happened over the last 12–18 months, only for the approach of elections to result in the reversal of the gains through indisciplined fiscal priming for narrow electoral gain.

Dr. Coomaraswamy went on to say that repetition of such fiscal indiscipline on this occasion would have much worse consequences than ever before, as the recent multiple crises have significantly eroded the resilience of a large proportion of the population.

Summing up

In a nutshell, so to speak, the government has made some progress towards policy reforms that have stabilised the economy. Yet there is much more to be done. There are many reforms to undertake to put the economy on a growth trajectory. The reduction of the fiscal deficit is a crucial condition that has to be met.

Although the economy has achieved a degree of stability and moved away from a crisis, there is a long way to go to achieve economic growth.

Compliance and continuity of IMF reforms are crucial for economic stability and growth.