Top economist says property tax will bring revenue without hurting the poor
Expert analyses Govt’s deal with IMF
Last Tuesday, the International Monetary Fund’s (IMF) Executive Board declared it had completed the first review of Sri Lanka under the 48-month Extended Fund Facility (EFF), providing the country with access to around US$ 337 million.
Peter Breuer, Senior Mission Chief for Sri Lanka, told a news conference in Washington D.C. that this second tranche brought the total IMF financial support disbursed so far to about US$ 670 million out of the total amount of about US$ 3 billion. The programme continues to support Sri Lanka’s efforts to restore macroeconomic stability and debt sustainability, safeguard financial stability, and enhance growth-oriented structural reforms, he said. He noted that Board approval recognised the challenging policy actions implemented by the Sri Lankan people to put the crisis behind them.
He added: “Sri Lanka’s performance under the programme was satisfactory. All quantitative performance criteria for end-June were met, except the one on expenditure arrears. All indicative targets were met, except the one on tax revenues. Most structural benchmarks were either met or implemented with delay by end-October 2023. These macroeconomic policy reforms are starting to bear fruit and the economy is showing signs of stabilisation, with rapid disinflation, significant revenue-based fiscal adjustment, and reserves build-up.”
In the wake of the news conference, Sri Lanka’s Ambassador in Washington D.C., Mahinda Samarasinghe, messaged the government about the view in the US capital. He said the view in government circles was that the credit should go to President Ranil Wickremesinghe for leading the drive to win IMF support backed by an efficient team of officials. The President himself took delight in the fact when he told Parliament on Wednesday, “Upon assuming leadership last year, I inherited a country struggling with financial distress. Remarkably, no political leader in our nation was willing to step forward and undertake the responsibility of steering the course of a financially ailing state. None of the heroes and leaders currently addressing this esteemed Parliament possessed the courage to step forward during the critical juncture when I assumed the responsibility of leading our nation…”
In an exclusive interview with the Sunday Times, Dr Shantha Devarajan, Professor of the Practice of International Development, Edmund A. Walsh School of Foreign Service, Georgetown University, Washington D.C. and an Advisor to the government, answered questions relating to the IMF and related matters.
The IMF has agreed on a second tranche of the Extended Fund Facility. What does this mean?
The approval of the IMF Executive Board of the first review of the EFF means that the macroeconomic stabilisation and the adjustment programme that the Government of Sri Lanka agreed to in March of this year are broadly on track. The programme includes various measures, in monetary and fiscal policy as well as regulations, with specific dates. The approval means that, in the opinion of the IMF and the Government of Sri Lanka, the reforms for the first review have been met. These reforms included changes in taxation, subsidies, interest rates, and cash transfers. The approval and the release of the second tranche of the EFF means that the debt restructuring programme with the official creditors and private bondholders is also making good progress and is likely to be concluded in the near future. Finally, not only will the release of the second tranche of about $337 million bring in muchneeded foreign exchange but the IMF Board's approval will also enable the World Bank and Asian Development Bank to disburse their budget-support operations, which could amount to about $800 million.
It is well known that the IMF sought an increase in electricity tariffs. These have risen to higher levels with wages remaining static. How do you see this?
The increase in electricity tariffs was part of the programme that the Government and the IMF agreed to in the EFF. The reason is that, without such an increase, the government was subsidising electricity, and these subsidies were draining public resources. Moreover, electricity subsidies disproportionately benefit the rich, since they have bigger houses with air conditioners and many refrigerators. Estimates are that about 40-60 percent of the subsidy goes to the richest 20 percent of the population. This is a huge waste of public money. By raising electricity tariffs and using some of the revenue to provide targeted cash transfers to the poor, we can insulate the poor from the price increase while making sure the rich pay their fair share.
An 18% Value Added Tax is coming into effect from January 1 next year. This is a three percent increase from the current year. It is bound to force prices to go up. Your view.
The increase in VAT is necessary because Sri Lanka has one of the lowest tax-to-GDP ratios in the world. The government needs to increase tax revenues from multiple sources, including VAT. It will raise prices, but this is a
one-time price increase. Furthermore, to the extent that the higher revenues contribute to reducing the fiscal deficit--which was the cause of the high inflation last year--the VAT increase will help control inflation in the future.
How would you view Sri Lanka's economic performance this year? What are the prospects for 2024?
Sri Lanka's economic performance this year was certainly better than last year, which was a disaster. Notably, Sri Lanka brought inflation down from 70 percent in September 2022 to 2 percent in September 2023, one of the fastest reductions that we have seen. Economic growth was still negative but much less than in 2022; it is expected to turn positive in 2024. If the government continues on the reform programme, the economic prospects for 2024 will be good, as confidence in the economy returns.
In your view, who would you give the most credit for the deals with the IMF?
I would give the most credit to Sri Lankan policymakers for the reforms that led to a successful first review of the EFF. In particular, Central Bank Governor Nandalal Weerasinghe, deserves credit for the remarkable stabilisation of the economy, including the reduction in inflation from high double-digits to low singledigits in less than one year. The Finance Ministry also deserves credit for the tax reforms and expenditure cuts that have brought the primary fiscal deficit down in line with a path that will lead to a sustainable debt. In addition to the policymakers, I would give credit to the Sri Lankan people, including civil society groups and opposition leaders, who scrutinised, debated and sometimes criticized the reform programme. These exchanges helped improve the programme and, more importantly, ensured that the direction of change enjoyed a broad-based consensus, which is essential for the sustainability of the economic recovery.
How would you describe the IMF's role in Sri Lanka's economy in 2024? This is particularly in the light of President Ranil Wickremesinghe dubbing 2024 as the election year. That is both for presidential and parliamentary general elections.
The IMF's role in 2024 will be no different from 2023, namely, to support and monitor the reform programme so that the country emerges with a sustainable debt and resumes economic growth. That 2024 is an election year could have two effects. On the one hand, the incumbent government would benefit enormously by sustaining the reform programme and helping the economy recover. On the other hand, the experience with elections around the world is that, during the election year, there is an increase in populist policies that benefit some groups in the short run but harms the economy in the long run. Which of these two effects dominates will determine the health of the Sri Lankan economy in 2024 and beyond.
There has been considerable speculation about property tax and other related measures. Your comments.
Sri Lanka needs to increase its tax revenues. As a general principle, the rich should be taxed more than the poor. One of the greatest sources of wealth among the rich is their property and this is largely untaxed. So, a property tax makes perfect sense if you want to raise tax revenues without hurting the poor.
Do you foresee a further liberalisation of exchange controls in the new year?
I cannot speculate on future exchange rate policy. What I can say is that, as the foreignexchange reserves position improves, it is likely that controls will be relaxed to enable more imports, which will, in turn, stimulate exports and economic output.
What are your views on dealing with mounting bribery and corruption?
The IMF's Governance Assessment Diagnostic (DAG) report and the Sri Lankan Civil Society report on Governance both highlight the depth and breadth of corruption in Sri Lanka. Weak governance is the underlying reason why Sri Lanka was forced to default on its debt and therefore strengthening governance is the key to reviving the Sri Lankan economy. For example, the IMF's GAD identifies the Inland Revenue Department and Customs Department as among the most corrupt ("least integrity"), with the corruption spreading to the bureaucracy. It is no surprise that Sri Lanka has such a low tax-to-GDP ratio. To raise tax revenues, Sri Lanka needs to increase the tax collected from existing tax policies, which means tackling the corruption that enables people to evade taxes.
Are there any prospects of stolen assets recovery for Sri Lanka?
The World Bank and the United Nations had initiated a Stolen Asset Recovery Programme (STARs) during the Yahapalanaya government, but it was stalled after the 2019 elections. President Wickremesinghe said in his throne speech (policy statement) early this year that his government was committed to restarting the programme. The World Bank and the UN are ready to resume the effort as soon as they receive an official request from the government.