Moving from market-oriented econ policies to state interventions and handouts

The Budget 2015 presented to Parliament a few days ago reflects the government’s effort to please as many as possible, perhaps in view of the upcoming elections. As veteran economist Dr. Nimal Sanderatne rightly stated in his regular column in this paper last Sunday, “Political compulsions rather than economic imperatives determine an election year budget”.

The problem is that an election is not a rare occurrence in Sri Lanka. Each and every year is an election year for us. We have had many elections, one type or other, in the recent past at frequent intervals. As a result, the government’s economic policies have been driven by the prime aim of winning the electorate by offering various types of handouts to voters rather than implementing farreaching economic policies to induce export-led growth with the private sector in the forefront.

So, the populist shot-term handouts have got accumulated over the years at the expense of long-term development. The Budget 2015 seems to have followed the same trend undermining the dire need to address the economic realities. Reportedly, there is something for everybody to ensure everything for somebody.

Budget reliefs

The key reliefs announced in Budget 2015 include tax reductions, pension and insurance schemes, low-interest loans, high interest rates for certain fixed deposits of elders, price reduction of local milk powder, increases in salaries and cost of living allowances, housing facilities, concessionary car import permits for migrant workers and many more.

The manufacturing sector will benefit from the proposed 10 per cent reduction in the corporate tax rates and a 15 per cent reduction in electricity tariff. The plantation sector is offered with concessionary credit, sharing of CESS on tea with producers and an increase in CESS on rubber imports. Although these reliefs would contribute to increase profitability in the manufacturing and plantation sectors, it is doubtful whether they could make a tangible effect given the problems of low productivity, technological drawbacks and poor export competitiveness encountered by the two sectors.

Economic growth depressed

Most of the handouts given in the current and previous budgets would have been unnecessary, had the economy grown at a rapid pace. High economic growth would have benefited the people by way of increased job opportunities and income generation activities. It would have also given greater potential to the government to mobilise increased revenue so as to plough back a part of it to the vulnerable groups by way of targeted safety nets instead of indiscriminate handouts. That would have eased the presently experiencing fiscal burden to a large extent.

Economic growth led by free markets is the key to reduce poverty as evident in India’s post-liberalisation phase started in 1991, according to a recent book, “Why Growth Matters” authored by Professors Jagdish Bhagwati and Arvind Panagariya. Following the promarket reforms in India, economic growth accelerated recording an average GDP growth rate of 6.9 per cent during the decade ending 2002-03, and 7.9 per cent during the decade ending 201213. The authors argue that India’s growth spur lifted many millions out of poverty. The poverty ratio fell down from over 50 per cent in the early 1990s to 20 per cent by now in India.

According to Bhagwati and Panagariya, economic growth reduces poverty, illiteracy, and ill- health through two channels. First, growth ‘pulls up’ people into gainful employment while also raising real wages throughout the economy. Growth, thus, helps eradicate poverty in a sustainable fashion while also equipping people to better access education and health. Second, economic growth provides rising tax revenues that allow the government to allocate additional finances for social services such as education, health, and subsidies to the poor.

Having liberalised the Sri Lankan economy way back in 1977, much earlier than India, the country has failed to sustain high economic growth. The annual average GDP growth remained around 6.5 per cent during 2004-2013. Following the cessation of the prolonged conflict, GDP growth rate rose from 3.5 per cent in 2009 to 8 per cent in 2010 and to 8.2 per cent in 2011 due to increased availability of resources, productivity improvements and pent up demand. However, the growth momentum could not be sustained for long, and the growth rate came down to 6.3 per cent in 2012 and 7.3 per cent in 2013 reflecting the normal trend.

The lack of coherent macroeconomic policy strategies, except the first wave of economic reforms implemented in

The problem is that an election is not a rare occurrence in Sri Lanka. Each and every year is an election year for us. We have had many elections, one type or other, in the recent past at frequent intervals. As a result, the government’s economic policies have been driven by the prime aim of winning the electorate by offering various types of handouts to voters rather than implementing far-reaching economic policies to induce exportled growth with the private sector in the forefront. So, the populist shot-term handouts have got accumulated over the years at the expense of long-term development. The Budget 2015 seems to have followed the same trend undermining the dire need to address the economic realities. Reportedly, there is something for everybody to ensure everything for somebody

the initial years of liberalisation, has been the most prominent impediment that constrained GDP growth over the years.

The growth setback was compounded by inconsistent foreign trade policies, labour disputes and election-driven policy decisions. The growth potential was further constrained by low productivity levels which emanated from inadequate research and development (R&D) expenditure and low priority given to science, technology and innovation (STI) fields in the budgetary allocations. By contrast, countries such as Korea and Taiwan have had well-structured R&D plans for decades that enabled them to achieve sustained GDP growth.

Budget lacks growth strategies

The incentives provided in the Budget to manufacturing and plantation sectors, as mentioned above, are a welcome move. However, these incentives appear to be isolated gestures rather than a stimulus package integrated into a broader economic strategy. Low productivity, high production costs and weak export competitiveness impede growth in the plantation sector. Policy interventions are needed in human capital, skills development and financial resources so as to raise productivity and to promote state-of–the–art technology and innovation within the plantation industry. Public-private sector partnership is essential to market tea and rubber products abroad in the midst of stiff global competition. Specifically, the current overvalued exchange rate has adverse consequences on the export capacity of the plantation sector though the trade chambers are silent on this crucial aspect nowadays. The Budget does not seem to have focused on these impending issues.

The case of the manufacturing sector is even worse. The country still depends heavily on garment exports having liberalised the economy three and a half decades ago. Sri Lanka has been losing her competitiveness in this type of lowwage labour intensive industries since the 1990s due to wage increases relatively to some of the low income countries that can offer cheap labour to foreign direct investors. Sri Lanka is already late by several decades to graduate from low-tech basic industries to high-tech products based on knowledge inputs.

High-tech exports account for only 0.9 per cent of total manufactured exports in Sri Lanka in 2012, compared with the corresponding ratios of 43.7 per cent in Malaysia, 26.2 per cent in South Korea, 26.3 per cent in China and 6.6 per cent in India. Overall, the Budget 2015 does not seem to have an underlying economic

strategy to address these critical issues.

R&D allocations insufficient

The Budget has allocated a sum of Rs. 900 million for 2015-2017 to implement the R&D Investment Plan (2015-2020) launched by the Ministry of Technology and Research recently. However, the amount allocated for 2015 for this Plan is only Rs. 100 million which will increase the present level of R&D expenditure by only about 1 per cent. This is the first ever R&D investment plan prepared for the country. The main objective of the R&D investment plan is to promote ‘smart’ technology and innovation solutions (as against ‘cheap’ solutions solely aiming at output growth) to improve people’s quality of life while ensuring economic, social and environmental sustainability for future generations.

The recognition of R&D in the present Budget is appreciative, though the allocated amount is hardly sufficient to make any significant impact on the country’s R&D expenditure which is currently at very low ebb of less than 0.20 per cent of GDP. In comparison, South Korea, for example, has maintained high R&D outlays of around 4 per cent of GDP for a long time. Hence, concerted efforts will have to be made to raise budgetary allocations for R&D to sufficient levels.

Inactive interest and exchange rates

The exchange rate and interest rates are two crucial instruments that can be used by the Central Bank to navigate economic activity to optimum levels in a market-based economy. When they become inactive, as in the current context, goods and financial markets operate at less optimum levels. It is not feasible to anchor both the exchange rate and interest rates in a situation of capital movements, as implied by the well established ‘impossible trinity’ theorem. I elaborated on this problem in my previous articles.

In recent times, the exchange rate and interest rates have become less responsive to market forces due to direct and indirect interventions by the Central Bank, which is not a healthy act for the economy. The Budget does not pay attention to the management of these two vital instruments though they have major implications for economic activity.

Fiscal Imbalances

The budget deficit is projected to increase from Rs. 500 billion in 2014 to a staggering Rs. 521 billion in 2015 though it shows a marginal decline from 5.0 percent to 4.6 per cent as a ratio of GDP. The revenue which is estimated to be around 14.9 per cent in 2015 would be insufficient to meet the expenditure outlay amounting to 19.5 per cent of GDP.

The bulk of the recurrent expenditure goes to salaries and wages, interest and subsidies and transfers. The government’s wage bill has gone up mainly due to an unprecedented expansion of the public sector with a huge work force running into over 1.3 million employees. In other words, one person out of every 15 persons is a government employee.

The concessions introduced in the present budget have contributed to augment the already high subsidies and transfers. The gravity of the fiscal imbalance could be understood simply by the fact that the entire government revenue has to be spent for debt service payments which consist of capital repayments and interest payments.

The government revenue, on the other hand, has remained stagnant around 12 per cent of GDP during the last couple of years mainly due to the non-expansion of the tax base. This again is a reflection of the slow GDP growth. The tax base has been further restricted by various forms of tax incentives provided by the government in successive budgets to boost the ailing economic activities. Thus, direct tax revenue in the form of personal income taxes and corporate taxes will generate only 22 per cent of the total tax revenue in 2015. The balance 78 per cent of tax revenue is to be generated from taxes on goods and services and import duties which would be passed on to consumers causing inflationary pressures and severe hardships to the poor.

The resulting budget deficit is expected to be financed by domestic and foreign borrowings. Excessive government borrowings in the domestic market not only create inflationary pressures, but also preempt resources from the private sector. The accumulated foreign borrowings particularly those in the form of commercial borrowings exert considerable burden not only on the budget but also on the balance of payments. Foreign borrowings have become imperative to service the previous debts each successive year.

Re-cap

A coherent macroeconomic strategy geared to sustain high economic growth is essential to attain a modern knowledge-based economy. In the meantime a robust policy environment is needed to address the problems of low productivity, weak export competitiveness, low business confidence and technological setbacks. Diversification of the export sector towards high-tech products should be induced by providing adequate R&D expenditure and prioritising technology and innovation in the policy agenda.

These production initiatives should be adequately supported by creating an investor-friendly market environment by freeing the output, financial and foreign exchange markets from excessive government interventions. In particular, the Central Bank’s intervention in exchange rate and interest rate determination should be minimised so as to allow them to be responsive to market forces. It is clear that these policy reforms are indispensable to attain durable economic growth and thereby to create better quality of life for people in terms of food and nutrition, safe drinking water, jobs, incomes, shelter, health and education. The need to offer various kinds of handouts and subsidies to selected groups will not arise at all in such a progressive economy.

(The writer is a former central bank official and university academic. He could be reached at

sscolom@gmail.com)