Budget 2021: Growth-oriented or more-of-the-same

The new Government will be presenting its first Budget in the midst of a second COVID-19 wave. What began as a national health crisis about nine months ago quickly morphed into a severe economic crisis. This shock will have lasting effects on the entire social and economic fabric of the country.

The Central Bank of Sri Lanka, the IMF, the ADB and the World Bank are projecting that the economy will shrink for the first time in two decades. Predictions vary from -1.7% of GDP to -6.3% of GDP indicating paramount uncertainty.

Wages and pensions of about Rs 1,000 billion and interest payments of Rs 900 billion are the two largest components in the 2020 provisional estimate of expenditure while projected revenue is about Rs 1,500 million. A tax giveaway of more than Rs 400 billion earlier this year has compounded the problem facing the Government.

The reality of the 2021 Budget is that allocations for many components such as wages, pensions and interest payments will increase. Tax increases are unavoidable unless there is drastic pruning of capital expenditure and so-called wasteful expenditure. The Government is also on a recruitment drive for 40,000 unemployed graduates and the 100,000 jobs programme. Moreover, plans for initiating new projects are frequently reported in the press, further increasing pressure on the Budget.

A forward-looking Budget needs to deliver on allocating funds to priority areas without excessive dependence on commercial bank funding. Painful decisions on reducing expenditures and increasing taxes will have to be taken. Otherwise, the country is back in the usual scenario of expansive promises of gifts to all and sundry on a non-existent resource base.

In the first nine months of this year, commercial banks had lent approximately Rs 800 billion to the Government, Rs 200 billion to State-Owned Enterprises (SOEs) and a meagre Rs 200 billion to the private sector. Banks, partly because of lack of private-sector demand for credit, have played it safe by lending to the Government and SOEs safeguarding their balance sheets in a depressed economy.

Credit is the fuel which drives the engine of private-sector growth. A signal in the Budget on how the Finance Ministry and SOEs are going to significantly reduce their reliance on commercial bank financing will surely compel the banks to increase lending to the private sector for sustaining higher growth over the medium-term. Reforms of revenue-earning enterprises such as SriLankan Airlines, Ceylon Petroleum Corporation and the Ceylon Electricity Board cannot be postponed year after year, thereby putting further strain on the Budget and the banks.

Draconian measures, not seen after 1977 such as outright import bans or temporary licensing and mandatory credit requirements to restrict imports, were introduced in March to ostensibly save foreign exchange. The net impact of this inward-looking trade policy from March to August this year compared to the same period in 2019 is a marginal saving of about $ 100 million on consumer items, $ 200 million on personal vehicles, and about $ 500 million mostly on investment goods. Restrictions on import of investment and intermediate goods will have a negative impact on the present and future growth of the Sri Lankan economy. The saving on imports of consumer goods is insignificant as it amounts to only around 5 percent, excluding personal vehicles. This import regime has hampered agriculture and industry, created supply bottlenecks, and raised prices while creating a mafia of commission agents and long delays benefiting a few rent-seeking elements. The sooner this import scheme is terminated, the greater will be the economic growth impact.

However, two major risks remain. First on COVID- 19, the Government is yet to fully master the intricate subject matter of effective public health interventions. Localised lockdowns will work provided they are based on a properly run testing, contact-tracing, mask-wearing and isolation programme. One crucial element in fighting the pandemic - educating the people so they can take care of themselves as well as others known to them is critical as seen in countries like Taiwan and New Zealand. A health-care approach to fighting the pandemic that wittingly or unwittingly stigmatises COVID-19 patients and generates fear in the public will only succeed in making it worse.

If the economy is to prosper despite COVID-19, we have to learn to live with the virus as an unrelenting but containable threat through the decentralised efforts of public health authorities and local communities that keep it at bay. Tactical lockdowns, as the authorities have now put in place, keeping groceries and pharmacies open and supply chains functioning to provide essentials for the community stand in contrast to the ‘quarantine curfew’ system of the past.

A large number of people are being or will be pushed to poverty and unemployment through successive waves of COVID-19 infections. Depressed demand and supply shocks have forced many enterprises to close down or downsize. A Coronavirus control programme based on the Government providing ample support to families and firms undergoing immense economic hardship is more likely to succeed than one which is not. The Government will need to secure a much larger volume of resources than what has been provided so far.

Second, the constant stress of commercial bond repayments, around $1,000 to $ 2,000 million annually, over the 2021-2030 period poses a major risk. After an annual repayment of $ 1,000 million in 2021 and 2022, the bond repayment obligation gradually rises from $ 1,250 million in 2023 to a peak of $ 2,150 million in 2025, which entails a relatively high probability of default.

It will be exceedingly difficult to sustain annual financing from China or India on term- loans or swaps or to rely on ad- hoc measures, such as import controls and provision of risk free cover for ‘ hot money’ ( no questions asked foreign remittances) flows to the bond market over the next ten years. The arsenal of Government policies will have to emphasise on crafting the right policy environment for larger FDI inflows, confining foreign funding to large, economically viable projects on a longer-term basis with low interest rates and tighter fiscal discipline.

The Government, with the enormous mandate received from the people has a window of opportunity to present a growth-oriented Budget this year or perhaps over the next two years. The alternative is to go with a ‘more-of-the-same’ approach resulting in low-growth equilibrium scenario with patched-up policies for fixing every emerging problem.

The latter approach, as the last regime found out, will almost certainly intensify the economic and social crises after the initial 2-3 year honeymoon period.