ECONOMYNEXT – Sri Lanka’s National Movement for Social Justice has presented a common minimum program for economic recovery as the country reels from the worst currency crisis triggered by conflicting money and exchange policies.
The carefully thought out program deals with a number of fiscal problems including state enterprises and budgets in detail.
It is also deals with trade and industry.
However the program is also advocating the adoption of a new draft Monetary Law, which in the early copies in circulation institutionalizes discretionary policy (flexible inflation targeting/dual anchor conflicts) that triggered serial currency crises and eventually drove the country into default.
Sri Lanka has been hit by inflation and forex shortages, accompanied by trade and exchange controls undermining economic freedoms and de-stabilzing the economy after an intermediate regime central bank was set up in 1950 with both monetary and exchange rate policies which conflict with each other.
For true inflation targeting (a rule to control the expansion of money supply) to operate the central bank has to stop intervening in forex markets or in other words have no foreign exchange policy.
For inflation targeting to work the currency has to float and the central bank should only have a monetary policy (open market operations) impacting reserve money with a single target (inflation) generally known as a domestic anchor.
Targeting the exchange rate to collect reserves or for any other objective, changes reserve money through foreign exchange operations, tying the money supply tightly or loosely to the balance of payments through pegging, depending on the degree of interventions.
A central bank, having a distinct foreign exchange policy (intervening in the market) will operate a pegged regime which will conflict with its monetary policy. Forex shortages can emerge whenever domestic credit picks up and attempts are made to push down rates with monetary policy.
In 2018 a currency crisis were triggered by open market operations despite the deficit being brought down, fuel being market priced, with the central bank independence given by Finance Minister Mangala Samaraweera, critics have shown.
A so-called ‘flexible exchange rate’ or non-credible peg operated by a reserve collecting pegged central bank is therefore prone to currency crises, and IMF bailouts, regardless of how good the fiscal policy is.
Then Governor A Jayewardene removed exchange rate policy from the central bank’s main objectives on the path to inflation targeting, by dropping the requirement to maintain the ‘external value’ of the rupee.
According to at least one draft in circulation, the course is reversed with a specific exchange rate policy being to be given legal effect and ensuring that there is no solution to the dual anchor conflicts that has created balance of payments trouble in Sri Lanka since 1950.
Article 7 (1) (a) of the draft law is to “determine and implement monetary policy”
Article 7 (1)(b) is to “determine and implement exchange rate policy”
Article 7 (1) (c) is to “hold and manage official international reserves of Sri Lanka”
Sri Lanka country’s current forex shortages with a 360 to the US dollar peg and fuel shortages are characteristic results of a pegged regime (non-floating ‘flexible’ exchange rate) having both a monetary and exchange rate policy.
The debt office
There are further problems with the draft, creating conflicts of interest.
Article 7 (1) (j) is to act as financial advisor and fiscal agent of, and Banker to, the government.
The common minimum program however has advocated a separate debt office, in a big improvement.
In order to operate a floating exchange rate the Treasury or debt office should also be able to buy foreign exchange to settle loans and manages its dollar balances.
In order to eliminate currency crises (and allow the debt office to buy dollars for rupees) the central bank has to either abandon foreign reserve collections (clean float the currency), or abandon monetary policy to artificially push down interest rates and run a credible peg or currency board.
The draft law as it stands allows policies similar to the past 70s years to be carried out by giving legal effect to even more discretionary policy involving an unstable peg with conflicting anchors (both monetary and exchange rate policies).
Under an IMF program, where a loan given to boost reserves of the central bank, a true inflation targeting framework cannot be implemented at least until the program ends and the reserve loan is repaid, or the debt is taken over by the government.
This is why countries that go the IMF continue to operate unstable pegs and get into trouble in the next credit cycle or usually the one after.
Common Minimum Program for Economic Recovery
Compiled by the National Movement for Social Justice
4 June 2022
We are in the throes of an unprecedented crisis. No useful comparisons may be drawn from the 2001-02 period of negative economic growth. The only analogue may be from 90 years ago, when per capita GDP collapsed from USD 80 to 33 in a few years as part of the Sri Lankan manifestation of the Great Depression.
Sri Lanka has the highest income inequality in South Asia (between China and the US in international comparisons) and provided little compensation for the harms caused by the pandemic and lockdowns. Our citizens in the lower deciles are unable to withstand more shocks. It will not be possible to get out of this crisis without any pain. But the pain can be minimized, especially for the most vulnerable, by a well thought out recovery program.
We should not abandon the commitments to fiscal discipline on the first possible occasion, as was the case in the past. We must be steadfastin our commitment to these reforms because they are our decisions and because this is the only way recurrences can be avoided.
Political actors may be unwilling to accept working within the framework of an IMF program because of the fear of being made responsible for the difficult, but necessary, reforms. That is why it is necessary tocommitto a common minimum program which provides a meaningful role to all participating parties and is anchored in Parliament’s Constitutional responsibility for the control of finances.
How the document was developed
By mid-2021, the National Movement for Social Justicerecognized the necessity of developing a national consensus on measures to get out of the crisis and to avoid recurrences. In keeping with its practice of drawing on expertise to develop policy positions, a series of “kathikawa” webinars were organizedstarting in July 2021. Subsequently, a draft of a common minimum program in all three languages was published in February 2022 for further discussion in the media and otherwise.
Around the same time, various organizations, including political parties, associations and think tanks, published recommendations. In the past few months many were published making it difficult to ensure comprehensive coverage. Economic recommendations that could be implemented within a short time frame were selected from an ideologically broad set of documents and were analyzed (annex 1). Significant agreement was found on topics such as the need for control of government expenditure and the establishment of an efficient and well-targeted social safety net. On issues such as trade and state assets, there were divergences. The results of the comparative analysis were presented to a group of economists (annex 2) who suggested changes in substance and prioritization. The revised recommendations were presented to a panel of business leaders (annex 3) for validation. Changes were made throughout. The final document differs significantly from the base document.
The proposals are organized under eight headings that were identified in the course of the analysis and validation. With each of the specific recommendations, the economists were asked to identify the relevant time frame for action: short-term (within 2022); medium-term (by end of 2023); and longer-term (completion after 2023). The time frames are provided as starting points for discussion only.
1. Macroeconomic stability
Given that the economic team is in place, the selection of advisors has been completed, and discussions with the IMF are ongoing, the proposals below look beyond these ongoing activities that are seen as being in good hands. Many of the base documents had been prepared before the above activities commenced. The recommendations that had been implemented by the time of the finalization of this document have been excluded.
It is recommended that priority be given to the Monetary Law Act (which exists in draft form), which will ensure the independence of the Central Bank, which is seen as essential for macro-economic stabilization. Attention is also focused on ensuring that data on public debt are accurate at all times and that a professional approach is adopted for the management of different forms of debt and guarantees. The proposed Public Debt Office should be an elite organization staffed by highly qualified and experienced professionals. It was felt that providing adequate compensation packages for such professionals would be a challenge unless the Office was located within the Central Bank. However, concerns were expressed about whether the placement of the Public Debt Office within the Central Bank would detract from the central objectives of the Bank.
2. Revenue consolidation
It is almost certain that the entering into an IMF program will require a commitment to a time-bound achievement of a primary surplus. This will require the raising of revenue above the current levels. Irrespective of the IMF, this is a laudable objective. Action to restore the tax regime that existed prior to December 2019 has already been initiated. Therefore, the proposals below look beyond the restoration of the 2019 revenue measures.
It is necessary to increase non-tax revenues by increasing the fees charged for services and revenues from state assets. However, it would be good if attention is paid at the same time to reducing the costs of collecting the revenue and improving the services provided. For example, paperwork can be simplified, and the frequency of collection can be adjusted. There is likely to be less resistance if service quality is improved when fees are increased. In some instances, the collected fees go into funds under the control of the responsible agencies. It is important that any funds more than what is required for operations be remitted to the Consolidated Fund.
There are many negatives to the practice of handing out tax exemptions to investors. Exemptions under the Strategic Development Projects (SDP) Act No. 14 of 2008, should be discontinued. Even those who currently enjoy SDP status should be subject to a minimum alternative tax, proposed as 15 percent. Sri Lanka should join the Base Erosion and Profit Shifting (BEPS) Framework. A progressive corporate tax regime, without sharp discontinuities, is recommended.
Customs reforms including changes to customs officers’ reward schemes are recommended. The complex duty structures should be replaced with a three-band scheme and para tariffs should be phased out.
The significant weaknesses in Sri Lanka’s revenue administration should be addressed. Though challenging, a unified revenue administration that would bring together inland revenue, customs and excise is an urgent necessity.
3. Primary expenditure control
The need to ensure that the provisions of the Fiscal Management (Responsibility) Act, No. 3 of 2002, are scrupulously followed was highlighted. Given the disappointing track record since enactment, opinion was split on the relative importance of strengthening the Act versus ensuring a culture of compliance. In the end, there was support for the amendments on the basis that compliance may be looked after by the engaged oversight provided by newly energized citizens.
Concern about large debt-financed projects lacking in feasibility is reflected in the proposal to mandate projects that are in line with the National Physical Plan and have been assessed as meeting all stated criteria. The entity responsible for the Physical Plan should be situated in an appropriate Ministry and must be adequately funded and empowered to ensure compliance.
4. Public sector and SOE management
A freeze on public-sector recruitment is strongly recommended, with all vacancies being filled with those already in state service (green sheeting). Defence expenditures are still the highest a decade after the end of the war and most of it is in the form of recurrent expenditures, with inadequate provision being made for force modernization. A serious effort is recommended to realign and reduce defence expenditures.
The actual personnel requirements of the state, of the armed forces, and SOEs must be calculated, and surplus personnel redeployed. The state must make major investments to upgrade the capacity of personnelin the public service, starting with the leadership layer. To assure productive performance, they must be provided with the necessary facilities. This should not be limited to tangible things such as computers, but must include proper performance reviews, the formulation of customized training plans and the provision of necessary resources for training, etc. Professor Mick Moore, a long-time observer of the Sri Lankan state, has documented the decline of the resources spent on making state employees more productive at the same time as the numbers of employees have been going up.
The privatization of at least one high-profile SOE such as SriLankanAirlines, as already announced, will communicate seriousness of purpose both to debt holders and to the various interest groups. A task force should be established to review all state corporations and state-owned companies andprioritize those to be divested, reorganized as PPPs, or subjected to management reforms. Markets where SOEs operate as monopolies or as protected suppliers should be liberalized.
It is proposed that all SOEs be converted into companies which will ringfence assets and liabilities, improveadherence to accounting standards,and allow for the floating of shares in the CSE under appropriate conditions. It is also proposed that procedures like the “fit and proper test” used for bank boards be established to ensure that persons appointed to the boards of SOEs can perform their duties.
Hard budget constraints should be imposed on SOEsengaged in commercial activities. State banks should be instructed to apply normal risk assessment criteria when lending to SOEs.
5. Social safety net
The Welfare Benefits Board Act became law in 2002, but it is yet to be implemented. It is recommended that the board be activated, the databases completed, and a social safety net be implemented immediately. Because of the similarities of the present situation with disaster and because surveys show that 77 percent of households that receive regular benefits from the government have access to bank accounts, it is recommended that cash transfers to bank accounts of mobile money accounts be used, with improvements to targeting being made over time.
6. Energy and public utilities
Refined and unrefined petroleum products account for around 15 percent of the country’s total merchandise import bill (it may be even higher in 2022).Formula-based pricing for imported fuel, which was recommended in multiple documents, has been implemented, though the actual formula and the periodicity remain opaque. It is recommended that these elements be addressed.
Because fuel is a key input for the production of electricity, which in turn is a significant input for the production of piped water, it will be necessary to extend formula-based pricing to these utility services as well. It appears that distributors of cooking gas are adjusting retail prices to reflect the cost of imports and the value of the rupee. It is recommended that all petroleum products, including cooking gas, be brought under utility regulation through a sector specific law, and price and quality regulation be entrusted to the Public Utilities Commission.
Because over 60 percent of fuel imported into the country is spent on transportation, it will not be possible to address the current account deficit and the volatility caused by world markets unless concerted action is taken to shift more passengers to efficient modes of transport. This will require a shift to a public transport first policy and the removal of various forms of subsidies currently in place for private transport. The investments required for this shift may have to be obtained from external sources.
Load shedding has many negative implications for the economy. To ensure regular power supplies for industry and for consumers, it is necessary to increase the amount of electricity generated from the abundant potential that exists for wind and solar. To take power from these intermittent sources and to remove the cause of periodic country-wide failures, additional investments are necessary to upgrade the transmission grid. The transmission network is currently operated under a separate license, but not as a ring-fenced and independently operating entity. Making it an independently operating entity will be necessary for the required investments to be made and procurements completed in a timely manner and for services such as wheeling to be introduced.
After the divestment of SriLankan Airlines has been completed, it will be necessary to attract airlines, especially low-cost carriers, to Sri Lankan airports. Mattala has been fully liberalized. It will be necessary to consider liberalization at least up to fifth freedom level at Colombo. The rights to provide ground handling services should not be bundled with the airline as part of the divestment. Separate and focused efforts should be made to improve the management of the airport including the lowering of currently non-competitive ground handling service fees and non-discriminatory treatment of all airlines using the airport.
7. Trade and industry
The committees established under the National Export Strategy of 2018 should be used to identify difficulties experienced by exporters. With the relevant state officials present at these meetings, quick action can be taken to remove the barriers to exports. It is likely that barriers include permits for imports of critical inputs and bank-related difficulties will feature large. The permit raj that has been established in the past few years has to be disassembled if exports are to be promoted. The necessity of imports for exports will have to be impressed.
The crisis and the accompanying failure of basic infrastructure services has brought industrial zones back into discussion. Unlike in the 1980s, it would be useful to allow privately managed industrial zones, where the operators will be responsible both for the investments and the recruitment of tenants.
8. Specialized legislation critical to recovery
It is expected that a large number of enterprises will fail and that hundreds of thousands if not more employees will be thrown out of work as a result of the crisis. Extant legislation is not capable of effectively responding to these unprecedented events. Unless new bankruptcy laws that are applicable to all enterprises are enacted quickly, the recovery will take long. In the same way, unless a more realistic mechanism than Termination of Employment of Workman Act (TEWA) for handling employees who lose their jobs as a result of the crisis is set in place, enterprises will not be able to survive.
Intervention 8 Time horizon
Fast track unified bankruptcy laws for all enterprises S
Replace TEWA with Unemployment Insurance Fund S