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Saturday June 15th, 2024

Sri Lanka should avoid ambitious short-term goals, target reforms: economist

ECONOMYNEXT- Sri Lanka should avoid ambitious short term goals amid fiscal constraints and make long-term economic reforms for sustained gains to avoid economic instability, an economist said as the island slashed taxes, which was later followed by a rate cut.

“The only way that this short term risk can be managed is if the government sets very modest public investment targets, and sets a measured pace for recovery of the Sri Lankan economy, without going steaming ahead with very ambitious targets,” Dushni Weerakoon, Executive Director of the Institute of Policy Studies (IPS), delivering a lecture in the memory of Gamini Corea, a former civil servant and economist.

“We should avoid setting over ambitious targets for growth that can undermine macro stability and hinder debt sustainability, which can lead to a short-lived economic boom, which may bring us back to the kind of boom-bust cycles we’ve seen in the past.”

“In this constrained space, short term growth objectives have to be balanced with long-term solutions to ensure that there is some degree of confidence that we can get out of this.”

Sri Lanka has slashed direct taxes for a wide range of businesses, which would boost investments, jobs and growth by pushing up investible capital, but has also slashed value added tax from 15 to 08 percent, which will hit state revenues.

The central bank cut rates Friday, as domestic interest rates were edging up, indicating that the economy was beginning to pick up (private credit), or state credit pressure was beginning to build, or both.

Weerakoon said it was :not surprising that the government would use fiscal and monetary stimulus to provide an initial boost.

With falling tax revenues from the stimulus, the government has planned on better management of state-owned enterprises to balance the shortfall, but pressure is building up on promises to give thousands of state-sector jobs, Weerakoon said.

Long-term policies which will provide some assurance to investors are needed as Sri Lanka goes to international capital markets to rollover debt, Weerakoon said.

She said reforms are required to promote the countries export sector and ensure mounting debt is paid back sustainably with non-debt inflows.

Dilemma

Weerakoon said the Sri Lankan economy is now facing a dilemma, amid a peak debt repayment season.

Debt, of which half is foreign borrowings, has grown to 85 percent of gross domestic product (GDP), rising after 2015 as well, she said.

“The fact is we borrowed but didn’t plan on how to repay that debt,” Weerakoon said.

“The dilemma is that you need some degree of fiscal consolidation to get to some comfortable level of debt sustainability.”

“But, fiscal conslidation means we have to raise taxes, and cut spending.”

“However, growth has to pick up, and that calls for some loosening of fiscal policy, but that means debt outlook will worsen as well.”

Already, ratings agencies Moody’s and Fitch have cut the outlook for Sri Lanka’s sovereign rating, threatening to push up premiums for debt rollover the state plans to undertake in 2020.

Weerakoon said there is consensus among economists that growth is the best solution for debt, which the current government will focus on as its priority for the year.

She said while the corporate, personal and consumption tax cuts undertaken were the least harmful to the economy, the benefits will take some time to trickle down.

The main problem, Weerakoon said, was post-war Sri Lanka focusing on the non-tradable sector for growth, instead of export-oriented industries.

With an economy of just over 20 million consumers, Sri Lanka cannot sustain high growth for 10 to 15 years without generating demand for goods and services from larger markets, she said.

Initial growth following the war reached 7 percent, but has by now slowed down to 2 percent or under, she said.

“We’ve relied on construction, and mining. When that happens, then the economy is dependent on consumption for growth.”

“When taxes are raised, and the focus is on fiscal consolidation, consumption falls and there’s no easy option to recover.”

“If the economy is export oriented, then we can export the surplus.”

“Because our economy was dependent on domestic consumption, then reviving growth takes a little more time.”

“That requires a few more complex policy measures to be adopted.”

The short-term post-war boom being fuelled by construction meant revenues did not increase at the same pace as growth, challenging the country’s fiscal balances, Weerakon said.

Recent Fiscal Consolidation Welcome

While Sri Lanka, now an upper middle income country, has performed poorly against peer economies on public spending and debt, fiscal consolidation has improved in recent years, she said.

“The only indicator where we are better than Asia is on fiscal deficit. We have been conveging with the emerging markets and middle income average.”

“Asian countries have been loosening fiscal policies, but that isn’t of much help because in the important indicator of public debt we are twice the average of emerging markets and middle income Asian countries.”

Although Sri Lanka has missed its consolidation targets by a large margin, the trend has so far been in a positive direction, Weerakoon said.

“There was a primary surplus. A primary surplus is the first step to stabilize debt.”

“So, steps have been taken in the right direction.”

“But if there’s slow growth, taxes will fall. Lower growth also means debt ratios can worsen.”

Weerakoon said ideally fiscal austerity is best undertaken when economic growth is high, but Sri Lanka has a history of engaging in pro-cyclical policies.

Tax cuts may not work

The IPS head said the new tax cuts promote equity and social justice, but the government may not see the desired results in a timely manner.

“Tax cuts can boost growth by encouraging consumption and investment, but it takes time.”

“Tax reductions may not always pass through as well.”

Inland Revenue Department officials have admitted that retailers may keep margins high and not pass on the tax benefits to consumers, to recoup lost margins when the rupee collapsed in 2018.

The government is also hoping the stimulus-induced growth in consumption and income to in turn lead to higher tax revenues.

“Tax revisions can stimulate growth but there’s no guarantee that revenues will pick up, at least in the short run,” Weerakoon said.

She also said if reducing income inequality is an objective, higher public spending would be key. Higher spending has more immediate multiplier effects on the economy, Weerakoon said.

However, in the current constrained fiscal space, it is critical to set modest public investment targets, she said.

Weerakoon said in Sri Lanka, tax policies are usually driven by politics and have very little to do with economics.

Investors too may be looking for indicators other than tax levels to consider bringing money to Sri Lanka, she said.

The new Inland Revenue Act enforced since 2017 has cut down many incentives, but the present government is bringing back a law which would give tax holidays to foreign investors.

The benefits of tax cuts for investors may be debated, although many developing economies still maintain such practices, Weerakoon said.

“Incentives are subject to abuse. Efficiency seeking investors would look for a sound investor environment,” she said.

Weerakoon said incentives could be justified if they promote desirable results, such as regional development and investments into high-tech and most desirable sectors.

Key Reforms Required

Investor friendly reforms are required to bring in non-debt inflows to boost low foreign reserves and service debt and create export industries, Weerakoon said.

Another area where reforms are required are on trade, since current import controls also hurt export competitiveness, she said.

“However, in this climate when there is backlash against pushing the trade agenda forward, any trade reforms to revive growth will take a bit of time.”

Pushing younger generations to enroll in more science, technology, engineering and mathematics (STEM) subjects will also pay dividends in the long-run with higher productivity, she said.

“But STEM education levels are quite low in terms of enrollment, and in terms of spending on education, upper middle income countries spend around 4.6 percent of GDP. Sri Lanka spends 1.8 percent.”

“With that kind of skill biased technological change, inequalities can also widen,” she said.

Reforms are also needed to mitigate an ageing workforce, she said.

An ageing population would increase the burden on the country’s health and social security spending, at a time when coverage for the elderly is already below desired levels, Weerakoon said.

“We will see fewer earner and tax payers as the dependency ratio climbs,” she said.

“Theory suggests people will adjust their consumption and save more. but if you look at savings patterns of Sri Lankans, I don’t think that is quite happening.”

Luck may run out

Weerakoon said over the past several decades, Sri Lankan has had the comfort of concessionary funding and bailout packages to manage its mistakes.

However, as an upper middle income country, concessionary funding is less accessible, with non-concessionary loans now making up 55 percent of the total, she said.

With persistant economic deficits leading to economic instability, the IMF has bailed out Sri Lanka on 15 occassions in 52 years, Weerakoon said.

“Seventy percent of our time has been under one IMF program or the other.”

“The deep reforms never took hold. In time our luck might run out.”

Weerakoon said Sri Lanka’s challenges are becoming complex as its income levels rise.

“Graduating to upper middle income was the easy part. Starting frow a low base, we can quickly get to 4,000 per capita.”

“Getting to 12,000 per capita is the harder bit,” she said.

“Out of 101 middle income countries in 1960, only 13 have made it to high income.” (Colombo/Feb03/2020)

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Sri Lanka beats key IMF program targets for March 2024 amid rupee stability

ECONOMYNEXT – Sri Lanka has exceeded key quantitative targets set in an International Monetary Fund program for March 2024, based on preliminary data the Washington based agency said in a report.

The March data are not performance criteria on which reviews are conducted but are indicative targets which shows the progress of the program and are a stepping stone for a September review based on June data.

An indicative target for the primary balance (roughly overall deficit minus interest costs), was assessed at 316 billion rupees more than four times the 70 billion rupee target set in the program.

Primary balance can be a big surplus if the interest bill is high and capital expenditure is cut and is a type of crisis management tool after a central bank triggers a currency crisis by cutting rates with inflationary liquidity tools.

However, Sri Lanka’s Treasury has also kept a lid on most current spending. A state salary hike is however due after the currency collapse made life difficult for everyone.

Meanwhile more taxes have been collected from the people to finance the island’s bloated state.

A 750 billion rupees central government tax revenue floor has been exceeded to reach 837 billion rupees.

Central bank credit to government (outstanding stock) has been reduced to 2,691 billion rupees in March compared to a target of 2,800 billion rupees. In December the CB credit was calculated 2,742 billion rupees.

Net international reserves of the central bank were brought up to a negative 1,268 million US dollars exceeding the target of a negative 2,035 by almost 700 million dollars.

In order to collect foreign reserves, which is a type of appropriation of domestic savings of the people by the central bank (taking in deposits) and exporting it to the US and other countries to finance their deficits or by other agency debt in reserve currencies.

In order to collect such ‘deposits’ the central bank has to prevent them from being invested domestically.

It is achieved with deflationary policy through sell-downs of down its Treasuries holding to domestic banks or others, at a market rate, collecting interest from the government or repayments of re-finance credits, subject to any nominal changes in reserve money at a given exchange rate.

In 2024 the central bank allowed the exchange rate to appreciate, which can also reduce prices of traded goods boost real and nominal savings and make it easier to collect foreign reserves.

When domestic credit is weak it is easier to collect reserves. Reduced domestic credit and collection of reserves, including by private banks which then cannot be invested domestically, can push the external current account into surplus.

The central bank also met a 5 percent 12-month inflation target, with an achievement of 4.3 percent.

Sri Lanka’s economy grew 5.3 percent despite reserve collections, amid the stability provided by the central bank.

There were no central bank purchases of Treasuries from the primary market.

However the central bank injected overnight and term money to banks (not on a net basis) showing how easy it is for a rate-obsessed monetary authority to get around the requirement and create external instability again as soon as private credit recovered.

The central bank also allowed excess liquidity from dollar purchase to remain unsterilized for an extended period under its ad hoc pegging arrangement, getting a short term falls in rates, but triggering pressure on the rupee as a result in May and June.

It is not possible to collect reserves with a free floating exchange rate. (Colombo/June15/2024)

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Sri Lanka GDP grows 5.3-pct in first quarter of 2024 amid monetary stability

ECONOMYNEXT – Sri Lanka’s gross domestic product grew 5.3 percent in the first quarter of 2024 data from the state statistics office showed as the central bank continued to refrain from generating monetary instability.

Instead of printing money to cut rates under ‘flexible inflation targeting’ and printing money to boost growth by taking into account ‘potential output’ as permitted by its new monetary law, the central bank ran deflationary policy and also allowed the rupee to appreciate.

“The Sri Lanka economy experienced a more favorable economic condition[s] in the first quarter 2024, when compared to the first quarter in the year 2023,” the Department of Census and Statistics said.

“The high inflation had prevailed in the first quarter of year 2023, gradually reduced to a lower level by the first quarter of 2024 and this low inflation incentivized the economy by providing inputs at [a] much lower price.

The agriculture sector grew 1.1 percent in the first quarter of 2024, after also growing 1.6 percent last year.

Industry grew 11.8 percent in the first quarter, against a 24.3 percent last year.

The economy grew amid falling prices, the statistics office said in sharp contrast to the Anglophone macroeconomic claim that inflation is needed to boost growth, on which Sri Lanka has 5-7 inflation target has apparently been set.

Related Sri Lanka central bank pushing for high inflation target to boost growth

“Among ‘Industrial activities’, coinciding with the decline in input prices, the ‘Construction industry’ grew by 14.2 percent, parallel to this, the ‘Mining and quarrying’ industry too expanded by 18.3 percent during this quarter,” the Statistics Department said.

Sr Lanka’s services sector grew 2.6 percent, against a decline of 4.6 percent recorded last year.

The International Monetary Fund has also urged the central bank to give priority to stability.

Sri Lanka dropped the stability mandate in the earlier monetary law which was violated after the end of a civil war to push the country into serial currency crises especially after the International Monetary Fund gave technical assistance to calculate potential output.

Related Sri Lanka has a corrupted inflation targeting, output gap targeting not in line with monetary law: Wijewardena

Sri Lanka survived a 30-year civil war by giving priority to a stability mandate despite shortcomings in its operational framework but defaulted in peacetime amid activist monetary policy which denied monetary stability to the people. (Colombo/June12/2024)

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Sri Lanka’s NPP notes five-point crisis for economic growth sans details

Former JVP MP Sunil Handunneththi

ECONOMYNEXT — The leftist National People’s Power (NPP) has identified five crises that need resolving for Sri Lanka’s economy to progress, much of which emphasise a production economy targeting export growth though sparse on the detail on resource allocation.

NPP spokesman and former parliamentarian Sunil Handunneththi speaking at an event in Mulaitivu on Thursday June 13 said Sri Lanka is grappling with firstly, a collapse of the production economy, second, a budget deficit, third, a balance of payment crisis which has, fourthly, created a debt crisis, and finally, a resultant gap between haves and have-nots.

“We must first understand the crisis. We reocgnise five main crises that have the same impact irrespective of differences between the north and south.

“The first is the collapse of the production economy. We can see this historically. Agriculture that used to be some 30 percent of gross domestic product (GDP) has now fallen to 8 percent. Essential food is imported. We cannot produce the rice needed for the small population here. Things that can be made here are also imported.

“Second is the income crisis. For the people, their expenses are twice their income. The budget deficit is two or three-fold every day. Banks cannot give loans to businesses and industries because the government takes funds to address the budget deficit. The government takes most of the people’s savings for this,” he said.

The balance of payment crisis Sri Lanka is facing the third crisis, according to Handunneththi, which has triggered a debt crisis, in turn leading to a crisis of income disparity among the people.

“Third is the balance of payments crisis. Imports are two or three fold export income. The government has to take 11 to 12 billion US dollars in loans from foreign countries. When GDP is 80 billion US dollars, debt has gone over 100.”

“All this creates a massive gap between haves and have-nots. Without finding solutions to these crisis, there is no point distributing goods,” he said.

Handunnethi’s remarks appear to be departure from the NPP’s anti-corruption rhetoric which had centred its economic development policy agenda primarily on fighting corruption.

‘Fighting corruption’ and ‘recovering stolen assets’ have been popular slogans since the Aragalaya protests in Sri Lanka and the NPP has made it its central theme in its bid for power. The leftist outfit had also adopted a position that’s cautiously critical of the International Monetary Fund (IMF) and the reforms the international lender has prescribed for Sri Lanka in exchange for a 2.9 billion-dollar bailout.

However, NPP leadership had recently acknowledged the need to continue the IMF programme since the agreement has already been signed.

The Marxist-Leninist Janatha Vimukthi Peramuna, which controls the NPP, though it was never in government barring a brief stint in an Sri Lanka Freedom Party (SLFP)-led coalition in the early 2000s, has been instrumental in driving popular support against privatisation.

Three key policy pillars articulated by the JVP from 2001-2004 and embraced by mainstream politician Mahinda Rajapaksa’s administration in 2005 onward have been highlighted by experts.

From 2005, Sri Lanka halted privatisation, started recruiting tens of thousands of unemployed graduates into the public service every year with lifetime pensions, expanding an already bloated public sector and denying any benefit of a peace dividend to the country.

Sri Lanka also abandoned a price formula for fuel that had helped keep the rupee stable and inflation low from 2001 to 2003 even as global commodity prices went up from the ‘mother of all liquidity bubbles’ fired by the Federal Reserve from 2001.

From 2001 to 2003, state workers fell from 1.164 million to 1.043 million. By 2020, the public sector cadre has grown to 1.58 million with another batch of 53,000 unemployed graduates being paid tax money. (Colombo/Jun14/2024)

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