Sri Lanka’s inconsistent vehicle taxes driven by soft-peg

ECONOMYNEXT – Sri Lanka’s latest ad hoc tax hike on vehicles came following a request from the central bank, showing the cost to policy stability and the disruption to the life of ordinary citizens and their aspirations that comes from a soft-pegged exchange rate.

Finance Minister Mangala Samaraweera said that the Central Bank had requested an import duty hike on vehicles with engine capacities less than 1000cc.

"Based on a request from the Central Bank, we had lengthy discussions and then decided on this policy,” he told reporters.

"We have seen the number of small vehicles being imported to Sri Lanka become like a tsunami in recent times.

"Through this, our foreign exchange came under a lot of pressure. Frankly, in recent months, this was one of the reasons for the depreciation of the rupee against the dollar."

Tax Inconsistency

The ad hoc tax hike on cars is the latest in a series fiscal actions that have been slapped to make up for loose monetary policy and the failed attempt to print money and target the exchange rate at the same time.

Sri Lanka has been hit by so-called balance of payments or ‘foreign exchange shortages’ since shortly after a soft-pegged central bank was created in 1951, allowing money to be printed at will, triggering, exchange controls, imports substitution and ad hoc controls on imports.

When the Bretton Woods soft-pegged regime failed in 1971-1973 Sri Lanka closed the entire economy, while successful countries floated or went back to currency boards.

The rupee came under pressure in April after the central bank injected liquidity (printed money) terminating reverse repo deals in March, cutting rates and injecting tens billions of rupees through term repo auctions and outright purchases of Treasury bills.





Before the ad ho tax hike in vehicles, undermining the aspirations of the people, a tax was also slapped on gold imports also to protect the balance of payments. The gold jewellery export sector is in trouble as a result.

Critics have pointed out that the ad hoc and inconsistent policy is driven also by Mercantilism – where money and credit problems, stemming primarily from domestic operations of the central bank – is blamed for developments in the trade front.

Analysts have called for urgent reforms of the central bank, or its abolition in favour or a currency board or dollarization, so-that aspirations of the people and their economic freedoms do not have to be continued to be sacrificed on the altar of the soft-peg.

Samaraweera said that the middle class will be the most affected by the latest tax hike.

"We noticed that most of the people buying these small cars are in the middle class, or the youth or people buying a car for the first time," Samaraweera said.

Monetary Dominance of Fiscal Policy

While it is generally agreed that the Finance Ministry should not interfere in monetary policy (central bank independence) the unstable soft-peg had created situation where the central bank is driving the finance ministry or monetary dominance of fiscal policy.

Samaraweera was asked whether the latest inconsistency was a revenue measure.

“Yes, of course, we want to boost revenue,” he said. “But there are other considerations as well.”

Deputy Treasury Secretary S. R. Attygalle said the higher taxes will reduce import and may also reduce revenues.

In the 2018 budget, a more rational tax based on engine capacity was introduced in a bid to replace ad hoc taxes and corruption of the past.

"In the 2018 budget we taxed vehicles on engine capacity," Samaraweera said. "From that, the general public got relief to purchase a small vehicle, and the government got much higher revenue, because we know that under the previous system there was corruption and fraud."

However he said this resulted in more than 4,500 cars and 1,000 vans with less than 1,000cc engine capacity being imported each month from January to May 2018.

"In the first 5 months of 2017 we had spent 316 million US dollars. In the first 5 months of this year, it has doubled to 666 million US dollars," he said.

Analysts say in the absence of money printing, imports of one good must be displace another and giving credit to one client in a bank must displace another.

In the same vein, falling retail oil prices does not improve the ‘balance of payments’, but increases non-oil imports, when people spend savings on fuel on other goods.

Rising oil prices also do not cause ‘balance of payments problems’ if oil is market priced, since people have to cut down other spending – or savings which in turn will reduce resources available for credit – to continue to buy oil. (Colombo/Aug02/2018)

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