Macroeconomics and vehicles

The Central Bank this week directed Licenced Commercial Banks (LCBs) to impose a 100% margin deposit requirement against Letters of Credit (LCs) for the importation of motor vehicles with immediate effect. This step is aimed at reducing stubbornly high imports, which could eventually have serious implications for macroeconomic stability. 

Given Sri Lanka’s high debt and low exports, any spike in vehicle imports increases the trade deficit, and in the current context of an appreciating dollar, places pressure on the rupee. This raft of challenges forces officials to keep a hawk eye on vehicle imports, and it is unfortunately the small car buyer that is often hit by tax increases and other measures to limit imports as that is where demand is the highest. So, can the system be changed to make it more equitable and give middle-class people a chance to own a vehicle? 

Over the last few months, vehicle imports have revved up significantly, effectively doubling from the same period last year. In the first five months of 2017, about $ 316 million was spent on vehicle imports, which rose to $ 666 million in 2018. This adds up to about 24,000 small cars each month and, as expected, the Finance Ministry responded this week by increasing taxes on small cars. The measure was felt to be unfair by many as the public feels that they are being used by the Government to prop up tax revenue as well. While the issue of an expanding trade deficit is a valid one, it may be possible for taxes to be managed in a more equitable manner. One possible measure is changing the Loan-to-Value (LTV) ratio so that the public would have to pay a higher share of the cost, but less than what the tax rate would demand. This would marginally reduce congestion on the roads but still leave room for average income earners to realise their dream of owning a car. Such macro prudential measures have been implemented successfully in the past and allows for environmentally friendly electric and hybrid vehicles to be given preferential treatment.

Another thorny point of contention is the permit system. Last year, a Right to Information (RTI) application by Attorney-at-Law and public interest litigation activist Nagananda Kodituwakku found that as many as 100 members of Parliament had sold their vehicle permits. Many public servants also sell their permits, usually at colossal prices, and the lopsided industry created by the permit system results in significant revenue losses to the Government. 

Interestingly, it was Finance Minister Ravi Karunanayake who, during the 2016 Budget reading, proposed to end the practice of giving tax-free vehicles to State workers and the elected ruling class. In his speech, Karunanayake admitted the Government had lost Rs. 147 billion in revenue from 2012 to August 2015, and acknowledged the system was “politicised” and “misused”. This announcement was lauded at the time and seen by many as a precursor to Sri Lanka finally righting its ailing economy, with the hope that it would eventually lead to a wholesale rethink when it comes to some of the exorbitant taxes and duties placed on motor vehicles. However, this was not to be and the proposal to change the permit system was rolled back completely. This has meant that the revenue losses have continued unabated. 

Obviously, the best long-term solution to the vehicle demand is to have a comfortable and efficient public transport system, especially for urban areas, starting with Colombo. It is the way that many other countries have dealt with their traffic challenges, and Sri Lanka would have to do the same to achieve equity in its transport system.