Why Sri Lanka must immediately transcend IMF Agenda

President Ranil Wickremesinghe with IMF Managing Director Kristalina Georgieva

Let’s face it. Whether we like it or not, Sri Lanka has no other options than moving ahead with rapid industrialisation. It is undeniable that the country is compelled to pursue that way as a means of economic progress, drawing from the successful historical precedent set by Asian nations post World War II. The significant economic growth and development experienced by Asian countries have been closely linked to their emphasis on rapid industrialisation, driven by various factors such as industrial policies, manufacturing focus, and integration into global value chains

Any rational resident of Sri Lanka will take the time to assess the potential increase in personal tax obligations beginning on 1 January, 2024. There will be a significant escalation in both direct and indirect tax liabilities following this date.

I have done this exercise, and the results are startling. On an aggregate, the state will be taking 30% of my earnings each month. This is in several components. On my primary earnings I would be paying 14% as tax. I am also in the highest tax bracket so that everything I earn from secondary employment is taxed at 36%. If I previously got LKR 20,000 for one session of lecture, now my earnings would be confined to Rs, 12,800. Then comes indirect taxes. On almost every LKR 100 I spend, the state grabs an additional LKR 18 as Value Added Tax (VAT). This further reduces my spendable income.

To spare you with the details, I would be paying 19% of my earnings in direct tax and 11% in indirect. In other words, I would be working more than three and a half months of a year for the state, unpaid. Depending on one’s earnings this could be anywhere between 2 months to sometimes as high as 4 months for any professional in Sri Lanka. This is if one neither smokes nor consumes alcohol. If you engage in any, it would certainly be more.

Are taxes unfair to the professionals?

Many professionals in Sri Lanka typically earn a monthly salary ranging from LKR 200,000 to 500,000, with a few outliers going beyond. However, these higher earnings are not the norm. In the IT industry, compensation tends to be slightly higher. Additionally, doctors often engage in private consultations outside their work hours. Despite the potential to earn a significant portion of their income from these additional services, it is crucial to acknowledge the considerable effort and hard work required to achieve such earnings. Professionals invest their physical and mental energy into their work, making it disheartening when a substantial portion of their income is deducted by the state.

While it is understandable that everyone has an obligation to pay taxes, it is essential for the state to establish reasonable taxation policies. It is unreasonable and unfair when the state utilises various means to excessively burden professionals and deplete their hard-earned income. The state stripping LKR 150,000 out from a monthly salary of LKR 500,000 is not a joke. Wouldn’t a consultant medical practitioner feel discouraged, frustrated, demoralised, resentful, or disheartened if the state deducts a significant portion of her earnings after working 12-hour days from 9 am to 9 pm?

Who decided that professionals in Sri Lanka have to pay a 30% tax? The International Monetary Fund? No. I would surely be corrected right away by the local economics pundits. They will pounce anytime if somebody were to say anything negative about the IMF, even before the IMF does! The IMF has not advocated for the imposition of taxes specifically targeting professionals, they would say. True, the responsibility for generating revenue through taxation has primarily rested with the state. In the absence of the option to create currency through printing money, the Government is compelled to devise means to gather funds from its citizens. The most efficient approach for channeling funds from individuals’ bank accounts to the Government’s Treasury is through taxation. Thus, despite the absence of explicit directives from the IMF regarding taxation, elevated tax rates have demonstrated a direct and beneficial correlation with IMF conditions.

Will taxing bring the desired outcome or make matters worse?

The proposed tax increase is not solely aimed at professionals; it would also impact the general population, albeit at a lower rate. VAT increase to 18% is corresponding to a 15% direct tax. Why tax the poorest of the poor one sixth of their income? Because we are in such a desperate situation. The rationale behind this decision, despite its potential impact on the most vulnerable segments of society, lies in the country’s dire financial straits. The state cannot run its affairs without taking part of the earnings of labourers and office cleaners. The situation is that bad. The Government will be collecting all the money it has spent over future prospects from the citizens.

This process will have a significant socio-economic impact on society, resulting in a gradual decline in living standards across all economic strata. The consequences may be such that individuals in each economic layer would be compelled to adopt the living standards of the layer below them. Only the affluent few are likely to withstand the effects unscathed. The upper middle class will descend to the lower middle class, while the latter will be pushed below the poverty line. In the words of President Ranasinghe Premadasa, those accustomed to wearing shoes with socks would have to forgo the luxury of socks, while those who can afford only shoes would have to settle for slippers. The most vulnerable individuals at the bottom of the societal pyramid will bear the brunt of these changes.

A few months back, a 10,000 person survey by LIRNEAsia, a regional policy research organisation, revealed some shocking facts about the growing poverty in Sri Lanka. Accordingly, Sri Lanka’s poor has surged by 4 million to 7 million since 2019 to 31% of the population in 2023. According to the same survey, 33% of the respondents had skipped a meal and 47% reduced their meal sizes, after the currency crisis. Poverty levels have jumped from 6% to 18% in the urban sector, 15% - 32% in the rural sector and - the worst - 34% - 51% in the estate from 2019 to 2023. Survey participants have mentioned that they did not have exercise books and had to make up books from empty pages of old books. Notably, this was before the Government started drilling their citizens. Post-excessive tax period outcomes could be far worse.

How is it worse? Let’s again take a leaf from the Chair of the same organisation Prof. Rohan Samarajiva, who is fond of talking about Kwashiorkor and Marasmus conditions in Sri Lanka during the 70-77 times, when the country underwent severe economic hardships and famine situations. Kwashiorkor is a condition resulting from inadequate protein intake. As protein deprivation continues, one sees growth failure, loss of muscle mass, generalised swelling (edema), and decreased immunity. A large, protuberant belly is common. Marasmus is a severe form of protein-energy undernutrition. It results from an overall lack of calories. I am not exaggerating, but Kwashiorkor and Marasmus may reappear in Sri Lanka, if the same tax conditions prevail, this time, courtesy the IMF.

 Is there an alternative to excessive taxing?

If we take the economics jargon out, Sri Lanka faces a fundamental problem. It has already spent the future earnings, i.e. billions of dollars that the country has not yet earned. The IMF program mistakenly assumes that this money is in the hands of the people. That is exactly what the textbook says. The text book is not fully wrong; high inflation means the people have too much money in their hands. What the textbook does not say is the limitation of the theory: It is valid only to a closed system. In reality, the bulk of the billions of dollars borrowed by the Sri Lanka Government has already left our shores. (A portion might be in the international bank accounts of some of the former ruling party politicians too; I cannot certainly say how much as I have no concrete evidence.) Thus, introducing taxes to “bring back the money to state” will not work. Citizens of Sri Lanka cannot return something they do not have in the first place.

There is a solution though. The debt has not gone to waste entirely. Prior to 2009, Sri Lanka had no highways. Now we have connected the Southern province and Airport to Colombo by highway. We have introduced the second international Airport. The Hambantota seaport is a new starter. Almost the whole island is covered with 3G with 4G available in the capital and major city areas and the suburbs. Sri Lanka has a total installed electricity generation capacity of 4,000 MW, with plans to expand this to 5,000 MW by 2025. The country is also committed to increasing the share of renewable energy in its electricity generation mix to 80% by 2030. Education, including higher education and healthcare facilities has improved rapidly since 2009. These are all outcomes of the post-2010 excessive debts. Now is the time to exploit these infrastructure facilities to gain income for the nation. The key is rapid industrialisation.

Nevertheless, most mainstream economists are pessimistic about developing the industry sector. They may have their own reasons. One such reason is the high cost of labour. This per se should not be a cul-de-sac. Opening up affordable labour from other South Asian nations through trade pacts can solve it. Political instability is another key issue. Resolving that is important and not just for this purpose. The list is long but one thing is clear. We talk about solving an unprecedented issue, so the solutions too may be ones we have ruled out previously for various reasons.

If industrialisation were our only transformation path, we must believe in it passionately. If we were not to have faith in it neither would the prospective investors. The slightest hint of our pessimism would rule out any opportunities we may have. It is a Herculean task building investor confidence given the current political and economic situation of the country. On the other hand, it is an ideal opening to make bold and blatant policy decisions we were afraid to make. Space constraints prevent me from a detailed discussion. That does not mean we shouldn’t get into that. If we were serious about our time, the numerous hours we spend unnecessarily filling our petrol tanks, which ideally should take no more than five minutes, our first task is to design a workable roadmap for the industrial revolution of Sri Lanka. Seriously, none of us wants to live in a low-income country.

 Why does the IMF program have no specific industrialisation targets?

The thinking of the International Monetary Fund (IMF) is rooted in the neo-liberal economic model that gained popularity during the 1980s under the leaderships of Reagan and Thatcher. This particular model did not place significant emphasis on industrialisation. Instead, it prioritised good governance in countries that were already industrialised and developed. Unfortunately, this crucial point is not fully comprehended by our local economic experts. It is essential to acknowledge that the application of this model in developing countries requires adjustments. Industrialisation is a prerequisite for good governance, as a country cannot effectively practise good governance while being impoverished and lacking industrial development.

Moreover, IMF programs often apply a standardised set of policy recommendations to countries facing economic challenges, regardless of their unique circumstances and development needs. This one-size-fits-all approach can lead to inappropriate and ineffective policies that exacerbate existing problems. They also often prioritise short-term macroeconomic stability, such as reducing inflation and balance of payments deficits, at the expense of long-term economic growth and development. This could lead to cuts in social spending, infrastructure investment, and other essential services that can hinder long-term economic progress. Thirdly, IMF programs often fail to adequately consider the local context and expertise of the countries they assist. This could lead to recommendations not well-suited to the specific needs and challenges of the country.

As discussed previously, IMF programs largely involve austerity measures, such as reducing Government spending and increasing taxes, to achieve fiscal consolidation. While these measures may be necessary in many cases, they could have a disproportionate impact on the poor and the vulnerable, exacerbating inequality and poverty. In light of these limitations, there have been calls for a more nuanced and context-specific approach to IMF programs, with a greater focus on long-term economic growth, social protection, and environmental sustainability. The IMF has made some efforts to address these concerns, but significant reforms are still needed to ensure that its programs are more effective, equitable, and sustainable.

There are three key arguments against an IMF program without industrialisation as a major component of it. First, the growth potential would be limited. Industrialisation is often seen as an engine for economic growth, diversification, and job creation. Without it, a country may struggle to achieve sustained economic development, potentially hindering the program’s overall success. Secondly and more importantly, such a country is always vulnerable to external shocks; it has to rely on primary commodities or low-value-added exports, and is more susceptible to external price fluctuations. Industrialisation can help build resilience and reduce dependence on volatile sectors. Thirdly, there is an issue of long-term sustainability. Without a focus on building productive capacity and exports, a country may remain reliant on external borrowing and aid, making it difficult to achieve long-term financial stability.

Are there viable alternatives to the swift industrialisation of the economy?

Since the 1990s, a segment of economic analysts in Sri Lanka has been advocating a partially accurate assertion that has since transformed into a misconception. While extenuating the significance of rapid industrialisation, they argue that superior economic growth can be attained through the development of the services sector. This notion seemed to be a panacea in the 1990s, particularly, with the swift expansion of the telecommunications industry, leading to a seemingly perpetual increase in the services sector’s contribution to the GDP.

In reality, the telecommunications sector continues to expand. Broadband data usage surged in the latter part of 2022, reaching 200-250 Petabytes per month compared to the previous year’s range of 80-160 Petabytes. At a cost of LKR 100 per Gigabyte, this translates to a substantial economic value of LKR 292 billion. However, the telecommunications sector itself still falls short of generating the desired foreign exchange. Only a few segments within the services sector have the capacity to earn foreign currency, with tourism as one. Although tourist arrivals are on the rise, the sector alone is insufficient to provide a substantial boost to the economy.

 Even within the manufacturing sector, there are constraints. Presently, the apparel industry stands as the primary source of export income in the country, representing approximately 44% of total exports and contributing around 33% of the country’s manufacturing employment. Sri Lanka has cultivated its competitive advantage over the years, focusing on value addition rather than low production costs, prioritising product quality and the ability to manufacture specialised products. The country›s apparel manufacturers have earned a strong global reputation for ethically producing high-quality garments trusted by international fashion brands. Sri Lanka›s apparel and textile manufacturing industry is also recognised as one of the most ethical and sustainable in the world, continually evolving to offer advanced and innovative solutions through fashion BPO services, research, development, and innovation centres.

However, our apparel industry has encountered limitations. Over the past decade, Bangladesh has gained a competitive advantage primarily due to its lower labour costs. Our prominence in the apparel industry has waned, necessitating the exploration of new avenues for sustainability.

Let’s face it. Whether we like it or not, Sri Lanka has no other options than moving ahead with rapid industrialisation. It is undeniable that the country is compelled to pursue that way as a means of economic progress, drawing from the successful historical precedent set by Asian nations post World War II. The significant economic growth and development experienced by Asian countries have been closely linked to their emphasis on rapid industrialisation, driven by various factors such as industrial policies, manufacturing focus, and integration into global value chains. Notably, East Asia has played a pivotal role in the region›s economic resurgence, contributing a substantial portion of the global GDP increase, manufacturing value added, and world exports. High-growth economies like Hong Kong, Singapore, South Korea, and Taiwan have sustained remarkable economic growth through exports and rapid industrialisation, positioning themselves among the world›s wealthiest nations since the 1960s.

Conclusion: IMF program must be supplemented with a viable country growth strategy

What’s wrong in having a country growth strategy in parallel? I guess nothing, so why not have it?  What prevents us? All this has to do with the reluctance of local policy makers to have central plans. This again stems from their ideological positions.

The most famous and perhaps the most criticised central planning example is Gosplan in the former Soviet Union. Central planning was seen as the solution to most economic woes faced by Stalin’s regime. So the State Planning Committee, commonly known as Gosplan, was set up in 1921. With the introduction of five-year plans in 1928, its main task was to create and administer a series of five-year plans governing the economy of the USSR. The initial five-year plans were created to serve the rapid industrialisation of the Soviet Union, and thus placed a major focus on heavy industry.

Gosplan was a success, not a failure. The reason: with it, the Soviet Union began its journey of becoming a world superpower. Before, it was primarily an agricultural society. Without the planning process, the Soviet Union would not have been prepared for the German invasion of 1941. It would have become a German territory, almost automatically. Due to the success of the planned industrialisation, the Soviet Union was able to build the weapons it needed to defeat the Germans by 1945.

Taking advocacy from the Soviet Union to come out of the present mess may look like a joke to most economists. If they need another example, take South Korea. Central planning was exactly the process South Korea too followed. Its central planning process has been characterised by a series of five-year economic and social development plans, designed to increase wealth within the country and strengthen political stability. The first five-year plan (1962-1966) sought to develop South Korea›s economy by investing in key sectors such as electric power, agriculture, and social overhead. The second plan (1967-1971) aimed to shift the country into heavy industry by making South Korea more competitive in the world market. The third (1972-1976) focused on the development of heavy industries and chemical industries, involving a more centralised, import-substitution orientation of the economy. That was the turning point that converted the poorest country in Asia to the eleventh riches in the world.

Whether we like it or not, this is the only way out for Sri Lanka. The IMF program should not be a hindrance for the country to have its own development plans.