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The Budget 2016 has been passed with a resounding majority in the Parliament. Time will judge whether this majority is a clear reflection of the views of the different sections of the society or it is the outcome of political manoeuvres to ensure the continuity of the Coalition Government.
It has been widely reported that some of the Budget measures were not well received by various sectors, though the general opinion in the forums where the Finance Minister himself or other senior ministers personally participated was much brighter.
Whilst the Government should be commended for some of the growth-oriented measures, good part of these criticism carry enough credence from the point of view of the respective sectors – raising indirect taxes and import duties on many items are invariably going to have a dampening effect on the level of business activity in the respective sectors or in other words potential drop in contribution from these sectors towards overall economic growth in 2016.
Alan Greenspan, former Head of the Federal Reserve in the United States, once famously said: “Whatever you tax, you get less of.” Let me refer another very interesting quote from the world renowned investor Warren Buffett: “The most important thing to do if you find yourself in a hole is to stop digging” – increasing taxes do not result in higher economic growth rather they tend to end up resulting in the opposite.
Minister of Finance Ravi Karunanayake presenting Budget 2016 in Parliament
There are genuine concerns about the proposed merger of the EPF and ETF – despite the stated objectives, so much will depend on the governing principles, modalities of implementation and the actual people who are appointed to run the merged fund. After all, these are very large institutions already and they hold public money too sacred to afford any mistake.
Nevertheless, the Government can take credit in the very fact that we have such an open and transparent environment for critique of Government policies. Understandably, the Government has been overwhelmed by the deteriorated public finance situation that it had inherited. Despite very challenging circumstances, the Budget has managed to take a growth orientation encouraging entrepreneurship, new investments and skills development.
We think the Megapolis, Financial Hub and SME assistance initiatives have the potential to become major contributors to the economy. Analysing the various provisions in the Budget, it appears the Government did have to juggle around the various ends that had to be satisfied – fiscal discipline, economic growth, social welfare and election promises.
Politics aside, as farmers, traders, academics, public servants, entrepreneurs, businessmen and fellow citizens we all want the stated objectives of the budget to succeed, for we as a nation will fall out massively in the international economy and market place should we not manage to significantly push up our economic growth rate in the next two to four years. There are vast amounts of capital and businesses being attracted to regional countries like India, Bangladesh and Vietnam. If we don’t position ourselves in the international arena as an attractive destination to do business within the next two to three years, achieving our socio-economic goals such as uplifting the living standards of all Sri Lankans are going to be an uphill task.
We should also recognise that in a developing country like Sri Lanka there is what is called a natural growth rate of the economy since we are still in the stages of capital formation from road infrastructure to housing – in other words, arguably, even if the budget was merely an income and expenditure statement the economy would still post reasonable growth. Credit towards this would invariably go to the local businesses that have been the backbone of this economy during the years of war as well as recent peace times.
Unfortunately, the package of measures in the proposed Budget, regardless of the intentions, results in a more difficult business environment to existing businesses, in its quest to encourage new investments. Whilst new investments are essential, it is no justification to make cost of doing business worse for the running operations of the existing local businesses. Whilst the increased indirect taxes will undoubtedly have an effect, imposing 2%-3%% charge on cash withdrawals and charging Rs. 60,000 per annum from limited liability companies are essentially going to move the informal business sector remain informal rather than go mainstream as incorporated businesses.
Besides, imposing 2%-3% charge on cash withdrawals is a hefty transaction cost – let the businesses manage their cash; it is setting bad precedent to impose such transaction costs on businesses. Any potential foreign investor is likely to negatively weigh these haphazard transaction costs. It is important that a Budget is thoroughly vetted for self-destructive measures of this nature prior to publication.
We can clearly see that despite repeatedly mentioning that the Budget is driven towards achieving higher economic growth, there seems to be a failure to fully grasp the underlying implication of the respective measures on economic growth to the extent that one would wonder whether there is a disconnect between the policy makers of the Ministry of Finance and the economists of the Central Bank.
Currently, the projected growth for the current year for the economy is 6%-6.5%%. If the current budget is to be considered anywhere close to significant towards economic growth, it should be able to raise the rate of growth by at least another 1%-1.5% for the next year. There is hardly any measure in the Budget that can reinvigorate economic momentum in the near term, in the absence of significant foreign investments. Some of the big factors that could create the environment for this end are the encouragement of consumer spending, improving financial flows and business sentiments.
Whether the policy makers like it or not vehicle ownership hence vehicle prices are an important barometer of sentiments in Sri Lanka. By significantly increasing the prices of even the entry-level vehicles including the electric vehicles the Government has effectively knifed into the heart of the very aspirations of many tens of thousands of people who would have dreamt of owning their first vehicle. The Government could have done this process more equitably keeping the window open for first time buyers of 
entry-level vehicles. If the Government was serious of containing road congestion and accidents, there should have been more stringent action on the biggest killers on the road, the intercity bus drivers and worst spoilers of road discipline, the three wheeler drivers.
It is critical to recognise that sentiments in general and business sentiments in particular play a huge role in generating and sustaining momentum in an economy – rhetoric and speeches alone cannot spur positive sentiment, people are intelligent enough to understand the effect of policy measures to their day to day life and business operations. It is strange to see such a drastic change in attitude from the Government ministers between this time last year and now – notably, there is growing insensitivity towards the feelings of the people which may eventually lead to a drastic change in the status quo. There was this quote circulating in the social media recently – “Two things define you: Your patience when you have nothing; your attitude when you have everything.”
We think a paradigm shift in getting the best economic outcomes from the Budget is not a choice but a necessity for the country. We have identified several aspects of the Budget which if brilliantly executed have the potential to set the Sri Lankan economy on a significant growth trajectory.
1. Business sentiment
If we take a completely honest view on this, the announcement of the new Budget measures have not lifted business sentiment much and in fact pointers are that a good part of the measures had a dampening effect. This is not unusual when a Budget has to be formulated with challenges of fiscal consolidation. When the new coalition Government took over in the United Kingdom in 2010, two years after the financial crisis of 2008, they were in a position where drastic measures had to be taken to ensure fiscal consolidation or rather bring about a sensible balance between Government income and spending and achieve economic growth too.
The Budget was meticulously worked out and there was clarity in the underlying direction and planned economic outcomes. We can see today how the British economy has successfully weathered some of the drastic turbulence taking place in the rest of the European economies. When we evaluate the Budget 2016 in Sri Lanka, it is not too difficult to identify inconsistencies and measures not so helpful towards economic growth.
The Government needs to show some swift results to regain momentum in this regard. People will genuinely gain interest and are likely to jump on the flow, moment they see activities happening. We need some ‘hand-holding’ here to have some of our businesses take initiative and launch some new projects.
President Ranasinghe Premadasa took extraordinary measures to facilitate local businessmen to set up garment factories in lagging regions. He had a good rapport and understanding with the business community which was leveraged to enable job creation. President Maithripala Sirisena and Prime Minister Ranil Wickremesinghe are in an envious position in this respect because the entire business community is behind them.
All what we need is to encourage a few large local businesses and provide them all necessary assistance to take the first steps and set up new investments in lagging regions for instance, the north and east. There will be others who will see the opportunity and follow – we can expect a chain of positive events to unleash from local job creation to growth in sustainable economic activity.
2. Financial Hub
Liberalisation of foreign exchange controls and moves to set up a Financial Hub is indeed a well-conceived policy measure and we commend the foresight shown by the Finance Minister. Dubai and Singapore relaxed controls in the early days and gained significant money flows to the country as a result. Sri Lanka, should it actually set up an Offshore Banking Centre in its true spirit, can stand to gain massively from the consequent flow of funds. India itself has the potential to be a vast source of fund flows to the Offshore Banking Centres.
Nevertheless, some of the Budget policy measures announced are not going to be helpful when it comes to promoting the Financial Centre – hefty transaction costs, be it on cash transaction or fund transfers, almost certainly will have negative impression.
It should also be borne in mind that fully liberalising fund movements carry significant risks as well – the policy could open up positions for international speculators and arbitrage traders to exert pressure on exchange rates and money markets. Ensuring world class monitoring and compliance mechanisms needs to be a top priority along with the setting up of the financial hub.
3. Re-evaluate the policy measures for their economic impact
A growth oriented fiscal Budget, particularly in a developing country, would normally have two key economic fundamentals that will drive policy measures;
a) Increase productive capacity in the country
b) Increase output from existing capacity
If we’d re-assess some of the policy measures against these critical economic imperatives to drive growth – whilst we can see a balance of measures on either side with some of the measures like SME incentives and export promotion likely to have a positive impact on expanding productive capacity, some of the other measures may impede growth.
Government intervention in labour market to the extent of legislating private sector wage increases and restricting working days in the private sector, whilst they maybe populist, are in fact regressive on the productive capacity in the country. Sri Lanka already ranks amongst the countries with the lowest number of working days and constraints of this nature are likely to be negatively viewed by potential foreign investors. These matters should have been left to the market forces.
The Budget is proposing a suite of measures to help the SME (Small and Medium sized Enterprises) sector and also a range of incentives to encourage investments. We think these are extremely good measures to increase productive capacity in the country.
The Megapolis project is likely to improve infrastructure in the Western province, which is the main economic hub in the country, and hence enable greater productivity across various industries and sectors.
The Budget and its measures hedge the success of their outcomes mainly on the ability of the country to attract new investments. Amongst all these measures, we think the agency which will handle inward investments and related incentive packages to investors will have a significant impact on achieving effective economic outcomes from the measures in the Budget. There is a proposal to replace the current Board of Investment (BOI) with ‘Agency for Development’.
Regardless of its name, what is important is that the agency is headed and resourced with capable people who understand the economics of doing business and people who can function as the true champions of the investors. It is a known fact that the current BOI, sadly, have ended up with people who have crossed their boundaries of incompetence as a result of excessive political interference. Whether the current BOI is restructured or a new agency is established, we need some critical factors incorporated in setting up the agency:
4. Public enterprises
We think this is an area of vast opportunity for these are very large enterprises and effective turn around in their financial performance, no doubt, has the potential to generate significant savings for the public finances as well as create substantial momentum in the economy.
Unfortunately, it is fairly apparent that the Government is still struggling for a clear plan to restructure these organisations. Amalgamating these enterprises into a Wealth Fund is no solution to overcome issues in the core business and related operational inefficiencies. Those who appoint people to head these enterprises should ask themselves whether they would still appoint the person, if he or she was not known to them. Turning around these organisations, with some of them like the SriLankan Airlines operating in fiercely competitive markets, will take exceptional talent and extra ordinary effort.
Changing heads of these organisations with personal acquaintances, unfortunately, will only make the process even more painful. There are plenty of case examples in the United States as to how Large Corporations there brought in CEOs specialising in corporate turn-around during times of difficulty, what calibre of people they took on and how effectively they implemented the restructuring plans.
The story of Qatar Airways during the last 15 years is an excellent example as to how they brought in world class talent and developed this airline from a flag-carrier brand to one of the highest ranked airlines in the world. It is no use Government ministers and people known to them trying to be airline experts and burning more and more public money. The need of the hour is to get professional thinking behind the turnaround of the Sri Lankan Airlines and bring in an airline CEO who has a proven track record in turning around a large airline of a similar scale. Business turnaround is a specialist arena today and without the right talent at the top, these enterprises will continue to swallow large chunks of the Budget and make things worse for the country’s indebtedness.
In addition, it would also be imperative that there is a team of crack professionals formed at the Ministry level who can take a granular and robust review of the operations of the respective enterprises, formulate top level restructuring plans and monitor their performance and effectively operate as a strategic advisory and feedback loop for the ministers in charge. This is similar to the strategy teams usually based at the corporate head offices of large conglomerates.
It is important to note that these enterprises are also very large employers in the country. Effective turn around in these enterprises and sustained growth will open up thousands of new job opportunities. This is why we see this as an area of vast opportunity for the economy.
5. Consumer spending – connect the loop
In many developed economies, including the United States and United Kingdom, approximately 2/3rd of economic activity is driven by consumer spending. Commendably, the Budget 2016 presented by the Finance Minister has spelt out some meaningful measures to encourage Sri Lanka as an attractive shopping destination. Whilst so much will depend on the extent to which these duty concessions will cascade into price savings at retail front, there are some other strategically important aspects need to be looked at in order to sustainably spur retail spending both from local consumers as well as foreign visitors.
Big cities like London, Manchester, New York and Geneva feature well designed pedestrian areas adjacent to or near shopping areas – these include entertainment, coffee shops, restaurants and any other facility that makes people come in and spend time. Footfall is the most critical pre-requisite for retailing and if we manage to generate sustained activity there should be good scope to attract international chains and brands.
The Megapolis project is a well-timed concept that can be rolled with these themes in mind. Besides, sanitation facilities in public areas, late night transport arrangements, and shop opening times are all going to be very important. Once again, it may be worthwhile to review the Budget proposal to restrict working days and legislate private sector wages and evaluate whether it’s prudent and sensible for the Government to increase its level of interference in labour markets. Developed economies tend to allow market conditions to decide these factors relating to the labour market.
6. Tourism – Missed opportunity?
Seeing the meagre fund allocation given to tourism in the Budget, it appears that there is less priority given to the sector with the biggest potential for economic revival in Sri Lanka. The Budget did announce incentives to set up theme parks, hotel schools and exhibition and convention facilities. These are all certainly very good measures to help develop the industry, however, we are still failing to address the core issue that the country and the industry badly needs addressed – destination promotion.
To put it in simple terms, the Government needs the private sector to invest in the hotel sector and for the private sector to be able to raise capital towards this end, one of the first things they need to be able to convince a potential investor is the ability to achieve viable room rates. In comparison to the costs of land, construction and successful launch, there needs to be a commensurate revenue side in the equation to justify the investment.
We can’t achieve higher room rates unless the perceived attractiveness is lifted in the minds of travellers – in other words, we have some serious work to do in effectively positioning the country with the right image in the right segments of the market. There are plenty of examples out there like Malaysia and Maldives where sustained destination promotions enabled drastic shift in the quality and numbers of travellers to those countries.
In a recent travellers survey by Conde Nast, the publishers of the prestigious Vogue magazine, Sri Lanka was ranked 13th amongst the top 20 travel destinations in the world voted by travellers. Despite its aesthetic beauty and having such a favourable following amongst international visitors, the country still attracts just around 1.5 million visitors per annum, including frequent visitors from India and Maldives and foreign nationals of Sri Lankan origin visiting their friends and families.
Maldives attracts similar numbers as Sri Lanka, however, the quality of the traffic in terms of spending is far higher. Malaysia and Thailand on the other hand attract 25-27 million visitors per annum. These comparisons simply show who we believe we are as a destination and where we actually stand in the world of tourism. Besides, we also need to gauge and monitor refined statistics of tourist arrivals which will indicate true demand to the resort and city hotels – in other words, we need to track tourist arrivals after adjusting for short term frequent visitors coming on personal visits. The latter form a large part of two of our largest sources – India and Maldives.
The Government could contemplate creating designated exclusive tourism zones in areas like Bentota, Galle, Pasikudah and Yala. The idea is to create areas of top end facilities and activities which together with the hotels can be marketed as high end niche destinations which would attract higher spenders. Initially, one such zone can be developed as a model zone. These areas would need to comprise top end infrastructure, entertainment, sanitation, restaurants and other facilities. This initiative should involve private sector contribution as well since improvements to their immediate surrounding will, invariably, help the marketability and profile of their respective hotels too.
Given the scale of resources involved and the necessity to have close oversight on promotions that involve the positioning of the country’s image, it is imperative that this whole process is carried as a Public-Private Partnership project of highest importance as outlined in the Prime Minister’s Policy Statements presented to the Parliament.
Regardless of differences amongst us, we all want our farmers, teachers, public servants, professionals, businessmen and all others to do well and prosper in life. We Sri Lankans would want to make a stop to circumstances that lead to women having to go abroad to find means to feed their children. We, as a nation, face a decisive moment where we can sit back and criticise Government policies or work together and make constructive contributions towards the development initiatives. The Budget is certainly not a perfect manuscript, however, we have the opportunity to make the best out of the framework and direction laid out in it so that the entire nation reaches a path of economic prosperity and equitable welfare.
[The writer is an Executive Director at Nortonbridge Capital Ltd. – The Corporate Finance and Investment boutique. He has completed his MBA from the Cranfield School of Management, United Kingdom. He is a member of ACCA, CIMA and CIM (UK) and he has also successfully completed Advanced Corporate Finance Programmes at the Kellogg School of Management, Illinois, USA. Over the years he has had many research based publications in the United Kingdom as well as Sri Lanka. Rizwan can be reached on [email protected].]
