Government need not be embarrassed by its new clothes

A Budget analysis by Eran Wickramaratne

The 2010 Budget is a departure from the Budgets that have been presented by the Mahinda Rajapaksa regime in the past. Its neither Keynesian or Marxian, but explicitly committed to limiting itself to fiscal variable targets. 

The president is on record to limit the budget deficit to 5% of GDP over the  medium term.  A mainstream liberal economic policy statement with incentives for big business and little else in terms of relief for the poor.  A reprioritization of the government’s economic goals to spur growth in the economy.  The government need not be embarrassed by its new clothes.



A Permanent  Office of the Budget

Government targets and estimates have invariably been inaccurate over a period of time.



To improve the accuracy and transparency of data, the budget exercise should be ongoing rather than an annual presentation of information.  There has also been a dangerous erosion of confidence in the information provided by the Central Bank.  To re-build the confidence in the integrity of data, to estimate more accurately, and to make the data and its assumptions available to all members of parliament, I suggest the setting up of a permanent independent office of the Budget.  This will also improve the quality of the Parliamentary debates as all members of Parliament will be arguing from the same set of data and assumptions, and will also strengthen accountability to financials that have been presented.  For example, the government is yet to fully disclose under Head 249 of the Foreign Loans Act (Amended), the total of foreign loans taken by source, amount, interest, fees and tenors during 2010.  A permanent office of the Budget set under Parliamentary jurisdiction will improve timeliness, transparency and accountability.



Economic Model

     The Government missed an opportunity to present a long term strategy.  Sri Lanka is a post war country but not a post conflict country.  Amongst the many challenges is the focus necessary to alleviate poverty, create employment and invest in education and health.  However the government’s priority continues to be investments in infrastructure.  We must not ignore the concerns raised by representatives from constituencies in the North and East, and the public making representations before the Lessons Learnt and Reconciliation Commission (LLRC) that individual’s security is paramount in rebuilding the war torn economy.  With the demise of the LTTE the lack of security for individuals is unacceptable and demands the government’s attention.  Investments will be made in a secure environment.

     Expenditure on Defense is Rs.215 billion, an increase despite the conclusion of the war over one and a half years ago.   The ratio of soldier to civilian is about 1 :  50.  In a country at peacetime the ratio should improve dramatically.  More than 70% of the defense budget is recurrent expenditure linked to the number of soldiers.  Expenditure will come down over time, when numbers reduce.  While the budget has quite rightly allocated funding for the welfare of soldiers,  it would be necessary to invest over the next few years in providing opportunities to develop alternative employable skills.  This would enable soldiers to make career moves contributing to national income.

   The budget emphasized the importance of Agriculture through the continuation of the fertilizer subsidy, expansion in tourism, through tax incentives and expanding exports.  A modern economy must benefit from economies of scale and a transfer of technology.  Agriculture & Tourism would provide limited scope for expansion and transfer of technology.  The scope for innovation is limited.There is a debate as to whether Sri Lanka should follow the Indian model or the Chinese model of economic expansion.  India is a democratic country with a free media.  Culturally it is close to us.  Economic policy can only be evolved in a socio political context.  

The government must conduct its foreign policy in a manner that would not create war in the future.  New relationships should be cultivated without alienating traditional relationships.

    Some have begun to argue that economic development inevitably has a trade off with democracy and freedom.  The off quoted example is the economic progress of Singapore.  The Lee doctrine is the exception rather than the rule.  

There is no historical evidence to prove a tradeoff between economic development and democracy.  

The contrary is true. Most countries which have economically advanced over time have had democracy as its foundation.  Nobel Economic  laureate  Amartya Sen not only argues for freedom as a prerequisite for growth, but redefines development as the maximization of freedom.

 He argues that with increased income freedom increases.  But there are also cases where expanding income does not always translate into increased freedom.  Sen argues that development is freedom.

  The government boasts of per capita income increasing from  US$ 1000 in 2005 to 2000 plus in 2010.  It has also set a goal of reaching a per capita income of US$ 4000 by 2016.

It is clear that a doubling of nominal income consequent to a GDP growth of 6 -7 % over 05 years does not translate into a doubling of living standards.  Development is the maximization of freedom, where income is but one component.  

We need to be vary of any move to restrict freedom which have been secured from Colonial rulers after  500 years of occupation.  As Nelson Mandela said in his famous speech on release from  26 years of imprisonment “I have fought against White domination and I will fight against Black domination”.  The enemy of freedom must be resisted if our economy is to grow in a sustainable and conducive Environment.

Investment or Debt

Economic growth requires both debt and investment.   

Investment when compared with debt is long term, it distributes the risk between investors and applies itself to the highest return.  Investors are more likely to make rational economic choices rather than governments which channel debts into grandiose projects.  Domestic investment must be supplemented with foreign investment for the economy to grow.  

One and a half years  after the end of the military conflict  Direct Foreign Investment (DFI) is still very small.  In 2008 it was US $ 889 Million,  2009  US$ 601 Million and only US$ 208 Million in the first half of 2010.  Instead of addressing the fundamentals that would increase DFI, the government has raised debt.

The Debt service ratio which was 4.8% of GDP in 2008 rose to 6.4% in 2009.  The Debt to GDP ratio which was 81.4% in 2008 rose to 86.9% in 2009. For most years from 2006 the debt service cost has exceeded the Tax revenue, with debt service cost being 133% of tax revenue in 2009.  

The foreign debt component of total debt has also risen from 32.8% in 2008 to 36.5% in 2009.  The foreign commercial debt is rising fast from 4.4% to 23.3% in 2009.  The country’s economy is being supported primarily by debt and more disturbingly by foreign debt.

The Euro 90 Billion Irish bailout has ended in a crisis.  Spain and Portugal may become victims of the contagion.  The European central Bank President,  Jean Claude Trichet said “ Global Finance and the Global Economy is extremely fragile.

 This is not a European crisis -  it is a repercussion on Europe” .  In a globalised world Sri Lanka could soon be badly exposed if it continues development mainly based on debt.  Debt must be serviced by export incomes for an economy to be healthy.

Exports

Even though the exports in 2009 reduced by 12.7% the balance of payments did not deteriorate due to the rapid fall in imports.  In 2010 the steep rise in imports has led to a deterioration of the BOP.  While we cannot influence global demand for our Textiles, Tea, Rubber, Tourism and Manpower, we can expect reasonable demand and prices for our exports in 2010.  

We have no control over the cost of oil.  To make our exports globally competitive we must provide energy at competitive rates (Sri Lanka has one of the highest cost of energy in the world).

We must reform our labour markets to increase productivity, and manage our exchange rate to make our exports competitive.



Energy

The debate on the alternative sources of energy is timely.  The decision for the CEB to invest in mini hydro projects where private sector investment is being made would be an irrational decision for a country which has limited savings.  Instead the limited investment should be channeled into priority areas where there is little or no private investment.  The debate on Nuclear Energy must now be expanded beyond the expert community to include the public.  Both benefits and the risk of nuclear energy generation will have a profound impact on the public and therefore they should be included in the emerging debate.

Labour Markets

Government employees amount to 1.3 million and have increased from about 700,000 in 2005.  While the Government considers this as an achievement it must be noted that net employment increased by only two hundred thousand from 2005 to 2010.  In effect private sector employment and the self employed reduced by four hundred thousand in the same period.  During the period 2001 to 2004 employment increased by 1.2 million while there was little increase in government employment.  It demonstrates that Investor friendly economic policies adopted by the Ranil Wickremesinghe government generated productive employment, income and wealth beyond any state initiative since then.  The labour laws should be reformed, so that productivity and remuneration are closely correlated. The government has not demonstrated the political will to do so as yet.

In 2011 most state employees will receive a rupee five hundred increase despite the promise to increase wages by Rs.2,500/-  The government is in breach of a social contract.  Employment and incomes can both increase if the economy, policies, laws, and institutions are reformed.

Foreign Exchange

The US$ to Rupee rate was 102 in 2005 and 111.40 in November 2010.  A strong rupee reduces the debt burden of the country, while it makes our exports less competitive.  The appreciation of the rupee has been compounded by the rising foreign currency reserves which are borrowings.  The rise in reserves has little to do with the growth of the real sector of the economy.  To the extent that the rupee appreciation is dependent on the increase of foreign currency borrowings the value of the Sri Lanka rupee is artificial.  It is a shame that our exports will be made to suffer as a result of such action.

Reforms

Along with lower energy cost, higher productivity of labour, and a more competitive exchange rate exports will grow reducing the debt burden and the possibility of a future financial crisis. A government that has embraced the liberal economy must now have the courage to reform creating the enabling environment for growth.  The government need not be ashamed of its new clothes.