18 January 2024 12:00 am Views - 971
Secondly, 2024 is an election year. If past elections in Sri Lanka and elsewhere are a guide, there will be a flurry of populist proposals by the government and opposition parties, aimed at currying favour with the voters. Candidates promise handouts and subsidy increases without mentioning how they will be financed. Ghana increases public servant salaries every election year; despite being in a debt crisis, they raised them by 30 percent this year. I advised the Finance Minister of another country to cut fuel subsidies and health expenditures on the rich. He said they would do it “after the elections.” They lost the election.
Sri Lanka cannot risk these populist policies when it needs to accelerate growth. It should avoid the “competitive populism” of past electoral campaigns where each candidate offers an even more generous handout than the competitors. The erstwhile rice subsidy scheme was a victim of this phenomenon: at its peak, the subsidy cost 6 percent of the GDP. More recently, the unfunded tax cuts of 2019 were a campaign promise of the previous President.
Sri Lanka is currently implementing the growth-oriented, structural reforms that are part of the programme agreed to with the International Monetary Fund (IMF). The list is long: Verité’s “IMF Tracker” shows more than a hundred commitments. To reduce the risk of another economic crisis brought on by populist policies, I suggest that the government prioritize those reforms that are either (i) difficult to reverse or (ii) constrain future governments from reckless behaviour. These reforms are different from stroke-of-the-pen reforms, such as changing a tax rate, which are important and necessary, but reversible, as we saw in 2019. The goal here is to put in place measures that make it difficult to lower the tax rate in future without corresponding revenue increases, expenditure cuts or prudent financing options.
What would these reforms be? From the lists in the government’s programme, the Civil Society Governance Diagnostic Report, and the IMF’s Governance Diagnostic Assessment, I would suggest the following four priorities:
1. Protect the Independence of the Central Bank of Sri Lanka. The Central Bank of Sri Lanka Act of 2023 (CBA) prohibits the government from financing its fiscal deficit by borrowing directly from the Central Bank. Not having such an Act in 2019-22 led to the record-high inflation of 70 percent. Following the tax cuts of 2020, the fiscal deficit soared to 12 percent of GDP. The government resorted to borrowing from the Central Bank, that is, printing money. As the textbooks would predict, the result was one of the highest inflation rates in the world.
Having the CBA in place will act as a constraint on the size of the fiscal deficit. If the government cannot finance the deficit by borrowing from the Central Bank, it will think twice about policies, such as tax cuts or expenditure increases that raise the fiscal deficit.
Although Sri Lanka has a CBA, the real test of the independence of the Central Bank will come this election year. The Central Bank will come under pressure to finance the (election-fueled) fiscal deficit. The CBA should be protected from such pressures — without exception.
2. Targeted Cash Transfers. A well-functioning cash transfer system —one that is targeted at the poor and not politically captured — is essential for providing much needed support to the poor and vulnerable Sri Lankans. The Samurdhi program was poorly targeted: only 40 percent of the poor receive transfers, and 16 percent of the non-poor also receive them. There is evidence of political capture. Districts that voted between 40 and 60 percent for the incumbent party received the most Samurdhi transfers — regardless of how poor they were. According to one study, “The niyamakas said that they are under pressure from area politicians and village-level party organisations to give the Samurdhi grant to [incumbent party] families and to deny them to [opposition party] supporters.” When a new system, Aswesuma was introduced, the people who were dropped from the rolls protested. A number of members of Parliament, who had recently approved the reform, demanded that these people be put back on the list, pending a review of their eligibility. The review has yet to be completed.
To make the cash transfer system water-tight, the criteria for eligibility should be robust (target the poor) and difficult to manipulate. The proposal for transfers to households that use less than 60 kilowatt hours per month, which would reach over 80 percent of the poorest 10 percent of households is an example of the former. Electronic transfers help with the latter.
A well-functioning cash transfer system also makes it easier to reform regressive and inefficient subsidies on fuel and electricity. When governments try to reform these subsidies, upper and middle-class people, with their gas-guzzling cars and air conditioners, will definitely be hurt, and will protest saying that the reform will hurt the poor. With a targeted cash transfer system, the government can — as governments in other countries have done — increase the transfers to the poor so they can pay the higher prices for fuel and electricity and call the upper classes’ bluff.
3. Taxation of Corporate Profits. Sri Lanka offers tax holidays and exemptions to domestic and foreign investors. The evidence that these exemptions attract foreign investment is extremely thin. Most foreign investors are looking for stability, not zero taxes. Furthermore, the country currently needs tax revenues badly. While the poor and middle classes are paying higher Value Added Taxes (VAT) and income taxes, many rich corporations pay nothing. And tax exemptions provide plenty of scope for corruption — sweetheart deals between investors and politically connected individuals.
The current policy is that most corporations will be taxed except for “strategic investments.” As long as there is this exemption, the policy will be ineffective. Instead, there should be a minimum, positive tax rate on all domestic and foreign corporations without exception. In the European Union, Ireland has such a low, uniform tax rate, whereas Germany has a complex set of exemptions and multiple rates. Ireland collects four times as much corporate tax revenues per capita as Germany.
4. Transparency. As U.S. Justice Louis Brandeis said, “Sunlight is the best disinfectant.” Publishing all procurement contracts over Rs. 1 billion, the asset declarations of senior government officials, and the names of all firms receiving tax exemptions — as recommended by both the aforementioned governance diagnostics — will go a long way towards preventing the excesses of the past. Publishing this information provides incentives for people to refrain from profligate behaviour. In this election year, another transparency measure would be for the independent think-tanks to calculate the fiscal costs of the various proposals of the candidates — and disseminate them to the public.
These four priorities are not the only things that need to be done this year. To accelerate growth, Sri Lanka needs to remove the anti-export bias that has plagued the economy for a long time. These four reforms are important to avoid the excesses that usually accompany an election season — and sometimes the post-election period. Moreover, these reforms will signal to the international community — official and private creditors as well as international financial institutions — that Sri Lanka is putting in place the institutional reforms needed to avoid a replay of the 2022 crisis. That increase in confidence is worth a lot.
Professor Shantayanan Devarajan is a Professor of the Practice of International Development, Georgetown University. He is also a non-resident fellow of Verité Research and a member of its ‘Sri Lanka Economic Policy Group.’