Fiscal stimulus presents “incredibly difficult balancing act” to govt.:WB

World Bank Chief Economist for South Asia Hans Timmer 
Pic by Waruna Wanniarachchi

By Nishel Fernando 
Sri Lanka’s new government will have to undergo an “incredibly difficult balancing act” to incorporate the recently introduced economic stimulus package to the system without undermining fiscal and debt sustainability in a global environment, where investors and lenders have become extremely sensitive towards uncertainty, a top economist at the World Bank said. 
“In general, it’s an incredibly difficult balancing act for any government in Sri Lanka. I find any attempt to stimulate the domestic economy, trying to revive investment is very natural and logical. 

At the same time, if it is done without a sustainable fiscal framework, then you can do more harm than good with that kind of a stimulus. It is not an easy task irrespective whoever is in charge,” World Bank Chief Economist for South Asia Hans Timmer said. 

Timmer was delivering a public lecture themed ‘Global Economic Outlook and Challenges with a Focus on South Asia’, at the Centre for Banking Studies of the Central Bank, on Tuesday. 
While acknowledging that such efforts to drive aggregate demand seem logical politically with elections nearby, Timmer cautioned that the government has to be prudent and sustainable in implementing such stimulus packages, which is an extremely difficult task.

Moody’s Investors Service estimates the hit from the tax cuts to state revenue to be around 1 to 1.5 percent of gross domestic product. The government has estimated the stimulus package to cost Rs.500-550 billion to the state coffers. 

Timmer pointed out that Sri Lanka along with other emerging markets need to be cautious on retaining and building investor confidence as the global investors as well as lenders have become wary of uncertainty. 

“Across the room, financial flows are very moderate while obviously, there’s lot of demand in emerging economies. Typically, with low interest rates in advanced economies, there should also be a high supply but it’s not happening, which means that the room for manoeuvre for countries such as Sri Lanka is indeed very limited. 

At the same time, you have to make sure that you create sustainability in your own system because otherwise you make things even worse,” he elaborated. 

However, Central Bank Governor Dr. Indrajit Coomaraswamy remarked that there’s space to boost the aggregate demand, given the slowdown in monetary aggregates due to political and security shocks. 

However, he stressed that the fiscal stimulus should be implemented under a stable framework without overheating the economy.

“The trick is to make sure that you don’t overdo it. If you overdo it, the economy will overheat and we will be back in square one,” he said. 

Timmer warned that Sri Lanka may risk facing other challenges, if the demand doesn’t pick up to the anticipated levels.

“The challenge is that Sri Lanka might run into problems even before overheating of the economy. If there’s still a lack of demand, then unsustainability of fiscal system can make the financing problem so big,” he said. 

Meanwhile, he advised the country’s policymakers to instead focus on building the investor confidence with specific policy reforms targeted at enhancing exports, fully utilising underemployed or underutilised labour and realising the growth potential of the neglected areas. 

“Through policy changes and with a strong vision of what you want to achieve, you can unleash that potential and you can create confidence in the economy. Rather than pouring money to create domestic demand, you can change policies to provide perspective to others to come in and spend,” he said. 

However, Timmer proposed to the government to focus on low-hanging fruits instead of bold policy reforms such as SOEs, which present long-term benefits to gain public support for reforms. 

“It’s never advisable in a tough economic situation to start with reforms that perhaps create gains in the long run at a cost in the short run. It makes more sense to focus on those reforms, which have big gains in the short run, perhaps not so much in the 
long run.  I would recommend Sri Lanka to focus on low-hanging fruits away from SOEs, even outside of formal economy to look at some sectors of the economy where you see unrealised export potential or where productivity can be increased,” he went on to say. 

Further, he insisted that integration is a must for Sri Lanka along with other South Asian economies to grow, with South Asia being considered as one of the least-integrated regions in the world. 

He pointed out that it’s impossible for economies to grow with only non-tradable sectors with no exposure to external competition, which hinders productivity gains. 
In order to drive integration, Timmer called for a major shift in public perception in the region.