False narrative of demonising fiscal deficits – Whose interests does it serve?

As the cacophony of noise predicting economic implosion from the bloated fiscal deficit and public debt pile up is getting louder every day, it is important to put the things into correct perspective for the benefit of everyone.  

Since the day the new government announced its tax reform package last November, as part of its short-term economic incentive package to revive a moribund economy, many went to town with a doomsday scenario that the economy is going to implode. They said the tax reform package is so big that it would suck out 1-1.5 percent GDP of revenue, resulting in at least 6.5 percent fiscal deficit for 2019. 

But this same people forgot that even with the International Monetary Fund (IMF)-led revenue-based fiscal consolidation brought only the opposite results to its desired intensions. In fact, the fiscal deficit rose during 2018 and 2019.

The fiscal deficit in 2018 was 5.3 percent of GDP, nowhere near the IMF-set target or the government’s own target. So, what’s all this noise?  

The same lot also forgot that the IMF-prescribed revenue-based fiscal consolidation programme had one big hole in it, i.e. it killed the incentive for growth. 

Thanks to that tunnel vision, Sri Lanka borrowed from the IMF debt-to-GDP mantra. Sri Lanka has seen its growth sputtering since 2017 and all indications were such that it would hit the bottom in 2019.

The Central Bank recently projected that the economic growth for 2019 could not be better than 2.7 percent the most, i.e. the lowest in two decades.  So, one needs only common sense to realise that their standard prescription is losing efficiency and thereby its appeal. And thus, one can conclude that the IMF bailout is a failed project. 

This is perhaps why the new Central Bank Governor Prof. W.D. Lakshman recently said that the IMF itself is rethinking its own policy based on the Washington Consensus. 

Damned if you do and damned if you don’t 
One should not forget that the Sri Lankan economy was already in the ICU when it was handed down to the Rajapaksa administration, on November 16. 

While this attempt is not to whitewash the record of the economic management during the 2005-2014 period, it is certainly better than the total cock-up during the five years that followed. 
Economic growth was half of what it used to be pre-2015, the per capita income was limping, public debt was higher, systematic risks had risen—build up of weaker asset quality in the banking sector and weaknesses in certain sectors such as property—emergence of sharp economic imbalances and the list goes on.

The most conspicuous was the absence of the economic actors—consumers, businesses and investors—who had gone into near dormancy as they got punished from all fronts—taxes, interest rates and regulations. 

Hence, something had to be done to give a lifeline to these sectors to help them return to normalcy.  Lower taxes and interest rates, moratorium for loans and relaxation of certain regulations are common tools at the disposal of every administration to make things work in the economy. The new administration quite generously is using these to kick-start the economy.

What more anyone could do in the short term?
Of course, there are so-called structural reforms but they are more medium and long term and the effects will only be visible in the fourth and fifth years of the administration, only if they start now. 

One such area of structural reform is the reforming the perennially corrupt and inefficient public sector, which no lesser authority than President Gotabaya Rajapaksa himself has taken an undertaking to clean it up. 

Also, he has already announced reforms to many other sectors such as education, healthcare, agriculture and environment. Of course, they are yet to be matched with the deeds. But at least we now hear the right things. 

There are daily attempts by various parties to portray the Rajapaksa administration’s tax reforms as a show of economic incompetence and a political play.  

While the latter could be partly true because the government was few months away from a crucial general election, the same could not be said of the former because tax cuts were on the cards for months and it is in their manifesto, which the people gave a strong mandate to implement. Nobody could say they totally miscalculated the consequences, given their track record in the earlier 10-year stint.  

Can there be a possibility to fail? Yes. But should we hope and pray every day that they fail? No. If the answer is yes, that’s pure hypocrisy. 

There were again attempts by some unscrupulous parties to depict the loan moratorium as something garnered to keep the bankers at gun point at the Temple Trees. Had these writers followed some of the stories in the business press during the final few weeks in December or had the patience to talk to any of the banking chiefs who were present during the meetings with the Central Bank and the government’s economic team, they would not have rushed to concoct false narratives of their imagination and mislead the public.

The same people have identified the initiative to train and recruit 100,000 youths in selected and productive areas of the economy in six months as a sin. One writer had even made attempts to portray that the programme would be run by the military when no such decision had been taken to that effect so far.  Which alternative is better? Leaving 100,000 youths unemployed and a heavy burden on the family, society and finally the state or uplifting 100,000 individuals from the depths of economic malaise and thereby their families from economic marginalisation, who will then be lifted out of poverty and entitlement culture? 

This is nothing but a loathsome effort by the parties with vested interests to scuttle any progressive attempts, which do not fall into their narratives and instil fear psychosis among people. 
Would they be silent if nothing was done? No. So, damned if you do and damned if you don’t.   

Demonising fiscal deficit – whose purpose will it serve? 
When asked if fiscal deficits are a good thing, a typical economist would flat out say, ‘no’. And he would go on to demonise fiscal deficits. 

But the context of the Sri Lankan economy is such (or any other economy for that matter) that it requires an initial nudge and that initial nudge most often should come from the government. 

This is when the government needs to provide incentives to the economy by way of fiscal (tax) and monetary (interest rates, moratoriums and
relaxed regulations) measures.

Ideally these stimuli should be provided to a few selected sectors identified as priority sectors by the government, which have the ability to improve incomes of a large number of people. 
According to economic analyst Waruna Singappuli, these sectors are technology, SMEs, tourism, port-related sectors and human resource development by way of universities and other tertiary education. 

While whether these are the right priority sectors and should there be more or less sectors could be later debated, what is important is to have a few sectors identified, where the government’s fiscal and policy support should be forthcoming in the initial few years. 

In this initial phase of the development journey, the government will have to spend and support these sectors because not many foreign investors may be willing to take the risk on developing our human resources and then investing. 

It will be the other way around. Investors will be attracted to where there are skills. 

If Sri Lanka already has skilled labour and an institutional network, which is well anchored by the state support, there is nothing stopping investors choosing Sri Lanka as their preferred choice of investment destination. 

In fact, at this juncture, Sri Lanka should priorities growth over being overly fixated on a fiscal deficit number, which inhibits Sri Lanka from growing. 

When growth is revived and sustained through the right mix of fiscal, monetary and public policy, growth itself will remedy the other associated issues such as fiscal deficit, balance of payment and inequality because when incomes rise steady and faster, a large number of people will be pulled out of poverty. 

But this by no means ‘growth at any cost’. Correct and pragmatic public policy becomes key to avoid some of the excesses made by other developed countries on their development journey and upward social mobility of their people. Values do matter, shared identity matters, reciprocal obligations matter and
purposive actions matter. 

In fact, investors will appreciate and be attracted to an economy with a steady growth of over 6.5 percent per annum and they are less worried about a fiscal deficit of about 6.5 percent of GDP or little higher for a period of about five years. 

And it will be less harmful and in fact, rewarding for the country too to have run with a mid-single-digit level fiscal deficit because the government has established the necessary soft and hard infrastructure required to maintain a sustained higher economic growth. Hence, the growth comes with higher revenues for the government and it will help gradually to consolidate the budget in the long term. 

But if the country decides to be fixated on a web of other issues without moving on with the pressing issues such as income-enhancing policies, then the fiscal deficit will be a waste. In fact, what these detractors precisely want is that. Entangle the state in a deep web of petty issues, which make headlines daily, so that they become preoccupied with these issues and the economy gets back seat. 

Then no amount of public sector salary increases and tax cuts just before an election would not resuscitate the economy nor will guarantee re-election. 

Hence, it is time for Sri Lanka to unshackle itself from the failed austerity policies and take a calculated risk to leapfrog.

It is a choice between meeting a tough 3.0 percent fiscal deficit target from day one, which might appease the IMF and investing to facilitate growth, which will help upward social mobility of a large swaths of people, who are otherwise eternally stuck in low-income agriculture. 

So, what about debt problem? 
Sri Lanka largely has a foreign currency debt problem and not a problem of domestic currency debt because the latter can be bridged through money printing. Money printing is not evil as some would like to depict. 

The only thing is that such printed money should be spent for right things as explained above. 

The Federal Reserve printed money and the European Central Bank prints money and so does the Bank of Japan when their respective economies needed support for nearly a decade after the global finance crisis, the process known as quantitative easing. 

Interestingly, Sri Lanka’s foreign currency debt intake has annually gone in lockstep with an external current account deficit and foreign outflows from the government securities market. The two figures are identical in 2015, according to ‘A Simple Plan For Sri Lanka’, a book authored by Singappuli. 

In that year, Sri Lanka’s current account deficit was US $ 1.9 billion and the foreigners pulled out another US $ 1.1 billion worth of capital from government treasuries. Sri Lanka’s foreign borrowings in that year were at US $ 3.0 billion, which nicely make up of the above two. 

What does that tell you? Sri Lanka will have to borrow externally as long as it imports. 

Hence, Sri Lanka’s foreign debt problem can be resolved through establishing sustained inflow of foreign currency via setting up firms in Sri Lanka, which can generate foreign exchange earnings – in other words, businesses that can offer products and services to the export market. 

This is important because the portfolio flows or the foreign investments into stocks and bonds are highly volatile and can cause diametrically opposite moves in their flows due to sheer geo-political or economic events while sustainable high foreign direct investment flows every year cannot be guaranteed either. 

How is this possible? 
This is possible by way of positive foreign relations with world powers such as the US and China et al. and negotiate with them with a clear aim for technology transfers and deeper market access to their markets. 

While this is tricky and easier said than done, this is not impossible. 

The key is to go for the negotiations with these countries with a clear idea of what our interests are. Our interests are simple; we need at least part of their companies to set up operations here, which will naturally bring technology along with them and open up job opportunities for our frustrated youth and then, finally to negotiate to have access to their or other new markets. 

If we can get a few semiconductor manufacturers or at least part of their manufacturing to set up shop here or to get a few auto parts manufacturers to follow them, this will not only bring in technology and jobs but also foreign direct investment.

The focus during these negotiations and foreign relations should be pure economic and commercial and not pure loans or infrastructure projects, which will mire the country more in debt. 

Hence, shouldn’t this be our new approach to foreign relations, which can make a whole new difference in the people’s income and the structure of the economy?  

So, what’s stopping us? 
Political will and attitude.
(The writer can be reached through [email protected])