How progressive is 2022 budget?

At first glance, the 2022 budget presented recently in Parliament looks impressive. This was the Finance Minister’s maiden Budget Speech and though it was way too long (so much so that he nearly ran out of gas before completing it), it struck a chord by emphasising the buzz words that economists love to hear, such as export promotion, financial discipline, fiscal consolidation, debt sustainability, macroeconomic stability and inclusive economic development. 

But the targets it identifies in respect of key macroeconomic indicators, though noble in intent, sound overly optimistic. For example: external trade to register a positive balance of US $ 1 billion in 2022, compared with an estimated US $ 7 billion negative balance in 2021; the budget deficit to be reduced from 11.1 percent in 2021 (estimated) to 4.8 percent in 2025 and GDP growth to exceed 6 percent per annum during the period 2022-2027, compared with an average of 3.7 percent per annum during the five-year period preceding the global pandemic (when the previous regime was in power). 

GDP growth plunged to -3.6 percent in 2020, due to the pandemic. The World Bank estimate for 2021 is 3.3 percent, compared with the government estimate of 5.0 percent. As to which is more accurate remains to be seen. Perhaps the actual rate will be in the region of 4.2 percent, which is the average of the above two estimates.  

Does budget address economic crisis?
The Sri Lankan economy is in dire straits with the country running out of external reserves, the rupee undergoing severe depreciation, food prices soaring, agricultural production stagnating, due to the ban of imports of inorganic fertiliser, a huge budget deficit of 11.1 percent reflecting gross financial mismanagement and the gap between demand and supply continuing to widen for a wide range of consumer and intermediate goods, resulting in widespread shortages and steep price hikes. 

People standing in line for rice, flour, sugar and kerosene is something the country has not seen since the days of protectionism (1970-1977). This was the period when nations like South Korea, Malaysia and Thailand were undergoing rapid economic development through the adoption of bold, export-led growth strategies while the Sri Lankan economy was floundering in the muddy waters of socialism. 

Nowhere in his speech does Finance Minister Basil Rajapakse indicate that the country is currently undergoing a grave economic crisis and that in the absence of far-reaching structural adjustments, the crisis is likely to deepen and push the economy to the brink of collapse. The speech by and large avoids discussing the need for urgent macroeconomic policy reform, which suggests that the government is unwilling to take the bull by the horns. 

Though the fiscal consolidation measures announced in the budget are likely to produce a modest reduction in the budget deficit, they do not address a central issue, which is the low ratio of income tax to total tax revenue: 24.7 percent in 2019 and 22 percent in 2020. By comparison, the corresponding ratio for a wealthy nation like Malaysia is roughly 70 percent. The low income tax to total tax revenue ratio could be regarded as a serious structural weakness in the Sri Lankan government’s revenue architecture. 

A disappointing feature of the 2022 budget is that it fails to identify the key structural changes required to deal with the current economic crisis in the short term while creating a policy environment conducive to achieving macroeconomic stability and steady GDP growth in the medium term. Given that the Sri Lankan economy is undergoing the worst economic crisis since independence, policy and institutional reform should have been the focus of the 2022 budget. 

Sadly, the budget does not have a focal point or central theme to serve as a contextual backdrop for the policies and expenditure proposals, which collectively do not represent what the business community (both local and foreign) is looking for: a clear signal from the government that it intends to create the right mix of policies and public investments for promoting rapid private sector development in Sri Lanka. 

The private sector is the engine of growth and to the extent that the 2022 budget is unlikely to lead to the creation of a dynamic business environment, one could state with a reasonable degree of confidence that it has missed the bus.

Export-led growth or import substitution?
The Finance Minister refers to the wealthy nations of Asia collectively as ‘prosperous countries’ and rues the fact that Sri Lanka was wealthier than most of them in the early 60s. In the Finance Minister’s own words: “The budgetary framework that I presented to make our country a prosperous land can be made a turning point only through embarking on a development route of similar to those ‘prosperous countries’.” 

But here’s the nub. Like the 2021 budget presented by his brother Mahinda Rajapakse, one year ago, this too is by and large inward-looking with emphasis placed not on export-led growth but on import substitution, the linchpin of the ‘Vistas of Prosperity and Splendour’ strategy for rural development outlined in the 2021 Budget Speech. 

To quote from the 2022 Budget Speech: “We are a country with an abundance of experience over a long period of time in promoting import substitution industries. While we have been successful in certain sectors, there has also been failures due to the incompatibilities with the government policies. ‘Vistas of Prosperity and Splendour’ has created a broad scope for the production of agricultural and industrial goods that are identified as import substitutes … HE the President has introduced a green economy concept in this regard and we should create a strong import substitution industries through the manufacturing of organic fertiliser, renewable energy and the production of milk, sugar and medicines. As such we must focus on creating a strong mechanism to improve domestic incomes while saving foreign currency outflows.” 

The message is clear: the government intends to develop the economy primarily through import substitution with export promotion playing a secondary role. This was the approach adopted by the inward-looking 1970-1977 regime with disastrous consequences for the economy. Not surprisingly, the ruling party was booted out of power in the 1977 general elections. Under the new regime the economy was liberalised and it swiftly moved to a higher growth trajectory, thereby ending the prolonged economic drought created by the previous regime. 

The bottom line is that no country in the world has achieved economic prosperity through import substitution for the simple reason that import substitution generally goes hand in hand with protectionism. Wherever there is protectionism, there is sluggish GDP growth resulting in widespread poverty, hunger and underemployment. By way of an example, the North Korean economy is inward-looking (protectionist) while the South-Korean economy is outward-looking (liberal). This is why North Korea is one of the poorest countries in Asia while South Korea is one of the wealthiest. 

If Sri Lanka wishes to emulate ‘prosperous countries’, it must become outward-looking and focus on export-led growth rather than on import substitution. In other words, rapid growth of exports through diversification and improved competitiveness should be the number one priority with competitive import substitution playing a supporting role. The term competitive import substitution implies that domestic production and processing should be promoted through technical innovation and business dynamism rather through protectionist trade policies, which interfere with market forces as well the allocative efficiency of scarce resources. Hence, goods that cannot be produced locally on a competitive basis should not be promoted by the state. The sooner it discards the umbrella of protectionism, the better.  

It is disturbing to note that the policies and proposals outlined in the 2022 budget are clearly intended to transform the market economy into a production economy through import substitution. This approach is incompatible with an export-led growth strategy based on market-oriented production of goods and services vis-à-vis improved productivity and global competitiveness. 

The prominent role that services play in the Sri Lankan economy should not be ignored or undermined. The removal of market distortions through policy reform and fostering of innovation capability via technology transfer are part and parcel of an export-led growth strategy. 

The irony of the 2022 budget is that in pursuing import substitution at any cost, it is likely to aggravate the existing market distortions and discourage innovation capability, thereby making the goal of inclusive economic development an unattainable one. 

Does budget outline strategy for promoting FDI inflows?
The government has identified a wide range of agricultural and industrial goods for export-oriented manufacturing by the private sector with infrastructure support to be provided by the state. But in addition to infrastructure support the state must also provide an enabling policy and institutional environment so as to promote private investment (both local and foreign) in the target sectors (including rubber industrial products, chemical materials, pharmaceuticals, electric and electronic appliances and IT products and sports equipment). But nowhere in his speech does the FM emphasise the need for such an environment. The topic of policy and institutional reform is judiciously avoided in the 2022 Budget Speech.         

Sri Lanka is unlikely to attain high economic growth rates in the absence of substantial foreign direct investment (FDI) inflows. The reasons why foreign investors, especially the big players, are staying from Sri Lanka including the following: (i) deeply entrenched land and labour market distortions; (ii) rampant corruption within the public sector; (iii) a weak institutional and legal framework for facilitating and supporting FDI in export-oriented economic activities; (iv) lack of macroeconomic stability; (v) a torpid business climate; (vi) excessive government controls and regulations, including a bewildering mix of licences and permits; (vii) inadequate financial and institutional support for applied research and development across all sectors and (viii) poor quality of economic infrastructure which raises the costs of 
doing business. 

Though the Budget Speech emphasises the paramount need for increasing FDI inflows, it fails to address most of these constraints. In fact the space devoted to promotion of FDI in the budget speech amounts to a few lines here and there. The Finance Minister mentions that various measures will be introduced to attract FDI but does not spell them out.         

                   
Can Sri Lanka become globally competitive through import substitution?
A hallmark of the ‘prosperous countries’ of Asia is that they are all ranked highly in terms of global competitiveness. Singapore is so advanced that it is viewed as one of the most globally competitive economies in the world. The inward-looking orientation of the ‘Vistas of Prosperity and Splendour’ narrative is incompatible with improved global competitiveness. The stark reality is that without becoming globally competitive, Sri Lanka has little or no hope of joining the ranks of the ‘prosperous nations’. The way forward is through export-led growth, not import substitution. 
In conclusion, the 2022 budget does not address the current economic crisis in any meaningful way; nor does it identify a coherent policy and institutional framework for stimulating inclusive GDP growth and making Sri Lanka a ‘prosperous nation’ in the long run. Hence, it is far from progressive and fails to live up to all the hype about a non-traditional budget. 

However, the high priority given to (i) fiscal consolidation; (ii) conversion of poorly performing state-owned enterprises into profit-making entities; (iii)  establishment of hubs across various sectors (naval, aviation, energy, commercial, knowledge); (iv) development of new major irrigation schemes and rehabilitation of large numbers of small tanks and anicuts; (v) provision of infrastructure facilities for the establishment of small and medium enterprises in rural areas and (vi) streamlining of social security measures is commendable.                    
(Seneka Abeyratne, a retired economist/international consultant to ADB/Manila, can be reached via [email protected])