Fiscal reforms backed by structural reforms imperative for sustained growth: SLEA President

Following is the address by SLEA President Professor A.D.V. de S. Indraratna at its 2016 Annual Sessions commenced last Friday. 

This is the 13th consecutive Annual Sessions of the SLEA, which I am addressing as its President. The theme of these sessions is ‘Fiscal reforms: An imperative for sustained growth’. It is a spin-off from or an offspring of the theme of last year’s Annual Sessions, namely ‘Policy reforms for sustained high growth’. Therefore, without making a long address on the overall theme itself, I will deviate from the tradition by making some introductory remarks starting from where I concluded last year. There is another reason for this – there are two eminent economists who will follow me as the keynote speaker and the chief guest to speak on it.

Last year, you may recall, I discussed the major problem facing Sri Lanka in the last one and a half decades as “Falling current revenue relatively to excessive current expenditure and the resulting unsustainable budget deficits, on the one hand and the rising public debt with limited foreign direct investment (FDI) flow, on the other. This has been the major impediment to the achievement of sustained high growth,” and in my own words, the problem was summed up as “living beyond means”. 

By way of solution to it, I also suggested that enhancement of the current revenue is crucial, mainly by increasing direct tax revenue while excessive current expenditure should be reduced by eliminating waste, corruption and extravagance. I also added that at the same time, an enabling environment with good governance backed by sound national policies must be created to attract FDI.

The finance minister seems to have   accepted that Sri Lanka’s “major problem has been living beyond means”. However, the remedial action taken so far for its solution has not been encouraging. Even though the trend of current revenue, which has fallen consistently as a percentage of gross domestic product (GDP) from 16.8 in 2000 to 11.4 in 2014, it has been reversed in 2015 with around 20 percent absolute increase in the total revenue over the previous year. This has happened due to the very large increase of indirect taxes, taxes on domestic goods, including excise taxes on tobacco, liquor, petrol, etc.

Of the total increase of around Rs.305 billion of total tax revenue, only around Rs.65 billion, that is only about 20 percent, was from direct taxes. This was rather in direct antithesis to the policy announced by the prime minister, just before the budget in November 2015. Worse still, the current revenue has increased at a much slower rate than the current expenditure, almost doubling the primary deficit as a percentage of GDP and the overall budget deficit to an unsustainable level of 7.4 percent of GDP in 2015.

On the other hand, the national debt – both domestic and foreign, has increased with the debt service ratio on foreign debt rising from 20.8 percent of GDP in the previous year to 27.7 percent in 2015, that is by more than 7.5 percent of the value of the exports of goods and services, which themselves have been falling. Even though part of this increase might be due to the inclusion of some earlier unregistered debt discovered latterly, the net increase is still significant. 

FDI, which is also necessary for sustained growth, has not improved either. With the end of the terrorist war and the establishment of peace, FDI was expected to increase significantly. This did not happen. FDI has in fact reduced to 0.83 percent of GDP in 2015 from more than 1.0 percent of GDP in each of the preceding four years. Foreign private investors desire good governance and an efficient and corruption-free public sector when deciding to invest in a country as a sole investor or more so, in partnership with the government in the form of public-private partnership (PPP). The inevitable conclusion is that without an enabling environment with good governance and its characteristic attributes, foreign investors are reluctant to come in a big way. And unfortunately, there is no substitute for good governance.
 

Long way to go 
With the new unity government, the journey to good governance has only begun: independence of the judiciary has been restored; rule of law has been made operative; right to information has been enforced even though subject to some limitation; media freedom improved and independent commissions have been appointed though integrity and independence of a few of them have been questioned. 
Nevertheless, there is a long way to go in the elimination of waste, extravagance, corruption including favouritism and nepotism and enforcement of transparency and accountability in public and corporate transactions, which are all attributes of good governance. There are allegations in respect of each one of these: one does not have to enumerate them; they are in the know of public domain and in the media and in the recent reports of COPE and COPA. 

It is common knowledge that fiscal operations over the years have resulted in a high budget deficit and an excessive debt burden, which has to be serviced without allowing it to pile up further. The government must take steps to curtail expenses, especially those of a current nature. Populist proposals such as salary increases and provision of various perks and consumer subsidies should not be undertaken without commensurate proposals for enhancement of revenue, especially direct tax revenue.

As I mentioned at the outset, an year ago, that was at the end of last October, the SLEA discussed that a series of policy and structural reforms on trade and other real sectors would be necessary in order to reduce the budget deficit, fill the serious resource gap and reverse the economy to a growth trajectory to have sustained inclusive development, which should be the ultimate aim. Of these, fiscal reforms are an imminent imperative. That is why the SLEA thought it fit to take it up as the theme of this year’s Annual Sessions this evening and the whole of tomorrow, only a couple of weeks before the 2017 Budget. 
Notwithstanding, one should not think that fiscal reforms are sufficient or overlook the fact that  they  must be accompanied by incentive and structural reforms especially with respect to trade and other real sectors, the regulatory environment and access to credit by small and medium entrepreneurs.

As regard the monetary sector, the Central Bank has been proactive and taken several measures to tighten the monetary policy and cautioned against fiscal profligacy with a view to facilitating the conduct of monetary policy. As regard trade policy, Sri Lanka must not rush to embrace bilateral trade agreements like the ETCA but focus more on regional and multilateral trade. At the same time, Sri Lanka should enhance its competitiveness by improving product quality and cost via improvement in productivity and adhering to standards needed to access international markets.

I hope the Development Framework or Plan, which the prime minister is scheduled to announce soon, would come out of a homegrown model determined by the endowment of the country’s natural and human resources, its strategic location and its insularity and small size. In this context, the SLEA is glad that the prime minister, according to the media, has thought it fit of appointing a committee comprising our own local economists and other professionals  rather than getting down foreign experts. 

Let me conclude with the hope that the SLEA discussions this evening and tomorrow will be fruitful and make the necessary impact on the relevant authorities and parties.