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by Lloyd F. Yapa

The purpose of this paper is to analyse the budget 2002 in order to come to conclusions as to whether it provides the country with a vision, strategies and financial provisions for the revival of the economy.

Almost twenty years of ethnic conflict and war have left Sri Lankans impoverished, bewildered and confused. In fact some of them have been leaving the country for good either by legal or illegal means in search of greener pastures. Apparently they think that there is no future for them and their progeny in this country. Now suddenly with the ceasefire signed between the government and the LTTE people have began to see the light at the end of the tunnel. However it is not yet clear what exactly the future holds for Sri Lankans. So that it is incumbent on the new government to throw more light on this aspect in their plans by explaining their vision and development strategies for the country. Speeches made by the Prime Minister and the Minister for Economic Reforms contain, copious references to such a vision, objectives and strategies. The budget should have therefore given expression to some statement in this regard. If I remember correct, the late President J. R. Jayewardene on assumption of office as head of the government in 1977 wanted to make Sri Lanka the Singapore of South Asia. What he meant was that he entertained the vision of making this country as affluent, disciplined, law-abiding, peaceful, well governed and highly respected in the international community as Singapore. More recently Dr. Mahathir Mohammed has announced that his government plans to take Malaysia to the ranks of developed nations by 2020. Of course such broad statements have to be elaborated on, with specific details of long-term objectives or goals, short-term objectives and targets.

Such a statement is necessary to build a consensus on a vision and goals and galvanise all sections of the people to the national effort of developing the country to achieve the desired ends. This is actually the answer to the question, 'where do we want to go from here...in about twenty years'? This is the first question, that we should raise, when formulating a 'road map' for the country. Although a vision and objectives are not spelled out, some short-term targets like desired growth rates are mentioned in the budget under the heading "Medium and Long-term Development".

The second question that has to be raised in preparing a road map for the country is where are we now? This is an analysis of the major 'road blocks' (weaknesses and threats) strengths and opportunities. The preamble of the budget statement provides a fair examination of such problems.

But important elements like poverty, youth dissatisfaction, lawlessness, low competitiveness of exports, which tend to discourage investors are absent. Perhaps the reason for lack of comprehensiveness is that the budget was prepared in an environment, where peace was the priority. In any case the identification of major roadblocks in the way of achieving the objectives, strengths and opportunities will yield the main strategies which constitute the answer to the question how do we get there? The strategies are formulated by finding means to overcome weaknesses and threats and by deciding on ways to build on the strengths and opportunities.

Strategies

Some important strategies such as good governance, deregulation, private sector participation, infrastructure development, youth employment, revitalising the rural economy, tax administration reform, liberalisation of the labour and land markets, harnessing the informal sector are directly mentioned in the budget while the major strategy of restoration of business confidence and the dire necessity of promotion of investments are implied.

These are not the only priority strategies required for the development of the economy. What for instance is the strategy, that would be adopted for tackling endemic indiscipline, lawlessness, bribery and corruption that discourage not only investment but also all other peaceful activities. Will the establishment of Independent Commissions deal with all these problems? Would this for instance ensure the amendment or introduction of laws and a more effective system of dispensation of justice to mete out swift justice to criminals of all types?

What of the urgent necessity to liberalise the financial markets including the reorganisation of the inefficiently run state owned banks, whose intermediation costs are so high as to push up interest rates for investors? What kind of monetary policies will be adopted to reduce inflation and keep down interest rates to stimulate investments and to ensure flexible exchange rates for maintenance of competitiveness of exports? What of the ambition of making Colombo a financial hub of South Asia? Perhaps these are implied in the various financial and company laws listed to be enacted. But this is not good enough, as it would not offer clear directions to the economic agents concerned.

Most importantly, what is the strategy to be adopted to obtain a much higher rate of growth of international trade which is considered to be the 'engine of growth' especially of small countries such as Sri Lanka with a small market and a narrow natural resource base. Perhaps this is also implied, in the other strategies mentioned in the budget along with the strategy of improving productivity which alone could be responsible for half the growth rate. The presumption must be that exports might expand with economic recovery.

This is the attitude, that the authorities took towards export development and investment promotion since 1994 before which the export sector was considered a lead sector and accorded priority treatment. This is not surprising since this may be a belief held by certain economists. This is a grave mistake. (It could be the other way round higher growth of exports could push up economic growth.) If countries adopt this attitude, the growth they will get is, what can be described as a 'wheelchair' rate of expansion of exports and GDP. What is called for is an 'activist' approach. What is an activist approach? The Prime Minister's programme for arriving at peace in Sri Lanka can be described as an example of activist plans. Taiwanese and South Korean programmes for development of exports in the seventies and eighties are the ideal role models, that are worthy of emulation in this respect.

Activities

The next step after formulating a set of major strategies is to allocate them among the ministers concerned (or rather decide on the ministries on the basis of the number of major strategies) so that they can come up with activities to achieve the vision, objectives and targets. The budget of course does not have to do this. It is only a part of an overall road map or plan prepared on the lines indicated above. The budget should actually emerge as a by-product of such a plan.

The budget, however, contains a list of exciting activities aimed at reviving the economy. Particularly noteworthy are the activities for liberalization of the land and labour markets. The authorities are apparently aware, that these need to be carried out with the utmost care. For example giving freehold possession of land belonging to the State to farmers could result in a situation, that prevails in the Philippines and South America, where large land owners hold sway over poverty stricken landless serfs. In Sri Lanka too this may happen, if the programme is not carefully planned. One of the ways to avoid this pitfall is to organize farmers into Joint Stock Companies and handover the land and the irrigation and other structures to them.

Such companies could be assisted by the government to manage their farms and any agro processing activities as commercial ventures and employ agronomists, accountants and other experts like any other private sector ventures. The extents of land to be handed over to these companies should be sufficiently large, as to enable them to earn economies of scale. Another option is to undertake a program of development of small and medium scale industries in the areas, especially where freehold possession of land is to be adopted to absorb labour exiting from agriculture.

In any case liberalization of the land market, along with action to clarify land titles, in the case of privately held land, is a must to motivate farmers and business persons to transfer the desired quantum of capital into agriculture to accelerate production, employment and productivity in a significant way, as demonstrated by countries such as Japan, Taiwan and South Korea, the economies of which began to develop rapidly after adoption of comprehensive land reform programmes.

The liberalization of the labour market is also full of 'land mines' as in the North and East. Hiring and firing of workers is one such sensitive area, although it is accepted, that enterprises must be downsized, whenever there are business downturns. Otherwise they could fold up and workers would lose their jobs. Another sensitive area is the right granted to trades unions to resort to strike action, whenever their grievances are not settled. Most trade unions in Sri Lanka are affiliated to political parties.

It is a well known fact, that most of often strikes are instigated by political parties to gain political ends and not to settle grievances of workers. Still another worrisome problem is the tendency not to tie wages to productivity. A large issue is the ability of those already in employment (insiders) to push up wages using their union power, thus preventing employers from hiring new labour (outsiders). Costs would begin to spiral up with a rising pay roll, so that employers would not be able to afford the recruitment of more labour. Such a system therefore creates unemployment. It is obvious, that neither public nor private businesses could thrive in such an environment. Liberalization of the labour markets is therefore absolutely necessary.

It is, however, also true, that some employers adopt an adversarial attitude towards their employees and have not realized, that they could raise production and productivity by adopting a more caring and motivational stance towards them and treating them as partners rather than adversaries. The task at hand is therefore to evolve a system, whereby employers and employees could function as partners, settling their problems amicably, without any interference from outside forces. This needs the co-operation of all parties concerned. Another activity in the budget, that catches the eye is the rationalization of tax incentives. It is essential to do away with some of the numerous and expensive tax incentives, which result in huge revenue losses to the state, and in return place investors on a low tax rate and a simple tax payment procedure. Apparently this is the purpose of the tax reform envisaged.

Of particular interest is the proposed deduction of expenses incurred on training, research and development. Sri Lanka has so far been exporting primary, low still and low budget items. The competition from low wage countries such as China in the export of such products is very heavy. Moreover the demand for such products is income inelastic unlike in the case of differentiated/value added products; consumers, especially of rich countries will not demand more of such products as incomes increase. Sri Lanka's export earnings have therefore never been as impressive as those of the Newly Industrialized Countries of South East Asia. The country could earn premium prices by exporting products, such as the various modern electrical and electronic products which are differentiated on the basis of identified need of consumers. Differentiation, can only be achieved by developing a Research and Development capability and training of workers. Entrepreneurs normally do not invest in such efforts, as they do not yield immediate returns.

The State has to step in to motivate them to do so. The incentives, that have been granted, therefore are quite timely. But this is not the end of the story. There are other ways of achieving this objective, such as rewarding of researchers and the development of a community of researchers. Development of tertiary education to produce engineers and scientists has therefore to be undertaken. Sri Lanka has lagged behind countries such as India and the East Asian countries in this respect, although literacy levels are high due to expansion of primary and secondary education. Still another method of producing differentiated products and services is by targeting and attracting leading foreign investors, such as Microsoft and Motorola, who possess the relevant technologies, in the case of the IT Industry, by creating the necessary conditions and offering specialized facilities. This is why an activist approach in respect of investment promotion and export development is advocated. Such competitive advantages will not accrue to the country, if we only offer a few tax incentives and implement a few hackneyed programs.

Another exciting proposal is the revitalization of the rural economy. The incentives, that are offered may or may not bring the desired results, though the tariff protection of 60% offered for rural products would make a difference in maintaining their profitability in the face of the flow of cheap imported goods. However, the prerequisites for rural uplift are land and water for cultivation, a high quality extension service, the necessary infrastructure facilities like roads and cheap power, easy access to credit and marketing facilities. If we can build a prosperous rural community in this manner, it will serve as a valuable market for our industrial goods and services. Elimination of rural poverty also will reduce the degradation of the environment, reduce urban migration, travel abroad in search of demeaning and lowly paid jobs, besides building a contented society.

The splitting of the VAT into bands and the absorption of the NSL into it is a smart move. It would enable the government to reduce prices of essentials, while earning much needed additional revenue at the same time. Still another point to be noted is, expansionary fiscal policies with the continuance of budget deficits invariably lead to an increase in demand for goods and services. In a country like Sri Lanka, where the prosperity to import is very high, increasing demand results in a higher quantum of imports and erosion of external reserves, while supply does not respond (in developing countries) due mainly to the underdeveloped nature of human resources and infrastructure. The higher VAT band of 20% could discourage the tendency to import more and at the same time provide some protection for locally manufactured goods, if the tax falls mainly on non essential imported goods. It will in addition help to conserve scarce foreign reserves and stabilize exchange rate movements. Actually the imposition of another higher band on imported luxury goods might have been appropriate to discourage conspicuous consumption, which is prevalent among people, who earn massive incomes from certain professional services and from illegal means such as the sale of narcotics, illicit liquor and smuggling.

This may be a better way of ranking in some revenue from 'black' money, than giving tax amnesties for making certain investments. Why should they invest and go through all the hassles involved in engaging in formal economic activities?

This paper would not be complete, if I do not comment on a very obnoxious tax proposal contained in the budget. That is the levy on savings. We understand, that the cut off limit has subsequently been raised from Rs. 6,000 to 72,000 per year. Why not raise it to Rs. 240,000, which is the new tax exemption threshold? The same concession given to tax payers should be given to savers, especially small time savers, among whom are retired persons, whose only income source is their savings. Small savers, are as important to the economy as affluent taxpayers, as savings are required to finance the massive investments, that are being planned. As of the year 2000, domestic savings amounted to only 17% of GDP. The required investments in the years to come will be in the region of 35-40% of GDP, especially to achieve a rate of economic growth of about 8% p.a. National savings in the country have amounted to about 21% of GDP.

Perhaps the assumption is, that the balance will be made up by foreign investors. It has to be remembered, that such investors are hard headed business persons, who select their investment locations on the basis of political stability, good law and order conditions, the existence of effective commercial laws, which respect ownership of property and contractual obligations, flexible labour laws, the availability of quality infrastcture facilities, an efficient and impartial bureaucracy, markets with high purchasing power, and a host of other facilities and not only on the basis of some tax concessions. That is why, South East Asian countries have taken pains to encourage the savings habit and secured national savings rates of more than 40% of GDP. Taxing small time savers, who are in a majority is a dubious way of encouraging.

Budget deficit

Now I wish to deal with the most important feature of the budget, that is the budget deficit. As a percentage of GDP, revenue accruing to the government is only 17.5%, while expenditure amounts to a whopping 26% of GDP. Sri Lankans have been living it up and as the famous economist Joan Robinson once said, we have tried to enjoy the fruit even before planting the tree! The government obviously did not want to take the risk of reducing the incomes of the public, who are already burdened by the spiralling cost of living, by cutting these expenses, although it is absolutely necessary to slash such unproductive consumption, to reduce the public debt, which is bigger than GDP itself (103%), curb inflation and the demand for foreign exchange gobbling imported goods, reduce interest rates and to increase productive public investments on infrastrcutre and social-economic services such as health, education, transport and communications.

However, the budget contains some 'gems' of ideas to do so, besides the high profile peace initiative. It is stated, that the budget deficit in 2002 will be 8.5% as a percentage of GDP, compared to 10.8% in 2001. What is the assurance, that it will be held at that level? A few supplementary estimates could easily trip it up, since there is no statement to the effect, that such belated estimates will not be entertained. In certain countries laws and other strictures have been introduced to curb the enthusiasm of legislators to spend tax payer's money freely, to protect their economies from spiralling inflation, high interest rates, reduction of the purchasing power of the currency, ballooning public debt and the steady erosion of foreign reserves leading to socio economic instability. So why not consider some such device to curb over-expenditure? The budget also states, that this deficit will be funded from non-banking sources to reduce inflation and lower the interest rates. But such non banking sources include EPF, ETF and insurance funds, which hold the bulk of savins in the country. Will not this manoeuvre by the government mostly for unproductive purposes, 'crowd out' the private sector from using such funds and drive up interest rates?

Public investment

A most surprising proposal in the budget is the reduction of public investments from a level of 5.9% in 2001 to 5.1% in 2002. Reduction of the allocation on productive public investment on infrastcture and economic/social services has been a favourite ploy of previous budget makers, so that they could loudly proclaim, that the budget deficit has been clipped despite various demands, to reduce inflation etc, when in fact, what has to be reduced is the recurrent expenditure on unproductive consumption. This time around, however, the reason for this tendency appears to be, that government expects the private sector to invest in infrastcture projects. It is doubtful, whether the private sector could be persuaded to make investments in large projects like coal fired power plants, ports, airports and expressways involving billions of rupees, long gestation periods and low returns. That is why in most parts of the world the State accepts that responsibility.

The budget taken as a whole, contains some exciting "germs of the government's future plans" to revive the economy, despite notable omissions like export development and some confidence building strategies like maintaining law and order. Definitely, therefore one can see the light at the end of the tunnel. The message of the budget, that is received loud and clear, in fact, is the necessity to make investments.

But what is not very clear is a message to the public, that investors need to be offered incentives to make such investments and some belt tightening is necessary (on the part of the public) before it becomes better, as the expenditure of the government is far in excess of its revenue. National consensus and/or a stronger government with a higher number of seats in Parliament are needed to make such unpopular but essential decisions, as slashing unproductive expenditure and liberalization of the labour market. The people, one is sure, will understand the message, especially if government leaders and the officials display fiscal discipline and set an example by making sacrifices themselves. They also must indicate details of future strategies and plans along with costs and benefits in order to build consensus. Failure to do so will be exploited to the fullest by mischief makers.

Above all, a lot depends on good planning, effective implementation, strict monitoring and changing strategy, when conditions change, as the budget contains only the gems of the plans of the government.

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