Budget and economic outlook

Sunil KARUNANAYAKE

In 2009 Sri Lanka Economy demonstrated its commitment and resilience by registering a 3.5 percent growth despite many challenges from both domestic and external conditions. This was facilitated by steady recovery in the second quarter.

Thirty years of destruction and carnage came to an end in early 2009 while the shattered global economy too showed signs of recovery.

The sudden withdrawal of capital by foreign investors in the aftermath of the global crisis was further compounded by contraction of the external trade, slow down of the domestic economic activity and declining foreign remittances. Government finances came under heavy pressure during this period owing to lower tax revenue and import levies, demanding expenditure in Northern resettlement.

President Mahinda Rajapaksa presenting the 2011 budget

By the end 2009 the country recorded unprecedented balance of payment surplus US $ 2.7 billion raising foreign exchange reserves from a paltry US $ 1.1 billion to a phenomenal US $ 5.1 billion.

Budget for 2011 was presented in this healthy environment. The budget though not being welfare oriented had focused on long term development that could enhance the quality of life.

Removing taxes

Some of the key features are, doing away of the Provincial turnover tax, abolition of debit tax, lowering the corporate tax and promoting long term lending by commercial banks. Treasury Secretary Dr P B Jayasundera was critical on the failure of the banking sector for their lethargic attitude on long term lending for projects with long gestation periods.

Treasury Secretary also advised the Inland Revenue officials the need to change their attitude and pursue high networth professionals who are currently outside the tax net as against pursuing minor defaults and the consequent prolonged review board hearings and litigation.

With the proposed elimination of tax files of PAYE tax payer, IRD officials will certainly will be able to concentrate on much needed higher tax revenues in a productive manner.

The budget also increased the export cess applicable to bulk tea and raw rubber by nearly 100 percent with the long term aim of encouraging shift to value added export products (prior to which Rs 3.50/kg promotional levy was introduced).

This may be a sensible approach for government revenue as commodity booms are not sustainable. It is also inevitable that producer margins may be reduced as the exporters costs will be higher.

Industry sources also feel that blended tea in bulk form cannot be considered non - value added (NVA) while exporters will find it hard to revise the prices of existing contracts.

Shifting to value addition

Both tea and rubber have made advancements in shifting to value addition- Tea bags, packets, Instant tea powder and green tea while the rubber industry too has made similar strides and emerged as a leading global supplier of industrial vehicle tyres.

However this transformation is not that easy and requires heavy investment Governments over the years have used the cess and duty as an instrument to mop up revenue from exports.

Since the early eighties duty has been progressively reduced and was eliminated leaving only cess.

According to the latest figures exports to end October amounts to US $ 1.1 billion and the year end figure is expected be impressive with no global excesses.

The tea industry has for several years been agitating for restoration of import of orthodox tea that was withdrawn in 1994, to promote blending of multi origin teas a vital ingredient for leading global brands.

Many bold moves

Present government that has initiated many bold moves to transform the economy should give serious consideration to this matter that will pave the way for more value added exports as well as attracting leading packers and blenders to Sri Lanka.

As at present this activity takes place in overseas blending centres with tea shipped from Sri Lanka.

The latest external trade figures released by the Central Bank indicates increases in exports, imports as well as private remittances key drives of foreign trade. Most encouraging was the increase of garment exports to USA as well as EU even in the absence of GSP plus concessions.

This phenomenon proves the customer preference for Sri Lankan products vis-à-vis competition from China and Bangladesh.

Close on the heels of the budget presentation the Government took another far reaching decision by further relaxing exchange controls.

Accordingly relaxations were made on regulations pertaining to investments abroad by Sri Lankans, permitting resident companies to borrow off shore (giving the advantage of obtaining low cost finance), investments by non residents to invest in Sri Lanka and foreign companies to open businesses in Sri Lanka. This relaxation follows the current account liberalization implemented in 1994 and 2001.

In Sri Lanka we do not have a fully liberalized Capital account even though the current account was liberalized in 1994 in compliance of the agreement with IMF Article Viii requirement.

Prior to this move exporters were required to account for their full proceeds in Sri Lanka and the Exchange Control Department monitored this tedious exercise through a series of documentary controls.

Contrary to expectations the relaxation on repatriation of export proceeds to Sri Lanka did not result in a massive outflow of funds from Sri Lanka. US Economic Professor Steve Hanka describes exchange controls as nothing more than a ring of fence within which governments can expropriate their subjects property.

The year 2010 was marked by the restoration of peace providing greater optimism for economic activity and a strong basis for long-term sustainable development supplemented by ongoing global economic recovery.

Robust economic growth remains

Economic growth remains robust and broad based. Capital market activity reached a peak with Colombo emerging as a fastest growing stock market.

Current market capitalization of US $ 20 billion and the all share index at an all time high of 6500 is noteworthy. Increasing investor confidence was amply demonstrated by the response to the successful issue of the 10 year international sovereign bond in September at a lower coupon rate of 6.25 percent with an over subscription of six times.

Long term bonds have been successfully utilized by Asian Tigers in their success stories and Sri Lanka no doubt will benefit from this mechanism in their pursuance of becoming "Asia's economic Miracle".

With the gradual shifting of the economic power to the East, Sri Lanka is well poised as countries like Vietnam has met with much success in attracting investments.

Largest ever FDI

Sri Lanka attracted its largest ever FDI from the Colombo South Harbour project developer whose investment has been reported at US $ 260 million in the US $ 550 million project.

A fair amount of interest has also been focused on the Magampura harbour in South Sri Lanka for investments in cement bagging, automobile plant, tea blending and bunkering.

These developments are expected to attract much needed foreign direct investments. This favourable position has resulted in the Sri Lanka Rupee appreciating.

Export sectors seem to be somewhat concerned about this trend owing to the potential adverse effects for Sri Lanka exports that should be carefully monitored.

Stability of the reserves depends on the long term sustainability of the funds for which appropriate investment climate and regulatory mechanism is essential.

The Leisure sector continues to perform well with high occupancy figures with the expectation of surpassing 600,000 arrivals. Leading operators in the sector have geared themselves to meet the increasing demand with heavy investments in construction of new hotels as well as in upgrading the facilities.

Sri Lanka in the coming years should do well to enhance the export earnings for tangible reserve accumulation.

Growth prospects -challenges ahead

According to latest forecasts it is clearly understood that the recent global crisis has underlined the emergence of Asia as a global economic stronghold.

Countries in the Asian region are generating remarkable growth outcomes facilitating to restore world economy. China and India are playing a leading role in this exercise but many other countries in Asia too have the potential to be partners to this process.

It is said that in the next five to ten year period the Asian economy could account for a significant share of the global output.

Sri Lanka too must benefit in this environment, while the recent developments have yielded positive results lot more needs to be achieved. The loss making state owned enterprises need to be made profitable enabling them to make a significant impact on prolonged issue of budget deficit.

These enterprises are going through a vicious cycle, competent management sans political interference could be the direction to resurrect them.

The Government recently acquired the key LPG supplier through the exit of Shell Gas, in addition Sri Lankan Airlines and the budget airline Mihin Air are now fully owned by the Government.

State owned enterprises needs to be given a new dressing with more flexibility for decision making. Self enforced code similar to the Corporate Governance code of the SEC and ICASL that's now enforced on listed companies and working well should be a useful model.

It is also important to reorient the thinking and attitudes of the public sector employees to embrace a spirit of flexible private enterprise culture for commercial enterprises.

Globally, climate change has been given priority due to its impact on economy and varying weather patterns. Recent volcanic eruptions in Iceland, earthquakes in Myanmar, frequent flooding in most south Asian countries has caused enormous hardships to people and the Governments.

Sri Lanka too must take note of this aspect as constant flooding, cyclones and landslides and varying rainfall has adversely affected agricultural output threatening food security and human quality of life at an added cost to the State.

Land for productive purposes

Climate based disasters directly affects the poor who are already under stress. There exists an urgent need to allocate high priority to deal with the potential adverse effects of climatic changes. The Budget however has not given adequate attention to this all important subject.

It is heartening to note the efforts taken by the Urban Development Authority to clean up the cities and release land for productive purpose as this has been one of the pressing needs of investors.

The oil prices have given indications of further increases that would affect adversely the countries like Sri Lanka. Current prices are said to be around US $ 82 a barrel.

Growth concentration in the Western Province is likely to see a correction in the near future with the commissioning of the Magampura harbour and the infrastructure development now taking place in the provinces, with significant rebuilding activity to be carried out in war affected North and East where the recovery is now progressing.

The Government must also give high priority to collection of tax revenues to meet the revenue targets particularly in the background of rebuilding activity that's now taking place in the war affected North and East.

Sri Lanka's secondary and tertiary education though being criticized has produced world class professionals now serving in leading capitals in the world.

On the other hand a large number of students leave Sri Lanka to pursue higher education at a tremendous social and financial cost to the country.

In this background Government initiatives to permit foreign universities is most welcome.

In this knowledge economy quality education is a precious commodity. Countries like Malaysia in the beginning and latterly regional counterparts in Bangladesh and Nepal have reaped good dividends through private university education.

It is no secret that a large number of Sri Lankan students attend these institutions. It is reported that nearly 500 students are attending Bangladesh Universities.

It is also important to strengthen the state university sector that yet attracts the cream of the student population. Authorities should be mindful in student related issues.

It was just a few weeks back in London that students clashed with police over Government budgetary measures. Nearly 50,000 students had invaded the Conservative Party headquarters causing much damage to the property somewhat resembling the recent riots in Paris not forgetting frequent student demonstrations around Ward Place.