Saturday, March 12, 2016

Sri Lanka’s credit- card economy

From The Sunday Times
At a local pub, Citizen Perera told ‘Eternal Grumbler’ Silva that he was amused by a recent media report where well-known Minister Sarath Amunugama had spoken on the topic “What’s so special about Sri Lanka” at an investment conference. “Why?” asked Silva. “Well … what’s so special is that we keep changing the goalposts on taxes every 3-6 months!”
Jokes aside the recent revised tax rates is another example of inconsistent policies, a bane of Sri Lanka’s political economy for many years. Because the economy is linked to political happenings, taxes have had no consistent policy structure or reforms. In recent times, it’s a case of one proposes and the other deposes!
That the economy is in dire straits is no secret anymore; that the country is on an economic downturn is also evident and cannot be hidden from public glare. The Government is finally admitting it, better late than never one would say. Economists argue that the signs were all there for the past three years but were ignored. The new administration, though it rode to power on a platform of ending corruption and excessive spending, and restoring proper fiscal management, has fulfilled only one (corruption) of the three promises.
Timing, it seems, isn’t the government’s best virtue. On the same day an investment conference opened in Colombo (on Tuesday morning) with a ringing call for foreign investment with no roadblocks, the government that evening announces a series of significant tax changes, changing tax rates (and reintroducing older ones) just three months after it was first announced! With a plethora of advisers, the Prime Minister, who has a good vision, should have been advised that the timing was poor in making such an announcement.
Over and over, foreign investors have identified the lack of consistent polices as one of the biggest deterrents to investment. The recent Harvard-led economic summit in Colombo drove that point home strongly, reinforcing what others in Colombo have been saying ad nauseam for many years. What would have gone through the minds of investors at the Colombo forum when they were informed of policy changes in taxes, as they toyed with the idea of investing? With the Prime Minister taking the reins whenever a financial crisis emerges, the credibility of the Finance Minister and his pronouncements are under question, not a good omen for investments.
The economic crisis is two fold: A spending spree by the previous regime and its debt spilling over in 2015-16, coupled with high spending by the present administration too (largely also due to a bloated public sector workforce, duty free vehicles, and poorly-targetted welfare measures). Debt piling up and a US$4 billion bill of loan repayments and bond outflows in the next 12 months is what the government is up against; hence the harsh tax measures impacting severely on the private sector because tax revenue is the only way out.
Another question being raised is whether a Finance Ministry announcement on Monday March 7 about the discovery of an unseen Rs.1 trillion loan owed by the previous regime which puts the economy further out of gear, was coincidentally made on the same day Fitch Ratings downgraded the Sri Lanka country rating. The ministry announcement was made on the evening of the morning of the Fitch announcement. Furthermore it’s puzzling how such an amount, which has to be in some Treasury book, wasn’t found by old and new mandarins of the Treasury in the past 14 months.
In defence, government economists argue that if the government was trying to deflect attention from the Fitch downgrade, it cannot be because the extra Rs.1 trillion burden is itself further negative to the ratings. On Thursday, Standard & Poor’s also downgraded the country rating with analysts saying such downgrades was not unexpected given Sri Lanka’s high risk owing to piled-up debt, payment dues and eroding revenue.
Economists like Colombo University’s Prof. Sirimal Abeyratne say that the present crisis is no surprise and was evident for many years. He says the usual practice of mixing politics and economics is still on and that there is no middle path. The country needs serious reforms or it could perish (economically), he argues. “The government came on a platform of corruption and lack of governance. But rather than admit these problems and take the public into their confidence, they proceeded as if there were no serious economic issues,” he said.
The government says the latest tax swings will not impact a large segment of the population. That’s easier said than done.

For instance, one is yet to see what items VAT will be increased while the rise in corporate taxes would be passed to consumers with indirect taxes rising. Capital Gains is another new headache for corporates. All what the average consumer sees are the macro changes in taxation while at a micro level, people are clueless about the impact.
Macro-economic issues however are the result of micro level problems (subsidies, handouts, excessing state spending, loans, etc). The reality is that the people need more jobs and better incomes. Taxes affect the people’s spending capacity, reduces demand in the economy which then lowers production, leads to less income and as a result less jobs. In such a situation, the policy of higher taxes amidst a proposed one million jobs plan is an inconsistent formula, Prof. Abeyratne believes. At the moment Sri Lanka is dabbling with a credit-card economy; the country is living on borrowed cash while the people are spending money they hope to earn in the future.
Foreign investment is needed to increase jobs as local investment is insufficient to meet that demand. More jobs means more money in the hands of people, more income means more spending power which leads to demand for goods and services and results in increased output/production. That growth unfortunately is not taking place right now. While foreign investment is still happening amidst changes in tax policy and the absence or delay in much-needed public sector reforms (particularly an urgent decision on the future of inefficient and highly indebted public companies), the kind of high-end investment Sri Lanka is trying to attract may take longer than anticipated.
While prescriptions are easy and implementation is the hard part, the government seriously needs to dig into its basket of formulas and avoid poor ‘timing’ announcements. It must go back to the drawing board and prepare a tax policy where occasional tinkering won’t impact investment decisions not only by foreigners but also local companies. The need for more tax revenue is inevitable as long as it’s properly done and minimises the damage that one sees today.

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