Finance of  the Budget

Prof. A D V de S Indraratna

The  second reading of the budget is over. The government has won it by a majority of 100 votes. The final reading is expected in about 3 weeks’ time. There had been a mushrooming of seminars and discussions  on the budget during  the whole of  last week of October. Many of them examined the budget from the view point of how it affected their organizers.  Workers’ unions and the public looked at  it from how it affected their livelihoods.  Hardly a few looked at it from an overall macro point of view. I do not wish to look at the individual proposals and pass  judgement. I will rather look at the budget ( or the entire budget arithmetic ), as a whole, examine it as a fiscal instrument in the mid-term development framework. and indicate any policy implications, as I see them, for consideration of the policy makers and the relevant public officials.  For this purpose,  I shall first rearrange the 2015 budget in  accounting format, as follows (see Table 1)

 In the backdrop of the preceding three budgets, I see  in the 2015 budget several healthy trends :  From 2009 until 2013, revenue as per cent of GDP has been declining; this trend was reversed this year 2014, with its revenue increasing  by 17 per cent to 14.4 of GDP from 13.9 % of GDP in the preceding year. This rising trend was maintained  in the  2015 budget, with  even a further  increased revenue estimate of 14.9 per cent of GDP. 

On the other side,  the recurrent expenditure apparently could  not be cut due to increasing salaries and wages and subsidies and transfer incomes of Rs. 146 billion, some of which, if I may, might have been prompted due to trade union pressure and electoral and political compulsions.   Nevertheless, the budgeted increase in recurrent expenditure has been kept less than the increase in revenue, thereby working out for a current account /revenue surplus of 1.1 per cent of GDP, for the first time in the last few years, (barring 2014 in whose revised estimates a very marginal surplus of Rs. 8 billion is expected) This is certainly an healthy trend, and should not be allowed to be interrupted by going in for  too many supplementary estimates of current expenditure. 

Table 1 – 2015 Budget in Accounting Format

( Rs. Billion)

			Amo    unt	% of GDP		Amount	% of GDP
I	Total Current Revenue		1,654	14.6	Total Current Expenditure	1,525	13.5
					Current Surplus c/d	129	1.1
			1,654	14.6		1,654	14.6
II	Current Surplus b/d		129	1.1	Public Investment	696	6.2
	* Grants		35	0.3
	Unspecified		11	0.1
	Overall Deficit c/d		521	4.6
			696	6.2		696	6.2
III	Financing of Deficit
	Foreign Borrowings       86.9)	453			Overall Deficit  b/d	521	4.6
	Less Repayment          (38.8)	202	251	(48.1)
	Foreign Investment on TBs & T Bonds		40	(7.7)
	Domestic Borrowings
	Bank                        (13.9)	70
	Non- Bank              (30.7)	160	230	(44.1)
			521	(100.		521	4.6

        Note:-  figures within brackets are percentages(%) of the overall deficit                  

        *I have entered the grants in the capital part of the account  since it is not revenue but                    usually  given for project/capital expenditure.          

Be that as it may, I may add a caveat here:  Given  the above  circumstances,  Current expenditure could be cut, if firm positive action were taken to reduce corruption, waste and ostentation, in the public sector, thereby increasing the current surplus further. The Prime Minister himself has suggested one way : cutting down the number of parliamentary sittings. This would no doubt reduce the cost of sitting fees and subsidized meals and refreshments etc and parliamentary overhead costs. There would be  other bigger cost cutting items, which a Parliamentary  Committee itself  is best allowed to sort out. Positive action in this direction would further enhance the current account surplus and correspondingly ease the burden of financing the capital budget.

 Another healthy feature of this budget is that the trend started in 2010, of  bringing down  the budget deficit   yearly,  has been  maintained  by budgeting for an overall deficit of 4.6 per cent of GDP. I have advocated as far back as  2011 ( see my latest book, Policy Issues for Sustained Development for Sri Lanka ) that to make Sri Lanka Wonder of Asia, one of the several targets should be a budget deficit of 3 %  in 2016 or failing which, 2017). The Government should be able to reach this target in 2017, if it  continues with this trend.

Coming to  the capital budget, it is gratifying to note that despite Government’s effort to maintain the  declining trend in the overall deficit, the planned infrastructure investment has not been reduced; on the contrary it has been increased by more than 20 per cent to more than 5 per cent of GDP and along with the increase in education and health of 54 per cent, the total public investment has been planned to increase to 6.2 per cent of GDP from 5.6 % of GDP in the preceding year. In my view, even this is not enough if Sri Lanka wishes to be the wonder of Asia, especially in the education sector. It would be healthier, of course, if any increase in public investment were to be financed with increase in public savings ( see below)  

I have advocated that public investment should be around 7 % by 2017 so that with the recommended  private sector’s increased contribution of around 28 %  of GDP, Sri Lanka will achieve a target of around 35. 0 % of GDP in total gross investment of the country.  However, Sri Lanka  cannot afford this  increased  investment  by increasing foreign debt  further  as I have argued elsewhere(op.cit) . It must come from  greater mobilization of  domestic resources,  and  increased  FDI.

Already we are heavily indebted. In 2013, as I have shown  elsewhere ( see op.cit), our debt burden, as measured by the debt service ratio, was around one fourth of the total export receipts of goods and services.  The estimated interest payment on debt for 2015 is as high as 425 billion,  only second to salaries and wages, and is likely to increase the debt burden further. If on the other hand, had it  been possible to keep it at half of this sum, for instance, it would be possible to bring down Sri Lanka’s overall deficit to less than 3 per cent of GDP, a target expected to be achieved  under the present scenario by around only 2017 or 2018.

In fact, the debt, in particular the heavy foreign debt is the villain of the piece. It is quite evident when we examine the provision made for financing  the overall deficit, as shown in Section III of the above  Budget Account. Other than the Rs. 202 billion to be set apart for repayment of the existing foreign debt, the total foreign debt including the foreign investment in Treasury Bills and Bonds account for 56 per cent of the total overall deficit in 2015.. And  with the Rs. 230 billion domestic borrowing, three fourths (3/4) of the total public investment is to be met by debt, only the other one fourth (1/4) being met by domestic resources. As I have argued else where (op.cit), this sort of scenario would not be sustainable and must cease . Increased public investment must be financed by increased domestic resources, not by increasing foreign debt.  By the time of the 2017 budget, if not able to swap the above position,  at least  half  the public investment will have to be met with increased domestic resources, ie., with the budget deficit around 3.0 per cent of GDP,  by increasing public savings/ increasing the revenue surplus. That will enable the Government to refrain from increasing the borrowing limit as has happened now. This is indeed necessary for sustained growth and development of the country.

  04.11.2014.

           

Bigger Government Isn't Always Better Government

By Priyanga Dunusinghe

Published in Ceylon Today on 9^th Nov. 2014

Since 2006, present government has taken a clear policy stance to do away with privatization of state-owned enterprises. It is said that government plans to transform state-owned enterprises to improve efficiency while keeping the public ownership. The budget 2015 has several proposals to expand public sector workforce and plans to extend public sector intervention into number of areas such as marketing goods and services and various commercial ventures. In addition, government plans to set up an entity to run plantation companies if they fail to improve present status quo of low productivity and low investment in essential areas. This piece of article attempts to discuss the rationale for public sector intervention in the economy and risks associated with such intervention. Moreover, it is expected to highlight some of the recent findings with respect to the effect of public intervention on economic growth and social development.

Why should the public sector intervene in the economy?

First, some goods and services have specific characteristics where a competitive market will not deliver an efficient amount of them, for instance, public goods and services. Those goods or services are said to be non-excludable in that it is impossible to restrict consumption of the good just to those who pay for it. The net result is that those goods or services will not be supplied (or will be under-supplied) by the market because producers are unable to earn income from its supply. Second, the government should intervene into the market whenever there are cases where producers and consumers do not bear the full costs and benefits of their activity. This is usually because there are costs or benefits obtained by people not directly involved in the transaction. An externality therefore describes a cost or benefit resulting from an economic transaction that is borne or received by parties not directly involved in the transaction.  Where externalities exist, the market will not deliver the efficient quantity of the good or service. Third, markets are efficient when all parties to a transaction have equal information about the good or service on offer. In practice, the overwhelming majority of markets are able to function even when this is not the case. However, particular problems may affect some markets displaying imperfect information. If the seller of a good or service has more information than the buyer on the quality of the good or service for sale then such a situation is known as asymmetric information and may result in less trade occurring than in a case where the consumer has better information. In the case where the consumer has much better information than the provider, information problems can produce examples of adverse selection with a similar result (lesstrade than in the case of perfect information). Moral hazard, meanwhile, exists when one of the parties to an agreement has an incentive, after the agreement is made, to act in a manner that brings additional benefits to himself or herself at the expense of the other party.It is in effect a problem of hidden action in that one party cannot observe the actions of the other party and yet the hidden actions of the other party are influencing the costs and benefits of their transaction. Fourth, imperfect competition usually occurs when there are not a sufficiently large number of suppliers in a market. In such a case there will be a lack of the competitive pressure necessary to ensure prices are kept at economically efficient levels. In other words, when there are few suppliers in a market then these suppliers have some market power and may in some cases be able to raise prices. Finally, interventions for social justice or equity reasons are based on the subjective decisions and judgments of democratically accountable politicians, but a market failure framework should still be used to inform decisions and to ensure the desired outcome is achieved in the most efficient and effective way.

What are the risks of public sector intervention?

The existence of a market failure is not a sufficient case for intervention. Public sector intervention comes at a cost. Therefore it also needs to be demonstrated that the intervention will make an improvement and that the benefits of intervention will exceed the costs.  The success of cost–benefit analysis, where all the costs and benefits of public sector intervention are considered, depends on the public sector’s ability to accurately assess both the costs and benefits of intervention. This is important because the public sector frequently has poor mechanisms available to it in deciding how to allocate resources. Indeed, government failure frequently occurs because the public sector faces the same, or worse, information problems than the market itself.  Public sector intervention may also fail to deliver the anticipated benefit if private agents do not respond to the intervention in the way the public sector thought they would. In particular there is a risk that public sector intervention may crowd out or displace future activity by the private sector, such that there is no overall improvement. Consideration also needs to be given to the displacement, substitution and income effects of an intervention.  Political failings arise when individual interests override the public interest, for example when special interest groups are successful in lobbying for an intervention for their own rather than the public’s benefit. Administrative failings arise primarily because public servants work for others rather than themselves and face different incentive structures to those of the private sector. In the public sector, there is limited or no profit motive. Because workers and managers lack incentives to improve services and cut costs it can lead to inefficiency. For example, the public sector may be more prone to over-staffing. The government may be reluctant to make people redundant because of the political costs associated with unemployment.

Neoliberal position on government intervention
 

Generally,neoliberal economists believe that the government's role should be severely limited. They feel that economic and political freedom is likely to be undermined by excessive reliance on government. Moreover, they tend to question the government's ability to solve social and economic problems. They believe that faith in the government's power to solve these problems is unreasonable. They call for more and better information about what government can reasonably be expected to do ­and do well. They point to the slowness of the government bureaucracy, the difficulty in controlling huge government organizations, the problems political considerations can breed, and the difficulties in telling whether government programs are successful or not. On the basis of these considerations, they argue that the government's role should be carefully limited.

  

Center-left position on government intervention

Center-left economists tend to question the market's ability to solve some of the failures just discussed. They point to the important limitations of the market system, and they claim that the government can do a great deal to overcome these limitations. Government can regulate private economic activity. It can also provide goods and services that the private businesses produce too little of. Moreover, they point out that the price system also involves a form of coercion by awarding goods and services to those who can pay the price. In their view, people who are awarded only a small amount of goods and services by the market are forced into discomfort and malnutrition.

Recent empirical evidence

According to Measuring the Size of the Government in the 21^st Century, published by the Fraser Institute, the average size of the public sector, both in developed and developing worlds, began to expand during the first decade of the 21^st century though its share in the economy declined during 1980-90s.For instance the average size of the government around the world, measured as a share of GDP, was 36 per cent; by 1999 it had declined to 31 per cent. However, by 2011, the average government-expenditure-to-GDP ratio for the world had climbed back to 33 per cent.

The authors of the Measuring the Size of the Government in the 21^st Century review a number of theoretical and empirical studies that look into the correlation between the size of the public sector and economic growth performance. They found that there is a hump-shaped relationship between the government expenditure to GDP ratio and the growth rate of per capita GDP. It implied that as government grows beyond a certain size, public sector can actually begin to hinder economic growth, thereby lowering living standards for average citizens. There also seems to be an association between smaller governments and greater efficiency in public service provision and often better performance outcomes. More specifically, the evidence suggests there are important implications for economic growth and social outcomes associated with the size of the public sector. It implies that there is an optimal size for the government sector when it comes to economic growth. Findings further suggest that government is indeed very important, and its programmes are important to improve quality of life. However, at the same time, the results demonstrate that more and larger government is not always associated with improved outcomes. In conclusion, authors argued that governments should learn how to provide more and better services while reducing the costs to the tax-paying public.

Conclusion

All the indications suggest that the government intends to expand public sector role in the economy further in coming years. Available data show that the share of public sector employment increased from 13 per cent in 2004 to 15.5 per cent in 2013. It is expected that this share will further increase with the new recruitments identified in the budget 2015. It is certainly sure that on-going public sector expansion is not going to deliver expected outcomes in terms of better public service delivery or it positively contributes to output expansion. This expansion not only eats out scarce resources but also send wrong signals to job seekers regarding their human capital investment decisions. It is important to reflect on recent empirical findings and authorities be reminded that bigger government isn’t always better government!

Food crop sector in Sri Lanka: Any Role for Youth?

By  Sisira Ekanayaka

Sri Lanka has been an agricultural predominant county over the centuries but the level of importance of the sector has changed over the year. In one hand, agricultural contribution to the Gross Domestic Products (GDP) has been decreasing gradually over the years. However, importance of the agriculture sector has been increasing remarkably in terms of food security of the nation, increasing nutrition level and reducing poverty.

The government of Sri Lanka, has given high priority to improve the agriculture sector. The government policy document “Mahinda Chinthana-2010: Vision for the Future” stated the necessity of the improvement of the sector.

Therefore, Ministry of Agriculture and its’ affiliated institutions have been implementing number of projects and programmes towards sustainable agriculture such as establishment of commercial farms, establishment of agro-parks and agri-entrepreneurship, fertilizer subsidy programme and Api wawamu-Rata nagamu (lets cultivate and built up the nation). On the other hand, though the government has given priority to attract youth to agriculture, there seems to be many challenges such as negative attitude towards agriculture and lack of information which causes to push them away from farming.

Youth in Agriculture

Definition of youth varied across countries as well as culture. The United Nations defined youth as ‘persons those within the age range of 15 to 24 years’ (Higgins,1997). Sri Lanka National Youth Service Council defined youth as persons within age range of 13-29 years (Ibargüen, 2004).

Global trend shows that young household heads in rural areas are more likely to engage in non-farm activities than their older household heads. Also, youth who engage in farming activities tend to earn higher income from their agricultural activities in comparison to older farmers. They earn such income through new crop varieties, adoption of new technology and post-harvest practices or following more profitable ways of marketing. Sri Lankan situation is similar to the global trend. As revealed by Damayanthi and Rambodagedara (2013), 70 percent of the youth are engaged in agriculture related various activities in prominent agricultural districts. Of them, however, around 39 percent engage in agriculture full time while around 40 percent and 26 percent engage in agriculture as family labourers and part time occupants respectively. Only 7.3 percent are engaged in agriculture related industries or business but most of them are small scale or home based industries or business. Majority of them can be categorized as self-employment activities such as maintain a grinding mill, vegetable or fruit stall and plant nursery.

Similar to the global trend, great majority of the youth who engage in full time farming or wish to engage in full time farming  in the future are less educated and without qualifications to do another job, poor having a small  family income and people who live in remote rural areas (Damayanthi and Rambodagedara, 2013). In other words most of them do not have another alternative for livelihood except farming.

The reasons for doing farming as a full time occupation are socio-cultural factors for a great majority of the youth. They are either bound with family responsibilities or have bitter experiences from urban centric jobs which they engaged in their early 20s. Also, most of them like to enjoy (mentally and physical or environmental) freedom at their village. Only 16 percent of the youth mentioned that they have the possibility to earn good income from farming and based on such situation they were selected the farming as a full time occupation (Damayanthi and Rambodagedara, 2013).

Challenges

Regarding agricultural development, four factors of production are crucially influential. Those factors are land, labour, capital and knowledge (including management and entrepreneurship skills).

 In prominent agricultural districts in Sri Lanka, 40 percent of the youth do not like to engage in full time farming in future. This is due to number of reasons such as uncertainty of market or low income/profit, difficulty to fulfill the basic needs such as land, finance, labour, inputs and water, not matching with educational qualifications, lack of social recognition, unavailability of job security, alternative income generation activities being more successful and unavailability/lack of awareness/ training on farming or not introducing modern technology (Damayanthi and Rambodagedara, 2013).

Around 71 percent of the agricultural lands plots in Sri Lanka is less than 2 acres. Furthermore, these lands are subject to fragmention due to population pressure. Therefore, the young generation does not have enough land resources to engage in farming in a profitable way. On the other hand, profit of the production does not merely depend on the land size but it depends on agro ecological conditions, crop, demand and supply as well as marketing channels.  For example, though youth can earn enough income from ¼ acres of potato or other cash crop cultivation in Nuwara Eliya district, farmers can not earn such income from cultivating crops in 2-3 acres in Anuradhapura or Monaragala districts. Therefore, farmers- specially young farmers- who wish to engage in farming as a livelihood, tend to be cultivated in large scale but scarcity of cultivable land is a crucial problem to them all over the country.

Since majority of the youth do not have capital, it is a crucial issue for a beginner in the Sri Lankan farming society. A large number of state and commercial banks, micro finance institutions as well as some of the non-governmental organizations provide credit or finance for agricultural purposes. At present, This is mainly due to banks not being  ready to take risk releasing credit for a beginner who does not have sufficient experience, good transaction history with the banks or capital or collateral for the loan. Even youth cannot get a loan from the ‘Farmer Banks’ even though the bank is established with the aiming the farmers.

Lack of awareness of modern technology and weak extension service badly affects on the youth contribution to the agricultural sector. New generation is more likely to practice modern agricultural technology which provides high income for them.

Market facilities are one of the major factors influencing youth in agriculture. As recent research revealed, majority of the youth (58 percent) is not willing to engage in farming. The major reasons were uncertainty of the market and low income earned from  farming. This proves that the failure or uncertainty of the market adversely affects the youth engagement in agricultural practices. 

Social recognition is one crucial factor influencing youth decisions regarding employment selection. Girls and their parents are not interested in selecting a farmer to get married. On the other hand, Sri Lankan culture creates some negative attitudes related to occupations such as “government servant is a master of the general public”,“a person who engage in farming is poor, uneducated, voiceless, helpless and haven’t qualifications to find any other job” and “agriculture is dirty job with less income”. Such negative attitudes influence youth and it helps to move them away from farming.

Possibilities

There is a number of possibilities to attract youth for agriculture and to ensure their well-being. Most important possibility is that the government interest towards the development of the agriculture sector and attracts youth for the sector. Second possibility is that, in general, young generation in Sri Lanka is better educated than their parents. Therefore, they are more likely to be open to change and adopt to new technologies.

Third, there is an increasing demand for organic and traditional food commodities in the market. In addition, there are many youth who are aware of the adverse effects of the agrochemical usage and high demand as well as profit.

Recommendations

1.      To promote youth in agriculture, the government should introduce and implement group/community system including development of farming and entrepreneurship.

2.      To fulfill the gap between financial facilities and the necessity of the youth a special loan scheme should be introduced.

References

Damayanthi, M.K.N. and Gamage, D., (2011). Transformation of Smallholder Agricultre Sector in Sri Lanka: An Annotated Compendium of Statistics, Colombo: Hector Kobbekaduwa Agrarian Research and Training Institute

Damayanthi, M.K.N. and Rambodagedara, R.m.M.H.K., (2013). Factors Affecting Less Youth Participation in Smallholder Agriculture in Sri Lanka, Colombo: Hector Kobbekaduwa Agrarian Research and Training Institute

Department of Census and Statistics, (2002). Agricultural Census-2002, Colombo: Department of Census and Statistics

Higgins, N., (1997). The Challenges of Youth Unemployment, Geneva: International Labour Officer

Ibargün, C., (2004). Poverty and Youth Issues in Sri Lanka; Briefing Paper Series, Poverty brief 5-2004, Colombo; Centre for Poverty Analysis

Ministry of Finance and Planning, (2010). Mahinda Chinthan 2010: Vision for the Future, Colombo: Ministry of Finance and Planning.

The Dark Side of the Low Interest Rate Regime

                                     

By Sandunika Lekamwasam

Cost of Borrowing

The Economics literature defines the interest rate as "the interest rate is the yearly price charged by a lender to a borrower in order for the borrower to obtain a loan. This is usually expressed as a percentage of the total amount loaned."

In general people talk about nominal and real interest rates which expresse the influence of inflation into the interest rate. In simple words, when people talking about interest rate they generally refers the nominal interest rate which is not been accounted for the inflation. Therefore the nominal interest rate always moves with the changes in the inflation rate. For an example, the lender will be compensated not only for delays his/her consumption but also for the fact that a rupee will not buy as much a year from now as it does today. The real interest rates are interest rates where inflation has been considered. This reveals in the Fisher’s theory of interest rate as well. Further in terms of theoretical explanations, classical theory of interest rate depicts that the natural existence of self‐adjustment mechanisms that the economy is always at or near the natural level of real GDP and the economy is self-regulating. Here the natural level of real GDP means the level of real GDP or the output that is obtained when the economy’s resources are fully employed. But is that practical? That is why intervention of the government taken place introducing the role of Central Bank.

Recent Trends in Interest Rates

Simply interest is the price paid for borrowed capital. There can be so many varieties of interest rate, but a country’s interest rate usually will be benchmark to interest on government securities. It is usually with short-term Treasury bill rate in Sri Lanka. According to the money regulating body, the central bank of Sri Lanka, the benchmark interest rate was last recorded at 6.50 percent and in average 8.20 percent from 2013 to 2014.(Trading Economics, 2014)We have been experiencing a declining trend in market interest rates since the latter part of 2012. The central bank is likely to continue lower interest rates as to support the economy to attain its growth potential since at the moment the country is a heavy borrower in the domestic market as well as from foreign sources. Thus setting lower interest rates makes the government an obvious beneficiary.  Government may seek a solution to loosen its debt service burden throughout this exercise.

Low Interest Rate Regime: Is It Always Good for All?

It is quite obvious that most developed nations are having low interest rates yet those are heading with low inflation and of course small, zero or surplus balance of payment which plays the exact opposite of the developing nations.

As a developing country there are both pros and cons in this prolonged period of low interest rates in Sri Lanka. According to the perspective of the authorities, low interest rate helps to enhance credit growth needed to boost investments and economic activities. But keeping interest rate low for a long period would generate inflation and thereby result a contradictory outcome which is opposing the purpose of expected economic growth and boosting investments. Other than to that, there is always a high chance of occurring an asset bubbles in low interest environment. In simple words asset bubbles are occurring when prices go way up, and suddenly they crash back down. This low interest rate environment is highly vulnerable to asset bubbles, because low interest rates can always create an over expansion of the money supply. For an example, in this sort of situation, investors can borrow cheaply but cannot receive much return on bonds they have invested, so that they use to look for another asset class. Meanwhile risk takers are inspired to engage in financial speculation leading towards asset bubbles that enhances the financial instability which was experienced by East-Asian countries during the financial crisis in 1990s. (Miller, M. and Luangaram,P. 1998)

There are also numerous adverse effects of low interest rates on household savings and balance of payment. This can be elaborated further as that the general public would tend to shift their savings from low return financial instruments to acquisition of valuable consumer goods such as luxury vehicles which of course would drive the traders to start importing such products by obtaining the real benefit of lower interest rates. Vehicle imports, which were on the decline since April 2012, began to increase from June 2013 and recorded a year-on-year increase of 109.1 percent in August 2013, becoming the main contributor to the increase in consumer goods imports.(Sirimane, S. 2013)This in one hand supports to create a gap in Balance of Payment and in another hand defeats the policy makers’ intention of improving economic activity by financing more on capital goods. Because this type of prolonged low interest rate environment inspire importing more of consumer goods which maximizes profit at the moment and avoid importing investment goods which is with less demand. This is an obvious negative impact on anticipated economic growth by the policy makers. This situation proves with the data published in 2013 as that the import of consumer goods have been increased by 7.2 percent meanwhile the export expenditure on intermediate and investment goods have been declined by 6.2 percent.(Colombage, S.S., 2014) This picture reveals that the nation is stepping backward in terms of capital investments which would initiate low productivity, lack of innovation, unemployment and etc. In brief all these would drive the economic growth further away.

At the same time as a result of high import demand initiated by low interest rate causes depreciation of Sri Lankan Rupee. So that pertaining a stable exchange rate and achieving economic growth would become a nightmare. The unstable exchange rate arising due to the differences in real interest rates, purchasing power parity or the relative rates of inflation, political and economic confidence have threaten the entire business sector since the exchange rate is affecting the business decisions in terms of marketing, production and finance. (Daniels, J.D , Radebaugh, L.H. and Sullivan, D.P. 2004)

It is already mentioned that boosting investment should be a key anticipation of keeping a low interest rate by the authorities. Even though the investment decisions are not merely based upon the interest rate or the Cost Of Capital (COC), yet it largely matters Return On Investment (ROI), trade openness, business confidence, technical know-how, fiscal sustainability, political stability and so on. So that I believe accelerating economic growth in terms of productive investments by reducing interest rate is something ends up with a big question mark.

According to the Central Bank data, average Treasury bill rate for the September 2014 for 91 days is 6.17 percent (Current Economic Indicators, Central Bank of Sri Lanka, 2014) whereas the ongoing annual inflation rate is 6.5 percent (Trading Economics, 2014) leaving a real interest rate of negative 0.33 percent. Always the near-zero interest rates have negative implications on savings. Obviously this reduces household savings since the interest rate and household savings are positively correlated. Further to that widening of saving- investment gap occurs with this situation which again restrain from reaching the potential growth level of the nation.

Conclusion

In conclusion, though the policy makers are assuming the reduction in interest rate would drive towards the potential growth level, it is not viable if simultaneous actions are not taken against these negative implications arriving. The economy might be able to sustain within the limits in black & white, due to huge foreign Direct Investment, Foreign debts and remittances and so on; yet revealing such a growth would merely become a financial manipulation and a misrepresentation. Actually the road ahead for sustainable development is to be of systematic process focusing the future than the present, thus productive investment and robust cash flow management is significantly important.

References

Miller, M and Luangaram,P (1998) Financial crisis in East Asia: bank runs, asset bubbles and antidotes, National Institute Economic Review July vol. 165,pp. 66-68

Current Economic Indicators, Central Bank of Sri Lanka, 2014,http://www.cbsl.gov.lk/htm/english/_cei/ir/i_3.asp

Sirimane, S. (2013-Oct) Economic potential for higher growth, Sunday Observer

Colombage, S.S. (2014- Feb) Central Banks Low Interest Rate Policy, Business Times

Daniels, J.D , Radebaugh, L.H. and Sullivan, D.P. (2004)International Business Environments and Operations, Pearson Education,Singapore, pp- 310

Budget 2015: A deeper look

By Priyanga Dunusinghe

Published in Ceylon Today on 2nd Nov. 2014

It is argued thatthe political party in office takes into account political economy considerations when deciding fiscal policy directions, namely expenditure allocations across sectors and revenue generation. Available literature provides evidence that the government expenditure is relatively higher in an ‘election year’ compared to a ‘normal year’. This time, it could be observed that the political party in power has carefully crafted the budget in such a way that it would significantly increase the probability of returning to the high office.

Budget 2015: Some Numbers

The budget 2015 was presented to the parliament on 24^th of October 2014 for seeking approval for spending around Rs. 2,210 billion and financing it through taxes, non-tax revenue, grants and borrowings. The total expenditure and revenue, relative to GDP, is 19.5 per cent and 14.9 per cent respectively. The budget deficit amounts to 4.6 per cent (Rs. 521 billion) in 2015and the government plans to borrow Rs. 251 billion from foreign sources and Rs. 270 billion from domestic sources to bridge this budget short-fall. Out of the total expenditure, the government plans to spend around 31 per cent as capital expenditure in 2015. Compared to 2014, total government expenditure has increased by 15 per cent in 2015.

More Funds for Human Capital Formation

This budget has allocated considerable amount of resources for human capital formation, namely forimproving education and health outcomes. For instance, the budget allocated around Rs. 96.5 billion for education (for the three ministries handling education related activities) in 2015 compared to Rs. 75.9 billion allocated in 2014. This allocation should be commendable given that stakeholders in the sector have repeatedly highlighted the need for more funds for education. As per the budget proposals, additional funds would be utilized for setting up new academic centers/faculties at national universities, higher payments for academic staff, new hostel facilities for university students, scholarships, recruiting teaching assistants to schools, and modernizing teacher training colleagues. Moreover, the government plans to launch fast-track skill development programmes for youth targeting both local and global labour markets.One of the issues in this regard is that it is not clear to what extent this investment helps in improving quality and the relevance of education and vocational training. Mere capacity build-up may waste the scarce resources.

Similarly, allocation for the health ministry increased from Rs. 117.6 billion in 2014 to Rs. 139.5 billion in 2015. As per the budget proposals, the government plans to develop a number of hospitals to cater to the needs of non-communicable diseases (NCDs) and other requirements. Similarly, funds will be made available for health check-ups to identify some of the diseases at their early stages. More funds to above mentioned areas are really significant given the fact that NCDs is widespread in the society and some of the diseases such as kidney related health issues are in rise in most dry zone areas. Moreover, it is commendable that the government identifies regular health check-ups for all citizens as a national priority in detecting some of the curable NCDs at their early stage. It is argued that regular health check-ups are not popular among most Sri Lankan. Hence, financing health check-ups at least for some years could educate and encourage people to be more vigilant about their health status on a regular basis.

Continue with Infrastructure Development

The budget 2014 has allocated a significant share of total expenditure for infrastructure developments. As per the budget proposal, it is planned to continue with constructing new highways connecting the capital city with major cities as well as with development of airports and sea ports for improving greater connectivity with the rest of the world. It appears that the government has identified exports and tourism as two major thrusts in driving the economy in the medium terms. When looking at these strategies, it is important that Sri Lanka sufficiently improve infrastructure because road connectivity between the capital city and some of the main cities still remain very poor. On of the biggest issues with previous infrastructure projects is that the costs of construction were really high because most of the tenders did not go through competitive bidding processes. Moreover, the government lacked proper planning in getting those facilities utilized though capacity development gave greater priorities. As a result, some of the infrastructure facilities remain still under-utilized.

Re-discovering Industrialization and Exporting

It seems that government has identified promotion of industrialization and exports is essential in achieving set targets set in 2020 vision document. This budget has given a number of concessions for Small and Medium entrepreneurs for setting up businesses and specifically it is planned to get private sector to set up 300 factories for promoting industrialization in semi-urban and rural areas. Similarly, a number of concessions have been extended to exporters for promoting export trade. For instance, it is proposed to set-up a one-stop place for export documentation and other requirement thereby simplifying the exporting procedures. Moreover, a number of concessions have been given for promoting research & development and innovation relating to export goods. According o some associations in the industry, these are some of the requests made by them for long years, hence, it is expected that above mentioned policies could make an impact.  

Less Attention on Public-funded R&D Activities

It seems that the budget has not sufficiently funded research and development activities. When looking at the allocations, the Ministry of Technology and Research has been allocated just Rs. 4 billion, which amounts to 0.23 per cent of total expenditure. Although the budget includes some incentive packages for incentivizing research and development activities, it is quite unclear to what extent those budget proposals could make a new research culture in the country. In recent month, a concerted effort was made by the ministry to draw the attention of policy makers for greater budgetary allocation for research and development, but yielded no returns. It is important to recognize that level of research & development activities carried out by firms is largely determined by the size of public expenditure on science and technology advancement. It is required to invest heavily in basic research by the government so that private sector takes initiatives to commercialize new ideas generated by public research institutes. It is quite obvious that private sector is not ready to under take costly R&D activities given the high risks associated and the presence of externalities.

Subsidy Leading to Trapping at Low Equilibrium

As many expected, there are a numbers of relief packages thinly distributed covering various segments in the society. It appears that the budget has covered almost all the social groups, such as children, women, differently abled, pensioners, private sector employees, public sector employees, some informal sector employees, farmers, fishermen, and the others segments in the society. By and large, there is something for each one in the budget. In this respect, it seems that the budget has carefully been crafted to get all on board.

One of the fears with certain subsidies for production activities is that such policies may delay the structural transformation in the economy thereby leaving resources trapped in unproductive activities. As economic theory argues it is imperative that an economy witnesses within-sector and between-sector resources reallocation in its economic growth process. It is required to move resources from relatively low productive sectors to high productive sectors so that growth gets accelerated. Specifically, the economy should witness resources moving from low productive agricultural activities to high productive agricultural activities (within-sector transformation) and moving resources from agriculture sector to manufacturing and services sectors (between-sector). Within-sector transformation is applicable any sector, i.e. moving resources from less productive activities to high productive ones regardless of the sector in which resources are previously employed. In Sri Lanka, agriculture sector accounts for 30 per cent of the total employment, however, its contribution to GDP is just 11 per cent reflecting low level of productivity in the sector.Over-emphasis on subsidies could hamper these processes thereby jeopardizing the medium and long-run growth prospects. It is imperative to note that certain subsidies do more harm than benefit in the medium to long—run though such subsidies could satisfy people in the short-run.

Taxation Leading to Moral Hazard Problem

One of the key revenue proposals in the budget is that the government plans to raise Rs. 40,000 million by extending a refinance facility for payment of tax arrears.According to the budget proposals, a special refinance facility scheme which is re-payable within 5 years will be provided at 6% interest rate to facilitate the settlement of arrears in EPF/ETF and arrears in taxes up to 31.12.2010. This raises a number of questions. First, is it fair to extend a loan scheme at a rate of 6 per cent for people who have evaded paying taxes and FPF/ETF contribution when poor people pay 12-14 per cent interest rate for housing loan? Second, is it fair for those who have complied with the state rules and regulations? Third, does this scheme create a moral hazard situation where tax payers avoid paying their dues expecting similar scheme in future? Finally, to what extent do tax evaders use this facility and settle the tax arrears? There are sufficient provisions in the Inland Revenue act in dealing with people who evade taxes. Hence, it is required to use such measures rather than creating moral hazard problem with respect to paying taxes.

As discussed in a previous article, existing tax regime in the country favors top income earning individuals and cooperates. Compared to early 2000, tax rates levied on top income brackets have come down over the years thereby violating the principle of fairness in taxation. The budget 2015 has not taken any step to tax top income categories sufficiently.It seems that government continues to raise income through indirect taxes while paying little attention to broaden the tax base as recommended by the presidential tax commission.

Several Ministries, But No Work

An analysis on the Appropriation bill highlights that nearly 72% of the total expenditure is allocated to seven key ministries where as 27.8% of total expenditure is spent by 53 ministries and other expenditure lines. A simple analysis on budgetary allocation shows that many ministries are maintained without a purpose. On the other hand, many ministries just attend to routine work rather than development related activities. Hence, the country lost a large sum of money by maintaining a larger number of ministries just to satisfy the personal ego of some politicians. It has witnessed in recent years that some key ministries such as the Ministry of Economic Development carrying out development activities which come under the purview of some other ministries. This clearly shows the waste of resources in terms of making idle some human and physical resources that were originally placed in carrying out such type of work. A simple calculation reveals that nearly 5-6 per cent of the total government expenditure wastes every year in maintaining ‘excess ministries’ which apparently have no work to attend.

Some Policy Inconsistencies

The budget 2015 proposes to provide motor cycles to certain categories in public sector workers at a concessionary price. At the same time, the budget reduced taxes on vehicles carrying school children and using in small business activities. Similarly, the budget reduced the taxes on Hybrid cars arguing that such reduction helps in reducing fuel imports and negative impacts on the environment. Vehicle ownership could be regarded as an asset; hence, public servants receiving above facility could be overjoyed. However, a deeper analysis shows that this policy of offering motor cycle is detrimental to the development of a sound public transportation system in the country. Such policy measures discourage public transport due to lack of demand for public transport services thereby resulting low investment for quality improvement. On the other hand, an increase in private vehicle use could pollute environment a lot and causes several health issues. Moreover, more vehicles mean more crude oil imports that in turn cause a heavy burden to the balance of payment. What is wrong in this regard is that the promotion of private vehicle use by the public policy when public transport generates a number of economic and environment positive externalities.

Pressure on Inflation and the Balance of Payments

In recent years, the economy has been on low interest rate regime, partly due to prudent fiscal and monetary policy management measures. The low inflation regime has helped the economy in a number of ways in improving business climate and competitiveness. However, it seems that certain budget proposals may have a up-ward pressure on inflation in the short- to medium-term due to an increase in consumers’ purchasing power. An increase in income due to various budgetary provisions may increase the aggregate demand in the short-run while there are chances in expanding credit to private sector. Similarly, there will be a pressure on the balance of payments if people decide to spend their additional income on imports. These possibilities should be factored out while taking into account the probability of holding an election in the next year. The balance of payment pressure may be contained to some extent due to falling oil prices in the world market and positive economic outlook in advanced economies.

Rising Labour Costs

The budget 2015 has proposed to increase the employer’s contribution to EPF by 2 per cent. This requirement certainly increases the costs of labour to firms thereby having negative impact on employment creation. It is argued that labour costs are relatively higher in Sri Lanka compared to her competitors and neighboring countries. Further increase could be detrimental to both businesses resulting slow growth of employment where firms decided to substitute labour with capital. One of the reasons for increasing this contribution might be that the government could invest such additional funds in productive areas in an environment where FDI are not flowing sufficiently to sustain a growth rate of 7-8 per cent per annum.

What Matter is Realization Not Provision?

While appreciating the allocation of additional funds for human capital formation, physical infrastructure development, and for other purposes, it is important to note that previous datashow that provisions do not necessarily translate to realization. At the end of the day, impact of the budget depends on what is spent not on the provisions. Financial statements of State Account Department show that a significant fraction of capital expenditure provision has not utilized in previous years. It is often highlighted that there is a delay in disbursement of funds promised in the budget. Hence, one should not be cautious in analyzing the impact of additional funds on the economy because the impact is determined by the amount actually spent not on the amount promised.

Conclusion

The budget 2015 has given something to almost every segment of the society. Hence, in the on-going budget discussions, many attempt to evaluate the budget from the perspective of what they received from the budget rather than from a holistic view. The foregone analysis attempted at discussing some of the implications of the budget from the perspective of national economy. Overall, it could be observed that there a number of positive features in the budget 2015 that could push the country towards the targets set by the ‘2020 vision’ document. At the same time, it is imperative to mention that there are some policy inconsistencies and lack of attention on certain areas which are essential in achieving the set economic targets. Specially, lack of sufficient drive towards structural transformation could be mentioned as one of the key missing areas in the budget. In recent years, it has become common that that most of the fiscal policy matters are decided outside the budget. Hence, it is important to be cautious in discussing pros and cons of this budget merely based on the presented data because it reveals a part of the fiscal operation for the year of 2015.

Overall, it seems that the budget 2015 has taken a new direction towards improving human capital (education and health) rather than developing infrastructure that had been the main trust in the fiscal policy during 2010-2014. This new direction is certainly welcomed by all segments in the society.