Meh, the Budget

The new budget is meh. Other than the out the blue devaluation of the Rupee, the budget didn’t deliver any major surprises. This is probably a good thing, the surprises sprung in past budgets have seldom been happy, but this budget wasn’t that solid either. While it has its positives most of  its proposals for development appeared to simply throw money at problems hoping they’ll solve themselves.  One very absurd example of ill thought out spending is making Sri Lanka a sporting hub, I mean, where did that come from? We’re not even good at any sports in particular aside from cricket, and now even that is open to debate.

Self Sufficiency?

Who, what and why came up with in idea of self sufficiency for Sri Lanka? This in an age where economic theory has proven again and again the benefits of robust international trade and specialization. Offering incentives for import substitution is a recipe to increase the burden on the average Mr. Silva. Have people forgotten the tough times Sri Lanka went through in the time of Sirimavo?

Import Substitution

Import substitution encourages local manufacturers to produce good of inferior quality to those that could have been imported. They are often more expensive as well. So while this creates the illusion of economic superiority all it will do is sell cheap quality produce at exorbitant prices to ordinary Sri Lankans. Your basic economics course teaches you that import substitution only reduces the level of wealth in an economy by benefiting a few (the producers) and negatively affecting the vast majority (the consumers).

What would have been much better is to structure domestic production strategically. Promote the resources we would have used for import substitution to create value in areas of export that are of long term worth. Essential items can be produced locally but that also with a keen ear to global supply considerations.

Simply saying we are going to be self sufficient and harking back to ancient Sri Lanka might be all very well to glisten the eyes of your average ardent patriot, but it’s not very good for the country’s economy.

Rupee Devaluation

The rupee devaluation was a shocking, but positive step. Many pundits were expressing fear about Sri Lanka’s increasingly precarious Balance of Payments position; the Central Bank was actively selling the dollars that came into the country to buy rupees, in order to prop up the value of the rupee. This is not harmful in itself, but subsequent re-injection of rupees into the system (sterelization) started creating a vicious cycle that was set to ‘crash land in the BOP’ as one LBO columnist put it.

The rupee devaluation was long called for by the IMF but the Central Bank was refusing to comply. Now the government has gone and done what the IMF wanted, purportedly for reasons of its own. The Central Bank it seems has been left in the dark.

Bad side of devaluation

The negative side of this move is of course loss in investor confidence. Right up to the point of the budget speech, investors believed Central Bank assurances promising that the rupee will not be depreciated. And then the government goes and does exactly the opposite in the budget (which is not expected to deal with exchange rates and monetary policy anyway). A central bank relies heavily on market credibility and, coupled with the expropriation bill and generally bad Public Relations, The whole thing might serve to spook would be investors even more.

Things could have been handled with greater delicacy.

Throwing Money at Infrastructure

The government h as planned to spend a lot on building schools. It has also resolved to provide vocational training to the large proportion of students who can’t enter university. While this is a good thing, what would make better sense is to reform our education system more along the lines of increasing opportunities via private universities and professional courses.

Vocational training will only be attractive to some. And the majority of people who try hard and fail to get into local universities are really quite clever, it’s just that the advanced level exam is a pipeline used to squeeze through just the amount of students the local university system can take. These students deserve more than simple vocational training. The economy needs entrepreneurs and innovators more than it needs mechanics and AC repairmen.

Roads to lead somewhere

There is also the question of roads. The government has pledged to build plenty of roadways. This is a positive thing, better roads improves access and quickens the lifeblood of the economy; logistics. Same goes for improving utility services. But what the government could improve on here is the trickle down effect. the very act of building infrastructure itself can be vastly beneficial to the economy when local contractors and workers are used wherever possible. So far most of the money spent on construction has been trickling down to China.

Reforming Tax

Tax reform is on the cards. But not the type of tax reform to get our Mr. Silva excited.  Currently Sri Lanka taxes poor people too much. Taxes like VAT take more money from the poor than they do from the rich, and are known as regressive taxes. The government is planning on moving into a more simplified tax system but will not be focusing on reducing the tax burden on the poor. They are moving from direct taxes into indirect taxes, and so will focus more on import duties, cess, VAT and commodity levies rather than income taxes. This is going to burden the public with higher prices.

Conversely tax breaks are planned for investors and entrepreneurs in specific industries, to boost business. They must be hoping this pays off in the long term. The public certainly should be.

The budget deficit

Will all these efforts cut government spending or improve revenue and reduce the budget deficit? The government thinks yes. I think maybe. The new venture to charge VISA fees from tourists can net a few million dollars, but that is petty cash compared to the vast amount of money we are spending. The budget deficit reduction will again depend largely on things out of our control like foreign direct investment, export growth and domestic revenue.

Is it good for the economy?

Is it good for the economy? Hard to say. A temporary squeeze on the prospects of the general public can be expected, inflation will go up and more bad fortune could be expected based on how absurd the government gets with this import substitution agenda. There is hope that foreign  investors will go for the better investment climate that the government is putting together, and this could ease things up in the future. But a lot will depend on what’s happening to the global economy and right now the global economy is not looking very good.

Policy wise, the government hasn’t changed much. Progressive thinking in the areas of reform will be needed if the money to be spent on education, infrastructure and reforming government institutions are to pay off. On an overall basis there’s nothing for the general public to get too excited about.

Sri Lanka’s Poverty and Subsidizing the Rich

slum, somewhere in Sri Lanka, image from JDS

The IMF’s Regional Economic Outlook talks a fair bit about the Sri Lankan economy and its growth prospects. The region as a whole has grown but inequality is still a problem. Inequality is not the same thing as poverty, which has decreased. Inequality is measured by the GINI coefficient, which is basically a measure of inequality in a statistical distribution, in this case income. The higher the coefficient the higher the inequality. The chart below shows the increase in the GINI coefficient for a series of countries in the region.

A reduction in poverty is good. Poverty is measured by an increase in per capita incomes, which is the GDP divided by the population. The flaw here is that per capita measurements completely disregard income distributions by taking the total of the country’s income and assuming everyone gets the same size of the pie. Which is obviously not the case. Growth with inequality, while still growth, is counterproductive to sustained growth. Japan and countries like South Korea, Taiwan, Singapore and Hong Kong all had growth with greater equality until the eighties which contributed to their superior economies today. Basically you can grow without equality, but you can’t grow much.

-in Sri Lanka, number people living under $2 a day reduced by 20 percent

Interestingly Sri Lanka’s GINI, at 49 points as at 2007, dropped to 47 points in 2009/10. Going by available data alone this paints an encouraging picture. Maybe subsequent government policies have actually contributed to a decrease in inequality. Or it could be a temporary blip caused by the peace dividend hitting previously poor populations of the North and East.

How to combat inequality?

It is all in the policy. inequality is not irreversible, but it doesn’t involve simply doling out money to the poor either, this being a fine way of exhausting a countries fiscal resources in record time. Countries like the Philipines have started Conditional Cash Transfer programs that make welfare programs conditional on the receiver’s actions. So instead of subsidizing university education in a broad free for all, tuition would be provided to those students who actually show results. Or on a more simple level, family grants can be conditional upon whether you actually use the money to send your kid to school, or take them to the doctor. 

The IMF also claims that carefully targeted social safety nets like unemployment benefits and pensions can combat inequality. This is especially so in spending on health.  In China, a one yuan increase in government health spending is associated with a two yuan increase in urban household consumption. We might think Sri Lanka has sufficient spending on public health, it being free and all. But there are several inefficiencies in the system. But we all know sanitation here isn’t the best, and a recent clinic held by the private medical college in Malabe drew several times the hundred or so people they were expecting to come, proving a large unsatisfied demand for convenient health services.

Subsidies

Subsidies, though ostensibly geared at helping the poor, rarely do. In Sri Lanka we have a regressive tax system. The amount of tax you pay as a portion of your income actually decreases as you become richer continuously expanding inequality. This is mainly due to regressive taxes such as VAT.

Subsidies like agricultural subsidies, if not exactly counterproductive, don’t really help. Farmers still get crushed by price fluctuations. The real problem is possibly investment in agriculture. Very little agriculture here is actually industrial. The technology and methods used still date back to the times of the ancients. Agriculture has become a dumping ground for labour, with it usually being considered a final option for people who can’t succeed in the industrial sector.

the IMF report carries an interesting chart on how oil subsidies during the time of the global crisis helped the rich more than the poor. It says that the benefit of one dollars worth of fuel subsidies to the poor generally costs about 14 dollars to the budget. This is because higher income households tend to consumer more fuel than lower income households.

Sri Lanka spent upto 80 percent of what it spends on education and health on fuel subsidies. Recent tax cuts for vehicle imports and export benefits etc also favor the rich. More because market policies and business environments discourage entrepreneurship among the poor.

Middle Class Hypocrisy

Swaminomics has an interesting take on poverty in India and how it is relative. For example, a recent report that draws India’s poverty line at Rs. 32 a day attracted middle class ire, but the middle class itself, while fighting against poverty on one side, refuses to pay its servants good wages and bargains down prices in shops.

Middle class folk don’t want to calculate the per capita daily spending of their servant’s family. They resent servants constantly wanting more pay, even if this falls short of the very level they find outrageous when specified by the Planning Commission.

This double standard is not restricted to paying servants. When middle class folk go to Dilli Haat to buy a sari, they will beat down the weavers to the lowest price possible. If told that the weaver earns only Rs 4,000 per month, will they change their attitude or agree that they have helped keep the weaver poor? No chance.

I think this draws interesting parallels with Sri Lanka, whose middle class is much the same. Will we also forego low fuel prices and higher taxes in order to reduce inequality between the rich and the poor? Interesting question.

Sri Lanka’s Central Bank; Crap or Brilliant?

The economy is about to be rescued from a potential plunge into the deep waters of crisis by an injection of cash from the IMF. Apparently historically, all nations ever to adopt the soft peg approach to currency buoyancy have faced that same fate.

Now there is talk that the IMF money is coming from a new ‘condition-free’ fund established exclusively for developing nations in trouble. Sri Lanka is almost depleted of foreign reserves after a binge of currency modulation during the final quarter of last year that saw us purchasing rupees with our dollars in order to ensure the rupee wasn’t devalued too much.

My CIM lecturer was telling me at that point that we are extremely stable for a war economy that didn’t rely all that much on taxes and he didn’t quite know why, and at that time i didn’t either. But i guess we do now.

Is the Central Bank an incompetent institution or is it pure genius though? that question kind of confuses me. There was the whole hedging fiasco that seems to have passed below the news radar, and not to mention the huge non-regulated financial sector holding who knows how much of the nation’s wealth that the Central Bank just failed completely to notice or moderate.

And now this pegging scenario which seems more attributable to a desperate short term measure to sustain a heavy war economy than anything else. And in that sense, it seems to have worked pretty well. The government ensures that they had sufficient funds to sustain the purchasing of weaponry while it was most needed at a time when it was sure that seeking foreign help for the war effort would have meant cumbersome conditions and impositions into its human rights track record etc.

So they went all out with the economy as well in order to sustain the war effort and did not really give a damn about the consequences. They were playing a dangerous game. They had to make sure the war was significantly completed by the time the economy started hitting the dirt. Guess they figured they’ll somehow build it all up later.

They first accumulated foreign currency through the massive sales of bonds. And later, when foreign markets turned volatile the government (or the CB) itself had to start buying Rupees so they used what foreign currency they had to buy our own money back. Thereby creating false (?) demand for the rupee and keeping its value up. We mainly kept in on par with the dollar, focusing on maintaining roughly the same dollar rate throughout. This is essentially called maintaining a ‘soft peg’ through currency manipulation.

The years of ‘GDP growth for the first ever time in the history of SL’ Back since 2004 was probably attributable to a loosening of the monetary and fiscal policies of the country and driving up inflation (which indicates positive growth, not to mention the including of government purchases of weaponry in the GDP calculations) we were at the same time buoying up our currency through the manipulation of dollars and it has all cumulated into a double whammy that would have surely sunk us to the bottom of the Indian ocean if it wasn’t for the IMF’s ‘bail out’. As explained in this LBO report.

was this all orchestrated with evil genius by an administration one track minded with pure focus on a winning a war by any means possible? Ruthless enough to disregard any and every long term ill effect to the economy which has undoubtedly magnified due the credit crunch? Or more likely they were simply seeking ways to be financially independent and were lucky enough to make it so far with barely a limp? (Which is probably a very subjective postulation)

Meanwhile most export industries are almost crippled with big garment companies the worst affected. The removal of the EU’s GSP plus taking away a cushioning affect that helped them along all this time making things worse.