JULY
TO
DECEMBER 2016
DIGEST
Benefits of a Potential
Singapore-Sri Lanka
Free Trade Agreement
page
18
Barriers Beyond Tariffs: Sri Lanka’s
Exports to China
page
14
Fiscal Policy for Growth:
Sustainable Financing for Development
page
06
Green Shine in
New Star Ratings
of Sri Lankan Hotels
page
22
Financing for Development
2 3
The Institute of Policy Studies of Sri Lanka (IPS) is an autonomous institution that aims to promote policy-oriented economic research and to strengthen the capacity for medium-term policy analysis in sri lanka. Its mission is to contribute to the socio-economic development of the country through informed, independent and high quality research that seeks to influence the policy process. With over two decades of substantial research expertise, IPS has emerged as a regional centre of excellence and the most influential think tank in Sri Lanka.
Editorial
The annual IPS flagship Publication - ‘Sri Lanka: State of the Economy 2016’ - was recently launched under the theme of “Fiscal Policy for Growth: Sustainable Financing for Development“. The widely distributed publication calls for fiscal consolidation efforts aimed at broadening Sri Lanka’s tax base while minimizing distortions, with expenditure measures aimed at rationalizing spending and improving efficiency. Drawing from the Report and its theme, Raveen Ekayanake and Kithmina Hewage in their article to TE Digest on ‘Fiscal Policy for Growth: Sustainable Financing for Development’, highlights the perilous state of Sri Lanka’s public finances, and the urgency for fiscal policy reforms to avert an economic crisis. Sri Lanka’s fiscal position in comparison to other developing countries is poor; government revenue generation is well below the desired level while government’s debt burden is much higher when compared to countries at a similar level of development. In this context, public expenditure needs to be rationalised by diverting resources away from loss making, state owned enterprises towards investment with high economic returns. But this an uphill task, requiring political will to reform. Simultaneously, government’s revenue base needs to be broadened given that revenue collection efforts have been unsatisfactory. In the article, they argue difficult reforms need to be undertaken to ensure macroeconomic stability and to improve the country’s economic outlook. On the trade and investment front, Sri Lanka has seen a steady decline in exports while foreign direct investment (FDI) flows to the country remain unsatisfactory despite the end of the war. Towards increasing exports and improving FDI to the country and driving economic growth, Sri Lanka is currently negotiating trade deals with India, China and Singapore, which are expected to be finalised during the course of this year. Sri Lanka’s forthcoming free trade agreement (FTA) with China is of importance given that it has the potential to be the biggest bilateral trade deal, in view of China’s population and status as the world’s second largest economy after the USA. However, the article, ‘Barriers Beyond Tariffs: Sri Lanka’s Exports to China’, argues that the ability to capitalize on a FTA depends on Sri Lanka’s capacity to simultaneously address both tariff and non-tariff measures (NTMs) in China. Concurrently, Sri Lanka is negotiating a FTA with Singapore, which was launched in 2016, with the aim of improving trade relations between the two countries. The article ‘Benefits of a Potential Singapore-Sri Lanka Free Trade Agreement’ examines what Sri Lanka can gain from such an agreement.Despite the poor macroeconomic and trade performance, Sri Lanka is witnessing a rise in tourism since the end of the war. An important aspect that needs consideration in the country’s post-war tourism development is ‘Making Sri Lankan Tourism Accessible for All’, while the right enabling environment could benefit the industry, which is explored in the article – ‘Sri Lanka’s Tourism Industry and the Foreign Ownership Debate’ by Chantal Sirisena. With the increase of tourist arrivals to the country, the demand for ecotourism also has seen a considerable rise. However, much needs to be done in order for the industry to reach its full potential. In the article, ‘Intellectual Property Rights (IPRS) as a Tool for Enhancing Ecotourism in Sri Lanka’, Dilani Hirimuthugodage highlights how IPRs can be used as a tool to support the development of the sector while in the article ‘Green Shine in New Star Ratings of Sri Lankan Hotels’, Kanchana Wickramasinghe explores the environmental, community and sustainability aspects in a new star rating system in the hotel sector and how hotels in Sri Lanka reap the benefits of the system to promote sustainable tourism in the country.In addition, the TE Digest contains articles on a broad range of economic issues, from’ ICT for Development’ to ‘Health Costs for Poor in Sri Lanka’, which would be of interest to policy makers, economists, universities, development partners, the private sector and the general public.We hope you will enjoy the 11th edition of the Talking Economics Digest and look forward to your feedback on the articles, which you may post on our TE website.Research Fellow janaka@ips.lk February 2017
Janaka Wijayasiri
EXECUTIVE DIRECTOR
Saman Kelegama, DPhil (Oxon)
DEPUTY DIRECTOR
Dushni Weerakoon, PhD (Manchester)
TALKING ECONOMICS TEAM
Janaka WijayasiriDishnika PereraBilesha WeeraratneKithmina Hewage Charmaine Wijesinghe
CONTRIBUTING AUTHORS
Abhinav Pandey Anarkalee PereraBilesha WeeraratneChantal SirisenaChinthani SooriyamudaliD. D. M. WaidyasekeraDilani HirimuthugodageDushni WeerakoonGanga TilakaratnaJanaka WijayasiriKanchana WickramasingheKithmina HewageManoj ThibbotuwawaNipuni PereraPriyanka JayawardenaRaveen EkanayakeSamanthi BandaraSuwendrani Jayaratne Vishvanathan Subramaniam Yolanthika Ellepola
IPS PHOTO CREDIT
Roshan KaluarachchiNalaka Liyanapathirana
INSTITUTE OF POLICY STUDIES OF SRI LANKA
100/20, Independence AvenueColombo 07, Sri LankaTel: +94 11 2143100, +94 11 2665068URL: www.ips.lk Blog: ‘Talking Economics’Web: www.ips.lk/talkingeconomicsTwitter: www.twitter.com/TalkEconomicsSL
DESIGN/LAYOUT
Shiran Sabar
Copyright and Disclaimer All material published in the Talking Economics Digest are copyright of the Institute of Policy Studies of Sri Lanka (IPS), unless otherwise specified. It cannot be quoted without due acknowledgement to the IPS and the author. It cannot be reproduced in whole or in part, without the written permission of the IPS. The content, comments and posts of the Talking Economic Digest and the IPS blog represent the views of individual authors and do not necessarily represent the views of the IPS.
Sri Lanka’s Extended Fund Facility Arrangement with the IMF: It’s Mostly FiscalFiscal Policy for Growth: Sustainable Financing for Development ICT for Development: Why Sri Lanka Needs to Address the Gender Digital DivideTrade is Not Just for Big Businesses: Role of Sri Lankan SMEs in TradeThe Red Dragon’s Leap: China’s 13th Five Year Plan and its Implications on Sri LankaBarriers Beyond Tariffs: Sri Lanka’s Exports to ChinaRegulating Financial Services for the Poor in Sri Lanka: A Closer Look at the Long-Awaited Micro-finance ActBenefits of a Potential Singapore-Sri Lanka Free Trade AgreementSri Lanka’s Tourism Industry and the Foreign Ownership DebateGreen Shine in New Star Ratings of Sri Lankan HotelsIntellectual Property Rights as a Tool for Enhancing Ecotourism in Sri LankaMaking Sri Lankan Tourism Accessible for AllIPS Publications Policy Instability : The Achilles Heel of Sri Lanka’s ProductivitySouth-South Cooperation – A New Lease of Life for Developing CountriesCrop Insurance: Is it Workable in Sri Lanka?Can Sri Lanka do more to help agricultural exporters meet Sanitary and Phytosanitary Standards?Burning Health Costs for Poor in Sri Lanka Achieving Inclusive Health in Sri Lanka through SDGsWhy Sri Lanka Need Comprehensive and Integrated Responses to Mental Health IssuesEconomics of the OlympicsDecrease in Remittances in 2015: Glitch or Beginning of the End?Taxation in Sri Lanka: The Need for Radical Change? Inside IPSIPS News Authors & TE Team Fast FactsIn a Nutshell
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CONTENTS
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Sri Lanka’s Extended Fund Facility Arrangement with the IMF:
It’s Mostly Fiscal
By Dushni Weerakoon
The often repeated pun on the IMF’s acronym satirically suggests that it prescribes a tighter fiscal policy, whatever an economy’s problem might be. Indeed, lower budget deficits and higher government revenues are central to Sri Lanka’s latest US$ 1.5 billion loan from the IMF. But, the economy’s booms and busts of recent years – including the current economic distress – go beyond merely the fiscal; much of it has manifested in the monetary and exchange rate policy spheres. It is hard, however, to get away from the argument that all roads lead back to the fiscal quandary; the frequent devaluation of the rupee for example, is a reflection in the monetary sphere of fundamental imbalances in the real economy – production, consumption, and investment. And fiscal policy is where the adjustments begin. The imbalances besetting the Sri Lankan economy produces ‘twin deficits’: budget deficits that mean debt is piling up and current account deficits that indicate overriding reliance on foreign capital inflows. At the heart of it, the imbalances mean a) national expenditure exceeds national income; and b) production of tradable goods and services is inadequate. So long as foreigners are willing to finance the external current account deficit, the economy can muddle along. But, if there is a reversal of such flows, as happened in 2015 (that coincided with a sharp increase in fiscal imbalances), painful adjustments have to be made. A current account deficit can be addressed by either cutting national expenditure or raising income. The latter cannot be increased sufficiently in the short term as GDP growth typically increases expenditures, and productivity improvements take time. Alternatively, governments can attempt to switch resources to produce more tradable goods and services. This calls for a depreciation of the currency. But, a nominal depreciation alone is insufficient; expenditures must also be reduced to keep domestic cost increases at bay, and ensure that a real depreciation of the currency takes place. Sri Lanka’s IMF programme signed in June 2016 has built all these elements into its framework – fiscal tightening, a soft inflation target, and a flexible exchange rate regime. Within this framework, GDP growth is expected to remain at a modest 5 % in the medium term, while export earnings are forecast to grow steadily (Table 1). Clearly, imbalances are to be addressed in the short term by ‘switching resources’ (flexible exchange rate) rather than attempting to boost national income. For a real depreciation of the currency to occur, expenditure (consumption or investment) must be reduced. Therefore, the government and/or private sector (firms and households) must curtail spending. This is being done by cuts in both current public spending as well as tax increases.The government’s current expenditure is to reduce from 15.2 % of GDP in 2015 to 13.9 % in 2016. Generous relief measures offered in 2015 will take a cut in real rupee terms in 2016-17; household disposable incomes will drop as fiscal expenditures on public sector salaries and wages, expenditures on other civilian goods and services and transfers and subsidies (of which nearly 80 per cent go to households) are squeezed (Figure 1). On the revenue side too, households’ disposal incomes and firms’ profits will be impacted with projected increases in collection from VAT and income taxes (Table 2). Not surprisingly, the overall macroeconomic framework points to declining private savings as a share of GDP, while private investment stagnates at 21.9 % of GDP in the coming years (see Table 1). While focusing on fiscal policy, the response of monetary authorities will also be critical to the question of who bears the cost of adjustment. If the rupee is not allowed to float freely, interest rates will rise, increasing the cost of credit to firms and households, and thereby reducing domestic expenditures. The prudent option is to allow the rupee to move freely on underlying economic fundamentals. Monetary policy can then be more stimulative to support growth, discouraging savings and encouraging borrowing (as the predicted savings-investment figures seem to suggest). Overall though, there is little room to provide a fiscal and/ or monetary policy stimulus to accelerate growth in the near term, evident by the IMFs modest 5 % medium term growth estimate. It will draw the usual criticism that fiscal austerity leads to a stagnant or shrinking economy, at least in the short run, and exacerbates debt burdens needlessly. However, there is no realistic alternative to fiscal tightening; Sri Lanka has pushed itself to a corner, dragging public finances down with low tax receipts and unaffordable spending sprees. What the economy needs most today is a credible fiscal consolidation plan that will restore macroeconomic stability and investor confidence in the country. If the only means of getting there is inking an agreement with the IMF, then it is incumbent on the government to deliver on the terms swiftly. The loan amount, spread over three years, is relatively small. In the circumstances, Sri Lanka needs to act early and decisively to fully leverage the IMF deal as a confidence-restoring measure in its efforts to attract investment flows, both local and foreign.
Real GDP growthAverage inflationExport value growthFiscal balancePublic debtPrivate savingsPrivate investment% charge% charge% charge% of GDP% of GDP% of GDP% of GDP4.80.9-5.6-6.976.028.021.95.04.1-0.5-5.477.227.821.95.05.34.6-4.775.525.921.95.05.18.2-4.073.124.821.95.25.07.0-3.770.724.221.95.45.011.3-3.565.223.621.9
2015 2016 2017 2018 2019 2020
civil service wagesother civilian g&ssubsidies & transfers2014201520162017250200150100500
i n fl a t i o n a d j u s t e d R s . m n .
2014 2015 2016 2017
1.92.62.321.92.62.62.9Income taxVAT
Table 1: Selected Economic Indicators, 2015-2020
Source: IMF, Staff Report for the 2016 Article IV Consultation
Figure 1: Current Expenditures
Source: IMF, Staff Report for the 2016 Article IV Consultation
Table 2: Tax Revenue (% of GDP)