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Sunday, April 21, 2024

Daunting Economic Challenges for the New Government

by Nimal Saderathne.

Enormous economic challenges confront the coalition government. Facing up to these economic problems after months of political preoccupations and electoral politics is no easy task. It is much more than changing the mindset from electoral politics to economic management as it has to deal with more serious fundamental economic problems than before the elections.

A strong resolve that transcends immediate political popularity is essential to solve the deep-seated economic weaknesses. Can the coalition government with diverse ideologies and policies implement the essential reforms?

Economy destabilized
The macroeconomic fundamentals have worsened during the year. The trade deficit is increasing, foreign reserves are declining, the balance of payments is deteriorating and global conditions, except the drop in international fuel prices, are not favourable. Government finances are precarious with expenditure rising without commensurate increases in revenue. The increasing fiscal deficit, public debt and trade deficit are closely connected and arise from the fiscal deficit to a large extent.

Political preoccupations neglect economy
Political preoccupations resulted in the neglect of these economic problems. From about the middle of last year the government’s focus was on the re-election of the incumbent president. After the new president was elected, the preoccupation shifted to the general election. During both these run ups to elections economic policies were aimed at winning elections rather than stabilising the economy.

Extravagant expenditure, including lavish entertainment at Temple Trees, duty concessions and duty waivers, free motor cycles to public officials, among other giveaways increased public expenditures and contributed to increasing the fiscal deficit to 6.0 percent of GDP exceeding the target of 5.2 percent of GDP that the Treasury repeatedly said would be achieved. This increase in the deficit was despite a decrease in debt servicing costs due to lower interest rates and a cut in capital expenditure.

Interim Budget
The Interim Budget of January 2015 too focused on giveaways rather than mobilisation of resources. Many of the concessions had adverse fiscal impacts and were responsible for increasing this year’s trade deficit that is likely to exceed last year’s high deficit of US$ 8.3 billion. Imports increased due to the reduction of tariffs and increasing aggregate demand due to increased disposable incomes and low interest rates. On the other hand, the Interim Budget’s rash revenue proposals were not implemented.

Foreign debt
The government debt that increased to US$ 49 billion at the end of last year was 75 percent of GDP, much above the safety threshold of 60 percent of GDP. With further borrowing it would have increased further this year.

Formidable challenges
The government is faced with the formidable challenges of decreasing the fiscal deficit, reducing the trade deficit and tackling the deteriorating external finances. Will the coalition of diverse economic views, be able to forge common consistent economic policies and take bold unpopular measures to revive the economy?

Budget 2016
The answer to this question will be evident in November when the Budget for 2016 is presented. Will this budget that is being formulated within a medium term framework of economic policies address the problem of inadequate government revenues, the curtailment of government expenditure by reducing losses in state owned enterprises and adopt prudent practices in government expenditure? Will there be effective policies to contain the public and foreign debt? Will fiscal policies reduce aggregate demand to reduce the trade deficit?

Incapacity of coalition economics
There is considerable scepticism of the government’s capacity to address these issues adequately. The hybrid government with its internal policy differences and ideological variance would find it difficult to pursue bold economic measures that are needed. The coalition government with diverse views and ideologies are likely to hamper adoption of consistent and pragmatic policies. The implementation of policies too would face stumbling blocks. The government is likely to be like a large slow moving elephant with several mahouts giving different directions.

Law and order and the rule of law
There have been political gains after the election of the new government that would benefit the economy. Law and order and confidence that the rule of law will prevail are important gains, not only for the freedom and dignity of the nation and its individuals, but a positive contribution to the economy as good governance and the rule of law are vital preconditions for economic development. However, they alone would not suffice. There have to be good economic policies and effective administration of the economy.

Erosion of confidence
Despite these favourable conditions there has been erosion in business confidence that was expected to be boosted by the election victory of the UNP. This did not materialise due to the poor economic management and inadequate policy directions. Another reason for the erosion of confidence in the government has been the departure from the constitutional provision of limiting the cabinet to 30 members by the 19th Amendment. This positive development for good economic governance was undermined by using the loophole left in the amendment of forming a “national government”. This disillusioned most people who had voted for change, good governance and good economic management.

Jumbo cabinet
Confidence in the new government has been severely eroded by forming a jumbo cabinet of 48 and a large number of other ministers. Such an unwieldy cabinet is not conducive for consistent economic policy formulation. Implementation too is likely to be inefficient and ineffective. It is widely believed that the choice of portfolios left much to be desired as well, especially in key areas of economic policy formulation and management.

The government has several advantages. It can blame the previous government for this state of the economy even though most of the ministers of the previous government are reincarnated as ministers in the current coalition government. Then it has a commanding majority in parliament and there is no doubt of unpopular measures not being passed in parliament or a defeat of the government in parliament. A third advantage is that the government is assured of a five year term of office.

These advantages must be exploited to adopt good economic policies that would be unpopular at the beginning but can rescue the economy and bring benefits that would make the government popular at the end if its five year term. The alternative is to not adopt pragmatic and essential policies now and compound the economic problems and face unpopularity at the end of its five year term.



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