- Country’s fiscal space can’t deliver State sector salary hikes and tax cuts without difficulty
- Increasing overall expectations of the people without resources to deliver can backfire
- All candidates saying they will continue with the IMF programme is a good sign
- Debt sustainability can be negotiated, but need to be very cautious about time factor
The current frontrunners in the Presidential Poll race – President Ranil Wickremesinghe, Samagi Jana Balawegaya (SJB) Leader Sajith Premadasa, and National People’s Power (NPP) Leader Anura Kumara Dissanayake – are promising more than what Sri Lanka’s fiscal space can actually deliver, especially when it comes to State sector salary hikes and tax cuts, said Advocata Institute Chief Executive Officer (CEO) Dhananath Fernando, in an interview with The Sunday Morning.
“That is a red flag and overall I feel that it is too much of an overpromise, which will be very difficult to deliver. We can deliver but it will come at a significant cost,” he warned.
Assessing the manifestos of these candidates, Fernando welcomed their stances of continuing with the International Monetary Fund (IMF) programme and outlined possible areas that could be renegotiated with the IMF, while noting that in terms of the economic policies presented, he did not see specific suggestions related to two factors that needed to be considered – debt negotiation and economic growth.
As for the promises being made in the course of campaigning, Fernando warned that the country’s stability would be threatened in the event they were not delivered on: “Election promises are not merely promises. With everyone collectively promising so many things in different ways, you are increasing the overall expectations of the people without having the resources. That is going to backfire.”
Following are excerpts:
What is your overall assessment of the manifestos of the three key contenders at present – President Wickremesinghe, SJB Leader Premadasa, and NPP Leader Dissanayake? What are the key proposals you would commend and what do you see as the main red flags?
Overall, I feel that all the contenders are promising more than what our fiscal space can actually deliver, especially when it comes to State sector salary hikes – which is the main expenditure item – and the tax cuts that are being proposed. That is a red flag and overall I feel that it is too much of an overpromise, which will be very difficult to deliver. We can deliver but it will come at a significant cost.
The second thing is, on moving forward with the IMF agreement, all candidates have said that they are continuing with the IMF programme, which is a good sign. Wickremesinghe’s one is not very clear, but I think that continuity is a given. The only challenge is that there is confusion on the NPP one. They have basically said they are going to do an alternate Debt Sustainability Analysis (DSA) and I am not sure what they actually mean.
According to my knowledge, there are three agreements that we have discussed. Based on the debt sustainability agreement, which is the first one, we entered into an IMF programme, which is the second agreement. The third one is the IMF Governance Diagnostic Report.
The debt sustainability agreement gives a few parameters very clearly – the 2.3% primary balance, 95% debt to GDP ratio, gross financing needs of 13% – which are pretty much non-negotiable. You can negotiate them, but we would be taking a bit of a risk if we were to do so, because of the time factor. Generally these negotiations take a bit of time and during that period continuation would be tight.
The second agreement can be negotiated and is in fact getting negotiated every time the IMF does a review for the continuation of the programme every six months. That’s when the IMF team led by Peter Breuer comes and meets the Central Bank Governor, the Treasury Secretary, civil society, and the business community and has a press conference, after which they come to a Staff-Level Agreement (SLA). Then they push that report to the IMF Board of Directors and release the first tranche, second tranche, and so on. That can basically be revised or negotiated every time based on the timeline, the circumstances, etc.
However, the IMF Governance Diagnostic is something different, which is more on the governance side. Debt sustainability can be negotiated, but we have to be very cautious about the time factor and whether we have the resources to actually do it during that interim period.
How practical are the economic policies presented by the main candidates, given that the country is in recovery mode and on the basis of what we need going forward?
Overall, I would say that there are two things that need to be considered – debt negotiation and economic growth. As I see it, the only way out is for us to basically get a better debt negotiation. If we are going to go ahead with that, we have to improve economic growth.
The growth parameters are not very specific and most of them are long-term. For us to get to 6-7% in the short term is also not easy, but most of what has been proposed is long term. It will take some time for growth to kick in.
For example, in the NPP manifesto, there are a few good suggestions, such as the single window at Customs and simplifying the tariff structure. Those are good things. But to do them and for exports to actually grow, it takes time.
The SJB is basically trying to lead growth through the private sector, Foreign Direct Investments (FDIs), and by connecting to the global value chains. Wickremesinghe’s manifesto gives proposals on fisheries and so many themes, but I believe his plan essentially comes with the Economic Transformation Act – private industrial zones, National Productivity Commission, Free Trade Zones (FTAs), etc.
It is pretty much on the same lines of what SJB MP Dr. Harsha de Silva said at the Ceylon Chamber of Commerce economic debate on Thursday (29 August). It was not specifically mentioned in the broader policy agenda but it is basically private sector-driven growth with trade openness and FDI through connecting the global supply chains. However, for growth to kick in, it will take time.
In this context, the only way that we can improve growth is through productivity. We cannot improve more resources; we already have a very tight budget. We also cannot get capital to increase productivity. For example, if we want to bring more computers or build something, we really don’t have the capital; nor can we borrow from the market because the interest rates are quite high. We cannot buy from the market because we are already at a junk rate due to our credit ratings.
In that scenario, the only available option is to improve productivity. We have to work harder; basically, we have to do much more with less. I didn’t see any proposals to improve productivity in itself. Productivity improves when you connect with the world, but what if we have a rational holiday structure? There are long weekends and so many holidays. If we can rationalise that, where everyone works for one or two extra days, then consumption and growth will happen. If we develop public transport with accessibility, that can drastically improve productivity.
There are some vague suggestions, but I think that we can do more with the existing resources. For example, if it’s public transport, we can have a franchise system for selected routes, upgrade the fleet, and have some structure to incentivise the pricing mechanism so that the middle class can travel in public transport, even paying a higher rate.
I did not see any such specific suggestions in the manifestos. If those things were included, there could be some sort of quick growth. On the growth front, I would say it’s pretty much a common weak area in all the manifestos.
For the people, the promises to reduce taxes and increase salaries are two key draws. Is this feasible in any way? Is there space to do this, manoeuvring in whatever manner?
I would say that it is very difficult. A suggestion in one manifesto is for the tax threshold to be increased to Rs. 200,000 from Rs. 100,000 monthly, which means that people who have registered are going to go out of the tax base. That would be a challenge because we have to expand the tax net. By bringing the threshold to Rs. 200,000, we will be contracting our tax base.
Another suggestion in another manifesto is to keep the tax threshold at Rs. 100,000, but start from 1-24%, bring VAT down to 15%, and bring the export tax down to 6% from 30%. In a way that is good, but when you have too many tax rates – I am not saying they are going to do that – it will also confuse people and will be difficult to collect revenue. Those are the two challenges that I see in relation to taxes.
On salary hikes, I think these promises are too far-fetched. If we were to increase salaries to Rs. 57,800 and increase the cost of living allowance to Rs. 25,000, all this will put significant stress on our balance sheet. That would be very difficult because the last time Government servants were on strike, it was the same Treasury which said that we would have to implement a 4% VAT increase or increase corporate tax.
I don’t think this is feasible. I am not saying it is impossible. You can do it, but then you have to compromise from somewhere. That is my worry – when you deliver things that you cannot deliver. Especially when you promise something like a salary hike to the State sector, you cannot reverse that. The pressure would be high. The military is one of the main expenditure items in the budget. When you make promises in relation to those sectors, you cannot reverse them.
So what are the options available? One option is to borrow from the market – basically the Treasury has to ask the Central Bank to issue more bonds and borrow more money. When you do that, interest rates go up – the interest rate is basically the cost of the money. When the Government is asking for more and more money, people who are going to give money to the Government will increase prices. When interest rates go up, Small and Medium-sized Enterprises (SMEs) and the rest of the economy will have a very difficult time. When interest rates are high, the economy won’t grow.
On one side, you need to grow the economy to come out from the debt problem and we are expecting 5-6% growth, but when you do this, interest rates are going to go high, which will then shrink the economy. If the economy shrinks, we will be in trouble again. In the next round they will request a moratorium saying we can’t pay debt, which will be a big problem.
The second worry is, if the Government is concerned about interest rate hikes and really wants to do this, then it has to print money or the Central Bank has to finance the budget deficit. According to the recently-passed Central Bank Bill, that is not possible. Then you automatically build pressure to amend the Central Bank Act, which is definitely a recipe for disaster. Or they will find another loophole in this act and try monetary financing of the budget.
That’s my real worry, because if that happens, it is not going to go well with the IMF. As we all know, when you do monetary financing – or in the common parlance, when you print money without changing interest rates – not immediately but in the medium term, after about 3-6 months, you are basically asking for another massive crisis.
When you print money, before it goes to inflation, there will be a balance of payments crisis and an acute dollar shortage. When you have too much money – basically giving it to State workers and all those other freebies we are giving – it will add as imports. When you have additional income, you go on a trip or have a picnic or stay in a hotel, which means you are combusting more fuel and increasing the demand for dollars.
When that happens, your dollar demand is going to go up and if you cannot support it with exports, remittances, and so on, there will be a shortage of dollars in the market. Then the currency has to depreciate, which affects inflation. Then the cost of living will go up and the same cycle will take place and people will again ask for another salary hike, which will add pressure on the private sector.
These fantastic promises are being made to the people at a time when we have an ongoing IMF programme, with discussions on the next tranche temporarily on hold, and debt restructuring also needing to be finalised. But if nothing is delivered, what kind of situation will Sri Lanka find itself in a few months down the line? Will stability be threatened?
Absolutely. Stability will be threatened because election promises are not merely promises. It’s also about managing expectations. When one candidate promises something and another promises something else, it does not mean that you have to deliver only what you promised when you get into power. With everyone collectively promising so many things in different ways, you are increasing the overall expectations of the people without having the resources. That is going to backfire.
When one says ‘I am going to increase salaries by 24%’ and another one, to match it, says ‘I am going to increase it to Rs. 58,000’ or something like that, you are increasing the overall expectation level and asking for a future problem, which will definitely threaten stability.
The IMF and the other bondholders will also be concerned, wondering how Sri Lanka is going to manage its fiscal space with all these promises. Generally, everyone is aware that especially in countries like ours, emerging markets, they promise so many things, but if we overdo it and if we do it to an extent that it affects stability, then it will be a big challenge.
We are now seeing a very temporary stability; things will start again after the elections. Then the debt negotiations will kick in and we should also not forget that there are more elections due. Generally during these periods, no one will invest. You are basically restricting a lot of channels and it seems like there will be another six months of election cycles if it goes as planned. It’s quite a challenging time for Sri Lanka.
If it comes to a position where the IMF agreement needs to be renegotiated, looking at it from a global context, has this worked in any other country and what would it mean for Sri Lanka given the current situation?
The SLA can be negotiated with revisions. We can say ‘we are going to increase public sector salaries which will cost Rs. 200 billion and we are going to increase some other taxes or impose a new tax to finance it’. That is something the IMF will agree to. Or we can say ‘we are going to change the thresholds or introduce a property tax or wealth tax’ – there are so many things we can do.
When it comes to the debt sustainability parameters, we can attempt that, but it’s a very risky negotiation. First, when you are going with alternate debt sustainability, we have to also look at the human aspect. It means we are, in a way, challenging the IMF DSA they have done.
I haven’t studied cases in other countries. I think former Minister of Economy of Argentina Professor Martín Guzmán and Indian development economist Dr. Jayati Ghosh who recently visited Sri Lanka said it would be better to go with an alternative DSA. I agree with them to an extent, but it could have been done when we were having the debt sustainability conversations with the IMF. I am not sure if they meant doing another one after agreeing to one.
The Government and the Central Bank would also have had their own DSA when we initially negotiated; they would not have gone with empty hands. The IMF does the DSA based on the information that we provide and they also have a lot of stakeholder consultation, as do our Central Bank and Treasury as well. I have a feeling they may have also provided their numbers. I am not aware if Greece did it, but according to my knowledge, renegotiating the parameters or the destination is difficult.
If I were to illustrate with an anecdote, when you are engaged to marry someone, you can change the wedding venue, the dates, the church, and so many things, but you cannot change the person. The person is the DSA. You can change but it is a lengthy, emotional, and tiring process. Everything else that can be changed – the dress, the number of bridesmaids, etc. – is the SLA, but the bride and groom, that’s the destination. You can make changes, but it would be a complicated process.
It doesn’t mean that the IMF is the only solution or that we have to be so dependent on the IMF. However, we have to go to the IMF because we really do not have an option to restructure debt and proceed without it. It doesn’t mean the IMF is the solution to our economic problems. We are basically going to the IMF when we hit the wall. We need an external supporter with credibility for debt negotiation in times of crisis and to move towards stability and growth. It doesn’t mean that the IMF recipe is the solution for any country’s economic problems. It is an interim measure we have to take.
When you engage in bad behaviour, like when you have poor food habits, and you have a heart attack at some point, you have to go to the doctor. It doesn’t mean the solution for heart attacks is always the doctor. You have to have healthy habits.