Keeping the economy on even keel

An interview with Dr Karunasena Kodituwakku-January 15, 2015

There were huge losses made by the Ceylon
Petroleum Corporation through disasters such as the hedging deal. Now
they have to recover all the losses. But the question is whether it is
reasonable to pass that burden to the consumer. There is a stable income
from the sale of petroleum. You have to target items like that for the
government to get a stable income. But the tax must be reasonable.
In this interview, The Island staffer C. A. Chandraprema speaks to UNP
working committee member Dr Karunasena Kodituwakku on the immediate
economic challenge facing the new government. Dr Kodituwakku is an
economist by training and a former cabinet minister in the UNP
government of 2001-2004. (The views expressed here are his own ideas
and not representative of his political party or the government.)
Q. With the change of government, a completely new situation has
emerged. In the past several years, the private sector and the general
public have got used to certain economic fundamentals which they thought
were going to be stable for the foreseeable future. The Rajapaksa
government maintained a low interest rate, very low direct taxes, they
kept the exchange rate steady and also managed to keep inflation low. A
lot of businesspeople have also made decisions based on those
fundamentals. If the interest rates go up for example, members of the
public who have taken housing leans and vehicle loans are going to be
badly affected, not to mention businesspeople who have taken loans for
investment. What is the plan that the new government has to keep these
fundamentals steady? If there is any change in this low interest, low tax,

steady exchange rate and low inflation regime anytime soon, there will be
pandemonium both in the private sector and among the general public.
A. As you say the interest rate was kept low and also inflation was
managed to some extent except with regard to some items. But one area
where this government failed was in the tax policy. About 80% of the taxes
come from indirect taxes. Normally in any country 50% or 40% has to
come from direct taxes. At present the highest income tax rate is about
25%. Even in the USA the highest income tax rate is 40%. This pro-rich
tax policy became a constraint for the government to fulfil even basic
requirements. For example everybody talks about 6% of the GDP being
allocated to education.
But, to do that you must have an income. You have to give incentives for
investment but not so much as tax holidays. When the hotel sector and
even casinos are given 10-25 year tax holidays, that affects government
revenue. One country that did not allow casinos until recently was Japan.
Later the Japanese government decided to allow casinos, mainly to get an
income through taxes. But as you said people have taken housing and
vehicle loans and the rates have to be maintained. They cant be suddenly
increased. As far as the fundamentals are concerned things looked good
but though there was a good growth rate, there were no results for the
public.
If you take the figure of 4000 USD per capita and you convert it to Sri
Lankan rupees, that is almost Rs. 40,000 per month. Ninety percent of the
government servants dont get that kind of money. That means that
growth did not percolate down to society. For example most of the
construction was done by the Chinese and all the money paid as salaries
even for the labourers went back to China. When the Mahaweli was done it
was a different story. Very few consultants came with the aid package and
most of the expenditure went to society. So I have doubts about this
growth rate. The agricultural and primary sector contributes only 10% to
the GDP. But 30% of the labour force depends on agriculture which means
that their income is not sufficient for them to survive. Welfare is still very
important because the gap between the rich and the poor is so high. But
that is an area that was badly neglected.
Q. From what you said about taxes, people might get the impression that
what you are saying is that direct taxes must be increased. But, if direct
taxes are increased, that will adversely affect the private sector. When the
income tax rates are reduced that increases their profits and they have
more money to reinvest. When I was in the Ceylon Chamber of Commerce

over two decades ago, the dream of the entire private sector was to have a
low tax rate. The Rajapaksa government exceeded the expectations of the
private sector in that respect. If direct taxes are increased, how do you
think the private sector will react to that?
A. In my opinion, a maximum tax rate of 35-40% is not too high. That is
the norm all over the world including the USA. I am not saying that the
middle level business should be taxed at that level. But for many corporate
sector entities, the after tax profit is often a billion or two. The government
must have revenue. In addition to the low taxes there is also the question
of the tax holidays that have been given. There is no doubt that incentives
have to be given to investors but not necessarily through tax holidays
alone. Because Lamborghinis are classified as racing cars, there is no tax,
but for a trishaw there is a tax. There must be a complete review of the
taxes and those who can pay must pay more. At the other end the
consumers of coriander have to pay a high tax. Of course these
adjustments must be done by professionals after thorough study. One of
the criticisms I have of the last government is that they were trying to
paint a very rosy picture without telling the people the difficulties involved.
They should have told the people that we need an income for the
government.
Q. If we take that demand that 6% of the GDP be allocated for education,
its only a very few countries with very small populations and very high
GDPs that have more than 6% allocated for education like Finland and the
Scandinavian countries and that too with the private sector being
involved with private schools and private universities. In this country
however, there is this prejudice against any private university. Even in
countries like the USA and Australia which have huge education industries
the education sector accounts for less than 6% of the GDP. When FUTA
said 6% what they meant was 6% from the state sector education alone!
How is the present government going to meet such an impossible demand?
A. The GDP is made up not only of government activity. So, 6% of that will
be the activities of both the private and state sector. But, in this country
anything coming from the non-government sector was opposed. That is a
very sad situation. In education what has to be maintained is the quality.
The government should look after those who cannot afford higher
education but those who can should be given a choice.
Q. There were some unrealistic pledges made on the common opposition
platform such as making large reductions in the price of fuel because the
world market price of crude oil was low. As an economist, do you think

that is possible or even wise?

A. There were huge losses made by the Ceylon Petroleum Corporation
through disasters such as the hedging deal. Now they have to recover all
the losses. But the question is whether it is reasonable to pass that burden
to the consumer. There is a stable income from the sale of petroleum. You
have to target items like that for the government to get a stable income.
But the tax must be reasonable.
Q. The tax on fuel is not just an income for the government but also a
measure to limit the fuel consumption. If you reduce the price of petrol
and consumption goes up, the government may get more revenue in terms
of taxes but what about the foreign exchange going out? It will bleed the
country dry.
A. That is why we need the correct policy. In 2001 when the UNP formed a
government, we introduced a pricing formula but people opposed it. The
price of crude oil is now around 50 USD. A few months ago, it was 120
USD. If the correct position is explained to the public, they will understand.
Whenever the price of crude oil comes down at least a part of that benefit
must be passed down to the consumer. But as you mentioned there have
also to be measures to discourage excessive use at the same time.
Q. You said that you had reservations about the growth rates that were
being given out by the government. But world bodies like the IMF and the
private funds that have been investing in Sri Lankan bonds and stocks
seem quite comfortable with those figures.
A. These figures are collected from two sources. Whatever is collected from
the formal sector of the economy is accurate. But the data collected from
the informal sector such as paddy cultivation and minor crops such as
vegetables is based on samples. There is a possibility of error there.
Q. You are a former ambassador to Japan. It was said on the common
opposition platform that the actual cost of the southern expressway was
just 2.5 million USD per kilometre but that it had been inflated to 7.5
million USD. The implication is that someone had pocketed five million USD
per km. Two of the four segments of the Southern expressway were
funded by the Japan International Cooperation Agency (JICA). After the
southern expressway was completed, JICA funded two segments of the
outer circular expressway as well. Now the outer circular expressway was
far more expensive than the Southern expressway. Do you think an
institution like JICA would be involved in a massive scam where the cost of

an expressway was inflated three to ten times more than its actual cost
just in order to make politicians and officials of the recipient country rich?
A. Organisations like JICA and the ADB have inbuilt anti-corruption
safeguards in place. But, we have to identify our priorities. The southern
highway is a priority no doubt. The Katunayake highway is also a priority.
But if the cost factor for a project is genuinely so high, then the
government must go for alternatives. In some cases we do need
expressways. But, in other cases bypasses may be an alternative. Apart
from these foreign funded projects, there are locally funded projects where
it is questionable whether we have got value for money. Its alarming to
see some of those figures. It is true that we must have a beautified city
and walking paths and so on. But, the main priority is transport. When I
was a member of parliament, I put up a private members motion to put
up a metro rail between Colombo and Battaramulla. When J. R.
Jayewardene planned to develop Sri Jayawardenapura, there was a plan
for a railway through Kolonnawa, Talawathugoda and finally to Moratuwa.
Even the lands for this were acquired.
Posted by Thavam