Budget 2016: Has it laid foundation for

implementing the policy outlined in EPS

of Yahapalana Government? Part 3

Monday, 23 November 2015

Economic Policy Statement has vowed to discipline the budget
The Budget of the new Yahapalana Government for 2016 was presented by
Minister Ravi Karunanayake in Parliament last week. This budget follows the
economic policy statement or EPS delivered by Prime Minister Ranil
Wickremesinghe in Parliament a few weeks back.
The EPS, while admitting the perilous state of the fiscal sector of the
country, had vowed to discipline the budget, introduce economy wide
reforms, convert the countrys simple production system to complex
production, generate wealth through linking the country to a wider global
market and address the need for security for the old-aged and vulnerable
groups.
Since the Governments economic policy package is to be implemented
through Government machinery, it is necessary that the Government
budget be aligned with the overall policy of the Government.
Putting a stop to the imprudent practice of living beyond earnings
The EPS had made one important diagnosis before it went to setting goals
for disciplining the imprudent fiscal sector. That was that Sri Lanka had

been living for years beyond its earnings.

This reference was in fact valid for the public sector rather than for the
private sector. That was because the private sector had factually lived
within its earnings throughout. If it had earned Rs. 100, on average, it had
spent on consumption only about Rs. 82, generating savings of about Rs.
18 for the nation for reinvestment in productive assets.
The public sector, on the other hand, had been spending on consumption
Rs. 102-Rs. 103 when it had earned Rs. 100. Thus, the notorious public
sector had been borrowing even for maintaining its consumption
expenditure programs, which are ballooned year after year through
politically popular free handouts offered to people.
This imprudent behaviour of the Government had prompted
Singapores Lee Kuan Yew to take a shot at Sri Lanka whenever
he was to give an example of a badly managed country. He
would say that Ceylon was notorious for living by selling even
the assets which it did not possess.
Accordingly, the curative procedure for the ailment from which
Sri Lanka was suffering had to be started by disciplining the
budget. Thus, the EPS had announced two quantitative and
several qualitative goals for the fiscal sector.
One was that the budget deficit be reduced to 3.5% of GDP from
the current high level of about 6-7% of GDP by 2020. Another
goal related to changing the tax structure which had heavily
been skewed toward indirect taxes. Thus, the EPS had set as a
target to reduce the share of the indirect taxes in the total tax
revenue from 80% to 60% and increase that of income taxes
from 20% to 40% over the medium term.
It has also suggested doing away with tax concessions and tax holidays.
The EPS had thus expected the maiden Budget of the Government to
reflect these economic reforms.
Budgets are just numbers-games
Budgets in Sri Lanka, in the absence of an effective monitoring mechanism,
had always been a numbers game. It has been the practice of the
Ministers of Finance to announce impressive budget numbers to Parliament
when the budgets are presented.
However, these budgetary numbers are never monitored either by
Parliament or civil society organisations, though a mechanism for such
evaluation has been provided by the enactment of the Fiscal Management
(Responsibility) Act of 2003.
In terms of the Act, several fiscal statements should be issued by the
Minister of Finance in order to increase public awareness of governments
fiscal policy and to establish standards for evaluating the Governments
conduct of its fiscal strategy.

The Minister is also required, in terms of the Act, to explain any departure
from the stated fiscal objectives and present strategies which he would
adopt to return to those objectives. However, in practice, the statements
issued by Ministers of Finance had been eulogies made about themselves
and the success of their economic policies. Though this was the game plan
played by Ministers of Finance neither the Parliament nor civil society
organisations took the Government to the task on this count. Hence, the
rosy budgetary numbers presented in Budgets were always missed, with no
concern about their disastrous impact on good governance or the credibility
of the Government.
Missing all the budget numbers for 2015
The final outcome of the interim budget presented to Parliament in January
2015 is a case in point, though the observations made are valid for all the
previous budgets. The interim budget had a revenue target of Rs. 1,535
billion or 13.6% of GDP. The provisional numbers say that the Government
raised only Rs. 1478 billion or 13.1%.
Similarly, the Governments consumption expenditure, also known as
recurrent expenditure, had been budgeted at Rs. 1552 billion or 13.7% of
GDP. But the provisional data show that the consumption expenditure had
overshot to Rs. 1648 billion or 14.6%.
The rosy budget had estimated a small deficit in the revenue account
amounting only to Rs. 47 billion or 0.4% of GDP. But the actual deficit had
amounted to Rs. 180 billion or 1.6%. This was evident in the overall budget
deficit too. According to the Budget, the overall deficit was to be restricted
to Rs. 490 billion or 4.4% of GDP. But, at
the end of the year, it had shot up to Rs.
675 billion or 6.6%. Accordingly, all the
interim budget numbers had been
missed except those relating to the
Governments capital expenditure which
had better performed by a small margin.
Budgets should really be evaluated
ex post
With these types of outcomes relating to
Government budgets, it is misleading to
evaluate them on the basis of mere
budgetary estimates. A meaningful
evaluation should be made only at the
end of the year when actual numbers are
available. But, that would be a postmortem serving only as a fault-finding

exercise. Hence, budgets should be evaluated not in terms of numbers but

on the basis of the soundness or otherwise of the proposals made in them.
In the case of the current budget, a useful evaluation would be to examine
its alignment with the economic policy statement announced by the
Government.
Need for promoting international trade
The Budget 2016 has announced that it is based on the medium term
economic strategy of the Government as outlined in the EPS presented by
the Prime Minister to Parliament. These strategies, according to the Budget,
encompass the following areas: Generating of one million employment
opportunities; enhancing income levels; development of rural economies;
ensuring land ownership to rural and estate sectors, the middle class and
Government employees and creating a wide and a strong middle class.
But these are just goals pronounced in the EPS and not the strategies
outlined therein. The main strategy for creating wealth, employment and
prosperity has been to promote international trade and link the economy to
the rest of the world as it had been in ancient times. This underscores the
promotion of exports, especially the high tech exports, by producing, as the
EPS had pronounced, for a market bigger than the local economy.
The main policy thrust would be placed on reforming the educational
system to produce quality manpower, promoting research, technology and
innovation and enhancing competitiveness. The leadership in promoting the
economy would be taken by the private sector and not by the state sector.
Budget 2016 has presented three different outcomes
When the Budget 2016 is evaluated on the basis of the goals and strategies
enshrined in EPS, it shows three different outcomes. Some are in line with
the EPS, some are neutral and some go against the EPS. Thus, most of the
proposals are either independent of the EPS or totally misaligned with it.
One glaring misalignment is the failure to lay the foundation for the
realisation of the overall budgetary targets in the medium term. The EPS
envisages changing the tax structure with more emphasis on income taxes.
It has even set a quantitative target of attaining 40% of the tax revenue
from income taxes by 2020 as against the historical average of 20% on that
count. This requires policies to reduce the share of indirect taxes from the
present 80% to 60% over the years.
Making even income taxes regressive
However, Budget 2016 has planned to raise even a bigger share of income
from indirect taxes. Accordingly, the share of the indirect taxes has shot up
to 86%, while that of income taxes has fallen to 14%. Worse, it has made
the income taxes regressive by applying a uniform rate of 15% on everyone

earning over the threshold limit of Rs. 2.4 million. Thus, Budget 2016 has
made both the indirect taxes and the direct taxes regressive which EPS had
sought to avoid.
Similarly, the budget deficit which the EPS is planning to reduce to 3.5% of
GDP by 2020 has been raised to 6% in Budget 2016.
Another deviation has been the funding of the overall budget deficit
through new borrowings amounting to Rs. 1,050 billion. This measure would
add to the existing level of public debt which the Government plans to
reduce over the medium term. Clearly, as far as the overall budgetary
discipline is concerned, Budget 2016 has moved in the opposite direction.
Once a budget goes out of control, it would be difficult to revert to the
correct path without causing social and political tensions among the
population. Hence, it is of utmost importance to lay the foundation for
eventual budgetary discipline right at the outset thereby getting space for
making a gradual movement toward the final goal.
Emphasis on reforms
Barring these deviations, the overall budgetary policy has been in line with
the EPS. It has emphasised the need for undertaking the necessary
economic reforms not only to nurture but also to foster private sector
economic activities and ensure their positive role in the entire economic
process.
Reforms are implemented particularly with reference to the state-owned
enterprises and international trade. Says the Budget 2016: With the
reforms, we need to improve local competitiveness, international trade and
investments as well as skills and productivity of our people, while being
conscious about the developments in the global economy. At the same
time, we must foster a knowledge based Social Market Economy built on
social justice principles.
Why another state university?
Thus, the thrust of the reforms has been to create an environment for the
private sector to operate freely and without impeding barriers. For that, the
economy should be freed. However, some of the policy reforms and policies
are to increase the size of the state sector and create more barriers for the
private sector to operate.
Take, for example, the proposal to establish another state university by the
name of Mahapola University to pay tribute to the late Lalith Athulathmudali
who created the pathbreaking Mahapola Scholarship Scheme.
For this purpose, the Budget has proposed to allocate a sum of Rs. 3,000
million initially. The establishment of new universities by the state should
not be done in an ad hoc manner but in terms of a national policy of
promoting higher education in the country.

The current challenge of the countrys higher education system is not the
establishment of new universities, but the consolidation of the existing
universities and upgrading their teaching and research qualities. If the
Government is desirous of honouring the late Lalith Athulathmudali, the
best course of action would have been to create a Chair in his name in a
law faculty of an existing university or establishing a new School of Law
named after him.
Leave the establishment of new banks to the private sector
The proposal to set up an Exim Bank with state participation to cater to the
international trading sector is another misconceived venture though it is
going to be a public private partnership.
The Government has already burnt its fingers in the banking sector by
getting the public funds to buy private banks and establishing two state
banks on similar lines earlier. Instead of exiting the Governments stake in
leading private banks it is continuing with the same bad policy which has
frightened the private sector.
In the other example, it set up two state banks called the National
Enterprise Bank or NEB to promote enterprises and Lanka Puthra Bank or
LPB to fund infrastructural projects. Both these banks became bankrupt
with undue political interferences which would have been the sole purpose
of setting up them. NEB had mounting loan losses and could not be
continued as a viable business.
LPB lent a huge amount to Mihin Air which the bankrupt airline could not
repay. The Treasury stealthily took over the losses of LPB and forced it to
absorb NEB but it was a marriage of two sick partners. The Budget 2016
has proposed to amalgamate it with the Regional Development Bank or
RDB. This would amount to making even the presently well-performing RDB
sick. The Budget has found fault with the prevailing banking system for not
supplying adequate credit for the micro, small and medium enterprise,
known as MSME sector.
But, RDB was specifically created for this purpose and it was doing an
impressive job on that count, while maintaining the required level of
efficiency and solvency. With the proposed dilution of its functions, it would
face a serious capacity problem to move into new areas. Hence,
establishing more and more state banks would simply add more burdens to
future budgets in the form of having to recapitalise them when they run
into problems. In this background, the government should have allowed the
industry to establish the Exim Bank if it so desires to do so with its own
private capital infusion and run it as a commercial venture.
Replace exchange control with exchange management
On the positive side, the Budget 2016 has proposed to liberalise foreign

exchange by repealing the draconian Exchange Control Act and enact in its
place a new business friendly Exchange Management Act.
Exchange Control was introduced to Ceylon during the war times to prevent
the countrys foreign reserves falling into the hands of the enemies,
namely, the Germans and the Japanese. It was meant to be a temporary
measure to be removed after the war. However, the independent Ceylon
made it a permanent law making exchange control offences criminal
activities. This gave opportunities for successive governments to use the
provisions of the Act to persecute their political enemies. Hence, it is now
time to decriminalise exchange control and make exchange management a
market friendly activity. Those who are opposed to the measure should
realise that in the neighbouring Maldives, there is no exchange control.
The Budget 2016 is aligned to EPS only in spirit but not in action. The
mistake made at the beginning will have disastrous effects on the
attainment of the goals enshrined in EPS.
(W.A. Wijewardena, a former Deputy Governor of the Central Bank
of Sri Lanka, can be reached at waw1949@gmail.com)
Posted by Thavam