Sri Lanka's budget for 2016 included several liberal measures but also many seemingly senseless interventions that may boomerang.
The budget contained the various give-aways to many constituencies: farmers, fishermen, housewives, and relatively higher salary earners who are in the pay-as-you-earn (PAYE) tax bracket.
The budget deficit is large and revenue proposals ambitious.
The budget takes some steps in the right direction, but overall, we consider it a mixed bag. There were no shocks as in the interim budget earlier in the year, but the extent and timeframe over which reforms will be implemented is crucial.
We have highlighted some of the key proposals below, classifying them as either Good: liberal measures that will help people, Bad: poorly-conceived proposals that may be administratively difficult and Ugly: those that will impair the quality of life and society of Sri Lankans.
There were some proposals, such as the one to strengthen law and order by building police stations, that appeared to be more in line with a police state.
We have emphasized changes in policy rather changes in tax rates.
The Good: Liberalisation Measures
The government deserves credit for restarting Sri Lanka’s halted reform program in the areas of finance and trade. The budget contains many solid proposals in this area, including the liberalization of certain trades that were previously closed, including removal of certain products from the ‘negative list’ where prior permission is needed for imports. The proposed repeal of the Exchange Control Act is also a major step in the right direction. This signals an end of an archaic law, to be replaced by a more market-friendly exchange management process.
Land lease and ownership regulations for foreigners are also to be to be eased. The tax imposed on land leases and the prohibition on freehold ownership were viewed as obstacles to investment. These measures should positively impact investor sentiment and encourage investment. This proposal also has the potential to inject fresh capital into Sri Lanka’s now fledgling real estate sector that has taken a brow beating following the curtailing of foreign state backed development projects.
Proposals to liberalise the labour market by allowing more part-time work, relaxation of rules on contract employees (although not spelled out in detail) is welcome. Sri Lanka’s labour laws are seen to be very rigid and a barrier to investment and overall business efficiency.
Also encouraging is the outward looking rhetoric of the government, including the proposed Financial Centre, modeled along the lines of Dubai’s International Finance Centre (DIFC). The DIFC operates as a tax-free zone which essentially imports laws and judges more familiar to international investors, and a similar model could help enhance Sri Lanka’s attractiveness in this regard.
The announced open sky policy is also a welcome move that could open up Sri Lanka as an aviation hub and help tourism.
We are also encouraged by the right rhetoric in terms of promoting Start-ups and small and medium enterprises including motivations to expand access to capital.
The decision to reduce import tariffs on consumer items such as electronics, shoes and clothing is also a welcome move so that people are able to enjoy more from their earnings than sending it to the government as well as playing a role in tourist spending.
Reforming Agriculture
Agriculture sector has suffered from years of populist pandering, price controls and a host of other misguided policies that has benefited neither the farmer nor the consumer. The moves to reform this sector is encouraging. Cash grant to small farmers in place of the fertiliser subsidy is a step in the right direction. While we view subsidies with caution, it is better to give the farmer an outright grant with the discretion to apply it where they deem necessary rather than blanket subsidy which may promote overuse or waste.
The over usage of fertilizer which was encouraged by the subsidies has resulted in unanticipated negative externalities such as the recent contamination of lakes, rivers and groundwater supplies. This is suspected to be the cause of kidney ailments of residents in in the Rajarata region.
Underutilised state land is to be leased to fruit and vegetable farmers. There are large tracts of marginal land under the State Plantations Corporation and the Janatha Estates Development Board. Allowing farmers access to this for other crops is far better than to allow the land to to lie fallow.
The budget also proposes that RPCs (Plantation companies) to be allowed more flexibility in land use. This will allow them to make better use of land uneconomical for tea or rubber greatly enhancing their economic freedom.
PPPs and State Reform
Reform of State-owned Enterprises is proposed. We welcome the fact that the problem is recognised and some attempt is being made to address it. Exiting from non-strategic holdings via the stock exchange is better than what the government policy has been for the last decade. While we advocate re-looking at privatisation of state industries that burden the government finances and in turn the taxpayer, we welcome the moves to address this problem.
Other noteworthy proposals such as restructuring the BOI, EDB and the Tourism Board to streamline operations and grant investment approvals within 50 days is welcome.
We are encouraged by the government’s apparent willingness to let the private sector into areas traditionally monopolised by an inefficient government sector.
Creating Special Purpose Vehicles (SPV) for state owned projects (the highways, coal plant, etc.) to attract private investment to repay debt requires further study but may be a step in the right direction. Public Private Partnerships (PPPs) on Domestic airports, monorail, investment zones, transport sector and developments in the proposed megapolis are all positive if carried out transparently.
The Bad
The budget text does have the customary give-aways and hand-outs as well as several measures that interfere unnecessarily in the market.
Price controls and subsidies on food items.
The Government has proposed price controls on six essential items including Mysoor Shal (Rs. 190/kg) , potatoes (Rs. 145/kg) , onions (Rs. 155/kg) , chicken (Rs. 480/kg) , packeted wheat flour (Rs. 95/kg) and dried chillies (Rs. 355/kg).
Price controls are administratively clumsy to implement and result in either goods disappearing from the shelves, lower quality goods, or the creation of black markets. This was a regular occurrence during the 1970s socialist era.
A License-Quota regime.
Licenses are notorious for creating avenues for graft. Fifty licenses for duty free import of gold unnecessarily regulates the market place. The government should focus on dismantling current licensing regimes instead of putting up new ones.
Unintended consequences
Proposals to tax cash withdrawals will have an adverse impact on informal sectors of the economy. The high rate (2% for withdrawals of Rs1-10m and 3% on withdrawals above Rs.10m) is designed to bring the informal sector into the normal banking system. While the objective is laudable it may hinder trade, especially among SMEs.
The proposal to spend Rs.21bn or Rs.1.5mn for each cluster village is not clearly spelled out. This could be a license for wasting tax-payer money.
Fixing non-existent problems
The government proposes introducing regulations into certain previously unregulated markets. This includes Three-wheelers, School Vans and Taxis. One of the redeeming aspects of Sri Lankan public transport is that the free-market in private transport provision including Taxis and three-wheelers that provides a better service than most countries in the region. While the type of regulation is not spelt out in the budget speech, the government intervention could very well worsen matters.
Similar micro interventions in a mandate to register all hotels, and government subsidies for accountancy students seem like solutions in search of problems. A mandate to to have four people in a vehicle entering Colombo is also bound to be unpopular and difficult to administer.
Left unsaid
Whilst the finance minister spoke for a taxing four hours on the budget proposals, there was still much unsaid. The budget was not explicit on what the government would do to tackle the over-staffed public sector. Nor were there proposals to put gasoline on a market-based pricing formula as was promised during the elections.
The Ugly
National Digital Identity Card.
Whilst there is a tendency in Sri Lanka to cheer on anything to do with technology, we advocate caution on this proposal. Little is known about the program except that it was initiated by the previous government. For a country that’s emerging from an all powerful state, a national security mindset, with the full extent of surveillance on citizens still unknown, people should demand more transparency and information before blanket implementation of this program. The country requires a robust debate on privacy and surveillance.
Micro interventions in the Banking & Financial Sector
Banks are asked to cease leasing operations from June 2016.
The rationale for this micro level interference in the banking sector is weak. It will be hugely disruptive to the operation of most banks with little benefit to anyone other than the non-bank financial sector.
Similarly the directive to lend to agriculture, SME's and Women & Youth (whatever that may be) is poorly thought out. Fixing the fees on bank drafts at Rs.150 is another intervention proposed.
We see no reason why government should be involved in these matters that should be left to the market place
Confusing “Canned Fish” Proposal
A buy back scheme for locally produced canned fish to be sold at a subsidised price may open the door to massive losses at Lak Sathosa. If prices are high enough supply of canned fish to Sathosa will increase significantly and the losses may exceed the amounts budgeted.
At the same time taxes on imported canned fish will be increased, which will only increase the pressure to consume the subsidised products driving up the final bill to the taxpayer.
In another part of the budget speech the Minister blames a policy at Lak Sathosa where rice was imported at Rs.75 per kg and sold at Rs.50 per kg for the Rs.8bn accumulated losses in that institution. The Minister is proposing the same policy, but for canned fish instead of rice.
The government seems to be concerned about reducing prices for the consumer as well as protecting local industry, these two objectives seems at odds with each other.
New Government entities and unfunded programs
On education, while the government has made election promises to expand state funding of education, the establishing of yet another state university (The Mahapola University, to teach ICT, business and English) is the wrong way to go about it. Instead of spending Rs. 3bn on buildings for a new state university the money would better spent on improving facilities at existing ones, expanding scholarships or setting up a market-led voucher schemes for funding of higher education.
The University of Moratuwa has a well deserved reputation for excellence in ICT, the Postgraduate Institute of Management has a similar reputation for business studies and faculties of English at both Colombo and Peradeniya produce high quality graduates. Should this money be better spent on strengthening facilities or faculties at these institutions? Much like the administrations before this, the government confuses funding for education with the provision of education.
A new proposal to spend Rs 1 billion on increasing the number of police stations from 428 to 600 is not explained properly. It is unclear if law and order will improve simply by building police stations. There is no mention of the manpower that is needed and whether that adds to the burden of an already mega public sector.
In Conclusion
The many steps taken by the government to transform Sri Lanka into a more outward looking, open market are welcome. The Finance minister certainly hit the right notes on Friday, about the government’s commitment to a market-friendly policy regime, a technology-focus and the emphasis on the private sector as the key driver of economic growth.
However glaring inconsistencies takes the shine off the Finance Minister’s claims. Continued use of price controls and a readiness to make micro-level interventions in markets is not how a thriving market economy operates.
As a society, Sri Lankan has also been unable to move away from expecting short-term goodies from the budget statement. Whether it’s price controlled big onions or powdered milk someone has to pick up the tab, and it’s often the same people as tax payers or their children in the next generation as government racks up debt.
There are reasonable questions asked whether the budget actually could meet the deficit target the set by the Finance minister. The elephant in the room as always is Sri Lanka’s mega government apparatus. Slow dismantling the leviathan should be the answer to the long-term untying of the Gordian fiscal mess.
Advocata Institute is a public policy think tank based out of Colombo, Sri Lanka.