Why is OT work necessary for women in Sri Lanka?

Originally appeared on the Morning

By Sumhiya Sallay

‘Overtime work for women’ is a topic that is not touched upon much in Sri Lanka, however, it can bring an array of benefits to women and our economy. It can improve financial security by providing an additional source of income and provide the next generation of women and girls with more opportunities to work and increase economic participation and improve productivity. 

Given Sri Lanka’s current economic crisis, there is a dire need for a dual income role in lower-income and lower-middle-income households. As Sri Lanka navigates through this economic crisis, where high levels of inflation have significantly reduced the purchasing power of the public, one earner is no longer sufficient for a household. This is where the need for laws that provide more opportunities for women are needed. 

The freedom to choose a job, a place of work, and how long to work are all decisions that should be given to every employee, whether male or female. However, in certain private sector industries in Sri Lanka, female employees do not have the legal right to choose overtime work, while male employees can [1]. 

Legal safeguards needed for overtime work

It is important for a country to have laws that support women so that women are given the choice and freedom to work in order to support themselves and their families. The World Bank’s ‘Women, Business and the Law 2021’ report states that when economies are more equal, they become more resilient [2].

It also highlighted the need to safeguard women’s economic rights under the law [3]. When laws are discriminatory against women, it makes it much more difficult for them to remain in the workforce. Therefore, it is vital for countries to enable laws that are more supportive towards women. 

The report, which captures the laws and regulations that restrict women’s economic opportunities, indicated that Sri Lanka scored 65.6 out of 100 in the ‘Women, Business and the Law’ 2021 index. Overtime work restrictions are also among one of the various discriminatory laws identified in Advocata’s report on ‘Gender Discriminatory Labour Laws in Sri Lanka and Female Labour Force Participation’. 

In Sri Lanka, women above the age of 18 are not allowed to work for more than nine hours per day (45 hours per week) within a five-day workweek, with an exception provided for female employees employed in residential hotels, clubs, and other places of entertainment or in any shop situated at an airport where they may be employed until 10 p.m. under specific conditions [4][5]. However, male employees are entitled to work for up to 12 hours of overtime per week (on a five-day work week). This discrimination towards female employees prevents them from working overtime. 

Although a practice known as administrative relaxation exists where the law is relaxed to allow women to work overtime, it is not recognised by the law [6]. Due to this, issues arise where employees who have worked overtime are not provided compensation for the hours worked overtime by the employer. Therefore, not having a formal, legally recognised law or regulation for overtime work discourages employees from working overtime. 

Furthermore, having laws that are not supportive towards women, especially discriminatory overtime laws that prohibit women from working overtime prevents them from having an extra source of income. 

Benefits of enabling overtime work

Given the current situation in Sri Lanka, with the high inflation rates, more income generation is needed and increasing female labour force participation by having supportive laws will give women the opportunity to earn more and also be financially independent. In return, women can increase their household spending on items that will enhance a country’s growth prospects by changing spending in ways that benefit children’s nutrition, health, and education [7].

Overtime work can not only benefit female employees but also benefit employers as it increases productivity and contributes towards the overall economic development of a country. The economies of both developed and developing countries would greatly benefit from increasing female labour force participation if women participate in the labour force at the same rate as men, work the same number of hours as men, and are employed at the same levels as men across sectors [8]. 

Overall productivity will increase if employees’ skills and talents are used more fully. There are several studies that have been published on how much more productive an economy could be if it took full advantage of the potential of its women workforce [9].

As more women enter the labour force, economies have the potential to grow faster in response to higher labour inputs. Women’s supply of labour increases household incomes, which helps families escape poverty and increase their consumption of goods and services. 

In Advocata’s report on ‘Gender Discriminatory Labour Laws in Sri Lanka and Female Labour Force Participation,’ key reforms and recommendations that need to take place in order to allow women to work overtime are highlighted. 

These recommendations include removing the restriction on overtime work under the Shop and Office Employees (Regulation of Employment and Remuneration) Act No. 19 of 1954 [10] and introducing a regulation to allow women to work overtime. In order to support this regulation, we also recommended that certain guidelines be included within the law to prevent the exploitation of excessive overtime. 

References

• Shop and Office Employees (Regulation of Employment and Remuneration) (SOE) Act No. 19 of 1954.

• Women, Business and the Law 2021, (Washington: The World Bank, 2021).

• Women, Business and the Law 2022, (Washington: The World Bank, 2022).

• Subject to conditions under the Shop and Office Employees (Regulation of Employment and Remuneration) (Amendment) (No. 32 of 1984), Section 2A.

• Employment In Terms Of The Shop And Offices Employees’ Act Monograph No. 17 (Rajagiriya: The Employers’ Federation of Ceylon, 2016), 13.

• Employment In Terms Of The Shop And Offices Employees’ Act Monograph No. 17 (Rajagiriya: The Employers’ Federation of Ceylon, 2016), 13.

• Ana Revenga and Sudhir Shetty, ‘Empowering Women Is Smart Economics’.

• McKinsey Global Institute (MGI), ‘The Power of Parity: How Advancing Women’s Equality Can Add $12 Trillion to Global Growth,’ (2015).

• McKinsey Global Institute (MGI), ‘The Power of Parity: How Advancing Women’s Equality Can Add $12 Trillion to Global Growth,’ (2015).

• Shop and Office Employees (Regulation of Employment and Remuneration) (SOE) Act No. 19 of 1954, Section 3 (1)(3)(a).

Sumhiya Sallay is a Programmes Executive at the Advocata Institute. She can be contacted at thilini@advocata.org. The Advocata Institute is an Independent Public Policy Think Tank. The opinions expressed are the authors’ own views. They may not necessarily reflect the views of the Advocata Institute.

Current Food Inflation in Sri Lanka: Causes, Consequences and Way Forward

Originally appeared on the Morning

By Thilini Bandara

In recent times, rising food prices have become a global phenomenon owing to various factors including the Covid-19 pandemic, climate impacts, the Russia-Ukraine war and the downturn of the global economy. These have played a part in Sri Lanka recording the highest food inflation rate of 94.9% in September 2022 according to the Colombo Consumer Price Index—a rate which averaged at 9.39 per cent during 2009–2022. The World Bank's food security update highlights  Sri Lanka among the top 5 countries with the highest food price inflation in September 2022. This article explores the recent trends, causes and consequences of food inflation in the country. 

Fluctuation of food prices over time

Advocata Institute’s Bath Curry Indicator (BCI) tracks the monthly changes in the retail prices of a limited basket of goods normally consumed by Sri Lankans as per the 2016 Household Income and Expenditure Survey (HIES). 

Accordingly, the BCI supermarket prices recorded a 78% increase between September 2021 to 2022.  However, there is a slight decrease in prices on a month-on-month basis of 7.63% in September 2022 compared to August 2022. Further, when considering the BCI-Supermarket prices, it has recorded an 83.88% increase between August 2021 to August 2022 on a year-on-year basis, while showing a slight decline of 6.59% between September 2022 and August 2022. 

Table 1 depicts the price fluctuations in terms of BCI and BCI-Supermarket from 2019 to 2022.

Table 1: Price fluctuation over time according to the BCI index

Causes of food inflation in Sri Lanka

At a glance, rising food prices can be attributed to disruptions in both global and local supply chains due to various factors that include the energy crisis, climate impacts, the pandemic and the Russia-Ukraine War. Additionally, domestic policy restrictions such as import bans of essential commodities, the rising cost of agricultural inputs, recent changes to agricultural policy, and the ban on chemical fertilisers and quick shift to organic fertilizer lowered agricultural production and heightened supply chain disruptions. 

Moreover, the expansionary monetary policy of the previous government through lowered interest rates and heightened money printing contributed to higher food inflation.

Additionally, due to the uncertainty surrounding imports entering the markets, traders must reassess their pricing decisions. This creates distortions in the marketplace and can lead to additional pressure on consumers. 

Consequences of food inflation

People living below the poverty line and middle-income groups with a fixed income are the most severely impacted by this high inflation. Food inflation rising rapidly in contrast to household incomes has widened the income gaps. It has further dealt a massive blow to the economic stability and well-being of the poor through poverty and malnutrition. A recent survey by the Sri Lankan Red Cross Society and the International Federal of Red Crescent Societies has revealed that 50% of households have reduced the intake of meat and fish, while 11% have completely dropped protein intake from their diets. Also, a survey conducted by WFP in September 2022, reveals that more than 1/3rd of Sri Lanka’s population is in food insecurity, while 79% of households are adopting food-based coping strategies to keep food on the table.  Moreover, the evidence revealed that even non-food expenditure such as education, housing, and health has lowered owing to rising food costs, which will lead to socioeconomic pressure.

Way forward

A recent report by the Food and Agriculture Organisation and the WFP highlights that the food security problem could be further heightened during the upcoming “maha” season between October 2022 - February 2023, if the country is unable to import sufficient amounts of rice and other food products to meet demand. In the absence of a sufficient supply of agricultural inputs such as fertilizers, pesticides, and other supplies, targeted assistance should be provided to farmers to increase domestic production and resilience of the agri-food systems. In fact, introducing incentive schemes, identifying special regions for off-season cultivation, implementing innovative food storage and preservation strategies, distributing farm inputs at subsidized rates, and promoting substitutes for imported items are some of the measures that can be implemented to address the food security problems. 

Targeted interventions should also be provided through social safety nets and humanitarian initiatives for low-income groups that are food insecure and require immediate assistance. Though funds for this have been already allocated from the 2022 interim budget, effective and efficient execution is required to identify the most vulnerable groups and provide them with the food assistance they require. 

References

Aneez, S. (2022). Crisis-hit Sri Lanka looks for foster parents to face malnutrition among children. Economynext. Available at: https://economynext.com/crisis-hit-sri-lanka-looks-for-foster-parents-to-face-malnutrition-among-children-101200/. [Accessed 17 October 2022]

CBSL. (2022). CCPI based headline inflation recorded at 69.8% on year-on-year basis in September 2022. CBSL. Available at: https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/press/pr/press_20220930_inflation_in_september_2022_ccpi_e.pdf. [Accessed 13 October 2022]

Economynext. (2022). Sri Lanka households drop meat from diet, slash drug doses as poverty worsens: survey. Available at: https://economynext.com/sri-lanka-households-drop-meat-from-diet-slash-drug-doses-as-poverty-worsens-survey-101259/.[Accessed 19 October, 2022]

FAO & WFP.(2022). FAO/WFP Crop & Food Security Assessment Mission (CFSAM) to the Democratic Socialist Republic of Sri Lanka. Rome: FAO & WFP. Available at: https://www.fao.org/3/cc1886en/cc1886en.pdf.[Accessed 17 October 2022]

OCHA. (2022). Food Security and Nutrition Crisis in Sri Lanka. OCHA. Available at: https://reliefweb.int/report/sri-lanka/food-security-and-nutrition-crisis-sri-lanka. [Accessed 17 October 2022]

Trading Economics. (2022). Sri Lanka Food Inflation. [online] Available at: https://tradingeconomics.com/sri-lanka/food-inflation. [Accessed 19 October 2022]

The World Bank. (2022). Food Security Update. The World Bank. Available at: Food-Security-Update-LXX-September-29-2022.pdf (worldbank.org). [Accessed 20 October 2022]

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.

Thilini Bandara is a Research Analyst at the Advocata Institute. She can be contacted at thilini@advocata.org. The Advocata Institute is an Independent Public Policy Think Tank. The opinions expressed are the authors’ own views. They may not necessarily reflect the views of the Advocata Institute.

Repeal para-tariffs on period products

Originally appeared on The Morning

By Thathsarini Siriwardana

On 2 October, the President’s Media Division announced that the Government had decided to remove all import duties on imported raw materials for domestically-produced sanitary napkins while providing zero VAT benefits for imported finished sanitary napkins. This is yet to be implemented; no gazette has been issued at the time of writing. 

The move to reduce tariffs is positive and doubtless well-intentioned and should be welcomed. These tax revisions will help to reduce the prices of domestically-produced sanitary napkins considerably. Nevertheless, we would have liked to see the tariff cuts on sanitary napkins as part of a broader overall reform of the tariff structure rather than an ad hoc adjustment.

Women constitute just over half of Sri Lanka’s population of 21 million. Of the female population, 5.3 million menstruate. Menstrual products had high tariffs prior to 2018. The total tariff imposed on sanitary napkins was over 101.2% [1] in 2018, but these were gradually reduced. 

The current total tariff on sanitary napkins is 46.9% [2]. Although the current tariffs are much lower, they are still quite high, so access to affordable and safe menstrual products remains a luxury for some women. 

The collapse of the currency and soaring inflation have brought a lot of pressure on household budgets. The Government should try to reduce inflationary pressure through supply-side reforms. Simplifying and standardising the tariff structure will facilitate trade and can reduce costs.

Sanitary napkins are vital for girls and women. High protective tariffs imposed on these products benefit producers, but this is at the expense of consumers. The inability to afford sanitary napkins in Sri Lanka is pervasive, especially among the low-income segment of society.  

Tariffs on menstrual hygiene products

It is clear that in terms of tariffs on menstrual hygiene products, such policy decisions benefit producers. The current total tariff of 46.9% consists of 15% (VAT) + 10% (PAL) + 15% (CESS) [3] and while this is an improvement, prices are still high.

When a protectionist tariff is placed on a good, it will achieve two main things. First, it will act as a barrier for new products entering the domestic market. This lowers competition and reduces the choice available to women when purchasing sanitary napkins. Secondly, high tariffs trickle down to final product prices, resulting in higher prices for both domestically-produced and imported products. 

Sri Lankan women and girls face challenges in choosing a menstrual hygiene product that best suits them. The ability to choose comes with the affordability and the availability of the product. The current high tariff rates hinder the choice of women and girls.

By reducing tariffs, the cost of importing products will decrease while simultaneously creating competition, which will help to reduce the prices. This will encourage new local producers to innovate better quality products while ensuring their prices remain low and competitive in the market. 

Cost analysis of sanitary napkins

A market price analysis of sanitary napkins shows that the average imported price per pad remained more expensive than the most expensive locally-produced price per pad as of September 2022. The currently available cheapest price per pad is Rs. 33. When comparing per-pad price changes within a year, it shows that both prices of local and imported brands have increased by more than 70%. 

Economic factors such as the depreciating exchange rate and high rates of inflation are the main contributors to this vast price increase. The increasing prices are also influenced by the high para-tariffs. Removing the imposed protectionist tariffs on sanitary napkins and menstrual hygiene products will provide some degree of relief for low-income-earning women.

Advocata Institute reported that in 2016 Sri Lanka’s absolute household period poverty rate was approximately 50%. This means that around half of the households with menstruating women do not report buying sanitary napkins as part of their household expenditure. In 2019, Sri Lanka’s absolute household period poverty rate was approximately 40%. Even though this is an improvement compared to 2016, the situation is expected to worsen due to the economic crisis.

To provide relief, the Government should also focus on removing the PAL (10%) and the CESS (15%) imposed on imported sanitary napkins. This will allow competition to enter domestic markets while providing cheaper and healthier options for women. 

Necessary tariff structure reforms

The Sri Lankan tariff structure is complex, disorganised, and comprises a combination of multiple para-tariffs and duties. The current protectionist import tax structure has significant negative effects on exports as well as the domestic economy. 

The International Monetary Fund (IMF) in its Article IV consultation in 2021 stated that high para-tariffs hindered competitiveness and growth [4]. This clearly shows that immediate reforms should be carried out on the Sri Lankan tariff system. 

To begin with, the existing Customs duty and excess para-tariffs such as PAL, VAT, CESS, surcharge, etc. should be unified into a single Customs duty. For a simpler tariff system, a single rate should apply across all categories where possible, within each HS code. A uniform tariff rate should apply for raw materials and components of the industry [5].

Sri Lanka has been a member of multiple international organisations such as the World Trade Organization (WTO) since 1955, the General Agreement on Tariffs and Trade since 1948, and the IMF since 1950, due to which we have to reaffirm commitments to the multilateral trading system. As members of these organisations, we have to adhere to their protocols and commitments to reducing barriers to international trade by eliminating or reducing tariffs and quotas. 

Thathsarini Siriwardana is a Research Assistant at the Advocata Institute. She can be contacted at thathsarini.advocata@gmail.com. The Advocata Institute is an Independent Public Policy Think Tank. The opinions expressed are the authors’ own views. They may not necessarily reflect the views of the Advocata Institute.

Restructuring SriLankan Airlines can help reduce our economic woes

Originally appeared on The Morning

By Anuka Ratnayake

There is much discussion on the precarious financial situation of the island’s National Carrier SriLankan Airlines. A month ago, Minister of Ports, Shipping, and Aviation Nimal Siripala de Silva revealed that “The only way to rescue the National Carrier is via urgent restructuring” [1].
The airline has racked up significant losses while its debt obligations have increased significantly with the depreciation of the currency. Getting rid of the airline will allow the Government to focus on its limited resources to strengthen social security nets and improve social infrastructure.
The argument regarding the airline has been muddied by emotion, for it is ultimately the people who pay for it and who have the right to ask if this is the best use of taxpayers’ money.
SriLankan Airlines’ Annual Report for 2020/’21 (latest available annual report) provides that the SriLankan Airlines Group recorded a loss of Rs. 49.7 billion. However, the Ministry of Finance in its latest Annual Report records that the loss (before tax) of SriLankan Airlines for the year 2021/’22 is Rs. 170.8 billion [2]. The accumulated loss amounts to Rs. 542.5 billion as at 31 March 2022. The National Carrier lost Rs. 248.4 billion in the first four months of 2022 due to the volatility in exchange rates [3].
The airline is in debt to the Bank of Ceylon and the People’s Bank to the tune of $ 380 million in 2022, while another $ 80 million loan has been obtained from the Bank of Ceylon by mortgaging shares of SriLankan Catering. The banks have extended support to the airline on the basis of letters of comfort issued by the Ministry of Finance.

Further, the airline has a debt payable on an international bond on a Government guarantee of $ 175 million. The guarantees extended by the Government to banks and bondholders represent additional potential losses of public funds. The group owes an arrears amount of $ 325 million to State-Owned Enterprises (SOEs) such as the Ceylon Petroleum Corporation (CPC), the Airport and Aviation Services (Sri Lanka) (AASL), and the Civil Aviation Authority of Sri Lanka (CAASL) [4].
The group’s current liabilities exceeded its current assets by Rs. 214.6 billion by 31 March 2021 and the total equity of the company as at reporting date has declined to a negative Rs. 281.5 billion.
The Auditor General’s report has continuously warned the company that “a material uncertainty exists that may cast significant doubt on the group’s ability to continue as a going concern” [5]. The Auditor General has relied on the Cabinet approval dated 7 February 2022 and the letter issued by the Secretary to the Treasury on 24 February 2022 confirming the support of the Government to the company to continue its operations as a “going concern”. In simpler terms, the SriLankan Airlines Group is technically insolvent and it continues to operate using taxpayer money.
The airline last reported a profit in 2008, under the management of Emirates. It has failed to report a profit in any year since then. The airline industry is known to be a high-risk, low profitability business.

Future losses and lessons learnt from India

The International Monetary Fund (IMF) has now reached a Staff-Level Agreement (SLA) with Sri Lanka to assist its economic recovery process. It was agreed that the IMF would provide an Extended Fund Facility (EFF) of $ 2.9 billion on a 48-month arrangement.
The total debt of SriLankan Airlines (just over $ 1 billion) is nearly one-third of the EFF. Sustaining further losses is an impossible task since the Government can no longer fund the airline. Covering future losses of the airline through tax increases is unacceptable given the dire economic conditions faced by the public.
Sri Lanka needs air connectivity, but this is best provided by privatising air services and not by operating an airline. A good example is the Air India privatisation which took place in the past year. The Indian National Carrier was sold to the Tata Group for the relatively small sum of INR 180 billion [6]. Prior to the sale of the airline, it was losing $ 3 million a day on average, which totaled to over $ 1 billion per year [7].
The rising aviation fuel prices and airport usage charges were not sustainable after the pandemic restricted air travel. Further, competition from low-cost carriers and the poor financial performance of the airline made things worse. Air India’s poor client orientation, lack of punctuality, obsolete productivity practises, and poor revenue generation techniques were among the reasons for its incompetency [8].
The impact of the Air India privatisation was discussed at a panel at the ReformNow Conference hosted by the Advocata Institute. The panellists stressed how the Tata Group had already begun the process of value addition through efficient customer care services, improving fleet productivity, and focusing on budget flights for the domestic market.

Aviation hub

Singapore’s aviation policy has been a key factor in the growth of Singapore’s Changi International Airport, where air transport contributed to nearly $ 20 billion of value added to the Singapore economy or about 6% of the Singapore GDP in 2011.
There is much public support for restructuring SriLankan Airlines due to its heavy burden on State coffers and thereby the taxpayers. However, rather than selling the airline alone, bundling the sale of the airline with the other business units such as SriLankan Catering and SriLankan Airlines Ground Handling would be attractive to investors. At the same time, the airport too can be included and marketed as an aviation package with a similar potential to the Changi International Airport.
A national carrier is a source of pride, but it is not a priority for a cash-strapped Government. The airline should be disposed of or even closed, and a liberal air services policy should be adopted instead.
This could boost growth and truly turn Sri Lanka into an aviation hub, freeing taxpayers’ money to be used for health, education, and other priorities.

References
1. https://www.ft.lk/top-story/Answering-aviation-Aragalaya/26-739243
2. https://www.treasury.gov.lk/api/file/a7a35d1a-556f-49b2-81e0-20294eb5a519
3. https://www.treasury.gov.lk/api/file/bc1e8eaf-91eb-4cb3-94e0-35d81f65a949
4. https://www.ft.lk/top-story/Answering-aviation-Aragalaya/26-739243
5. https://www.srilankan.com/pdf/annual-report/SriLankan_Airlines_Annual_Report_2020-21_English.pdf
6. https://www.indiatoday.in/business/story/explained-air-india-handover-government-to-tata-group-changes-1904217-2022-01-25
7. https://www.advocata.org/commentary-archives/2021/10/11/air-india-sold-privatise-srilankan-now
8. https://www.bbc.com/news/world-asia-india-60150531

Anuka Ratnayake is a Research Assistant at the Advocata Institute. She can be contacted at anuka.advocata@gmail.com. The Advocata Institute is an Independent Public Policy Think Tank. The opinions expressed are the authors’ own views. They may not necessarily reflect the views of the Advocata Institute.

New electricity tariff structure leaves room for considerable improvement

Originally appeared on the Daily Mirror, Timesonline.lk

By the Resident Fellow of Advocata Institute

The recent revision of electricity tariffs is a step towards reducing the fiscal burden caused by the supply of electricity below its cost of production. While the new tariff structure is an improvement on the previous one, anomalies remain.

 In determining tariffs, there are three characteristics of electricity that must be noted:

I. Electricity is a commodity that is interchangeable, both in its generation and use. One megawatt hour (MWh) of electricity produced from coal or hydropower contains the same amount of energy. Different categories of users consume the same product.

II. It must be produced and used simultaneously. Electricity storage is still prohibitively expensive. Supply must meet demand exactly in the power grid.

III. The cost of supplying electricity fluctuates throughout the day, depending on the power generation mix, cost of fuels used, transmission costs and energy losses.

As electricity is a commodity, there should be no difference in the prices charged to different users. The tariff should also reflect the varying cost of supply, depending on the time of day and should as far as possible, balance the generation of electricity with its use. For sustainability, the tariff needs to be on a cost-recovery basis.

The new tariff addresses some of the shortcomings of the existing structure but there is still considerable room for improvement.

1. The proposed structure reduces the discrimination between different types of bulk supply customers.

For users below 42kVA, the different rates that were charged to hotels, government and general-purpose bulk supply, have been amalgamated into a single general-purpose tariff but a lower rate remains applicable to ‘industrial’ customers. However, it is positive that the differential between the general-purpose bulk supply and customers categorised as ‘industrial’ has decreased.

For larger bulk customers, it is welcome that the distinction between categories has been done away with and a single tariff, close to cost recovery and reflecting time of use, has been applied.

The Public Utilities Commission of Sri Lanka (PUCSL) consultation document states that the average cost of generation is Rs.32.87 but the tariff charged to low-use industrial users (Rs.20) and low-use general-purpose customers (Rs.25 for those below 180kWh) is both below cost.

The only justification for a discriminatory tariff is for a lifeline tariff for the poor. While the domestic users below 90kWh do receive a subsidised tariff, the domestic consumers, who exceed this, pay the highest tariff (Rs.50 for usage between 90-180kWh, Rs.75 above 180kWh), which is almost double that of all bulk users. Thus, high-use domestic consumers are subsidising industrial and commercial users.

Moreover, instead of increasing the rate for each block of use, the moment domestic customers exceed 60 units, the tariff increases from an average of Rs.9 to Rs.16. A customer, who consumes 59 units, will pay Rs.9 but one who consumes 61 units will pay Rs.16 per unit. This is unfair and can promote corruption in meter reading. In general, such cross subsidies are undesirable, as they can lead to inefficient resource allocation or have unintended consequences.

For example, the higher domestic tariff may serve as a disincentive for remote work. Remote or flexible work arrangements can reduce transport costs, congestion, energy use and for some, enable a better work/life balance. The government should be facilitating flexible work but the higher rates applicable to some domestic consumers may be a disincentive.

The PUCSL has an unusual definition of industry. It includes, ‘agriculture’, ‘forestry and fishing’, ‘mining and quarrying’, ‘manufacturing’, ‘electricity, gas, steam and air conditioning supply’, ‘water supply, sewerage and waste management. As a matter of principle, the producer should not make judgment on how the product is used or attempt to encourage or discourage particular activities through prices. If the government does wish to encourage particular industries, it is more efficient to do this through a transparent system of grants, rather than distorting prices.

Economic activity is increasingly complex and a value chain can involve many different sectors. For example, the tea industry involves agriculture, processing in factories, transport, warehousing, blending, financing, marketing and exports. Moreover, products are now more knowledge intensive, so a greater part of the value addition arises in non-production-oriented components of the value chain. With differential tariffs, parts of the same value chain may pay different prices for use of the same commodity.

Religious and charitable bodies continue to enjoy preferential treatment under the domestic tariff category but there is a small decrease in the discount offered to these bodies. High-use customers in this category should also be subject to a time of use (TOU)-based tariff. Advocata reiterates that there should be no price discrimination between users; at most there should be two categories, households and businesses.

2. It is welcome to note that the new tariff structure extends the TOU tariff to the agriculture subsector but this should be extended to smaller bulk users and made compulsory for the high-use domestic category. For customers using solar power on a net metering basis, the export and import tariffs should be based on TOU. A TOU-based tariff reflects the changing cost of generation across the day. Generation during peak hours relies more heavily on thermal power, which is more costly. Tariffs charged to customers should reflect this, so that the consumers are incentivised to shift demand to off-peak hours.

3. The new tariff maintains a lower rate for low-use domestic customers and it is welcome that the new structure applies marginal tariffs based on different slabs of usage. The previous system was inherently unfair to the consumer; the new tariff removes this anomaly.

4. The decision to charge for street lighting, which should be paid for by the local authorities, is welcome. Previously, as the Ceylon Electricity Board (CEB) did not charge for street lighting, the local authorities, which have control over when the lights are switched on and off, had no particular incentive to switch off street lights during day time. A lower rate for street lighting is justified because the major part of the use falls into off-peak hours.

5. It is regrettable that the PUCSL permitted the CEB to compel selected clients to pay for electricity in US dollars. This is a step towards forced dollarisation of payments and is precluded under Section 4 of Monetary Law Act No. 58 of 1949. The proposal is meant to address the current shortage of US dollars for importation of fuel for the energy sector. However, this would only divert resources from other alternative users and may not be the most efficient way of allocating the scarce foreign exchange in the country. It would be preferable to allow US dollars to flow into the banking sector (by removing any restrictions and requirements such as forced conversions and surrendering requirements) and for those funds to be allocated based on price (exchange rate).

The increase in the electricity tariff is unavoidable but will impose an additional burden on consumers. Therefore, it is imperative that this must be accompanied by increased transparency and efficiency

within the utility.

Consumers may expect to pay for higher world prices but cannot be expected to pay higher costs, due to inefficiency, waste or corruption. State enterprises need to be open and transparent in their affairs, particularly in procurement and where possible should operate in competitive markets.

As a first step, the CEB should provide a detailed breakdown on the components of its tariff:

• Energy costs: (Own generation costs and that paid to the private generation companies). This must be broken down into the fuel cost and the costs of operating the power stations, such as the manpower and maintenance costs as well as the capital cost of the stations.

• Network costs: This reflects the cost of transporting electricity through the power grid.

• Overhead: This is to recover the costs of central administration, billing and meter reading, data management, retail market systems as well as market development initiatives.

The opinions expressed are the authors’ own views. They may not necessarily reflect the views of the Advocata Institute.

Invest to progress, not to regress: Bridging the infrastructure gaps in Sri Lanka

Originally appeared on the Daily FT, the Morning, Lanka Business Online, Groundviews, Ada Derana Biz English

By Tiffahny Hoole and Janani Wanigaratne

Sri Lanka is going through a crisis of a magnitude that has never been witnessed in its economic history. The country is in disarray as people wait in lines to purchase essentials. Official reserve assets have plummeted to a $ 1,920 (1) million by May this year and the debt to GDP ratio has reached an all time high of 104.6% by 2021. (2) The country is struggling to meet its domestic needs while having fallen into a debt default for the first time in its history. Why did Sri Lanka’s debt obligations escalate to the point of an economic crisis? Debt taken on to finance unproductive infrastructure is a part of the problem. (Debt was also taken to finance recurring expenditure including interest on past debts and subsidies to SOEs). 

Professor Amal Kumarage, one of the leading experts on transport infrastructure in Sri Lanka says, “Sri Lanka’s inability to service debts is a clear indication of inefficient infrastructure investment. Over 50% of the foreign loans in the past decade were for different transport infrastructure projects that have not delivered the anticipated economic outcomes. The professionals who promoted unfound optimism in economic analysis of these projects to please the political masters must come forward and accept their responsibility for contributing to this crisis.”

Since the end of the civil war, there has been a longstanding commitment towards developing large-scale infrastructure projects (See table 0.1). (3)In the first eight months of 2020, Sri Lanka’s public expenditure on infrastructure development amounted to Rs. 98 billion. (4) The Ministry of Finance aims to maintain public investment at an average of 5-6% of the GDP per annum till 2025. (5) In terms of performance however Sri Lanka infrastructure falls short – it ranked 61 out of 141 under the overall infrastructure performance indicator by the ‘Global Competitiveness Report 2019’. (6)  

Sri Lanka does have an infrastructure gap but it must invest in the right projects. The World Bank (2014) reports that Sri Lanka still needed $ 36 billion worth of investments to close its infrastructure gap, which amounts to 40.5% of the GDP in 2018. (7) To avoid wasteful investments, Sri Lanka requires a fact-based project selection process and an optimised operation and maintenance system for existing large-scale infrastructure projects to close this gap.(8) This would also reduce the country’s spending significantly. Among the numerous factors that fuelled this crisis, lavish investments in infrastructure of limited benefits seems to have played a crucial role. 

Useful infrastructure projects should enable the best return to public investment with higher efficiency, increased safety and minimal environmental damage. It should also have a positive spillover effect which may range from generating employment and increased foreign direct investment to improved tax revenue.

How are large-scale infrastructure projects financed? 

In an effort to close the gap between existing and required infrastructure, the Government resorted to foreign loans. Foreign borrowing amounted to $ 1,710 million in the first eight months of 2021.(10) This accounts to an increase of 16% of foreign financing disbursement in comparison to the previous year.(11) Sri Lanka’s disbursement commitments consist of loans from multilateral agencies, such as the World Bank and the Asian Development Bank, and bilateral partners including China, Japan and India(.12) 

With the provision of foreign loans to finance large-scale infrastructure projects among numerous other borrowings, Sri Lanka’s debt to GDP ratio has reached 104.6% in 2021. Based on the high foreign loans obtained, in conjunction to Sri Lanka’s current economic status, there seems to be a strong indication that large-scale infrastructure projects severely indebted the State. If so, where did Sri Lanka go wrong? 

Lack of preliminary procedure 

Taking on multi-million dollar investment projects is a complex task. Large infrastructure projects need to pass the test of utility in order to serve long-term demands before public money is spent.(13)

This means, thorough scrutiny is mandatory to enable the gains of large-scale infrastructure to be fully realised. This would include looking at the interest rates, grace periods and maturity periods provided. It also requires a comprehensive understanding of the type of loan provided. These can be achieved through conducting proper feasibility studies and risk assessments which will shed light on the project’s potential to service debt and its sustainability in the long run. For instance, loans obtained through multilateral agencies such as the World Bank and Asian Development Bank require a competitive bidding process to select a contractor. (14) In contrast, projects funded by bilateral agencies are through tied loans.(15) This means that bidding is limited to contractors from the lender’s country.916) During the period of 2005-2018, 28 out of 35 high value bilateral loans were procured without a competitive bidding process.(17) The inability to gauge all available contractors at competitive rates to construct large-infrastructure potentially results in poor quality infrastructure at a cost of very high prices.(18) 

The National Procurement Agency was a statutory body that handled competitive public procurement. However, right before the height of Sri Lanka’s investment spree in 2008, it was removed. In lieu of this, the Standing Cabinet Approved Review Committee (SCARC) was set up in 2010 to approve projects without public tendering or parliamentary approval. This creates additional concerns over the commercial viability of the project approved.(19)

Take for instance the Colombo Port City. Soon after SCARC approval, it was heavily criticised on the claims that its Environmental Assessment Impact was compromised. Further fuelled by the opposition from the fishing community, the project was temporarily suspended. The interim review of these concerns cost the Government $ 143 million as compensation. If proper procedures were followed, these costs could have been circumvented.(20) 

Public infrastructure or political infrastructure? 

Investments in large and complex infrastructure projects have also been a fertile ground for corruption, thereby increasing the risk of creating ‘White Elephants’(.21) Rather than considering the economic value of obtaining loans from foreign lenders, governments utilise large-infrastructure projects as a tool to win the votes from the public. In the event such projects are not completed within their term, successive governments are inclined to halt its operations.(22) This leads to unconsummated, poorly built infrastructure with limited benefits to the people.

Gaps in information: Calling for increased transparency

An effective mechanism of ensuring public money is spent to the best of its ability is to increase the access to information. There is a significant gap in data available to the public on large-infrastructure projects in Sri Lanka. For instance, a comprehensive breakdown of the loan amount, its repayment and interest rates are inconsistently provided in the Ministry of Finance Annual Reports. Selected projects financed through bilateral agencies have been completely omitted. Furthermore, information pertaining to the project’s appraisal and performance is not publicly available. This hampers the ability for the public to conduct an analysis on the investment made. The public must relegate to submitting Right to Information applications to the relevant implementing agency. However, comprehensive responses are rare.  Nevertheless, investment on large infrastructure is a necessity. It has been assessed that 1 dollar worth of infrastructure investment can raise GDP by 20 cents in the long run.(23) Furthermore, infrastructure development can facilitate trade and foreign direct investment. 

In order to ensure that the benefits of each and every infrastructure project undertaken is fully realised, it is vital to set up a comprehensive framework with active public policy, transparent and competitive procurement, proper evaluation and an in-depth financing structure.(24) Hard infrastructure should be accompanied by soft components such as policies and regulations in order to facilitate efficient performance.(25) Therefore, a long-term plan for national infrastructure that is publicly available has the potential to pivot the feeding ground of corruption to the stepping stone of development. 

Refernces:

1CBSL

2CBSL

3https://www.ips.lk/talkingeconomics/wp-content/uploads/2012/09/pb10_Infrastructure-Challenges.pdf

4https://www.treasury.gov.lk/api/file/0d77beee-4e42-478b-9089-7f09be23a0e0

5https://www.treasury.gov.lk/api/file/0d77beee-4e42-478b-9089-7f09be23a0e0

6https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/publications/annual_report/2020/en/13_Box_02.pdf

7Chinese Investment and the BRI in Sri Lanka

8https://www.mckinsey.com/business-functions/operations/our-insights/bridging-infrastructure-gaps-has-the-world-made-progress

9CBSL Annual reports from various years

10https://www.treasury.gov.lk/api/file/16e9c6ec-7a13-4220-a8a7-1427c5d14785

11http://www.erd.gov.lk/index.php?option=com_content&view=article&id=94&Itemid=216&lang=en

12http://www.erd.gov.lk/index.php?option=com_content&view=article&id=94&Itemid=216&lang=en

13https://www.echelon.lk/a-circus-of-white-elephants/

14https://www.veriteresearch.org/wp-content/uploads/2021/07/VR_Eng_RR_Feb2021_Opportunities-to-Protect-Public-Interest-in-Public-Infrastructure-1.pdf

15https://www.veriteresearch.org/wp-content/uploads/2021/07/VR_Eng_RR_Feb2021_Opportunities-to-Protect-Public-Interest-in-Public-Infrastructure-1.pdf

16ibid

17ibid

18Key Informant Interview

19‘Locked in’ to China: The Colombo Port City Project

20‘Locked in’ to China: The Colombo Port City Project

21https://www.veriteresearch.org/wp-content/uploads/2021/07/VR_Eng_RR_Feb2021_Opportunities-to-Protect-Public-Interest-in-Public-Infrastructure-1.pdf

22https://www.chathamhouse.org/sites/default/files/CHHJ8010-Sri-Lanka-RP-WEB-200324.pdf

23https://www.mckinsey.com/industries/public-and-social-sector/our-insights/four-ways-governments-can-get-the-most-out-of-their-infrastructure-projects

24https://www.adb.org/sites/default/files/publication/177093/adbi-wp553.pdf

25https://www.adb.org/sites/default/files/publication/29823/infrastructure-supporting-inclusive-growth.pdf

Janani Wanigaratne is a research intern at the Advocata Institute. She can be contacted at janani.advocata@gmail.com. Tiffahny Hoole is a former researcher at the Advocata Institute. She can be contacted at tiffahny.advocata@gmail.com. The Advocata Institute is an Independent Public Policy Think Tank. The opinions expressed are the authors’ own views. They may not necessarily reflect the views of the Advocata Institute.

Timescale confusions in solutions for the crisis

Originally appeared on the Daily FT

By Prof. Rohan Samarajiva

A few days after the tsunami, I was called to an expert meeting at Temple Trees by the then Prime Minister, Mahinda Rajapaksa. I was seated next to Arisen Ahubudu, the famous giver of names. He stated that we had lost too much territory, including Madagascar, and that we could not afford to lose more. He proposed building a wall around the country, using the traditional techniques used in protecting tank bunds, the ralepanawa. I was stunned that such a nice and well-meaning person could come out with such arrant nonsense. He had confused geological time with human time. 

Timescale confusions of a smaller magnitude are evident among many proposing solutions to our current multi-faceted crisis. 

Solutions to power cuts

We all experience the problem. Some of us understand the cause: no dollars to pay for fuel for the generators that make up for the shortfall from lower production from the hydro generators and Norochcholai. Even if we had the dollars, such fuel is priced in dollars and subject to price fluctuations that we cannot control. It is common sense that we should shift to electricity produced by renewable sources such as solar and wind. 

The problem is that under current market and technology conditions, both the distribution network (low voltage) and the transmission network (high voltage) are limited in how much solar- and wind-generated electricity they can accept. We can, and should, increase the use of electricity from renewable sources, but we need to upgrade the transmission network to be able to do so. Solar panels yield electricity when the sun is out (not at night and not when clouds pass over the panels); the wind will produce electricity even in evenings when our use is highest, but it is still intermittent. Batteries are not cost-effective yet.

Given the need to balance supply and demand of electricity in real-time caused by lack of cost-effective storage technologies, we need a large and modernised system in order to absorb more energy from these intermittent sources. We need to invest in upgrading the national grid and possibly connect to the large Indian grid. Feasibility studies must be done, and investment mobilised. It will take several years for the desired outcomes to be achieved. Increasing solar- and wind-based energy is not a viable solution for our immediate problems, though it is a solution in the long term. Within the applicable timescale, what we need are dollars for coal and diesel.

Promotion of manufacturing

Twin deficits, exacerbated by recent economic mismanagement, caused the crisis. More exports would have addressed the current-account deficit and may have helped with the fiscal deficit if the right tax policy was in place. Roughly $ 11 billion was earned from the export of goods such as apparel, tea, and value-added rubber products before the pandemic. Around $ 7 billion was claimed from service exports such as tourism, software and business process outsourcing. 

It is true that the East Asian Tigers and China took their people out of poverty through the production of goods for export. One has to ask why Sri Lanka (and to a significant extent, the rest of South Asia) failed to ramp up the production of goods for export, relying more heavily on service exports. One could even argue that the apparel industry is a service industry. A tailor who makes a suit out of material given to him is undoubtably a provider of services. The Sri Lankan apparel industry, which is the largest importer as well as the largest exporter, is doing what a tailor does, at scale. If it is manufacturing, it is manufacturing lite.

Until the market opening in 1978, the answer to the question of why we had no industries was that our private sector was weak and lacked capital. Therefore, the State went into manufacturing: steel, plywood, tyres, sugar, paper, shoes, cooking implements, etc. were all produced by fully State-owned enterprises under protection. They produced shoddy goods at high prices for the local market and lost enormous amounts of money. The plywood factory resulted in the clear-cutting of half of Sinharaja. After the market was opened to imports, they went out of business.

Since 1978, we have relied on private investors, with or without foreign partners, to manufacture for export (and for domestic use). They have tended to invest in sectors that did not rely too heavily on cheap energy (because our electricity prices were high, especially for industrial users). Except in the case of a few sectors such as apparel and rubber-based products, our producers failed to secure access to markets. Restrictive laws and para tariffs hindered local producers from getting integrated into global production networks, with very few exceptions. 

So, the industrialisation prescription as a solution to the crisis will take time and effort to implement. We would have to ensure reliable and low-cost energy (and other infrastructure services such as waste disposal), eliminate para-tariffs, and create the conditions for market access. The latter is the most challenging. 

Investors such as Michelin ensured market access for the solid tyres produced in Sri Lanka. The apparel industry also benefited in the early stages from foreign investors who facilitated market access. Attracting such investors and entering into trade agreements are needed for market access. But both take time. 

Industrialisation may be a good solution, but it is not for the Government to decide on manufacturing priorities. Because China has established itself as the factory to the world, countries such as ours must identify and exploit niches. Those best positioned for this are those with intimate knowledge of the markets, with skin in the game, namely private investors. The State must create the conditions and leave the actual investment decisions to such players. All this will occur on a timescale different from what is relevant to emerging from the present crisis.

Constitutional reforms

It has become evident that the hyper-presidential system created by the 1978 Constitution has failed to yield the promised benefits and has caused serious damage after the enactment of the 20th Amendment, which removed all the checks that were placed on the President by the 19th Amendment. For example, the Minister of Finance has stated that specific officials were responsible for the tax cuts that triggered the present crisis and the delay in debt restructuring. In the current system, the sole authority for those appointments was the President who must therefore be held accountable for the current crisis.

To address the demands of the protestors, the President must go. He must resign or be impeached. The former can take place immediately would allow the country to return to normal (if such a condition exists after the devastation wreaked by the President and his appointees). The time taken to impeach will be too long. 

The next best solution is to reduce the powers of the President. This would require a Constitutional amendment. An amendment that is approved by Cabinet can be completed within around six weeks. If it is moved as a private member’s motion, it could take more than six months, outside the timeframe needed to calm the country and get the debt restructuring done. The announcement that the Government is proposing the restoration of the 19th Amendment suggests a solution within the required timescale. Of course, it would be necessary to scrutinise the proposed amendment and ensure the President’s powers are meaningfully reduced immediately.

In innumerable discussions I have participated in, I hear proposals for Constitutional reform that pay no heed to the time factor. Some talk of a Constitution authored by the people, modelled on what is going on in Chile. The process began with an amendment to the Constitution and a referendum in 2020. This was followed by an election for a Constituent Assembly in April 2021. Its deliberations are ongoing. How realistic is this kind of process for the kinds of issues that have brought our people to the streets?

In these days of limited attention (and paper supplies), it would be useful if greater weight is given to the appropriateness of the proposed solutions for the time needed to solve the problems that beset us.

Rohan Samarajiva is founding Chair of LIRNEasia, an ICT policy and regulation think tank active across emerging Asia and the Pacific. He was CEO from 2004 to 2012. He is also an advisor to the Advocata Institute.

Sri Lanka’s economy is entering a dangerous tailspin

Originally appeared on Daily Mirror

By Ravi Rathnasabapathy and Rehana Thowfeek

Sri Lanka has just entered the deepest economic crisis in its history. Shortages and rising prices that people face today are only the first inkling of what lies ahead. Unless decisive action is taken, it can go into a destructive tailspin. 

Downgrades and forex shortages mean foreign banks will only accept upfront payments for imports until credibility is restored. This means the country is now in a hand-to-mouth existence: imports are restricted to the quantum of foreign exchange inflows. These inflows are shrinking. 

Production of goods and services, for both exports and domestic consumption is contracting due to shortages of fuel, power and other inputs. Exporters are losing orders as overseas buyers, concerned about the inability to supply and missed deadlines are switching orders to other countries. Tourist numbers dwindle due to long power cuts, lack of fuel for transport and the closure of restaurants due to lack of gas. 

Lower exports lead to even lower foreign exchange receipts, which in turn limits production even further. With each cycle, the noose tightens further, until eventually most activity ceases. 

The shrinking supply of goods and services within the economy leads to increases in prices, as spending outpaces production. Businesses become unviable due to their inability to function at normal capacity and people lose their livelihoods. As activity shrinks, individuals and businesses alike find it difficult to repay their bank loans and the pressure shifts to the banking sector. This cycle continues until most economic activity grinds to a halt. As the country is pushed into a subsistence existence malnutrition and hunger become widespread.

The crippling effects of the inability to import are similar to that of being under international sanctions except that these have been self-inflicted. Now that the downward cycle has started, it is very difficult to stop as the forces of destruction gather momentum and speed. Until the appointment of the new governor last week, Sri Lanka was in free-fall. The best hope now is to arrest the descent and stabilise it at some point. The governor has taken only the first step on the path to stabilisation but much more needs to be done.

It is clear from the people’s protests that the public have lost confidence in the government. What people don’t realise is that multilateral agencies, international banks and rating agencies have also lost confidence. The government budgets the last two years were replete with errors: overestimated revenues, irreconcilable differences and unrealistic assumptions. Abrupt changes in polices and asinine statements by officials underlined these concerns; one international bank entitled its update “Denial is not a Strategy”. Even before the default many foreign banks refuse to accept letters of credit from Sri Lankan banks unless guaranteed by an international bank.    
A key benefit of an International Monetary Fund (IMF) programme is that it will restore confidence. The mere fact that the government budgets and forecasts are being reviewed by the IMF signals that they are based on realistic assumptions and reasonable estimates. Together with concrete steps towards repairing public finances it will restore some confidence among lenders and pave the way for bridge finance – to relieve some of the crippling shortages that are choking production and livelihoods.

Returning to growth is not impossible but this means addressing the structural issues within the economy, a matter that is all but impossible due to the thicket of vested interests that have grown during the past two decades.

Stabilisation – averting complete meltdown
The major cause of the disequilibrium in the economy was the excessive money printing carried out by the Central Bank since 2019. Money has been printed to finance government expenditure at an alarming rate. The huge increase in government spending results in strong demand for goods and services within the economy. High levels of demand feed into local products and services as well as for imports. Historically, whenever the government has run a large budget deficit financed by the Central Bank credit, it has always resulted in a current account deficit.
The first step to addressing the problem of money printing is to borrow from the domestic market, instead of the Central Bank. Given the enormous sums being borrowed, the government needs to offer a sufficiently high interest rate to attract the required quantum of funds. This is why rates have been raised sharply. Higher rates will reduce consumption by the private sector (which also reduces imports) but may also affect investment, so such high rates, while unavoidable to stabilise the present situation, cannot be maintained in the long term.

For rates to reduce, the levels of government borrowing must reduce. This means cutting the budget deficit. This will have to be approached in two ways: an increase in taxes and a reduction in expenditure.

Increases in personal taxes will reduce the government deficit and therefore the government borrowing requirement reducing the pressure on interest rates. Higher taxes can help curtail private consumption (including import consumption) but may also impact savings and therefore investment. Increases in corporate taxes could curtail investment.

To minimise the negative effect on investment, the government should not rely on taxes alone, expenditure must be cut but the recurrent expenditure is very rigid (mainly salaries, interest and pensions), so reducing capital expenditure is more feasible both politically and practically. Resistance will however be encountered due the corruption involved, especially in highway projects. Reducing the drain from state enterprises and the disposal of idle or underutilised assets are other avenues to close the deficit. Some trimming of unnecessary current government expenditures can increase available fiscal space for social transfers.

Since the majority of the government expenditure is spent on salaries, pensions and interest, a recruitment freeze and a freeze on increments will halt further expansion. All discretionary expenditure unless directly welfare-related must be frozen along with capital expenditure at least in the short term. All transfers and support to state-owned enterprises must cease.

The imbalances will be resolved due to a combination of factors: contraction of demand due to higher interest rates and higher prices which follow from the adjustment of prices to the realistic exchange rate. Prices will need to rise to the market-clearing rate, critically energy prices, which are dependent on the exchange rate. This, however, delivers a huge negative shock to the poor, so it must be cushioned with social transfers.

These are purely stabilisation measures. If carried out properly, this can restore the economy to its state in 2019 but at a higher price level, higher unemployment, lower levels of output and higher levels of poverty. Those in the middle and lower-income groups will be pushed further down the income spectrum: large sections of the middle class will find themselves poor and the poor will be left in abject poverty. Due to low levels of productivity growth will be stagnant at 1-2 percent.

Some of the destruction that has been wrought on businesses will be permanent. The rate of increase in prices will slow to tolerable levels but prices for the most part will not decline from the current high levels. Lower incomes and high prices lead to much lower living standards for most people. The low levels of productivity within the economy mean that prospects for escaping poverty remain poor but on the positive side, things will stop getting worse.
If people are to have some hope, then growth needs to be restored, which means addressing the problem of productivity.

Growth – Restoring prospects for recovery 
The people will have little prospects unless growth returns but growth is impossible unless the barriers that impede it are addressed. 

Sustained economic growth and productivity improvement are intricately linked. These are two sides of the same coin: a faster rate of economic growth cannot be maintained without productivity improvement. Higher productivity must be achieved in all sectors of economy, including the government, public sector and agriculture, where it is weakest.

At its simplest, productivity is a measure of an economy’s ability to produce outputs (goods and services) from a given set of inputs. The more productive the economy, the more value it is able to generate, either through more efficient allocation of inputs, greater productive efficiency in converting inputs into outputs or through innovation – coming up with new products and processes. Achieving sustained economic growth ultimately depends on an economy’s ability to increase its productivity over time, so improving productivity should be the key long-term goal of economic policy.

Many of the barriers to increased productivity are the result of policies and regulations of past governments. Misguided or poorly implemented measures to protect or encourage particular sectors have stifled the competitive forces that drive productivity resulting in higher costs of production. Competitive intensity is a key driver of productivity. It is only in a highly competitive business environment that firms have a strong incentive to adopt best-practice techniques, and technology and engage in innovative activity. This works in three main ways. 

First, within firms, competition acts as a disciplining device, placing pressure on the managers to become more efficient. Secondly, competition ensures that more productive firms increase their market share at the expense of the less productive. These low productivity firms may then exit the market, to be replaced by higher productivity firms. Thirdly and perhaps most importantly, competition drives firms to innovate, coming up with new products and processes, which can lead to step-changes in efficiency. Protectionism shields them from these competitive forces and eliminates a vital incentive, stunting long-term growth. 

Increasing competition means opening the country to investment and trade, reducing the tariffs and regulatory impediments to both. This can help reduce consumer prices and prices of inputs. Import competition spurs local businesses to greater efficiency. With sound macroeconomic policies in place imports can flow in freely.

Within the government, productivity must be addressed through the process of privatisation of commercial activities that could be more productively undertaken by the private sector and the closing down of non-viable state-owned entities, reforming the legal foundations of the economy and substantially increasing the efficiency in critical government functions. For example, increasing the efficiency in the areas of tax and custom procedures and reducing trade and regulatory barriers to enhance competitiveness, digitisation and better systems that improve efficiency and ease of doing business.

Policymakers have no idea of how grave this crisis is or how bad things could get. It is a classic debt and balance of payments crisis, which, if mishandled, can result in a complete meltdown of the economy. The government has appointed, at long last, competent officials in the governor and the treasury secretary aided by a solid team in Indrajith Coomaraswamy, Shanta Devarajan and Sharmini Cooray. They must have unwavering support from the executive and legislature. All political parties need to work together towards resolving the political deadlock and restoring political stability to ensure economic change can be achieved without delay. 

Policy actions: Not quite enough

Originally appeared on Daily FT, Lanka Business Online and Groundviews

By Dr Roshan Perera and Dr. Sarath Rajapatirana

Key macroeconomic indicators signal an economic crisis

A reading of key macroeconomic indicators reveals the extent of the economic crisis Sri Lanka is faced with. Indicators in all four sectors of the economy (i.e., the real sector, fiscal sector, external sector, and monetary sector), have been at their worst level in recent years, and in some cases, at levels never before seen in the post-independence history of this country. 

Growth was negative in 2020 and continued in the negative territory in the third quarter of 2021. This was obviously partly due to the pandemic as well as the measures taken to curtail its spread. However, growth in Sri Lanka continued to remain subdued while other countries in Asia were firmly on a path to recovery. Macroeconomic instability will continue to negatively impact investor sentiment and growth prospects in 2022. This will be further exacerbated by the impact of the war in Ukraine, as the region accounts for a large share of tourist arrivals and is one of the key destinations for Sri Lanka’s tea exports.

Inflation as measured by the CCPI has reached double digits (15.1% YoY in February 2022). These levels were last seen only during the last stages of the civil war. Many countries around the world have also been experiencing an uptick in inflation due to higher commodity prices, especially energy prices and supply side issues due to pent up demand with the opening of countries.

However, in Sri Lanka, an extremely loose monetary policy due to excessive money printing by the Central Bank of Sri Lanka (CBSL) to finance the Government’s deficit has pushed inflation to double digit levels. Further, core inflation – which excludes food and energy – had risen to 10.9% by February 2022, reflecting the demand pressures in the economy. Food inflation has risen even faster, with the year on change reaching 25.7% in February 2022. The recent outbreak of war in Ukraine sharply increased energy prices, with Brent crude oil prices rising to over $ 100 in March 2022 – levels last seen in late 2014.  With domestic fuel prices adjusting to higher international prices, inflation is likely to increase even further.

Meanwhile, the fiscal sector continues to deteriorate. Ad hoc tax changes made at end-2019 resulted in tax revenue declining by around Rs. 500-600 billion in both 2020 and 2021. This decline will continue in 2022 unless measures are taken to reverse this trend. Consequently, tax revenue collection has fallen to the lowest level in history (8% of GDP). This has led to widening fiscal deficits and interest payments absorbing more than 70% of Government revenue.

The significant contraction in revenue with no adjustment to Government expenditure increased the fiscal deficit to 11.1% of GDP in 2020. This is likely to have increased further in 2021. A deficit of this size was last witnessed in 2009 (9.9% of GDP) and 2001 (10/4% of GDP). The sharp decline in revenue and the worsening fiscal position led to international rating agencies downgrading the sovereign, effectively locking Sri Lanka from international capital markets. Hence, the Government resorted to domestic sources to finance the widening fiscal deficit. However, with a cap on interest rates, it fell on the CBSL to do the heavy lifting.

Consequently, money supply rose to unprecedented levels, mainly driven by credit to the Government from CBSL, as the net foreign assets (NFA) of CBSL turned negative for the first time ever. Net Credit to the Government (NCG) in 2021 increased by Rs. 1.454 billion (38.2% YoY) with CBSL being the main provider of credit. Credit to the private sector increased by only Rs. 810 billion (13.1% YoY) during the same period.

The extent of the monetisation of the fiscal deficit is seen by the sharp increase in CBSL’s holdings of Government securities from Rs. 75 billion at end 2019 to Rs. 1,417 billion at end 2021. This has further increased to Rs. 1,529 billion by 11 March 2022. By artificially suppressing interest rates to keep Government borrowing costs low, the CBSL was forced to purchase Government securities not taken up in the primary market. This had increased reserve money (base money) by 35% (YoY) in 2021. The increase in base money would have been even higher if not for the decline in CBSL’s NFA to a negative Rs. 386 billion due to the use of foreign reserves for debt service payments and to support the ‘fixed’ exchange rate.

On the external front, the Government’s large foreign debt repayments and its inability to tap foreign capital markets due to the sovereign downgrade led to the use of foreign reserves for debt service payments. Consequently, the country’s official foreign reserves fell to precarious levels. To address the imbalance in the external sector, the Government restricted imports of many goods. The CBSL also imposed a 100% margin requirement on importation of selected “non-essential” goods.

Notwithstanding these import controls, the trade deficit (the difference between exports and imports) widened in 2021. In addition, in September 2021, CBSL fixed the exchange rate within a band of Rs. 200 to 203 per US Dollar and instructed banks to carry out transactions within this narrow band. Since demand for US Dollars outstripped supply at this “fixed” rate, a black market developed.

On 7 March 2022, when CBSL allowed “greater flexibility” of the exchange rate, the US Dollar was trading at around Rs. 260-270 in the black market. The large deviation between the official exchange rate and the black-market rate led to a significant decline in foreign inflows. Workers’ remittances, which hitherto helped cushion Sri Lanka’s trade deficit, had declined by 23% to $ 5.5 billion in 2021, with the decline continuing in 2022.

Recent policy actions not sufficient to stabilise the economy

To address the deteriorating macroeconomic environment on 4 March 2022, the CBSL revised its policy rates by 100 basis points, thereby raising the Standing Deposit Facility Rate (SDFR) to 6.50% and the Standing Lending Facility Rate (SLFR) to 7.50%. In the same monetary policy announcement, CBSL as the Economic and Financial Advisor, proposed several policy measures to be taken by the Government to address the current economic situation, such as;

• Introducing measures to discourage non-essential and non-urgent imports urgently

• Increasing fuel prices and electricity tariffs immediately, to reflect the cost

• Incentivising foreign remittances and investments further

• Implementing energy conservation measures, while accelerating the move towards renewable energy

• Increasing government revenue through suitable tax increases on a sustained basis

• Mobilising foreign financing and non-debt forex inflows on an urgent basis

• Monetising the non-strategic and underutilised assets

• Postponing non-essential and non-urgent capital projects

However, a few days after this announcement on 7 March, CBSL permitted “greater flexibility in the exchange rate”. Although the CBSL indicated that it was of the view that transactions in the foreign exchange market should be conducted at not higher than Rs. 230 per US Dollar, by 11 March, the US Dollar was trading at Rs. 265/275.

This was partly due to confusion in the market with parallel announcements being made by the Cabinet regarding increasing the incentive payment to Rs. 38 per US Dollar from the current rate of Rs. 10 per US Dollar for repatriations by migrant workers. Maintaining the exchange rate at these levels would require further policy action while restoring the confidence of migrant workers to use formal channels for their remittances.

While the monetary policy tightening cycle has commenced more needs to be done as inflation and inflation expectations remain elevated. The last time inflation was at these levels in 2009, policy interest rates were at 10.50% (SDFR)/12.00% (SLFR) and the 91-day Treasury bill rate was close to 16%. Higher interest rates are also necessary to maintain the interest rate differential given the Federal Reserve Bank of the US has signalled it will continue to raise interest rates to address “surging inflation”. The difference between the current policy interest rates and market interest rates also provides an arbitrage opportunity for investors to make supernormal profits. This opportunity is higher given the large liquidity deficit in the overnight market, which stood at Rs. 704 billion as at 11 March 2022.

Tackling inflation also requires bringing down aggregate demand in the economy. Excessive money printing by CBSL has increased currency in circulation by Rs. 290 billion (59%) from end 2019 to end 2021. The large tax cuts in 2019 have left around Rs. 1 billion in the hands of individuals and businesses. In addition, although workers remittances did not come through formal channels, there was a thriving informal system known as the ‘Hawala’ or ‘Undiyal’ system, by which remittances came into the economy. The increase in cash in the economy has elevated demand for both domestic and imported commodities, thus exerting upward pressure on domestic prices and increasing demand for foreign exchange to support higher imports.

Suppressing imports, particularly of cars, has also left money in the hands of dealers. This excess money in the system is likely to have driven the boom in the stock market and pushed up land prices and the market for second-hand vehicles. The higher money supply in the economy has thus driven speculative activities rather than being channelled into growth-enhancing economic activities. Addressing the build-up of aggregate demand pressures requires, in addition to further tightening of monetary policy, raising taxes and curtailing the monetisation of the deficit through CBSL financing.

Further, the exchange rate should be the mechanism through which imports are discouraged and exports incentivised. Imports in 2021 increased by 28.5% from 2020. However, the increase from 2019 was only 3.5%. Further, the main increases were in medicines, fuel, textiles, base metals, machinery and equipment, and building materials.

Allowing the market mechanism to determine prices would be the most efficient way to ensure that goods get allocated to their highest use. This is particularly important in the case of fuel, which is priced significantly below cost. Interference in the market mechanism leads to shortages and the development of a black market. There are plenty of examples in the recent past that amply demonstrate the impact of administrative price controls on the availability and quality of goods in the market. In addition, controlling the price or supply of commodities leads to a transfer of “profit” to those who control the market while taxing consumers in terms of time and effort expended to source goods.

Sri Lanka faces twin problems of an internal imbalance with high domestic inflation and an external imbalance with external outflows well in excess of inflows (in other words, a deficit in the balance of payments). The root cause of the twin problems is the Government continuing to run fiscal deficits and financing these deficits through high-cost external borrowing and monetary expansion. Addressing these issues requires policy action on several fronts. However, first, a debt restructuring programme needs to be put in place to give the country some breathing space to stabilise the macroeconomy and to implement growth enhancing reforms. 

A comprehensive macroeconomic stabilisation programme and overall economic reform agenda will impact key economic variables; some desirable and some not so. Low-income groups will be particularly affected by these policy adjustments. Hence, attention needs to be paid to ensure an adequate safety net to protect the most vulnerable in society from the fall out of policy adjustments.

The current Samurdhi programme is woefully lacking in terms of adequacy and targeting. There needs to be a more comprehensive social protection scheme. The additional cost of the programme could be funded through savings from the fuel subsidy (which currently disproportionately benefits richer households), reversing the tax cuts and reallocating Government expenditure (1).

References

1. Tackling the COVID-19 economic crisis in Sri Lanka: Providing universal, lifecycle social protection transfers to protect lives and bolster economic recovery, UNICEF Sri Lanka Working Paper, June 2020

Dr. Roshan Perera, Senior Research Fellow, Advocata Institute and former Director, Central Bank of Sri Lanka.The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute, or anyone affiliated with the institute.

How can affordable electricity be assured 24x7?

Originally appeared on the Daily FT

By Prof. Rohan Samarajiva

The best way to understand the value of something is to experience life without it. These days, the Government is giving us a crash course on the value of reliable electricity supply. An unpleasant lesson, but nonetheless a learning opportunity.

If we probe the causes of load shedding, the learning can be deeper. Load shedding can be eliminated but at a cost. When hydropower declines due to periodic drought, the difference can be made up with generators running on imported fuel, the dollar price of which is determined by world market conditions. We can have 24x7 electricity, but not at an affordable price.

The Government created the immediate conditions for unreliable electricity supply through mismanagement of the country’s external debt. Today’s problems are not caused by delays in building additional generating capacity; they are caused by the lack of dollars to provide fuel for the existing generating plants. But there were deeper weaknesses in the organically developed system that must be understood.

With benchmark crude oil prices going over $ 100 per barrel, we must rethink our dependence on imported fossil fuels.

Reducing dependence on fossil fuels

Examination of the composition of our imports (Figure 1) shows that refined petroleum and crude oil taken together is the largest or second largest category of what is imported. It follows then that reducing the import of petroleum products would be an action that would satisfy many: those concerned about global warming will be made happy; those who want self-sufficiency would also be pleased. 

Petroleum imports are not used solely for electricity generation. But the way to reduce the consumption of petroleum products for transportation also involves electricity generated by renewables: buses and trains that are powered by electricity; lorries, cars, three-wheelers, and two-wheelers that are powered by electricity. Promoting electric vehicles makes no sense unless electricity comes from renewable sources. 

The significant increase in expenditure for fossil fuels starting in 2011 (Figure 2) appears correlated with the massive increase in the vehicle stock after the end of the conflict, leading to a doubling by 2014. Luckily, the biggest increase was in two wheelers, which do not take up a lot of road space and consume less fuel. 

Generating electricity from renewables does require some imported elements such as low-cost, efficient turbines and photo-voltaic panels but the costs and dependence is nowhere near that which exists with imported oil and natural gas. In fact, it may be possible even to export electricity at certain times of the day or even for months on end. But this will require substantial investment in the transmission grid.

Preconditions for increasing use of renewables

An economics commentator whose work I follow had expressed puzzlement at “demand for electricity is higher than supply” being given as a reason for load shedding. Others had expressed outrage at some Facebook posts that I had shared, which stated that solar and wind could not provide a complete solution to our energy woes. These responses by well-meaning and intelligent commentators made me realise the need for a better understanding of how the electricity is generated, transmitted, and distributed.

For all practical purposes using currently affordable technology, electricity must be treated as something that cannot be stored (but see discussion of pumped storage below). That means that it must be generated at the same time as people consume electricity by activating lights or appliances. Peak consumption in Sri Lanka (in the evening hours starting from around 6:30 p.m.) is around 2 or 2.5 times that of lowest use which is around 1000 MW. 

That necessitates a cheap source of baseload electricity that can be drawn upon throughout the day. In addition, we must have other sources that can be mobilised as demand increases. One would think that the major hydroelectric plants that have been built on the main rivers which generate cheap electricity that is unaffected by world market prices and the value of the rupee could serve as the source of baseload power. But there are constraints, such as competing demands from agriculture. The weather affects hydropower, as we are experiencing now. 

Therefore, planners in the past argued for coal as the ideal baseload for Sri Lanka. If Norochcholai does not keep breaking down and operates optimally, it can give 900 MW continuously whether or not the rains come. But it does break down, and it appears there have been irregularities in coal purchases. Coal, even if procured on long-term contracts at the lowest possible price, still must be paid for in dollars.

There are those who argue that Sri Lanka has plenty of wind and sun, and we can solve all problems by shifting to wind and sun. But the simple fact is that these are intermittent sources. Solar does not produce electricity when the sun does not shine and produces less when clouds cover the sun. Wind can produce throughout the day and night, but there are times when the wind dies down. It requires complex system controls to blend these intermittent sources into a centralised system designed for large, stable and controllable generators. 

Countries have incorporated massive amounts of intermittent renewable sources. In 2019, 47% of Denmark’s electricity came from wind. But they have a very sophisticated grid that is capable of handling intermittent power sources, and they use interconnections with other national systems to help balance the system. So, for example, when excess power is generated by the Danish wind turbines, it is used to pump water back up into reservoirs in Norway and Sweden (a method of storing electricity in the form of water known as pumped storage), which can then be run through turbines again to produce more electricity when needed. Yet with all that, Danish consumers pay more for electricity than their neighbours.

Similarly, if Sri Lanka is to increase the use of intermittent power sources, we will have to upgrade the grid and the system control centre’s software. Given the difficulties of synchronising the frequencies to one big plant such as Victoria, it may even be necessary to gradually convert the grid to direct current. If the Sri Lankan grid is connected via a high voltage direct current cable to the Southern Indian grid, the much larger combined system can absorb a greater amount of wind and solar power. 

Interconnecting does not mean that a country gives up on generating its own electricity. It simply means that marginal amounts of electricity will flow in either direction when it is advantageous to two (or more) systems. The fact that the peaks are different in the two systems can also be used to reduce the high costs incurred at peak.

It may be necessary to directly link revenues derived from regulated prices to those who make the substantial investments needed for the grid. This will almost necessarily require a restructuring of the current ungainly, unresponsive, and money-losing CEB in a manner that allows the transmission unit to be run efficiently. 

All these options require careful study in terms of costs, benefits and energy security. The relations between Denmark and its neighbours are such that all the parties can be confident about the contracts being respected and any disputes that arise being settled in a fair manner. We must ensure that the interconnection agreements with India have all these safeguards. The precedent of India’s interconnections with Bhutan shows that mutual interdependence is achievable in South Asia. The experience in Europe where interconnection, including over long distances across water, is growing rapidly even after Brexit, will have to be studied. 

Rohan Samarajiva is founding Chair of LIRNEasia, an ICT policy and regulation think tank active across emerging Asia and the Pacific. He was CEO from 2004 to 2012. He is also an advisor to the Advocata Institute.

Special Goods and Services Tax: Issues and Concerns

Originally appeared on Ceylon Today, Daily FT, The Island

By Dr Roshan Perera & Naqiya Shiraz

I. Background

The new bill titled ‘Special Goods and Services Tax’ was published by gazette dated 07 January 2022. (1) The Special Goods and Services Tax (SGST) was originally proposed in Budget speech 2021 but was not implemented. It has once again been presented in Budget 2022. The SGST aims to consolidate taxes on manufacturing and importing cigarettes, liquor, vehicles and assembly parts, while also consolidating taxes on telecommunication and betting and gaming (see table 1 for existing taxes on these products and table 2 for taxes consolidated into the SGST as per the schedule in the gazette). The rationale for this new tax as per the bill is “...to promote self-compliance in the payment of taxes in order to ensure greater efficiency in relation to the collection and administration on such taxes by avoiding the complexities associated with the application and administration of a multiple tax regime on specified goods and services.”

Given the multiplicity of taxes and the complexity of the current tax system as a whole, rationalising taxes is necessary to improve collection. However, whether the proposed SGST simplifies the tax system while ensuring revenue neutrality or even improving revenue collection, needs to be carefully examined.

The SGST Bill is silent on the treatment of the existing VAT on these goods and services. However, according to the Value Added Tax (Amendment) Bill also gazetted on 07 January 2022,(2) liquor, cigarettes and motor vehicles will be exempted from VAT while telecommunications and betting and gaming services will still be subject to VAT. 

While the gazetted Bill sets out some of the features of the proposed SGST there are many important areas not covered in the Bill.  These are expected to be gazetted as and when required by the Minister in charge. 

II. Issues & Concerns

The motivation behind SGST is the simplification of the tax system. Although the objective of introducing the SGST is to improve efficiency by reducing the complexity of the tax system there are many issues and concerns with this proposed tax.

1. Revenue

Tax revenue which was 13% of GDP in 2010, declined to 8% in 2020.  Ad hoc policy changes and weak administration contributed to the decline in tax revenue collection.  This continuous decline in tax revenue has led to widening fiscal deficits and increasing debt. One of the main reasons for the current macroeconomic crisis is low tax revenue collection. Hence, any change to the existing tax system should be with the primary objective of raising more revenue.  

According to the budget speech the SGST is estimated to bring in an additional Rs. 50 billion in revenue in 2022. (3) Revenue from taxes proposed to be consolidated under the SGST has significantly declined over the past 3 years. Given the already difficult macroeconomic environment, along with ad hoc tax policy changes raising the additional revenue estimated at Rs. 50 billion seems a difficult task. 

2. Tax Base and Rate

For the SGST to raise taxes in excess of what is already being collected through the existing taxes, the rate and the base for the SGST needs to be carefully and methodically calculated. Further, the existing taxes have different bases of taxation. For instance the basis of taxation of motor vehicles is both on an ad valorem (4) basis and a quantity basis while the basis of taxation of cigarettes and liquor is quantity. (5) In light of this, the basis of taxation on which SGST is applied becomes an issue. Having different bases and different rates for various goods and services would complicate the implementation of the tax These issues need to be carefully considered to ensure the new tax is revenue neutral or be able to enhance revenue collection.

3. Efficiency

One possible revenue benefit of this proposal is the inability to claim input tax credits on the sectors exempted from VAT. However, the issue is the cascading effect that would result where there would be a tax on tax with the end consumer paying taxes on already paid taxes. If the idea was to raise additional revenue by limiting tax credits, it would have been simpler to raise the tax rates on the existing taxes rather than introduce a new tax. 

4. Administration

According to the bill, SGST  will now be collected through a new unit set up under the General Treasury where a Designated Officer (DO) will be in charge of the administration, collection and accountability of the tax. The existing revenue collection agencies, such as the Inland Revenue Department (IRD) or the Excise Department will not be primarily responsible for the collection of this tax. By removing the  IRD and Excise Department, a parallel bureaucracy will be created, at a time when public spending needs to be carefully managed. The General Treasury also has no previous experience and expertise in direct revenue collection. Weak administration is one of the key reasons for the low tax collection and success of this tax would depend on the strength of its administration. 

In addition to the above-mentioned concerns, as per the Bill the minister in charge of the SGST has been vested with the power to set the rates, the base and grant exemptions. Accordingly, Parliamentary oversight over fiscal matters is weakened under this proposed Bill. 

It could also lead to a time lag between the gazetting and implementing of changes to the SGST (such as the rate, base etc) and obtaining Parliamentary approval for those changes.

5. Dispute resolution 

The SGST Bill also focuses on the dispute resolution mechanism. Under the present tax system,  with the enactment of the Tax Appeals Commission Act, No. 23 in 2011 the Tax Appeals Commission has the “responsibility of hearing all appeals in respect of matters relating to imposition of any tax, levy or duty”.(6) The most recent amendment to the Tax Appeal Commissions act (2013) (7)  seeks to address the large number (495) of cases pending before the Tax Appeals Commission (8) by increasing the number of panels to hear the appeals. 

Under the proposed SGST disputes will be handled through the court of appeal. However, the time period by which specific actions need to be taken is not provided in the bill. In addition, disputes have to be taken to the court of appeal.  Hence, the entire process will be more time consuming. This could result in revenue lags and difficulties in revenue estimation until disputes are resolved.

Additionally, in the case that no valid appeal has been lodged within 14 days, any remaining payments would be considered to be in default. Thereafter, the responsibility is shifted to the Commissioner-General of the IRD to recover the dues. Given the IRD is completely removed from the normal collection process, the rationale for bringing defaults under the IRD is not clear.

III. Policy Recommendations

As discussed, the SGST Bill has several limitations and much of this is due to the ambiguities in the Bill.  

• If the tax is implemented, the rate and basis of taxation need to be revenue-neutral to ensure tax collection is maximised and administrative costs minimised.

• The rates, basis of taxation, exemptions etc should be specified in the Bill, as done in most other Acts. This would avoid the power for discretionary changes to the tax being placed in the hands of the minister in charge. 

• Given the already weak tax administration, it would be more sensible to strengthen the existing revenue collecting agencies and address the weaknesses in the existing system without creating a parallel bureaucracy.

• In the case where VAT is consolidated into the proposed GST, the issue of cascading effect of input tax credits needs to be addressed. This is relevant particularly in the case of capital expenditure. 

Given the critical state of revenue collection in the country, the question to ask is whether this is the best time to introduce a new tax. Focus should be on fixing issues in the existing tax system to ensure revenue is maximised.  The VAT is the least distortionary tax and it is the easiest to administer. Given these features, it can be a very efficient revenue generator for a country. Therefore instead of introducing a new tax, capitalising on systems that are already in place and amending the VAT rate, threshold and exemptions may be a more practical solution to the revenue problem that the country is currently facing. 

Dr. Roshan Perera, Senior Research Fellow, Advocata Institute and former Director, Central Bank of Sri Lanka.

Naqiya Shiraz is a Research Analyst at the Advocata Institute.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute, or anyone affiliated with the institute.

References:

1. http://documents.gov.lk/files/bill/2022/1/162-2022_E.pdf

2. http://documents.gov.lk/files/bill/2022/1/163-2022_E.pdf

3. https://www.treasury.gov.lk/api/file/0c3639d9-cb0a-4f9d-b4f9-5571c2d16a8b

4. A value based tax base of ad-valorem refers to a rate of tax, where revenue will increase if the value of tax base increases. 
   A quantity based tax base is a tax imposed on a per unit quantity of the product.

5. https://www.treasury.gov.lk/api/file/304e2f2f-f215-40ad-b613-4d7cc3427178

6. https://www.treasury.gov.lk/api/file/4028b5a0-f166-4f1d-a076-299e32200212
   http://www.cabinetoffice.gov.lk/cab/index.php?option=com_content&view=article&id=16&Itemid=49&lang=en&dID=10210

Sri Lanka Railway railed with strikes and losses; Time to reform?

Originally appeared on The Morning.

By Anuka Ratnayake and Aaditha Edirisinghe

On 13 January 2022, the Station Masters’ Union launched a 24-hour token strike cancelling over 200 scheduled trips. As a result, commuters heading back home from Colombo, long distance travellers, tourists (both local and foreign) were all inconvenienced and left stranded in stations partway through their journey. Angry commuters attacked the train bound to Batticaloa when it passed the Kekirawa Station. This public outrage at the services provided by Sri Lanka Railway (SLR) is nothing new. However, little has been done to reform or restructure amidst public disappointment and escalating losses.

Why should the Railway be reformed? 

Operating as a Government institution under the Ministry of Transport, SLR is the country’s primary alternative mode of public transport to the often congested road network. Underpricing of railway fares along with systemic issues including mismanagement and poor governance have led to recurring annual losses. Despite budgetary support, the railway has recorded an accumulated loss of Rs. 46.7 billion in the years 2015-20. 

As with many transportation networks globally, the impact of Covid-19 has made SLR’s financial position increasingly precarious; with revenues down, losses amounted to over Rs.10 billion in 2020 alone. The widening chasm between the revenue raised and expenditure incurred, stood at a staggering Rs. 22 billion in 2018, as per official records. This has led to the dependence on Government bailouts. The Treasury spent a grand total of Rs. 48.7 billion in 2020, of which around Rs. 14 billion was for recurrent expenditure such as salaries, subsidies and grants. 

Sri Lanka Railway has an exceedingly large workforce with very active trade unions and an extensive bureaucracy. According to the official statistics of 2019, SLR has 14,207 employees. The total personal emoluments incurred for the same year was Rs. 9.8 billion, which was up by Rs. 809 million compared to 2018.

Due to the overstaffing issue, work duplication is often seen at SLR and is a serious issue affecting efficiency. Union actions are a burden on the operations of SLR, as observed during the last week of December 2021 and on 13 January 2022. 

In an interview conducted in January 2022, the Station Masters’ Association Chairman Sumedha Someratne claimed that as a result of the strikes in December, SLR incurred a loss as high as Rs. 20 million per day although the Railway General Manager quoted a much lower figure. 

A major reason for SLR’s budgetary reliance is the lack of cost reflective pricing. As of now, for a trip between 51-100 km, the fare per kilometre is around Rs. 3.30 for first class seats and Rs. 1 for third class seats. This underpricing has led to a reduction in the availability of funds to cover operational costs, resulting in the lack of finance for maintenance and repairs; by 2017, 65% of SLR’s locomotives were over 30 years old. 

The Urban Transport Master Plan 2014 identified several irregularities of the condition of the railway. A few noteworthy issues were the malfunctionings in the signalling system along with the deformation of rails and irregularities in alignment, which caused delays and sudden cancellation of trains. This poses a threat to passenger safety and is increasingly dangerous during inclement weather conditions. 

Reform recommendations 

Given that Sri Lanka is facing an economic crisis, the treasury cannot afford to shield SLR from the adverse repercussions of its inefficient operations. Immediate reforms are needed to get SLR back on track. 

Since most of SLR’s issues stem from its inability to raise sufficient revenues, the implementation of a cost-reflective fare structure should be prioritised. However, standing in the way of such price reform are the cheap fares of public bus service, the primary substitute to rail transport.

Therefore, for the price revision to be viable SLR should look into improving the quality of service to justify higher prices while reducing costs to be more competitive. 

Furthermore, to offset some costs SLR can focus on the profitable use of its vast asset base, such as its 13,000 acres of land which can be capitalised for this purpose. In 2017, it was reported that nearly 15% of land owned by SLR was leased to 6,400 users. Yet it has been unable to collect Rs. 1.46 billion in lease revenue from the users of the land owned by the department. Better management of real estate would bring in massive revenues to the Railway Department, which can be used to finance repairs and maintenance. 

Moreover, the Railway Department can focus on improving freight transportation, a lucrative and profitable source of revenue generation. According to the Asian Development Bank, by 2017, the freight transportation service market share of Sri Lanka Railway had eroded to less than 1%. The lack of necessary transportation and containerisation equipment limits the freight business to goods such as cement and petroleum. In the interest of expanding the freight service with the available resources; tracks which are reserved for passenger transportation during the daytime can be utilised under a night schedule. 

Furthermore, portions of SLR’s underutilised land can be used profitably for freight-related logistics services which will also bring in much-needed revenue to the loss-making institution.  

To bridge the prevailing investment gap at SLR, public private partnerships (PPPs) should be encouraged for operations and maintenance. A major bottleneck in SLR’s ability to deliver a consistent service is the outdated and malfunctioning infrastructure it owns, such as signalling and tracks. Investments in this respect will allow SLR to provide the public a consistent service while accumulating a sustained influx of cash. 

Colossal losses of state-owned institutions such as the Sri Lanka Railway is a burden on the state coffers, and ultimately the taxpayer. The Government’s increasing reliance on debt to keep such institutions afloat is compromising the economic future of Sri Lanka. Thus it is the need of the hour to begin reforming and restructuring potential cash cows such as Sri Lanka Railway. If reformed, Sri Lanka Railway would undoubtedly be a pillar of Sri Lanka’s transport infrastructure, contributing to the overall productivity of the economy.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute, or anyone affiliated with the institute.

Repay Foreign Debt or Finance Essential Imports

Originally appeared on Daily FT, Lanka Business Online and Groundviews

By Dr Roshan Perera and Dr. Sarath Rajapatirana

The available foreign reserves of the country can be used to either repay foreign creditors or to finance imports of essential goods and services required by its citizens. This is the dilemma facing Sri Lanka today. Repaying the full value of the bond using the limited foreign reserves available would provide a windfall gain to those currently holding these bonds. But it will be at great cost to the citizens of the country who will face shortages of essentials like food, medicine, and fuel. 

In these circumstances, it is in the best interest of all its citizens, for the government to defer payment of the US dollar 500 million International Sovereign Bond (ISB) coming due on 18 January 2022, until the economy can fully recover and rebuild. 

Just as an individual with co-morbidities is more vulnerable to develop severe illness if infected with COVID-19 and more to likely require hospitalisation and even treatment in an ICU, Sri Lanka was vulnerable to economic shocks long before COVID-19 struck. The country was already facing several macroeconomic challenges. Muted economic growth. An untenable fiscal position. Although a tough consolidation programme was put in place to bring government finances to a more sustainable path, sweeping tax changes implemented at the end of 2019 reversed this process, with adverse consequences to government revenue collection. Weak external sector due to high foreign debt repayments and inadequate foreign reserves to service these debts. COVID-19 only exacerbated these macroeconomic challenges. And like a patient who gets over the worst of COVID-19 has a long road to recovery; the economy of Sri Lanka faces many challenges to get back on track. 

The onset of COVID-19 in early 2020, only worsened an already grim macroeconomic situation. The country lost the confidence of international markets, and the ability of the sovereign to rollover its external debt became difficult if not impossible. In these circumstances, there was a solid argument for a sovereign debt restructuring. But the response from the government and the Central Bank of Sri Lanka (CBSL) was a firm “No”. The argument was that Sri Lanka never defaulted on its debt and it was not going to do so now. The official position was also that the government had a ‘plan’ to repay its debt and hence there was no reason to engage in a debt restructuring exercise. However, Sri Lanka faced high debt sustainability risks: the debt to GDP ratio at 110% was one of the highest historically and interest payments to government revenue at over 70% was one of the highest in the world. 

Table 1: Summary of External Sector Performance Q1 – 2017 to 2021 ($mn)

Therefore, it is in the best interest of the country and its citizens for the government to defer payment on its debt and use its limited foreign reserves to ensure uninterrupted supply of essential imports. But this requires a plan. To minimise the cost to the economy, the government must immediately engage its creditors in a debt restructuring exercise. This will require a debt sustainability analysis (DSA) by a credible agency to identify the resources required for debt relief and the economic adjustment needed to put the country back on a sustainable path. This will be critical to bring creditors to the negotiating table and provide them comfort that the country is able and willing to repay its debt obligations in the future. 

The cost of not restructuring is much higher. A non-negotiated default (if and when the country runs out of options to service its debt) would lead to a greater loss of output, loss of access to financing or high cost of future borrowing for the sovereign. It could even spill over to the domestic banking sector, triggering a banking or financial crisis. 

The consequences are clear. What will we choose?

Dr. Roshan Perera, Senior Research Fellow, Advocata Institute and former Director, Central Bank of Sri Lanka.

Dr. Sarath Rajapatirana, Chair, Academic Programme, Advocata Institute and former Economic Adviser at the World Bank. He was the Director and the main author of the 1987 World Development Report on Trade and Industrialisation.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute, or anyone affiliated with the institute.

National Single Window: Paving the way for paperless trade

Originally appeared on Daily FT, The Morning, the Island, and Lanka Business Online

By Mithara Fonseka and Kavishka Indraratna

In 2016, Sri Lanka ratified its Trade Facilitation Agreement (TFA) with the WTO and in 2017 a Secretariat was established for the National Trade Facilitation Committee to drive much needed trade reforms in the country. Currently, the rate of Sri Lanka’s implementation commitments under TFA stands at 34.9% with a timeframe ranging from 2017-2030. Reforms include the Trade Information Portal, streamlining customs processes and revamping the systems for post-clearance audit. However, progress of one of the key reforms, the National Single Window (NSW), has been stalled. Deviating from the initial time frame of completing the Single Window in December 2022, the target date has been delayed to 2030. The NSW, a globally recognised trading portal, acts as a one-stop shop for exporters and importers where customs documents, permits, registrations and other information can be submitted online at once. The definition of a Single Window, as provided by the UN/CEFACT Recommendation No. 33, is as follows: “A Single Window is defined as a facility that allows parties involved in trade and transport to lodge standardized information and documents with a single entry point to fulfil all import, export, and transit-related regulatory requirements. If information is electronic, then individual data elements should only be submitted once”. Putting such a reform on the back-burner will only delay Sri Lanka’s transition to a system of streamlined, paperless trade processes and therefore acts as an impediment to local and foreign investment.

Why should Sri Lanka implement a NSW?
Sri Lanka has been underperforming in global trade rankings, where we sometimes rank in the bottom 50 countries. According to the Ease of Doing Business in 2020, in the trading across borders pillar, Sri Lanka ranks 96 out of 190 economies. While several of Sri Lanka’s indicators perform better than the South Asian average, there is significant room for improvement. When comparing with OECD standards, Sri Lanka takes 72 hours for border compliance regarding imports and 48 hours for export documentary compliance whereas the OECD average stands at 8.5 and 2.3 hours respectively. Lengthy customs procedures and multiple inspections impede efficiency. Meanwhile, we ranked 94 out of 160 countries under World’s Bank 2018 Logistics Performance index and 103 out of 136 for the World Economic Forum’s 2016 Enabling Trade index. Notably, one of the indicators from the Enabling Trade Index, the customs services index, which considers factors such as clearance of shipments via electronic data interchange and the separation of physical release of goods from fiscal control, we rank 116 out of 117 countries. A lack of transparency, inter-agency coordination and lengthy cumbersome processes contribute to Sri Lanka’s poor trade environment. An average trade transaction can involve over 30 different agencies and upto 200 data elements, a lot of which have to be repeated. There is thus an evident need to streamline trade processes through digitisation, creating a business friendly environment that supports small businesses as well as foreign investors.

A Background into the National Single Window

In 1989, the Government of Singapore introduced the world’s first NSW, known as Tradenet. It took two years for the model to become operational and has now become one of the most advanced models in the world. Since then, many countries have adopted similar models and a NSW has become a critical tool in facilitating efficient and paperless trade. The annual survey conducted by The United Nations on trade facilitation identified that almost 74% of countries surveyed in the Asia Pacific region have to some extent engaged in creating a NSW (this includes countries which are only in the pilot stage). While a NSW is universally known for promoting the transition from paper-based to electronic customs processing, each window developed by a country is unique and varies according to the context of the country. For example, in Chile and Malaysia, the NSW enables traders to submit their export and import declarations, manifests and their trade-related documents to customs authorities electronically. In Korea and Hong Kong, private sector participants including banks, customs brokers, insurance companies and freight forwarders are also connected through the portal.

Single entry, single submission, standardized documents and data, sharing of information (information dissemination), centralised risk management, coordination of agencies and stakeholders, analytical capability and electronic payment facilities are some of the key functions included in a Single Window. In Sri Lanka, the World Bank did several studies on the NSW, identifying different operational models, best practices and a final blueprint document was given to the government and Sri Lanka Customs (SLC) in July 2019. However, since then, there has been no news of progress. While many countries including Sri Lanka are keen to emulate Singapore’s pioneering model, a lack of clear targets and timelines deteriorate the chances of implementing such a system.

The Mutual Benefits of a NSW

Businesses in countries without an integrated trade system find it difficult to compete in the international arena given the time and money spent to simply get clearance. Streamlining the entire process from start to finish in a manner that’s comprehensive and transparent, sans bureaucracy has a number of positive effects for traders. It was estimated that Singapore’s TradeNet saved its traders around US$1 billion per year. Korea’s uTradeHub allowed its business community to save approximately US$ 818.9 million. These were savings from the use of e-documents, automated administrative work and information storage and retrieval with the use of ICT. A Single Window automatically simplifies the compliance requirements traders face. In Mozambique traders benefited from faster clearance times, where through the NSW, the time was reduced from 3 days to a few hours. Meanwhile, Thailand’s NSW transformed the customs clearance turnaround time (measured as per declaration) to 95% in 5 minutes. Using a single portal has enabled traders to avoid visiting multiple agencies and simply submit an application at their convenience from any location. NSW has supported businesses through the removal of unnecessary costs, time and red tape, factors which tend to act as key deterrents to small businesses as well as foreign enterprises. 

The NSW system has similarly provided noteworthy cost-savings for government entities involved in trade. Singapore Customs, has claimed that for every US$1 earned in customs revenue, it only spends 1 cent, implying a profit margin of 9,900%.  In Hong Kong, trade facilitation measures have provided them with HK$1.3 billion in annual savings. The NSW has also reduced revenue leakages which may arise through transit. For example, Mozambique is a transit country to Swaziland, South Africa, Zimbabwe, Zambia and Malawi. By expanding their NSW to include value added services such as GPS tracking of consignments in transit, automatic detection of breaches in consignment and deviation from assigned transit corridors the NSW prevents revenue leakages and the opportunity for corruption, maximising revenue collection. The NSW has further led to productivity and efficiency improvements. A Single Window has enabled authorities to handle a larger volume of applications with much more ease. Mozambique, which used to face infrastructural weaknesses, through the implementation of its single window, is able to handle roughly 1,500 custom declarations per day.  Shifting to paperless customs processes would reduce costs for inventory and assist in improved resource allocation as personnel would not be required for trivial and mundane tasks such as preparation and cross checking of numerous documents. In totality, a fully digitised system provides government agencies with the means to do away with inefficiencies that hold back the speed of document processing, approval, communication and inspection stages. Further contributing to efficency, a NSW has also facilitated the dissemination of data through multiple agencies ranging from border control authorities, freight forwarders, customs brokers, shipping agents, banks and so on. As a result, there is improved inter-agency coordination and increased transparency.

Apart from a substantial increase in government revenue, the NSW will contribute to an improved business environment in Sri Lanka. The domino effects include an upward movement in the country’s global rankings, incentives for FDI and local business as well as a global recognition. 

Driving forces for implementation

While the NSW on the surface seems like an IT-based innovation, it is rather a platform for inter-agency and private sector collaboration. As the NSW is a system which requires involvement from government, the private sector and the transport community, it is crucial to ensure inter-agency collaboration. Ensuring public-private sector participation, introducing mandates and a steering committee to oversee implementation is crucial in developing such a system. The system as a whole is one that constantly evolves with no end stage. It requires continuous maintenance, support, and enhancement. This should be supplemented by the appropriate legislation, disclosure and publishing, backed by training and airtight data security policies. Thus governance of the NSW needs to be executed appropriately so that new technologies, techniques and new modes of trade can be leveraged. In best performing nations, a Single Window is not considered a single system but rather “a combination of trade-related platforms that serve various trade communities and modalities”. This has enabled leading countries such as Singapore and Hong Kong to facilitate seamless trade by building an environment of interoperable trade systems.

1. WTO, Trade facilitation Agreement Database, https://tfadatabase.org/members/sri-lanka , Accessed January 6, 2022.

2. WTO, Trade facilitation Agreement Database,10.4-Single Window, https://tfadatabase.org/members/sri-lanka/technical-assistance-projects/article-10-4

3. United Nations, UN/CEFACT, ‘Recommendation and Guidelines on establishing a Single Window: to enhance the efficient exchange of information between trade and government, Recommendation No.33, (2005), https://unece.org/fileadmin/DAM/cefact/recommendations/rec33/rec33_trd352e.pdf Accessed January 6, 2022.

4. World Bank Group, ‘Doing Business 2020’, Economy Profile Sri Lanka, Comparing Business Regulation in 190 Economies,(2020), https://www.doingbusiness.org/content/dam/doingBusiness/country/s/sri-lanka/LKA.pdf Accessed January 6, 2022.

5. World Bank Group, ‘Doing Business 2020’, Economy Profile Sri Lanka, Comparing Business Regulation in 190 Economies,(2020), https://www.doingbusiness.org/content/dam/doingBusiness/country/s/sri-lanka/LKA.pdf Accessed January 6, 2022.

6. World Bank Group, ‘Logistics Performance Index 2018’, (2018), https://lpi.worldbank.org/international/scorecard/radar/254/C/LKA/2018#chartarea Accessed January 6, 2022.

7. World Economic Forum,’The Global Enabling Trade Report 2016, Enabling Trade Rankings’, (2016) https://reports.weforum.org/global-enabling-trade-report-2016/enabling-trade-rankings/#series=CUSTSERVIND

8. World Economic Forum, ‘Enabling Trade Index 2016’, (2016) https://www3.weforum.org/docs/WEF_GETR_2016_report.pdf Accessed January 6, 2022.

9. World Economic Forum, ‘The Global Enabling Trade Report 2016, Enabling Trade Rankings’, https://reports.weforum.org/global-enabling-trade-report-2016/enabling-trade-rankings/#series=CUSTSERVIND Accessed January 6, 2022.

10. Johns, M. “Trade facilitation reform in Sri Lanka can drive a change in culture”, World Bank Blogs, 2017

    https://blogs.worldbank.org/endpovertyinsouthasia/trade-facilitation-reform-sri-lanka-can-drive-change-culture Accessed January 6, 2022.

11. UN ESCAP,’Digital and Sustainable Trade Facilitation in Asia and the Pacific 2021’, (2021)
      https://www.unescap.org/sites/default/d8files/knowledge-products/UNTF%20Report.pdf Accessed January 6, 2022.

12. UN ESCAP,’Single Window Planning and Implementation Guide’,

    https://www.unescap.org/sites/default/d8files/5%20-%201.%20Introduction_0.pdf Accessed January 6, 2022.

13. UN ESCAP, ’Single Window Planning and Implementation Guide’

     https://www.unescap.org/sites/default/d8files/5%20-%201.%20Introduction_0.pdf Accessed January 6, 2022.

14. UN ESCAP, ‘Single Window for Trade Facilitation: Regional Best Practices and Future Development’ https://www.unescap.org/sites/default/files/Regional%20Best%20Practices%20of%20Single%20Windows_updated.pdf, Accessed January 6, 2022.

15.  UNECE, ‘Trade Facilitation Implementation Guide, Singapore case study’, https://unece.org/fileadmin/DAM/cefact/single_window/sw_cases/Download/Singapore.pdf Accessed January 6, 2022.

16. United Nations ESCAP, ‘Single Window Implementation: Benefits and Key Success Factors’, (2012), https://unnext.unescap.org/sites/default/files/switajik-sangwon.pdf Accessed January 6, 2022.

17. UNECE, ‘Trade Facilitation Guide, Single Window Implementation in Mozambique’,
    https://tfig.unece.org/cases/Mozambique.pdf Accessed January 6, 2022.

18. UNECE,Trade Facilitation Implementation Guide, Interagency Collaboration for Single Window    Implementation:Thailand’s Experience, https://tfig.unece.org/cases/Thailand.pdf Accessed January 6, 2022.

19. United Nations, Single Window Planning and Implementation Guide, (2012) https://www.unescap.org/sites/default/files/0%20-%20Full%20Report_5.pdf Accessed January 6, 2022.

20. United Nations, ESCAP, Single Window Implementation: Benefits and Key Success Factors

     https://unnext.unescap.org/sites/default/files/switajik-sangwon.pdf Accessed January 6, 2022.

21. UNECE, ‘Trade Facilitation Guide, Single Window Implementation in Mozambique’,   
        https://tfig.unece.org/cases/Mozambique.pdf Accessed January 6, 2022.

22. United Nations, ESCAP, Single Window for Trade Facilitation:Regional Best Practices and Future  
    Development, (2018),  https://www.unescap.org/sites/default/files/Regional%20Best%20Practices%20of%20Single%20Windows_updated.pdf Accessed January 6, 2022.
    

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute, or anyone affiliated with the institute.

State-owned enterprises: A major crisis in the making

Originally appeared on Daily FT, The Island, Ada Derana Biz, Ground Views and The Morning

By Migara Rodrigo

Sri Lankan State-Owned Enterprises: A Major Crisis in the Making

Sri Lanka has a whopping 527 state-owned enterprises (1) (SOEs). The 55 SOEs classified as “strategically important” alone employ 10% of the public sector workforce (2) or about 1.9% of all workers. Such a large number of SOEs are not the norm globally(3); many other countries (such as India) have been reducing their stakes in SOEs and, in some cases (e.g. Air India), have been privatizing them entirely. SOEs - particularly many in Sri Lanka - tend to be grossly inefficient, loss-making, and a burden on the taxpayer. The time is ripe for major SOE reforms. 

What is an SOE?

An SOE is traditionally defined as a commercial entity that has majority ownership/control by a nation’s government – in Sri Lanka, this can include statutory bodies, regulatory agencies, promotional institutions, educational institutions, public and limited companies. While Sri Lankan SOEs have traditionally been incorporated by an Act of Parliament, in recent years these entities have also been incorporated under the Companies Act instead. 

Sri Lankan SOEs can be divided into three categories: 55 Strategic SOEs, 287 SOEs with commercial interests, and 185 SOEs with non-commercial interests. Unlike nations such as India which mandate internal audits of their SOE’s business activities and publish an annual overview with a balance sheet of each individual business, the majority of Sri Lankan SOEs do not reveal this pertinent information to the public; financial information is available for just 10.4% of SOEs. 

Fundamental problems with Sri Lankan SOEs

Contrary to what some believe, low quality of talent is not the most significant issue with SOEs; many employees are eminently qualified and capable. Unfortunately, these organisations fall victim to government mismanagement and corruption. In addition to excessive employment to fulfil their political ambitions, there have been allegations that some SOEs have been formed purely to facilitate corruption – for example, the Lanka Coal Company engaged in fraudulent deals to purchase coal causing a loss of over Rs. 4 billion (allegedly with the knowledge of the minister in charge)(4). 

SOE financials are late and few obtain ‘clean’ audit reports. Investigations have revealed repeated instances of fraud, mismanagement, corruption and negligence. Furthermore, the internal control, monitoring and governance frameworks seem inadequate to deal with these problems – of over 500 SOEs, regular information is only available for 55. Even obtaining a complete list of entities proved to be a challenge. Public access to information is limited – the Department of Public Enterprises has not released an annual report since 2018, and right-to-information requests often go unanswered.

Figure 1 Source: Ginting, Edimon et al, 2020, Reforms, Opportunities, and Challenges for State-Owned Enterprises, Asian Development Bank

Moreover, SOEs have few budget constraints and shareholder (public) accountability and therefore have limited incentive to control costs. Unlike with private sector enterprises, which have a need to make a profit, many SOEs (particularly in Sri Lanka) can simply borrow from other state organisations/banks or the government when they require additional funds, which undermines the threat of bankruptcy as a source of discipline(5). Some recently established SOEs have found a new way of bypassing budgets and oversight: by incorporating as companies rather than through an act of Parliament, they are excluded from Parliamentary accountability and allowed to rack up unsustainable debts and surpass budgets more easily. This has led to SOEs burning through taxpayer rupees: the cumulative losses of the 55 strategic SOEs from 2006-20 amounts to Rs. 1.2 trillion.

Finally, while some SOEs do manage to make a profit this is, more often than not, due to the advantage that these companies have in an uneven playing field. In addition to lax budgetary requirements and the ability to rack up unsustainable debts, these companies are supported by the government through direct subsidies and state-backed guarantees; by regulators through exemptions from antitrust policies and preferential treatment; and by the justice system through an ability to sidestep parliament. This has led to private sector organisations being crowded out of the industries that SOEs operate in. Instead of having private firms in the marketplace with efficient and high-quality services, the Sri Lankan taxpayer is beset with SOEs with total liabilities of 4-5% of GDP(6).

Potential reforms 

Given that the nation has reached an economic tipping point, with serious questions about debt sustainability and government solvency, it is clear that immediate action must be taken. Advocata proposes a short-term policy solution consisting of privatisation, restructuring and disinvestment, and listing on the Colombo Stock Exchange. None of these solutions are particularly radical in the global or local context. According to Lankan Angel Network Director Anarkali Moonesinghe, the two main policies of both Western and Eastern governments when reforming SOEs are to reduce subsidies and increase efficiency, forcing SOEs to compete more equitably with private enterprises.

Alternatively, full or partial privatisation is a possible solution: SLT-Mobitel’s service has markedly improved following its 1997 privatisation and the entrance of competitors such as Dialog Axiata, all held accountable by the broadly competent Telecommunications Regulatory Commission. Listing on the CSE would allow these firms to have broad-based direct ownership, while also improving the growth of the CSE and capital markets. Importantly, these firms would have to be ‘corporatised’ before listing, an opportunity to improve productivity and eliminate bloat. 

There are, unfortunately, firms that will essentially have to be given away due to their huge debts and poor reputations. A prime example of this is SriLankan Airlines, which has racked up Rs. 316 billion in losses (7) since control was taken from Emirates in 2008. While some will regard this as a blow to our national pride, Sri Lanka would not be alone in taking such a pragmatic step to improve government finances and customer experience; Air India, the Indian national carrier, is currently in the process of being sold to the Tata Group for the relatively small sum of INR 18,000 crore. This would also inspire confidence in Sri Lanka amongst foreign investors as it would show the country’s commitment to meeting its upcoming debt servicing obligations.

Furthermore, long-term solutions include strengthening governance/limiting corruption and influence, improving efficiency, enacting cost-reflective pricing, and finally unbundling key sectors. This applies particularly to firms like the Ceylon Electricity Board which, as a natural monopoly, cannot be broken up and privatised without losing efficiency. A 2006 study by the Japan International Cooperation Agency recommended breaking up CEB into three parts: “making the generation, transmission, and distribution divisions…independent” (8). Despite the 15 years and multiple nationwide blackouts that have occurred since, GoSL continues to drag their feet on the issue, as it is politically unpopular. 

Cost-reflective pricing (also prevented due to political unpopularity) is another essential reform. The existing system of having electricity tariffs priced below cost is a public subsidy whose cost will be borne by future generations. It is also inequitable, as the Government could provide low-cost services to those who need it by giving them direct cash transfers, instead of subsidising the wealthy who can afford to pay. A similar situation is evident with the Ceylon Petroleum Corporation, which currently makes a loss of Rs. 23-38 per litre of fuel (9); again, a public subsidy to those who can often afford to pay the market price. Finally, greater accountability, by means of annual internal audits and the availability of SOEs’ financial information to the public, is also important to ensure these firms stick to the targets they are given.

A successful and thriving market, in most industries, will only occur with the presence of three crucial factors: competition, a good framework, and competent regulation. By reforming Sri Lanka’s SOEs to meet these criteria, we will ensure a good customer experience, a reduction in the government deficit, and general prosperity for all key stakeholders. 

References:

1 Ratnsabapathy, Ravi et al, 2019, The State of State Enterprises in Sri Lanka, Advocata Institute

2 Dissanayake, Imesha, 2021, SOE Reforms; the Impetus for Post Pandemic Economic Revival, Ceylon Chamber of Commerce

3 Büge, Max et al, State-owned enterprises in the global economy: Reason for concern? Last modified: May 2nd, 2013 

4 ColomboPage.com, President to take action against removal of head of Lanka Coal Company, Last modified: January 21st, 2017, http://www.colombopage.com/archive_17A/Jan21_1484983651CH.php

5 Ratnsabapathy, et al, The State of State Enterprises in Sri Lanka

6 WorldBank.org, South Asia Must Reform Debt-Accumulating State-Owned Banks and Enterprises to Avert Next Financial Crisis, Last modified: June 29th, 2021, https://www.worldbank.org/en/news/press-release/2021/06/24/south-asia-must-reform-debt-accumulating-state-owned-banks-and-enterprises

7 PublicFinance.lk, Sri Lankan Airlines: Annual and Accumulated Loss to the Public, Last modified: 24th August 2021, https://publicfinance.lk/en/topics/Sri-Lankan-Airlines:-Annual-and-Accumulated-Loss-to-the-Public-1629789830

8 Saito, Yoshitaka et al, 2006, Master Plan Study on the Development of Power Generation and Transmission System in Sri Lanka, Japan International Cooperation Agency Economic Development Department

9 EconomyNext.com, Sri Lanka’s CPC says petrol, diesel losses rise as LIOC hikes prices, Last modified: 25th October 2021, https://economynext.com/sri-lankas-cpc-says-petrol-diesel-losses-rise-as-lioc-hikes-prices-87276/#modal-one

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute, or anyone affiliated with the institute.

Reform or Regress

Originally appeared on The Morning

By K D Vimanga

The Sri Lankan economy’s crossroads

The great South African Statesman Nelson Mandela once said: “It always seems impossible until it is done.” Well, in our case, the time to get things done is already here. If we keep calling the act of reforming our economy impossible, then this country for sure will continue on a very dangerous path. So the longer we postpone the possibility of reforms, the more painful the process is going to be. So, we all, both policy makers and citizens alike, need to realise that the only way we can get out of this crisis is by implementing immediate and hard reforms, which this column has over and over again expounded on. 

Implementing reforms remains impossible for the sole reason that there remains very little political will to do so. However, what history teaches us is that the only way for nations to emerge from a crisis is by implementing bold reforms, even if they are politically unpopular. Such bold policy decisions, taken for the greater good of the nation, have been instrumental in releasing millions out of poverty. The best example is the economic reforms in India, which commenced from the 1991 economic crisis. The bold decisions taken by Prime Minister Narasimha Rao and Finance Minister Manmohan Singh were taken during compelling times. India was facing a similar situation, where the country was finding it hard to meet external debt obligations along with a serious balance of payment crisis. India was almost bankrupt as a result of the post-independence command and control-driven economy that brought the nation to the brink. However, amidst all odds, at the height of the crisis, Prime Minister Narasimha Rao and Finance Minister Manmohan Singh opened its economy to be driven by market forces, while dismantling the license quota raj. This also involved the devaluation of the rupee at the height of the crisis. It were these hard reforms that laid the foundation of India emerging out from the depths of bankruptcy. As a result of these reforms from 1992 to 2005, foreign investment increased by 316.9%, and India’s gross domestic product (GDP) grew from $266 billion in 1991 to $2.3 trillion in 2018 (1). 

Sri Lanka is facing a similar or far worse crisis. It is public knowledge that the economy has reached a boiling point, with the country’s reserves falling to $ 1.57 billion, while Sri Lanka has debt payment commitments of $ 4.5 billion (2) for 2022. Inflation has been rising to 9.9% (3). Advocata’s Bath Curry Indicator, which tracks the price of essential food items, records that since 2019, prices have increased by 44%. This means that an average family who spent Rs. 960 weekly on the BCI basket of food items in November 2019 now has to pay Rs. 1,390 for the same basket of goods just two years later. Continued printing of money, along with the implementation of policies without foresight – such as the overnight move to organic fertiliser – have all significantly added to this present rise in food prices. Therefore one cannot deny the existence of the crisis anymore. 

So what needs to be done? 

The answer is simply, implement a comprehensive programme of reforms now. For this week’s column, I would like to discuss the role of privatisation in the most immediate and short term. Implementing such a programme of privatisation which releases commercial activities carried out by the state can bring in significant cost savings for the Government while also bringing in short term liquidity. More importantly, such a programme can become a much needed productivity boost to the economy while opening up for private sector participation. Closing down non-viable state-owned entities is another key requirement of such a programme. 

The country is also currently in desperate need for Foreign Direct Investment (FDI). The Finance Minister admitted in Parliament that Sri Lanka is not getting FDIs as fast as expected. Therefore privatisation can be the fastest route to capture foreign direct investment. FDIs jumped in the 1990s mainly due to their ambitious privatisation programme. Out of the total privatisation proceeds realised during 1989-2005, 59% was financed by foreign investors as illustrated by the Central Bank (4). Privatisation served as a significant channel for FDI entry. Privatisation-related FDI accounted for at least one-third of FDI in the 1990s. The largest 20 foreign investors in Sri Lanka all arrived in the 1990s and made significant contributions in telecommunications, power, ports, and other areas of services and manufacturing. However, to be effective, it is critical that privatisations are carried out through open and transparent processes.

One way to maintain this transparency is maintaining oversight. The Public Enterprises Reform Commission (PERC) was established under an Act of Parliament in 1996 to be solely responsible for ensuring that the privatisation process occurred in a transparent and structured manner. Although not entirely free of controversy, PERC increased transparency and public information about the privatisation process. The PERC was shut down, and it is now necessary to revive PERC and put in place measures to ensure transparent and competitive processes.

Successful privatisation, if done right, can reduce the drain of government resources, especially at a time when government expenditure and mismanagement of state-owned enterprises are a serious burden on the fast draining government coffers. A second benefit is the generation of new sources of government revenue through receipt of proceeds, at a time where the Government is in desperate need for government revenue. The improvement of infrastructure and delivery of public services by the involvement of private capital and expertise is another important benefit. Other merits of privatisation include the improvement of the efficiency of the economy by making it more responsive to market forces, the broadening of the base of ownership in the economy; and the enhancement of the capital markets. 

A programme of privatisation can be the center point of the reform programme. However, macro-economic stabilisation, which we have discussed over and over again, must be carried in tandem. What is crystal clear is that time to implement these is running out if we continue to be blindly critical of these painful reforms and be complacent of its merits. Unlike at any other point in time, policy makers also need to be ready to make bold reforms and this will be the ultimate test of the resilience of our economy. The tipping point has been reached, we have no choice but to get these reforms done. Bold policy making is the need of the hour!

References

• Dutta, M. K. and Sarma, Gopal Kumar, Foreign Direct Investment in India Since 1991: Trends, Challenges and Prospects (1 January 2008).

  Ministry of Finance Annual Report 2020

  https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/press/pr/press_20211130_inflation_in_november_2021_ccpi_e.pdf

  https://www.cbsl.gov.lk/sites/default/files/cbslweb_docu-ments/publications/annual_report/archives/en/2007_17_Appendix.pdf

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute, or anyone affiliated with the institute.

Urgent need for justice reforms: Digitalisation can lead the way

Originally appeared on The Morning and Daily FT

By Tiffahny Hoole and Sumhiya Sallay

The Supreme Court, in the 1994 case of Jayasinghe v. AG, correctly asserted that “justice delayed is justice denied” (1). While the very apex of the justice system recognised that delays in court proceedings hinder litigants’ access to justice, there is a major backlog of cases in Sri Lanka. The entire court process, from the point where a case is taken up to court until its final verdict, is an extremely time-consuming process.

The operation of a country’s legal system significantly influences several components of its economic development such as the optimal allocation of resources and the increase in total factor productivity (2).

In 2021, a three-year plan targeting digitisation of courts was implemented to make the judicial system more efficient. Digitisation of the courts would mean a more streamlined process of court hearings.

Shortcomings of the Sri Lankan legal system

By the end of 2019, there were 4,767 pending cases to be heard in the Supreme Court, while 6,813 were to be heard in the Commercial High Court (3). In the speech delivered by the incumbent Minister of Justice at the Bar Association’s 47th Annual Convocation, it was stated that a total of 766,784 cases were pending by the end of 2019, with approximately 350 judges to hear those cases (4). The situation was only exacerbated in the wake of the Covid-19 pandemic. With periodic lockdowns consequent to seasonal outbreaks of Covid-19 cases, both the Supreme Court and Court of Appeal suspended proceedings (5).

The increased backlog of cases prior to and during the pandemic is attributable to the very nature in which the justice system operates. Sri Lanka’s court procedure and practice has been heavily reliant on in-person proceedings, physical filings, and production of documents and evidence respectively (6); a system too archaic to withstand any external shocks such as natural disasters, fires, or more specifically, a pandemic.

Ease of doing business: A point of discussion

The continuous delay in court proceedings over the years is one of the key factors which contributed to Sri Lanka’s low rank in the World Bank’s “Ease of Doing Business” index (7). Contract enforcement is one of Sri Lanka’s worst performing pillars in the index, as it ranked 164 out of 190 countries in 2020 (8). The average time period required to enforce a contract stands at 1,318 days (3.61 years) (9). In comparison, New Zealand, which topped the index, takes 216 days (0.6 years) (10). In his speech, the Minister of Justice further stated that market research prior to any investment would result in flocking towards countries with higher indexes, concluding that we would be losing “big” (11).

With the data highlighted by the index, in conjunction with prolonged lockdowns, the Minister of Justice soon realised that the backlog in cases had reached saturation. Speedy resolution in litigation is a prerequisite on foreign investments (12). Thus, with the aim of administering the public’s access to justice, major reforms are finally underway.

Reforms: Future of court procedures in Sri Lanka

Upon comprehensive studies conducted in 2017 with the assistance of the Information and Communication Technology Agency (ICTA) in Sri Lanka, the Ministry of Justice embarked on a court automation and digitisation project (13). In the recent Budget 2022 speech, the urgent need for reform was highlighted by Minister of Finance Basil Rajapaksa. Following this, a proposal to allocate a further Rs. 5,000 million towards this cause was presented (14).

The Covid-19 pandemic brought to light how far behind Sri Lanka is in terms of judicial digitised systems. Many countries were able to quickly recover post-Covid, as they already had systems in place to shift to virtual court hearings. However, courts, and other dispute resolution mechanisms such as mediation and arbitration in Sri Lanka, were far behind.

Prior to the commencement of this project, digitisation in court proceedings was being experimented in selected courts on an incremental basis. In November 2020, the “Virtual Courthouse Programme” was pioneered by the Commercial High Court in partnership with Sri Lanka Telecom and the Colombo Law Library (15). Similarly, a key person interview conducted by the Advocata Institute brought to light the efforts made by the lawyers in the courts of Mount Lavinia to transform court proceedings to an entirely virtual platform. In response to the pandemic, reformation was witnessed on an incremental basis. Finally, operations of virtual court hearings were formerly recognised by the Coronavirus Disease 2019 (Temporary Provisions), Act No. 17 of 2021, subject to the condition that physical hearings cannot be held (16).

Nevertheless, by taking into account the complexity and gravity of court procedure, it was understood that reform needed to be holistic. Accordingly, digitisation is not limited to virtual court hearings but also envisions the registration component of the judicial system. This includes scheduling, managing documents, recording proceedings, etc. Furthermore, payment of court filing fees will be shifted to an online platform. In respect of court hearings, reformation is twofold; the first phase is a pilot project which covers 18 courthouses within the Colombo District (17). The second phase is expected to implement court automation procedures across 100 courthouses in Sri Lanka (18). In the interim, existing online platforms such as Zoom and Google Meet will be utilised for this purpose.

A major challenge going forward will be data security and privacy. However, the issue of security already exists even with physical documents and in-person court hearings. Documents are tampered with, stolen, or even damaged. Witnesses may be coerced to perjure in or outside court. Thus, moving towards an online platform will circumvent the damages caused to case documents such as a fire, similar to the recent incident in the Supreme Court Complex (19). In order to minimise the concerns raised, the Ministry of Justice has partnered with professional experts in the ICT sector to build a data protection and data security plan and develop remote data storage facilities (20).

The long-term benefits of digitisation

In the long term, digitisation and automation will make the litigation process far cheaper. Litigation in Sri Lanka is known to be a very expensive procedure. Instead of requiring a 100-page document to be submitted to each judge on a panel prior to the case hearing, litigants would now be able to send a pdf through an online portal. Electronic delivery of paper documents would also speed up the filing procedures (21). Rather than having to commute all the way to a district court that is outside one’s residence, litigants are able to participate in court hearings through Zoom.

Reforms in the justice system play an essential role in restoring the confidence of investors. A representative of the World Bank in the Legal Department highlighted that encouragement of foreign direct investment is at the forefront of government thinking behind legal reform (22). In the wake of the pandemic, it is pivotal that the State prioritises and ensures such essential reforms do take place so as to attract foreign investors. Justice is only delivered in the absence of delay.

References

• ayasinghe v. AG [1994] 2 SLLR, https://www.lawnet.gov.lk/wp-content/uploads/2016/11/005-SLLR-SLLR-1994-V2-JAYASINGHE-V.-THE-ATTORNEY-GENERAL-AND-OTHERS.pdf, last accessed 1 December 2021

• Marilene Lorizio, “Efficiency of Justice and Economic Systems”, Innovation and Society 2013 Conference, IES 2013, ScienceDirect. Procedia Economics and Finance (accessed 5 May 2020)

• Ministry of Justice, “Case Statistics of Sri Lanka – 2019”, https://www.moj.gov.lk/images/pdf/Statistics/Case-Statistics-2019.pdf, last accessed 1 December 2021

• “Rolling out holistic solution to perennial problem of laws’ delays”, The Island Online, 29 March 29 2021, https://island.lk/rolling-out-holistic-solution-to-perennial-problem-of-laws-delays/ (accessed 1 December 2021)

• “Due Process and Preparedness for Public Emergencies”, (Verite, June 2021), https://www.veriteresearch.org/wp-content/uploads/2021/07/VR_ENG_RB_Jun2021_Due-Process-and-Preparedness-for-Public-Crises.pdf (accessed 1 December 2021)

• Ibid.

• “Economy Profile: Sri Lanka | Doing Business 2020”, (World Bank Group, 2020) https://www.doingbusiness.org/content/dam/doingBusiness/country/s/sri-lanka/LKA.pdf (accessed 1 December 2021)

• Ibid.

• Ibid.

• “Economy Profile: New Zealand | Doing Business 2020”, (World Bank Group, 2020) https://www.doingbusiness.org/content/dam/doingBusiness/country/n/new-zealand/NZL.pdf (accessed 2 December 2021)

• “Rolling out holistic solution to perennial problem of laws’ delays”, The Island Online, 29 March 29 2021, https://island.lk/rolling-out-holistic-solution-to-perennial-problem-of-laws-delays/ (accessed 1 December 2021)

• Sarath Wijesinghe, “Laws delays, lawyers’ delays or system delays?” Sunday Observer, 3 January 2021, http://www.sundayobserver.lk/2021/01/03/impact/laws-delays-lawyers%E2%80%99-delays-or-system-delays (accessed 1 December 2021)

• Rohan Samarajiva, “Failure in the Core Business: Administration of Justice”, Echelon, 7 May 2021, https://www.echelon.lk/failure-in-the-core-business-administration-of-justice/ (accessed 1 December 2021)

• Ministry of Finance “Budget Speech 2022” https://www.treasury.gov.lk/api/file/91c69189-9b2f-4ab2-8e90-53213a60cddd (accessed 1 December 2021)

• “Due Process and Preparedness for Public Emergencies”, (Verite, June 2021), https://www.veriteresearch.org/wp-content/uploads/2021/07/VR_ENG_RB_Jun2021_Due-Process-and-Preparedness-for-Public-Crises.pdf (accessed 1 December 2021)

• Coronavirus Disease 2019 (COVID-19) (Temporary Provisions) Bill, 8 June 2021, https://www.parliament.lk/uploads/acts/gbills/english/6219.pdf (accessed 1 December 2021)

• Ministry of Justice, “Pre-Qualification for Design, Supply, Implementation and Maintenance of a Court Automation System for Judicial System of Sri Lanka”, https://www.moj.gov.lk/images/pdf/2021/Prequalification_Document_Final.pdf (accessed 1 December 2021)

• Ministry of Justice, “Pre-Qualification for Design, Supply, Implementation and Maintenance of a Court Automation System for Judicial System of Sri Lanka”, https://www.moj.gov.lk/images/pdf/2021/Prequalification_Document_Final.pdf (accessed 1 December 2021)

• Ifham Nizam, “Scary fire in Supreme Court complex ground floor, but no big harm” (2020), https://island.lk/scary-fire-in-supreme-court-complex-ground-floor-but-no-big-harm/ (accessed 1 December 2021)

• Ibid.

• “Technology For Court Efficiency”, OECD Library, https://www.oecd-ilibrary.org//sites/40c8c1fb-en/index.html?itemId=/content/component/40c8c1fb-en#boxsection-d1e5561 (accessed 1 December 2021)

• Amanda Perry, “An Ideal Legal System for Attracting Foreign Direct Investment? Some Theory and Reality”, American University International Law Review, Volume 15, Issue 06, https://core.ac.uk/download/pdf/235401967.pdf (accessed 1 December 2021)

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute, or anyone affiliated with the institute.

Cattle Slaughter Ban: It’s Not Intentions But Consequences That Matter

Originally appeared on Daily FT, Daily Mirror and The Island

By Sathya Karunarathne and Pravena Yogendra

The Cabinet of Ministers approved the Bill to amend laws to ban cattle slaughter in the third week of October. While this is a contentious policy measure, it did not come as a surprise as the Prime Minister proposed the same policy just over a year ago in September of 2020. 

From the outset, it may seem that the policy is well-intended. Alleviating animal suffering is a noble cause that many Sri Lankans would identify with. Unfortunately, even well-intended policies have unintended consequences. In the case of a cattle slaughter ban, the consequences can be dire for the livelihoods of thousands of people. As stated by the Department of Census and Statistics, 117,033 farmers raised cattle and/or buffalo locally and 56,984 farmers raised improved cattle and/or buffalo in 2020.1 Further, as reported by the Livestock Statistical Bulletin there were 296,111 cattle farms and 26,284 Buffalo farms registered in 2020.

The cattle rearing industry does not exist in isolation, nor is it sustained to nurture the beef industry alone. Cattle are an integral part of the dairy industry, leather tanning industry and footwear and leather goods industry. The dairy industry sells unproductive cattle, where 50% of the animal is salvaged as beef (3) and other parts are sold as raw material to other industries such as the leather tanning industry, etc. Therefore, a cattle slaughter ban would have consequences on all these sectors.

The Government’s intention in banning cattle slaughter is to increase dairy production and local agriculture as reported by the media. According to Central Bank data in 2020, the annual milk production from cattle was 414 m litres and 78 m litres were produced by buffalos. In the same year, Sri Lanka imported 102,355,524 Kgs of milk and milk products, and exported 1,057,079 Kgs of the same.

To keep this dairy industry running, milk producers need to get rid of unproductive cattle. Eranga Nihal Perera, the Chief of the Ceylon Cattle Farmers Association, put this into perspective speaking to the Sunday Times a few weeks ago. He stated that a bull or milch cow requires 10% of its body weight in food daily. For example, an adult stud bull weighs about 400 kgs. That is approximately 40 Kgs of feed per bull, every day. Therefore, a bull would require a monthly cost of around Rs. 26,000 to be maintained. It makes limited economic sense to sustain unproductive cattle incurring such costs as it will increase costs of maintenance with no return on investment. 

A total of 162,000 cattle were legally slaughtered in 2020. Key person interviews with leading industry stakeholders revealed that the cattle population which amounted to 1,628,771 in 2020 can grow up to three times within 10 years with the implementation of a slaughter ban with 75% of them counting to be unproductive.(10) The costs of maintenance will therefore evidently be unbearable. These cost increases, if they can be sustained at all, will be passed on to consumers as price increases in milk. A further stress to an industry already reeling with shortages and high prices. 

Beef is sourced from cattle deemed as unproductive by the dairy industry. Male cattle or bull calves are used to identify female animals in heat and to serve stud purposes, aiding the artificial insemination process. They are slaughtered for beef when they reach about three months of age. Milch cows are slaughtered after completing four calving cycles as they are considered aged, unproductive and unprofitable to maintain at this juncture. Unproductive animals must be culled to maintain the overall productivity of the herd as unproductive stud animals could mate with productive cows, producing low yielding calves. 

The latest available data shows that beef production in 2019 amounted to 29.87 metric tons.

Smallholder dairy farmers contribute to this as smallholders dominate the livestock industry. For example, a 2019 study by the University of Peradeniya revealed that among private dairy farms in the country about 95% are small scale producers. While cattle farming in Sri Lanka is running on narrow margins, a significant contribution of the marginal profits comes from the sale of these animals to the beef industry. 

Dairy farmers make an annual lifetime profit of ~30% from the sale of an animal. Therefore, small farmers who raise cattle individually for an additional income will be severely impacted by the ban. They will not be able to afford the additional maintenance costs of unproductive cattle and will have to halt their small scale business operations.

Banning cattle slaughter with the intention of increasing dairy production therefore is contradictory as it proves to be counterproductive. As illustrated above the milk industry can barely sustain itself without the beef industry. 

A slaughterer purchases an animal for ~LKR 300 per Kg live weight. Live weight ranges from 300-500kg. Thereafter, 50% of the animal is salvaged as beef and the remaining is sold to other industries.(14) The leather tanning industry is one such industry that sources raw material from cattle slaughter. A slaughtered cow yields 15-16 sq ft of rawhide. Rawhide is sourced from the slaughterer by the leather tanning industry at Rs. 45 per Kg. Domestically tanned leather is sold to the footwear and leather goods industry as raw material at Rs. 175 per Kg as opposed to imported tanned leather priced at Rs. 250 per kg ($1- 1.20).(15) 

Moreover, discussions with the industry revealed that about 60% of leather needed to produce affordable footwear is produced domestically and banning cattle slaughter will directly impact the accessibility of affordable footwear by the middle and lower-income earners of the country. Further, more than 60% of the footwear and leather goods industry consists of micro and small businesses.(16) Therefore, this policy measure will indeed hamper their access to affordable raw material and their very sustenance.

Implications of cattle slaughter 

As stated by the Buddhasasana, Religious, and Cultural Affairs Ministry Secretary, Prof. Kapila Gunawardana the Government is discussing the possibility of exporting ageing cows that will not be slaughtered in Sri Lanka with the implementation of the ban. However, exporting aged live cattle is challenging as there is a high probability of international markets being reluctant to purchase cattle exposed to infections in the process of transportation. 

With the increase of idling cattle, the Government will have to invest to build new cattle salvage farms, ensuring adequate veterinary facilities and daily feed. The NLDB has only two salvage farms in Kurunegala and Anuradhapura with a combined capacity of 1,000 animals at a time. About 400 cows are legally slaughtered per day.(19) As aged cattle require high maintenance costs with no return on investment, this will be an added strain on Government expenditure given Sri Lanka’s current limited fiscal space and precarious economic conditions. This will also clash with limited agricultural land available in the country leading to a serious threat to crops. 

Moreover, with the local beef industry coming to a complete halt, the domestic production and importation of alternative sources of protein such as chicken and fish will have to increase, meeting domestic demand and ensuring affordability for the average consumer. It is important to note that the prices of these alternatives have experienced a steep increase. According to the Department of Census and Statistics weekly retail prices, one kg of fresh chicken that cost Rs. 558.93 in November of 2020 costs Rs. 727.27 now. Further, one kg of salaya that cost Rs. 252.67 in November of 2020 is now priced at Rs. 291.67.

Moreover, a flat-out ban on cattle slaughter will breed an underground economy of illegal slaughter and trade. This will foster animal cruelty as the industry will not come under the purview of welfare authorities, creating the environment for low-cost slaughtering techniques defeating the very moral grounds of a cattle slaughter ban.

Further, banning cattle slaughter with no ban on beef consumption allowing for beef imports will only shift the burden of slaughter elsewhere. This is hypocritical as cattle will still have to be slaughtered abroad, for the consumption of Sri Lankan people. It is worthy to note that India is the fifth largest carabeef exporter in the world earning 2.8 billion dollars in exports in 2020 despite the country’s religious veneration of cattle. 

It is evident that even though a slaughter ban may sound ideal in theory, it springs a chain of unintended economic consequences hampering the dairy, beef and other related industries, paving the way for further price increases and posing a threat to business operations. 

Therefore, it is clear that when making economic decisions it is paramount to look at policies in terms of incentives they create rather than blindly pursuing a goal. This simply means that immediate and long term consequences matter more than intentions. Economic policies therefore must strive to go beyond intentions crafted by hopes and inspiration. Failure to do this will certainly lead to disastrous outcomes for the whole nation. 

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute, or anyone affiliated with the institute.

Did we miss the opportunity to formulate ‘a non-traditional budget’?

Originally appeared on The Morning

By K.D.D.B Vimanga

A non-traditional budget was what the country needed. In general, budgets in Sri Lanka have mostly been giveaways to maintain political status quo or simply an outline of the Government’s plan for the economy, without taking into consideration current economic realities. As a result of numerous governments prioritising political gains over economic realities, the nation is currently experiencing severe economic consequences. These are manifested to the public in the form of steep price increases, shortages of essential goods, import restrictions, and much more. The macroeconomic consequences of this are fiscal and monetary instability, coupled with serious questions on Sri Lanka’s debt sustainability. A non-traditional budget would have indicated the broad policy direction and priorities of the Government with an understanding of where the economy is right now. The Budget would have prioritised macroeconomic stabilisation, taking into consideration the seriousness of the present economic crisis. Whether the budget proposals for 2022 achieve this remains a question.

Analysing the Budget Speech makes it clear that the intention of the Budget was to be conscious of government expenditure. Is this consciousness sufficient? Especially at a time where the foreign debt service forecast for 2022 is an estimated $ 4,483.80 million? (1), when the state of the country’s foreign reserves stood at about $ 2.6 billion in September 2021 (1.7 months of imports [2]), and following which the net foreign assets have been negative in the months after. This very question of debt sustainability remains the elephant in the room. Yet, the Budget Speech failed to elaborate on specific measures that the Government hopes to utilise to meet this target. A budget that understands the present challenges would have presented a roadmap of actions to meet these outflows. The failure to do so highlights the failure to streamline the Budget to meet the seriousness of the present economic crisis.

A certain amount of credit must be given to the Government for refraining from making excessive government expenditure proposals. There is a slight increase in government total expenditure from the revised estimate of Rs. 3,387 billion for 2021 to Rs. 3,912 billion for 2022. This remains prudent in comparison to the Government’s total revenue from the revised estimate of Rs. 1,556 billion in 2021 to Rs. 2,284 billion (3). According to the figures provided by the Ministry of Finance, the budget deficit would see a reduction from Rs. 1,826 billion in 2021 to Rs. 1,628 billion in 2022. However, it should be noted that while the Budget Speech of 2021 promised a deficit of 9%, the revised estimate of the deficit has increased to 11.1% as per the Fiscal Management Report of 2022.

The budget deficit still remains unsustainably large for a country with a gross domestic product (GDP) of $ 80.7 billion in 2020 (4). The Budget tries to reduce government expenditure by proposing policies to reduce recurrent expenditure. These include reducing the fuel allowance provided to ministers and government officials by five litres per month, a 25% reduction in telephone expenses, and increasing the eligibility of MPs to receive a pension from five to 10 years. The magnitude of these cuts in government expenditure remains insignificant in contrast to the real need of the hour; especially when the Budget has made provisions to further expand the public sector, by offering permanent appointments to over 53,000 graduates which would drain a further Rs. 27,600 million from the exchequer. Such is counterintuitive to policies aimed at countering recurrent expenditure, and maintaining a bloated public sector is simply unaffordable with the current state of our public finances. Bold cuts to government expenditure would have reassured Sri Lanka’s creditors, donors, and lenders that we are serious about reforms while also making more resources and talent available to the private sector. Maintaining inflated departments with little or no productive output is a luxury we cannot afford anymore.

The continuation of financing this budget deficit through the domestic market borrowings will have a crowding out effect, especially as it will stunt credit available for the private sector and in return slow the country’s medium to long-term growth potential. Therefore, an ideal budget or a non-traditional budget would have prioritised fiscal consolidation. This includes setting a clear path to reduce the fiscal deficit to 5% by 2024. More efficient tax policy alternatives would have been reintroducing PAYE and withholding taxes and widening the tax base and spreading the tax burden to include a significant number of organisations that were given long tax breaks.

The Budget Speech highlighted three policies that, if implemented right, could direct the economy towards growth. The first being the acknowledgement that price controls have failed, and that market intervention creates uncertainties that affect consumers. This must be looked at with pragmatism, as the complete elimination of price controls including in the energy sector, can achieve better outcomes for the economy. The second being a policy focus to ensure a fair and competitive market. Recognising the role of the market economy and competition is a move in the right direction. This remains the only tried and tested solution to lower prices in the economy. The third policy that should be highlighted is the Finance Minister’s acknowledgement of a re-examination of the Samurdhi scheme. The scheme currently excludes some of the most vulnerable households and therefore, there is a need for tighter administration to ensure benefits accrue to those who need it most. The focus to streamline this initiative towards building entrepreneurship, fostering SMEs, and skill development is the right decision. However, for this to materialise, the Government needs to implement comprehensive reforms to improve ease of doing business and a comprehensive programme of digitalisation.

Addressing macroeconomic imbalances should have been a policy priority of the Budget. This includes addressing the fiscal deficit and the external current account deficit which have effects on the rest of the economy through interest rates and exchange rates. The Budget tries to address this issue by focusing on empowering local production. Prioritising self-sufficiency without opening the domestic market for competition is untenable. The Finance Minister’s speech outlined proposals to boost productivity, which are indeed pragmatic. Yet, one cannot increase productivity without improving competition. Focusing on improving national output has no economic impact without boosting domestic competition.

In the background, there was hope that the Government would start stabilising public finances, which would restore confidence. However, analysing the policy priorities of the Budget makes it clear that there has been little attempt to address the deficit and debt sustainability. Therefore, markets are unlikely to respond positively. At this juncture, Sri Lanka cannot afford to be complacent about our credit ratings. The Budget provided an ideal opportunity to provide a credible plan of action to get our credit ratings up. However, we seem to have missed this opportunity.

Measures to control public finances: spending, budget deficits, and debt 

Year after year, the budget proposals have highlighted large-scale policies that remain limited to budget speeches. However, the present economic storm makes no space for such complacency. Hard structural reforms will need to be implemented inevitably. The Budget could have been the starting point. However, it seems that this window has passed. Therefore, there is a conscious need to build consensus for the implementation of key structural reforms that achieve macroeconomic stabilisation and long-term economic growth. Without macroeconomic stability, there will be no growth. Furthermore, these reforms need to be institutionalised. One way of doing this is the adoption of a medium-term fiscal and monetary framework that gives confidence to donors, lenders, investors, and citizens. Having such a framework will act as a clear sign that the State is committed to fiscal prudence and monetary stability. A medium-term expenditure framework is a tool for establishing public expenditure programmes within a coherent multi-year economic and fiscal framework. 

Other key structural reforms for macroeconomic stabilisation, as outlined in Advocata’s Framework for Economic Recovery, include public finance management and public sector reforms, state-owned enterprise reforms, enhancing monetary policy effectiveness and maintaining exchange rate flexibility, supporting trade and investment to strengthen external trade, land reform, improving ease of doing business, and bridging infrastructure gaps. The only salvation to Sri Lanka’s present economic crisis is such a comprehensive reform package that goes beyond a traditional budget.

References:

1. MOF annual report 2020

2. CBSL Recent Economic Developments: Highlights of 2021 and prospects for 2022

3. https://www.treasury.gov.lk/api/file/0c3639d9-cb0a-4f9d-b4f9-5571c2d16a8b

4. https://data.worldbank.org/indicator/NY.GDP.MKTP.CD?locations=LK

K.D.D.B. Vimanga is a Policy Analyst at the Advocata Institute. He can be contacted at kdvimanga@advocata.org.

The Advocata Institute is an Independent Public Policy Think Tank. Learn more about Advocata’s work at www.advocata.org. The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute

Is Wealth Tax the Solution to Sri Lanka’s Low Tax Revenue Collection

Originally appeared on Daily FT, Biz Adaderana , The Morning, Daily Mirror, The Island and Lanka Business Online

By Sathya Karunarathne

Successive governments have run fiscal deficits. Inadequate revenue collection and unrestrained government expenditure have worsened the country’s fiscal position.  

Tax revenue which averaged over 20% of GDP in 1990 has declined to under 10% of GDP in 2020. Ad hoc tax policy changes have significantly eroded the tax base. Weak tax administration has also contributed to the sharp decline in tax collection.

While tax revenue has contracted, government expenditure has ballooned over time. Today, government revenue is not sufficient even to meet its expenditure on salaries and wages and transfers and subsidies to households which include pension payments and social welfare payments such as Samurdhi.  

In this context, there are various proposals put forward to raise government revenue. One proposal is the reintroduction of the wealth tax.  

A wealth tax is expected to bridge the gap between the rich and the poor, achieving equality. This tax shifts the tax burden to affluent households, taxing an individual’s net wealth, which is the market value of total owned assets. Proponents of wealth taxation argue that this is a progressive system of taxation and is a more powerful tool in comparison to income, estate or corporate taxes as it addresses the issue of wealth concentration.  

Moreover, a tax should ideally satisfy basic characteristics of taxation: it should not be distortionary; it should be fair, and it should not be difficult to collect. 

The rationale for a wealth tax

One of the earliest proponents of the wealth tax for developing countries was Nicholas Kaldor.  Based on his recommendation, a wealth tax together with an income tax, expenditure tax and a gift tax were introduced in Sri Lanka in 1958. However, these new taxes yielded little revenue due to difficulties in determining the tax base and problems in administration.  Following the recommendation of the Tax Commission in 1990, the government abolished the wealth tax from the year of assessment 1992/1993.

Wealth taxes have mainly been implemented in European countries. In 1990, twelve countries in Europe had a wealth tax. Today, there are only three: Norway, Spain, and Switzerland.  Several non-European countries have also imposed wealth taxes from time to time including such as Argentina, Bangladesh, Colombia, India, Indonesia, Pakistan 

In recent times there has been renewed interest in wealth taxes. Presidential candidates in the US proposed various forms of a wealth tax. In the UK and France, there were proposals to impose “super taxes” on the rich. The primary justification was to address the increasing inequality in society.  

Issues with a wealth tax

Despite renewed interest in the wealth tax as a progressive tax based on equity, it scores poorly on the criteria of efficiency, and administrative feasibility.  

Many factors have justified the repeal of wealth taxes in OECD countries. The reasons cited are related to efficiency costs, risk of capital flight particularly in light of increased capital mobility and wealthy taxpayers' access to tax havens, failure to meet redistributive goals as a result of narrow tax bases, tax avoidance and evasion, high administrative and compliance costs compared to limited revenues (high cost yield ratio).  

To understand the efficiency costs of wealth taxes one can look at taxing a person’s wealth accumulated through savings. Despite the common consensus that taxing savings is an effective way to redistribute, a person’s saving decisions reveal little about their underlying lifetime resources and wellbeing. It only reveals their preference to consume tomorrow rather than today. Thereby a wealth tax imposes a tax on those who prefer to spend their money later as opposed to taxing the wealthy. Efficiency costs refer to the reduction of the welfare of the taxed individuals by more than $1 to generate $1 of revenue. Therefore, the efficiency cost of a wealth tax in terms of taxing savings is a reduction of  future consumption that can be bought with earnings, reducing incentive to work for those who prefer to consume the proceeds later and reducing incentive for young people to save for their retirement.

Capital flight is the possibility of holding assets outside of one's resident country without declaring them.As wealth taxes are imposed on residents it increases the risk of the wealthy

reallocating their assets to avoid taxation. Therefore a high tax burden encourages taxpayers to change their tax residence to a lower tax jurisdiction or tax havens.

Both income-generating and non-income generating assets are taxed under wealth taxation. They can include land, real estate, bank accounts, investment funds, intellectual or industrial property rights, bonds, shares, and even jewellery, vehicles, art and antiques. However, this tax base for wealth taxes has often been narrowed through exemptions. These exemptions have been justified most commonly on the grounds of social concerns such as the negative social implications of taxing  pension assets. Further liquidity issues (eg - farm assets), supporting entrepreneurship and investment (eg- business assets), avoiding valuation difficulties ( eg- artwork and jewellery) and preserving countries cultural heritage (eg - artwork and antiques) have also been cited as reasons for wealth tax reliefs. While some of these exemptions can be justified, they have led to the reduction of revenue raised from wealth taxes. They have also contributed to wealth taxes being less equitable as the wealthiest such as businesses benefit from these exemptions defeating the very purpose of imposing a wealth tax which is to meet its redistributive goals.

Narrow tax bases in wealth taxation often leads to tax avoidance and evasion opportunities. For example, Spain's 1994 wealth tax exemption for the shares of owner managers resulted in wealthy businesses reorganizing their activities to reap benefits of the exemption resulting in a significant erosion of the wealth tax base. 

Further, several other factors have also discouraged countries to sustain a wealth tax. They are namely, the difficulty in determining the tax base or what assets to be taxed, underreporting and undervaluation of assets, difficulty in measuring wealth taxes, distinguishing between individuals who are asset rich but cash poor, the constant need to value assets and audit returns increasing administrative and enforcement costs

Low revenue collection as well as the other reasons discussed have led to the abolishing of wealth taxes in most countries  (See Table 1 for details) . Tax revenue from individual net wealth taxes in 2016 ranged from only 0.2% of GDP in Spain to 1.0% of GDP in Switzerland. Sri Lanka’s experience with wealth taxation was no different with the tax yielding low revenue as reported by the 1990 Tax Commission.

Table 1: Implementation of Wealth Taxes in Selected Countries

Conclusion 

Taxing the wealth of the rich to generate income and to eliminate economic inequality sounds promising in terms of political debate. However, wealth taxes have failed to generate adequate revenue, failed to meet redistributive goals as a result of narrow tax bases, proven to have high administrative and enforcement costs, resulted in tax evasion and avoidance due to underreporting and undervaluation of assets, increased the risk of capital flight and access to tax havens and may have contributed to the reduction of investment and employment. 

Therefore, imposing a wealth tax may not be the ideal policy response to Sri Lanka’s low tax revenue, especially given the country’s previous experience with the tax yielding low revenue.

Sathya Karunarathne is the Research Analyst at the Advocata Institute and can be contacted at sathya@advocata.org. Learn more about Advocata’s work at www.advocata.org. The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute, or anyone affiliated with the institute.