Why are we poor?

By Ravi Ratnasabapathy

Originally appeared on the Daily FT

Economists tell us that Sri Lanka’s economy has stabilised but what does this mean if so many are struggling?

To economists stability means that the imbalances in the economy have been resolved. The symptoms of the imbalances appear as rising prices, shortages of foreign exchange and goods. These have indeed disappeared but what does it mean to ordinary people? It only means that the rate at which people were being impoverished has slowed. We were crashing down the mountainside but the fall has been broken, if only temporarily. This is no mean achievement but obviously people expect much better.

People enjoyed a particular standard of living in 2020 but three short years later find themselves pauperised and cannot fathom why. What caused this steep decline in living standards? Corruption, poor governance and weak public finances are blamed but these were prevalent for decades. Why did the effects of these pass unnoticed for so long and how did they suddenly manifest?

The fact is that while these are connected to the problem they are not the immediate causes. To understand the causes of poverty today we must understand what changed between 2020 and 2023.

Two distinct causes of poverty today

There are two distinct causes but for the sake of clarity they must be dealt with separately.

Between December 2019 and August 20221 the Central Bank printed huge volumes of money – net Central Bank credit to Government grew 10-fold; from 363 billion to 3,162 billion. The end result of the increase in the supply of money is the fall in its value. This is reflected in rising prices and depreciation of the rupee in the foreign exchange market.

The Government at the time tried to mask the symptoms of the problem by imposing price controls; the exchange rate for the rupee was fixed at Rs. 200 along with the prices of many other goods. The result was scarcities – of foreign exchange and of goods which were visible in the long queues and in power cuts. As the printing continued, the Government imposed ever tighter import and price controls until eventually economic activity ground to a near halt. People were either standing in queues or sitting in the dark. Work in factories and offices stopped because of the unavailability of materials, the inability to transport staff or products and the lack of power.

To resolve this problem the only option was to allow interest rates to rise to slow the credit growth that was fuelling excess demand. A partial devaluation was initially attempted without a significant rate increase but this failed and forex shortages persisted. The corner was turned only when rates were hiked significantly and a peg re-established at 360.

As the rupee fell all prices rose. Price controls had to be removed, most importantly on energy – fuel, electricity and cooking gas to reflect the diminished value of the currency. This explains the sudden increase in prices of both goods and services.

Unfortunately while prices rose people’s incomes and savings did not. People’s living standards are measured not by their income but by what that income can procure. When the value of money falls living standards fall.

Effects of currency debasement are permanent

How is this to be reversed? The tragedy is that the effects of currency debasement are permanent. Complete reversal requires that stock money to shrink back to the level it was in 2019 – this would lead to a massive increase in interest rates; much higher than present. The consequences of this would be widespread business collapse and an economic contraction that would impose even more suffering.

What should be done? The debasement of the currency can only happen through the Central Bank. It must be prevented by rules from ever doing so again.

People mistakenly think that the Central Bank should try to keep interest rates low but the only way in which this can be done is (a) if the Government reduces its volume of borrowing, the sheer size of which puts significant upward pressure on rates or (b) if the Central Bank keeps increasing the supply money (money printing) which lowers rates. It is difficult to reduce Government spending in the short term, therefore the borrowing will have to continue. This means the only avenue to lower interest rates is money printing which ultimately impoverishes all.

The Central Bank should not engage in activist monetary policy to stimulate the economy. It must not finance the Government’s budget deficit and in its role as provider of liquidity to the banking sector it must not become a banking intermediary. Liquidity to the interbank market needs to be purely temporary, based on market rates with an added premium to prevent moral hazard. Central Bank intermediation is in some way a substitute for interbank markets and therefore the relative level of costs between the two is crucial.

If the value of the rupee holds it will allow people to try and restore what has been lost. People need to start all over again and through their own efforts try to rebuild their lives.

Second reason for increase in poverty – increase in taxes

The second reason for the increase in poverty is the increase in taxes. People who have already suffered terribly because of currency debasement now face another blow when the Government appropriates even more of their income and raises the prices of goods through sales based taxes. The Government is fixing the problems in its own finances but doing so by passing the buck on to the people.

In the short-term some increases in taxes were unavoidable because of the rigidity in Government spending – the bulk of which is salaries, pensions and interest. These must be reduced but this takes time. However there is no excuse for making no attempt to cut costs. For example, the high prices of electricity and fuel include the extra costs caused by corruption in fuel purchases, inflated power purchase costs, excess payroll and inefficiency.

Corruption and waste become relevant to the problem of impoverishment when their costs are transferred to citizens through increased taxes, higher prices and poorer quality of services provided by the Government. The use of debt and more moderate levels of money printing allowed the Government to conceal the real burden of its spending from people for decades.

The public blames the general increases in prices that result from money printing on “profiteering” by traders. Increases in debt have no immediate impact, it is only when it has to be repaid are the consequences felt at which point the lenders are blamed.

Citizens who voted repeatedly for corrupt populists have awoken from slumber as the costs of past profligacy have finally become apparent.

Ability of the Government to disguise the real burden of its activities

Because of the ability of the Government to disguise the real burden of its activities, in the context of corruption citizens need to have a singular focus on all economic activities of the Government. It is Government spending rather than taxation that ultimately determines the total burden of Government activity on the private sector. The critical question citizens must ask is how far does Government activity and spending actually improve the lives of citizens?

The IMF program is trying to reduce the Government’s deficit and debt – but the approach they have taken is to simply increase taxes rather than doing so concurrently with cutting expenditure. There seems to be unquestioned acceptance of the level of public spending, regardless of its quality or nature.

Tax morale – citizens’ willingness to pay taxes – depends on the trust they have in the Government and the quality of services they receive. In the modern world a state must earn the right to collect tax. To do so it must treat its citizens fairly. It must be responsive and seen to be addressing needs and improving services. The lack of this was evident in the protests of 2022.

The Sri Lankan State fails in the provision of the most fundamental of public goods – those that cannot be provided by private markets: the rule of law and a functioning system of justice. While some useful services are provided in health and education, quality is poor. The spending on private tuition, private schools and private healthcare is a testament to this. Corruption is rampant. For example, COPE reports show the State Pharmaceuticals Corporation has repeatedly procured substandard drugs2, dud software3 and failed to follow strictures imposed by COPE4.

Promises of jobs are a vote-winner. Elections have been won, jobs have been created but only now have the public been presented with the bill. A large proportion of taxes are in effect sustaining the patronage system that enables the election of corrupt politicians.

Voters must realise that there are no easy or painless solutions. After a crisis such as this, countries may experience ‘a lost decade’ before output reaches its pre-crisis level. Populists who promise quick solutions without proper diagnosis or are unable to locate the sources of the problem could easily tip the country back into crisis

Identify the villains in this tragedy

People need to identify clearly the villains in this tragedy; the Central Bank and mis-spending by the Government. Public outrage is justified but unless the sources of the problem; the Central Bank and Government spending are correctly identified, they may well be duped again.

That the rate of impoverishment has slowed will not satisfy the public but do they realise the fragility of this meagre achievement? Politicians are eager to promise quick and painless solutions. The electorate can expect to be subjected to “death by slogan” over the election cycle. A fairer society. End corruption. A brighter future.

Desperate people may clutch at any alternative assuming that things cannot get any worse but they are gravely mistaken. Politicians who do not grasp the problem may trigger another spiral. Criticism of the current approach is needed but people should look for politicians who offer realistic alternatives. How should voters evaluate alternatives?

To avoid another crisis it is vital to maintain monetary stability and fiscal prudence. Serious politicians must commit to both. Ambitious manifestos must be seen to translate into pragmatic programs within the fiscal constraint. The British tradition of access talks: pre-election talks between opposition politicians and civil servants helps prepare the opposition for Government. They need to decide on policy priorities and the mechanics of delivery. Those who have done their homework will demonstrate familiarity with the public finances5.

Some talk of billions in stolen assets and imply that all it takes is to recover this and all will be well. Have they examined the complexity of the legal proceedings in the recovery of stolen assets? The international record of successful of stolen asset recovery is poor. The Stolen Asset Recovery (StAR) Initiative – a partnership between the World Bank and the United Nations Office on Drugs and Crime (UNODC) has over 15 years recovered a total of around $ 1.9 billion6. The most successful has been the Philippines which recovered more than $ 1 billion over 21 years. This is a tidy sum but do those who tout this as a solution understand the gargantuan size of the Government expenditure?

Public salaries and wages cost Rs. 956.2 billion in 20227. For year of 365 days that works out to Rs. 2.62 billion per day. Subsidies cost another 1,020 billion or Rs. 2.23 billion per day. Including interest total recurrent expenditure runs at Rs. 9.64 billion a day.

The sum total recovered under the StAR over 15 years would only cover the public sector salaries for a little over seven months; total recurrent expenditure for only two. In any case can a realistic budget be built on such an uncertain stream of revenues? Can the rich pay for this all? How many billionaires and millionaires does the Government need to find to sustain spending at a rate of Rs. 9.6 billion per day?

Government spending

Government spending can create the opportunities for corruption; affecting not just the level of public expenditure, but also its composition, favouring projects that allow the collection bribes.

If the misspending in the public sector were reduced greatly then the tax burden could be reduced. Salaries and pensions for the 1.5 million employees of public sector and the 672,0008 pensioners made up 36% of recurrent spending in 2022 (interest took up 44%). This is an ongoing expense that needs to be paid. Are the citizens receiving valuable public services in return?

In 2016 there were 230,525 teachers and around 62,000 in the health service. The problem is with the million others in employment. The number in public employment stood at 812,472 in 19949 but is now estimated at 1.5 m10. Was there a proportionate increase in the quality of services that people received?

Voters must realise that there are no easy or painless solutions. After a crisis such as this, countries may experience ‘a lost decade’ before output reaches its pre-crisis level. Populists who promise quick solutions without proper diagnosis or are unable to locate the sources of the problem could easily tip the country back into crisis.

Footnotes:

1 Sri Lanka: Macroeconomic Developments in Charts, First Quarter 2023, p34 https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/statistics/mecpac/Chart_Pack_Q1_2023_e1.pdf

2 See reports: https://www.advocata.org/commentary-archives/2019/11/5/coping-with-latest-cope-report; https://www.dailymirror.lk/breaking-news/Fraud-corruption-rampant-at-SPC-GMOF/108-276243;

3 https://readme.lk/spc-has-paid-lkr-644-million-for-software-that-doesnt-work/

4 https://www.news.lk/news/political-current-affairs/item/26077-govt-agencies-failure-to-act-on-cope-recommendations

5 The Institute for Government, a think tank offers a useful guide: https://www.instituteforgovernment.org.uk/sites/default/files/2024-01/preparing-for-government.pdf

6 https://star.worldbank.org/blog/fifteen-years-star

7 Ministry of Finance Annual Report 2022, p109, https://www.treasury.gov.lk/api/file/39a16e61-7659-476b-8f18-d969c7a69733

8 https://www.parliament.lk/uploads/documents/paperspresented/1662013778004147.pdf

9 “Census Of The Public And Semi-Government Sector Employment 1994”. 1994. Statistics.Gov.Lk. http://www.

statistics.gov.lk/PublicEmployment/StaticalInformation/census_reports/CensusOfPublicAndSemiGovernmentSectorEmployment-1994FinalReport.

10 https://economynext.com/crisis-hit-sri-lanka-finally-starts-to-deal-with-bloated-public-sector-96277/

(The views expressed in this article are those of the writer and do not reflect the views of organisations he is affiliated to.)

High tariffs on basic food items: A blow to the struggling masses

By Dhananath Fernando

Originally appeared on the Morning

Last week it was reported that the Government has again imposed high tariffs (Special Commodity Levy) on some food items such as cowpea, finger millet, undu, maize, and a few others. At a time when seven million people are below the poverty line, tariffs on food items are a crime. Imposing tariffs on such food items is not done just to increase Government revenue.

The tariff on undu has increased to Rs. 300 from Rs. 200 per kg. For finger millet and other items, it has increased from Rs. 70 to Rs. 300. How much can a Government earn from a population of 22 million by imposing a Rs. 300 tariff on finger millet and cowpea?

According to the Ministry of Agriculture, the per annum demand for cowpea in Sri Lanka is 15,000 MT, while the demand for finger millet stands at 10,000 MT. Even if we import the entire demand for finger millet and cowpea, the amount the Government can earn as tariff is about Rs. 7.5 billion for the entire year.

This is a negligible amount compared to our expenditure. The expenditure for the President is about Rs. 5.8 billion as per the Budget estimate for 2024. It is clear that the increase of the Special Commodity Levy (SCL) for food items will have an impact beyond taxes, because at this tariff rate no one will import finger millet or cowpea.

However, it means that the consumer will lose the opportunity to purchase cowpea, undu, and finger millet for Rs. 300 less than what is available in the market. How can we justify people paying an additional Rs. 300 when seven million people – one-third of our country – live in poverty?

This general justification is that this tariff is imposed to protect local manufacturing of finger millet, cowpea, and maize. Even if this is true, what is the justification in terms of consumers when they no longer have access to affordable food items?

Given existing lifestyle changes, products such as undu, cowpea, and finger millet are mainly consumed not by the wealthiest section of the society but the poorest. Diabetes patients, pregnant mothers, estate workers, people in the north and east are the primary consumers of these food items.

It doesn’t stop there. High prices on maize will impact the entire food supply chain as maize is one of the main expenditures of the poultry industry. About 40% of the cost of poultry is on food, primarily driven by maize. This indicates that the cost of main protein sources such as chicken and eggs will increase.

The cost of chicken and eggs in turn impacts the costs of the bakery industry and all food items at restaurants and eateries.

Accordingly, the net impact on the entire food supply chain due to this ad hoc Special Commodity Levy is much greater than what we see at the surface level. Although it is not ideal, if the Government really wishes to protect finger millet, cowpea, and maize farmers, it can give a direct subsidy of Rs. 7.5 billion, based on the productivity and efficiency of farms.

This would mean that at least those who push for better cultivation methods receive an incentive to ensure a better harvest, rather than asking consumers to shoulder a flat price hike for all food items at a time when they are struggling to put three meals on the table per day. People are facing excessive burdens due to inflation and the high tax rate in order to pay for the mistakes of our policymakers.

The second argument against the high SCL on imported food items concerns saving foreign exchange. Firstly, we cannot save foreign exchange through higher tariffs because the demand for imports is determined by the money supply within the economy. People buy forex to import by spending the rupees they earn. When they buy forex in rupees, they have to reduce their consumption by some other means.

If we can save forex simply through higher tariffs and import controls, we have to question how we ran out of forex when import controls, in place since Covid, existed until very recently.

We even controlled some of our pharmaceutical imports but we were still unable to save forex. Foreign exchange cannot be saved by import controls or high tariffs.

Secondly, 40% of our imports is fuel. If we really want to cut down on our imports, we must reduce fuel imports, which this column has recommended multiple times, suggesting a market system for public transport. By imposing a Special Commodity Levy on food, we are simply asking the poorest of the poor to face starvation while providing the opportunity for rent-seeking behaviour of a few crony elites.

Whether in socialism or in capitalism or with the argument of saving foreign exchange, how can we justify a Special Commodity Levy of Rs. 300 on basic food items when one out of every three fellow Sri Lankans are forced to skip a meal due to poverty?

Prioritising SOE bill over OSA: A shift in economic direction

By Dhananath Fernando

Originally appeared on the Morning

While the Government has prioritised the Online Safety Act (OSA), which is extremely negative for our economy, there are other bills in the line-up which are expected to get through. One such bill is on the State-Owned Enterprise (SOE) holding company.

The SOE Restructuring Unit (SOERU) has outlined the principles of SOE reforms, which are in the right direction, but the Government’s prioritisation of bringing the OSA is definitely in the wrong direction.

Key principles

While the bill on the SOE holding company is yet to be released, the SOERU has outlined nine key principles on which they expect to base the SOE reforms. In the first principle it admits the Government has no role in commercial activities except for three instances.

(1) If there is a concern on national security, the Government can engage in business.

(2) If there will be no private participation in certain industries given the size of our market, the Government can engage in business. For instance, if we open the rural bus routes for the private sector, there may be a possibility that, given the nature of the low population density, no private bus operator will be interested in entering the market. While it can be to an extent addressed through allowing to charge a higher price and the Government providing a direct cash subsidy to the citizens in the rural area, there can be practical challenges. In that case the SOERU principals have left the space for the Government to enter business.

(3) If the service from the Government is essential in nature but if the regulatory mechanisms are weak for competition, where there is opportunity for market exploitation by the private sector, the Government can be in the business.

While the three areas are logically right, we have to wait for the final bill to see how exactly this has been worded. The danger is that governments are so powerful that even in the above three areas, it can leave a lot of room to keep a lot of existing SOEs under the government of the day if the political ideology is to keep SOEs, claiming it is under national security.

In the Right to Information (RTI) Act, there is provision that the authority can decline to disclose the requested information if it threatens national security. For most RTI requests, many Government institutions have been responding that the information cannot be disclosed due to national security reasons. Therefore, defining national security or the process of deciding how an organisation or industry comes under national security is important.

Unless the Government can always build a logical stand, even institutions like the Cashew Corporation will have to be under the Government as it can impact national security.

On the second condition, that in the absence of a private player due to limitation of the market size or another criterion for a service that is essential in nature, the guidelines have to be developed in the case of what could be a new player wanting to join the industry later.

For example, it could be an industry with high capital investment and low market penetration, making Sri Lanka unattractive at the beginning due to the market size. As a result the Government can be in that business as the service is in the nature of being essential.

But over the years as technology and other parameters develop, at one point there may be new players interested in joining the industry. At that point, a natural resistance may occur from the SOEs over a new entrant being in the market as they will lose their monopoly status. The same happened when Lanka IOC entered the market and still there is some resistance to the entrance of Sinopec and other players in the energy market.

Deciding what an essential service is also requires a framework. Otherwise, when a government wants to be in a business, it can easily announce that industry as an essential service and enter the business, bringing forth various reasons.

All of the above are beyond the scope of the SOE law, but we need to keep in mind that these are the loopholes governments always have when ideological stances are different. Even if the new bill passes, we should not underestimate the skills of policymakers in finding the loopholes.

Other principles

The fourth principle of the SOE holding company is to bring all SOEs under one registration format. At the moment, different SOEs have different structures with a very high degree of complexity. For instance, the railway is a commercial activity and runs as the ‘Railway Department,’ while the Ceylon Electric Board runs as a board under an act. Meanwhile, Lanka Hospitals is a hospital but operates as a private limited company. Therefore bringing them all under one registration is vital when we set up the SOE holding company.

The fifth principle mainly focuses on the governance of SOEs as the SOE reform process is a longhaul game. The SOE holding company and the subsidiaries are required to adhere to Colombo Stock Exchange guidelines. This includes releasing quarterly financial statements and the board of directors being required to conform to the Code of Best Practice on Corporate Governance.

The other principles in the list are on unbundling the regulator and the operator in certain industries. There are industries run by the Government where the Government is a player as well as a regulator at the same time.

Overall the SOERU’s principles to base the SOE holding company is in the right direction, although there is always room for politicians to exploit the principles.

It is sad to see the pushing back of such important SOE holding company legislation over the draconian Online Safety Act.

Housing affordability in Sri Lanka: The looming crisis and need for multifaceted approach

By Advocata Institute

Originally appeared on the Daily FT

Sri Lanka is at a crossroads, confronting with a mounting crisis in housing affordability that demands immediate and comprehensive attention. The complexity of this challenge is underscored by the stark disparities between the escalating housing demand and the sluggish pace of housing supply growth. Data derived from the 2012 Census of Population and Housing Survey paints a stark reality: housing demand has surged by 11.9%, reaching 5,875,009 units from 2012 to 2022. In contrast, housing supply has lagged, with an increase of only 9.5% to 5,685,151 units. This glaring gap which is approximately 3.23% of housing units (189,858) raises a red flag, necessitating urgent and effective policy interventions.

Delving deeper into the district-wise dynamics exposes the severity of the issue. Colombo, as a critical urban hub, experienced a 10% surge in housing demand, reaching 635,385 units in 2022. However, the corresponding supply increase was a mere 7.4%, resulting in a substantial shortfall of approximately 26,978 units. This scarcity not only exerts upward pressure on house prices but fundamentally challenges the broader affordability of housing, impacting citizens across various socioeconomic strata.

Challenges

At the heart of this crisis lies a multifaceted challenge. Urbanisation, population growth, and evolving societal needs have outpaced the pace at which housing supply is expanding. A legacy of historical housing policies, coupled with limited private sector participation, has left the Government shouldering the bulk of responsibility. The absence of a robust regulatory framework and streamlined approval processes further impedes the swift execution of housing projects. This perfect storm of factors has led to a housing deficit that reverberates across the nation.

To this, in the housing landscape in Sri Lanka, a disconcerting reality emerges from the statistics. Out of the 6,094,115 families, a fraction grapples with precarious living conditions, with 0.73% residing in cadjan/palmyrah houses, 4.56% in temporary structures, and 6.35% inhabiting partly constructed houses. The prevalence of households not yet plastered stands at 13.79%, while 7.25% have roofs consisting of galvanised sheets. Alarmingly, 3.55% represent homeless-landless families, and 0.49% temporarily dwell in quarters for job requirements. Another 2.74% of families are categorised as homeless yet possess a block of land, and 1.31% are temporarily living on rent while maintaining a permanent residence elsewhere. Additionally, 8.39% face challenges with proper water supply, 2.97% lack adequate access to roads, 3.19% lack proper sanitation facilities, and 2.74% are without electricity. These realities underscore the multifaceted challenges faced by a significant portion of the population in securing decent and dignified housing.

Housing demand, a pivotal component, is linked to demographic trends, housing finance accessibility and cost, and Government policies encompassing taxation and subsidies. The precarious nature of property rights, particularly insecure tenure, has the potential to hinder investments in housing. Conversely, housing supply is contingent upon factors such as land availability, robust infrastructure, construction material costs, and market efficiency. The interplay of consumer, producer, and Government behaviour further shapes the delicate equilibrium of demand and supply in the housing sector. Government policies, notably those governing land use and building regulations, wield significant influence over housing construction, subsequently impacting the supply of affordable housing.

Multifaceted approach

To navigate this housing affordability crisis, a multifaceted approach is imperative. Reforming housing policies is imperative for the Government, necessitating an alignment with contemporary needs and fostering adaptability to evolving trends. Priority should be given to strategic reforms that emphasise affordable housing development in both urban and rural areas. Facilitating collaboration between the public and private sectors emerges as a key solution to bridge the housing gap. Incentivising private developers to partake in affordable housing projects, coupled with supportive measures like infrastructure and regulatory facilitation, can yield significant positive outcomes. A pivotal aspect involves strengthening the role and capacity of the National Housing Development Authority (NHDA). This entails regular leadership by the NHDA in conducting comprehensive housing needs assessments that encompass qualitative dimensions. Securing adequate funding, autonomy, and an unwavering commitment to improving living standards within NHDA are indispensable components of this multifaceted strategy.

Housing affordability is not just an economic metric; it's a barometer of societal well-being. A secure, affordable home is the bedrock upon which individuals build their lives. It impacts education, healthcare, and overall community prosperity. Failure to address this crisis risks leaving a lasting scar on the nation's social fabric.

The absence of a cohesive, long-term housing policy focused on low-income housing has significantly contributed to the limited construction of affordable houses. Historically, the Government's housing initiatives, especially in the past two decades, primarily aimed at clearing slums for land development rather than addressing affordable housing concerns directly (The World Bank 2012). Resolving housing policy issues is crucial, and it's equally vital to address market failures in land, building materials, and the construction industry to enhance housing affordability (World Bank 1993).

To enhance the business environment, the Government should transition from being the sole provider of housing to creating a legislative, administrative, and policy framework that fosters a competitive market. Direct Government involvement in construction, coupled with regulatory roles, may lead to conflicts of interest. Instead, policies should incentivise private entities to engage in affordable housing construction. This involves eliminating protectionist measures like import tariffs, para-tariffs, and addressing concentration issues in building materials industries.

Addressing institutional failures is paramount. Multiple agencies with overlapping functions create bottlenecks, hindering policy development and project execution for adequate and affordable housing. Streamlining these agencies, ensuring coordination, and establishing a robust regulatory framework are necessary. Regulatory issues, such as land availability and titling problems, are major barriers. Unlocking Government-owned land for housing projects, improving titling processes, and digitizing land registries can facilitate development and clear ownership, enabling better access to finance.

Provision of infrastructure and support services is crucial. Government investment in public services like water, sanitation, and public transportation can unlock regions for housing development. Improving the efficiency and productivity of the construction industry, potentially through standardised housing units and prefabrication, would significantly reduce construction costs.

Reducing the cost of borrowing and enhancing financing options for low-income households is a challenge. Mortgage guarantees, encouragement for banks to access low-cost wholesale funding, and addressing issues related to land titling and borrower risk can enhance access to affordable financing. Additionally, focusing on the underdeveloped incremental housing finance market can cater to the unique needs of low-income households.

Improving data availability is essential for effective planning. Establishing a centralized mechanism to collect, analyse, and disseminate recent housing data is crucial for long-term planning and achieving sector and economic objectives. Conducting regular surveys and censuses will provide up-to-date insights into the state of the housing sector in Sri Lanka.

In conclusion, addressing these multifaceted challenges requires a holistic and well-coordinated approach involving comprehensive policy reforms, market enhancements, and improvements in data collection and analysis mechanisms.

Middle class caught in housing dilemma

By Dhananath Fernando

Originally appeared on the Morning

The system in Sri Lanka often categorises many individuals in the middle class as products of failure, not because they have failed themselves, but because the system has failed them. An evident sign of this failure emerges when individuals strive to afford a house, as the decision to build or buy a basic house in Sri Lanka frequently forces them to sacrifice many other life choices due to the exorbitant cost of construction.

Dr. Roshan Perera and Dr. Malathy Knight of the Advocata Institute recently authored a research report revealing that property prices in Colombo exceed the same income-to-property ratio found in New York, Tokyo, Beijing, and London.

The exorbitant cost of construction primarily stems from the steep prices of raw materials in Sri Lanka. For instance, a tonne of cement costs about $ 114 in Sri Lanka, compared to $ 53 in Thailand. Similarly, the cost of a tonne of steel in Sri Lanka is around $ 760, in contrast to $ 561 in Singapore.

Factors behind high costs

Two main factors force consumers to pay higher prices. First, Sri Lankans encounter restricted access to construction materials at lower prices due to import restrictions or tariff barriers, even when Free Trade Agreements (FTAs) are in place, as most construction items remain on the negative list. A negative list refers to an exclusion clause in an FTA that prevents an item from being imported.

Second, the high tariffs or import protection for construction materials are often justified under the narrative of ‘saving dollars’ or ‘preserving valuable foreign exchange’. However, the truth lies in the high cost structures of local manufacturers, making them unable to compete if import bans or tariffs are reduced.

For example, the total tariffs on tiles were approximately 83% in 2021, with para-tariffs such as CESS and PAL making up about 50%. High energy prices in Sri Lanka contribute to the high costs for local companies, and importing tiles may actually reduce foreign exchange expenditure due to energy savings.

Far-reaching impact

The high cost of construction for the middle class results in sacrificing many life choices, including higher education, education for children, investments, and wealth creation. This challenge becomes even more pronounced when faced with an interest rate of 10% for housing loans or business expansion.

The impact of the high cost of construction extends beyond housing to the tourism sector. Hotels require refurbishment approximately every five years to remain competitive, and with high construction costs, room rates tend to be high. This puts a strain on hoteliers, including small and medium-scale hotels, making them less competitive with markets like Thailand or the Maldives.

According to research, a 500 sq ft house can only be affordable for Sri Lankans in the 70th income percentile, while a 1,000 sq ft house is attainable only for those in the 75th income percentile, highlighting the underlying tragedy of the high cost of construction. Many construction inputs in the market exhibit characteristics of monopolies or oligopolies.

The solution to reduce construction costs involves first removing construction materials from the negative list and eliminating imposed para-tariffs. This competitive market approach will lead to lower prices, benefiting consumers. As a result, aspirational Sri Lankans will have more space in life for better choices, rather than spending their entire lives paying off housing loans. When the middle class has more choices in life, their decisions become a source of income for many other industries, fostering economic growth.

Economic freedom for true independence

By Dhananath Fernando

Originally appeared on the Morning

For the last 76 years, we Sri Lankans have looked at different ways of making Sri Lanka a wealthier and developed country. A popular refrain during every Independence Day celebration week has been that “when we got independence, we were only second to Japan”. Another quote bragged about how good we were, as “Singapore was behind us and they took Sri Lanka as their model for development”. 

Unfortunately, much of Sri Lanka’s independence has only been ceremonial, not real. We have still failed to capture the science of equitable wealth creation, which only comes with economic freedom. Economic freedom leads to true and meaningful independence. All countries in the region, including Singapore and Japan, overtook us by establishing the elements of economic freedom at various degrees rather than simply taking Sri Lanka as an example.  

Science of wealth creation 

Wealth creation is science, not magic. It has always been a function of maximising the use of limited resources and increasing productivity. Both can be done when individuals have better incentives to create wealth. For individuals to create wealth, their rights over property have to be secure. The government should ensure that the property of people belongs to them. 

The government should allow individuals to do business and create wealth instead of trying to intervene in markets and pricing. Further, a government poking its fingers in and preferential treatments in a sector serve to discourage individuals from being in the same business. 

Wealth can also be created when raw materials are competitive in price and good in quality. Having a variety of choices in a competitive market system is paramount. The simplest way of creating a competitive environment is by opening up for international trade. 

Regulatory barriers have to be minimal. This does not mean the government plays no part in regulation. The government can adopt a regulatory function without intervening in the market to ensure that the competition and competitive nature of the industries are protected. 

Lastly, all transactions in the modern world take place in a fiat currency. Simply put, we store all our production as individuals in a form of a paper called money. The monopoly of money belongs to the government and when it does not protect the value of the money, it amounts to theft of the hard work and production of an individual. 

The science of wealth creation is simply establishing these five principles. This has been statistically proven by the Economic Freedom of the World Index by the Fraser Institute. 

Over the decades, it has monitored these five indicators and data have shown the relationship and causation between wealth creation. 

The per capita GDP of countries with the highest level of economic freedom is on average about $ 48,000 while for countries with the lowest level of economic freedom the per capita GDP averages at $ 6,300. 

Even if we consider the standard of living amongst the poorest 10% of the population in the countries with higher economic freedom, the income distribution among the poorest 10% is eight times higher than in countries with very low economic freedom. 

Sri Lanka falls under the third quartile, meaning that our performance in economic freedom is not that great. We have ranked 116 out of 165 countries. 

Science of economic freedom

In modern times, many people consider happiness as a function of wealth, freedom, and independence. When we look at the data on economic freedom, it is clear that countries with higher ratings indicate a higher score on the UN World Happiness Index as well. 

Even if we look at poverty numbers, the countries with higher economic freedom obviously have low poverty rates compared to countries with low economic freedom. 

Over the last 76 years, the science of economic freedom is something we have failed to utilise. One reason this column has always advocated for reforms of State-Owned Enterprises (SOEs) is because a limited government improves the economic freedom of people, which leads to creating wealth. People having ownership and rights over land is another reform we require to improve the property rights indicated in economic freedom, which will also lead the process of wealth creation.   

On this independence day, our prime focus has to be on creating wealth. We can create wealth by establishing economic freedom. When we have wealth and economic freedom, we become independent. That is when we leave the trap of poverty, our standards of living improve, and we provide value for the globe. 

Happy Independence Day, Sri Lanka.

The dangers of the Online Safety Bill

By Dhananath Fernando

Originally appeared on the Morning

The Online Safety Bill is scheduled to be taken up for debate at its second reading in Parliament on 23 and 24 January. Unfortunately, this bill is going to make our current economic situation a bit more difficult in the short run and as well as the long run.  

The Asia Internet Coalition (AIC), where tech platform giants such as Google, Meta, and Amazon are partners, twice brought up the danger this bill could pose to the digital economy.  

Economy is beyond just supply and demand of rupees and cents. Economies are mainly the ideas that solve a problem of fellow humans and an exchange of those products and services with scarcity of resources. 

Problem-solving for humans comes with the freedom to think and with freedom of speech and dissemination of information. All attempts to restrict our freedom of expression, speech, and dissemination of information will backfire on the country and the economy. 

Sadly, the Online Safety Bill seems to be doing just that.

Self-censorship kills ideas for prosperity 

The bill has left significant room for vagueness in many clauses and definitions. According to the proposed bill, the commission appointed by the Constitutional Council has the powers to determine whether some facts are true or false and take follow-up actions. 

One example to showcase the impractical nature of this approach is the case of the Government decision on cremation of Covid-infected bodies, claiming that viruses could leak into the waterbed and cause contamination. This decision was highly debated on social media platforms and even scientists were divided on the decision. 

So if someone complains based on the Online Safety Bill, how does the committee decide on what is true and what is untrue when even scientists are unsure? Later the Government withdrew its decision and changed its initial stance. What was perceived as truth at one point was proved to be wrong at another point. What could have been the outcome if the Online Safety Bill had been enacted by then and if legal proceedings had been taken forward for those who commented for and against cremation of Covid deaths?

Looking at lessons from history, Galileo was killed for bringing an alternative view of the perceived truth on the shelving of the solar system. This act in this form takes us back to the repression faced by Galileo. It is severely problematic when the arbiter of ‘truths’ of fringe politics can also hand out punishments.

Generally when there is uncertainty, for their own safety, people engage in self-censorship. Self-censorship restricts the flow of ideas and minimises the ability of the economy to solve the problem. 

Let’s imagine that the Online Safety Bill had been enacted before 2021. During that time many analysts and economists on all social media platforms warned the Central Bank that excessive money printing could lead to inflation. The Central Bank was of the view that there was no relationship between money printing and inflation. So if the Central Bank complained to the Online Safety Commision on the opinions on the matter, most of the economists would have been punished by the bill by the time inflation was hitting 72%.

If the Central Bank says inflation has no relationship to money supply, there would have been no other way the commission could establish what was true or what was false at that point of time. The other possibility is that most of the economists would have self-censored knowing the repercussions of the bill, which could have caused greater harm to society.

If this bill creates a culture of self-censorship, our ability to hold the State accountable, ability to innovate, and ability to create would be quenched, leading to a stagnant economy. 

Impact on SMEs

The business models of tech giants are very cost effective. They do not have offices in every country, nor staff to monitor all content. Most of that is done through algorithms. They regulate harmful content through technology (algorithms) and very strict community guidelines are adhered to.

Anyone can read how comprehensive the guidelines of these tech platforms are on safety and trust and how effective they are on responding to these platforms’ community guidelines. Tech firms have refined algorithms to an extent that not a single photo falling under nudity can be found as the algorithm restricts them automatically. In that sense the tech companies have done a fantastic job compared to what a government tries to do with a bill in a market-based system.

Platforms such as TikTok are not only concerned about human rights but also about human safety, where drone shots with a risk of accidents are eliminated due to very high community standards.

If the Online Safety Bill becomes too much of a burden for these tech companies, with a response time of 24 hours for inquiries by the commision as per the bill, they will tune their algorithms to be very strict, which will have an impact on SME businesses run on social media. Simply, the competitors can complain on certain pages featuring products with various claims and pose an unnecessary burden to SMEs. 

Our tourism industry, where we have a long-tail SME sector, especially uses these platforms for room reservations. The reviews coming in the form of discrimination will fall under this and the booking sites will also fall under that purview, so they are likely to react to the online safety regulation, which will have an impact on our dollar-earning tourism industry.

The AIC has already twice highlighted its displeasure in diplomatic language, claiming as follows in a statement: “The proposed legislation, in its present form, poses significant challenges that, if not addressed comprehensively, could undermine the potential growth of Sri Lanka’s digital economy.”

Wrong signals to markets 

The Online Safety Bill also provides wrong signals to the market, including the International Monetary Fund (IMF) and our creditors. The IMF has provided a governance diagnostic where many other pieces of legislation, including the SOE Holding Company Act and Procurement Law, are among the top 16 priorities. Sadly our Government has brought a bill on Online Safety Bill, for which no stakeholder group which assisted Sri Lanka during the economic crisis has shown any interest other than highlighting its problematic nature, which ultimately impacts economic growth. 

Since actions speak louder than words, this will provide the wrong messaging to our creditors, bilateral and multilateral partners, and investors that our Government’s priority is not the economic crisis.

From the point of view of the investor, this will also have a serious impact on attracting FDI and key players with the potential to transform our economy. For instance, one company which has shown interest in investing in Government shares of Sri Lanka Telecom is Jio, where a majority share is with Reliance Group in India. Meta, Google, Intel, and the Saudi Arabia Wealth Fund are a few other strategic partners and shareholders of Jio. Can we expect a tech company to provide a positive referral to its main shareholder in an investment decision when its own platforms are under risk through an Online Safety Bill in Sri Lanka?

This bill is beyond repair and just plastering over its shortcomings will not make it any better. If this goes through Parliament, the risks on freedom and signalling for investors will be quite negative. Importantly, in an environment where freedom does not prevail, economic growth and prosperity will fail drastically. The only solution left for this bill is to repeal it.

Non-negotiable reforms for election manifestos

By Dhananath Fernando

Originally appeared on the Morning

The year 2024 will be an election year. The general flow of events is that each political party and candidate will launch a manifesto of a grand-scale and present their plans for the people and the country. Most of these promises will not be implemented or will only be half implemented. In certain cases, the opposite of what was promised will be implemented. 

Most manifestos are presented in general terms with a target of 20 years ahead with little data. Many manifestos across all party lines are wish lists with no action plans.

In my view, this time there is a slight difference. 

Regardless of the party formation or whoever the presidential candidate will be, there are few reforms that are non-negotiable. Ideally, across all manifestos, there are five basic ideas which have to be the common denominator.

Strengthening social safety nets 

Following the worst economic crisis in Sri Lanka’s history and high inflation, about four million people have fallen below the poverty line. That puts seven million people under poverty. The recent Household Income and Expenditure Survey carried out by LIRNEasia and the World Bank indicates significant poverty levels and aftereffects of poverty due to the economic crisis. As a conscientious society, we need to take care of our poor people with the social safety net. 

The social safety net is not just an allowance. It is a system and a process of targeting the right people, providing an exit route, and with proper administration. The current Aswesuma programme is making some progress with World Bank assistance, but regardless of the political leader who comes to power, it is a non-negotiable condition that social safety nets have to be strengthened and improved. 

The current process has too many loopholes which have to be addressed and improved. Simplifying the process, providing the exit route, and monitoring and depoliticising has to be a continuous effort from the new leadership of the country.

SOE reforms 

Thus far, mandatory SOE reforms have been painfully slow. Many parties with vested interests are trying to delay it until the election. However, the continuation of SOE reforms is a must. 

Colossal losses, interference in the private sector, intervening in markets, creating an unfair playing field, and inefficiencies are a few reasons why SOEs played a pivotal role in Sri Lanka’s economic crisis. SOEs are vehicles of corruption and have diluted entrepreneurship and Foreign Direct Investments significantly. Without reforming SOEs, the future of Sri Lanka appears to be bleak. 

The principles announced by the SOE Restructuring Unit are in the right direction, but the SOE Act and reforms of the Ceylon Electricity Board, Ceylon Petroleum Corporation, and many other networking industries are a must. 

Anti-corruption and governance reforms

Execution of anti-corruption laws and governance reforms is another area which has no room for negotiation. The International Monetary Fund (IMF) Governance Diagnostic and many other locally-developed reports on governance provide direction on what needs to be done. 

Strengthening our Judiciary system, transparency and accountability in our tax system, removing tax exemptions, and repealing the Special Commodity Levy and the Strategic Development Act too falls under governance and anti-corruption reforms, as those acts provide the legal opportunity for corruption. 

There is a strong sentiment from people on the contribution of corruption to the crisis, so taking long-term measures regarding corruption is a must. Anti-corruption and governance reforms go beyond going after corrupt politicians. Rather, it is a system and framework for minimising government influence. Some reforms are complementary and reforming SOEs is also a key component of anti-corruption and governance reforms, as these SOEs play a vital role in corruption.

Following the IMF programme and debt restructuring 

Given the international financial architecture, we have no option other than sticking to the IMF programme. We can negotiate some of the actions that we have promised, but overall indicative targets and reforms have to be maintained. Otherwise, it will be yet another incomplete IMF programme and the debt restructuring process will be in jeopardy. 

Debt restructuring and the continuation of the IMF programme are very much interconnected. At the moment, external stakeholders are concerned about political instability and in fact, the IMF’s first review identifies the political risks for the continuation of the IMF programme. A commitment from any political leader on sticking to the programme will help Sri Lanka in rebuilding relationships with the world.  

Trade reforms and joining global supply chains 

We have to grow our economy to emerge from this crisis. Tax revisions make it likely that growth will slow down and the only solution to grow small island nations like Sri Lanka is through global trade. Our problems regarding global trade are mainly the problems in our own regulations and systems. 

We have to remove our para-tariffs and simplify the tariff structure for a few tariff lines. Not only will this help trade, but consumers will also have a greater choice of goods and services as well as competitive prices. 

On the other hand, the Government can improve the revenue from Customs since at the moment, the high tariffs are a main reason for revenue leakage in the form of corruption. Trade reforms are about growth, minimising corruption, encouraging exports, and assuring reasonable prices. Even at present, after very high taxes, there are levies such as the Special Commodity Levy, Ports and Airports Development Levy, and a huge array of taxes which hinder the competitive nature of our economy.

These five policies, in my view, are non-negotiable. If any administration deviates from them, it is very likely that we will fall back a few miles behind where we started. 

Understanding the economic crisis: Corruption a symptom, not the root cause

By Dhananath Fernando

Originally appeared on the Morning

The most common rationalisation of Sri Lanka’s economic crisis is to blame corruption, which is a complete mischaracterisation. This is not to say that corruption had no part in the crisis, but to place the blame solely on corruption would be inaccurate. In my view, there has been an economic policy problem which incentivised corruption, hence that is a problem that we have to fix, rather than trying to fix corruption. Corruption is just a symptom and policy is the root cause.

However, policy problems cannot be analysed in a vacuum, because simply having a policy does not mean everything will be alright. Policy has to be analysed based on the strength and stability of institutions.

One good example is the Fiscal Management (Responsibility) Act No.3 of 2003. According to the act (policy), the Government cannot exceed the budget deficit above 5% of the GDP. Since the act has enacted every budget we have presented, our budget deficit has been above 5%. Nothing has happened to any government for violating their own rules. We have the policy, but we do not have the institutions to enforce it or the stability or capacity for institutions to abide by the policy.

The anti-corruption commision is another good example. Many countries that wished to eradicate corruption have set up anti-corruption units, but when anti-corruption units are also corrupt, since they have been established by the existing powers, it is self-defeating.

Therefore, thinking that we can avoid an economic crisis or overcome the crisis by focusing on corruption as the sole measure shows a lack of depth. We have to evaluate the system somewhat more broadly to fix it.

A common question people ask is, “where are the assets for the loans we have taken?”. In that case, people think we have taken loans and syphoned that money out without investing. The deficit of the value of the projects and the loans we have taken is generally considered to be that which has been spent on corruption. While there have definitely been kickbacks from the projects, most of the money we have borrowed has been borrowed not for projects but to pay the interests of the loans we had borrowed before.

From our debt, about 74% has been used to pay interest or for exchange depreciation (40% for interest and 33% for currency depreciation). Since 1999, most of our debt has gone towards bad policies in the form of interest and for the exchange rate. At the point of borrowing money, similar to what happened in the Central Bank bond scam, there can be corruption, but the corruption is often an outcome of a bad policy or a poor system rather than a standalone problem.

Thus, rather than thinking about jailing the corrupt, it is easier to fill the gaps in the system where corruption takes place. This is where a market system is needed. The market system has the power to make the players of corruption uncompetitive, because corruption is costly. When the cost is too high, provided the consumer has a choice, they can shift to alternatives. Therefore, it is vitally important to set the market system straight and keep entry and exit barriers at a minimum.

Framework of the market system to think about corruption

How do we decide the project?

Generally, corruption takes place in projects and the decision-making processes of the projects. These mainly come as unsolicited proposals. Someone proposing a solution for a problem that even the government is unaware of falls under the category of unsolicited proposals. The government has the discretionary power to decide which projects are to be done and which projects are to be set aside. This is how quite a lot of construction projects, instead of education and healthcare, get priority.

Most projects under SOEs also fall under this category, which is why SOEs are considered vehicles of corruption and SOE reform is a must. Adhering to the National Physical Plan and getting it through Parliament is one way to minimise it.

Who does the project?

When the project is decided, the selection of the implementation partner is the next window for corruption. Again, it can be awarded through unsolicited proposals or there can be technical corruption where the specifications of the supplies are in favour of a selected supplier.

Unsolicited and competitive processes violate the market system, and on a technical level, corruption is very hard to detect even at the legal stage. However, with an open process on complaints and reevaluation, there is still room for improvement. There are also cases where even the competitive process is established due to a lack of trust in the system; the most suitable person doesn’t want to apply and go through the process.

Deciding on the price

The other point of corruption is when it comes to deciding on the price. It could be the interest rates on bonds, the contract value, or the price of the energy purchase. Price discovery is also a market-based process. When prices are allowed to be set without a market-based approach, there is room for corruption. That is how most of the energy agreements were signed and we borrowed money to pay the price. Rather than trying to fix the individual involved in corruption because the next person could repeat these same actions, it is advisable to fix the problem first.

Deciding the quality of materials

The fourth case is where even the people selected through the competitive process simply use inferior quality products. Our experiences in poor quality medicine at the Ministry of Health is just one example.

Corruption can take place in projects or in processes based on any of the above or a combination of any of the four. However, this takes place only when the decision-making power or discretionary power is given to someone who is not the owner of the risk or the investment. Otherwise, it leaves competition out or maintains information asymmetry for someone to benefit from.

In a market system where competition is given priority and prices are allowed to reflect the scarcity value of money, it naturally leaves corruption behind, but creating the information balance is not easy.

Therefore, while no market or government is perfect, a market system is a better system to avoid corruption, rather than expecting the government to eradicate corruption, since the government has no interest or incentive to do business or to eradicate corruption.

It is not about the private sector versus the government – it is all about a market system which incentivises transparency and minimises room for corruption. Our continuous failure to build that system was the reason for our fall (economic crisis) and we can only overcome it by fixing it, since it is the root cause, and not by fixing the symptom called corruption.

(Source: CBSL, Advocata)

VAT: The good, the bad and the solutions

By Dhananath Fernando

Originally appeared on the Morning

The Value Added Tax (VAT) increase from 15% to 18% and the removal of about 95 items from the VAT exempted list to a VAT applicable list has raised concern among politicians and people alike. 

When taxes change too often, public confusion and erosion of tax revenue both have to be expected. VAT was once 8% in Sri Lanka and then revised to 12%. It was again increased to 15% and finally now to 18%. The VAT threshold was once at Rs. 12 million and later increased to Rs. 300 million. Currently it is at Rs. 80 million and expected to be reduced to Rs. 60 million. 

When the VAT threshold was increased to Rs. 300 million from Rs. 12 million, the number of individuals registered for VAT dropped to 8,000 from 28,000. Our policymakers are discussing expanding the tax base after diluting our tax base through our own inconsistent policies. 

One of the key principles of taxation is stability, according to the Tax Foundation. The other principles are simplicity, transparency, and neutrality. When tax rates and thresholds are changed often, thIMFe markets and individuals react and tax revenue will erode. 

A complicated context 

Sri Lanka’s context is sadly more complicated than many other cases. We have given a commitment to the International Monetary Fund (IMF) on increasing our tax revenue because our interest costs are extremely high. Most of the interest is inherited due to bad financial management over the years and there is very little meaning in blaming each other. 

On one hand, the Government has no other option but to increase revenue through taxation. However, on the other hand, when taxes are increased the economy will contract. Growth, which is also a key requirement for us to emerge from the crisis, will be affected due to the lowered purchasing power of the people. When the economy contracts, tax revenue will also start to decline.  

Given the perennial weaknesses in our tax administration, the Government has selected the most convenient option of VAT to be increased, since it can be collected easily compared to other taxes. VAT is considered to be better compared to other taxes such as the Nation Building TAX (NBT) or the Social Security Levy (SSL), which are considered to be cascading taxes, where throughout the economic process one tax is applied on top of the other. 

This leads to a situation where the effective tax rate becomes very high, but with VAT, tax will only be applicable for the value added throughout the supply chain. Also, high income earners generally contribute a higher VAT in total as VAT is a consumption tax. People with higher incomes tend to consume more, so the more they spend, the more taxes the Government can recoup. 

The negative impact of VAT can be witnessed when it is applied to food items. The poorest of society gets adversely impacted, since their percentage of expenditure on food is very high compared to people who fall into higher income brackets. 

There will be considerable impact on the overall prices for the common people with the new VAT revisions. The price of petrol and diesel is expected to increase by about Rs. 50-60 (provided the other taxes are not changed and global fuel prices remain the same). LP Gas (12.5 kg cylinder) will increase by about Rs. 500-600. 

Prices of solar panels, electronic items, laptops, and mobile phones are expected to rise. This will also have an impact on inflation as well, but we need to keep in mind that inflation is always a monetary phenomenon. With high prices, people may consider cheaper alternatives and supply and demand will readjust, provided we keep our monetary policy right. 

Solutions 

A key solution to bringing down prices of food items is to remove the Special Commodity Levy (SCL) applied to these items. The SCL not only increases prices, but the provisions provided to the minister to impose and remove the SCL overnight opens significant room for corruption. The recent increase of the SCL on sugar to Rs. 50 from 25 cents is a good example of how an overnight gazette creates room for corruption and passes the burden to the people. 

Other taxes on food items including CESS, Ports and Airport Development Levy (PAL), and many other para-tariffs should be removed. There is a myth that productivity can be improved by imposing tariffs on domestic food items. If that is the case, our industries for milk, yoghurt, cheese, and many other food items have to be extremely productive and efficient. Instead of domestic product growth, we see the same producers ask the Government for further protection. 

Tax competitiveness as a framework 

 Moving forward, Sri Lanka has to look at tax competitiveness as a framework for thinking about taxes. In the global context, everything is about competitiveness, including the tax system. As an example, if corporate tax is 25% in competing markets in the region, we cannot increase the corporate tax to 30%, only considering the revenue requirement of the Government. 

At the same time, we cannot compromise our healthcare and education systems, which help to develop better skills through taxpayer money, by bringing taxes unnecessarily down and compromising our tax revenue. In a market system, competition and prices play a key role, and the same is applicable for taxes, FDIs, and many other variables. 

We have to first take the basic steps of improving tax administration. We then have to rationalise our expenditure and spend where we need to spend, thereafter raising revenue by being competitive. A VAT increase to increase Government revenue alone will not solve our macro instability. We have to ensure macro stability by being competitive in all aspects of the economy.  

Looming political and economic challenges ahead of elections

By Dhananath Fernando

Originally appeared on the Morning

“We know what should be done to get the country on the right track, but we don’t know how to get power back after implementing the policies.” This is a popular statement I hear often when I meet quite a few politicians. The truth is that politicians do not know how to get back power because it’s not an attractive solution.

The popular policies that bring politicians into power are the very same that inspire their ousting at the very next election cycle. People hardly object to good policies unless the same politicians instigate false propaganda. The Right to Information (RTI) Act was just one such instance.

As an election is due next year, it is vital to understand and remember our priorities, otherwise our politicians are likely to take a wrong turn and pass the buck back to the people.

In an election year, the behaviour of any political party is to completely abandon rational economic reforms and play to populist narratives that result in outcomes that are the complete opposite, with the motive of coming to power.

Bringing down fuel prices and announcing other types of subsidies are common tactics. This is harmful, especially when those benefits cannot be financed sustainably, or in some situations, brought into life in the first place.

Even if it does not retain power, the newly-elected government will have a tough time preventing plans that have already been put in place and enacting better policies.

Political risk

In the current context, we run a very high risk of our politicians bringing us back to square one; i.e. another economic crisis. This, given the fact that 2024 is set to be an election year, is a recipe for disaster.

All political parties will shift their focus to slowly becoming more populist rather than being driven by objectivity. Therefore, the real risk is going back to another debt restructuring if we fail to grow the economy and our exports.

There are many politicians who do not understand the gravity of the need for reforms. Regardless of which party or coalition comes to power, there are fundamental issues that need to be addressed.

The process is more or less the same as handing over a house with structural issues from one tenant (government) to the other. The new tenant cannot function because neither the previous tenant nor the owner (people) is willing to fix the fundamental problems.

Risk of a second debt default

Given the unstable political environment coupled with a country already going through debt restructuring, the risks of a second debt default are astronomically high. As we are still struggling with finalising the first debt restructuring, adding a second one into the mix will leave us in dire straits.

The second one will undoubtedly be harder, especially given the significant increase in interest rates and being unable to print money with the new Central Bank Act. If we fail to raise money through markets in order to roll over debt and if we are not open to increasing interest rates, the only option we will be left with is to default again. At that point, most likely there will be pressure once again to amend the newly-enacted Central Bank Act to allow money printing.

Of course, that would be an inflationary measure and we will be back at square one with a balance of payments crisis, debt crisis, humanitarian crisis, and likely a banking crisis too.

Solutions: A common minimum programme for reforms

Reforms are easier in the first 100 days of any government. If we fail to enact reforms within the first 100 days, more often than not, no reforms will take place. Failing to undertake reforms in 100 days means a cost of a five-year delay plus many bad policy decisions in the middle, which are costly and difficult to reverse.

Ideally, if key political parties come to an agreement before an election on selected reforms and execute them regardless of who comes into power, it will at least ensure some stability for Sri Lanka. There are many ideas that all political parties have in common.

Regarding State-Owned Enterprise reforms, there is no political party that says the Government should run an airline. Even National People’s Power Economic Advisor Dr. Anil Jayantha, in an interview with Advocata, noted that they did not believe the Government should do any business with hotels.

Accordingly, there are many other similar areas where we can arrive at an agreement with little difficulty. Therefore, regardless of who wins elections, people can win and sustain some of the economic reforms.

The truth is that reforms are inevitable if Sri Lanka needs to move forward and for any political party to sustain its power. Implementing bad policies, especially considering the status of our country, will make it very difficult to sustain power, because then we will be setting the standard for a new normal in economics and politics.

Fiscal path amidst promises and uncertainties

By Dhananath Fernando

Originally appeared on the Morning

Starting from the second week of November, every minute in Parliament will be focused on the national Budget. Fortunately or unfortunately, many of the promises outlined in the Budget are unlikely to be implemented or fulfilled.

At the same time, items that are not in the Budget may be implemented midway through the year, based on the direction of the wind. Things are especially likely to take a completely different turn in an election year.

A key criticism against this Budget is that the revenue proposals to cover up the expenditure proposals are not adequately mentioned. A revenue of Rs. 4,100 billion is expected for an expenditure of Rs. 6,900 billion. It’s akin to wanting to spend Rs. 69 while only having Rs. 41 in hand. The challenge is that we are uncertain as to how we will earn even Rs. 41.

An earlier proposal to increase VAT by 3% and remove the exemptions on VAT can be seen as a measure to increase revenue. There are a few proposals to increase the tax base, which is a step in the right direction, such as the requirement of a Tax Identification Number (TIN) for opening a current account, obtaining a building licence, and for revenue licences for vehicles.

The question that arises is what would happen if we fail to generate even the expected revenue and I think there are three scenarios that can occur if we fail to achieve the revenue targets in the middle of the year.

Scenario 1: Cutting down on capital expenditure

Approximately Rs. 1,200 billion has been allocated for capital expenditure in the 2024 Budget. This includes some proposals such as a new airport and building a few universities. So we will likely have to rechannel some of the capital expenditure to recurrent expenditure if we fail to generate revenue.

What is important to note is that, compared to last year, capital expenditure makes up a lower percentage of total expenditure. So in a context of starting with an already lower capital expenditure base, cutting capital expenditure from key areas of growth such as health or education further will maim our growth in the long run.

Slower growth is also not favourable for Sri Lanka because the need of the moment is growth. Only growth will increase our tax revenue and create more employment opportunities and business opportunities.

Scenario 2: High inflation

The second scenario would be the Government exploring the opportunity to get finances from the Central Bank to bridge the deficit. With the new Central Bank Act, the space for doing this is very low, but if past experiences hold true, anything is possible. There is a transition period of about 18 months and we should not underestimate the crafty nature of our politicians to find legal loopholes.

If the Budget deficit is being financed through the Central Bank (money printing), further increases in cost of living and high inflation are unavoidable. It will also drain our forex reserves and build additional pressure on our currency and likely end up with a currency depreciation after a few months’ cycle: a cycle not so distant in memory.

The Central Bank financing this Budget deficit will also challenge the sustainability of the IMF programme. As the next year is an election year, politicians will mainly think about the elections before the economy, despite promises made. While the new Central Bank Act tries to stop this from taking place, the possibility cannot be ruled out fully.

Scenario 3: Hike in interest rates

The third scenario is where the Government borrows money from the market to bridge the gap and allow interest rates to move. This will not cause inflation as the Budget deficit is not being financed through the Central Bank, but the cost of money will go up (interest rates moving up).

When the cost of money goes up, growth will contract. When this happens, businesses start winding-up operations and expansions become difficult. Also, banks will lend more money to the Government at higher interest rates, slowing down credit for the private sector.

When the economy slows down there may be an impact on the tax revenue on one side. On the other side, with limited growth, achieving debt sustainability will be challenging.

Solution

In order to prevent these scenarios from taking place, it is imperative that we reduce wasteful expenditure. The key solution is to focus on reforming State-Owned Enterprises (SOE). SOE reforms can increase revenue, cut down expenditure, bring down our debt, and attract foreign investments.

The bank recapitalisation of Rs. 450 billion, mentioned in the Budget, is due to the debt owed by two SOEs that have losses which amount to Rs. 1,800 billion. The taxpayer is now expected to pay the bill. It amounts to about Rs. 20,000 per citizen from taxpayer money for bank recapitalisation. That is a staggering Rs. 80,000 per household of four members.

Boosting tourism is also another option. While there is a fund for tourism promotions which has to be utilised well for building our brand image, it will all be in vain if we do not do things as simple as removing regulatory barriers to tourism.

The final bird in our hand as a solution is the Colombo Port City. We have to accelerate the process and attract investments.

If we play our cards right, we can at least move a step ahead in 2024.

Price controls are not the way to bring down the price of chicken

By Pravena Yogendra

Originally appeared on Newswire, Lanka Business Online, the Morning and Daily News

Most HoReCa channels in Sri Lanka sell a packet of chicken rice and curry at a higher price than a comparative packet of fish rice and curry. The price of a portion of chicken rice and curry is ~30% more than that of a portion of fish rice and curry. This differential has remained over time, as this existed in the pre-crisis environment as well, albeit at low prices.

Is this because of a difference in production costs or due to undue policy intervention by the government?

Sri Lanka has a long history of implementing price controls dating back to the 1970s. In recent years, the government has implemented price controls on various essential goods, including food, fuel, and pharmaceuticals. While the resulting lower prices may have been popular among consumers, they have had significant unintended consequences on the economy.

Such price controls create distortions in the marketplace by interfering with the pricing mechanism, thereby preventing resources from being allocated efficiently. The government’s current effort to control the retail price of chicken is a case in point.

Chicken and eggs are the most affordable and culturally accepted meat source in Sri Lanka. The domestic poultry industry produces 240,000 MT of chicken per year, with current per capita consumption standing at 10.8 kg. 

The recent economic events, such as the forex shortage and the ban on chemical fertilizers, led to a series of events that artificially inflated chicken prices, making them expensive for regular consumption. As a result, the state felt the need to intervene by controlling the price of broiler chicken.  

However, these price controls have only been imposed on the organized/ formal market. Industry specialists classify the domestic chicken market into the formal/ organized market, which accounts for 60% of the market, and the informal/ wet market, accounting for the remaining 40%. Branded broiler chicken producers cater to the organized market, and small and medium-scale poultry farmers cater to the wet market.

The formal market comprises highly productive tax-paying private-sector poultry operators whose products are on par with international quality, health, and safety standards, presenting an excellent opportunity to expand into export markets. This is proven by the fact that these poultry operators supply to sectors that insist on high-quality standards, such as multinational hotels and restaurants operating domestically and abroad.

However, the pricing restrictions imposed on these more productive players have created a situation where the producers cannot pass on their increased production costs to consumers, resulting in them facing compressed profit margins. The short-term implication would be a lower placement of chicks, resulting in a contraction in production, leading to shortages in the market. The medium to long-term significance would be a decline in investments channeled into capacity expansion, which also reduces innovation and technological progress.  

 It is also important to note that since the wet market players form the larger part of the industry, they are the price setters; and the branded players must follow suit to maintain demand for their products. Wet market chicken prices are mainly determined by the price and availability of other protein substitutes. 

Taxation significantly impacts the retail price of chicken while the burden on fish is lower. Fish is VAT exempt. The major source of costs is labour and entrepreneurship with inputs such as fuel (kerosene) having low tax incidence. In comparison, chicken is subject to VAT, with most producers lying above the VAT threshold of LKR 80Mn. The major cost is the cost of feed which is subject to VAT. It is estimated that both direct and indirect taxes account for 19.6% of the retail price of chicken. The tax treatment between the two alternatives significantly impacts relative prices, disadvantaging chicken over fish. This non-equitable VAT treatment of the two substitutes is expected to be further exacerbated in January 2024 as VAT rates are set to increase by 3% to 18%. 

Although the state is focusing on controlling the final retail price of chicken, the real issue lies in inflated input costs. Poultry producer’s input costs have escalated due to the depreciation of the rupee, higher staff costs, and higher admin costs. However, manufacturers' main point of contention has been the feed cost.

Maize is the largest component of poultry feed, accounting for ~60% of weight and 45% of feed cost. Although nutritionists discovered that rice can be used as a 1 for 1 substitute for maize, its utilization for purposes other than human consumption remains highly regulated, resulting in minimal availability

Domestic maize prices are currently at abnormally high levels as maize production is still reeling from the after-effects of the fertilizer crisis.

Sri Lanka's annual maize requirement is ~500,000 MT, of which ~300,000 MT are produced domestically. Roughly ~210,000 MT are cultivated during the primary Maha season and another ~90,000 MT during the secondary Yala season. The yield on maize cultivation by smallholders is currently 1.5 tons per acre. However, industry experts believe that a yield of 2.5 tons per acre can be achieved if correct farming practices are deployed. A kg of maize currently retails at ~LKR 160. Pre-crisis, it used to retail at LKR 45.

Industry practitioners believe that several efforts can be undertaken to improve the productivity of domestic maize cultivation, thereby bringing costs down. A higher yield can be achieved if proper agricultural land is utilized. Currently, maize farming is conducted on encroached forest land. Due to red tape, the 17,000 hectares allocated by the Mahaweli scheme for agriculture remain largely unutilized.

Farmers can also yield more if maize fields are irrigated instead of rainfed. Experts also believe that the right farming practices are not undertaken as proper soil analysis and spraying are not performed.

Currently, maize can be imported from Pakistan at USD 250-260 per tonne, which works out to LKR 110 per kg, including a special commodity levy of LKR 25. The SCL is a contentious tax and was even highlighted in the recently issued IMF technical assistance report, citing corruption. 

The SCL is a seasonal, quantity tax imposed on certain essential commodities as a composite tax in lieu of other prevailing levies such as customs duty, VAT, EDB, CESS, Excise duty, PAL, and NBT. The SCL has come under fire as it is subjective and arbitrary, imposed at the discretion of the finance minister, creating uncertainty among industry stakeholders.

In the case of maize, seeds imported for the purpose of animal feed production have been subjected to SCL during lean production periods, to facilitate imports. When the SCL is not in effect, a general duty of 20%, CESS of 30%, VAT of 15%, and SSCL of 2.5% are imposed at the border. 

Therefore, not only does the SCL drive up the cost of chicken, but it also creates uncertainty due to the unpredictability and subjective nature of the tax

Maize continues to remain a controlled import that can only be imported by license holders. Licenses to import maize are issued by the import controller based on recommendations issued by the agricultural minister, who issues said recommendations based on his view of the industry’s maize requirement. 

Sri Lanka's organized players are second to none in the poultry breeding process- they have adopted international quality standards regarding feed conversion ratio, mortality rates, farm productivity, etc., putting them on par with foreign players. In addition to being highly efficient, the industry also contains sufficient productive capacity to be self-sufficient, thereby rendering the case for importation redundant.

The industry also maintains biosecurity standards and adheres to industry and farming best practice to ensure healthy, safe, and high-quality output that match the quality and certifications required by export markets. 

The government should step back from intervening in the market for both maize and broiler and allow the magic of the hidden hand to do the heavy lifting. Not only will this lead to more stable prices, but competition will drive further innovation and productivity improvements, leading to more production and lower prices.

Navigating salary hikes amid the storm of inflation

By Dhananath Fernando

Originally appeared on the Morning

Sri Lanka is currently going through a difficult period and this extends to Government sector employees as well. In light of these difficulties, there have been recent discussions centred around the possibility of a salary hike of Rs. 20,000 for Government sector employees in the upcoming Budget. While a salary increment is desirable, a more effective policy-level alternative could be maintaining a low inflation rate, which is more than equivalent to a salary increment across the board. 

The call for salary increments in the Government sector intensified following last year’s inflation, which exceeded 70%. Private sector salaries are just now adjusting to the new economic landscape. Inflation is a significantly more severe and burdensome tax on people, and unfortunately, we have been experiencing its effects over the last year or so.

Government employees are undeniably facing a challenging period, but it’s crucial not to overlook the fundamental cause of the high cost of living. The current cost of living crisis is the direct result of carrying out excessive money printing, as endorsed by the Modern Monetary Theory (MMT).

If the salaries of Government sector workers are increased by Rs. 20,000, a simple back-of-the-envelope calculation suggests that it will cost the Government an additional Rs. 360 billion (1.5 million Government employees x Rs. 20,0000 (increment) x 12 (months) = Rs. 360 billion). 

For the year 2023, the expected Government revenue from PAYE Tax is approximately Rs. 100 billion following the tax revision. Notably, the salary increment alone requires more than three times the amount of tax collected through PAYE Tax.

In 2022, the collection of VAT amounted to Rs. 464 billion. This proposed Government sector pay increase would equal more than 75% of the total VAT collection. Even with a more modest increment of Rs. 10,000, it would still be 1.5 times the PAYE Tax collection and one-third of VAT collection. 

An alternative approach to financing this salary increase is to borrow from the Central Bank. Since the new Central Bank Act imposes significant restrictions on borrowing, it is not entirely impossible, especially during the transition period. 

If the Government opts to borrow from the Central Bank to cover additional expenditure while artificially keeping interest rates low, a second round of high inflation becomes almost inevitable. On the other hand, if the Government borrows at market rates, it would result in an increase in interest rates, potentially slowing down economic growth and creating challenges for businesses. 

If the Government intends to pursue this path, it is advisable to let interest rates fluctuate rather than resorting to money printing and keeping interest rates artificially low. This is because, in the aftermath of a high inflation cycle, there was an inevitable need to raise interest rates to curb inflation. 

On the other hand, we need to keep in mind that the last inflation cycle pushed four million Sri Lankans below the poverty line, bringing the total number of people in poverty to seven million. This has forced many to reduce the number of meals or the size of their meals. The latest reports indicate a rise in malnutrition levels, particularly among infants. 

Given the limited resources, the Government should prioritise assistance for the truly vulnerable and allocate the limited resources to social safety nets. For the last two months, the new Aswesuma programme has faced delays in cash distribution due to various political and logistical challenges. By continuing to not prioritise social safety nets, the Government is inviting instability at the grassroots level. 

International partners and donor agencies have generously supported the establishment of these social safety nets by providing foreign exchange. Delaying and complicating the process may result in the perception that addressing the issue is of lower priority, potentially reducing the willingness of stakeholders to contribute further.

According to the Appropriation Bill tabled in Parliament, total Government expenditure is expected to exceed Rs. 6 trillion for the first time in history. A substantial portion, over Rs. 2.5 trillion, accounts for interest expense on loans. There is limited room for new expenditure items as we are already on an IMF programme and any deviations could have a direct impact on debt restructuring. 

High inflation, though currently low, has lasting negative effects from the previous year. This cost of living crisis, affecting all citizens, particularly hits those below the poverty line. Some of the potential solutions may be challenging and carry potential risks, so the Government must exercise caution in implementation to avoid exacerbating problems.

Understanding corruption: How Sri Lanka’s economic system favours a select few

By Dhananath Fernando

Originally appeared on the Morning

Dr. Sharmini Cooray, one of the Advisors to the Sri Lankan Government regarding the IMF, at the 73rd Oration at the Central Bank made an interesting comment, “Lots of Sri Lankans say nothing works in Sri Lanka. That’s not true. Things work well for a small group of people”. 

Unfortunately Sri Lankans do not understand how things are set up to work for a small group of people. The common narrative is that corrupt individuals created the system we are in today, but the stark reality is that the economic system has been set up in a way to incentivise corruption for individuals. Misdirected anger is then projected on individuals forgetting that the system itself creates the corrupt individuals. This is not to say that the individuals are completely absolved of responsibility, a part of the responsibility is on the individual, yet without fixing the system we cannot fix individuals. 

Below are a few examples of how the current system works for corruption.

Last week the President as the Minister of Finance issued a Gazette notification to increase the Special Commodity Levy (SCL) from Rs.0.25 (25 cents) per Kg to Rs.50 per Kg overnight. The problem here is twofold; it creates the possibility for corruption that incurs a cost to the consumer but also ensures that the government loses tax revenue. 

Information symmetry

Information symmetry or availability of information for all players in the market is very important. As the finance minister increases the tariff by almost 5000% if one importer gets to know of this decision before it is enacted he can easily import adequate stocks for about a year early at Rs. 25 cents per Kg before the festive season. The other players' prices now simply become uncompetitive because their 1Kg of sugar has to be at least higher than Rs. 49, given the tariff rate imposed overnight. As a result the small and medium sugar importers will be wiped out of  the market as they simply cannot compete where one or few players have already imported enough stocks at 25 cents tariff and now the rest have to import at Rs.50 per Kg tariff rate. That is how things are made to work only for a small group of people. One of the main criticisms for the Gotabhaya Rajapaksa Government was that the sugar scam was done in a similar manner. 

Most importantly the tariff increase on sugar will not generate revenue for the government because adequate sugar has been already imported. After about a year it is just a matter of another gazette notification to the finance minister to bring the tariff back to 25 cents and claiming that the relief has been provided to the betterment of the poor people. So ultimately a selected group of people are just getting benefited with the support of the politicians. The truth is the loss tariff revenue will be collected from the poverty stricken by increasing the indirect taxes such as VAT.  

This is one reason this column constantly highlighted the need for keeping a simple tariff structure with menial deviations among HS codes as well as over a period of time. This is just one way of how things are only getting worked out for a selected group of people. 

As a result the public builds a bad perception with a misunderstanding of markets that all businesses are run on the same operating system. The truth is the system affects other businesses very badly because of not having a level playing field. 

The solution is to change regulation where any tariff lines cannot be imposed just by the minister of finance. It ideally has to go through parliament and keep the tariffs on HS codes simple and consistent. The more we keep it complicated the more we incentivise corruption. 

The need for a competitive system has to be institutionalized. The best governance system is making sure competitiveness remains stable. We can only do that by removing laws empowering policy makers that further information asymmetry and provide more power to the people so the market system continues. 

Tax shenanigans 

Not only have we  increased SCL by 5000%, our VAT has also been increased by 3%. When we observe the VAT rate changes, the threshold changes over the last 5 years is very concerning. By doing so we have violated the tax principle of “Stability” by changing things often. When we make one mistake at the beginning, retroactively correcting it is not easy. The VAT increase may have come to compensate for the 20,000 salary hike for the 1.5 million government employees. To make things politically digestible, an attempt may be to increase the VAT before the budget as a press release and announce a big salary increase for government employees as victory. On top of it there vehicle permits and so many perks are the system of how things are making well for a small group of people.  

The simple truth is to make governance work, we have to make market works. Governance is the system of making markets work and making a level playing field. The moment we deviate from markets there is no way we can keep the governance going.  

Can Sri Lanka’s Economic Revival Weather the Storm of a 2024 Election?

By Rehana Thowfeek

Originally appeared on Groundviews

Photo courtesy of EFE

By all estimates, Sri Lanka’s economy is expected to grow around 1.5% in 2024, making inroads into reversing the economic contraction the country experienced since 2020. Sri Lankan authorities have reached a staff level agreement with the IMF earlier this month and, pending executive board approval, Sri Lanka will receive the second tranche of $330 million soon.

Sri Lanka’s reserve position has improved somewhat from the record low levels it was once at – there are $3.5 million currently in reserves, which is sufficient to cover 2.6 months worth of imports, albeit still a worrisome situation. Tourism earnings and worker remittances are picking up and the cumulative trade deficit has narrowed in comparison to last year. Inflation is tapering at 0.8% in September (the base year has been revised to 2021), the result of the tight monetary policy stance taken by the Central Bank since April 2022.

Import restrictions brought in response to the dwindling foreign reserves are now being phased out with all but a few items still restricted. Due to the rapid decline in purchasing power experienced by the people in the past year, demand for imports may remain subdued but maybe offset by more favorable credit conditions. Policy rates have been further reduced and due to more favorable economic conditions banks are now showing greater willingness to lend in comparison to 2022, which bodes well for business revival.

The ability of Sri Lanka’s economy to redeem itself and firmly place itself on a path of inclusive and sustainable growth lies in how successfully the country can execute the necessary economic and governance reforms. Debt restructuring will ease the burden of external debt repayments in the medium term but eventually Sri Lanka will have to start servicing its external debts once again.

If Sri Lanka does not manage to adequately grow its economy to accommodate these payments with sufficient tax revenues and export earnings, the country risks slipping back into a situation similar to that experienced in 2021 and early 2022. The global situation is not favorable for economic recovery with many large economies undergoing recession and multiple wars being fought on different fronts.

The tourism industry shows signs of recovery but can be impeded by the labor migration. The tourism industry already faced issues with attracting labor, as it is not seen as an attractive or well-paying industry to work in. With workers either having left the industry to join other industries in the wake of the Easter attacks and the Covid impact or migrating to other countries due to the crisis, the industry will struggle to cater to the demand that it once managed to.

This calls for exploring the possibility of opening up the borders for foreign labor to work in Sri Lanka, which is a controversial issue to say the least. With mass migration, the country’s health sector is also in a bad state but opening up this sector to foreign labor is even more controversial than it would be to the tourism sector.

The importance of governance reforms cannot be overstated; addressing the governance failures that precipitated Sri Lanka’s economic decline over the past few decades is the only way to prevent reneging back into bad policy making. Checks and balances are important for a well-functioning economy and society. Since pockets have grown fat and powerful with lax governance structures for many decades, dismantling these systems that work in favor of a few and shaping them to work in favor of many is a difficult endeavor in the best of time.

Reforms to state owned enterprises are in the works, albeit at a slow pace. There are plans to pass the necessary laws to divest State Owned Enterprises (SOEs) and to set up a holding company to manage whatever SOEs remain. Reforms to SOE behemoths like the Ceylon Electricity Board are being tackled separately. The country’s flagship poverty program, Samurdhi, is being rehauled into a consolidated welfare program called Aswesuma with better targeting mechanisms, better entry criteria and exit clauses to make the program more effective. The new program also attempts to depoliticize welfare which hindered the effective function of its predecessor.

The budget, which can effectively signal the incumbent government’s commitment to reforms, is already off to a bad start. The government announced that public sector salaries would be increased. With no access to printed money from the Central Bank since the enactment of the new Central Bank Act nor access to foreign loans, the government has decided to increase VAT, perhaps to fund these salary increments.

The incumbent government has made no attempt to cut public sector expenditure and has instead opted to further increase its salary bill, which already swallows up a massive share of the tax revenue – 65% in 2022. This number is even higher when you add in the pensions bill. The government has fallen short of IMF targets on tax revenues in the recent review, so increasing expenditure further, especially just to pacify public sector workers in the light of elections, is utterly imprudent in the context.

Continuing to burden the general public with taxes to fund frivolous, unbridled expenses with no meaningful reform of public expenditure would serve as a harsh reminder to the people of Sri Lanka that the system change once demanded by the sea at Galle Face is yet to be seen, precipitating another wave of civil unrest.

It is not an understatement to say that the precarious stability that has been achieved hangs in the balance, and now with a looming election, the precarity worsens. There is no political consensus on the way forward which can solidify the reforms that the country ought to take – every possible reform is contested which does not bode well for the economy. The jostle is between the NPP, SJB, SLPP+UNP and other possible wildcards such as Dilith Jayaweera and Dhammika Perera, all of whom propose varying economic policies.

The resolution lies in a concerted effort towards comprehensive economic and governance reforms, fiscal prudence and a unified political will that transcends party divisions. The critical choices ahead will determine whether Sri Lanka can chart a stable, inclusive and sustainable economic course or succumb to the persistent vulnerabilities that always threaten its progress.

What happened to our debt?

By Dhananath Fernando

Sri Lanka’s debt situation is still a mystery for some. During a panel discussion, I pointed out that Sri Lanka’s State Owned Enterprises (SOEs) have amassed a staggering 1.8 trillion in debt, all guaranteed by the Treasury and classified as ‘Public Debt’. One question from the audience was, “What did we do with the money we borrowed?” The simple answer is that money was borrowed primarily to service the interest on the initial loans Sri Lanka took out. Therefore,  despite borrowing substantial amounts, there is nothing tangible or visible to show for it, as a majority was essentially sunk into interest. 

To provide context, since 1999, approximately 74% of the increase in debt can be attributed to interest payments and currency depreciation. Interest payments accounted for a substantial 40% of the debt accumulated since the 1990’s, while the exchange rate depreciation contributed to 33%. 

What Sri Lanka faced was a precarious combination in terms of borrowing and our monetary policy. Our expansionary monetary policy played a significant role in the depreciation of the currency over the years, exacerbating the situation further. Compounding this issue was the fact that approximately 50% of our borrowing was in foreign currency. As it is indicated in 2022, with Modern Monetary theory in play, the significant depreciation of the exchange rate since 2020 led to an accumulation of debt beyond our repayment capacity.

Printing more money artificially increases the demand for foreign exchange.  However, after depleting our reserves in an attempt to defend the currency, the only option left was to allow the currency to float, leading to a sharp depreciation. In the case for Sri Lanka, it was not just the currency depreciation; social unrest, debt default, and numerous other crises followed when the government resorted to borrowing from the Central Bank through money printing.

As at the end of June 2023, our total public debt has increased to USD 96.5 billion, with approximately 50% of it in domestic debt. The country’s public debt now stands at about 127.4% of GDP. Even if debt restructuring is successful after negotiations with the Paris Club and separate discussions with China, we only anticipate a reduction to 95% of GDP by 2032. 

Undoubtedly, expediting the debt restructuring process is crucial, especially given the unpredictable twists in geopolitics. While the tentative agreement with China Exim Bank to restructure the debt is a positive development for Sri Lanka, we must fast track negotiations with our other foreign creditors. Complicating matters, as we approach an election year, there is a significant risk of derailing the process as unfortunately, there is a lack of consensus among political parties regarding the economic stabilization program for the next few years. This further exacerbates the challenges Sri Lanka faces.

Solution 

If Sri Lanka is genuinely committed to resolving its debt crisis, a crucial step is to establish a consensus on public finance across the major political parties. At the very least, adherence to a single plan, such as the IMF program, is necessary. However, even the IMF program alone will be insufficient to take Sri Lanka to the next stage of economic stability. Therefore, there must be a fundamental agreement on specific reforms across party lines. For example, there exists a common minimum program in Parliament, shaped with contributions from the business community and organizations like Advocata. It is not too late to revisit and endorse this document. Committing to these agreed-upon reforms before political parties develop their individual manifestos in the coming years could provide a stable foundation for Sri Lanka's economic future.

Reforming the tax incentive structure in Sri Lanka

Originally appeared on Daily FT

By Roshan Perera, Thashikala Mendis, and Janani Wanigaratne

The second tranche of the International Monetary Fund’s (IMF) Extended Fund Facility (EFF) was delayed as the country failed to meet some of the program targets including the Government revenue target. This prompted the IMF in their latest review to reiterate the need to “strengthen tax administration, remove tax exemptions, and actively eliminate tax evasion” to ensure revenue is collected as per the program targets. This requires intense efforts by the Government if the country is to achieve sustainable macroeconomic stability.

Corporate Income Tax (CIT) in Sri Lanka has the potential to significantly contribute to Government revenue. However, CIT performance has been dismal with collection averaging around 1% of GDP over the last two decades although economic growth averaged around 4% during the corresponding period. It peaked at 1.9% in 2022 due to some one-off taxes.1 Compared to other countries in the region as well, CIT collection in Sri Lanka has been abysmally low (see Figure 1).

Further, CIT collection is concentrated in a few sectors in the economy. The 230 companies listed in the Colombo Stock Exchange (CSE) for financial year 2019/20 account for around 25% of total corporate income tax collection. However, financial services, food & beverages, and telecommunications account for a disproportionate share of taxes (see Figure 2). Sectors such as wholesale and retail trade, real estate and transportation which account for more than 25% of GDP, contribute less than 2% in CIT. Tax holidays and concessionary tax rates to selected sectors have eroded the CIT tax base, leading to lower CIT revenue collection. Ad hoc tax concessions complicate tax administration, distort resource allocation and provide opportunities for rent seeking and corruption.

Tax incentives

With the liberalisation of the economy in 1977 and the shift to a more export oriented development strategy, the Government sought to attract foreign direct investment (FDI) by offering attractive tax incentives, first under the GCEC Act No. 4 of 1978 and subsequently the Board of Investment (BOI) of Sri Lanka from 1992. Tax incentives were also offered under the Inland Revenue Act. The enactment of the Strategic Development Projects (SDP) Act, No. 14 of 2008 permitted the Minister in charge of investment the discretion to grant incentives to projects deemed of strategic importance with only subsequent ratification by Cabinet and Parliament.

The lack of clear criteria of what constitutes a “strategic development project” in the SDP Act and the discretion given to the Minister to decide on what constituted a “strategic” project led to generous tax holidays and incentives granted to projects that were not in any sense strategic (see Table 1 for a list of projects granted under the SDP Act). Furthermore, tax concessions under the Act have been awarded to projects that are not purely foreign funded, violating one of the core objectives of this Act, which is to attract foreign investment.

The operation of multiple tax jurisdictions has led to an overlap of tax incentives, obscuring the process of monitoring the overall benefits and costs of tax incentives provided. Lack of transparency and well-defined criteria as well as poor evaluation of projects has led to the granting of tax incentives without proper justification, leading to large revenue losses.

Transparency, availability and accessibility of information regarding companies that have received tax incentives, especially under the BOI Act, are limited3. In light of this, the IMF diagnostic report has highlighted the need for a more transparent data sharing protocol.

The case of Port City

More recently the Colombo Port City Economic Commission Act, No. 11 of 2021 was given the authority to grant tax incentives within the Port City.

The CPC Act grants incentives to businesses that are identified as strategically important. Extraordinary Gazette 2343/604 lists several industries as strategically important. Even though the Act provides a descriptive definition of a business of strategic importance, the rationalisation for these industries to be selected for special incentives is unclear. Especially as some of these industries already exist in Sri Lanka, which puts them at a disadvantage. Moreover, under section (4) subregulation (3) of the Extraordinary gazette 2343/60, one of the criteria for granting incentives is the ability of the business to demonstrate to the Port City Commission the potential contribution to Sri Lanka’s economy and social development by fostering innovation, knowledge transfer, technology transfer, research and development. This criteria is vague and subjective, thus allowing the Commission to grant incentives at its discretion.

Granting incentives often leads to differential tax treatment creating an unlevel playing field. While an entity in an already established industry within the country located within the CPC is provided generous tax incentives, the firm located outside is subject to the normal taxes operating in the rest of the country. Such differential treatment could create labour market distortions, as the employees in the Port City benefit from tax exemptions.

Sri Lanka has not been able to attract Foreign Direct Investments (FDIs) despite the plethora of incentives offered. It is questionable whether we can expect different results by applying the same failed strategy with the Colombo Port City. For instance, out of 74 land plots, only 6 were leased so far, and even those have not yet materialised.

To improve the performance of CIT, reforming the existing incentive structure is critical.

Improving investment environment

Evidence suggests that tax incentives are not the most important factor attracting FDI. Rather investors prioritise factors such as macroeconomic stability, access to skilled labour, and quality infrastructure facilities when making investment decisions. Therefore, shifting focus from relying on tax incentives to creating a favourable macroeconomic environment and policy consistency while providing the necessary resources and infrastructure will be more important to attracting investments. This will reduce distortions in the economy while ensuring the Government’s revenue base is protected.

Renegotiating tax incentives

Given the weak fiscal position of the country and the debt restructuring exercise being carried out at present, a similar exercise to renegotiate existing tax incentives may be warranted. Rationalising existing tax incentives would widen the tax base and enable lowering corporate tax rates.

Centralising tax incentives

If tax incentives are to be granted it should be done by a centralised authority. This authority should be able provide justification for granting special tax incentives by carrying out a cost benefit analysis. Clear objectives and proper criteria for granting incentives should be established and the authority held accountable for monitoring the progress of the investments to ensure the objectives of the investment are fulfilled. Failure to meet the objectives should lead to an immediate cancellation of the incentives granted. To ensure transparency, all incentives granted should require Cabinet and Parliamentary approval and information on incentives granted made publicly available through gazette notices. Sunset clauses will ensure that incentives have a limited timeframe and are periodically reviewed.

Conducting tax expenditure analysis

Tax expenditure refers to concessions such as tax exemptions, deductions, concessionary tax rates, etc. granted to specific industries or entities. While typically a government budget provides estimates of government revenue, tax expenditures are rarely reported. However, given the generous tax incentives offered it is vital to ensure the costs and benefits of tax expenditures are properly accounted for. Conducting regular tax expenditure analysis will enable comprehensive cost benefit analysis to evaluate the potential revenue loss and the expected economic benefits of tax incentives. Moreover, it is essential to carry out regular assessments to ascertain whether the revenue loss resulting from tax exemptions is justified by the employment, GDP contribution, and economic impact of these projects.

Global Minimum Tax 5

When tax incentives and holidays are granted, it should be ensured that their rates are not lower than the rate recommended by the Global Minimum Tax (GMT). This is an agreement introduced by the OECD/G20 in October 2021, with the purpose of establishing a minimum tax rate of 15% for large multinational companies. It allows countries with taxable parent companies of Multinational Enterprises (MNE) to impose a top-up tax on the profits of any foreign subsidiary that pays an effective rate less than 15%. It also allows the host country where the MNE subsidiary carries out its activities to charge a top-up tax rate on subsidiaries, if the home country of the parent company imposes a CIT rate less than 15%. So even if the countries are free to grant tax holidays and incentives with a CIT rate lower than 15%, the agreement grants the taxing rights to either the FDI exporting countries or the countries in which the MNE subsidiaries are operated. Therefore the MNEs would not be benefitted by lower rates as they will be taxed by either country.

The countries that do not adopt this GMT rule would lose out on tax income as the other countries will adjust their domestic tax rules to top up undertaxed profits. This proposal has already been strongly backed by 130 countries. Unfortunately, Sri Lanka was one of the nine countries that did not agree to this proposal.

The country is struggling to meet its revenue targets. The potential of CIT as a significant source of revenue has not been not fully exploited. A plethora of tax incentives granted under numerous agencies have seriously eroded the tax base. Reversing these trends are vital for restoring fiscal sustainability and enabling the Government to promote sustainable and inclusive growth.

Footnotes:

1This is due to the imposition of a retrospective one-time surcharge tax of 25% on individuals, companies, and partnerships with a taxable income exceeding 2 billion for the 2020/2021 tax assessment year.

2Based on the taxes paid by around 230 listed companies on the Colombo Stock Exchange in 2019/2020.

3Information on projects granted under the SDP Act are publicly available through gazette notices which are mandatory. This is unlike projects granted incentives under the BOI Act which are not publicly available. An RTI filed to extract this information was also not responded to by the relevant authority.

4http://documents.gov.lk/files/egz/2023/8/2343-60_E.pdf

5World Bank, 2023, “Can the global minimum tax agreement reduce tax breaks in East Asia?” https://blogs.worldbank.org/developmenttalk/can-global-minimum-tax-agreement-reduce-tax-breaks-east-asia#:~:text=In%20October%202021%2C%20the%20G20,to%20be%20implemented%20in%202024.

(Roshan Perera is a Senior Research Fellow at Advocata Institute. She can be contacted via roshananne@gmail.com. Thashikala Mendis is a Data Analyst at Advocata Institute. She can be contacted via thashikala@advocata.org. Janani Wanigaratne is a Research Consultant at Advocata Institute. She can be contacted via janani.advocata@gmail.com.

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

Shaping Sri Lanka’s growth narrative

Originally appeared on The Morning

By Dhananath Fernando

Securing the second tranche from the International Monetary Fund (IMF) is an important step, especially to support our ability to successfully carry out the debt restructuring process. It is not just about the $ 330 million that this tranche brings; it is about the credibility it gives to the reform process and the confidence it instils in the international community, including bilateral and multilateral creditors. 

The moment we deviate from the IMF programme and allow our debt to remain unsustainable, we risk regressing to square one. However, we should not get our aims and priorities mixed up. Our aim is not to secure IMF tranches. We need to prioritise achieving deep and meaningful reforms. The IMF tranche will follow as a result. 

Ultimately, our goal should be to ensure that, in the future, we never find ourselves in a position where we need to turn to the IMF for assistance.

As this column has discussed many times, it is essential to recognise that the IMF can only stabilise the economy and facilitate credit access, which is a crucial element in our debt restructuring process. The responsibility to clear out the roadblocks that stand in the way of economic growth rests solely on our shoulders. We have to carry out reforms that go beyond the scope of the IMF programme. 

Three key reforms aiming to boost economic growth will be discussed below.

Reforms to attract more tourists 

Focusing on tourism can significantly contribute to the country’s economic recovery. In addition to bringing in foreign exchange, their spending in domestic markets contributes significantly to Government revenue through VAT. Instead of fixating on the number of inbound tourists, our focus should be on the number of nights a tourist stays in the hotel/country. Simplifying the entry process will attract more tourists, and more importantly, entice them to prolong their stay. 

In line with Daniel Alphonsus’ recent article, making the visa process more flexible for tourists is crucial. Our focus should not be on visa fees, but rather to encourage tourists to spend more. This allows local industries to capture the revenue and enhances Government revenue through VAT and various other forms of fees and indirect taxes.

Offering a two-year multiple-entry visa for citizens from countries with a per capita GDP four times higher than Sri Lanka’s is a strategic move to attract high-income tourists. Given our current fiscal situation, carrying out extensive global promotional campaigns are beyond our financial capacity. Therefore, our focus should shift to initiatives that can be implemented effectively with just a stroke of a pen.

Addressing labour force shortages 

Retaining skilled talent within Sri Lanka is a challenge faced by many industries, including blue chip companies. These labour shortages are anticipated to affect us from next year onwards, jeopardising the sustainability of existing businesses.

To address this issue and prevent businesses from relocating, it is essential to allow companies the flexibility to recruit from international markets. This approach is crucial to sustaining businesses and their supply chains. Permitting companies to hire skilled labour from outside Sri Lanka will not only alleviate pressure on the country’s labour market, but also offer advantages to consumers and businesses competing in global markets.

Further, it encourages the transfer of knowledge and skills, leading to improved productivity. For example, collaborating with professionals from countries like Japan could introduce advanced productivity management techniques, enhancing overall efficiency. Free movement of people is a crucial step in improving our productivity and driving the economic growth of the country.  

If relaxing labour market regulations proves too complicated, a pragmatic alternative is to permit foreign spouses of Sri Lankans to work in Sri Lanka. This measure could help in attracting more skilled workers, providing an incentive for Sri Lankans with families of mixed citizenship to return and settle here. Importantly, this reform won’t incur any costs for the Government; it simply involves changing existing regulations.

Industrial zones for private sector and simplifying tariffs  

For us to emerge from this crisis, our primary focus should be on global trade. The complicated tariff structure that is currently in place enables corruption and is a source of frustration for both exporters and importers. Simplifying the tariff structure into three to four tariff bands is essential to streamlining Government revenue administration. 

The existing high and complicated tariffs lead to massive leakages of tariff revenue. Moreover, these tariffs discourage imports, hampering productivity and burdening consumers. Implementing a straightforward tariff structure is imperative, removing para-tariffs such as CESS and PAL. Furthermore, we must ensure that the tariff structure for any HS Code is easy to compute and has minimal deviations.

A significant bottleneck in our system that hinders investments and export growth is the shortage of land for industrial activities. Currently, 95% of the land in Board of Investment (BOI) industrial zones in the Western Province is occupied. Investors are required to obtain approximately 17 approvals in order to set up operations and this process can take more than two years. 

Regrettably, the BOI has not initiated any development projects in the last 15 years. A viable solution that the Government should consider is utilising State-Owned Enterprise (SOE)-owned land and allowing the private sector to develop industrial zones on it. 

Private sector-run industrial zones can operate as a plug-and-play model, where the private sector attracts investors and secures the necessary approvals in advance. This approach does not require any Government investments; in fact, it can generate more revenue for the Government through leasing or selling the land for development. 

If Sri Lanka is genuinely committed to economic growth and recovery from the crisis, our primary focus should be on implementing these reforms rather than solely relying on the IMF.  While the IMF can provide us with short-term stability, it’s our responsibility as Sri Lankan citizens to shape our own growth narrative.

Borders & the Budget

Originally appeared on the Daily FT, Daily Mirror

By Daniel Alphonsus

Visa reform will boost tourism and reverse brain drain

Three million tourists are set to visit our shores next year. We will issue nearly as many online visas - millions too many. ETAs are a tourist's bane: rather than dreamy sun, sea and sand, the weary salaryman’s getaway begins with the tedium of forms. 

The tourist’s ayubowan to Sri Lanka begins with ferreting for flight details and credit cards. Warm-up complete, the ordeal begins in earnest: 20 clicks to navigate through the ETA form and countless key strokes to fill out the 27 form fields. Each question brings forth its own miseries, and sometimes mind-reading feats: “They’re asking me for my address in Sri Lanka. Hmm, does this mean my first address, my last address…but I haven’t even booked my hotel..dear, dear maybe I should book the Maldives instead. They’ve got a visa-on-arrival.” Followed, naturally, by web-pages reloading with unsaved data and vindictive payment gateways rejecting credit cards for arcane and esoteric reasons. Rather than a Small Miracle, they experience So Sri Lanka. 

This charade costs us millions of dollars every year. We are losing tens of thousands of tourists to our competitors.

Based on the three scenarios below, switching from ETA to visa-on-arrival à la the Maldives or Singapore should generate between $24 million to $145 million in additional tourism revenue.

The precise number is not especially relevant. The point is that these roughly right numbers are substantial enough to generate a robust prima facie case for experimenting with opening up visa-on-arrival and optimising the ETA experience

For workings click here.

Visas-on-arrival

Sri Lanka already operates visa-on-arrival for Singapore, Maldives and Seychelles citizens. In light of the tens of millions of dollars we’re losing in the absence of visas-on-arrival, very compelling reasons must be provided for not opening-up visa-on-arrival for citizens of our main tourism markets (such as the EU, China, Russia and UK). Plus those who have passed extensive checks in the process of traveling to other countries. For example, travelers holding multiple entry visas to the US can visit about 51 countries visa free. 

The burden of proof is therefore on those who say we ought not have a visa-on-arrival regime. All the more so because it appears that, even though not advertised, in a pinch, obtaining a visa-on-arrival is possible at BIA. Also note that airlines share passenger records with governments 24 hours before arrival. It takes seconds for our border agencies to check the relevant blacklists as they already have API integrations in place. The response time of an Interpol database query is half a second.

In addition, immigration department annual reports show that almost all rejections and deportations are from a handful of countries, mainly India. Other than a German and an Australian, no UK, EU, ASEAN or Australian national was rejected or deported in 2022. This suggests a risk-based, optimized approach is very much possible, and prudent.

Many of us have experienced this personally. We are more likely to tour Singapore because Sri Lankans enjoy visa-on-arrival. In fact, on average it only takes us 10 minsto enter Singapore. As shown in the picture above, for passport holders of 50+ countries, the experience is even more smooth. Using automated immigration gates, they clear border control in less than two minutes.

Optimize the ETA process

Some tourists may still prefer to secure an ETA before arrival. Therefore, we should do our best to ensure the application is seamless. Currently it is not. Of the 27 fields requested on the ETA, about 20 can be found in passenger record details airlines share with immigration authorities. They are redundant. Questions on the ETA should be limited to around seven fields. The amount of information gathered should be commensurate with the risk: those from high risk countries could be subject to additional questions.

Eliminate the ETA fee

Credit card payments are often an even greater source of friction. Tourists need to pay $20 via credit card for an ETA. This deters potential tourists; it's another step in the journey and credit card payments often fail. So much so, the our embassy in Germany issued the following notice:

“On Arrival Visa at the Port of Entry to Sri Lanka: submit visa application and payment at Colombo International Airport. A fee of USD 60 will be charged for this service. Please observe that this option of obtaining a visa is available only for German passport holders, who have tried to obtain a visa via the ETA-system www.eta.gov.lk, but failed due to not being able to pay the fees with credit card.” 

It's not only card friction that is the problem. Many Chinese citizens no longer own cards and use Alipay instead.

Wiser countries like Singapore understand that reducing friction encourages more tourists to arrive, and thereby spend more. Which is why they don’t charge tourists a fee.

*Note the ETA fee is $20 for SAARC and $50 for other nationalities. $40 is a rough weighted average. For workings click here.

Based on the rough estimates above, if the ETA fee or friction puts off even three percent of tourists, then Sri Lanka stands to unequivocally benefit from eliminating the ETA fee. The exchequer will be worse off for now. But the Treasury still recoups some of the lost visa fees by higher VAT revenue directly, and indirectly via higher income tax from tourism sector firms and employees. (1)

Brain Gain

Since Independence Sri Lanka has lost or chased away lakhs of skilled workers. Many middle class families can proudly count at least one doctor, accountant and engineer (among many other species of the middle bourgeoisie) among their relations overseas. Between 2005 and 2015, the BOI estimated that around 20% of STEM graduates left the country every year. With COVID and the economic crisis, emigration was particularly acute the last few years. But it's not new. Skilled emigration is a chronic problem we’ve faced for decades.

(2 ) This report offers a rigorous treatment of the topic from the 1970s.

We desperately need to reverse brain drain. Of course, the central challenge is building a Sri Lanka in which Sri Lankans want to stay. But that is beyond the scope of this article. Here we shall only discuss how we can make it easier for skilled talents to come, and contribute. 

Some readers may be perplexed that even a handful of skilled non-Sri Lankans want to live and work on our island. But we live in a nomadic, connected and occasionally romantic age. These rare souls exist. 

We must do everything in our power to welcome and encourage them. Above all, by simply removing barriers to them legally working here. For the path to prosperity is paved by productivity growth. Therefore, it makes absolutely no sense for us to create barriers for skilled migration. It is the opposite of what smart countries do - especially via human capital theft aka points-based migration. There are three main ways foreign talent raises Sri Lanka’s productivity, growth and thereby prosperity. Foreign talent:

1. Adds human capital: whenever someone who has higher productivity than the average Sri lankan worker moves to Sri Lanka, they raise Sri Lanka’s average productivity directly. We already have huge talent shortages in key sectors like IT. 

2. Upgrades existing human capital: foreign talent, directly or by osmosis, teaches their skills to others.  

3. Increases existing human capital productivity: the whole is often greater than the sum of its parts. Skilled talent enables others to be more productive. For example, having access to a pediatric neurosurgeon makes all pediatricians more productive as knowledge is shared from expert to generalist. Alternatively, having a Japanese team-member makes the whole team more effective when working with Japanese clients. 

Per capita GDP is a good proxy for average worker productivity. Therefore, if someone from a richer country moves to a poorer country, then the average productivity of the poorer country will improve. How do we do this? The Harvard Centre for International Development has some ideas from which I borrow liberally. 

The fastest way for Sri Lanka to have brain gain to compensate for some of the brain drain is to:

Offer a two-year visa-on-arrival for those from countries that are 4x richer than Sri Lanka

1. Offer a two-year renewable visa-on-arrival for citizens or permanent residents of countries which have per capita incomes at least four times that of Sri Lanka. (3)

2. Amend the Citizenship Act such that any person who has at least two Sri Lankan grandparents is eligible for citizenship. ()4 

3. Regularize employment of all foreign spouses of Sri Lankan nationals, including a path to permanent residency and citizenship. (5) 

The first of these measures can be implemented by the stroke of the minister’s pen.(6) Sri Lanka’s immigration act provides for broad ministerial discretion. The minister is empowered to make entry regulations for visas upto five years in length. He or she can implement Point A above without requiring primary legislation.

We have little to lose, and all to gain. Try these measures for a year, try them for a few countries. Then roll-back or amend accordingly. Sri Lanka has a long history of policy-instability, but we should not confuse the many cases of foolish equivocation with genuine experimentation. That is what this budget should propose: bold measures to breakthrough our malaise and initiate the process of transitioning from stabilisation to recovery.

(1) As this article is solely on matters related to the immigration act, I’m not going to discuss this in detail. But it's worth noting that levying a flat (dis)embarkation levy is also a deterrent against short-haul traffic. Instead, the airports authority should price the levy based on the distance between Sri Lanka and the origin/destination airport.

 (2) Diaspora remittances do little to compensate: Sri Lankans remit more from the Maldives than Australia.

(3) For those that ask why a per capita GDP based criterion rather than points-based criteria, my answer is simple. A points-based system inherently involves discretion, and in the context of our state (in)capacity and corruption, will result in friction (countless people will not bother applying with all the documents that will be required), many false positives (as the assessors of points, e.g. a degree certificate’s legitimacy, will be corrupt) and false negatives (because those with skills we want may not have the right paper to demonstrate it). Considering this range of incentive problems and Type I/II errors, a very conservative threshold like the 4x per capita GDP one suggested is most optimal.

(4) For further details on this point and the next point, see page 14 of this study on Sri Lanka’s immigration framework.

(5) Reaching consensus in Parliament on this point should be easy. Sajith Premadasa’s manifesto promises dual citizenship after three years of residence for foreign spouses of Sri Lankans. See page 39.

 (6) Soon, one hopes, his or her digital signature. In fact, the President should announce that he will only sign documents via a digital signature from 31 December 2023 onward.

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.