Though relatively stable for the most part, economic activity likely to be constrained in 2017
Characterised by changes in the policy and regulatory environment
Fiscal consolidation needed
More growth, more business activity, more personal and business tax revenue required for fiscal growth
Some level of austerity expected
Higher taxation may reduce consumption growth
High interest and corporate tax likely to negatively affect investment
Government keen on boosting FDI
Several FTAs on the cards
China (because China)
Global economic uncertainties to consider
Trump’s interest in India could prove beneficial to SL
Export will likely get a boost from GSP+
The day after Finance Minister Ravi Karunanayake had presented Budget 2017 in Parliament last year, we noted with cautious optimism that, significant reductions in expenditure notwithstanding, the Yahapalana Government appeared to have hit the right notes in terms of getting the economy back on track in the year 2017. Attempts were also being to, in the long run, get the country out of a potentially crippling debt trap whose threat of veritable disaster remains imminent. We’re into the second month of 2017 now, and though Sri Lanka still appears to be on track for the most part (at least on a macroeconomic level) things are not exactly looking up for most ordinary citizens who are forced to bear the brunt of high taxes and other austerity (or non-austerity, depending on whom you ask) measures adopted by the Government just to stay afloat.
On top of all this, there are the global economic uncertainties that came in the wake of Brexit and the advent of Trump to consider, in addition to the Government’s ongoing mating dance with China, with an increasingly possessive India keeping a close if somewhat guarded eye. Prime Minister Ranil Wickremesinghe is expected to visit Beijing in May to discuss a proposed FTA with China. Several free trade agreements (FTAs) are on the cards, ostensibly with the objective of attracting more export-oriented foreign direct investment (FDI). Import growth is expected to take a hit this year, while export will likely get a boost if and when the promised GSP+ trade concessions materialise.
Prime Minister Ranil Wickremesinghe is expected to visit Beijing in May this year to discuss a proposed FTA with China. Image courtesy lankapage.com
All things considered, it should prove to be a relatively stable year for the economy (at least on paper), with a few hiccups along the way. This is an attempt to examine the nitty-gritty of what to expect.
Economist Deshal De Mel believes that economic activity will be constrained in 2017. After a year of macroeconomic stabilisation in 2016 with tightening policies on the fiscal (higher taxes), monetary (higher interest rates), and external (gradual rupee depreciation) fronts, he said, 2017 will be a year of relative austerity for the Sri Lankan economy. De Mel predicts that higher taxation will reduce disposable income dampening consumption growth (both domestic and imported consumption), while high interest rates and higher corporate tax will have a negative effect on investment and business expansion.
“Therefore, economic activity will be constrained with GDP growth in the 4% to 5% range. Interest rates are likely to remain elevated for most of the year, with a modest decline in the second half of the year. The rupee is likely to be range-bound (expecting up to 5% depreciation in 2017) as import growth will be low, [with] exports possibly getting a mild boost in the second half of the year if GSP+ comes through as expected. The key driver of LKR movement in 2017 will be foreign activity in the LKR denominated treasury bill/bond market,” he told Roar.
Exports are expected to get a boost this year if the promised GSP+ concessions materialise – Image courtesy lankabusinessonline.com
Chief Economist at the Ceylon Chamber of Commerce, Anushka Wijesinha, is of a similar view. Speaking to Roar, Wijesinha said that on the domestic economy, Sri Lanka would see a low economic growth environment during 2017, with tighter fiscal and monetary conditions as well as the impact of the drought. He also warned that there will be a drag on consumption growth over the next few months.
Policy changes in the UK under the Trump administration, among other things, will present challenging external conditions to Sri Lanka in 2017. According to Wijesinha, tensions around trade policy and protectionism, elections in key European states as well as new developments with regard to Brexit, could mean that Sri Lankan exports ‒ 60% of of which go to the US and the European Union (EU) ‒ will be affected in some way.
“2017 will also be characterised by changes in the policy and regulatory environment in Sri Lanka, with revisions to several laws (Customs, Inland Revenue, Securities and Exchange, Exchange Control) in the works. These bring both opportunities and challenges and the private sector would need to closely watch these changes and adapt accordingly. On a positive note on the macro front, the commitment to fiscal consolidation, focus on macroeconomic stability, and predictability and credibility of Central Bank operations, will be a boost to the overall business environment. These benefits may not be felt in 2017 itself, but is a solid foundation that is much needed,” Wijesinha told Roar.
Meanwhile, left-leaning economist Ahilan Kadirgamar, a strong advocate of protectionist measures, is far less optimistic. He believes Sri Lanka is in for a rough ride this year.
“It is becoming a recurring problem. The same happened in 2016. In January 2016, at the Economic Forum, there was talk of Sri Lanka pursuing the Singapore model, but then by March 2016 the Government claimed Sri Lanka was in crisis and budgetary reforms were announced, and then in June 2016 Sri Lanka signed an IMF Agreement with many conditions. Similarly, the Budget for 2017 was announced amidst grand plans for further financialisation and trade liberalisation without addressing fundamental issues. This year more, problems are likely to emerge that may again cripple the economy,” Kadirgamar told Roar.
In spite of the Government’s economic vision for the next few years (not to mention its incessant grandstanding), the people – that is, everyday middle-class folk – have really started to feel the burden, what with all the indirect taxes threatening to suffocate them from all sides. Would there be a lightening of this proverbial load this year? Or are we going to have to keep tightening our belts?
De Mel warns that 2017 will be a tough year for consumers and businesses alike. After substantial expansionary macroeconomic stimulus in 2015 (with higher government spending and low interest rates) driving consumption and imports in particularly, he pointed out, Sri Lanka ran into balance of payments trouble, creating difficulty in meeting external debt repayment obligations. Had that expansion continued unabated, he said, Sri Lanka may have run into real difficulties in debt repayments – and a debt default situation would have been disastrous for the economy. (Read our report on the looming debt crisis and what Sri Lanka could do to get out of it here).
“The prevailing belt-tightening is necessary to rebalance the economy and give the country a chance to meet the large external debt obligations that fall due from 2019. It looks like these tough conditions will be necessary for at least 2017 and most of 2018,” he said.
Wijesinha pointed out that Sri Lanka, having lived beyond its means for many years now, is clearly on a fiscal consolidation path. The fiscal situation, he said, is too precarious to put off any longer, adding that Sri Lanka is one of the lowest tax-GDP ratios for a country in lower middle-income status with its level of high social spending.
“I hope the focus will be more on direct taxes than indirect taxes (which are regressive) or trade taxes (which hurt competitiveness). For this, the government is trying to expand the tax base and close tax loopholes. We either raise money through domestic resource mobilisation (i.e., taxes) or through foreign debt. The former is a more sustainable strategy, if done right, in a way that doesn’t place undue burden on the most vulnerable, as well as doesn’t snuff out business activity,” he said.
In order to achieve fiscal consolidation in the medium term, Wijesinha proposed more growth, more business activity, and increased generation of personal and business tax revenue.
“If we don’t focus on growth, we will keep taxing a low growth base. Policies that boost business activity, that generate more good jobs, bring in FDI that promote exports and sustainable growth ‒ these are what will help boost revenue in the long term. Alongside this, we cannot ignore the spending side. While people and firms are expected to adjust to a tighter fiscal policy environment, government spending also needs to consolidate ‒ whether it is leakages in welfare transfers, spending on wasteful or low-return public projects, or rationalising the state sector,” he said.
Prime Minister Ranil Wickremesinghe on Thursday said that 2017 will see a minimum of USD 2.5 – 3 billion inflows and “much more next year and beyond,” depending on progress made on the proposed Hambantota Port and Financial City public-private partnerships. A confident Premier told the American Chamber of Commerce that the real “game changer” this year in getting more FDI will be private sector-based investments rather than taxpayer-funded infrastructure growth.
Budget 2017 presented by Finance Minister Ravi Karunanayake was met with mixed reactions. Image courtesy colombogazette.com
It goes without saying that Budget 2017 got mixed reviews. While some lauded it as being progressive and effective, others called it worthless and full of austerity measures that would only add to the burdens of an already beleaguered people. One of the biggest criticisms levelled at this year’s Budget was the many reductions in state expenditure ‒ though it was really a case of capital expenditure vs. recurrent expenditure. But how much of the more salient aspects of Budget 2017 will actually come to pass?
Says De Mel: “The 2017 budget was a lot more realistic and credible than the 2016 budget, and I believe most of the proposals will go through. The problem with so many of the budgets of successive Sri Lankan governments has been a weakness in implementation. Many of the expenditure proposals from 2016, for instance, have been repeated in 2017 due to a lack of implementation (eg. EXIM bank). There is an urgent need for greater accountability of Sri Lankan budgets to ensure that what is committed is actually implemented.”
Wijesinha shied away from speculating.
“It’s hard to say at this point, but I feel that more of Budget 2017 is likely to be passed, even though it may not happen according to the specific timeline announced,” he said.
For instance, he explained, the change of SVAT (simplified value added tax) announced in the Budget as coming into effect on January 1, is now likely to be done from April 2017.
“We also must bear in mind that many measures outlined in Budget 2017 have a horizon of several years, and are not to be done in 2017 itself,” he added.
When the present Government came into power, it was with the promise that growing Chinese influence on the Sri Lankan economy would be curtailed. In fact, in the run up to the January 8 polls in 2015, the UNF coalition promised to scrap the Chinese-funded Port City (now rebranded as the Financial City) in its entirety. No sooner than the new Government was sworn in, it was forced to eat its words, having no choice but to go ahead with the controversial project in the face of the Chinese state-owned company demanding compensation for the resultant delays.
According to the PM, 2017 will see a minimum of USD 2.5 – 3 billion inflows depending on progress made on the proposed Financial City PPP. Image courtesy newsfirst.lk
Riddled as it was with the looming debt and balance of payment crisis, the Government, in desperation, decided to offer 80% of the USD 1.5 billion Hambantota deep-sea port (which they had previously called a white elephant) to a state-owned Chinese company, with the objective of easing some of the debt Sri Lanka owes to China (to the tune of some USD 8 billion) by way of an equity swap. The Mattala Airport ‒ the butt end of many a joke and now considered the world’s emptiest airport ‒ too was to be handed over to a Chinese company. On top of those were the proposed 15,000 acre industrial zone to be built near the Hambantota Port ‒ also Chinese-funded. Special economic zones have also been proposed for Ruhuna and Matale.
How will these developments affect the country’s economy in 2017?
Wijesinha prefers to take a pragmatic view on the matter. He told Roar that it will be in Sri Lanka’s best interest to play ball with the emerging superpower.
“The reality is that China is now one of the largest capital-exporting countries in the world. If Sri Lanka wants FDI, China cannot be shut out. The key would be to ensure the projects attracted are done so in a transparent manner, and that those are growth-promoting. The Chinese are savvy investors. They wouldn’t come in unless they see good returns,” he said.
De Mel, too, sees no harm in going forward with the projects. He believes that the Port City, for example, could prove to be “very constructive for the economy,” if properly implemented.
“The project has the potential to create an urban space that is well planned, opens up areas for leisure, high-end residential and commercial real estate, and entertainment. This would be a unique proposition for the South Asian region with potential for attracting investment interest from corporates looking to set up HQs and regional HQs catering to the Indian subcontinent. To enable this, though, Sri Lanka’s external policies need to be re-oriented towards a more open environment, with immigration reform for example to facilitate foreigners to live and work in Sri Lanka,” he said.
He calls for suitable reforms to Sri Lanka’s immigration policies that will help tap foreign potential, in terms of human resources.
“At present, Sri Lanka’s immigration policies are highly restrictive for foreign talent. The success of the port city rests on effective implementation of supportive infrastructure, urban planning, careful management of the environmental implications of the reclamation, and policy reform to attract foreign talent and capital,” he said.
De Mel does, however, concede that, taking into account the geo-political sensitivities around the Financial City project, it is important that the project is implemented within a fair and transparent rules-based framework that provides comfort to domestic and international stakeholders.
Mostly unconcerned about the Hambantota Port sale, De Mel points out that the Port was designed to be an industrial bulk port rather than a container port primarily, and therefore the success of it will rest on the development of industry around the port to use the connective infrastructure of the port. The debt to equity swap which would sell ownership of the port to a Chinese enterprise can work in theory, he said, since this would mean they have a real stake in the success of the project.
“The nature of Chinese state-owned enterprise investment is such that the Chinese government can drive Chinese enterprises to invest in the region around Hambantota in industries that can use the port to, for instance, re-export to China through the bilateral FTA being negotiated and also to other countries as well.
“The terms of the deal are not yet fully clear – but the theory behind it is feasible,” De Mel said.
(Both economists declined to comment on the proposed sale of the Trincomalee deep-sea harbour to India ‒ which India subsequently denied – citing a lack of information).
Singapore’s Minister for Trade and Industry, S. Iswaran calls on Minister for Development Strategies and International Trade, Malik Samarawickrama in Colombo. Image courtesy MTI Singapore
Talks of FTAs/PTAs (preferential trade agreements) with Singapore and other countries that were reported last year has led to a debate on the usefulness of such agreements and whether or not they would prove beneficial to the country in the long run. Wijesinha says it will depend on the sector.
“The proposed PTAs can help expand our market access, and position Sri Lanka as an economy that has wider market reach than just our small domestic market. Whether these will help Sri Lanka or not will ultimately depend on which sectors we manage to negotiate and get preferential market access for; whether non-tariff barriers will be tackled in a systematic way; and whether we use the PTAs to then bring in investors to leverage on in the trade-investment nexus, i.e., attracting export-oriented FDI,” he told Roar.
Spelling out the long term benefits of signing FTAs, De Mel pointed out that trade agreements can play an important role in Sri Lanka’s re-orientation towards external sector-led growth.
“Having a relatively small domestic market of US$ 85 billion, Sri Lanka will always find it difficult to grow in a substantial and sustainable manner if it maintains an inward growth orientation. Therefore, it must necessarily embark on a greater degree of exports of goods and services to drive long-term growth. Sri Lankan firms struggle to compete in global export markets since Sri Lankan costs of production (labour, utilities) are expensive compared to countries like Bangladesh and Vietnam and are unproductive compared to countries like Thailand and Malaysia. Therefore, in order to compete, it must operate in the export of products that can command a higher price – that is products with higher embodiments of technology and complexity, and export services with higher embodiment of knowledge, skill, and expertise,” he said.
According to De Mel, the fastest way to go about this would be to attract export-oriented FDI to set up in Sri Lanka and bring in these technologies, expertise, access to markets and networks, and access to talent. However, he cautioned, such FDI will not find a small market like Sri Lanka attractive without a larger market that it can also tap into.
“The objective of Sri Lanka’s FTAs is to create this larger market that would be attractive for productive investment of this nature. Again, this is sound in theory, but there are several other barriers to FDI such as access to land, access to talent, rigidities in business process (again in procedures of obtaining land, exercising legal processes, paying taxes) that need to be addressed in parallel to facilitate FDI,” he said.
Kadirgamar, however, who has long been a critic of trade liberalisation, sees no benefit in opening Sri Lanka’s doors to the world.
“The Government has been adamant in pursuing trade liberalisation, despite much of the Western world becoming protectionist. Furthermore, the global trend is in the opposite direction. In the 1990s, global trade growth was twice or even 2.5 times global economic growth. Since the Great Recession of 2008, global trade growth has been equal to and last year less than global economic growth. Even India and China, with whom Sri Lanka plans to sign trade agreements, are importing less than they were a few years back. This is what the WTO data shows. So, it makes no sense to open Sri Lanka’s markets through trade liberalisation. Export-led growth, which is extremely unlikely now, even during favourable times decades back, used to take years. So, trade liberalisation, even for economists concerned only about growth, will not address the near-term problems,” he told Roar.
Opinion is divided on the impact US President Donald Trumps’ protectionist policies could have on Sri Lanka. Image credit Rainier Ehrhardt/Reuters
The completely out of left field election of Donald Trump as US president presented with it an altogether unexpected set of problems to Sri Lanka, though really it’s still early days. Trump’s protectionist agenda as well as his well-documented opposition to free trade, analysts warned, could set the stage for an international trade war followed by a global recession. A key promise made by the Trump campaign was to impose high tariffs on exports from smaller economies with the intention of protecting the industries within its own borders. The US is Sri Lanka’s biggest export partner, with over 26% of the country’s exports making their way to American shores every year. Higher tariffs, then, is bad news for Sri Lankan traders. It is, however, possible that these dire warnings may have been reactionary and a tad alarmist.
According to De Mel, Trump’s presidency is expected to have a positive short-term impact on the US economy through lower taxes driving investment and consumption, and renewed infrastructure spending and economic de-regulation boosting business sentiment. This, he believes, would be a positive story for export growth from countries like Sri Lanka – particularly if there are targeted trade measures that undermine the competitiveness of Sri Lanka’s competitors such as China and Mexico.
“These same measures by stimulating US growth and inflation expectations could, however, lead to a faster interest rate hiking cycle by the Federal Reserve, thus driving capital out of emerging and frontier economies such as Sri Lanka – putting pressure on currencies and driving up interest rates in these countries. This would be a negative for Sri Lanka particularly given the delicate external economic situation the country faces today,” he said.
Trump appears to have found a friend in Indian Prime Minister Narendra Modi, and De Mel believes this could turn out to be beneficial for Sri Lanka. As India’s immediate neighbour, the country could benefit from a strong Indian economy through potential trade, services (logistics), and ability to attract investors looking to tap into the Indian market.
Wijesinha, too, posits that the devil may not be as black as it is painted, at least with regard to any immediate impact on the Sri Lankan economy. He does, however, caution that any slashing of taxes under Trump’s fiscal policy could hurt Sri Lanka’s borrowing costs.
“There is a lot of uncertainty on what the entire policy focus of Trump will be. Except for any shock events like a trade war that may be sparked by protectionist moves, it’s unlikely that Sri Lanka will face any immediate direct impacts. Trump’s plans for expansionary fiscal policy by way of cuts in taxes and an increase in infrastructure spending will provide a boost to the US economy, and would also prompt the US Fed to raise rates faster. This, of course, would impact Sri Lanka’s international borrowing costs. Elections in key European states as well as how Brexit pans out will have an impact on investment decisions and business activity in Europe, which would also have a bearing on Sri Lankan firms doing business with those countries,” he said.
Kadirgamar, who believes that with continued foreign borrowings, Sri Lanka is again likely to face a balance of payment problem as there is increasing capital flight, warns that Trump’s infrastructure development plans could adversely affect Sri Lanka.
“If Trump institutes policies of infrastructure build-out, the US Federal Reserve will increase interest rates, which in turn will drastically increase the cost of capital for Sri Lanka, resulting in market borrowing becoming difficult or at much higher interest rates. Therefore, what the Government refuses to do in order to keep the IMF and World Bank happy, which is restrict imports, becomes necessary. This shift in approach to reduce imports is going to be a major challenge as the Government’s economic establishment is full of neoliberal experts with their free market orthodoxy,” he told Roar.
Privatisation of state-owned enterprises and other national assets has been suggested as a means of helping Sri Lanka out of the sticky situation it currently finds itself in. To say that this is a taboo topic would be an understatement. Vocal opponents of privatisation, such as Kadirgamar, warn darkly that the present Government will use the prevailing uncertainties in the global economy as an excuse to sell off assets.
“The central issue facing the Sri Lankan economy is the global political-economic situation. And the Government seems oblivious to this context in terms of its policies. When the crisis deepens, the Government will use the crisis to sell state assets; that is, privatise public goods, and shift the burden to the people. This is where the students protest around SAITM are so important. The support for the protests reflects the increasing awareness that what is at stake is not just privatisation of education but also increasing privatisation of healthcare, which will continue to increase inequalities in Sri Lanka and increase the social burden on the citizenry,” he told Roar.
If privatisation is not an option, then, what is the solution? How does Sri Lanka ever hope to get out of the imminent crisis knocking on its door?
De Mel proposes that fiscal consolidation is the way to go ‒ at least in the short term.
“The government’s short-term strategy, at least until 2019, ought to be to consolidate the fiscal gains made in the last seven months. This consolidation of fiscal prudence and external reserve build up is necessary to build global market confidence in the country’s ability to meet external payment obligations that bunch up from 2019. This would enable the country to borrow from global markets at an affordable rate to roll-over debt when these payments do come due. In parallel, it is essential that Sri Lanka builds up the capacity to generate its own non-borrowed external inflows to meet future external payments. It is unlikely that these inflows would materialise in sufficient magnitude within 2 years, but this is why Sri Lanka needs to attract export-oriented FDI from now itself,” he told Roar.
In the longer term, he went on to say, it is important to gradually reorient the role of the government from one of large-scale dominance of economic engagement (1.3 million public servants, 245 state-owned businesses) to a more streamlined entity that has a focus on setting the rules of the game, providing public goods, smart unobtrusive regulation, and well-targeted interventions to ensure social justice outcomes as well.
“This streamlining of public expenditure is needed to reduce future debt creation and to ease the tax burden on private citizens and private enterprise in the medium to long term,” he added.
Some economists believe the Hambantota deep sea port could prove to be “constructive for the economy” – Image credit: AFP/Lakruwan Wanniarachchi
Taking the different viewpoints into consideration, it’s clear that Sri Lanka still has a fairly long way to go, and the many stumbling blocks in its path are not going to make matters easy. A local government election is on the horizon, and the UNF coalition, if it is serious about surviving the next few years, can no longer afford to tighten the screws on the hapless public. The people are slowly but surely losing patience, and the Government is in the unenviable position of having to keep the populace happy while making unpopular economic decisions that could only prove beneficial in the long term. It’s in the current administration’s best interest, then, to strike that all-important balance, and 2017 may very be the year that makes it or breaks it. In the unfortunate event that it turns out to be the latter, here’s hoping it doesn’t take the country down with it.