The other day I was invited to a closed door seminar organized by the Pathfinder Foundation to discuss the IMF stand by arrangement. A total of about twenty five or so policy makers, professionals, academics, and businesspeople attended and engaged in a fairly mundane discussion on why we had to go to the IMF. While some squarely put the total blame on the global economic crisis others were more intellectually honest about the domestic causes. Having paid tribute to President Rajapaksa`s commitment to eliminate the LTTE came the now overused clich `The government must prosecute the economic war the same way it did the terrorist war.`
Prosecuting the economic war
What does prosecuting the economic war really mean beyond the clich ? As elaborated by General Sarath Fonseka at the PIM (I saw one of the many re-runs on TV) should we re-strategize and break with usual tactics? Surprise the enemy? Or should we continue with the current thinking? This is where the discussion became interesting. A section of the gathering were of the opinion that in this new post-war post-IMF paradigm the government had the best chance to re-strategize to formulate crucial economic reforms and use the unprecedented strength of the Rajapaksa government to push through its implementation. It was argued that these would include essential reform in the public sector by reducing its size and restructuring loss-making state owned enterprises and urgent reforms in laws and policies that restrict trade, labour markets and also restrictive property rights for agricultural land. Proponents of this view spoke out on the need for drastic expenditure reduction and prudent monetary policy, the need to target subsidies and minimize state intervention in financial markets. They lamented on the heavy burden of taxes in doing business some twenty odd taxes as opposed to an average of five or six in more progressive economies in the region. The gist of the argument was depoliticizing and reducing the interventions of the state in the economy. A prominent academic running a partially state-funded think tank was of the view that after (not if, but after) the victories of the presidential and the parliamentary elections President Rajapaksa will make these tough changes in economic policy. The argument was that post-election reality will be 180 degrees opposed to what will be promised at the forthcoming elections!
Chronic budget deficits
The view of this group is founded on the premise that the fundamental macroeconomic problem in Sri Lanka is her chronic budget deficits that multiple other problems originate from deficits leading to reduced national savings and lower investments resultng in lower economic growth along with associated problems of increased borrowing leading to unsustainable debt and large repayment obligations, pressure on interest rates and exchange rates leading to destabilizing fiscal and balance of payments problems. As a matter of fact Sri Lanka`s total debt repayment for 2009 is close to LKR 750 billion while the expected total revenue of the state is, going by the first six months revenue, is less than LKR 600 billion.
Government agrees to implement Ranil`s Fiscal Management Act?
The reason why this reform view is important is because the primary `structural benchmark` that Minister Siyambalapitiya and Governor Cabraal agreed with the IMF besides the `performance criteria` of external reserve floor and net domestic asset ceiling, is to reduce the budget deficit to 7 percent by end 2009 and 5 percent by 2011. Ironically, this is precisely what then Prime Minister Wickremesinghe`s UNF government made in to law with the Fiscal Management (Responsibility) Act of 2003 (inter alia to bring down the deficit to 5 percent by 2006). Of course this obligation was ignored by the UPFA government since 2004. It is noteworthy that this time around, unlike in the past, the IMF did not specify how to reduce the deficit only that the deficit per se had to be reduced. Given the already high tax burden on the people, deficit reduction is more an undertaking to drastically reduce government expenditure than increasing taxes. However, it is not to say that it is possible that the current VAT be replaced with a turnover tax that would increase the burden on the people even more actually by another 2 percent of GDP, which is the undertaking given to the IMF for the loan.
Latest numbers are scary we really need to cut the deficit
The Central Bank has just released the actual turnout of the revenue and expenditure figures for the fist half of 2009. Table 1 gives a summary or more aptly the unfolding horror story. As things now stand, the annualized deficit is almost 11 percent. To meet the 7 percent IMF undertaking, the deficit can only increase by another LKR 81 billion that means from LKR 263 billion to LKR 344 billion. Consider how realistic this sounds: `First 6 months deficit of LKR 263 billion but the second 6 months a deficit of just LKR 81 billion`. You be the judge.
Cutting budget deficit is NOT prudent policy
Now, this is where the conflict arises Mahinda Chintana, the vision for Sri Lanka is very clear on where President Rajapaksa stands on the deficit. The very first paragraph on `macroeconomic management` goes like this: `The mere reduction of public expenditure and the resulting reduction of the budget deficit per se is not a characteristic of prudent public finance management`. If that is the case, why did Mr Siyambalapitiya and Mr Cabraal sign on the dotted line to reduce the budget deficit per se to 7 percent by 2009 and 5 percent by 2011? Did they have the blessings of the President to fall in line with Wickremesinghe`s policy instead of upholding the Chintana? Or was it pure eye-wash with no real intention of bringing down the deficit? I don`t know the answer, but it is noteworthy that President Rajapaksa, who should have signed the agreement in his capacity of the Minister of Finance, did not place his signature on the document, but instead, it was Mr Siyambalapitiya who had to do the honours as the acting minister for 3 days. The 2001 and 2003 agreements were however signed by President Chandrika Kumaratunge and Mr K N Choksy as ministers of finance respectively along with Governor A S Jayawardena.
Chintanaya beats the
It is here that the views of the other group (not the pro-reform group) become important. The view of this group was very clear in that there is no need to reduce the budget deficit per se and that the so called `traditionalist view` where deficits are `bad` is no longer relevant. The government can and will continue to play an important role in the economy and spend on numerous ministries, subsidies and other expenditures as planned. It will also continue to make investments in development projects. If that creates a 7, 8, 9 or 10 percent budget deficit, so be it. This argument, be it `Ricardian`, `Keynesian` or `Mahindian` was put forward quite vociferously by a very senior personality in the Rajapaksa government holding several senior advisory positions to the president and chairing a crucial commission on raising state revenue. In fact it was boldly mentioned that there is more than one view within government itself and that the Siyambalapitiya-Cabraal view, whatever that may be, could be just one of them, but not the view held by him, I presume, to advice the President as the Minister of Finance who ultimately is in charge of the Treasury.
Will this deficit be cut?
So, here is the dilemma. What is the convergent view of the Mahinda Rajapaksa government on the budget deficit? Are high budget deficits a real problem that need to dealt ala IMF in this case, or is it not something to be worried about ala Mahinda Chinatana? Razeen Sally, a Sri Lankan born academic writing in a recent issue of the Far Eastern Economic Review says `The government has spent like there was no tomorrow.` He adds `Subsidies have also increased, especially to agriculture to shore up vote banks in the countryside. A bloated public sector, employing around one million people in a labor force of under seven million, has swelled even further.` The result of all of this is obviously an unsustainably high budget deficit. Mr Sally continues `Academics and other government advisers advocate a state-directed economy, infant-industry promotion and agricultural self-sufficiency - all old ideologies that are back in fashion.` Mr Sally is quite accurate when he says `Policy making is more populist, opaque and unpredictable, favoring the politically-connected and sidelining technocratic advice.` So then, will this deficit be cut? Most likely not! There is another technicality that favours the government the new IMF conditions are not as stringent on the deficit as in the past now it is only a flexible `structural benchmark`.
What is in store?
I don`t share the view of my professional colleague who is of the opinion that after an election victory the President will make drastic changes to his Chintana ideology of economic management. In fact my view is that a second term of Mr Rajapaksa, if there is one, will be more of the same but in larger doses. In that the future will only see half-hearted attempts at addressing the structural problems of the economy. Big government will continue and state and political interventions in the market will increase. Deficits will endure. Mr Sally, who does not live here, is more hard-hitting he refers to a `creeping Russification` where he warns of `a parastatal network of politicians, Mafiosi and the military could extend its tentacles into business life.` Some recent appointments surely suggest that Mr Sally is not completely out-of-line.
Beyond the clich
Beyond the clich , prosecuting the economic war in my view, calls for radical change in strategy. We need to face reality and address the fundamental problem of a bloated and completely politicized government that is living beyond its means day-in day-out. A leading chamber personality at the discussion put it aptly when he said `I am yet to come across the magic formula which will allow me to consistently consume way more than I produce.` The President will have to re-look at his economic Chintana and take technocratic advice if he is to successfully prosecute the economic war.