Reform

The 2016 Budget in Sri Lanka -- The Good. The Bad. And the Ugly.

Sri Lanka's budget for 2016 included several liberal  measures but also many seemingly senseless interventions that may boomerang.

The budget contained the various give-aways to many constituencies: farmers, fishermen, housewives, and relatively higher salary earners who are in the pay-as-you-earn (PAYE) tax bracket.

The budget deficit is large and revenue proposals ambitious.

The budget takes some steps in the right direction, but overall, we consider it a mixed bag. There were no shocks as in the interim budget earlier in the year, but the extent and timeframe over which reforms will be implemented is crucial.

We have highlighted some of the key proposals below, classifying them as either Good: liberal measures that will help people, Bad: poorly-conceived proposals that may be administratively difficult and Ugly: those that will impair the quality of life and society of Sri Lankans.

There were some proposals, such as the one to strengthen law and order by building police stations, that appeared to be more in line with a police state.

We have emphasized changes in policy rather changes in tax rates.

The Good: Liberalisation Measures

The government deserves credit for restarting Sri Lanka’s halted reform program in the areas of finance and trade. The budget contains many solid proposals in this area, including the liberalization of certain trades that were previously closed, including removal of certain products from the ‘negative list’ where prior permission is needed for imports.  The proposed repeal of the Exchange Control Act is also a major step in the right direction. This signals an end of an archaic law, to be replaced by a more market-friendly exchange management process.

Land lease and ownership regulations for foreigners are also to be to be eased. The tax imposed on land leases and the prohibition on freehold ownership were viewed as obstacles to investment. These measures should positively impact investor sentiment and encourage investment. This proposal also has the potential to inject fresh capital into Sri Lanka’s now fledgling real estate sector that has taken a brow beating following the curtailing of foreign state backed development projects.

Proposals to liberalise the labour market by allowing more part-time work, relaxation of rules on contract employees (although not spelled out in detail) is welcome. Sri Lanka’s labour laws are seen to be very rigid and a barrier to investment and overall business efficiency.

Also encouraging is the outward looking rhetoric of the government, including the proposed Financial Centre, modeled along the lines of Dubai’s International Finance Centre (DIFC). The DIFC operates as a tax-free zone which essentially imports laws and judges more familiar to international investors, and a similar model could help enhance Sri Lanka’s attractiveness in this regard.

The announced open sky policy is also a welcome move that could open up Sri Lanka as an aviation hub and help tourism.

We are also encouraged by the right rhetoric in terms of promoting Start-ups and small and medium enterprises including motivations to expand access to capital.

The decision to reduce import tariffs on consumer items such as electronics, shoes and clothing is also a welcome move so that people are able to enjoy more from their earnings than sending it to the government as well as playing a role in tourist spending.

Reforming Agriculture

Agriculture sector has suffered from years of populist pandering, price controls and a host of other misguided policies that has benefited neither the farmer nor the consumer. The moves to reform this sector is encouraging.  Cash grant to small farmers in place of the fertiliser subsidy is a step in the right direction.  While we view subsidies with caution,  it is better to give the farmer an outright grant with the discretion to apply it where they deem necessary rather than blanket subsidy which may promote overuse or waste.

The over usage of fertilizer which was encouraged by the subsidies has resulted in unanticipated negative externalities such as the recent contamination of lakes, rivers and groundwater supplies. This is suspected to be the cause of kidney ailments of residents in in the Rajarata region.
 

Underutilised state land is to be leased to fruit and vegetable farmers. There are large tracts of marginal land under the State Plantations Corporation and the Janatha Estates Development Board. Allowing farmers access to this for other crops is far better than to allow the land to to lie fallow.

The budget also proposes that RPCs (Plantation companies) to be allowed more flexibility in land use. This will allow them to make better use of land uneconomical for tea or rubber greatly enhancing their economic freedom.

PPPs and State Reform

Reform of State-owned Enterprises is proposed. We welcome the fact that the problem is recognised and some attempt is being made to address it. Exiting from non-strategic holdings via the stock exchange is better than what the government policy has been for the last decade.  While we advocate re-looking at privatisation of state industries that burden the government finances and in turn the taxpayer, we welcome the moves to address this problem.

Other noteworthy proposals such as restructuring the BOI, EDB and the Tourism Board to streamline operations and grant investment approvals within 50 days is welcome.

We are encouraged by the government’s apparent willingness to let the private sector into areas traditionally monopolised by an inefficient government sector.  

Creating Special Purpose Vehicles (SPV) for state owned projects (the highways, coal plant, etc.) to attract private investment to repay debt requires further study but may be a step in the right direction.  Public Private Partnerships (PPPs) on Domestic airports,  monorail, investment zones, transport sector and developments in the proposed megapolis are all positive if carried out transparently.

The Bad

The budget text does have the customary give-aways and hand-outs as well as several measures that interfere unnecessarily in the market.

Price controls and subsidies on food items.

The Government has proposed price controls on six essential items including Mysoor Shal (Rs. 190/kg) , potatoes (Rs. 145/kg) , onions (Rs. 155/kg) , chicken (Rs. 480/kg) , packeted wheat flour (Rs. 95/kg) and dried chillies (Rs. 355/kg).

Price controls are administratively clumsy to implement and result in either goods disappearing from the shelves, lower quality goods, or the creation of black markets. This was a regular occurrence during the 1970s socialist era.   

A License-Quota regime.

Licenses are notorious for creating avenues for graft. Fifty licenses for duty free import of gold unnecessarily regulates the market place. The government should focus on dismantling current licensing regimes instead of putting up new ones.

Unintended consequences

Proposals to tax cash withdrawals will have an adverse impact on informal sectors of the economy. The  high rate (2% for withdrawals of Rs1-10m and 3% on withdrawals above Rs.10m) is designed to bring the informal sector into the normal banking system. While the objective is laudable it may hinder trade, especially among SMEs.   

The proposal to spend Rs.21bn or Rs.1.5mn for each cluster village is not clearly spelled out. This could be a license for wasting tax-payer money.

Fixing non-existent problems

The government proposes introducing regulations into certain previously unregulated markets. This includes Three-wheelers, School Vans and Taxis. One of the redeeming aspects of Sri Lankan public transport is that the free-market in private transport provision including Taxis and three-wheelers that provides a better service than most countries in the region. While the type of regulation is not spelt out in the budget speech, the government intervention could very well worsen matters.

Similar micro interventions in a mandate to register all hotels, and government subsidies for accountancy students seem like solutions in search of problems. A mandate to to have four people in a vehicle entering Colombo is also bound to be unpopular and difficult to administer.

Left unsaid

Whilst the finance minister spoke for a taxing four hours on the budget proposals, there was still much unsaid.  The budget was not explicit on what the government would do to tackle the over-staffed public sector. Nor were there proposals to put gasoline on a market-based pricing formula as was promised during the elections.

The Ugly

National Digital Identity Card.  

Whilst there is a tendency in Sri Lanka to cheer on anything to do with technology, we advocate caution on this proposal.  Little is known about the program except that it was initiated by the previous government.   For a country that’s emerging from an all powerful state,  a national security mindset, with the full extent of surveillance on citizens still unknown, people should demand more transparency and information before blanket implementation of this program. The country requires a robust debate on privacy and surveillance.

Micro interventions in the Banking & Financial Sector

Banks are asked to cease leasing operations from June 2016.

The rationale for this micro level interference in the banking sector is weak. It will be hugely disruptive to the operation of most banks with little benefit to anyone other than the non-bank financial sector.  

Similarly the directive to lend to agriculture, SME's and Women & Youth (whatever that may be) is poorly thought out. Fixing the fees on bank drafts at Rs.150 is another intervention proposed.  

We see no reason why government should be involved in these matters that should be left to the market place

 
Confusing “Canned Fish” Proposal


A buy back scheme for locally produced canned fish to be sold at a subsidised price may open the door to massive losses at Lak Sathosa. If prices are high enough supply of canned fish to Sathosa will increase significantly and the losses may exceed the amounts budgeted.

At the same time taxes on imported canned fish will be increased, which will only increase the pressure to consume the subsidised products driving up the final bill to the taxpayer.

In another part of the budget speech the Minister blames a policy at Lak Sathosa where rice was imported at Rs.75 per kg and sold at Rs.50 per kg for the Rs.8bn accumulated losses in that institution. The Minister is proposing the same policy, but for canned fish instead of rice. 

The government seems to be concerned about reducing prices for the consumer as well as protecting local industry, these two objectives seems at odds with each other.

New Government entities and unfunded programs

On education, while the government has made election promises to expand state funding of education, the establishing of yet another state university (The Mahapola University, to teach ICT, business and English) is the wrong way to go about it.  Instead of spending Rs. 3bn  on buildings for a new state university the money would better spent on improving facilities at existing ones, expanding scholarships or setting up a market-led voucher schemes for funding of higher education.

The University of Moratuwa has a well deserved reputation for excellence in ICT, the Postgraduate Institute of Management has a similar reputation for business studies and faculties of English at both Colombo and Peradeniya produce high quality graduates. Should this money be better spent on strengthening facilities or faculties at these institutions? Much like the administrations before this, the government confuses funding for education with the provision of education.

A new proposal to spend Rs 1 billion on increasing the number of police stations from 428 to 600 is not explained properly. It is unclear if law and order will improve simply by building police stations. There is no mention of the manpower that is needed and whether that adds to the burden of an already mega public sector.

In Conclusion

The many steps taken by the government to transform Sri Lanka into a more outward looking, open market are welcome. The Finance minister certainly hit the right notes on Friday, about the government’s commitment to a market-friendly policy regime, a technology-focus and the emphasis on the private sector as the key driver of economic growth.

However glaring inconsistencies takes the shine off the Finance Minister’s claims.  Continued use of price controls and a readiness to make micro-level interventions in markets is not how a thriving market economy operates.  

As a society, Sri Lankan has also been unable to move away from expecting short-term goodies from the budget statement. Whether it’s price controlled big onions or powdered milk someone has to pick up the tab, and it’s often the same people as tax payers or their children in the next generation as government racks up debt.

There are reasonable questions asked whether the budget actually could meet the  deficit target the set by the Finance minister. The elephant in the room as always is Sri Lanka’s mega government apparatus. Slow dismantling the leviathan should be the answer to the long-term untying of the Gordian fiscal mess.

Advocata Institute is a public policy think tank based out of Colombo, Sri Lanka. 

 

Post-Election Agenda: A Sri Lankan Economy That is More Open to the World

By Anushka Wijesinha

This article originally appeared in the Daily Mirror on 06 August 2015.

Over the past decade or more the Sri Lankan economy has become less and less open to the world than it has ever been. Exports to GDP has nearly halved; the share of trade in overall growth has fallen, our overall tariff protection rates are higher now than in the past; our export diversification and product complexity now is far behind countries that were at the same level as we were several decades ago; and our foreign policy has not focused enough on economic relations and trade agreements. Looking at Sri Lanka’s export product categories, not much has changed between 1990 and 2013, whereas in countries like Thailand there are dramatic shifts from basic exports to highly sophisticated exports.

Reforms to Open Up

We must change the orientation of the Sri Lankan economy, if the country is to succeed at achieving sustained high growth and boost prosperity for our people. When you measure along trade openness (exports + imports as % of GDP) and along public vs. private sector participation – the Sri Lankan economy in 2013/2014 looks more like 1970, according to analysis in a forthcoming World Bank publication.

But the positive news is that when Sri Lanka did undertake liberalization policies in the past, the economy saw positive results. In the years following waves of reforms – both in the early 1980s (after 1977) but most clearly in the late 1990s and early 2000s (after the 2nd wave of reforms in 1990) the economy was more export oriented and more private sector driven. In the last couple of decades, in the absence of critical next generation reforms, we have slid back.

 

The Sri Lankan economy has a lot going for it – an unviable strategic location, rich biodiversity, a strong human resource base due to past investments, in the midst of the Asian century, and in close proximity to major markets like India. But the reality is that we are not the only ‘hot stuff’ on the market. We are in a dynamic region, but around us we have a lot of dynamic countries doing a lot of progressive things that make them attractive locations for international business. Sometimes I wonder – have we tricked ourselves into thinking that Sri Lanka is such a magical country where investors ought to come to, where foreign companies ought to do business with us?

Sri Lanka must reposition itself on the global stage and provide the right climate for companies to thrive on that stage. Two aspects are important for Sri Lankan companies to gain from this – a level playing field here at home and opening up of the playing field overseas.

A Better Playing Field at Home

Creating a level playing field at home means removing unnecessary and harmful distortions that have crept in over the past decade and incentives that really haven’t worked. Protectionism for selected industries and producst – often benefitting one or two recognisable firms with political patronage – have created disincentives for competition and dynamism. There has been a noticeable bias towards domestic economic activities and domestic non-tradables than export orientation in the past decade. While this would be fine for a large economy with a large domestic market, for Sri Lanka such a strategy is not sustainable.

Meanwhile, we must look strategically at leveraging on the massive new infrastructure outlays of the past decade – some of which have been doubted for their usefulness but can boost growth if managed cleverly. For instance how can we make Hambantota work and not abandon it due to political compulsions? Already it is emerging as a key vehicle transshipment port in the region. But beyond this, a private-public partnershuip approach is necessary to operationalise the port-airport-industrial zone nexus and make it an export hub like what Malaysia did in Penang.

Opening Up The Playing Field Abroad

Opening up the playing field abroad is a must to help Sri Lankan firms gain a greater foothold in the international market. This is a key area the state can help. It is where our foreign policy and international economic policy comes in. In recent years, much of our foreign policy has been preoccupied with managing international relations related to the end of the war, human rights, and governance issues. We must reorient this. Future foreign visits must necessarily have a strong trade and investment component with a strategically planned international business agenda. Diplomatic delegations must take with them foreign investors who have set up here and are thriving – let them tell the Sri Lanka story. That’s what the Penang Development Corporation in Malaysia did when they wanted to attract international business into the Penang Export Hub. When 3M first invested there, top executives from 3M were taken along with Malaysian political delegations to convince other foreign investors about the benefits of locating in Penang. Having global multinational executives selling your country for you is a powerful signal to potential new international investors.

Supporting Firms To Go Global

Much of Sri Lanka’s – and indeed many Asian countries – industrial policy approaches of the past have been focussed on trying to identify export sectors and providing a host of incentives and support to growth them. It worked in many East Asian coutnries only because of strong state capacity. Unfortunately, the Sri Lankan institutional set up to support exports and industry has not kept up with evolving needs. While traditional sectors like garments, tea, rubber, gems, etc., would continue as in the past, I would advocate that state institutions focus less and less on promoting full sectors. The future focus should be – “how can we help more Sri Lanka firms go global?”, rather than be obsessed with identifying and promoting sectors. This goes back to the argument on the states’ role in providing a level playing field at home and expanding the playing field overseas. There are a lot of very competent and competitive Sri Lankan firms who have proven that Sri Lanka can win in lucrative niches that may not be part of full sectors. Sri Lanka can boast of a manufacturing company that produces the impact sensors for airbags and seatbelts for much of the Japan’s automobiles; a technology company that produces combat simulation software for the US military; and a medium-sized fly fish producer that supplies the leading US brand of sport fishing equipment. These are all individuals companies winning in the export game. We need to help more of them emerge and win new markets. We may have to end our preoccupation with trying to promote whole sectors, and state institutions like the EDB and Ministry of Industries would have to reorient to support this new agenda.


Anushka Wijesinha is visiting Scholar at Advocata and currently the chief economist for the Ceylon Chamber of Commerce.  He has previously worked at Institute for Policy Studies, The World Bank and the presidential commision on taxation.  His writings on economics are found on his blog -- The curionomist.  You can follow him on Twitter @anushwij

Reforming Sri Lanka’s power sector

By Ravi Ratnasabapathy

 The article originally appeared in the Daily News.

Electricity was introduced to Ceylon by a private company in 1895, but since 1927, with the formation of the Department of Government Electrical Undertakings the industry has been a vertically integrated state monopoly.

The electricity infrastructure comprises generation, transmission and distribution. Transmission refers to the bulk transfer of electricity from power plants to substations located near demand centres. Distribution is the delivery of power to consumers from substations.

Some reform of the industry took place during the 1980's and 1990's. LECO, a state owned private company established in 1983 to undertake the distribution of power in Kotte. Independent Power Producers (IPPs) and small hydro developers entered the industry in the mid1990s when generation was opened to private investors following a severe power crisis in 1996.

Since 2004 policy reverted to state-lead investment with the exception of small renewable power projects. The CEB reports regular losses, is heavily indebted and has invested billions but does Sri Lanka have an efficient and economic system of electricity supply, the stated mission of the CEB?

The disaster that is the coal power plant is well known and provides good reason to reassess the long term plans for the provision of power.

Before examining long term solutions there are immediate problems that need to be addressed so some short-term measures are necessary. A peculiarity of Sri Lanka's electricity demand is the high evening peak load. A steep increase in demand occurs between 6pm-7pm which then peaks from 7pm-8pm. Thereafter demand gradually eases over the following three hours.

Peak demand is about 50% higher than average demand and coping with this presents the most urgent problem for the CEB. A study by the Public Utilities Commission of Sri Lanka (PUCSL) in 2012 recommended that “aggressive action is still required to curb further growth in peak demand, since an adverse trend is observed during recent past”.

The simplest solution to this is to move to daylight saving time, which means setting the clock forward by an hour. This proved to be an effective curb on demand when it was implemented after the power crisis of 1996. It was previously used in Ceylon during WWII to conserve power and also by Pakistan after a power crisis in 2008. It is a simple cost free solution that demands immediate implementation.

The management of the demand for power by bulk consumers is also needed. An overlooked aspect of this is the waste of power in the telecommunications industry. Transmission towers consume a lot of power but operators in Sri Lanka do not have a comprehensive infrastructure sharing regime. Operators regard their networks as a source of competitive advantage and share only limited sites. This has resulted in widespread duplication of infrastructure, unnecessary strain on the grid and unsightly visual pollution. The Telecommunications Regulatory Authority (TRC) needs to impose a proper infrastructure sharing regime. Sharing must cover all infrastructure including SLT’s fibre backbone and the TRC should incentivise the decommissioning of redundant sites. Moving on to longer term solutions should private power have a role to play?

In Sri Lanka IPPs have been controversial but the solution is not be to ignore the private sector but instead to move to electricity auctions to procure power. Auctions increase the competition and transparency of electricity procurement and are now quite widely used. Examples include the UK, New Zealand, Australia and Singapore. Open, transparent competition promotes efficiency and reduces costs to consumers. Singapore moved from state monopoly in 1995 to competitive market in stages over a period of years, yielding tangible benefits to consumers. Although the price of oil, the major cost in electricity generation, increased by 152% between 2001 and 2008, Singapore’s electricity tariff rose only 14% during that period. This was possible largely due to efficiency gains in generation, such as utilising more cost-efficient technology.

Competitive pricing encouraged firms to invest, for example in more efficient gas fired combined cycle turbines and retro-fitting existing plants. The share of electricity generated in Singapore by natural gas increased from 19% in 2000 to 79% in 2010 and overall power generation efficiency increased from 38% to 44%. Consequently, carbon dioxide emissions per unit of electricity generated declined by 30% between 2000 and 2007.

The tangible benefits from liberalising the electricity market make a compelling case to move in that direction although the process is by no means a simple or easy. Even in Singapore the major reforms were introduced gradually over a period of a decade, but this should be the vision for Sri Lanka’s power sector.

The Pathfinder Foundation published a paper in 2007 examining in some detail how Sri Lanka could move to a competitive electricity market. The conceptual model for an electricity market, in very simple terms is to have the generation, transmission and distribution split into independent units with competition between them.

It is essential to have several entities carrying out generation (IPPs and entities carved out from existing CEB generation assets). These will compete in a daily computerised auction to sell power to the transmission entity, which should have no links to the generating entities. The auction is usually held a few says before the actual despatch of power is needed. The generating units compete to supply power for fixed time slots in the day, usually for each hour or half hour and the system automatically awards the time slots to each generating unit based on the lowest cost. The transmission entity in turn sells the power to distribution units, which will be monopolies in their respective areas of operation. When distribution utilities operate in similar operational areas, the regulator can easily set up realistic performance targets by comparing their performances. Similarly since the transmission will be carried out by a separate entity the losses in transmission are easily monitored and the incentive is created to minimise leakage.

If practical advice were needed the Government of Singapore has always been willing to share its expertise.


Ravi Ratnasabapathy trained as a management accountant and has broad industry experience in finance. He is interested in economic policy and governance issues.