Colombo, Economy, Elections, Politics and Governance

Promising the moon to lure the voters is dangerous for the economy

The country is being told some dangerous lies by both main candidates contesting the Presidential election. The manifestoes put by both main candidates with much fanfare are ignoring economic realities. MR wants to give us more of the same when he has failed to resolve the problems of the economy or run any public service satisfactorily except the war where he had the horse sense to pick the right man in SF. He will build 60,000 houses in the north and east when he has not built even one so far, 6 months after the war ended. He will give land to public sector employees to build houses etc. It is a wish list not an economic manifesto. Mahinda Chinthanaya is silent on how he will get the money to do development and provide other goodies in breach of the commitments to the IMF. He will lose the next few tranches of the IMF credit if he violates the mutually agreed performance targets. Ranil says he will re-negotiate the IMF Agreement. But re-negotiation will only postpone our economic ills. The economic reality is that the economy is bankrupt. It is not the global economy that brought on the economic decline from which the economy is still recovering. We have unsustainable current account defiicits in the balance of payments as well as in the budget. Neither candidate has addressed the economic issues. SF may be excused because he is campaigning on a transitional program to restore democracy. This is enough for the economic program could be worked out by the next government which holds office after the election. But he has no excuse for making all those populist promises.

We are living beyond our means.

The situation can be made only worse by doing more of the same we have been doing for the last three decades. An open economy cannot be maintained unless there is macro-economic stability. A closed economy a la the JVP of old is to become another North Korea.

We are far from achieving macro-economc stability. This requires cutting down on the absolute quantum of the budget deficit. The Central Bank and the government talks only about the size of the budget deficit relative to the Gross Domestic Product in nominal terms. But economists agree that the absolute size of the budget deficit is more important. Relative measures are used to compare with other countries. The GDP in nominal terms can be increased by increasing the rate of inflation. If the nominal GDP grows faster than the budget deficit then the budget deficit relative to the GDP comes down. But this is of no significance since the improvement is due to higher inflation, itself induced by a larger budget deficit. So the Central Bank and the government should not mislead themselves by assuming that conditions have improved because the budget deficit relative to the GDP has come down.

Over-indebtedness makes us vulnerable
We have a significant foreign debt as well as high domestic debt. The domestic debt was a massive Rs 3578 billion in 2008 although the debt/GDP ratio declined from 85% to 81.1%. Here again the absolute value of the debt is as important as the relative Debt/GDP ratio. The higher the debt with greater borrowings lower the ratio unless higher inflation increases the nominal GDP even more when the ratio will come down. This is inflating away the debt ratio. The debt repaying capacity improves only by running a sufficient surplus in the primary account of the budget. But we are running increasing deficits in the primary account now almost 3% of GDP. The debt repaying capacity is worsening not improving. The Debt/Dependency ratio is also rising and now exceeds 30%. The foreign debt service and debt ratios are also worsening. The total Foreign debt/Exports ratio was a high of 153% estimated for 2009. In the 1987 debt crisis in Latin America the ratio was 122%. The foreign debt service ratio to Exports is also rising and likely to reach 15% by end of 2009.We are vulnerable and dependent on foreign capital inflows, but what we need is direct foreign investment which is available only from the developed western capitalist economies and not from Iran or China where borrowings will be only on government to government basis. We cannot isolate ourselves from the West without risking both growth and debt repayment. If we don’t get foreign capital inflows to roll over foreign debt falling due for repayment we are in danger of defaulting on foreign debt. Foreign debt servicing cost Rs 150 billion in 2008. Our total foreign debt is close to Rs 1500 billion and this will grow not only with more foreign borrowings and higher interest rates on new borrowings but also on exchange rate depreciation. There is both a domestic Rupee funding problem as well as a foreign exchange funding problem for foreign debt. The government in 2008 borrowed for the banking system Rs 231 billion (money printing). Similarly the recurrent budget is also in perpetual deficit and that deficit too is increasing each year. At this rate we will never achieve macro-economic balance. Any economic growth induced by such deficit budgeting and money creation is not sustainable as our economic history of the last few decades has shown.

Tax Cuts and giveaways unsustainable
In this context the lavish populist promises of the rival candidates is economic populism at its worst. Economic policy should be evidence based and not on unsubstantiated if not downright false economic premises and assumptions. Figures are trotted out for the magnitude of corruption which is obviously fictitious. To make promises on the basis of fictitious figures is not only dishonest but also foolish. The incumbent President has responded with tax cuts, particularly indirect tax cuts which previously pushed up the prices of goods. They will have to be restored if he wins. The protectionist argument is hardly valid and only pushes up the prices of domestic goods both agricultural and industrial, which have to be paid for by the consumers. What is required is to bring down the price level and this requires not low inflation but negative inflation. We have to reduce prices but to do so by tax cuts instead of spending cuts is not sustainable. All the evidence in the market place suggests that the tax cuts are a waste of money and will only benefit the traders and not even the domestic producers. It is too late to have any impact on the election for prices are not coming down despite the tax cuts. A period of adjustment is always required for the market to settle at new levels. If these tax cuts are to be maintained after the election or if election promises have to be kept at all costs (no matter how inflationary), then the economy will face a worse crisis with much higher inflation for there has to be more money printing which is the legacy of the SLFP.

The problem is wider than the tax cuts. The campaign of the incumbent President is a classic from the Clinton copybook. Narrow the distance with the rival; make small and symbolic promises, just as Bill Clinton did in ‘96. It’s a great way to try to win an election, but a dumb way to govern. While the internal funding can be overcome by printing more money the external funding requires more foreign inflows of funds which could be the undoing of a re-elected President. Despite the boom in the stock markets foreign investors are selling out and the bond market yields are no longer attractive given the risk of exchange rate falling.

The Common candidate is using the argument that since the President and the Ministers live off taxes paid by others, they only have to cut down on the number of Ministers and their perks to pay for the tax cuts. But this is far from the truth as any calculation will show. It sounds good to trot this argument that money taken from the President and his Ministers can be used to give tax relief to the people.

Impact on the Poor
Both populist leaders are wealthy beneficiaries of the war economy with all its lavish spending on arms and on the Armed Forces. Their electoral base consists of the war economy’s impoverished losers. As someone said “top leaders millionaires, supporters paupers”. The populist challenger exploits the corruption issue (exaggerating its magnitude,) as well as a certain level of public fatigue with long-serving mainstream politicians. The SLFP has been the main party that formed the government in the last two decades (except for a brief UNP interlude). Both parties are guilty of grand corruption as the COPE Report and the Auditor Generals reports show. They have invariably run coalition governments with minority parties who have made excessive demands on the States resources ostensibly for the benefit of their people but with significant amounts ending in their own pockets. They are still there and will exploit the situation in the future as well.

Waste and Corruption
The President’s leadership was marked by his government’s inability to reign in wasteful public spending. The country was in deep trouble even before October, when it went to the IMF for a bail-out with less than $1 billion in the Official Foreign Reserves, not enough to meet repay foreign debt servicing and continue importing for much longer. In a country with a population of 20 million, less than a million people pay income tax, unemployed is 6% of the working population and the employed include 200,000 or more in the Armed Forces who now do not have any productive work to perform. There are almost half a million pensioners, of whom over 20,000 are disabled soldiers.

By all accounts, the competition in populism bodes ill for the responsible management of the national purse. Indeed, it seeks to create a vested interest in poverty.

When a modern state turns provider instead of enabler, it encourages a culture of dependency which eventually saps the growth of the economy and proves counterproductive for all its citizens.
The tsunami of election-eve sops, therefore, is bad for the country.