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Budget 2021 likely to worsen macroeconomic instability amidst COVID-19 pandemic

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By Prof. Sirimevan Colombage

The Budget Speech 2021 was presented at a time when the country is being severely hit by the COVID-19 pandemic. GDP growth is projected to be down to negative 2 percent this year. Despite this economic setback, the government envisages to maintain an inclusive GDP growth rate of 6 percent per annum over the medium-term while containing inflation to around 5 percent, according to its macroeconomic programme, ‘Vistas of Prosperity and Splendour’.

 

Less emphasis on COVID-19

Given such optimistic targets, it is somewhat puzzling that the Budget Speech does not pay much attention to Covid-19 pandemic which has paralyzed virtually all economic activities by now. Reflecting mixed-up priorities, the Budget has given undue resource allocations at this difficult juncture to some arbitrarily selected projects such as urban townships, sports, road construction and walking paths, which have no direct relevance to revive the pandemic-hit economy, though they may have their own merits during normal times.

A coherent economic recovery strategy, apart from the fiscal and monetary stimulus already granted, is the need of the hour to revive the economy from the fallout. The pandemic has severe consequences on the Sri Lankan economy, which had already encountered multiple economic setbacks including low economic growth, fiscal disarrays, balance of payments deficits and foreign debt burden even prior to the health crisis. The pandemic has adversely affected the export sector, domestic production, inward remittances and distribution network. Poor households who are mostly working in the informal sector with irregular income sources have become extremely vulnerable in the present crisis situation.

 

Escalating fiscal imbalance

The budget deficit is projected to rise by 24 percent from Rs. 1,266 bn. (7.9 percent of GDP) in 2020 to Rs. 1,565 bn. (8.9 percent of GDP) in 2021, reflecting a severe deterioration of the fiscal position (Figure 1). It is expected that the total revenue would rise by 28 percent in 2021 as against 26 percent increase in total expenditure. Such exorbitant revenue growth cannot be expected for a single year even during normal times. The projected increase in revenue is said to be based on the assumption of 5 percent growth in GDP in 2021. This assumption seems to be over-optimistic considering the negative impact of COVID-19 in years to come, and the country’s limited growth potential experienced even before the outbreak of the pandemic. Slower GDP growth in 2021 means low level of government revenue, and consequent expansion of the budget deficit much higher than what is expected. Thus, the budget deficit is likely to be 10 percent of GDP or more in 2021.

 

Monetary implications of fiscal imbalance

With the rise in the budget deficit, the government is compelled to rely increasingly on the banking system to finance the deficit. Net bank credit to the government rose by 46 percent from Rs. 2,732 bn. in September 2019 to Rs.3.980 bn. in September 2020. The Central Bank has accommodated government finance requirements by directly purchasing Treasury Bills at primary auctions. The Central Bank’s net credit to the government rose by 50.8 percent from Rs. 383.2 bn. in September 2019 to Rs. 577.7 bn. in September 2020.

The monetary easing policy adopted by the Central Bank to relieve the households and businesses adversely affected by Covid-19 too accelerated the annual money growth from 7.4 percent in September 2019 to 19.2 percent in September 2020 (Figure 2). The monetary easing measures included sequential reductions of the policy interest rates and Statutory Reserve Ratio (SRR), which led to inject substantial liquidity into the market, and to reduce borrowing costs significantly. Concessional credit schemes were also introduced to facilitate the activities of Small and Medium-scale Enterprises (SMEs), alongside debt moratoria granted for businesses and individuals distressed by the pandemic.

Nevertheless, the annual growth of commercial bank credit to the private sector has remained stagnant around 5 percent reflecting the slow pick up of economic activities. In contrast, net commercial bank credit to the government rose by 44.9 percent in the 12-month period ending September 2020. In this background, the excessive money supply growth is bound to create demand pressures augmenting inflation and imports in the coming months.

 

Inflation-targeting monetary policy missing

Surprisingly, the Budget Speech does not make any reference to monetary policy which is vital in achieving macroeconomic stability, and sustaining economic growth. The Central Bank made concerted efforts about two years ago to launch the inflation-targeting monetary policy framework with the expectation of close coordination with fiscal authorities while regaining its independence. I categorically warned in these columns that such efforts would be suicidal for the Central Bank, unless the fiscal sector is aligned with such process committing to low budget deficits.

It is evident by now that inflation-targeting monetary policy is a remote possibility, as such policy is completely neglected not only by the fiscal authorities in the latest Budget Speech, but also by its architect, the Central Bank. Inflation-targeting monetary policy framework is not focused in the Central Bank’s publication, ‘Recent Economic Developments – Highlights of 2020 and Prospects for 2021’.

Understandably, it is not feasible to implement such rule-based policy amidst the current economic crisis, but the Central Bank should have displayed its long-term commitment to run the inflation-targeting monetary policy framework, which was declared with much grandeur not so long ago. That would strengthen the Central Bank’s independence, which is vital to operate monetary policy without undue political interference.

Demand pressures mounting

The easy monetary policy implemented by the Central Bank under the Presidential directive following the pandemic is unlikely to boost production activities significantly as expected, given the inherent weaknesses of enterprises, uncertain macroeconomic environment and imperative health-related precautionary measures imposed by the government including curfews, lockdowns and travel restrictions.

The global economic downturn resulting from the pandemic has dampening effects on the export sector. Further, business decisions in the private sector are mostly based on comparisons of the expected rate of return on investment vis-à-vis opportunity cost of investment. Interest rates represent the opportunity cost while expectations are influenced by many factors including macroeconomic economic environment, technological changes, exchange rate volatility, capacity utilization, export competitiveness, aggregate demand, fiscal stability, inflation, political stability, business confidence, and cost of production.

The present low interest rate environment encourages consumption, as savings yield low returns. Thus, low interest rates have negative effects on domestic savings. This is reflected in the downfall of domestic savings rate from 24.8 percent of GDP in the first half of 2019 to 20.8 percent in the corresponding period of 2020. Meanwhile, private consumption rose from 66.7 percent of GDP in the first half on 2019 to 70.5 percent in the same period of 2020. Given the low returns on savings, the surplus-fund holders tend to move to alternative assets such as commodities, real estate and risky financial instruments. Such fund diversions lead to distort investment decisions, and to create asset bubbles harming financial stability.

The rising consumption demand has spill-over effects on domestic production and imports exerting pressures on inflation and balance of payments deficits. Inflation, in addition to cheap credit, makes imports attractive and exports unprofitable, causing further deterioration of the trade balance. Unless the exchange rate is allowed to depreciate freely to achieve external equilibrium, import restrictions become imperative to avoid deterioration of the trade deficit. This type of inward-looking foreign trade policy seems to be the government’s policy choice at present, as can be evident from several import controls imposed in recent times. Although such measures are inevitable amidst the pandemic, it must be noted that they have adverse consequences on competitiveness, productivity and export-led growth in the long run. Hence, it is important to phase out import restrictions and to allow free trade.

Policy concerns

Given Sri Lanka’s long track record of low economic growth and macroeconomic imbalances, it is a major policy challenge to mitigate the economic fallout from COVID-19. Budget 2021 does not contain any coherent policy strategy to overcome the crisis. The budget deficit in 2021 is likely to be much higher than what is given in the official projections due to inevitable revenue shortfalls and expenditure overruns amidst the pandemic. In financing the widening budget deficit, increased reliance on bank borrowings results in liquidity injections, and consequent pressures on the money supply, inflation and balance of payments. The import restrictions imposed recently to arrest the balance of payments deficit might give wrong signals to the market depressing outward-oriented growth. Meanwhile, recourse to foreign borrowings escalates the already heavy external debt burden.

The response of the private sector to monetary easing seems rather weak due to structural factors while cheap credit has tended to encourage extravagant consumption, speculative asset holdings and risky financial dealings. The neglect of inflation-targeting monetary policy launched by the Central Bank about two years ago is a matter of concern from the viewpoint of optimal monetary-fiscal policy mix. A systematic growth strategy, backed by a realistic macroeconomic framework, is essential to recover the economy.

(The author is Emeritus Professor in Economics at the Open University of Sri Lanka)

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Features

Govt.’s choice is dialogue over confrontation

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By Jehan Perera

Preparing for the forthcoming UN Human Rights Council cannot be easy for a government elected on a nationalist platform that was very critical of international intervention. When the government declared its intention to withdraw from Sri Lanka’s co-sponsorship of the October 2015 resolution No. 30/1 last February, it may have been hoping that this would be the end of the matter. However, this is not to be. The UN Human Rights High Commissioner’s report that will be taken up at the forthcoming UNHRC session in March contains a slate of proposals that are severely punitive in nature and will need to be mitigated. These include targeted economic sanctions, travel bans and even the involvement of the International Criminal Court.

Since UN Secretary General Ban Ki-Moon’s visit in May 2009 just a few days after the three-decade long war came to its bloody termination, Sri Lanka has been a regular part of the UNHRC’s formal discussion and sometimes even taking the centre stage. Three resolutions were passed on Sri Lanka under acrimonious circumstances, with Sri Lanka winning the very first one, but losing the next two. As the country became internationally known for its opposition to revisiting the past, sanctions and hostile propaganda against it began to mount. It was only after the then Sri Lankan government in 2015 agreed to co-sponsor a fresh resolution did the clouds begin to dispel.

Clearly in preparation for the forthcoming UNHRC session in Geneva in March, the government has finally delivered on a promise it made a year ago at the same venue. In February 2020 Foreign Minister Dinesh Gunawardena sought to prepare the ground for Sri Lanka’s withdrawal from co-sponsorship of UN Human Rights Council resolution No 30/1 of 2015. His speech in Geneva highlighted two important issues. The first, and most important to Sri Lanka’s future, was that the government did not wish to break its relationships with the UN system and its mechanisms. He said, “Sri Lanka will continue to remain engaged with, and seek as required, the assistance of the UN and its agencies including the regular human rights mandates/bodies and mechanisms in capacity building and technical assistance, in keeping with domestic priorities and policies.”

Second, the Foreign Minister concluding his speech at the UNHRC session in Geneva saying “No one has the well-being of the multi-ethnic, multi-lingual, multi-religious and multi-cultural people of Sri Lanka closer to their heart, than the Government of Sri Lanka. It is this motivation that guides our commitment and resolve to move towards comprehensive reconciliation and an era of stable peace and prosperity for our people.” On that occasion the government pledged to set up a commission of inquiry to inquire into the findings of previous commissions of inquiry. The government’s action of appointing a sitting Supreme Court judge as the chairperson of a three-member presidential commission of inquiry into the findings and recommendations of earlier commissions and official bodies can be seen as the start point of its response to the UNHRC.

 

 

NEGATIVE RESPONSE

 

The government’s setting up of a Commission of Inquiry has yet to find a positive response from the international and national human rights community and may not find it at all. The national legal commentator Kishali Pinto Jayawardene has written that “the tasks encompassed within its mandate have already been performed by the Lessons Learnt and Reconciliation Commission (LLRC, 2011) under the term of this President’s brother, himself the country’s Executive President at the time, Mahinda Rajapaksa.” Amnesty International has stated that “Sri Lanka has a litany of such failed COIs that Amnesty International has extensively documented.” It goes on to quote from the UN High Commissioner for Human Rights that “Domestic processes have consistently failed to deliver accountability in the past and I am not convinced the appointment of yet another Commission of Inquiry will advance this agenda. As a result, victims remain denied justice and Sri Lankans from all communities have no guarantee that past patterns of human rights violations will not recur.”

It appears that the government intends its appointment of the COI to meet the demand for accountability in regard to past human rights violations. Its mandate includes to “Find out whether preceding Commissions of Inquiry and Committees which have been appointed to investigate into human rights violations, have revealed any human rights violations, serious violations of the international humanitarian law and other such serious offences.” In the past the government has not been prepared to accept that such violations took place in a way that is deserving of so much of international scrutiny. Time and again the point has been made in Sri Lanka that there are no clean wars fought anywhere in the world.

International organisations that stands for the principles of international human rights will necessarily be acting according to their mandates. These include seeking the intervention of international judicial mechanisms or seeking to promote hybrid international and national joint mechanisms within countries in which the legal structures have not been successful in ensuring justice. The latter was on the cards in regard to Resolution 30/1 from which the government withdrew its co-sponsorship. The previous government leaders who agreed to this resolution had to publicly deny any such intention in view of overwhelming political and public opposition to such a hybrid mechanism. The present government has made it clear that it will not accept international or hybrid mechanisms.

 

 

SEQUENTIAL IMPLEMENATION

 

In the preamble to the establishment of the COI the government has made some very constructive statements that open up the space for dialogue on issues of accountability, human rights and reconciliation. It states that “the policy of the Government of Sri Lanka is to continue to work with the United Nations and its Agencies to achieve accountability and human resource development for achieving sustainable peace and reconciliation, even though Sri Lanka withdrew from the co-sponsorship of the aforesaid resolutions” and further goes on to say that “the Government of Sri Lanka is committed to ensure that, other issues remain to be resolved through democratic and legal processes and to make institutional reforms where necessary to ensure justice and reconciliation.”

As the representative of a sovereign state, the government cannot be compelled to either accept international mechanisms or to prosecute those it does not wish to prosecute. At the same time its willingness to discuss the issues of accountability, justice and reconciliation as outlined in the preamble can be considered positively. The concept of transitional justice on which Resolution No 30/1 was built consists of the four pillars of truth, accountability, reparations and institutional reform. There is international debate on whether these four pillars should be implemented simultaneously or whether it is acceptable that they be implemented sequentially depending on the country context.

The government has already commenced the reparations process by establishing the Office for Reparations and to allocate a monthly sum of Rs 6000 to all those who have obtained Certificates of Absence (of their relatives) from the Office of Missing Persons. This process of compensation can be speeded up, widened and improved. It is also reported that the government is willing to consider the plight of suspected members of the LTTE who have been in detention without trial, and in some cases without even being indicted, for more than 10 years. The sooner action is taken the better. The government can also seek the assistance of the international community, and India in particular, to develop the war affected parts of the country on the lines of the Marshall Plan that the United States utilized to rebuild war destroyed parts of Europe. Member countries of the UNHRC need to be convinced that the government’s actions will take forward the national reconciliation process to vote to close the chapter on UNHRC resolution 30/1 in March 2021.

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Features

Album to celebrate 30 years

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Rajiv Sebastian had mega plans to celebrate 30 years, in showbiz, and the plans included concerts, both local and foreign. But, with the pandemic, the singer had to put everything on hold.

However, in order to remember this great occasion, the singer has done an album, made up of 12 songs, featuring several well known artistes, including Sunil of the Gypsies.

All the songs have been composed, very specially for this album.

Among the highlights will be a duet, featuring Rajiv and the Derena DreamStar winner, Andrea Fallen.

Andrea, I’m told, will also be featured, doing a solo spot, on the album.

Rajiv and his band The Clan handle the Friday night scene at The Cinnamon Grand Breeze Bar, from 07.30 pm, onwards.

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LET’S DO IT … in the new normal

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The local showbiz scene is certainly brightening up – of course, in the ‘new normal’ format (and we hope so!)

Going back to the old format would be disastrous, especially as the country is experiencing a surge in Covid-19 cases, and the Western Province is said to be high on the list of new cases.

But…life has to go on, and with the necessary precautions taken, we can certainly enjoy what the ‘new normal’ has to offer us…by way of entertainment.

Bassist Benjy, who leads the band Aquarius, is happy that is hard work is finally bringing the band the desired results – where work is concerned.

Although new to the entertainment scene, Aquarius had lots of good things coming their way, but the pandemic ruined it all – not only for Aquarius but also for everyone connected with showbiz.

However, there are positive signs, on the horizon, and Benjy indicated to us that he is enthusiastically looking forward to making it a happening scene – wherever they perform.

And, this Friday night (January 29th), Aquarius will be doing their thing at The Show By O, Mount Lavinia – a beach front venue.

Benjy says he is planning out something extra special for this particular night.

“This is our very first outing, as a band, at The Show By O, so we want to make it memorable for all those who turn up this Friday.”

The legendary bassist, who lights up the stage, whenever he booms into action, is looking forward to seeing music lovers, and all those who missed out on being entertained for quite a while, at the Mount Lavinia venue, this Friday.

“I assure you, it will be a night to be remembered.”

Benjy and Aquarius will also be doing their thing, every Saturday evening, at the Darley rd. Pub & Restaurant, Colombo 10.

In fact, they were featured at this particular venue, late last year, but the second wave of Covid-19 ended their gigs.

Also new to the scene – very new, I would say – is Ishini and her band, The Branch.

Of course, Ishini is a singer of repute, having performed with Mirage, but as Ishini and The Branch, they are brand new!

Nevertheless, they were featured at certain five-star venues, during the past few weeks…of their existence.

 

 

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