*Warns against using reserves to stabilise exchange rate, Archaic labour laws, Expropriation Law must be done away with
A senior economist argues that both fiscal and monetary policy of the country have not helped the export sector which has seen a decline in competitiveness over the years. Expenditure consolidation, public debt reduction, a flexible exchange rate regime and attracting more FDIs are also necessary in order to boost the country’s export earnings.
While the government has shown some improvement on the fiscal policy side over the past few years, now showing signs of unravelling, monetary policy has been found wanting with balance of payments crises emerging in 2009 and, to a lesser extent, in 2011/12.
The annual sessions of the Sri Lanka Economic Summit last week highlighted the importance of boosting the country’s exports in order to realise more inclusive and sustainable growth.
The country’s export earnings which stood at 33 percent of GDP in 2000 have declined gradually over the years to 18 percent in 2011 and estimated to reach 15 percent of GDP this year. Imports too have declined but at a much slower pace from 44 percent of GDP in 2000 to 28 percent this year, resulting in a widening trade deficit.
"The falling export growth trend cannot be reviewed in isolation since it is the result of international demand and domestic macroeconomic, trade and related policies. Sri Lanka cannot influence world demand and supply. The implication is that we take terms of trade as given and have to address the issue through domestic policies that go beyond the export sector. World experience suggests that macroeconomic policies are often implicated in falling export growth and slow GDP growth and indeed growth collapses," Sarath Rajapatirana, former Central Banker and Economic Advisor to the World Bank said addressing the SLEA annual sessions.
Arguing the case for better fiscal management he said, "the relationship of Fiscal policies to export growth arise from three ways: (a) large deficits crowd out private sector. (ii) borrowing from domestic sources raises the interest rate, encouraging inflows of portfolio capital and appreciates the exchange rate. (iii) inflation leads to demand for higher wages, import competing activities can pass on the cost increase to the domestic market, exporters facing world competition cannot raise price and triggers a decline in the export growth rate. These developments have occurred in 1982-85 and during 2006-2010".
"The relationship to monetary policy comes directly from the management of the exchange rate. Allowing inflation to take place (either through monetization of fiscal deficits or through private credit) lead to an appreciation of the exchange rate on the one hand and a rise in interest rates. And, when the Central Bank sold foreign exchange to the market to support the rupee, it lead to an involuntary open market operation since dollars are exchanged for rupees, leading to a reduction in liquidity in the domestic money market and a rise in interest rates.
Increased foreign borrowings coupled with the sterilization of inflows lead to higher interest rates where the economy is put on an unstable path by discouraging FDIs but encouraging short term capital flows or the carry trade. These have adverse repercussions on the rate of export growth.
"Sri Lanka’s recent history from 2005-2011 show the manifestation of these relationships : The situation was ameliorated by the government’s decision to go the IMF in July 2009, reluctantly, after decrying such an effort for a couple of years and thereby accumulating higher amounts of debt compared to an early adjustment of the exchange rate," Rajapatirana pointed out.
He went on to suggest a few policy prescriptions which could help the country build its exports sector.
"Fiscal consolidation is imperative to create conditions for strong export growth and better resource allocation. The near term action must be on the expenditure side and raising the return to public expenditures and allowing headroom for private investment. We should use the 2003 budget balance legislation (Fiscal Management Responsibility Act) to implement fiscal consolidation.
"A flexible exchange rate policy would be helpful to raise competitiveness and export growth. One cannot say what level of the nominal exchange rate will prevail. It would depend on a host of factors including future supply and demand for foreign exchange, rate of domestic versus foreign rates of interests, net capital inflows and net access to Sri Lanka’s bond market. Make the exchange regime predictable and not try to fix it again around Rs. 125 a dollar by using reserves.
"Reduce barriers to FDI by improving the investment climate going beyond economic policies to issues of rule of law, protection of property rights and good governance. Get rid of the Termination of Employment of Workmen (special provision) Act No: 45 (1971) and Revival of Underperforming Enterprises and Underutilized Assets Act. (2011). Send a positive signal by these actions," Rajapatirana argued.
Total government revenue as at end July reached Rs. 564.4 billion, an increase of 12.85 percent from a year ago. Total expenditure reached Rs. 981.7 billion, increasing 25.13 percent from a year ago.
Tax revenue during the period January to July 2012 amounted to Rs. 490.4 billion, growing 11.93 percent from a year earlier. Recurrent expenditure grew 19.40 percent to Rs. 695.3 billion while capital expenditure or public investments grew 41.64 percent to Rs. 286.4 billion.
The overall budget deficit as at July 2012 reached Rs. 417.3 billion, expanding 46.72 percent from a year earlier, reaching 5.56 percent of GDP during the first seven months of this year. The full year target is 6.2 percent.
Total outstanding debt of the government reached Rs. 6,161 billion as at end July 2012, growing by Rs. 1,027.6 billion during the seven month period this year. According to the 2012 budget, the government’s borrowing limit for the full year is Rs. 1,104 billion, Central Bank data shows.