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FINANCIAL CHRONICLE™ » FINANCIAL CHRONICLE™ » Sri Lanka's lower inflation, narrowing budget deficit to boost growth: ADB

Sri Lanka's lower inflation, narrowing budget deficit to boost growth: ADB

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Vice President - Equity Analytics
Apr 01, 2014 (LBO) - Sri Lanka's current relatively low inflation and a narrowing budget deficit will boost investment and growth helped by recovering exports and domestic demand, the Asian Development Bank said.

Last year Sri Lanka gross domestic product was estimated to have grown by 7.3 percent in the middle of recovering from a balance of payments crisis triggered by a credit bubble.
Positive Cycle

ADB's senior country economist Tadateru Hayashi said the economy was expected to grow 7.5 percent in 2014 and 2015.

Investment and domestic demand would be boosted by lower inflation and falling interest rates, he said.

Exports which started to grow from the second half of 2013 amidst a recovery in developed markets would give a boost throughout 2014. Tourism was also doing well after the end of a 30-year war.

The central bank has also kept inflation low in 2013, after raising interest rates sharply in 2012 to curb bank credit and floating the rupee to arrest a balance of payments crisis which initially pushed inflation to almost 10 percent.

ADB's Asian Development Outlook (ADO 2014) report released Tuesday also advocated greater state intervention and spending of people's money by the state to arrest what it claimed was growing inequality in the region.

Critics warn that advice to flatten incomes - originally an objective of European socialist interventionists - through taxation of the people and state spending would give elected rulers more ammunition to engage in costly income redistribution programs.

Sri Lanka has a long history of backfiring state interventions and ruler spending to flatten incomes through state interventions which eventually pushed unemployment close to 20 percent in by the end of the 1970s.

Hasitha Wickremasinghe, senior economics officer at ADB Sri Lanka said the agency was only advocating selected spending in education and health and not blanket state interventions.

Haysashi said all subsidies should be targeted only to the needy.

Hayashi said Sri Lanka's budget deficit has been brought down progressively to 5.8 percent of GDP from 9.9 percent in 2009, mostly by compressing current spending and not taking more taxes from the people.

Compressing current spending is the highest quality budget deficit reduction possible, as taxing the people more to sustain a high spending state is a second best solution.

Deadly Cure

"Those people who are properly worried about the deficit unfortunately offer an unacceptable solution: increasing taxes," US economist Murray Rothbard once wrote.

"Curing deficits by raising taxes is equivalent to curing someone's bronchitis by shooting him. The "cure" is far worse than the disease."

"No, the only sound cure for deficits is a simple but virtually unmentioned one: cut the federal budget. How and where? Anywhere and everywhere."

A lower tax to GDP is also an important economic freedom, analysts say.

A lower tax would leave more money in the hands of the people who can by-pass a costly bureaucracy and elected rulers and that second-guess how best and where to spend their own hard earned money.

Analysts say there is more room to compress state spending especially in subsidies to special interest groups such as farmers and big farming companies as well as military spending and the bloated public service.

Though Sri Lanka's state revenues are now about 14 percent of GDP, even when revenues were over 20 percent were being extracted from the people in the 1980s the state was using them mostly for current spending.

Going by Sri Lanka's past experience there is no guarantee that if more taxes are extracted from the people that they would not be spent on vote-buying political programs and special interest groups.

Data Tangle

There were also questions whether Sri Lanka's GDP was over-estimated, in which case the actual revenue to GDP ratio would be higher than stated.

Hayashi said the ADB had no way of double checking GDP numbers in individual countries and usually took data given by the state agencies as a given.

Data show that Sri Lanka's value added taxes had fallen from about 5.8 percent of GDP in 2004 to 2.7 percent amid exemptions to special interest groups.

But Hayashi said some exemptions had ended in the latest budget and VAT had been expanded deeper into the retail trade to raise revenue, which showed the taxation system was moving in the right direction.

There were opportunities for measures like capital gains tax which was progressive he said.

Critics however say progressive taxation can destroy capital formation and future jobs by transferring potential investment capital into the hands of elected rulers to fritter away as consumption spending.

Gulf countries for example, have resisted attempts by the international agencies to introduce progressive income tax, and have created tens of millions of jobs for South Asians and others in their countries.

There is however room to improve Sri Lanka's tax system and bring back justice, legislators and analysts have said.
They have pointed out that Sri Lanka's tax structure is skewed and unjust with high import duties on items involved in ending hunger (food) and homelessness (building materials) to satisfy politically powerful production lobbies.

While building materials ranging from steel to power cables to tiles used by ordinary people are heavily taxed to help domestic production lobbies, luxury condominiums and hotels built with tax breaks are allowed to import materials duty free.

Branded luxury goods are also allowed duty free while shoes worn by ordinary school children are under duty protection.

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Thnx for the information.

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