Import substitution as an ideology is a total failure and that is being proved in country after country for the last half century. It’s not a matter of a billion or a matter of IMF doctrine it’s simply a matter of fact, according to International Monetary Fund (IMF) Resident Representative Koshy Mathai.

“The country has to be very careful and much more efficient rather than – in an accounting sense -, trying to reduce imports in order to improve the balance of payments,” he told his last media briefing in Colombo this week, before ending a 3-year term in Sri Lanka.
He said it was more important to promote exports in areas of comparative advantage and not provide artificial incentives for capital, labour and other factors of production to shift into import substitution when it may not be in the country’s best interest.

Koshy Mathai

Mr. Mathai noted that the IMF evaluation programme on Sri Lanka from 2009 to 2012 was successful. It had restored stability to the economy and prevented the balance payments crisis. At the end of the programme it was mentioned that Sri Lanka was left with vulnerabilities such as fiscal weaknesses and external sector weaknesses. A standby arrangement was created as basically a short term emergency arrangement to stabilise the economy and get it back on its right track.

But goals of improving the fiscal balances and goals of improving the external balances required more time. State enterprise reform and revenue administration strengthening also required more time and a structural look. According to the programme there could have been more detailed measures underpinning some of the goals that are laid out.

“According to the Post Program Monetary (post SBA monitoring), the country is doing relatively well. There was turbulence in global markets earlier this year and all emerging markets were affected. Sri Lanka did relatively well, wasn’t affected too badly but managed to come out of it. The GDP growth was solid and quite strong. Some areas needs to be concerned such as trade statistics, revenue and spending statistics, credit indicators which shows some softness. Overall the growth is at a steady rate of 6.5 per cent and is good compared to other countries that are facing crises,” said Mr. Mathai. He also mentioned that inflation seems not too bad right now. In terms of the fiscal position, there is progress in bringing the deficit down to 5.8 per cent of the GDP this year and 5.2 per cent the GDP next year. More importantly revenues have been weak. The government has sought to maintain the momentum towards reducing the deficits by controlling expenditures. Also there is priority on keeping the capital expenditures up.

Capital expenditure needs to rise over time. 6.7 per cent is good for 2014. But over time that figure needs to rise substantially. It’s only with the capital expenditure that the government can achieve the country’s growth target. Rising capital expenditure plays a big role in raising the country’s revenue. Measures such as the extension of the VAT on retail and wholesale trade, other revenue measures that the public is not keen on, increase on import and export taxes, the IMF believes goes against the direction of trade liberalization and competitiveness, he noted.

“Exemption of NBT to the banking sector could see lending rates going up which is not helpful to the economy at this stage of development. Taxes on professionals have been reduced. The idea was trying to retain talent in the country and reverse brain drain. But the IMF prefers it done through administrative measures such as an upfront licensee on professionals or withholding tax could have been better which could increase taxation for professionals without simply giving away money in terms of reducing rates. 24 per cent personal income tax rate is attractive compared to many other destinations. More focus on tax administration in the budget perhaps measures to deal with the simplified VAT and increase staff at the Inland Revenue Department could have been better,” Mr. Mathai emphasised.

The weakness in revenue comes from direct taxes and not from indirect taxes. Direct taxes are weak on account of tax holidays and incentives being given in the past. There could have been a comprehensive inventory of tax holidays and incentives done. According to the budget the Ceylon Electricity Board (CEB) and Ceylon Petroleum Corporation (CPC) have made a turn around. There could have been more structural measures to ensure that position is sustained. It’s not just relying on pricing and good weather. Sri Lanka has gone a long way but the IMF doubts that the country could claim victories in the future. Sri Lanka achieved the targets because some of those performances were a result of good weather, he added.

Growth of the county, inflation and fiscal policies are pretty good, he noted. External balances have to improve. The country has seen exports going up and imports coming down. Tourism in remittances remained quite strong and as a result the current account deficit has come down. Going forward its important to stick to the flexible exchange rate. A new IMF representative would be appointed in mid February or beginning March, he said.