A major hindrance to economic growth in Sri Lanka is the lack of dynamism in the export sector, in contrast to the fast growing East Asian economies. The country’s export growth fell from 11 % in 2007 to 6 % in 2008 and to a negative 13 % in 2009. Although export earnings rose by 10 % in the first eight months of this year, the export sector is yet to recover from the downfall. Apart from the adverse effects of the global recession, there are many reasons that originated from the local conditions for the export setback.
Global Competitiveness
The failure of domestic industry to meet global competition is a major counteracting factor. According to the latest Global Competitiveness Report published by the World Economic Forum, Sri Lanka is ranked in the 67th position in 2010 reflecting an improvement from the 79th position in 2009. Although this is a noteworthy achievement, it needs to be recognized that several countries in the South and East Asian regions are ranked ahead of Sri Lanka. Malaysia (26), Thailand (43), India (56) and Vietnam (64) are a few examples.
A country’s competitiveness depends on a multitude of factors including robustness of institutions, infrastructure, macroeconomic environment, health and education, market efficiency, financial market development, technological readiness and market size. These factors are critical in competing with the rest of the world, and boosting exports. For a country like Sri Lanka, stronger global competitiveness is more important, as it is mainly through export growth that the country could achieve a higher economic growth path. It is in this context that I would like to review the Budget 2011 in this column.
Tax concessions for industries and exports
It is encouraging to note that the Budget has recognized the need to be more productive and competitive in export and import activities. For this purpose, the Budget has offered a few tax and import duty concessions for value-added export ventures. This includes exemption of value added exports from a proposed CESS imposed on all raw and semi processed exports. Import duties and taxes on machinery, equipment and raw material are to be reduced. Several income tax reductions have been proposed for manufacturing and export enterprises. Machinery and equipment to manufacture textile, leather, footwear and bags are to be exempted from import duties and VAT.
Improvement of productivity by 5-6 % in the ‘development decade’ is recognized as a key goal of the government in the Budget. Provision of training of selected youth and assistance to the SMEs are two major steps. It is also proposed to encourage enterprises to undertake Research and Development, registration of patent, trademarks and designs, automation through technology and training of workers. R&D is expected to be improved through certain incentives offered. It is also proposed to relax administrative procedures to encourage partnerships between Government and private sector research centres to undertake R&D initiatives. Certain proposals are laid down to strengthen the secondary and tertiary education sector so as to uplift the country’s human resources capabilities. The budget proposals pertaining to the investment climate include restructuring of BOI investments and simplification of foreign exchange and trade control arrangements.
Outward-oriented approach lacking in Budget Speech
Although the above proposals would have a positive impact on the country’s production capacity and competitiveness, the big question is whether they are sufficient to effectively address the problems in an ailing economy. As claimed in the Budget Speech, we may remain complacent about doubling of our per capita income during the past five years or so to the present level of around $ 2,000. But the picture is not that rosy if we compare ours with the per capita income levels of South East Asian countries such as Singapore (over $40,000), Malaysia (over $13,000) or Thailand (over $4,000). Given the low capital-output ratio and the resource constraints, Sri Lanka will find it extremely difficult to attain such high income levels in the coming years. Drastic policy reforms are needed to accelerate economic growth so as to uplift the per capita income level.
The country’s economic growth heavily relies on the performance of the export sector. Having liberalized the economy three decades ago, we have failed to effectively face global competitiveness, and to boost our exports. In the context of the extremely competitive global market, Sri Lanka needs a quantum leap to transform the export sector. The current Budget lacks a coherent policy to make such a radical trasnformation. The tax concessions proposed in the Budget to promote value-added exports are not sufficient to diversify the export sector, which still depends on the manufacturing of garments and a few other primary products. No policy strategy is articulated in the Budget Speech to promote high-tech manufactured exports, which are essential to make a meaningful positive impact on the export sector and GDP growth.
Specifically, there should have been a special effort to attract Foreign Direct Investment (FDI) which amounts to less than 2 % of GDP at present. Drastic improvements in the climate investment are needed to attract FDIs. Apart from a few marginal proposals with regard to BOI investment pledges, there is no systematic strategy in the Budget Speech to improve the investment climate so as to foster FDIs.
Another vital factor that is neglected in the current policy stance is exchange rate flexibility. The exchange rate has not depreciated enough to compensate for domestic inflation in recent years. According to the Central Bank, the Real Effective Exchang Rate (REER), which is the exchange rate adjusted for the differential of domestic and foreign inflation rates, rose from 100 in the base year 2006 to 122 by August this year. This means that the rupee is overvalued by about 22 % reflecting an erosion of export competitiveness. Thus, the export sector, which is already suffering from low productivity and inadequate FDIs, is further hit by the exchange rate overvaluation. There is no mention in the Budget Speech of how this problem is going to be addressed.
A visible improvement is needed not only in economic dimensions such as macroeconomic stability, infrastructure, financial facilities and exchange rate flexibility but also in the spheres of good governance, transparency and institutions. Foreign investors would continue to shy away if such improvements do not take place in the foreseeable future. Domestic investors are also discouraged. Therefore, drastic and consistent policy reforms, rather than the ad hoc tax and duty concessions proposed in the Budget Speech, are imperative to revitalize the export sector and to accelerate economic growth. |
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