30th June 1996

Economy suffers self inflicted recession

By Naarani, our economic correspondent

Dr. Howard Nicholas said in the annual report of Econsult for 1995 that it is now known that the policy makers of the government are allowing the World Bank and IMF to author the economic policies of the government. In fact, there have been repeated warnings that the "auto-pilots" are taking the country on a path to economic stagnation.

The Treasury adopted a tight monetary policy during the period mid 1994 to mid 1995 and had inflicted a recessionary situation in the economy.

Dr. Nicholas stated: "It is most likely that the advocates of the monetary strategy in the government will end by rebuking it. The problem is the damage done by the strategy in the meantime".

This is precisely what has happened and the Treasury and the Central Bank should accept full responsibility for the current economic crisis. Perhaps the Governor of the Central Bank had realised this and relaxed the tight monetary policy that he was adopting.

The 1995 Central Bank report says, "Towards the latter part of the year, the Central Bank relaxed its tight monetary policy somewhat by purchasing all Treasury Bills and permitting limited foreign borrowings by financial institutions to ensure that productive economic activities were not unduly suppressed by liquidity tightness and from high interest rates".

The dawn of wisdom has been too late in the day and the damage has been done. So much so during the latter part of 1995, the interest rates moved up sharply particularly the call market rates which fluctuated between 16% and 102%.

When business confidence is lost, the Income Multiplier operates in the reverse. In Keynsian macro-economic analysis, an initial injection of demand say by Rs. 100 million will increase the final (income) demand by an inverse factor of the community's marginal propensity to save minus leakage via imports. In our scenario, the estimated import content is around 30% and initial injection of Rs. 100 million into the system will raise the final demand (income) to Rs. 350 million. Pull back of Rs. 100 million will in the reverse direction affect the final demand (income) by Rs. 350 million.

In simpler terms, the tight monetary policy had curtailed productive credit and resultantly affected "business confidence" and virtually inflicted recession. So long as there is no coherent economic management, business confidence is likely to remain depressed. Domestic and foreign investment may take a nose dive and the economy is bound to suffer.

Although the government professed that it will not print money to finance the budget in '95 it ended up by printing and/or resorted to Central Bank borrowing of over Rs. 7,000 million. This amounted to little over 1% of the GDP. In 1990, the then UNP government borrowed from the Central Bank 1/10th of 1% and in 1994, 0.2%. This is the true picture. Attempts seem to have been made to hide the actual bank borrowings. One of the reasons attributed by the Central Bank for the high call market rates during the third quarter of 1995 was delays in settlement of government obligations to the state banks. Can the government tell the country what was the total amount borrowed from commercial banks or not settled to the commercial banks on account of various purchases made?

It is reported that the People's Bank had advanced to the CWE moneys for the purchase of wheat/wheat flour and the amount outstanding as at the end of December 1995 was around Rs. 3000 million. Similarly, unpaid moneys by the Paddy Marketing Board amounted to another Rs. 3000 million. It is also reported that unpaid bills on account of other activities also amounted to Rs. 5000-6000 million. If these are added to the money lent by the Central Bank, in other words to arrive at the total bank borrowings, bank financing would exceed well over Rs. 13,000 million. In such a situation it is quite inescapable that the private sector was "crowded out" and was starved of credit to carry out its economic activities and hence the stagnation.

The budgetary numbers for 1996 appear to be questionable. The minister and key advisers have reportedly spent several months in preparing the 1996 Budget. It is now irrelevant. Expenditure, particularly on wheat flour subsidy has been grossly under provided. Additional Rs. 5000 million will be required on top of the Rs. 3000 million needed to settle last year's bills to the banks. Free market riders do not tolerate a two tier pricing of flour. Why subsidise 5 star hotel bread, fast foods and pizza for the sake of non-distortion of the market. Subsidy of Rs. 8000 million in itself is distortion. So why not with a two tier pricing. We "Yakos" can be given bread at Rs. 5 per pound. It will require only say 420,000 mt. per annum. Why subsidise 300,000 to 400,000 mt. at this time when the war effort demands more money, on a bill of Rs. 3500 million.

Further, nearly Rs. 3000 million will be needed to settle the loans advanced by the People's Bank to the Paddy Marketing Board. All these taken together with a supplementary allocation for defence and security of another Rs. 20,000 million will push up budgetary expenditures by Rs. 31,000 million.

On the other hand, look at revenue estimates which is undiluted fiction! Can the government obtain Rs. 220,000 million by the sale of public enterprises in 1996? The BTT and Income Tax collections are expected to be down by over Rs. 6,000 million. In this situation the Treasury will have to print money or borrow from the banks to the tune of Rs. 35-36000 million. Inflation will definitely shoot up. In May alone, the prices increased by around 6%. Similarly drop in foreign reserves is expected. In just one month the decline was US$ 50 million.

What is the strategy of the government to overcome these disastrous developments? It is very likely that things will drift and drift with no end in sight. Will the country have to suffer the consequences of incompetent economic management for some time to come?

It is quite apparent that on the dictates of the IMF, the government was pursuing "hands off" policy in respect of the incentives to the export sector which was assiduously built during the previous 6-7 years and relentlessly pursued by the then Trade Minister Lalith Athulathmudali. The export community knows very well how he tried to structure the export incentives and the institutional mechanism for an export-led growth. He was a strong advocate of an acceptable exchange rate policy, if not keeping the rupee under valued. He was probably guided by what Korea achieved in the first phase of its economic take off during the decade following assumption of office by President Park Chung Lee. The government directly intervened and played an active role which transformed Korea into one of the fastest growing economies in the world. Extensive export subsidies, tax holidays, lower tariff rates for public utilities, customs draw-backs and simplified import/export custom procedures, accelerated depreciation allowance on capital goods, liberalisation of credit restriction and import/export credit for overseas market were all implemented by the export council of ministers supported by the Economic Planning Board. In fact, this was followed somewhat at a low-key in Sri Lanka, but unfortunately these incentives and the direction to push exports have received a back seat now, in the name of equalisation of incentives for exports and the domestic industries.

One can see the spectacular achievement in the initial phase of the Korean economic take off. The GNP per capita rose from US$87 to US$288 by 1982 and exports virtually doubled from US$3000 million to US$ 6009 million, achieving an annual growth of 39%. The investment virtually doubled to 25% from 12.8% with the back up of domestic savings which rose from 3.2% in 1962 to 14.2% in 1982. The savings rate is somewhat similar to what our country is experiencing now. The question is whether we can ignore this reality. Korea faced certain problems after 1982, and took measures to correct them, but it was after achieving a spectacular growth.

It is claimed that one of the reasons for increasing the budget deficit is the defence expenditure. It is true that the defence expenditure rose by Rs. 12 billion in 1994 over 1993 and by Rs. 8 billion in 1995 over 1994. If there was a compelling need for additional non-inflationary resources for the conduct of the war, one wonders why the taxes were reduced, particularly income taxes which have fallen by Rs. 7500 million in 1995.

Tax reductions will not have a positive impact if there isn't the appropriate economic environment and in the absence of such an environment, it may prove to be disastrous to reduce even tariffs in a situation where more non-inflationary resources are needed. According to Dr. Chelliah of the Indian Planning Commission who was with the IMF, developing countries have various forms of distortions which if corrected in a hurry would lead to serious fiscal imbalance. What our "auto-pilots" have done is to give away revenue and drastically reduced capital expenditures to keep to budgetary fiscal targets agreed with the IMF. For example, capital expenditure of the government was 6.8% in 1991 and is going down to 5.6% in 1996. This is a most unsatisfactory budgetary policy.

Bungling of financial management will cost the country very dearly. It is now projected that the growth rate for 1996 would not exceed 4.7% and would dip to around 4.2-4.3% in 1997. Investment will fall from about 25.6% to something like 23% in 1996. Inflation will pick up and reach 16-18% by the end of this year. The overall balance of payment which was in surplus of around 5% in 1993 would decline to a deficit of 2% by the end of this year. A turn-around of 6.9%, which is very serious.

Foreign reserves will fall from about 7 months of imports in 1993 to less than 3 months by the end of this year. All these would push the Rupee/US$ rate further - to be around say Rs. 60/= to a Dollar by the end of the year and if the government does not adjust the exchange rate, it will create a major adverse impact on exports.

Present indications are that the policy makers are unable to reverse the trend.

Flattering fallacy

By Rajpal Abeynayake

A now well known smart alec editor, writing under the pseudonym Aravinda, has decided to try out his inconsiderable editorial skills over somebody else's newspaper.

Referring to a review of a recent documentary on the life of Prime Minister Sirimavo Bandaranaike the writer takes umbrage over the fact that the reviewer "microscope in hand, was hunting for dissimilarities in the styles of government of Prime Minister Sirimavo Bandaranaike and President Kumaratunga" (Observer, Sunday June 23).

It's a fairly vicious comment, given that he launches a personal tirade against the reviewer concerned, taking into account his physical attributes as if that had anything to do with the art of making a review.

Well, Mr. Smart Alec has clearly asked to be paid back in his own coin. Obviously, this medium-sized mediocrity is making a Don Quixotic attempt to score some points with those who are, after all, his employers. Though our President, the amiable lady that she is, doesn't care a whit about being called youthful (as opposed to her mother), our man henchman is miffed scarlet. He says such dissimilarities between mother and daughter were not there "for that was not the intention of the film".

The problem is that Aravinda has got his concepts of reverence and relevance mixed up. Though the President has quite graciously gone on record saying that she wouldn't even mind a programme on the lines of Yes Minister that would satirize her (refer TNL interview just prior to the 1995 Presidential Elections) henchman as usual is more Presidential than the President. A reviewer can see the dissimilarities between mother and daughter for all he likes, because that's his prerogative.

If both parties gave personal narratives in the movie (see box) such a comparison would arise as naturally as night follows day, even if you account for daylight saving time, that is.

But no, henchman decides we made a mistake. So, what's new anyway? It is common knowledge in this country that henchman is a hypocrite, and an arrogant one at that. Anything that fits in with his opinions (take it from me, the man is opinionated) is the objective truth. Anything that doesn't is a prejudice, or "the writer's own opinion." In Aravinda's world, there is only one frame of reference: his.

It's an easy guess why the man is a humbug. He wants to have his arrack and drink it too. Henchman still thinks he is an "independent journalist". Oh, if wishes were horses: The man is a self-appointed "progressive", so when the so-called "progressives" are in power, he thinks that being an apologist for the government is just right. Which is why he regularly delivers himself of diatribes against those whom he thinks are "abusers" of the right of the freedom of the press.

Henchman's favorite line is that journalists did not enjoy such freedom as they do today under previous regimes. That's a fallacy, because the Sinhala tabloid newspapers, for instance, ripped a previous President apart without any difficulty. But, even assuming for sakes of argument that our apologist's contention is correct, it seems that he expects journalists to be deferential because of the great favors granted to them by being given their freedom. Who knows, when you are this ingratiating, our good and youthful President might even ask Aravinda out for lunch?

Aravinda prides himself on being bi-lingual, so maybe he would appreciate that old Sinhala saying which paints a flattering portrait of men like him.

They used to say: 'Pinvath Samidu gen lebunath sevenella, katurasa lovina balugen netha gelavilla' (Even if the kind master will offer succour, you can't escape the curs which lick the bones). For cur there, replace lap dog or pet poodle.

(By the way, show me a lady who is not flattered when she is called youthful. Lunch anytime, Mme President?)