Government capital spending, long regarded as an essential pre-requisite for high economic growth, has a tendency to promote corruption and actually retard growth, a new study by IMF has found.
Political or 'grand corruption' was often tied to capital projects, especially in countries with weak controlling or auditing institutions.
"Corruption distorts the decision making process connected with public investment projects." IMF Survey said, quoting a working paper by researchers Vito Tanzi and Hamid Davoodi.
"It is likely to increase the number of projects undertaken in a country and to change their design by enlarging their size and complexity."
While the share of public investment GDP may rise as a result, the average productivity of such investment tended to fall.
"The net result is that public investment ends up having a negative impact on growth," IMF Survey said.
Since the Second World War it has become an established economic principle that countries needed capital to grow and it was even considered all right to borrow, for capital spending but not for current spending.
"Politicians have internalised the bias in favour of capital spending and have exploited it, by, for example, staging public ceremonies to celebrate the opening of major projects such as roads, power plants, schools, and hospitals," IMF Survey said.
Though the nature of capital spending invited corruption, current spending allowed very little discretion, discouraging corruption.
The researchers say some current spending, such as those for keeping infrastructure in a running condition and spending that contributes to accumulation of human capital can promote growth more than capital spending.
"Capital spending in contrast is highly discretionary, especially when the decisions are made by influential political figures, such as members of parliament, ministers, or even heads of state," the researchers noted.
These officials made basic decisions about the investment budget, such as its size and general composition, they also selected specific projects, their sites and design.
Because the projects are very large and are contracted out mostly to private enterprise, they tended to be very profitable. As a result contractors were willing to pay a commission to win contracts.
"Commissions are often a percentage of the total cost of the project, and the public officials who receive a payment for helping an enterprise win a contract will have a vested interest in increasing the scope or size of the project so that can get a larger commission," IMF Survey said.
The IMF researchers say corruption can occur at several stages in a capital project, where decisions have to be made, not only at the start. A project is not complete until someone has verified that the work was done according to the contract.
The design specifications could also be tailor-made for a given enterprise.
Though commissions can be large, a private enterprise could recover the cost through several ways. It may win the bid at a price which includes the cost of the commission (up front recovery).
It may arrive at an understanding with a public official that the initial low bid can be adjusted upwards later to reflect modifications to the basic design.
They could also reduce costs by skimping on the quality the work done or material used. Ultimately the country will end up with a project that cost higher, is larger and more complex than necessary or one of inferior quality that will not perform to the required standards and may also require costly upkeep and repairs, the researchers say.
Another form or corruption is where political personalities steer projects towards their home districts. Projects may be piloted towards particular areas because of convenience, in a bid to political support or as a means of increasing the value of assets (such as land owned by politicians) in those areas.
As we look back at the year that is ending the business community can be satisfied in many ways. Foremost among the reasons is that the economy was not disrupted by severe security problems, power failures or large scale labour unrest as in the previous year.
Improved corporate profits during the year are indicative of 1997 being a reasonably satisfactory year for business enterprises. Reduced interest rates, a declining rate of inflation and an improvement in economic fundamentals, fostered greater business confidence.
Continued bureaucratic lethargy, inability to resolve the terrorist problem and the economic crisis in the Asian region are factors impeding faster economic growth.
The economy itself grew by about 6 percent exceeding last year's diminished performance. The 6 percent growth however is not one to be particularly satisfied with as it reflects mostly a recovery rather than enhanced growth. Yet 1997 could be considered a year of adequate growth, if it is a springboard for higher growth in 1998.
Partly aided by good weather, agricultural production increased.Production of tea and rubber continued its increasing trend. Tea production is increasing at about 6 per cent and is likely to reach a new peak level of around 260 million kilograms. The food crop sector recovered from its disastrous drought affected conditions and paddy production reached average levels in the two seasons.
Whilst in the case of tea, prices too reached new heights and the industry benefited by a larger margin between the cost of production and prices. Paddy production continued to face a serious crisis owing to higher production costs and relatively low prices. The cost price squeeze continues to be a serious threat to the viability of the paddy sector, which harbours around one million farmers.
Paddy farming is soon becoming a part-time occupation and off-farm incomes are providing a higher proportion of total paddy farmer incomes. Greater efforts are needed to ensure that the paddy economy is made viable as it is a vital means of livelihood for a significant proportion of the population.
Despite the high prices of vegetables in retail markets, vegetable producers still seem to obtain low prices indicating a serious problem in marketing. The plight of farmers has been made more uncertain and precarious owing to sudden imports of agricultural produce depressing their incomes.
Hopefully 1997 may be remembered as a year when the government began to recognise serious problems in the food crop sector. The budget for 1998 specified a number of programmes to relieve the predicament of farmers. The budget focus on marketing, storage and credit was much overdue.
Unfortunately whether farmers would ultimately benefit by these measures and when they would obtain tangible benefits depend very much on a creaky and inefficient administration. It is one thing to promulgate policies to alleviate farmers, it is quite a different and difficult thing to implement them effectively.
Industry too recovered during the course of the year. Export statistics bear witness to an industrial export growth of around 15 percent. The exports of garments continued to lead with an export growth of 21 percent. Rubber manufacturers too showed an improved growth of around 19 percent.
The export growth in garments was partly the result of increased quotas. But non-quota exports contributed significantly to this export growth. The increase in quotas prompted the government to revive the idea of setting up garment industries in remote areas.
Whether this policy would meet with greater success than the earlier attempt of the 200 garment factories is to be seen in the near future. We can only hope that the new garment industries will be based on hard economic realities and that viable and efficient garment industries would be established.
Although rubber goods manufactures increased, some new problems appear on the horizon as a consequence of the financial and economic crisis in East and South East Asia. The large devaluation in currencies in rubber producing South East Asian countries resulted in a decrease in rubber prices and local producers of rubber goods resorted to the import of rubber for their industries.
The increasing trend to consume more local rubber in our industries can be reversed and in turn rubber producers affected adversely if remedial measures to resolve this problem is not taken early. If the country does not opt for a competitive devaluation then it should adopt other measures to protect rubber producers.
While the export of other industrial goods too increased by about 5 percent these industries too appear to face severe price competitiveness owing to the devaluations in the region. It is essential that the devaluation of competitive currencies do not endanger our industrial exports.
To sum up, while industrial export growth was good during most of 1997, the year ends with some concern regarding the impact of devaluations in East and South East Asian countries and our giant neighbour, India.
Most of this year witnessed an upturn in tourism making up for the reversals that had occurred in 1996. The bomb blast on October 15 created an anxiety that tourists would cancel their bookings and the expected revival would be reversed. Fortunately the evidence so far available to us indicates that there has not been a serious reversal of tourist traffic even though the growth levels may have been affected somewhat.
The tourist industry is quick to reflect security concerns and has continued to live with a great degree of anxiety over the recent years. Yet there appears to be an optimism in the long term prospects of the industry as investments in tourist hotels continue.
The financial sector saw interesting changes during the course of the year with the reversal of government policy on interest rates. The increased liquidity of the banking system owing to the reduction of the reserve ratios of commercial banks and lower yields on treasury bills were pressures to bring down bank interest rates.
Interest rate declines were somewhat sluggish at the beginning of the year owing to the dominance of the state banks and the cost of funds not decreasing sharply owing to existing contractual arrangements on savings and fixed deposits.
The latter part of the year saw a significant decline in lending rates, with government intervention for state banks to bring down their interest rates. 1997 saw a clear indication that the high interest rate regime was at an end and that for some foreseeable time interest rates would remain lower than in the past.
The reduction in the treasury bill limit, increased revenue from privatisation and a lower rate of inflation sustained the lower interest rate policy.
The balance of payments is expected to be in surplus at the end of 1997. Both export and imports grew and the trade gap is likely to increase. The main factor which would offset the deficit in the balance of payments would be the capital inflows, particularly the official inflows.
Official inflows, which declined in the first part of the year saw an increase later on. The privatisation proceeds boosted the inflows. Consequently foreign exchange reserves increased by around 15 per cent at the end of October from an year ago and maintained a healthy level adequate to finance nearly six months of imports. Yet the East Asian crisis may have an adverse impact on the reserves.
Among the favourable developments in policy was a reinforcement of the government's commitment to assist private enterprise. The budget of 1998 once again confirmed the government's commitment to let private enterprise play a lead role in the economy. Labour unrest, while still continuing, was of a lesser magnitude.
The completion of several privatisations was responsible for improving the public finances which in turn gave the government an opportunity to improve the economic fundamentals. Yet the fundamental weakness of most revenues being absorbed by mostly unproductive current expenditure continues to reduce the role which the government could play with respect to development of infrastructure, so essential for economic growth.
As the year ends we can hope that the favourable developments in 1997 will provide opportunities for a higher growth in 1998.
January
* Central Bank announces that the non-BOI sector would be permitted offshore borrowing of monies.
* Government proposes to set up new Regional Development Banks (RDBs) in every province to replace the Regional Rural Development Banks.
* Citi National Investment Bank, a joint venture between the National Development Bank (NDB) and Citibank, launched.
February
* A new Equity Capital Fund, the Ayojana Fund, which is a joint venture between the NDB and the Commonwealth Development Corporation (CDC), launched.
* The Tharuna Aruna programme for educated unemployed youth gets a headstart with applications for the skills development programmes being called.
* Amana Investments, Sri Lanka's first ever Islamic Merchant Bank conforming to Islamic monetary laws, including non-levying of interest, launched.
March
* In a move to provide the Agricultural export sector with laboratory testing, the Society General de Surveillance (SGS) establishes an SGS Lanka office.
* United Tractor & Equipment Ltd., hands over the country's first ever rehabilitated locomotive undertaken with German collaboration to Sri Lanka Railways (SLR).
April
* Government formally launches the Private Sector Infrastructure Development Co. Ltd. (PSIDC), to provide long-term loans to private sector infrastructure projects.
* A joint venture agreement to develop the local dairy industry was signed between the National Dairy Development Board of India and the Sri Lankan Government.
May
* First ever Malaysian Trade Exhibition held in Sri Lanka.
* Sri Lanka's premier Industrial, Investment and Trade Exhibition, INTRAD '97 begin.
June
* Germany pledges Rs. 2,475 billion aid for Sri Lanka's social and economic development in 1997/98.
* Celltel introduces Cellcard in a move to broaden its subscriber base.
July
* Hilton International signs 33 year management contract to manage the JAIC Hilton Tower.
* Toslanka Co. (Pvt) Ltd., a fully owned subsidiary of Tosslec of Japan commences operations in the Biyagama Export Processing Zone.
August
* NCE Export Awards '96 organised by the National Chamber of Exporters of Sri Lanka (NCE) held.
* The Government and the Commonwealth Development Corporation (CDC) sign accord facilitating an additional US $86.4 million of CDC direct investment in Sri Lanka's private sector expansion.
September
* The Bank of Ceylon placed among the top ten most profitable banks in Asia by Asiaweek Magazine.
* SAARC Tourism Ministers hold two day conference on issues relating to tourism and tourism development in the SAARC region.
October
* Entrepreneur of the Year Awards, organised by the Federation of Chambers of Commerce and Industry of Sri Lanka (FCCISL) held.
* The World Trade Centre formally declared open.
* Terrorist bomb blast in Colombo with Galadari Hotel and Colombo Hilton suffering severe damage.
November
* Sri Lanka's premier export exhibition Expo '97 organised by the Export Development Board (EDB) held.
* Sri Lanka's Gem and Jewellery show Lustre '97 organised by the Sri Lanka Lapidarists and Exporters Association held.
* The Business Today Top 10 Awards ceremony held.
December
* Sampath Bank introduces the SET/CIRRUS/MAESTRO Debit card in a pioneering move to broadbase cashless banking among Sri Lankans.
* In a bid to promote Sri Lankan business interests overseas through the national media, the National Chamber of Commerce of Sri Lanka (NCCSL) establishes the NCCSL Media Club.
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