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by Lloyd F Yapa

The annual budget of any government is an important policy announcement, which will affect the economic performance and indeed the social conditions in the country for a number of years, besides being a statement of its revenue and expenditure for a particular year. As such it must state clearly, at the outset, what it hopes to achieve.

After the review of the government's performance during its two year stewardship, the Minister of Finance announced, that "employment generation, increased wages and tax relief for the lower and middle income classes", as well as "a further reduction in prices of consumer goods" will be the objectives of this budget and that they are offered as a the reward to the people, who had bravely borne some essential cuts in government expenditure, mainly on welfare, for two years.

The first objective of employment generation can be achieved only by investment (replacement of depreciation as well as new investment) in physical infrastructure such as roads, railways, ports, power and water supply/irrigation facilities and services such as education, health, maintenance of law and order and the public service as well as on the means of production of goods such as farms and factories.

The other way of achieving this objective, ie increasing the efficiency and productivity mainly through economic reform and restructuring, also needs investment.

Investment

What are those conditions, which would promote investment? First, the level of savings should be commensurate with the level of investment required.

The rate of economic growth envisaged in the Regaining Sri Lanka document (for reducing the backlog of unemployment of about one million jobs and for creation of about 150,000 jobs for those joining the labour force every year) is 8-10%. The quantum of investment required for this purpose would easily exceed 30% in GDP terms. However, the level of savings generated in the country has only been around 20% in GDP terms (compared to 30-50% in South East Asia), as we have opted to enjoy the fruits of development even before the tree is planted ! This means, that the balance has to be contributed by foreign investors, the long term types of which can be attracted only by a healthy/stable political, social and economic climate.

This in turn can be generated by, i) continued peace and security in the country, ii) good democratic governance, iii) an impartial and efficient public service, iv) law and order conditions of the highest order, v) a disciplined and skilled (not just literate) work force, vi) developed infrastructure, vii) stability of the general level of prices or low inflation, viii) open and liberalized labour, land, capital and foreign exchange markets, where prices will primarily be determined by supply and demand forces, untrammeled by excessive regulation, as in the case of high performing economies in the rest of the world .

The leaders of this country, unlike Lee of Singapore and Mahathir of Malaysia, have failed miserably to create a national consensus to implement measures, either to induce the people to save more, or create the above mentioned ingredients, which are prerequisites for any type of investment. Instead, our leaders have selfishly resorted to politicking of the worst kind and opted for the easier but more expensive way out by offering incentives to investors.

Such a policy can only attract 'footloose' investors, who intend only to make a fast 'buck', subsidized by the Lankan tax payer and take to their heels at the first hint of instability. In the case of infrastructure projects, the gestation periods are long, the investments themselves are usually large and the profit margins are normally rather low.

Therefore the private sector is not inclined to make such investments. This is why the State is compelled to undertake such projects. However, in this budget projected public investment amounts to only 5.3% in GDP terms, only a part of which will be used to develop infrastructure.

This is a marginal increase over the expected outturn (5.0%) in 2003, considering the criminal neglect this area has suffered for decades. This is due to the fact, that the government has decided to give in to the political compulsion of increasing unproductive expenditure such as wages, certain subsidies, (besides paying off debts and maintaining the alertness of the security forces at a high level), at the expense of capital expenditure, which can generate a return by way of economic growth or prosperity.

The fact, that capital expenditure in the country has not exceeded 6% or so during the last few years means, that the country may have to continue to put up not only with frequent breakdowns in infrastructure facilities and services but also with the neglect of investment in essential infrastructure, especially in economically depressed areas of the country, depriving the people concerned of additional employment opportunities, as private investors would avoid such areas.

Perhaps to make amends for keeping capital expenditure at a minimal level in 1994, a three year plan to develop infrastructure at a cost of Rs 400 billion has been included in the budget. It is very doubtful, whether adequate public funds will be available for these projects.

Even if the local private sector could scrape together funding for some of the more lucrative infrastructure projects, they will almost certainly withdraw into their shells in the wake of the stalled peace effort and the dangerous game of musical chairs, that is now going in the highest echelons.

Long term foreign direct investments are sure to bypass the country and move into greener pastures such as China and the Baltic nations in the absence of the above mentioned conditions necessary for attracting investments? We are then left with the World Bank and the IMF, (the favourite punching bags of our leftists, whose pastime is scaring off investors and pushing up unproductive expenditure, perhaps in their pursuit of 'revolution'), the lesser known ADB and the other donors, who promised several billions of aid at the Tokyo Meeting. Even these institutions will think twice before financing this development programme, if they feel, that the present mess and the stalled peace talks will prevent the timely implementation of these projects and the repayment of whatever debts.

Let us therefore hope and pray, that the Head of State and the Prime Minister will resolve the present impasse between them in a Mandela/ de Clerk- like manner, instead of scoring points over each other, purely on legalist and political grounds, selfishly ignoring the greater welfare of 19 million people.

Government expenditure

The actual level of total government expenditure in 2001 was 27 .4% in GDP terms, while it was 24.2% in 2003 . The government, armed with a Fiscal Responsibility Law, is expected to reduce the budget deficit to 7.8 % in 2003, through such cuts in expenditure.

The government has also been working hard on essential measures for liberalization of various markets and above all securing a degree of much needed peace by signing a peace deal with the LTTE. The Finance Minister reports with justifiable pride, that reduction of expenditure has brought inflation down to 7.2% at present from 14.3% in 2001.

Interest and exchange rates seem to have followed suit. Credit is due to the authorities for this achievement, as one of the basic ways of achieving price stability or a state of low inflation, essential for achieving competitiveness and lowering the cost of living, is to reduce the budget deficit both by slashing unproductive recurrent expenditure and increasing revenue. However, one does not know, whether the official inflation rates are realistic, as they are calculated on baskets of goods decided long years ago.

Anyway, curbing inflation is also the best way of protecting the purchasing power of consumers, rather than giving wage increases in nominal terms, although politicians, especially of the socialist ilk, do not seem to realize it.

Another observation, which should be made is that interest rates on savings are way below the rate of inflation robbing the purchasing power of savers, especially of retired persons and fixed income earners. Private savings are also taxed, when deposited in bank accounts or when invested in the stock market and sold, whereas the government itself is far from being frugal, where recurrent expenditure is concerned.

Such a policy of 'burning the candle at both ends', would tend to lower the savings available for investment and increase the dependence on foreign investors. The latter too would not invest just because interest rates are low, unless the prevailing sense of uncertainty is removed. So, the prospect of creating additional jobs appears to be in grave jeopardy.

Government revenue

The government revenue level to be achieved in 2004 is only 16.4% in GDP terms compared to the expected outturn of 16.3% in 2003.The absence of any notable improvement in revenue can be attributed, in the main, to the inefficiency in collecting taxes and the reduction in the rate of effective taxation over the years on those, who can afford to pay ie businesses, certain professionals and wheelers and dealers, versus the increase in the rate on those, who find it difficult to pay ie the ordinary consumers, most of whom are poor.

Inflationary pressures may build up again, since, revenue shows a decreasing trend and unproductive recurrent expenditure of the government, especially on wages and vote catching welfare payments, in all likelihood, may continue to be increased ,( if the prevailing political uncertainty spills into 2004), followed by compensating wage increases, (untied to productivity increases) especially in the private sector.

The currency would respond by depreciating once more, pushing up the prices of imported goods and services, on which the country is dependent.

Vision and strategy

There are a few more (constructive) criticisms, which could be leveled against the powers that be. Conspicuous by its absence is a nationally agreed vision, strategy and a sequential 'first things first' action plan. (The budget has to be derived from it).

The present constitutional crisis, for instance, could have been avoided and the peace process saved, if an understanding regarding the peace process, constitutional changes and fundamentals of economic development had been arrived at among the Head of State, the Prime Minister and the other stakeholders, at the outset. There appears to be a sudden realization, that without such an understanding, it is impossible to proceed further.

International trade

Another sign of the absence of a clear vision and a calculated strategy is the apparent lack of a realization, that one of the very few options, available to a small nation with a small market to achieve prosperity through a faster pace of economic growth is to expand trade with the rest of the world.

In order to do so successfully, the nation has to improve its competitiveness drastically. A ranking of 75 countries in respect of global competitiveness undertaken by the World Economic Forum in 2002, placed Sri Lanka in the bottom quarter of the list -(61st.Malaysia 30th).

This means, that this country has to implement a 'crash' programme to upgrade its ability to compete in the international market, especially with China, the super competitive juggernaut. There is no other way to do this but to slash costs and add value to our products and services (or differentiate) by various means including strategic management, innovation using R&D as well as branding.

As already mentioned, this gallop towards improving competitiveness includes reducing/stabilizing prices by steadily whittling down the budget deficit and liberalizing labour, land, capital and foreign exchange markets, hacking away at the pile of cumbersome 'red tape' built up over the years and investing as much as possible on developing infrastructure, both physical and soft and above all reforming the system of education, especially tertiary education, to teach people to take risks, impart the skills/technologies, that are required to cater to the needs of discerning local and foreign consumers and to raise productivity. This is just the beginning of the journey.

Investors are not going to risk their money just because costs are declining, and attractive incentives are being offered. As stated earlier, the prevailing uncertainty, as to where the country is heading, has to be removed, especially by achieving ethnic peace, better governance, an efficient public service and improved law and order conditions.

This second requirement to continue the journey to achieve competitiveness is something, that cannot at all be digested by most of our politicians used to a diet of statist or Marxist approaches to managing ( or mismanaging) an economy.

South East Asian nations such as Taiwan and Singapore have even gone beyond by adopting an interventionist approach- ie by establishing powerful special sectoral institutions empowered with the task of picking sectors with growth potential, targeting key investors, 'holding the hand' of local exporters until they can 'stand on their own feet', using every possible means, where promotion of value addition, improvement of productivity and expansion of markets are concerned, eg setting up geographic clusters based on a single product with potential and allied supporting industries/ services, to improve competitiveness, through scale economies.

This is the third stage of the journey. The fourth step is to help firms to improve their efficiency/competitiveness substantially by infusion of strategic management/innovation skills. The country has failed to set up a business school of high calibre for this purpose,even after more than 50 years of independence.

As stated earlier, government has been active in achieving price stability, (This may be nullified by the inflationary pressures, arising in the wake of increased unproductive government expenditure in 2004, in an environment of uncertainty).

This is the least, that can be done to improve competitiveness. What about the rest of the agenda ? The government in a previous budget introduced a few measures to improve the ability to improve competitiveness by offering tax incentives for training as well as research and development (R&D). Sadly this theme of achieving competitiveness (through value addition) has not been picked up and pursued in the following budgets, despite the 'sword of Damocles' of phasing out of protective quotas by 2005 is hanging over the apparel sector, which earns more than 53% of total export turnover.

The government has also rightly been active in signing free trade pacts with a number of countries. But of what use is this, if competitiveness is so abysmally low? It may promote imports, not exports and damage local businesses. Obviously the key result strategy of job creation by export expansion has been neglected.

Powerty alleviation

Another aspect, that has not received adequate attention in the budget is poverty alleviation, not only to wipe out deprivation but also to boost domestic demand for and supply of goods/ services, apart from lowering social tensions and preventing environmental degradation. In fact it should have been one of the major objectives of the government.

Around 40% of the 19 million people in Sri Lanka are considered poor and most of them live in rural areas, where the main livelihood is agriculture If their incomes increase, the resulting rise in demand would catalyze the emergence of numerous enterprises.

Successive governments have emphasized on the Western type of industrialization or conversion of Colombo to a services hub similar to Singapore, apparently on faulty the assumption, that development will trickle down to the hinterland- the country does not possess the necessary infrastructure and skills for this purpose.

The more logical way is to transform the prevailing system of subsistence agriculture (and fisheries) to one capable of producing a substantial value added surplus by channeling a stream of investments to empower farms to acquire the best available production/processing technologies and expertise in management and marketing.

The starting point , as demonstrated by Japan, South Korea and Taiwan, is grant of freehold possession of the land to farmers, consolidation/amalgamation of the fragmented lots to more economic (corporate/business) units and supporting them with infrastructure, at least. The present government has rightly and boldly decided to go ahead with grant of ownership of land to farmers.

It is stalled in its tracks by law suits, as its merits ( and demerits if any, as well as means of overcoming them) have not, as usual, been discussed and consensus for its implementation created among the people of this country, most of whom do not possess entrepreneurship and are used to hand- outs by the State, (which is now heavily indebted as a result). This is the fate, that has befallen such essential market liberalization programmes aimed at improvement of competitiveness .

Another such casualty is the liberalization of the labour market (with safeguards and a safety net for workers). The proposed bill to stimulate private investment in water supply facilities may meet the same fate.

Implementation

Talking of casualties, another area, that should be mentioned is management and implementation of budgeted programmes. The writer is not only referring to non- utilization of voted funds but also to the glaring inability of the public service to ensure quality services at the least possible cost ; notable areas of failure during the last two years are health, university education, justice including police work (to curb the rising wave of crime), passenger transport, rehabilitation of the war ravaged areas and the provision of security, (especially to the people of the Eastern Province). Their inefficiency has brought much misery to the people and worsened the prevailing uncertainty. The causes of the failure of the public service (notablly politicization) in this manner are well known, though the bickering politicians of the country have consistently failed to resolve them.

All such problems, including the economy's inability to generate sufficient jobs, while reducing price levels to push down the cost of living, as envisaged in the 2004 budget, can be traced back to an absence of a consensus among the main political parties on a clear vision and strategies, as well as a sequential and single minded, implementation of suitable action, for achieving peace and prosperity.

Such a vision/strategy will provide a framework of reference for all to do the right thing, at the right time, to realize the vision and avoid dilatory/costly digressions like communal/religious strife, politically motivated work stoppages and tugs of war.

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