Responsibility for the current economic crisis 

March 18, 2016

Politicians in government are generally profoundly economical with the facts. The Prime Minister is no exception. In a recent statement in Parliament he asserted that the current economic predicament faced in the country was attributable to economic mismanagement of the Rajapaksa regime notably the piling up of huge debts. Nothing could be further from the facts. The responsibility for the current economic crisis can be laid fairly and squarely on the Yahapalanaya Government.

The crisis is of the government’s own making for the following reasons. First, the government provided the fuel for a huge consumption boom. Government spending ballooned, inflated by substantial wage hikes to public servants, only partially offset on overall budgetary expenditure by reductions on government capital spending that inter alia slowed economic growth. Likewise, purchasing power of the public was boosted as petrol taxes and some other taxes were reduced. The impact on consumption was compounded by the reduction of interest rates. The Government encouraged unbridled lending by financial institutions to the private sector with no restrictions or incentives by sector. The result was that little extra lending was provided by financial institutions for broadening the productive capacity of the economy, and much lending was provided for imports, particularly of motor vehicles and consumption goods.

Secondly, tax revenue was reduced from what it would have been under the Rajapaksa Government to the tune of billions of rupees by reducing petroleum prices from the level set by the Rajapaksa Government. The effect of higher government spending and lower government revenue mentioned above was negative for the spiraling fiscal deficit.

Thirdly, the consumption boom had negative implications on the balance of trade. Notwithstanding the fall in the value of petroleum imports of some $1.8 billion, or more, total value of imports of Sri Lanka in 2015 barely fell. The huge windfall to the country from the decline in petroleum prices that could have been used to pay off the country`s foreign debt was thus frittered away to pay for soaring imports, notably of motor vehicles.

Budget deficits, interest rates, exchange rates are all connected. The consumption boom exerted pressure on the exchange rate. It was allowed to fall willy-nilly by some 8% in 2015. No one engaged in foreign exchange transactions was sure how much more it would be allowed to slide. Nothing is worse than uncertainty in foreign exchange markets. Foreign exchange amounting to billions of rupees was withdrawn by foreign investors from government financial institutions and sent abroad. Government`s foreign exchange reserves declined precipitously in 2015. Likewise, leads and lags in the trade sector because of uncertainty relating to the exchange rate depreciation worsened the foreign exchange reserves of the country. Moreover, the uncertain financial environment was inimical to inflows of FDI flows.

It is the substantial loss of foreign exchange reserves that sowed the seeds of an economic crisis in the making. The government has so far been staving off the crisis by borrowings, short, medium and long at rates more than that paid during the "bad old days" of the Rajapaksa government; begging the IMF to give a huge loan (figures of $3-4 billion are bandied about in city circles); and pleading with ADB, China, India, Japan and Korea to bring in foreign exchange and invest in big projects in Sri Lanka.

The Rajapaksa foreign and local debt would have been manageable, even if much higher than previously known, thanks to the windfall from the petrol price decline in 2015 and the financial flows from China, other Asian countries and institutions for projects. Even a much higher debt to GDP ratio than the 75% today would be sustainable when government economic policies have credibility in the market, rating agencies and foreign investors. Several countries such as Japan have much higher debt/GDP ratios. Japan, unlike Sri Lanka, is trying desperately to prevent not a devaluation but a revaluation of its currency.

To attribute the gathering economic and foreign exchange crisis to the debts incurred by the Rajapaksa government is just not credible. The facts prove otherwise. The gathering crisis flows directly from the profligacy of the incumbent government and awful economic management that has caused market uncertainty. It is foolish for the government now to harbour unimaginable fantasies that an IMF bailout would solve our economic problems as FDI would cascade into the country.

It is better for the government to learn from their mistakes in 2015, and to give priority to home-grown solutions that the public deems fair.

Atticus