By Dr. S. Colombage
The year 2001 ended with a gloomy outlook for the economy. The GDP is estimated to have fallen by around 0.6 percent in 2001. In the third quarter the GDP declined by 3.7 percent. The average growth rate in the first three quarters of the year was a negative 0.7 percent. This is considered to be the worse slump that the country has experienced since the great depression of 1929-31. Meanwhile, the annual average inflation shot up to 14.2 percent in 2001 from 6.2 percent in the previous year. This was the first time that inflation rose to two-digit levels since 1996. The government is facing a huge budget deficit. On the external front, the official foreign reserves are sufficient to meet only about two months' imports. This is the legacy of the PA regime that had a poor record of economic management and governance.
All sectors experienced production setbacks in the third quarter of last year. Agricultural production fell by 1.3 percent and manufacturing by 10.5 percent. The output of the services sector, which made a significant contribution in the past, fell by 2.6 percent. As usual Central Bank authorities, in its latest press release on the GDP blamed outside forces like the world economic recession, the terrorist attack in the United States, the north-east war, the attack on the Katunayake International Airport and the failure of the north-east monsoon. But we should note here that the deterioration of the economy was evident much before all those incidents occurred. Such natural and man-made disasters have occurred from time to time throughout our economic history and the economy should be resilient enough to absorb these shocks.
By late last year the economy had become stagnant as it grappled with a number of fundamental weaknesses such as low rates of savings and investment, high interest costs, soaring inflation, excessive budget deficits, labour market problems and poor infrastructure. The policy makers, particularly the monetary and fiscal authorities who were the architects of the then government's economic policies, failed to deal with these problems effectively. Policy decisions were taken on a rather ad hoc basis without adequate background research. Those policies were inconsistent and they gave wrong signals to the market. The private sector, which is considered the engine of economic growth, got confused in the midst of such conflicting policies and virtually stopped functioning. The result was that the economy plunged into a deep crisis. Reviving the economy is not going to be easy now.
Fiscal indiscipline in the past has caused a severe strain on the economy. It is revealed that the government revenue of Rs. 275 billion is not enough even to meet the loan repayments and interest payments for 2002, which amounts to Rs. 300 billion. Revenues from GST, excise taxes, National Security Levy and import duties declined in 2001. Pre-election handouts, including the increases in salaries and pensions, pushed up government expenditure heavily. As a result, the budget deficit in 2001 would be around 11 percent of GDP, as against the target of 8.5 percent.
In a bid to push down interest rates, the Central Bank reduced the Bank Rate from 23 percent to 18 percent with effect from December 27. The Bank Rate is the rate at which the Central Bank provides credit to commercial banks to meet their temporary liquidity shortfalls.
But commercial banks hardly use this window nowadays. Therefore, it is questionable whether the reduction of the Bank Rate will have any impact on market interest rates, as it is more an indicative rate than an operational rate. There does not seem to be any significant decline in market interest rates following that decision.